But obstacles include lack of standardized approach, focus on short-term goals
As we head into a new year, planning around compensation is front and centre for many organizations.
The pandemic, of course, has seen many employers struggling to reward employees during tough times, while others that are doing well strive to recognize staff for their achievements, while also maintaining equity.
Also on the radar? The push to align executive compensation with environmental, social and governance (ESG) objectives. This may involve metrics such as employee engagement, diversity and inclusion, and workplace safety.
It’s a newer trend in Canada over the past couple of years, say experts, but is only expected to grow – so HR, take note.
More companies in Canada are expected to put ESG metrics into their programs, to continue to evolve and tweak them, even if they've already got them and grow the weight of them, says Michelle Tan, a partner at Hugessen Consulting in Toronto. So if they've got ESG metrics currently at 10 per cent, that could slowly increase “relatively and steadily” over the next couple of years.
“It's a trend that I think will pick up steam as the terminology for the management comfort level with E&S [environmental and social] topics and terminology and metrics gets more normalized across industries and sectors.”
For executive compensation, the form, design and metrics used tend to be a slow moving trend, she says.
“Even the move away from stock options has been happening over at least 10 to 15 years. Whereas this particular trend [around ESG] feels like it's got a bit more momentum behind it. And so I could see it moving a bit quicker than would otherwise be the case, simply because of the broad pickup across broad stakeholders, shareholders, suppliers, customers and employees.”
Why does it make sense to focus on ESG metrics?
While the whole point of having a corporation is profit maximation for shareholders, there has been a shift in that thinking as organizations and society also consider the impact of a corporation, says Christopher Chen, managing director at Compensation Governance Partners in Toronto
“What's the real role of the corporation in society? Is it just to profit maximize? Or are there other stakeholders that need to be taken care of; for example, customers, the community, the nation, the environment, the work-life balance of employees — all of these things are now swirling around in the minds of society. And that's put pressure on organizations to take seriously ESG,” he says.
“What gets measured gets done, right? So it's all well and good for an organization to say, ‘Yes, ESG is important.’ The question becomes: ‘How will you make sure or track that ESG is being taken seriously by the organization, and that positive steps are being made to improve your performance in ESG areas?’ And one of the clearest and most sure ways to do that is to ensure that executives get paid for improvement on ESG metrics. It's where the rubber hits the road.”
These days, environmental and social topics are being picked up by other stakeholders, such as suppliers, customers and especially employees who are interested in new topics and want to see where the company's at, how they're walking the talk, says Tan, “so that then puts this bigger focus on ESG.”
“Directors look at it and say, ‘Well, if we're going to measure this and award for it, in the pay-for-performance world that we work in, shouldn't we also be including these metrics in our executive compensation programs?’”
While there has been plenty of talk in the past about compensation gaps between executive and employee salaries, a new study out of the U.K. is proving that too large of a chasm will actually harm performance.
Challenges to measuring ESG performance
While intentions are good, there are definite challenges to the whole process. First, there is a measurement issue, says Chen.
“There are a variety of standards worldwide which I would say are competing for pre-eminence. So how do you measure? There are indices out there, there are various sustainability guides, [but] right now there isn't real clarity… as to which set of metrics everyone should be using to measure their own performance.”
Performance is not going to just be measured internally, he says.
“The outside world is going to ask these organizations: ‘OK, that's great, you're doing well internally [but] how are you doing compared to all your peers in your sector? Are you lagging? Are you in front?’ That relative benchmarking is going to be a big part of all of this, especially for publicly traded companies.”
ESG can mean different things to different organizations as it’s not standardized, says Kelly O’Ferrall, a lawyer specializing in employment law and executive compensation at Osler in Ottawa.
“It might mean to one organization customer satisfaction, and another organization might be focused on diversity,” she says. “What I hope would happen is that as more and more companies start to focus on this, we'll get more consensus on what ESG means, what's encompassed within ESG issues.”
Another challenge is the number of measures that could potentially be measured by ESG, which is “really astonishing,” says Chen. These could include people and culture, which also involves succession planning, employee engagement and work-life balance, along with workplace safety and environmental catastrophes.
“When you list out all the metrics, there could be 15 to 20 different things to measure,” he says. “There's so many other metrics already that executive teams are measuring… the challenge becomes for you, as an organization, as an HR professional, which one of the metrics in ESG do you choose to measure? Which is most important to you? Which is the most important to your stakeholders? And can you even measure it? So this is not easy.”
Eventually, there will be a limit just because the more metrics you add, the more they’ll start to offset each other and we won't get a fair picture, says Tan.
“The general trend right now is still a very large weighting for more than 50 per cent, closer to 60 and even 70 per cent, being on those traditional financial, operational, strategic-type metrics that we've always had. And so [it’s about] baby steps, first steps, putting in sort of 10 [per cent] and then moving that up 20, and even hopefully, a third of the overall weighting of a corporate scorecard, in terms of these E&S metrics.”
How to collect the data to be measured is also not easy. For example, there could be human rights or privacy issues when it comes to collecting demographic data on employees for diversity and equity initiatives, says O’Ferrall.
“That's a bit of a challenge in that you've got a lot of organizations trying to do some good things; they're trying to measure how they're doing from a diversity and inclusion perspective, both from an employee perspective and a customer perspective, and they're hitting roadblocks in terms of other laws that they might be offside.”
In addition, a lot of these measures are subjective and not quantitative, she says.
“It's hard to base compensation arrangements on ESG measures, given the inherent difficulty in figuring out whether and to what extent the employer is achieving those metrics… You're entirely reliant on self-disclosure by the employees and employee surveys, and that could obviously take up time and resources and be difficult to reliably assess.”
And a metric like diversity can be challenge to assess, says O’Ferrall.
“You might be doing a great job in promoting a diverse workplace, but you may not see the results of that work for four years down the road. So it's a difficult thing to measure because certain of these metrics are so long term.”
Initially, ESG metrics were built into short-term incentive programs, at least for public companies, she says.
“And for most companies, short-term plans are easier to change than these long-term compensation arrangements that usually involve equity. And if the company's public may require shareholder approval… [But] there's a disconnect between the length of the performance period in a short-term arrangement and the length of length of time it likely takes to see results on ESG metrics.”
Many corporations measure incentives on a short-term basis, when ESG is a long-term issue, says Chen.
“I get the granularity of it, which is that you can focus people initially, but almost no one is putting ESG metrics into the long-term incentive plans, and those long-term incentive plans, many of them can be three, four, five years till the payments are made and they come to fruition. So wouldn't it make sense to align ESG to those long-term incentives?”