Robert Jan van de Kraats on the Link Between Remuneration and ESG Policy

Various stakeholders often expect a different performance from the organization: Financial return, or societal value creation. To what extent are these expectations at odds with each other and how should non-executive directors manage this?
‘As a non-executive director, you think about all stakeholders and try to assess and weigh up the individual needs, interests and expectations. That can cause for tension. The management board and supervisory board are primarily responsible for the continuity of the company. An excellent financial performance is necessary to ensure continuity. So is ESG performance. For example: Institutional investors often invest the assets that pension funds manage for their participants. Despite the fact that the topic of ESG is high on their agendas, achieving a good return should not suffer from that, in my experience. Institutional investors are focused on an excellent FESG performance, including excellency in the financial field. This is because their clients expect them to do so: Pensioners simply want a good and preferably indexed pension. An additional challenge here is that, on average, these investors do not hold on to their shares for very long. It is essential that society realizes that the necessary alignment on this issue is rare.’

At certain companies, the sustainability policy does not exceed greenwashing: Nice words, yet no actions. Do you recognize this with institutional investors as well?
‘The ESG specialists of institutional investors address in boardrooms and at shareholder meetings that sustainability is crucial to them, but it is the fund managers who often set their sights on maximum return in their investment decisions. For example, the American investment company Blackstone. They claim to be committed to a sustainable attitude. However, a study by De Volkskrant shows that Blackstone does not pay tax in the Netherlands on the rental incomes they generate from the numerous buildings they own in Amsterdam. If sustainability is paramount to you, why would you use a tax construction to avoid having to pay a cent in tax? Even when I still served as CFO, the conversations with the fund managers never touched upon sustainability, while you would actually prefer the fund managers to be included in the priorities set in the institutional investor’s investment policies.’

In the Dutch governance model there is a distance between the company and its shareholders. That distance can lead to tensions if the performance remains behind.
‘Shareholders are the owners of the company. They want you to meet their performance requirements, so their focus is often short-term and return-oriented. But there are rare exceptions. American investment company Tweedy Brown had invested in AkzoNobel for 25 years. In 2017 they wrote a letter to AzkoNobel in which they made it clear that performance requirements should be met. The investor aptly indicated that a company cannot underperform for a long time and that performance is measured from a very broad perspective.’

How should non-executive directors manage their mandate in this area of tension? What needs are they required to serve?
‘Non-executive directors must immerse themselves in the interests of all stakeholders and ensure that these are represented and weighed up well. That is a position of responsibility which costs a significant amount of time and energy. In this country we underestimate the role of non-executive directors. In comparison to directors, lawyers and accountants the remuneration is low. For instance, in the case of the going rate for lawyers and accountants, which is 500 euros per hour, the total remuneration for non-executive directors does not provide sufficient time to do the work properly. The reward does not display the expectations clearly. Fortunately, many non-executive directors take their responsibility and are highly involved. In any case, it is not right.’

How can the supervisory board formulate financial and non-financial goals? And how can they evaluate and reward performances?
‘It goes without saying that a broad set of financial and non-financial targets is important. As previously mentioned, this relates to FESG, rather than ESG. However, nobody can see into the future, it is largely a game of chance. Therefore, when determining remuneration on the basis of performance, non-executive directors should not only focus on the formally set targets, but current events should also be taken into account. For that reason, in addition to the targets, it is appropriate to include recent market developments and developments in society. Looking at the context together, with a glass of wine in hand, may be helpful in the introduction of realism to the evaluation. From there on it is crucial to be well prepared for any discussions with directors and stakeholders.’

What are the best practices in the area of ESG in the Renumeration policy?
‘There are no fixed frameworks for rewarding ESG performances yet, and we should not yet care for that either. As mentioned, non-executive directors should engage in a conversation with executives and stakeholders. Exchanging thoughts on what is important results in a better understanding. In the long run, best practices will naturally follow. Conduct a dialogue according to the principles of the remuneration policy and do not look at targets mechanistically. If, for instance, you have a growth target of 10% and the company realizes 15% growth. Has the board earned a bonus? Not if the market has grown 20%. On the other hand, if the market is weak and the company has realized a growth of 5% anyway, the board has indeed earned a bonus. Despite the fact that the goal has not been achieved.’

An unsustainable attitude may jeopardize the organization. For example, its reputation. How can these be involved in the remuneration policy?
‘Organizations have to do the right things the right way. Sustainable business operations are the foundation, which should be just as common as compliance. If you are not compliant, or if you do not behave within a sustainable framework, your variable remuneration will be reduced. If an industrial company does not have their security in order, causing a considerable amount of accidents, or if international laws and regulations are violated, a discount of 100%, or even a parting of ways, may be justified.’

Does that lead to tensions with executives?
‘Similar to raising children, you have to set boundaries. In the Netherlands we always try to stay in the middle. For exceptionally good achievements, a reward is appropriate, and vice versa. Executives must also take responsibility for their remuneration and act with integrity. As the Monitoring Committee, we have included this in the Corporate Governance Code as well. According to the code, executives must remark on their own remuneration: They cannot simply point out that someone else has determined it. It is their responsibility as well. This can also mean that directors forego their variable compensation, even though they are formally entitled to it.’

ESG can also bring opportunities: New business, new customers or a better position in the job market. Could bonuses possibly assist in using sustainability as a driver for value creation?
‘If ESG is strategically important and contributes to distinctiveness, both in business and in society, this can be translated into a bonus. For example, if a company succeeds in reducing CO2 emissions at an accelerated pace through powerful innovation, with a positive effect on reputation, dialogue with stakeholders and employee involvement. This can also apply to a socially responsible attitude, such as building a sustainable relationship with customers, suppliers and employees.’

How important is transparency of the remuneration policy? The supervisory board has the discretionary power to determine or adjust the level of the remuneration within the remuneration policy at its own discretion. The outside world often experiences this as a black box.
‘It is a good thing you cannot look into that box as an outsider, because the necessary context and insights are lacking. The supervisory board needs to be transparent about the principles of the remuneration policy, without going into further details. When a shareholder asks if the executives have met their targets, the supervisory board could answer by saying that by taking everything into consideration, they have determined that the performance justifies the bonus awarded. Naturally, you must have a complete picture in order to answer any questions properly afterwards.
People might lack context to understand these considerations. This also applied to my father, who is almost 90 years old now. When I was still working at Randstad, he always looked up my salary in the annual report. After which he said: “You must have earned it, but I cannot say that I understand it.” Crucial to discretion is an authentic and autonomous attitude on the part of the non-executive directors. To all the companies I supervise I am able to explain how we have arrived at the final pay-out. That I can guarantee, I have nothing to hide. The same is true for my own remuneration as a non-executive director and during my time as executive.’

What role does interaction with the external environment play in the sustainability ambitions of companies?
‘A sustainable attitude of the business community is driven by demand from society. Shareholders and stakeholders should have open conversations with companies, this is more effective than the hasty implementation of a fixed reporting framework. This way, issues become apparent, and companies can communicate clearly on how they will respond to these issues. This conversation can revolve around priorities and which indicators can be used. This creates a relevant and concrete balance between supply and demand. This way you push each other in the right direction. This dialogue can be intensified and integrated with financial performance expectations. This can also mean that the financial return is given a lower priority. In my surroundings I notice that pensioners are still far away from accepting this fully.’

This is reminiscent of Mark Carney’s ideas about the ‘tragedy of the horizons’: Different stakeholders have various time horizons and therefore different perspectives and demands. For example, for pension participants: Returns are important for older people because they want to enjoy a good pension in the short term; sustainable investment is important for the younger generations because they want to safeguard the quality of life on earth in the future.
‘For this reason we have to exchange views with each other and increase and broaden the knowledge and understanding of stakeholders. “Put the fish on the table and let everyone smell it.” Make the consequences crystal clear: “If sustainability is important to us, this can have consequences for the return and therefore for the level of your pension benefit.” But also: “If we merely strive for maximum efficiency, it will have consequences for the environment.” Along with that I see a role for pension funds: Explain to participants that a good pension is about more than just financial results. That could ease the pressure institutional investors feel to prioritize financial returns. However, alternatively, you should also explain that sustainability is not the priority, but one of the priorities. As a company you have to do the right things the right way, but you have no choice but to stay competitive.’

To what extent does this also apply to the international competitiveness of the Netherlands?
‘We are a strong country, but we have to keep it that way. For example, the court ruling on Shell's carbon policy could go two ways: It could accelerate companies' climate ambitions, or cause them to move their headquarters abroad. Compare it with the banking sector, where the bonus cap has severely damaged international competitiveness, because politicians wanted to score some cheap points. Or take the tax-friendly climate in the Netherlands, with which we attract international companies. These societal issues are still under discussion. However, we must realize that countries compete with one another through taxation. Although recently slightly eased, this remains a leading principle. Furthermore, investors look at tax efficiency of businesses and these companies are also assessed on this. Again, we need to have a conversation with the stakeholders about this: If you do not pay a penny in tax, like Blackstone, then something is at fault. If you pay more tax than others, then something is wrong too. Hence, tax policy must be responsible and efficient. You have to take a holistic approach and look at the impact on society as a whole. Put the fish on the table. Only then can we remain that powerful country we are, in the broadest sense of the word. I would like to contribute to that. I have children and now I have a grandchild too. For their sake I want to leave the world a little better than I found it.’

Interview by Vanessa Otto-Mentz, partner and leading the sustainability practice at Deloitte Nederland Risk Advisory, gepubliceerd in Management Scope 09 2021.