Simplification, Engagement and Accountability – Highlights from the PRI in Person Conference in Berlin (September 2017)

During the last week of September there were several Environmental, Social and Governance (ESG) related events taking place in Berlin, and I was honoured to be invited to speak at two of them: the ‘PRI in Person 2017’ conference organised by the United Nations-supported Principles for Responsible Investment (UNPRI) and the Private Equity International (PEI) Responsible Investment Forum.

Both of these events were promoting Responsible Reward (*) and how to integrate ESG factors into pay structures.

The PRI event attracted around 1,000 professionals and sold out within a matter of weeks, which demonstrates the high level of interest from investment specialists, activists and politicians across Europe who understand that ESG matters for the future of our economic and financial system, underpinning society as a whole.

I was privileged to share the “Executive Pay” panel of one of the break-out sessions with Professor Christian Strenger from Deutsche Asset Management and Euan Stirling, Investment Director at Standard Life. Debi O’Donovan moderated our panel.

The first question was, “What’s working well in executive pay?” The rather short answer was “Not so much!”

Apart from increased disclosure over the last few years, there was little else positive to say.

‘Executive pay structures need to be simplified. They are too complicated to be understood by the executives themselves, investors and other stakeholders’.

Examples of corporate failures with resulting large unwarranted pay-outs (e.g. Wells Fargo, VW) were cited to illustrate the disconnect between pay and performance. ‘Remuneration which delivers the wrong results usually indicates failures in other aspects of governance.’

The recent political results from the US, UK, and Germany partly reflect the societal dissatisfaction in quantum misalignment between executive pay and mainstream pay – and investors have a responsibility to address this when voting on executive pay proposals.

Continuing the theme of societal impact, I explained that Responsible Reward is an increasing trend which combines Responsible Investment and Reward by integrating ESG into pay structures, and drew on the recent Responsible Reward survey that my company, PeopleNet Ltd, carried out.

The audience, comprised mainly of UNPRI signatories, were likely to be familiar with the six overarching UNPRI principles that they have signed up to. What they may not have been aware of was that the UNPRI also conducted two pieces of research in 2012 and 2016 which resulted in three recommendations on how to integrate ESG issues into executive pay:

  1. Identifying appropriate ESG metrics
  2. Linking ESG metrics to executive pay
  3. Disclosure of company practices

To facilitate the implementation of the UNPRI executive pay guidelines, I have designed the five-step ‘EARTH’ methodology:

Step 1: Evaluate your current ESG positioning, relevant metrics, and remuneration structures.

Step 2: Ascertain your targets: where would you like to be at the end of the performance period?

Step 3: Realise the changes that need to be made to people, policies, systems, and processes.

Step 4: Tell internal and external stakeholders your Responsible Reward successes and challenges.

Step 5: Help monitor progress on an on-going basis. Responsible Reward is an iterative process impacted by business strategy and external factors which vary year-on-year.

Following these five steps provides an organisation with the right framework to become both an investor and an employer of choice.

These UNPRI recommendations apply to companies where investors are shareholders. However, I question whether it is credible to ask firms to pay their executives taking ESG into account without the same prerequisites applying to investors themselves?

ESG factors are financial factors which must align to the company’s business strategy. It is also important that investors clearly state their views on ESG in writing so that companies know what they are going to be measured against.

When time and resources allow, investors engage with the Chair of the Remuneration Committee and/or the Chairman of the Board as they are independent and act in the interests of shareholders (with the exception of a guilty few).

As a remuneration specialist, I take a rather pragmatic approach. I explained that when an organisation receives technical queries on its executive pay proposals from investors, the questions are often cascaded down from the Chair of Remuneration Committee via the Company Secretary to the Reward team, which is part of the Human Resources function, for reply. The role of the Reward function is to propose options on remuneration quantum and design, hence the need for simultaneous direct engagement between the investment team and the internal reward team to resolve any technical queries or misunderstandings.

So, how do we make executive pay more effective?

Reward structures need to be simplified and not rely on peer or benchmarking pressure to justify proposals. Investors are to deliver a clear and consistent message if they wish corporations to listen to them. Both sides must concentrate their time, efforts and resources on their long-term strategy.

If investors do not support pay proposals, they already have the power to vote against them as well as against the re-election of individual Remuneration Committee members. They should abstain only when there is a conflict of interest, not to indicate disapproval. Malus and clawback provisions exist to rectify misalignment between pay and performance, so companies need to make sure these clauses are part of their remuneration policy and are enforced when necessary. Investors should show up at AGMs and state their views. Controversial pay proposals can reach the media and affect a firm’s reputation (and in turn, its financial value) so it is in nobody’s interest to be in that position.

The final point raised by the audience was whether it is hypocritical that fund managers, who are well remunerated themselves, should condemn other companies’ pay structures?

My answer to that question was to reiterate that linking ESG to pay structures, and especially the ‘G’ for good ‘Governance’ – which underpins Responsible Reward – should apply throughout the whole investment chain.

If you wish to discuss this article or find out how to apply the EARTH methodology to your company’s pay structures, please Contact Us.