How to reward executives for sustainable practice

Are sustainability-dependent executive bonuses the answer to saving the planet? Research recently conducted by the Centre for Corporate Governance at the University of Technology, Sydney, examined whether a sample of Australia’s leading corporations are rewarding their executives for achieving sustainability targets as well as financial targets.

The study was based on annual report disclosures and assessed twelve leading Australian companies in terms of their structures and processes for communication, commitment, leadership and implementation of sustainability. The companies (Rio Tinto, BHP Billiton, Bluescope, Orica, ANZ, NAB, Qantas, Telstra, Woolworths, Wesfarmers, Coca Cola and Foster’s) were benchmarked against each other using a scorecard system.

The question of how sustainability might be linked to executive remuneration was part of a broader study of how companies are integrating sustainability objectives into their core business strategies.

Most large companies in Australia have developed sustainability strategies over recent years, but in a rather piecemeal fashion in response to specific external demands – reducing greenhouse gases, implementing family-friendly policies and so forth. They are now looking to find ways of measuring, monitoring and integrating these programs into their overall business planning.

The research report, entitled Steering Sustainability, was commissioned by think tank Catalyst Australia as part of its Full Disclosure campaign. The campaign’s objective was to explore the growing influence of corporations in society and assist communities in articulating what standards and behaviour they expect of companies.

Given that most academics and practitioners struggle to define sustainability and/or corporate responsibility in a meaningful fashion, it is not surprising that the concept is poorly understood by non-specialists.

The terms “corporate sustainability” and “corporate responsibility” can be used interchangeably and, at their simplest, mean that a company is committed to acting in an economically, socially and environmentally sustainable manner. To achieve this, a company has to balance the needs of all of its stakeholders (those with an interest in its operations: shareholders, employees, customers, suppliers, regulators, local communities and the environment).

This is not an easy balancing act as there will inevitably be circumstances when the interests of the different groups will come into conflict. In the past, many company directors believed that they were under a duty to give priority to shareholders’ interests: profit maximisation.

However, two inquiries conducted in 2005-2006 confirmed that this was not the case – that Australian directors have the discretion to take other interests into account in order to promote the best interests of the company in the long term.

The argument is that a company is likely to do well financially in the long run if it acts in a responsible manner. This could include maintaining a good reputation with customers; training and developing its workforce appropriately; not squandering natural resources; and engaging with local communities affected by its operations.

The UTS/Catalyst study explored the mechanisms that boards of directors are using to assist in this balancing act. It looked at how corporate governance systems are being adapted to integrate sustainability initiatives into core business strategy.

The study focused on the structural frameworks supporting sustainable practice because the actual meaning of sustainability will vary significantly depending on a company’s operations. A mining company, for example, will need to reduce damage to the natural environment and ensure its miners work in safe conditions; a bank may focus on treating its customers fairly and retaining its skilled employees.

The study did not try to compare apples and pears, but looked for evidence of structures and processes for governing and communicating sustainability.

The twelve companies were assessed in four areas and given a rating of below average, average or above average: (1) communication processes and methods; (2) voluntary commitment to measuring and reporting; (3) evidence of leadership structures; and (4) evidence of processes for implementation of sustainability, including incorporation into remuneration systems.

Catalyst/UTS Centre for Corporate Governance

Communication: The study found a variety of communication methods. In particular, there was a move away from standalone sustainability reports towards integrated reporting. In 2011, four of the twelve companies produced only one annual report including both financial and sustainability information and, for three of these companies, this was the first year of doing so. All companies referred to engagement with their stakeholders but only a handful went into detail on exactly how they communicate with each different group and the results of such communication. Companies received “below average” ratings if it was difficult to find sustainability information online or if it was poorly organised.

Commitment: There was a strong commitment to sustainability reporting in terms of voluntary use of standards and guides such as the Global Reporting Initiative (GRI) and the Carbon Disclosure Project. Ten of the 12 companies reported formally against the GRI, with seven of these 10 obtaining independent verification of their use of the GRI. A very positive finding was that all of the companies were members of the Carbon Disclosure Project, meaning that they measure and report their greenhouse gas emissions in a way that enables international benchmarking.

Leadership: In terms of leadership of sustainability, 11 of the 12 companies had either a board sub-committee or senior management committee responsible for sustainability issues. This is key to ensuring that sustainability issues are discussed, – and strategies developed – at the highest level of the company, in conjunction with wider business strategy. Wesfarmers did not refer to a committee and hence received a “below average” rating, whereas companies that explained how their committees functioned, or gave examples of topics addressed, received an “above average” rating (NAB, Foster’s, BHP, Orica, ANZ and Woolworths).

Implementation: Information on processes and structures for implementing sustainability strategy at the lower levels of the company was hard to find, with only two companies explaining, for example, that they had site-level committees (Orica) or business unit leaders (Foster’s) responsible for sustainability.

Remuneration: A key question for the research was whether (and to what extent) companies are incorporating sustainability performance into their remuneration schemes. If employees are only rewarded based on measures of short-term financial performance, it sends the message that sustainability comes second.

The researchers were pleasantly surprised to find that nearly all of the companies did mention some aspect of sustainability performance when describing their remuneration policy. Most commonly this was an element of the short term incentive (STI) plan – a small (although possibly very small) proportion of executives’ bonuses were linked to non-financial indicators such as safety performance or customer satisfaction.

Detail on exactly what proportion of overall pay was dependent on non-financial indicators and how these were measured was very unclear. Industry-specific differences were apparent, with service and retail companies including measures of customer satisfaction in their STI schemes, and the resources and manufacturing companies including occupational health and safety. Interestingly, only two companies (Bluescope and Rio) described the actual measure used (for example, lost time injury rate) and no company explained any incorporation of environmental performance.

As the study was being conducted, several of the companies in the sample received negative publicity in the area of corporate responsibility.

Orica was slow to alert the authorities regarding a toxic chemical spill, Qantas hit a low point in industrial relations, and the mining companies were dealing with striking workers in South America. This reminds us that systems, structures and reports can never fully reveal whether a company is fostering a positive culture and value system for its employees. On the other hand, we know from corporate governance case studies that, without formal systems for communication and accountability, companies will flounder when faced with challenging circumstances.

Because the meaning of corporate responsibility/sustainability depends on the nature of a company’s operations, general guidance on implementation is hard to find. However, the structures and processes necessary for developing and managing sustainability strategies are universal. Companies need to engage with stakeholders in a consistent manner and ensure that the information gathered is fed into high-level decision making, ideally through a board or senior management committee.

Once strategies are decided upon, lines of responsibility and accountability must be clearly defined such that progress is monitored, measured and fed back into strategy development and reward schemes. Rewarding executives for sustainability performance could be the answer to ensuring companies do what they promise. As the old saying goes, companies need to “put their money where their mouth is” – in more ways than one.

This article first appeared on The Conversation.