Executive pay – ESG Club feature


Clare Richards, director, social, in the responsible investment team at the Church of England Pensions Board, says that no one is saying everyone should be on exactly the same pay. “That’s not the point,” she adds. “It is about getting a more holistic sense of what rewards mean within a company, rather than just being fixated on one or two numbers.” Shareholders should not fall into the trap of high pay, means high reward. “Interestingly, we have not found clear evidence of a link between high pay and better performance, which is essentially what shareholders want,” Herms says. She points to research by not-for-profits and Morgan Stanley that shows high pay does not necessarily produce high profits. “In fact, over the years, their total shareholder return is less than that of other companies’,” Herms says.


Under pressure


A wide pay gap between directors and the factory-floor employ- ees could cause unrest leading to low productivity and strikes, which could ultimately impact profitability. “The biggest risk for a company is a disconnect between management and the workforce,” Richards says, adding that it is all down to commu- nication. Does the workforce understand that the executive team are driving the value creation needed to protect the jobs of the wider workforce? There are other risks. “Consumer-facing companies could face a public backlash,” Dervan says. “Consumers seeing such a wide pay gap between workers and senior management could become a brand reputation issue.” Manulife has enjoyed some success in ensuring that corpo- rates are not being extravagant when paying their executives.


This is the result of a mixture of policy and support for share- holder proposals to get boards to think about the ratio of CEO to median worker pay. “We have seen more disclosure of that ratio,” Dervan says. “We need maybe a little more of a history of data to see how it correlates to company performance and the workforce, but at least that data point is out there for boards and investors to consider.”


Sustainable gains


Income inequality is not the only issue here. “This is another externality investment managers need to grapple with in sus- tainable investment, like climate change or water risk,” Der- van says. Herms says ESG issues can be financially material in the medium to long term, so this should be linked to executive remuneration but warns that when it comes to the metrics, there is no one-size-fits-all solution. “Not all ESG metrics are made the same,” she says. “It is going to be specific, based on the sector, and on where the company is in terms of disclosures.” Herms says that LGIM asks companies, especially those carry- ing higher ESG risk, to include relevant and measurable tar- gets in their executive pay packages. “Our mantra is what gets measured gets done,” she adds. “If the metrics have a direct impact on an executive’s take home pay, the attention they give that will be manifold.”


We have not found clear evidence of a link between high pay and better performance, which is essentially what


shareholders want. Karoline Herms, Legal & General Investment Management


Including appropriate ESG metrics in executive pay is much more than just signaling. It should address financially material risks and opportunities. “We would expect companies that have a big influence on the climate to include climate transi- tion targets in their pay.” Like emission reductions, and water conservation, these issues cannot be solved in a year. Dervan is seeing more companies including environmental and social factors in terms of their annual bonuses. “Right now, companies are comfortable in the one-year term, measuring these and incentivising them, but they are struggling with incentivising them over the long term.”


Quantitative metrics investors can measure year on year include: how many tons of greenhouse gas emissions were reduced? How many gallons of water did you reduce? By how much did you reduce your exposure to deforestation in your supply chain? Companies are integrating environmental and social factors into their executive compensation plans, but for Dervan, more work is needed in this area. His concern is these factors are not being included in longer-term pay packages. Unless investors treat the topic of executive pay seriously, they could lose out while executives laugh all the way to the bank.


Issue 126 | September 2023 | portfolio institutional | 33


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