Encouraging Effective Executive Pay Structures

Executive pay packages are facing increased scrutiny from investors. Finding the right formula to align compensation with performance is a complex exercise. But companies that integrate environmental, social and governance (ESG) goals with pay incentives are more likely to deliver on their responsibility pledges to stakeholders.

Executive pay is a powerful motivating factor. But investors need to consider whether executive pay incentives are fully aligned with the goals of the business. Today, ESG factors are widely recognized as essential to a proper evaluation of the risks and opportunities facing a company. For that reason, AllianceBernstein (AB) believes it’s vital to incorporate ESG both into our investment research process and into executive compensation metrics. In this way, the full spectrum of risk, opportunity and goal-setting can be viewed in proper perspective. We find that companies with meaningful ESG goals embedded in their executive compensation schemes tend to have a better understanding of the ESG factors that are material to their business, use specific key performance indicators (KPIs) and are more likely to achieve goals.

Effective Pay Structures Need Appropriate Goals

Total executive compensation has increased steeply over recent years, particularly in the US (Display, below), where the pay ratio between CEOs and the typical worker surged over twentyfold since 1965.* Skeptics point to several perceived failings in the remuneration process, including: a cycle of upward-only peer reviews by compensation committees; inconsistent/self-serving use of financial metrics; and the incorporation of nonfinancial metrics such as vaguely defined strategic goals or individual objectives. These nonfinancial metrics are also often combined into a scorecard which is hard for investors to evaluate.