Remuneration & diversity – incentivising change

The new diversity frontier

The link between environmental performance and executive pay is front-of-mind amongst Remuneration Committees. However, an entity’s social performance is now garnering increased attention and diversity measures are at the top of the list.

Amidst growing stakeholder pressure and focus on the “S” in ESG (namely understanding and managing risks to people, including employees, customers, suppliers and impacted communities), boards are increasingly turning their attention to whether executives should be assessed against, and rewarded for, achieving sustainable outcomes in the interests of different stakeholder groups.

A number of ASX companies have adopted social measures tied to their unique value drivers (such as strategic community investment, financing of new businesses, maintaining responsible business practices and collaboration on other community initiatives (e.g. animal welfare).

Importantly, workforce diversity and inclusion are firmly in the spotlight. Over the last decade, gender diversity has been the focal point. Measures relating to the representation of women have frequently featured in executive bonus programs in Australia and strides have been made in this space in corporate Australia[1]. This work is far from done. There remains continued underrepresentation of women in key-decision making roles across the ASX200,[2] and recent corporate and government reports highlighting workplace sexual assault and sexual harassment demonstrate the gulf that remains to be bridged.

However, gender diversity is not sufficient to create productive, safe, and inclusive workforces that represent the communities in which they operate. Holding executives to account and rewarding them for progressively achieving this is simply good business. While calls for visibility for underrepresented people, often with a range or intersecting attributes (such as ethnicity, age, LGBTQ+, disability, neurodiversity and more) are not new, recent social movements like Black Lives Matter, and the legalisation of same-sex marriage in Australia have made it impossible for boards to ignore.

In this context, the following question arises: should ASX companies be tying executive remuneration to broader diversity measures beyond gender to hold executives to account for their progress in this space?

This article explores current trends in linking executive pay to diversity and inclusion efforts in Australia (as compared to overseas markets) and key considerations for Remuneration Committees who are ready to bolster their efforts in this space.

An Australian perspective

While diversity metrics have featured in executive incentive plans in Australia over the last five years, these measures are generally limited to the representation of women. Typically, they are given a smaller weighting under short-term incentive (STI) plans, often wrapped up into more general social assessments against community, culture and corporate reputation.

However, there are some examples of ASX100 Australian companies with broader diversity metrics in executive pay arrangements focused on other underrepresented groups beyond women. For example, Suncorp’s FY21 STI metrics are related to increasing the proportion of employees aged over 55 years to promote mature age hires and increasing the focus on First Nations hires, in addition to increasing female representation across senior leaders. Other examples include South32[3], QBE[4], IGO[5] and Origin Energy[6].

The overseas state of play

In contrast to Australia, the UK and US are far more progressed when it comes to quantifiably tying executive pay to broader diversity measures, with several companies maintaining clearly quantifiable uplift targets or “modifiers” (including under long-term incentive (LTI) plans which represent a larger portion of executive pay packets).

In the UK, in addition to the push for the introduction of mandatory ethnicity pay gap reporting, several FTSE100 companies such as Lloyds[7] and Natwest[8] have diversity measures beyond gender under their STI and LTI programs.

In the US, driven in part by the Black Lives Matter movement and in response to community and investor demands to show stakeholders that they can “put their money where their mouth is”, several large US companies have also adopted broader diversity metrics beyond gender including Starbucks[9], Nike[10] and Uber[11].

Key questions for Remuneration Committees

It is widely acknowledged that diversity supports long-term value creation by helping to prevent “group-think” (encouraging employee creativity and productivity), better representing customers, communities and markets, enhancing corporate governance and aiding talent attraction and retention (by supporting employee well-being and a sense of community).

Including diversity metrics in executive incentive programs communicates to employees, investors and the public that fostering an inclusive workforce and nurturing diverse talent is a key priority.

Guiding questions for Remuneration Committees who are considering either adopting diversity related measures (or extending their existing measures to cover other minority groups) include:

Can the company set clearly quantifiable and stretch diversity measures and targets?

This will support palatability with external stakeholders (such as proxies) who have previously criticised companies for including “vague” diversity measures within their STI plans (which were seen to reward executives for their “day job”). We note that CGI Glass Lewis have recognised the difficulty in measuring diversity and “tend to view discretionary assessments in these areas with less scepticism than they would for financial or operational performance”. Institutional Shareholder Services will assess these metrics on a “case-by-case” basis and will consider whether they are likely to “enhance or protect shareholder value”.

Can the diversity measures be clearly linked to long-term value creation?

Remuneration Committees should ensure that any measures are underpinned by a well-developed diversity and inclusion strategy to avoid any perception that the measures are inauthentic and lack ‘tangibility’. Social ‘bluewashing’ is also a real concern.

What portion of reward should be tied to diversity?

In Australia, diversity measures have typically only been observed and supported in STI plans with a small weighting. In our view, there is a long way to go before we follow in the footsteps of the UK and the US and incorporate these measures into LTI plans. While this will be a space to watch, consideration could be given to approaches adopted by companies such as CSL which incorporates diversity objectives within its “Leading and Managing” modifier (which can increase or decrease both STI and LTI outcomes), or a performance underpin on the LTI or restricted equity grants which may include multiple ESG factors including diversity (e.g. Origin Energy).

Diversity in leadership and across the workforce are critical to the future success of companies. As we enter a new frontier where investors’ expectations are changing from profit maximisation to sustainable value creation, executive remuneration is one lever to incentivise change for the better.

 

Contributors: Tim Nice, Partner, Performance & Reward & Dr Meg Brodie, Partner, KPMG Banarra, Human Rights & Social Impact

[1] For example, achievements such as no all-male boards and 30% representation of women directors in the ASX200
have been achieved in the last 3 years. There has been continued improvement in this area but as revealed by responses to the Australian Institute of Company Directors’ December 2021 Director Sentiment Index, a greater balance of gender is desired.
[2]  The 2021 Chief Executive Women Senior Executive Census suggests that greater efforts are required to strengthen the female talent pipeline to management roles and in particular, to executive ‘line’ roles that typically lead to CEO positions.
[3] South32’s FY21 STI metrics related to targets for Black People in management roles in South Africa to reflect the geographic location of some of their operations, in addition to the representation of women on the Board, amongst executives and at the broader employee level.
[4] QBE has an FY21 STI metric related to being a top LGBTIQ+ employer based on the Workplace Equality Index.
[5] IGO’s FY21 STI metrics relate to the percentage of Aboriginal employees (threshold and target of 10% and 14% respectively) in the workforce as well as female employees (threshold and target of 24% and 27% respectively).
[6] Origin Energy has a performance underpin on its FY21 restricted equity grants which considers, amongst other factors, “People” including Indigenous representation and progress against a Stretch Reconciliation Action Plan, as well as female representation in executive and senior leadership positions.
[7] Lloyds tied 3.75% of its 2021 annual bonus to increasing the senior Black, Asian and minority ethnic representation by 1.7% over the financial year at full vesting, in addition to female representation within their senior population.
[8] Natwest included diversity and inclusion as a measure in the pre-grant assessment on its 2021 LTI. The targets included increasing the percentage of Black, Asian and minority ethnic UK employees in the top four layers from 10% to 11% in aggregate and increasing the percentage of females in the top 3 layers from 39% to 40% over the prior financial year.
[9] In 2021, Starbucks introduced a representation modifier into its long-term performance RSUs which could increase or decrease the final payout. In 2021, the representation target focused on improvement in Black, Indigenous and LatinX representation at the manager level and above, with a 3-year target of improving Black, Indigenous and LatinX representation by more than 5% by 2023.
[10] Under its 2021 LTI, Nike had a “People & Planet” modifier which allows final vesting outcomes in respect of relative TSR to be increased based on factors including diversity and inclusion. In 2021, this included diversity targets such as 50% representation of women in the global corporate workforce, 35% representation of racial and ethnic minorities in the US corporate workforce and all women in supply chain roles having increased access to career opportunities.
[11] Uber has maintained a Diversity and Inclusion measure (assessed over 3 years) for a number of years under its long-term performance-based RSUs, which considers the representation of women and under-represented minority employees at certain employee levels. This measure accounted for 10% of the grant in 2021.
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