ESG Goals in the Remuneration Policy

ABP and its administrator APG do not hesitate to call to account the companies in which they invest the pension money entrusted to them with regard to their remuneration policy. They do so by engaging in dialogue or, if necessary, by voting against remuneration proposals at the company's shareholder meeting. Criticism of remuneration policies by pension fund ABP and pension administrator APG Asset Management is taken seriously by companies at home and abroad. With 2.8 million participants, ABP is the largest pension fund with pension assets amounting to over €465 billion. This money is managed by APG, which in turn engages third parties to manage some of it.  The pension administrator manages more than €512 billion of pension money for various pension funds and is the largest investor in the Netherlands.

More than just profit  
The pension specialists are not necessarily against high remuneration for executives, provided they add value that consists of more than just profits and a high share price. ‘Remuneration must be in line with the company's long-term value creation,' says Griffioen. The interests of shareholders and other stakeholders play a role in this. Customer satisfaction, employee satisfaction and sustainability of the organization also contribute to the long-term value creation of the company and should therefore affect the remuneration policy. Besides, remuneration should not be excessive. ‘Companies are willing to take steps, but they don't always know how to improve their remuneration policy,' says Deloitte partner Vanessa Otto-Mentz, who is leading the discussion. Otto-Mentz leads Deloitte's Dutch advisory practice and, among other things, advises remuneration committees on sustainable criteria. This is a good reason for us to have a conversation about the risks of excessive bonuses and the value of good feelers.  

Executive remuneration is in the spotlight. Shareholders and other stakeholders increasingly want companies to include financial and non-financial metrics in the remuneration policy for their top executives. How do you incorporate this into your investment policy?  
Griffioen: The basic principle is that we offer our three million members a good pension. Not just in financial terms: everyone should be able to enjoy their pension in a liveable world. That's why in every investment decision we weigh not only the return, risk and costs but also the sustainable performance of the companies in which we invest. Good corporate governance and thus, executive pay is an important parameter.’
Bronsdijk: ‘We expect the companies we invest in to disclose how they deal with executive pay.  What are the targets? What performance level must be achieved before any reward or bonus is paid? We also expect companies to include non-financial criteria in their remuneration structure, such as employee satisfaction and customer appreciation. But also think of criteria around occupational health and safety, the violation of compliance rules or the ethical codes by the company. These criteria must be transparent, objectively measurable and relevant to the company's strategy. Executives themselves often know very well which indicators are the most relevant to the business.’
Griffioen: ‘You can’t separate financial and non-financial goals. In a company, non-financial performance is always linked to the company's financial performance. For ABP, it is a prerequisite that the remuneration policy reflects that connection. It's not acceptable for a company to score badly on non-financial metrics but still be rewarded for its financial results.’

Many companies include sustainability criteria in the strategy that reveal how the company takes people, the environment and society into account in its activities. The next step is to integrate these into the company's remuneration policy as well. Remuneration committees and HR professionals are looking for the right approach here. There is little standardization and a limited number of best practices. Do you experience this in practice?
Bronsdijk: 'We see the struggle of companies to incorporate appropriate non-financial criteria into remuneration policies. This is also challenging, especially if the policy has traditionally focused only on financial criteria such as profit and sales targets. Companies ask us more than once what we expect from them. We don't prescribe anything; remuneration committees are ideally equipped to identify relevant indicators.'

In practice, companies often do not get any further than good intentions. Although the vision and ambitions of many companies are good, there is a gap between ideas and execution. How do you, as committed shareholders, help these companies to move forward?
Griffioen: ‘We are happy to share our knowledge with the companies we invest in. Where necessary, we vote against unreasonable remuneration proposals at the general meeting of shareholders. The people who implement our investment policy prefer to enter into a dialogue with the executive directors and the remuneration committee. We believe in the power of collaboration and put together our policies in consultation with our stakeholders: participants, NGOs, scientists and the government, among others. This preference for engagement has its roots in the past. Our sustainable investment policy started with active shareholdership, which involves voting and engaging with companies. We then moved on to excluding businesses that were not socially responsible. We decided to stop investing in tobacco products, for example. The next step is ESG integration: we now invest in companies that operate sustainably and responsibly. These companies, for example, contribute in a positive way to combating climate change or operate with respect for human rights.’
Bronsdijk: ’The remuneration policy is always a reflection of what is going on in the organization and of what executives think is important. Fortunately, an increasing number of executives recognize the importance of value creation in the long term and integrate this into the strategy. Remuneration policy then usually follows as a matter of course because an executive who focuses on long-term value creation will always want to prevent short-term interests, such as bonuses, from undermining sustainable operations. If the board does not believe that the organization should develop a more sustainable strategy, we as shareholders will discuss this with the company.’

Pension money is invested worldwide. Do you perceive differences in how companies deal with corporate social responsibility and executive remuneration in different parts of the world?
Bronsdijk: 'There are big differences. To start with, every country must deal with laws and a corporate governance code, from which it follows what shareholders can expect from executives in terms of sustainability. Our expectations often go beyond that. With companies in emerging economies, it sometimes takes some effort to explain why the company's non-financial criteria are also important to us as shareholders. Our task is to make it clear that the sustainability level of a company affects long-term value creation and therefore the results.’

This can cause tension. How do you ensure that companies understand your vision of sustainability as a proposal for collaboration and not, for example, as shareholder activism?
Griffioen: 'Our knowledge of cultural aspects helps matters. At companies in Asia, we discuss the social aspects of business operations with the management from a governance perspective. Dutch investors and companies regard the reduction of industrial accidents as a social issue, whereas in Asia this is regarded as part of good governance. The idea is that if employees are not happy, this will affect operating results.
Bronsdijk: 'It is important to keep explaining what your expectations are, and why. It helps to cooperate with other asset managers in this process, for example, through our membership of the Climate Action 100+: an initiative by institutional investors from developed and emerging markets, which monitors what 100 companies globally emit the most CO2. We are in dialogue with these companies. By cooperating, we show the executive directors of these companies that sustainability is of concern to shareholders worldwide.’

If you were to organize a master class for executive directors, what advice would you have for them when it comes to adopting a well-considered remuneration policy?
Griffioen: ‘Avoid excessive remuneration. Instead, choose a remuneration structure that is in line with long-term value creation. We expect clear and measurable performance targets to be attached to executive pay. Linking a target to the company's inclusion in a sustainable stock market index such as the Dow Jones Sustainability Index is not enough. It does not provide a proper understanding of the specific sustainable performance of the company and therefore does not provide a control mechanism. Criteria such as employee and customer satisfaction do and are therefore more appropriate.’
Bronsdijk: ‘Transparency is an important condition for a good remuneration structure. If we, as shareholders, do not know how management is rewarded, it is impossible to form a good opinion. We want information about the structure of the remuneration policy and the performance indicators used, but also about its practical implementation: which objectives have been achieved and what was actually paid to the executive directors.’

What best practices can executives and remuneration committees benefit from?
Bronsdijk: ‘Royal Dutch Shell is taking big steps forward. The company has included an energy transition target in its long-term remuneration policy. It has also included indicators on safety and the environment that determine management remuneration in the short term. Some targets are still under development, but we see the efforts. Another Dutch example is PostNL, which includes concrete and measurable indicators such as employee engagement, customer satisfaction and climate impact in its remuneration policy. The company makes a connection between strategy, business operations and remuneration policy. An example of advancing insight is the remuneration policy of Ahold Delhaize. The supermarket chain has included sustainability criteria in the long-term management remuneration for several years. To our surprise, the company decided to reduce the importance of these criteria last year (from 20 per cent to 15 per cent, ed.). That is remarkable for a retail company that is so concerned with sustainability, for example in its product range. This was reason enough to vote against the new remuneration policy at the shareholders' meeting and to enter into discussions with the remuneration committee. Although the proposal was accepted, the remuneration committee decided to include sustainability criteria in the annual bonus in addition to the sustainability criteria in the long-term incentive plan. This is a good example of the effect of a constructive dialogue.’

In the current exceptional times, executive remuneration is receiving extra attention. Companies are directly challenged on excessive remuneration. The question then arises whether the executive board and the remuneration committee are sufficiently connected to the world around them. How do you view this?
Bronsdijk: ‘A very topical example is the ‘say-on-pay’ proposal for the CEO of coffee chain Starbucks, which was rejected by shareholders. (In the United States, shareholders have an advisory vote on remuneration proposals, the ‘say on pay’ as it is called. This is a non-binding recommendation, ed.) It is very unusual for a say-on-pay proposal to be rejected in the United States. It shows that a company must know what shareholders think of the level of remuneration in relation to the performance of top executives (Starbucks laid off hundreds of employees since the corona crisis and closed more than 300 branches, ed.). Starbucks' disregard for corporate social responsibility has a negative impact on the organization. This attitude harms the trust that the various stakeholders have in the company.’

Companies that excessively reward their executive directors in the eyes of stakeholders are therefore at risk. Do you have any advice for executive directors and supervisory board members struggling with this issue?
Bronsdijk: ‘Share your struggles and considerations around remuneration policies with shareholders. In particular, make sure that your social feelers are working properly. I speak to executives and members of remuneration committees who have little feeling for what is happening in the general society, a society where their employees and customers are suffering. Some companies pay a bonus while the organization has had to suspend dividends. Or they reward management, while large groups of employees have to be made redundant or sent on unpaid leave.’
Griffioen: I advise executives to start improving transparency. Share the dilemmas of remuneration policy in this pandemic. As shareholders, we also understand that executive remuneration is sometimes higher than desired. Everyone understands that mistakes are made and must be corrected, as long as you are open about it as a board and show that you learn from the past –  and take appropriate action to correct the mistakes.

This article was published in Management Scope 04 2021.