2015 12 executive remuneration version finale eng...executive remuneration. only one japanese listed...

Executive remuneration: Does social responsibility

really matter?

December 2015

Vigeo rating October 2013 2

Copyright 2015 Vigeo – All rights reserved

Vigeo rating December 2015 2

Foreword

In recent years the allocation of

huge bonuses to some executives

in large corporations has been

object of several controversies. The

criticisms on executive pay lead in

certain cases to legal proceedings,

to shareholder revolts or to drastic

reductions of the bonuses. In all

cases, the image of the company

and the reputation of managers

may have been affected, alongside

with the trust of the working force

in the top-management and the

support of shareholders. These

tensions question the idea of

remuneration itself, its contents

and its objectives: what is the goal

to be achieved though the variable

remuneration plan of CEOs? What is

the meaning of merit and

performance when applied to top

executive functions? Even if they

have a formal employment contract

and are defined as “executive

officers”, top managers are neither

employees in a strict sense nor

mere executors of the Board’s

wishes or of shareholders’

interests.

Top managers represent the

company from a legal point of view

and towards third parties. They

exercise their leadership on the

entire workforce, with a link to

every employee through a cascade

of delegations and mandates. It is

their responsibility to adopt

commitments and engage with all

concerned stakeholders to promote

the success of the company and

the sustainable development of its

environment. The problem is that

t h e s e d i m e n s i o n s a n d

responsibilities are very rarely

translated with enough clarity on

the policies, processes and

performance indicators linked to

the remuneration of managers.

And, in fact, the executives remain

today highly exposed to skepticism

and criticisms about their

remuneration, which is often

considered disproportionate and

unjustified.

Against this background, the main

arguments of the Board of

Directors and of the executives

themselves to justify unreasonably

high bonuses range from the need

to attract “rare high-level profiles”,

the dimension of company’s

capitalization, turnover and

economic results, the presence of

specialized committee at Board

level in charge of compensation

decisions, the strict observance of

procedures and due diligences with

the support of external pay

consultants and their peer

benchmarking exercises. However

the aversion of the public opinion

and the uneasiness of the

shareholders – either individual

shareholders or institutional

investors - seem to be based on

other fundamental questions: in

exchange of what, and on which

criteria is the remunerations of top

managers decided? Is the

remuneration of executives

coherent with the broader human

resources strategy of the company?

Integrate into executive manager’s

remuneration precise criteria of

social responsibility

We believe that the executive

remuneration policy is both a tool

and an indicator of the ability of a

governance framework to properly

mitigate and manage risks and to

promote a sustainable long-term

value-creation for the company

and its stakeholders. Since the

experience clearly shows us that

pure financial and economic

indicators are not sufficient to

provide a reliable picture of the

performance of a company, the

integration of social responsibility

factors in the performance

assessments of executives can

reinforce the objectivity, long-

termism and acceptability of the

remuneration practices. This vision

is now recognized by guidelines

and recommendations with an

increasing influence, in particular

the Principles of Responsible

Investment (UN-PRI). Some signals

in this direction are also offered by

the proposed revision of the

Shareholder Rights Directive,

presented by the European

Commission in 2014 and voted by




the EU Parliament in July 2015,

which aims amongst others to

increase the engagement of

investors and asset managers in

investee companies on the

management of environmental and

social risks. The present study,

starting from a universe of more

than 2,000 listed companies

worldwide, precisely investigates

the commitment and the capacity

of the Board and top managers to

be monetarily accountable for the

fu l f i lment of the i r soc ia l

responsibilities in a broad sense.

executive remuneration and its link

with company’s long-term

performance.

Human resources and customers

are the stakeholders the most

often taken into account in the

calculation of the variable

remuneration of executives

On a panel of 2,129 European,

North American and Asia-Pacific

companies, 14% of them report to

consider social responsibility

metrics in the allocation of

remuneration to their executives. It

is not a lot, but it is a material

tendency despite the still large

discrepancies between regions and

sectors. National culture and

regulatory frameworks exercise a

key influence on the way

companies communicate about

executive remuneration. Only one

Japanese listed company for

instance discloses information on

the consideration of social

responsibility factors in executive

remuneration, against 46% of

Australian companies, 32% of

Dutch companies and 29% of the

Canadians. The influence of the

"Say-on-Pay" principle and the

level of engagement of investors

are clear aspects in this respect.

The best performing sectors on

this topic are Waste & Water

Utilities (75%), Mining & Metals

(45%), Energy (43%) and Oil

Equipment & Services (32%). Vigeo

database reveals that among the

companies which report a link

between executive remuneration

and social responsibility, only

17 ,4% d isc lose quant i f i ed

performance targets. The most

transparent companies in this

regard are the North-Americans in

the sectors of energy, electricity

and gas, and the mining and metal

industry. Beyond all regional and

sectorial peculiarities, one of the

key findings of the study is that

there is a relationship, and a

positive one, between the


considerations in executive

remuneration and the general

profile of social responsibility of

the company. The consideration of

social responsibility factors in the

allocation of bonuses to the

executive teams can constitute, at

the same time, a tool to manage

strategic risks connected to the

management functions, a way to

internalize in the company’s

s t ra tegy the in teres ts o f

stakeholders in a broad sense, and

a positive message to the markets

and both internal and external

stakeholders.

The process of integration of social

responsibility in the executive

remuneration has been so far

uneven. The topics the most

frequently taken into account

concern human resources (in 40%

of cases) and the relations with

customers (25%). Executive

managers remain relatively not

accountable and only marginally

sanctioned, either in a positive or

n e g a t i v e w a y , o n t h e i r

commitments and results in terms

of respect of human rights,

p reven t ion o f co r rup t ion ,

contribution to the social and

economic development of the

communities in which they operate.

But the situation is fluid and is

evolving rapidly. Corporate social

responsibility is already important

for investors and during Annual

General Meetings the expectations

towards Boards in terms of


in the company’s strategies and

governance are growing. This study

shows that, independently from

any direct constraint from

shareholders, the most advanced

companies in terms of social

responsibility are also the ones

where top managers agree to be

evaluated on these factors and to

be kept accountable for that.

Fouad Benseddik Director of Methods




Table of contents

1. Introduction 5 2. Key results 7

3. Context 8

4. Executive remuneration: Vigeo findings 10 4.1. Executive remuneration: overview of performances 10 4.2. Adoption of ESG-linked remuneration 13 5. ESG-linked remuneration and overall CSR score 17 under Vigeo ratings 6. Good practices 24 7. Conclusions 29




1. Introduction

Since the “Shareholder Spring” in 2012, executive remuneration is a hot topic of corporate governance. Shareholders and investors are i n c r e a s i n g l y a w a r e t h a t compensations practices that fail to align manager behaviors with the long-term interest of the Company can lead to huge costs and value destruction.

R e m u n e r a t i o n - r e l a t e d con t rove r s i e s m igh t have negatively impacted the reputation of companies, affected the trust and cohesion of their workforce and increased critics and negative votes from shareholders during annua l gene ra l mee t ings . Controversies on executive remuneration raise at least three main chal lenges, that are addressed by Vigeo in its assessment framework. First of all, social justice and inequality: the spectacular widening of the pay gap between executives and employees calls for a re-considerat ion of executive remuneration as part of the broader incentive structure of the organization and not only as a tool to attract managers based on horizontal benchmarking. A second main issue is the level of transparency of remuneration, which not only relate to the total amount of bonuses paid out to

executives but also to the performance conditions attached to the allocation of such bonuses. Despite the progresses made in recent years, the current design of d i s c l o s u r e o n e x e c u t i v e remuneration remain limited, making highly difficult to visualize the coherence of bonuses paid with t h e a c t u a l c o m p a n y ’ s performances. A third aspect, relates to the structure of executive remuneration plans, and in particular the nature and the time-horizons of the performance conditions. Short-term economic and financial indicators - such as ROE, TSR, economic profit - fail to fully account for important elements that concerns the long-term wellness and prosperity of the company. For all these reasons, Vigeo’s rating focuses more and more on integration of social responsibility and sustainability drivers in the agenda of the boards and their committees, and in the remuneration plans for executives.

The question is to know whether CSR-linked executive remuneration receive the attention it deserves from companies and Boards of Directors. We do believe that the use of CSR (or ESG) metrics in executive remuneration is a promising solution to anchor the bonuses of managers to a

perspective of long-term value creation and to protect shareholder value.

Vigeo’s methodology assume the set of postulates issued by the guidelines for “Integrating ESG issues into executive pay” published in 2012 by the United Nations Principles for Responsible Investment (UN PRI):

- Aligning executives’ incentives with long-term strategic plans contributes to the delivery of sustained shareholder value creation;

- Long-term thinking about the company’s future performance and tangible leadership from the top is rewarded, and senior m a n a g e m e n t i s h e l d “accountable” for sustainable performance;

- Identifying key CSR value drivers and risks relevant for each specific company and sector t r i g g e r s n e w b u s i n e s s opportunities and costs savings;

- ESG issues are more likely to be integrated into the company’s dialogue with shareholders on its business strategy, effectively acknowledging their impact on corporate performance.




While there is a growing empirical evidence on the positive link between an adequate management of ESG risks and positive financial returns, the literature on the benefits of the integration of CSR performance targets in executive remuneration is still quite limited. Nonetheless, few research documents seem to suggests that the use of CSR objectives, as an explicit incentive for managers, can be a source of competitive advantage*.

With this study Vigeo brings its contribution to shed light on the current practices of CSR-linked executive remuneration in order to provide some insights on these questions. The research cover the l a tes t da ta on execu t i ve remuneration (from February 2013 to August 2015) for 2,129 companies in Europe, North America and Asia-Pacific, covering a total of 32 countries and 36 sectors. The key results of the study are summarized in Section 2. In Section 3 we discuss the context and the growing importance of executive remuneration for companies and investors. Section 4 presents the key findings from Vigeo database about companies behavior across sectors and c o u n t r i e s o n e x e c u t i v e r e m u n e r a t i o n a n d , m o r e

specifically, in terms of CSR-linked executive remuneration. Section 5 investigates the correlation between the adoption of ESG-linked executive remuneration with the companies’ overall CSR performance and involvement in controversies. Section 6 presents some observed good practices and draws some key takeaways addressed to companies and investors interested in better understand how to integrate ESG issues in executive remuneration.

In the study we make use two widespread acronyms: ESG and CSR. The term “ESG” indicates the «Environmental , Social and Governance» issues and it has been popularized by the launch of the investor initiative Principles for Responsible Investment (PRI), in partnership with the UNEP Finance Initiative (UNEP FI) and the UN Global Compact. The term “CSR”, which stands for Corporate Social Responsibility, is more general and refers to the responsibilities of c o m p a n i e s t o w a r d s i t s stakeholders. Following a general convention, throughout the study we use the term “ESG” issues when referring to an investment perspective and “CSR” when referring to the enterprise management perspective.

* Among the studies, Berrone and Gomez-Mejia (2009) showed a positive effect of CSR-linked compensation on the envi-ronmental performance of companies in high-polluting industries. Berrone, P., Gomez-Mejia L. R. (2009), “Performance and executive compensation: An integrated agency-institutional perspective”, Academy of Management Journal, 52, 103-126. A more recent contribution on the topic can be found in Hong, Li, Minor (2015) “Corporate Governance and Execu-tive Compensation for Corporate Social Responsibility”, Harvard Business School Working Paper No. 16-014.



2. Key results

1. Only 14% of the 2,129 companies under this Vigeo’s review appear to integrate CSR issues in their executive remuneration policies.

2. Differences between countries and sectors are strong in terms of culture and practices. Countries leading the way of ESG integration in companies’ executive remunerations are Australia (46.1% of companies), the Netherlands (32.1%), UK (29.4%) and Canada (29.0%). Advanced prac t i ces on executive remuneration appear influenced by the effects of “Say on Pay” principle coupled with a leading role of institutional investors in the engagement with investee companies. At sector level, ESG-linked remuneration are more frequently observed in the Mining & Metal (45.7% of companies), Energy (43.2%) and Oil Equipment & Services (32.7%) sectors.

3. E v e n w h e n e x e c u t i v e remunerations are do linked with CSR performances, quantitat ive targets are disclosed only in 17.4% of cases. The disclosure of

quantitative targets on selected ESG metrics appear more spread in the North American region and in particular in industrial sectors in the field of Electric & Gas Utilities, Energy and Mining & Metals.

4. A strong positive relationship is o b s e r v e d b e t w e e n t h e integration of ESG objectives into executive remuneration policies and the overall CSR performance of the company under Vigeo rat ing. In particular, companies with ESG-linked remuneration are more frequently associated with a high Vigeo’s overall CSR score (>50/100) than others. Correlation is not causation, but the finding suggests that C S R - l i n k e d e x e c u t i v e remuneration can be an important signal and tool of a strategic and comprehensive approach to sustainability and integration of CSR drivers.

5. While it is not possible to define a “one-size-fits-all” approach on the convergence between ESG strategies and executive remuneration, the good practices observed by Vigeo suggest some aspects that are

particularly important in this field. The key takeaways include: the identification of material ESG issues and the related performance indicators; the adoption of quantitative targets on selected ESG indicators, both for annual and long-term incentives; the adoption of downward d is c re t iona ry adjustments and claw-back provisions in cases of serious ESG controversies.




3. Context

Currently, the “Say-on-Pay” principle is widespread in many countries: it has been introduced in Australia in 2005, in the US in 2010 through the Dodd–Frank act, in Italy and Spain in 2012 while in France in June 2013, through the self-regulation by AFEP-MEDEF Governance Code. The UK - the forerunner country on Say on Pay - has introduced in 2012 a stricter Say on Pay with a mandatory binding vote on a forward looking report which sets the remuneration policy at least every three years, following the requirements already in place in the pre-crisis era in some Scandinavian countries (Sweden, Netherlands, Norway).

In 2014 the European Commission proposed a revision of the Shareholder Rights Directive (2007/36/EC) with the objective to increase shareholder engagement, which is still under discussion at the EU Parliament and Council. With the revision of this Directive, amongst others, the Commission wants to reinforce shareholders’ control over management pays and require companies to explain during the general meetings how the remuneration policy

contributes to the long-term interest of the company.

The “Say on Pay” principle needs to be supported by an active engagements and dialogue of investors with investee companies on executive remuneration and other key issues linked to the long-term value-creation. Responsible remuneration practices are fostered by the awareness and the active participation in the company’s life by institutional investors and shareholders.

MAIN LEGISLATIVE TRENDS IN TERMS OF EXECUTIVE REMUNERATION




Companies' efforts to integrate ESG principles and goals in the remuneration of their top-managers is analyzed

by Vigeo as part of its Corporate Governance assessments.

Vigeo’s assessment model on executive remuneration is based on the principles identified in the widely

recognized Corporate Governance reference codes (mainly the UK Corporate Governance Code), International

recommendations (the OECD 2015 Principles of Corporate Governance) and best practices in terms of

convergence and coherence between corporate governance structures and social responsibility strategies.

Key aspects under our review are the existence and independence of a Remuneration Committee, the level of

transparency on senior executive individual remuneration, the adoption of clear performance indicators and

targets for the allocation of annual bonuses, the adoption of long-term incentives linked to transparent multi-

year performance conditions with targets ideally linked to performance peer groups, the integration of material

ESG performance conditions in the variable remuneration plan, and the adoption of specific thresholds on

severance payments. We also question and take in account the trend of the gap between CEO’s total

compensation and average salary of employees, and more generally the alignment of executive remuneration

with the overall remuneration and CSR strategies of the company.

VIGEO RATING FRAMEWORK ON THE INTEGRATION OF ESG FACTORS IN

EXECUTIVE REMUNERATION




The following analysis is based on the review of information on executive remuneration for 2,129 selected companies comprising 32 countries and 36 sectors, assessedfrom February 2013 to August 2015. 42.3% of the companies in the panel analysed by Vigeo are located in Europe, 34.2% in North America and 23.5% in the Asia-Pacific region.

4. Executive remuneration: Vigeo’s findings

This section presents an overview of the performances observed by Vigeo in terms of transparency and

soundness of executive remuneration strategies. The average score of companies rated in Vigeo’s universe on

executive remuneration is limited (35.5/100 on scale from 0 to 100, where 100 is the best performance), but

characterised by high variability of performances with a standard deviation of 23.3/100.

As showed in the Chart 1, the highest average scores are achieved by Australian and British companies. It

appears to be a clear country-effect on the performances on executive remuneration:

– UK is the forerunner of the Say on Pay (adopted in 2002) and shareholders are well aware of their

influencing role when speaking about remuneration: the “2012 Shareholder Spring” was largely driven by

the activism of many institutional investors that exercised their voting power to ask more transparent and

fair remuneration policies in large corporations such as Aviva or AstraZeneca.

– The best performances of Australian companies can be partially attributed to the 'Two-Strikes' Rule, in

place since 2011. According to this type of reinforced Say on Pay, when more than a quarter of

shareholder votes are cast against a company’s remuneration report for two years in a row, a further vote

is triggered – on a straight majority – requiring all Directors to face re-election.

– Netherlands has a binding Say on Pay rule on new or significantly revised remuneration policies since

2004. In France, the Say on Pay has been introduced with the revision of the AFEP-MEDEF Code in June

2013.

4.1. EXECUTIVE REMUNERATION: OVERVIEW OF PERFORMANCES




Chart 1 – Average scores on Executive Remuneration, by country (scale from 0 to 100)

Source: Vigeo Research

The sectors that achieve the best performances on executive remuneration are Waste & Water Utilities, Tobacco and Oil Equipment & Services (Chart 2). However, performances within sectors are heterogeneous, with high standard deviations ranging from 15.3 to 27.4. All in all, when considering the issue of executive remuneration,

3,2

5,3

6,7

15,2

16,6

16,8

23,2

23,8

24,5

25,3

25,8

26,3

26,5

31,9

34,6

35,0

35,8

36,4

39,6

40,2

40,5

41,7

46,9

48,0

50,3

54,7

59,8

60,3

0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0

Japan

Czech Republic

China

Greece

Hong Kong

Bermuda

Sweden

Luxembourg

Singapore

Spain

Austria

Germany

Denmark

Belgium

France

Italy

Finland

Switzerland

Portugal

New Zealand

Canada

Norway

United States of America

Tunisia

The Netherlands

Ireland

United Kingdom

Australia




Chart 2 – Average score on Executive Remuneration, by sector (scale from 0 to 100)





4.2. ADOPTION OF ESG-LINKED REMUNERATION


Information about inclusion of ESG objectives in the determination of the executive variable compensation is disclosed by 299 out of 2,129 companies (14.0%). About half (49.5%) of these 299 companies are located in Europe (49.5%; 148 companies), followed by North America (88 companies, 37.7%) and Asia-Pacific (39 companies, 13%), partially reflecting the geographical distribution of the panel. When reported to the total number of companies in each area, the share of companies adopting ESG-linked remuneration is pretty balanced in Europe and North American - 16.4% and 15.4% respectively, followed by the Asia-Pacific region at 7.8%.

When we move the analysis to a country-based analysis (Chart 3), we notice that the weak performance noticed in the Asia-Pacific region is heavily affected by Japanese companies: only one out of 337 refers to ESG objectives in the determination of executives’ variable remuneration. On the other hand, Australia has the highest percentage (46.1%) with 35 out of 76 enterprises adopting ESG-linked bonuses of executives. Within the European region, the countries achieving the strongest results are The Netherlands (32.1%), UK (29.4%) and Belgium (22.2%). In North America, the share of companies ESG metrics in their remuneration policies is far higher for Canadian (29%) than for American companies (13.8%).

Chart 3 – Percentage of companies with ESG-linked executive remuneration, by country

0.3%

3.6%

6.5%

7.4%

7.9%

8.3%

9.1%

9.4%

13.8%

15.0%

16.7%

16.7%

18.2%

20.0%

21.1%

22.2%

29.0%

29.4%

32.1%

46.1%

0,0% 5,0% 10,0% 15,0% 20,0% 25,0% 30,0% 35,0% 40,0% 45,0% 50,0%

Japan

Finland

Singapore

Austria

Germany

Switzerland

Denmark

Spain

United States of America

Italy

Luxembourg

New Zealand

Portugal

France

Norway

Belgium

Canada

United Kingdom

The Netherlands

Australia





When we consider the share of companies with ESG-linked executive remuneration within each sector (Chart 4), the most advanced sector appears to be the Waste and Water Utilities with 8 out of 11 companies (72.7%) having ESG objectives in the allocations of executives’ remuneration, followed by the Mining & Metals (45.7%), Energy (43.2%) and Oil Equipment & Services (32.7%) sectors.

Chart 4 –Share of companies with ESG-linked executive remuneration, by sector

72.7%

45.7% 43.2%

32.7% 31.5%25.0% 25.0% 23.1% 21.4% 21.3% 20.8% 20.0%

11.5%8.2%

4.3%

‐5,0%

5,0%

15,0%

25,0%

35,0%

45,0%

55,0%

65,0%

75,0%





What kind of ESG indicators ?

Chart 5 - Scope of ESG-linked executive remuneration, per domain

Examining the nature of the ESG performance indicators used (Chart 5), in most cases companies adopt performance conditions linked to human resources (39.5%), business behavior (25.4%) and environment (17.7%) areas, accounting together for 82.6% of all the ESG metrics reported. 4.8% of companies make reference to generic ESG performance, without any other specifications. More in detail, human resources objectives pertain most of the time to health and safety (e.g. absenteeism rate, lost time injury frequency rate), employee engagement and retention, workforce diversity. Performance conditions linked to business behavior are mainly related to fair treatment of clients (e.g. net promoter score, customer satisfaction index), product safety, supply chain, compliance and business ethics. Environmental objectives include performances related to environmental indicators, like water consumption, energy efficiency, industrial safety (e.g. loss of primary containment) and pollution prevention.





Chart 6 – Number of companies adopting ESG-linked executive remuneration, by nature of indicators

Deepening the nature of the indicators used, it emerges that 160 companies (equal to 53.5% of those setting ESG-related objectives) report to consider health and safety performances. Other frequently considered ESG performance conditions are linked to customer satisfaction and employee engagement, used respectively by 31.1% and 25.8% of companies (Chart 6).

It is worth noting that some key ESG factors do not yet appear to be considered as performance indicators in the remuneration of executives. Despite a growing scrutiny of investors and stakeholders on these issues, the management of risks related to the promotion of professional diversity, the prevention of corruption, the impact on the environmental and climate change, the respect of human rights, the dialogue with social parties and the management of supply chain is still very rarely considered by the Remuneration Committees when allocating bonus to executives.

Among the 299 companies that have linked executive remuneration with ESG performance conditions, only 52 companies (17.4%) disclose quantitative targets on specific ESG indicators. Amongst these 52 companies, 39 are from the North America region (75%), 10 from Europe (19.2%) and only 3 companies belong to Asia-Pacific region (5.8%). With regard to the sector distribution, the sectors with highest number of companies adopting quantitative targets on the selected ESG performance conditions are the Electric & Gas Utilities sector (16 companies), the Energy sector (12 companies) and the Mining & Metals sector (9 companies). In general, the integration of ESG performance metrics in executive remuneration without transparency on indicators selected and on performance targets is a source of concerns. The achievement of qualitative objectives in fact is difficult to evaluate from an external perspective and stakeholders are increasingly asking to be able to link the payouts with the company’s performance.

12

15

20

26

28

32

34

35

40

42

52

77

93

160

0 20 40 60 80 100 120 140 160 180

Stakeholder engagement

Others (*)

Energy efficiency

Employee retention/Talent management

Diversity

Generic CSR objectives

Compliance / business ethics

Customer protection

Industrial safety

Risks & internal controls

Environmental performance

Employee engagement

Customer satisfaction

Health & safety




5. ESG-linked remuneration and overall CSR score under Vigeo ratings Vigeo’s overall CSR score is based on the performance of companies - in terms of policies and allocation of responsibilities, measures in place and results achieved - in 6 domains: Business Behaviour, Community Involvement, Human Rights, Environment, Corporate Governance and Human Resources. Companies achieving overall scores equal or higher than 50/100 qualify as being robust CSR performers.

Chart 7 - ESG-linked executive remuneration versus CSR overall score

The analysis shows that companies integrating ESG objectives in the variable remuneration of executives are more frequently associated with a robust overall CSR score than others (28.8% vs 8.2%). It must be stressed that this correlation does not imply any direct causal relationships. However, the finding does indicate that the integration of ESG performance conditions in executive remuneration can be an important proxy and tool of a comprehensive sustainability strategies of the company.





ESG-linked executive remuneration are more often associated with Robust performance in all domains under review.

Table 1 – Percentage of companies with and without ESG-linked executive remuneration and Robust CSR score (=>50/100) under individual domains

It is worth noting that, as showed in Chart 8, the integration of ESG issues in executive remuneration is

associated with an higher average scores in all three main geographic areas.

Chart 8 – Average CSR overall score with and without ESG-linked executive remuneration, by region (scale from 0 to 100)


Companies with ESG-linked executive remuneration Other companies

Business Behaviour 24.40% 9.50% Human Rights 31.10% 11.40% Environment 29.40% 13.00%

Community Involvement 27.10% 8.3% Human Ressources 22.10% 6.50%

Corporate Governance 83.9% 43.3%




On average, in the Asia-Pacific region the adoption of ESG-linked remuneration is associate with a score higher

by 13.4 out of 100 points higher, followed by Europe (10.9 points out of 100). In the North American region,

ESG-linked remuneration practices are associated with an average CSR score 6.3 points higher.

Table 2 compares the share of Companies with Robust CSR score among companies with ESG-liked remuneration

and the others, on a country basis. In France for instance the share of companies with ESG-remuneration

achieving robust CSR performances is significantly higher than the share of robust CSR performers among other

companies (84.6% vs. 33.7%). Similar considerations can be made for the UK (35% of robust CSR performers with

ESG-linked remuneration vs. 14% of robust CSR performers among companies without ESG-linked remuneration),

the Netherlands (47% vs 22%) and for countries where ESG-linked remuneration practices appear rare at the

moment (e.g. Italy, Spain).

Table 2 - Share of companies with ESG-linked executive remuneration and Robust CSR score, by country (excluding countries with just 2 or less companies with ESG-linked remuneration)


Companies with ESG-linked remu- Other Companies

Country Number of Companies

Share of Com-panies with Robust CSR

score Number of Companies


score Australia 35 17.1% 41 7.3% Belgium 6 33.3% 21 14.3% Canada 20 20.0% 49 2.0% France 26 84.6% 104 33.7%

Germany 10 20.0% 116 13.8% Italy 9 77.8% 51 17.6%

Norway 4 25.0% 15 6.7% Spain 5 80.0% 48 16.7%

Switzerland 4 25.0% 44 13.6% The Netherlands 17 47.1% 36 22.2% United Kingdom 60 35.0% 144 13.9%

USA 90 4.4% 563 2.0%




Table 3 - Percentage of companies with and without ESG-linked executive remuneration and Robust CSR overall score, (by sectors with more than 3 companies with ESG-linked remuneration)


Companies with ESG-linked remu-neration Other Companies

Sector Number of Companies


score Number of Companies


score

Banks 40 47.5% 148 12.2% Energy 38 10.5% 50 0.0% Mining & Metals 37 32.4% 44 11.4% Electric & Gas Utilities 35 17.1% 76 25.0% Insurance 24 33.3% 72 2.8% Chemicals 18 38.9% 60 200% Oil Equipment & Services 17 5.9% 35 5.7% Transport & Lo-gistics 12 8.3% 44 6.8% Telecommunica-tions 11 27.3% 42 7.1% Financial Servi-ces - Real Estate 10 50.0% 113 5.3% Waste & Water Utilities 8 37.5% 3 33.3% Food 6 50.0% 46 2.2% Automobile 5 40.0% 56 7.1% Financial Servi-ces - General 4 25.0% 90 6.7%




When comparing the overall average CSR score of companies with ESG-remuneration with that of other

companies, and focusing again on sectors with more than 3 companies with ESG-linked remuneration, it is

possible to observe a significant positive difference for all sectors, ranging form 21.6/100 in the Food sector to

3.8/100 in the Electric and Gas Utilities.

All in all, the use of ESG metrics in the allocation of executive remuneration is associated with higher average CSR

performances, regardless of the country and sector to whom a company belongs to. All these findings suggest

that the adoption of ESG objectives in executive remuneration packages can be identified a strong “signaling

power” of the company’s robust ability to manage its responsibilities towards stakeholders and to mitigate

related risk factors.


Chart 9 - CSR overall score with and without ESG-linked executive remuneration, by sector (scale from 0 to 100)

Adopting a sectorial point of view, and considering only sectors with more than 3 companies adopting ESG-

linked remuneration for more statistical significance, Financial Services - Real Estate (50.0%), Banks (47.5%) are

the sectors where practices of integration of ESG factors in remuneration are more often associate with a robust

overall CSR performance.




FOCUS ON THE ENERGY SECTOR

The Energy sector includes 88 companies of whom 38 adopt ESG-linked executive remuneration: 20 are located

in North America (52.6%), 13 in Europe (34.2%) and 5 in the Asia-Pacific region (13.2%).

Chart 10 - Scope of CSR-linked executive remuneration in Energy sector

Source: Vigeo research

The ESG metrics used to structure executive remuneration packages in the energy sector are mostly related to

Health & Safety, industrial safety and environmental performance. Notably, 12 out of 38 companies (31.6%) have

adopted quantitative ESG performance targets, related either to health & safety and energy efficiency indicators.

Amongst these companies, 11 are from North America and only 1 from Europe.




FOCUS ON THE BANKING SECTOR

The panel includes 188 Banks, of which 40 adopted ESG-linked executive remuneration: 8 in North America, 26

in Europe and 6 in the Asia-Pacific region.

Chart 11 - Scope of ESG-linked executive remuneration in the Banking sector

Source: Vigeo research

The integration of ESG factors in the remuneration of bankers is mainly done through qualitative objectives

(92.5%), with no disclosure of quantitative targets. The areas most covered are risks & internal controls

(especially in Europe), relation with customers and with employees (including employee engagement and

retention, diversity). Banks’ indirect social and environmental impacts, such as the impacts in terms of climate

change or human rights, have not been considered by any bank in the panel.




Good practices

The present section presents some examples of good practices observed by Vigeo.

Good practices are followed by some key takeaways on how to integrate ESG factors in executive remuneration and on how to evaluate the observed practices.

NextEra Energy (Electric & Gas utilities, Canada)

The 2013 annual bonus was determined based on a rating (“NextEra Energy performance rating”) derived by combining the Company’s financial performance as measured by the financial performance matrix (weighted 50%) and the Company’s operational performance as compared to the operational performance goals (weighted 50%). Targets for financial, operational and CSR performance indicators are disclosed, and include:

– Employee safety - OSHA recordable per 200,000 hours: 0.73

– Significant environmental violations: 0

– Performance under FERC and NERC reliability standards: no significant violations

– Execute on schedule and on budget approved North American wind projects: 225 MW

The Long-Term Performance-Based Equity Compensation is based on the following 3-year targets:

– 3-year TSR relative to the companies in the S&P 500 Utilities Index

– 3-year adjusted return on equity and adjusted EPS growth

– 3-year average employee safety—OSHA recordables/200,000 hours

– Nuclear industry composite performance index

– 3-year average equivalent forced outage rate

– FPL 3-year average service reliability—service unavailability




Fortescue Metals Group Ltd. (Mining & Metals, Australia)

The Executive and Senior Staff Incentive Plan (ESSIP) includes financial and non-financial performance objectives. The financial performance measures were chosen as they represent the key drivers for the short term success of the Company and provide a framework for delivering long term value. The non-financial component of the ESSIP is measured with reference to an assessment against a range of measures, mainly quantitative-based. The CSR performance objectives in 2015 include target percentage reduction (15%) in Total Recordable Injury Frequency Rate (TRIFR), achieve agreed workforce culture and engagement targets.

Land Securities (Real Estate, UK)

For 2015, allocation of annual bonuses to executives is based on the Group’s ungeared Total Property Return (TPR) relative to an IPD benchmark, the absolute growth in revenue profit and a series of specific business targets including:

– Development of the culture of Land Securities with a focus on diversity (1.8% of award, or 2.6% of salary), based on the improvement in specific engagement survey scores and diversity metrics

– Completion of mandatory Health and Safety training (1.8% of award, or 2.6% of salary), with target of 100% of mandatory training completed within six months of joining.

Severn Trent (Waste & Water Utilities, UK)

The bonus in respect of Severn Trent Water performance for the 2014-2015 year was operated by reference to a balanced scorecard of measures, based on 10 of the company’s 16 Key Performance Indicators (KPIs), including employees indicators (Lost time incidents rate, Employee motivation), Customer (Service Incentive Mechanism, Serviceability Waste, Serviceability Water), Financial (Capital expenditure, Operating expenditure), Environment (Pollution incidents, Leakage). In addition, each director has 10% of their bonus opportunity measured against a set of personal performance metrics.




Alcoa (Mining & Metals, United States)

The corporate annual cash incentive compensation plan for 2014 was designed to achieve operating goals set at the beginning of the year:

– 80% of the cash incentive formula was based on achieving financial targets for adjusted free cash flow (33%), adjusted net income (40%) and average year-to-date DWC (7%); and

– 20% of the formula was based on achieving safety, environmental and diversity targets.

The quantified targets are disclosed for each performance indicators. Safety targets included a reduction in the DART (Days Away, Restricted and Transfer) rate, which measures injuries and illnesses that involve one or more days away from work per 100 full-time workers and days in which work is restricted or employees are transferred to another job due to injury per 100 full-time workers. The environmental target highlights the company’s com-mitment to reduce CO2 emissions in 2014 and make progress against its 2030 environmental goals. Diversity targets were established to increase the representation of executive and professional women on a global basis and to increase the representation of minority executives and professionals in the United States.

Xcel Energy Inc. (Electric & Gas Utilities, United States)

The 2014 Executive Annual Incentive Award Program at Xcel Energy included the following corporate operational goals:

– Reliability: System Average Interruption Duration Index (target: 97min)

– Value to the customer: Public safety index (target: 100); Customer Value (survey rating) (target: 85%); pub-lic safety index (target 100)

– Employee safety and engagement - OSHA recordable incident rate (target: 1.17%); Employee engagement (survey rating) (target: 82%)

In addition, 37.5% of the 2014-2016 Performance Share Awards are subject to the achievement of specified re-ductions in carbon emissions over the three-year performance cycle ending on December 31, 2016, with a mini-mum threshold of a three-year average reductions of emissions of 18% and a target reduction of 21%.




Koninklijke DSM (Chemicals, Netherlands)

The Managing Board members will be eligible to receive performance-related shares. Under the performance share plan, shares will conditionally be granted to Managing Board members. Vesting of these shares is condi-tional on the achievement of certain predetermined performance targets at the end of a three-year period. Since 2013, four performance measures are applicable in equal measure for the calculation of the vesting of LTI perfor-mance shares:

1. Comparable Total Shareholder Return (TSR) performance versus a peer group

2. Greenhouse-gas emissions (GHGE) reduction over volume-related revenue

3. Return on Capital Employed (ROCE)

4. Energy Efficiency Improvement (EEI)

BP (Energy, UK)

Safety performance measures are included both in the determination of the company's annual bonus and long-term incentives. The 2014 annual cash bonus comprised Loss of primary containment (target: 3-10% improve-ment), Tier 1 process safety events (target: 3-10% improvement) and Recordable injury frequency (target: 3-10% improvement). In addition, the determination of 2012-2014 performance shares included safety risks such as Loss of primary containment, the number of reported work related incidents and tier 1 process safety events. Percentage improvement targets (between 10 and 15%) were set for these performance measures.

Scotiabank (Diversified Banks, Canada)

Scotiabank uses three steps to calculate the all-bank business performance factor for the annual incentive. The bank calculates a preliminary performance factor based on performance against financial metrics. Then the bank adjusts the factor up or down based on how it performed against non-financial and relative performance metrics, including: People metrics; Customer metric and Relative performance metric (which measures Scotiabank’s per-formance compared to the banks in its performance comparator group based on: net income growth, EPS growth, revenue growth, operating leverage. Executives will be required to forfeit outstanding incentive awards and repay compensation that has already been paid if there is a material misstatement of the bank’s financial results, inap-propriate risk taking, a breach of compliance rules or the bank’s guidelines for business conduct or inappropriate conduct resulting in significant losses, fines or penalties.




Barclays (Diversified Banks, UK)

In 2013 Barclays started to use the concept of materiality to determine which issues should be included in its Citizenship strategy and reporting. In its Citizenship Reporting Protocol of December 2013, the bank describes its dialogue with key stakeholders in assessing the materiality of its ESG issues and in identifying the related Key Performance Indicators to be monitored. In order to measure progress, Barclays has designated five stakeholder groups and set targets to be achieved by 2018. In 2014 the Balanced Scorecard was used throughout the organi-zation and now forms part of the framework by which all staff are assessed. Performance against the commit-ments in the Balanced Scorecard is considered for remuneration of top executives: in 2014, 35% of Annual Bonus and 30% of Long-term Incentive Plan (LTIP) are linked to the achievement of Balanced Scorecard performance measures.

– Disclose the process of identification of the most material ESG issues to be included in the executive packages (e.g. key stakeholder engagements, materiality mapping). Disclose the specific indicators used to assess ESG performances, explaining why they are considered relevant as proxies for the company’s long-term value creation.

– Adopt and disclose quantitative targets on selected ESG indicators, with a clear weights over total

compensation. While ESG performance indicators at company level can be easier to monitor and control, possibly also include ESG performance targets at individual/department level (balanced scorecard approach).

– Adopt a long-term incentive plan based on a multi-year performance period (3 years or more), balancing

key financial targets against a disclosed peer group and ESG-linked performance targets.

KEY TAKEAWAYS TO INTEGRATE ESG ISSUES IN EXECUTIVE REMUNERATION




Conclusions

The disclosure of companies on

executive remuneration has

increased significantly in recent

years, thanks to stricter regulatory

frameworks and higher scrutiny of

shareholders. However, the topic of

executive pay remains highly

controversial, due to a still

insufficient transparency on the

links between payouts and

performances as well as due to the

huge economic inequalities, within

and outside companies. Against

this background, in 2014 the

European Commission proposed

the revision of the Shareholders

Rights Directive which aims to

i m p r o v e t h e l o n g - t e r m

sustainability of EU companies, also

through the introduction of a

binding Say-on-Pay in Europe’s

largest companies, str icter

transparency requirements on the

link between pay and performance

and a higher level of engagement

by institutional investors and asset

managers during General Meetings.

The structure of the executive

remuneration in listed companies

plays indeed a crucial role in

aligning the interests of top

managers with a perspective of

long-term value creation. We do

believe that a responsible

remuneration - a remuneration

policy that integrates ESG issues as

part of the overall business

strategy - is a proxies for

measuring the company’s chances

of success and ability to manage

long-term risks. If ESG factors are

material for investors and

shareholders, then executives

should be incentivized to perform

in accordance with the company’s

CSR strategy and rewarded for the

creation of long-term value.

The study shows that, despite the

growing attention to sustainability

and extra-financial factors, still

very few companies appear to

consider ESG performances in the

allocation of bonuses. When ESG

performance conditions are do

i n t e g r a t e d i n e x e c u t i v e

remuneration, quantitative targets

on identified indicators are very

rarely disclosed (only in 17% of

cases), calling for a more

transparent and rigorous approach

to responsible remuneration.

The ESG issues most frequently considered by companies in the a l l o c a t i o n o f e x e c u t i v e remuneration refer to the relation with clients and the management of human resources, while other crucial CSR issues are very rarely considered. Sustainability drivers such as the respect of human rights, the prevention of corruption and the contribution to the social and economic development can have a very significant and material impact on the company and on its stakeholders, and they should not be overlooked when assessing the performance of executives and rewarding their behavior. The fight to climate change, one of the greatest challenge of our Society and of the global economy, is almost never rewarded as part of the remuneration plans in energy companies for instance, despite a growing evidence on the huge f inanc ia l costs potent ia l l y associated with a short-termism on this topic and with the risk of stranded assets. In a responsible remuneration perspective, bonuses in high-impact sectors should incentivize the reduction of greenhouse gas emissions and the investments in support to the energy transition.

The study also showed that p r a c t i c e s o f E S G - l i n k e d remuneration are on average associated with higher CSR




performances, regardless of the geographic area and sector in which the company operates. This important evidence suggests that CSR-linked remuneration may be used by companies to build a clear message to stakeholders and to protect their image, but most importantly to demonstrate to stakeholders a higher level of commitment on CSR and to set the right tone and the right example from the top for the whole organization.

I n c o n c l u s i o n , e x e c u t i v e remuneration and CSR are already important elements for a modern and efficient corporate governance. But for the years to come the attention on these issues by investors, asset managers and proxy advisors is expected to further increase steadily. We think the time has come for large companies to bring together these two top ics , by des ign ing remuneration practices that are coherent with the company’s CSR and ESG strategy to publicly demonstrate their level of

commitment to sustainability issues and to improve their sustainability performances.




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This study was written:

UNDER THE SUPERVISION OF:

FOUAD BENSEDDIK Director of Methodology and Institutional Relationships [email protected]

T +33 (0)1 55 82 32 73

VIGEO RATING: THE LEADING EUROPEAN EXPERT IN RESPONSIBLE PERFORMANCE Founded in 2002 and led by Nicole Notat, Vigeo is the leading European expert in evalua ng corporate social responsibility through six domains: environment, human rights, human resources, community involvement, business behaviour, and corporate governance. Vigeo offers two types of services through two business brands: • Vigeo ra ng – the way to responsible investment – offers a broad range of products and services to investors and asset managers who seek a sustainable and responsible performance of their investments on more than 3 000 issuers: companies, regions and states; • Vigeo enterprise – the way to responsible management – works directly with organiza ons of all sizes from both public and private sectors, conducts global CSR audits and benchmarks, supports teams and integrates CSR/SRI criteria into business func ons and strategic opera ons. Vigeo Ra ng's research meets high quality standards and has been externally cer fied to the Arista standard since 2009, a quality standard for SRI research.

GIUSEPPE BRESIN Sustainability Analyst [email protected]

STEFANO RAMELLI SRI Research Manager—Financial Sector

[email protected]

ROBERTO SAVIA Senior Sustainability Analyst

[email protected]




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