Most CEOs have no financial incentives around sustainability, research shows

HR has a vital role to play in influencing effective executive remuneration, particularly on issues of corporate responsibility, say experts

Only six per cent of UK CEOs have a financial incentive encouraging them to focus on environmental or sustainability initiatives, according to research. 

They are much more likely to have long- and short-term incentives focused around income, revenue and profit, employees, customers, safety, innovation and shareholder return, research from Belgium’s Vlerick Business School found.

While most UK firms have at least one non-financial KPI forming part of the criteria their CEO’s bonus is awarded on, the research found that only one in five had long-term incentives that aren’t related to profit or return on investment, and less than one per cent have long-term incentives based on the environment. 

Researchers analysed CEO pay levels, habits and incentives in 899 European companies and found that long-term incentives are a bigger part of remuneration packages in the UK compared to other European countries. This means UK CEOs are more incentivised to grow share prices compared to other nations, according to the study. 

Overall, the research showed that most UK CEOs have no incentive to enact green initiatives and policies, according to Xavier Baeten, professor in reward and sustainability at Vlerick Business School and director of the school’s Executive Remuneration Research Centre. 

“A number of firms think environmental initiatives will lead to cost increases and therefore, I think they’re waiting [to see] what others do – everybody is looking at each other – and they are also waiting for government initiatives,” Baeten said. 

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However, he questioned the efficacy of governments imposing KPIs focused on the environment.  

“It would be much more effective if firms thought about exactly how the climate crisis will affect them and then look to first develop a sustainability strategy. Then, after identifying these, firms can select the relevant KPIs to include in CEOs’ remuneration”.

Edward Houghton, head of research at the CIPD, agreed that such activity should be business-led. But the government also has an important role to play, he said.

“There is space for progressive policy to promote the type of measures we want… We need to see organisations looking at values around sustainability, and incorporating these values into how [they] measure leadership performance,” he said.

Houghton added that HR had a key role to play in influencing effective executive remuneration, particularly on issues of corporate responsibility, saying the HR function is a “good home for corporate responsibility and sustainability functions, and is an important part of modern business practices.”

There are encouraging signs of investors becoming increasingly interested in measures around management and leadership performance, diversity and inclusion and fair pay practices, said Houghton, however the Vlerick Business School study demonstrated there was a long way to go before specific environmental measures were factored into reward, he said. “We know it’s difficult to shift incentivising performance to tools for the long term… despite there being more holistic data and indicators we can capture,” he said.

Alex Edmans, professor of finance at London Business School, said the best way to incentivise CEOs to take their environmental responsibility seriously is to pay them according to the firm’s long-term stock price – for example, by giving them equity that they can’t sell for several years.

“Evidence shows that the long-term stock price is affected by not only profits, but also how a company treats its employees and customers, and its stewardship of the environment,” he said.

However, environmental KPIs might encourage CEOs to fixate on this area to the detriment of stakeholders, Edmans warned. “For example, a company can hit its greenhouse gas target by not opening new sites, even though doing so would create new jobs for workers,” he said. 

“Also, a KPI may lead to excessive focus on only that KPI being measured. For example, a CEO might be able to hit a greenhouse gas target, but do so by using more water. It’s very well-known that KPIs lead to excessive focus on the KPI – for example, if you pay teachers according to their students’ test scores, they ‘teach to the test’ rather than instilling a love of learning and a respect for authority.”