After a string of ‘first strikes’, should directors' compensations be tied to ESG goals? Picture Getty
At Wednesday’s annual general meeting (AGM), shareholders of Magellan Financial Group (ASX:MFG) vented their anger at management’s poor performance, voting 58% against the fund manager’s remuneration report.
While Wallabies legend John Eales – who is a director of MFG – survived a protest vote, shareholders have delivered a “first strike” against Magellan’s board.
A ‘first strike’ occurs when a company’s remuneration report — which outlines each director’s salary and bonus — receives a ‘NO’ vote of 25% or more by shareholders at the AGM.
The ‘second strike’ occurs if a subsequent remuneration report also receives a ‘NO’ vote of 25% or more, and when that happens, shareholders will vote at the same AGM on whether those directors will need to stand for re-election.
This then leads to what’s called the “spill” resolution, a decision on whether the company must hold another general meeting (known as the ‘spill meeting’) to consider spilling the board.
If this ‘spill’ resolution passes with 50% or more of eligible votes cast, then a ‘spill meeting’ will take place within 90 days.
At the spill meeting, the directors in question will be required to stand for re-election, other than the managing director or CEO, who is permitted to continue to run the company.
Apart from Magellan, another ASX company to have been slapped with a first strike this year was Woolworths (ASX:WOW), where 28.04% of proxy holders voted against its report on executive pay at the October’s AGM.
It was the first time Woolworths had received a first strike.
And last Friday, Qantas (ASX:QAN) shareholders also voted overwhelmingly by 83% to protest against the airline’s remuneration report after a string of controversies damaged the national carrier’s reputation.
Qantas shareholders were also angry after former CEO Alan Joyce received a $21.4m golden handshake on his early exit.
The string of first strikes has reinforced the growing consensus that execs’s compensation must somehow be tied to metrics other than financials, like the company’s ESG performance.
A recent global study conducted by the IESE Business School found that 38% of companies now tie their directors’ compensations to ESG goals.
Europe is where most of this action takes place, where linking executive compensation to ESG criteria has resulted in real improvement in European firms’ environmental performance.
But while the concept sounds good, consulting giant PwC says linking pay to ESG brings challenges of its own.
“There is a risk of hitting the target but missing the point, where a ‘tick the box’ mentality is fostered rather than genuine improvements on ESG matters,” said PwC’s report.
“An example may be a bank that is reducing its own carbon emissions, while still financing companies or projects associated with large carbon footprints.”
There is also the risk of miscalibration of targets, in that companies may set out easily achievable strategic targets that they know they will hit.
“It is therefore important that ESG factors are integrated directly into the strategy of the firm, with pay incentives being used as a tool for mobilising the executives behind a new set of priorities.
“Pay should therefore follow strategy; it shouldn’t drive firm strategy,” the PwC report added.
The short answer is: while there has been a surge in the number of companies linking ESG goals to exec bonuses, it is often unclear how an accomplishment of the goal is measured.
“Rarely is the goal described to the level of detail that someone outside the company would be able to interpret what specific progress occurred,” said Just Capital research analyst, Molly Stutzman.
Measuring accomplishments on ESG goals can be challenging to monitor because some ESG risks simply aren’t quantifiable, nor can they be defined in terms of dollars and cents.
For example, ESG data on supply chain information or environmental and social impacts can be difficult to obtain, while tracking data that are accessible can be complex and resource-intensive.
However there are companies which have made a success of their ESG-tied remuneration program; like for example, US-based Chipotle which established its program in 2021.
Chipotle has made its ESG goals easy to measure; for instance, the company stated that it needs to purchase at least 37.5 million pounds of local produce for its operations a year.
Other easy-to-measure goals Chipotle has implemented include improving the company’s diverse employee retention, and the number of restaurants with composting programs.
On the ASX, about 55% of companies have tied a proportion of their chief executive’s bonus to ESG metrics.
A study by the University of Technology Sydney (UTS) shows that Financials and Mining were the two most common sectors where ESG is being tied to compensation.
“We found about 17% of bonus pay is typically attributed to ESG targets. For the average chief executive in our study, this translates to around $200,000 in extra income,” said UTS’ report.
But there’s been some controversy. The Commonwealth Bank (ASX:CBA) was criticised for ‘vague performance targets’ after the bank tied its CEO’s bonus to to relatively intangible metrics.
In its 2020 report, CBA’s “people measures” covering “culture, wellbeing, talent and capability” made up 9% of the chief executive’s bonus.
The CBA was also criticised for ‘massaging’ its annual safety report.
According to the UTS report, the bank’s 2017 annual report showed 1.1 injuries per million hours worked. However, in its 2018 annual report, the bank revised the 2017 figure from 1.1 to 1.6, which meant the 2018 report showed injury rates as having decreased relative to the previous year.
And in 2023, the CBA’s annual report featured a change to the way full-time equivalents are calculated, but without explaining how or why the previous years’ figures were adjusted.
“We therefore advise users of this information to exercise caution when comparing performance to adjusted numbers, particularly as little information is typically given to explain why the adjustment was made,” said UTS’ report.
Despite these apparent challenges, tying exec compensation to ESG goals has its obvious merits.
As the drive to combat climate change continues to take centre stage and policy becomes more stringent, establishing and achieving ESG goals will inevitably be fundamental to a firm’s long-term success.
Linking specific components of executive compensation to ESG performance metrics can also be a good way to both highlight a company’s commitment to its sustainability goals, and to focus senior executives’ responsibilities in delivering on these ambitions.
“Connecting these goals more closely with executive pay would be a natural next step, however it is important that these are done with care and thought, so as to ensure financial incentives are truly driving the ESG agenda,” said PwC.
For retail ESG investors, achieving ESG goals often drives their own personal values, and is simply just the right thing to do.
“The corporate world is at a crossroads, where companies and leaders are debating their fiduciary responsibilities, while society is demanding that businesses be held accountable to a wide constituency,” added PwC.
