Put Your Mouth Where Your Shareholder’s Money Is

Less than half of CEOs rewarded for extra-financial performance
Put Your Mouth Where Your Shareholder’s Money Is Put Your Mouth Where Your Shareholder’s Money Is
Publ. date 27 Jan 2016
As a growing share of a company’s value is locked into intangible assets, investors are making more and more use of extra-financial indicators to determine a company’s health and investment potential. However, only few CEOs are being evaluated on this type of metrics when it comes to their annual performance reviews.

Only 48% of CEOs in Western Europe evaluated on non-financial targets

A research team at Vlerick Business School led by professor dr. Xavier Baeten has analyzed the remuneration reports from 669 listed companies in the United Kingdom, Germany, France, Belgium and the Netherlands (FTSE 100) and found interesting insights with regard to CEO salaries. Despite the shift towards integrating extra-financials in company valuations, bonus criteria for these Western-European executives remain largely tied to the “usual suspects” such as EBITDA, profitability and share price.

Less than half of the CEOs in the study (48%) were evaluated on non-financial targets in 2014. About one fifth of the companies used people-related KPIs  such as employee engagement, satisfaction,  and safety, while 19% applied efficiency-related measures. Regarding customer centricity as part of strategy the results are also revealing: only 10% apply customer-related KPIs such as customer satisfaction and net promoter score or environment-related KPIs such as CO2 emissions.

Furthermore, the study found that the highest paid executives can be found in the UK, which is also where the variable part of CEO remuneration has the largest share (74%) of the total sum.  The country of residence’s corporate governance model was found to play an important role in the composition of the CEO’s remuneration package, as the more “uncertainty avoiding” countries Belgium and France display a much lower proportion in variable remuneration (36% and 34%, respectively).

Non-financials as more reliable prediction factor for shareholder value

Large investors and rating agencies such as RobecoSAM often perceive long-term remuneration as a valuable instrument for aligning company interests with those of the executives in charge. Professor Baeten challenges this model, noting that the postponement of reward for a period of one year already diminishes its psychological value by 30%.

Moreover, Professor Baeten underlines that sustainable value creation can be integrated in short-term remuneration periods, and that these kinds of KPIs form a much better prediction model in comparison to for instance profitability, which only relies on past performance. As an example: DSM applies a mixed model of 50% financial objectives and 50% sustainability objectives for the CEO’s bonus. The latter is measured by the percentage of successful product launches that meet ECO+ criteria, the company’s employee engagement index and its safety performance.

Integrating extra-financials to align shareholder and CEO interests

In conclusion, extra-financial indicators are warranted a solid position in both short- and long-term remuneration model for CEOs. Not only will this act as a driver to increase societal value, but it also facilitates investors in using these data as predictive factors for corporate performance and will further strengthen the link between CEO compensation and future value. It is clear that companies need to be more innovative on measuring the right metrics. Too bad that just 7% of the CEOs in the study were assessed on KPIs related to innovation.

Ready to change your approach?

Finch & Beak has broad experience in designing KPI models that integrate extra-financials as performance indicators for executive remuneration. If you are looking for practical guidance on aligning incentives with future shareholder value, call Jan van der Kaaij today at +31 6 28 02 18 80 or email him: jan@finchandbeak.com.

Image source: Maurizio Pesce, Flickr.

About Nikkie Vinke

Multidisciplinary advisor in ESG benchmarking, sustainability strategy development and execution. | nikkie@finchandbeak.com

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