in the final installment of a three-part series on reinforcing environmental, social, and governance elements through executive compensation, a Harvard Business Review article by Semler Brossy’s Blair Jones and Seymour Burchman explains how companies should go about effectively designing incentive compensation plans that incorporate sustainability goals. The article details several of the challenges companies must overcome, including wading through the sheer number of potential metrics, fitting the sustainability goal timeline to the incentive period, and why they should be used in the first place, especially if their results are going to show up in the core financials. The authors provide a five-step process to help address these challenges.
- Reexamine the Context: The first step involves analyzing the business case for the sustainability metric – “your initiative” as the article refers to it. Will improving the performance of the metric result in positive contributions to direct financial results? Will it enhance intangible, off-balance sheet assets (such as brand or reputation) which have value beyond just reinforcing financial performance? Clearly identifying the business case for the initiative creates the foundation for the metrics inclusion in the incentive plan.
- Clarify the Organizational Scope: Determining how broadly the incentive should be applied – to Section 16 officers, a business unit, company-wide – is the next important step. Compensation is a fundamental form of communication for your employees. Determining how broadly the sustainability metric will apply, which will be directly related to strategy, will send profound messages to stakeholders about your commitments.
- Quantify the Duration: Determining how long the incentives will be addressed is the next step. Some metrics are obviously addressed in shorter periods (e.g., reducing restaurant waste) vs. those with much longer targets (e.g., lowering a global carbon footprint).. Thus, determining how the incentives time frame will interact with each plan as well as other mechanisms, like stock holding requirements, is of fundamental importance.
- Consider the Means and Ends: The article argues that the journey -- how the company achieves its ESG goals -- is as important as the end. Although this applies to all incentive plans, it is perhaps particularly important for the use of sustainability measures. Creating milestones or other measures as part of the “journey’ to the goal with a correlating discretionary adjustment at the end is a solid strategy to preventing unintended consequences.
- Structure the Incentives: Once the scope and context are done, you will have the specific goals relevant to your plan and company. The last step is determining what the incentives will be and “whether you need to move beyond traditional targets and time frames.”
The article also provides some examples regarding how the five steps can be implemented. The advice in the article is very timely as companies are experiencing a wide press by almost every stakeholder group to consider sustainability as part of the company’s mission. Many critics have pointed out that the quickest way to ensure sustainability is taken seriously is to have it tied to pay. However, as with other objectives, incorporating sustainability measures into pay should be very carefully considered -- both whether to do so and how. The article provides companies with a helpful starting point.