Companies and Investors: Work Together Towards a Modern Remuneration Policy
A company's remuneration policy should reflect what it wants to achieve according to its goals, values, and strategy. It should include incentives and consequences for achieving or not achieving the company's financial as well as sustainability and social goals. Remuneration terms should also encourage long-term value creation rather than short-term financial results.
These are some of the principles of responsible remuneration presented by Reward Value at the World Economic Forum in Davos early this year. The principles are building blocks for a modernized executive compensation policy that does justice to the social context in which companies operate. We all know that remuneration influences behavior and that the transition to sustainability and long-term value creation requires a fundamental change in behavior. Remuneration is therefore a steering instrument for change.
A blunt instrument
In practice, however, remuneration policies are rarely the catalyst for change that they could be. 'Still too few companies are transparent about their sustainability targets and about how they factor sustainability performance into executive pay,' said multi-executive Gisella van Vollenhoven recently in an interview with Management Scope about remuneration policy. At present, the remuneration discussion often remains about the assumption that in a listed, international environment, top salaries would simply be necessary to bring in quality or prevent top managers from leaving prematurely. To draw a bold comparison: in fact, this way you bring in a 'mercenary army' instead of executives who really feel involved with the organization and who want to commit themselves to long-term goals and strategy.
> See also: Gisella van Vollenhoven: 'Still Much Progress to be Made in Assessing Executives'
At the same time, because there is increasing discussion about the undesirability and/or absurdity of the level of top salaries, the remuneration policy has also become a reputation risk. All in all, we have worn down and blunted the remuneration instrument over the past decades. Now that we need to use it to achieve the desired sustainable transition, we need to re-sharpen it and perhaps replace it with another tool. There is no point in trying to suddenly steer the company in a different direction with the same blunt knife. You only slow down the transition.
From 'why' to 'how'
A positive development is that in listed environments there is an increasing interest in addressing dilemmas around remuneration policy. As Jolande Sap put it in an interview with Reward Value: 'Many directors and Supervisory Board members feel that things should be different but are unwilling or afraid to act on it professionally.' So, the question seems to have shifted from ‘why should we?’ to ‘how can we?’
> See also: Jolande Sap: ‘The Remuneration Policy Is Not Yet An Engine of Change’
The realization that reward affects behavior exists, but we still find it difficult to move away from the old familiar methodologies. To do so, there are several hurdles to overcome. These in part relate to stakeholders. For example, shareholders in the Netherlands have a say in the remuneration policies of large, listed companies. On behalf of investor organization Eumedion, Reward Value compared the status and effectiveness of these say-on-pay rules with those in several other jurisdictions. This revealed a number of shortcomings in laws and regulations, but are not exclusive to the Netherlands. To address these, more research is needed to know which legislative reforms will have the most impact. Moreover, such interventions might best be addressed at the European level, for example in the upcoming review of the Shareholders' Rights Directive.
Our research also provides three important recommendations to stimulate the discussion of remuneration policy on the governance side. First, Supervisory Board members and Remuneration Committees must become more familiar with the dynamics of remuneration policy, especially now that alongside financial – also non-financial performance criteria play an increasingly large role , and in fact all themes of a company converge here. The idea is that if Supervisory Board members are better informed, the discussion with shareholders will also gain in quality. Second, companies must be more transparent about their quantitative and qualitative targets in sustainability and about how sustainable performance is taken into account in directors' remuneration. That transparency, by the way, must come from both sides. For example, if investors cast a protest vote or vote against a sustainable remuneration system, they must be able to clearly justify why. Last but not least, more substantive dialogue is especially needed between companies, investors and/or the external advisors on whose advice many investors base their voting.
Stop templates and invest in understanding
Reward Value's research makes it clear that both shareholders and companies themselves have a need for more substantive dialogue. In principle, the rules of the game are satisfactory, but not the mutual contact. Shareholders see more openness from companies about the considerations in their remuneration policy as a prerequisite for a better dialogue. For Supervisory Board members, a good dialogue is only possible if shareholders are truly willing to invest in a solid understanding of a company's remuneration policy and are not content to allow the advice from advisors suffice. In practice, the latter unfortunately happens all too often. Especially as investors grow larger, the distance from companies increases. Passive index investors with voting rights in thousands of companies do not spare enough time and manpower to delve into the specific situation of individual companies. Even the consultancies they hire for this purpose have too little manpower and work with templates that leave little room for nuances or innovations in remuneration systems. This is problematic. If, as an investor, you can only grow through that with each new company less attention is given to the others, the result is loss of quality.
Shareholder voting is, in the words of Amy Wilson of consulting firm EOS, ‘a very important responsibility and a right’ (No. 07, 2022). Those who take that responsibility seriously cannot look at returns exclusively but must also examine whether remuneration policies are aligned with the expectations an organization creates with its purpose and goals. The line from goals to strategy, performance and compensation must be clear, true, and appropriate. If there is a mismatch there, it leads to less motivated employees, delays in transition and ultimately a negative impact on a company's performance and long-term value creation. Moreover, you detract from your credibility. This is detrimental to all stakeholders, including shareholders. For this reason alone, there is much to be gained from more dialogue outside of shareholder meetings.
> See also: Amy Wilson (EOS): 'Simplify Pay Structures'
Activation to a modern remuneration policy
In short both large and small investors will have to invest in engagement and give substance to their role as partners in business operations. Just as you must talk to each other in a marriage if you want to move forward together, investors and companies will also have to keep talking to each other to avoid growing apart. That dialogue must be based on detailed and transparent reporting, but also requires well-versed interlocutors - both Supervisory Board members and shareholders - who have delved into the matter and know and understand the individual, specific situation of a company.
My appeal to Supervisory Board members, investors and their advisors is therefore to sit around the table with each other more often and jointly bring about the activation of a modern remuneration policy. Sooner or later, rewards will be linked to sustainability goals mandatorily. It is better to keep control of this development and take the initiative now instead of waiting for the legislator, if only from the intrinsic need to initiate positive change.
This essay was published in Management Scope 04 2023.