Reforming Executive Compensation To Align With Stakeholder Value

Executive compensation used to mean generous pay and attractive benefits packages. Now, executives and directors are being held accountable to make decisions and strategies more transparent. Many organizations are preparing for longevity by reforming executive compensation to align with stakeholder value.

With a tight labor market and economic recession concerns on the horizon, organizations are protecting workers and prioritizing stakeholders by reforming executive compensation. To promote longevity and maintain strong reputations, companies must align bonuses and incentives with long-term company missions.

Initiatives that support diversity, equity, and inclusion (DEI) or environmental, social, and corporate governance (ESG) are showing up in corporate boardrooms. Rather than focusing on short-term growth and productivity metrics, corporations are evolving to meet the needs of stakeholders: workers, consumers, communities, and investors.

ESG metrics are concerned with the following criteria:

• Environmental: The energy and resources companies consume and the waste they create.
• Social: The relationships businesses foster within communities, which include but are not limited to diversity, equity, and inclusion (DEI).
• Governance: Internal practices and procedures that follow law, regulation, and external shareholder expectations.

Most companies that concern themselves with ESG performance have seen higher equity returns. So how can board members reform executive compensation to meet today’s economic climate and yield long-term, valuable results?

Determine the Needs of Key Stakeholders

Since resources are finite, directors should first align core company objectives with the needs of stakeholders most vital to the company’s success.

Key stakeholders are highly invested and most impacted by the company’s success: employees who hold critical roles in production, customers who offer the potential for revenue growth, essential suppliers, and more. Competitors are also important stakeholders, as they inform business development and strategy. Communities, too, limit or support operations.

After identifying priority issues around stakeholder needs, companies should make sure that initiatives and strategies:

• Capitalize on significant opportunities or address significant risks
• Speak to growth in essential markets
• Can be addressed by the organization’s current capabilities
• Offer positive outcomes for key stakeholders without detriment to others

Boards should also determine whether partnerships are needed and if business costs surpass the benefits.

Determine Key Incentives and Metrics When Reforming Executive Compensation

Today’s business stakeholders are values-based, and stakeholder metrics are taking shape around ESG procedures. Values-based consumers, employees, and investors are vocal when business practices don’t align with core values and company-wide missions. And public advocacy campaigns often lead to irreparable damage done to company branding.

With mounting societal pressure for corporations to emphasize ESG strategies, investors focus more on executive accountability through compensation. For example, in 2021, nearly $600 million paid to S&P 500 companies was determined by ESG metrics, according to Glass Lewis.

But reforming executive compensation is less a disruption of the status quo and more of an opportunity to produce results that matter most in the long run. Inclusivity of ESG and stakeholder metrics is an outward-facing indication of company commitment.

After identifying key stakeholders, boards should narrow down prior incentives. There are many other ways to keep organizations accountable, like public reporting, which most companies already perform.

Here are some factors directors are considering when choosing incentives to include in executive compensation:

• Inadvertent consequences like job loss due to waste reduction and operational closures. Incentives require a complete cost-benefit analysis.
• Board readiness to remain transparent to investors if pay incentives fail. If directors are nervous about sharing any failed incentives, they should reconsider those incentives.
• Whether required data can reflect tangibles to measure success, a good reputation is essential but hard to define in metrics that justify incentives and compensation.

Align ESG and Stakeholder Metrics with Executive Pay

Once boards and executives have determined stakeholder needs and reliable incentives, they can strategize how to translate those priorities into compensation.

Internal and external targets typically define strategies. Internal targets, or inputs, measure progress toward DEI hiring practices, for instance, or investment in clean energy. Inputs also monitor resources consumed. External targets address stakeholder concerns like production and community impact.

Some ways to implement these compensation plans include:

• Bonuses: incorporate ESG and stakeholder metrics annually as opposed to long-term incentive plans.
• Scorecards: implement incentives based on four or five quantifiable measures that determine payout, a practice typically adopted early on in ESG-driven companies and helpful in providing transparency.
• Modifiers: quantifiable measures that increase or decrease rewards. For instance, 10-20% of the incentive payout falls when goals are unmet—likewise, 10-20% of the incentive increases due to progress.
• Hurdles: quantifiable measures that must be met for incentive plans to activate. This option is attractive to companies invested in demonstrating that their commitment to ESG metrics is a baseline priority and that performance should exceed stakeholder expectations.

However a company decides to move forward with reformed compensation plans, boards should consider more than just data. Competitors can also attract top talent with desirable packages.

Today’s business needs are a response to unprecedented times; employees are calling for a dramatic shift in priorities, and employers are listening. When ESG metrics matter to executives as much as they do to stakeholders, satisfaction leads to long-term results that matter to company revenue and reputation.

To ensure progress toward a higher-value company, boards will need to thoughtfully communicate strategies and incentives to internal and external stakeholders. Reforming executive compensation to align with stakeholder value demonstrates that accountability is more important than short-term growth and productivity metrics.