By Charles Cotton, Senior Policy Adviser – Performance and Reward.
HR leaders know too well the struggle that can be involved in getting people matters elevated to the same level as financial ones during executive and board meetings. But over the last few years the tide has started to turn, and issues such as culture, leadership, talent and engagement have begun to take their rightful place near the top of the corporate agenda.
There are several drivers for this increasing interest in ‘the people stuff’: the growing focus on values and behaviours in the wake of the 2008 financial crisis, the revised Corporate Governance Code requiring more explicit reporting on culture, and the rise of environmental, social and governance (ESG) criteria for investment decisions. Companies that have a poor reputation on such issues as customer service, climate change or corporate governance, in theory should receive less investment compared with those that have a good reputation. During the pandemic, ESG funds have so far outperformed non-ESG funds.
In the world of work, how the workforce is managed, developed and rewarded usually falls under ‘S’ (for social) in ESG. Other people under the ‘S’ umbrella include a company’s customers, contractors and communities. Decisions made by a company board around what to pay a CEO (and how, when and why) are typically seen as coming under ‘G’ (for governance).
Given the importance that both investors and firms place on employees, seen simultaneously as an organisation’s most important asset as well as its largest source of risk, we partnered with the High Pay Centre to explore the extent to which FTSE100 CEOs are incentivised to invest in this asset.
Despite interest in the ESG agenda, our review CEO pay and the workforce finds that executive performance-related pay plans are still heavily weighted towards financial measures of corporate success.
According to this report, all the FTSE 100 companies that had analysable data on executive performance-related pay had some form of financial metric in their performance-related pay plan, while the typical proportion on offer for hitting these targets was 82.4% of total variable pay. By contrast, just over a third used employee measures in their CEO performance-related pay plans, while the typical proportion on offer in these firms was 5.9% of total variable pay.
Why the low use of people metrics?
One explanation for the limited role of workforce metrics in CEO pay plans is that the investor community is unsure about the accuracy of these measures.
Another is their comparability. If these measures aren’t comparable, it becomes difficult for shareholders to benchmark CEO impact across other firms and industries.
In addition, there might be a lack of awareness among the financial community about which employee measures they should be asking firms to provide. While absolute and relative financial indicators, such as total shareholder return or return on capital employed, have been around and understood for many years, this isn’t the case for workforce measures.
Considering this, it’s not too surprising that most investors haven’t been voting against remuneration policies that fail to include employee metrics.
What can be done?
While there has been little agreement in the past about how to define and measure employee metrics, gradual progress is being made in these areas, through such initiatives as the ISO standard for human capital reporting, the reporting requirements of the US Securities and Exchanges Commission, and the UK’s Financial Reporting Council.
Choosing a standardised approach to measuring human capital will allow investors and remuneration committees (RemCos) to benchmark the performance of organisations and CEO remuneration. However, a lack of consensus over what methodology to use should not prevent companies from adopting their own approaches.
There’s a role for the RemCo to explore with their stakeholders which people metrics, as well as other ESG measures, should be used to reward, recognise and incentivise senior executives and why. The default ought to be that all publicly listed firms should use such measures, but they must also be free to select those that make most sense for their situation.
The role of HR
There are implications of this for our profession in terms of working with RemCos and corporate stakeholders, such as investors, to work out which workforce metrics make most sense to the business given its situation.
For instance, while some workforce performance measures might be universal (such as employee engagement) others might be specific to certain sectors. For instance, customer service might be more appropriate in the hospitality sector than in the mining sector, while safety might be more appropriate in mining than in hospitality.
As well as helping to inform the RemCo and corporate stakeholders about which people measures to use in CEO incentive pay plans, we should also help inform them about how big a part these indicators should play in these plans.
In addition, we should be ready to give an opinion about which of these measures could be used in short-term incentive plans and which could be used to reward longer-term performance; what happens if workforce targets aren’t met and the issue of malus and clawback; and whether assessments of success should be limited to employees, or extended to include indirectly employed workers.
We’ll also need to discuss with our RemCos what people information is needed, when and in which format, to inform its decisions about performance. We will not only need to invest in the HR systems that collect the data that’s needed, but also in our analytical skills so that we can analyse, interpret and present the information.
While this creates cost implications there are also benefit implications in that it will help us to collect and better understand data that is critical to the success of the business.
For the CIPD’s part we’re working with UK and international bodies to help standardise employee measures so we all understand what they mean and how they should be calculated. We’re looking at the links between employee engagement and organisation performance, and the metrics in this area that may be appropriate to inform CEO pay. In addition, we’re also exploring how firms can report on their people measures more generally so stakeholders get a better idea of the effectiveness of the people management policies.
Hopefully, our latest report will further the conversation among investors, regulators and RemCos about their attitudes to the use of employee performance measures, both in terms of how they should be used to determine senior pay, as well as how they should be reported so appropriate investment decisions are made. We also hope it raises awareness among the profession of the potential implications for them if workforce metrics become more central to business decision making.
Thank you for your comments. There may be a short delay in this going live on the blog page as we moderate the comments added to our blogs.
This is really interesting and something my team have been discussing within the last couple of weeks! Please Could you share a copy with me too? email@example.com
My work email is firstname.lastname@example.org
Hi Charles, thanks for your reply. No, it's not available publicly but I can send you a copy - let me know the email I should send it to. Thanks - Geoff
Thanks for your comments, Geoffrey. They are very interesting. Is your research publically available? I would love to know more about it.
Thanks for this interesting blog and thought-provoking research report. My own MA research into employee engagement as a factor in measuring and rewarding Swiss top executives identified several barriers, many of which are relevant to ESG metrics generally, namely:
1. Executives were not always convinced about the link between such metrics and business performance, or felt that such metrics were an outcome rather than a driver of business performance
2. There was a lack of top management (and especially CEO) commitment, without which such metrics were unlikely to be taken seriously by the organisation
3. Changes in business priorities meant such metrics could be discontinued (e.g. not measuring employee engagement during a workforce restructuring, or being difficult to measure in the light of M&A)
4. Lack of resources could be a problem (especially for smaller companies), given that measurement would require follow up action later
5. Companies might have a preference for qualitative assessments, or for using surrogate metrics such as absenteeism and voluntary turnover levels, rather than measuring employee engagement itself
6. Infrequency of measurement was an issue, as most organisations conducted engagement surveys less than once a year, and so metrics would not be aligned with the annual performance and rewards cycles used by most companies
7. Unlike financial measures, it was often not treated as a key business metric and in some cases regarded as a goal for the HR department rather than the top management team
8. There were doubts over the use of extrinsic motivation to encourage such performance
9. Concerns were also expressed about such metrics driving the wrong behaviours, e.g. executives 'gaming' the system to encourage employees to give positive staff survey ratings that would improve their bonus.
At the same time, some potential barriers - such as the absence of a universal standard tool for measuring engagement, or difficulties in defining improvement targets - surprisingly did not emerge as obstacles from the Swiss research.
There are ways to overcome these issues, but a lot more work will be needed to help ESG metrics become embedded, and I would be happy to contribute to furthering this initiative.
Subscribe to the CIPD Newsletter