Executives: bonuses for good grades in CSR

Mix­ing the envir­on­ment and busi­ness is still prov­ing dif­fi­cult, but to tackle the issue, a new scheme is spread­ing with­in mul­tina­tion­als. A large pro­por­tion of exec­ut­ives now have their vari­able bonuses linked to their com­pany’s social respons­ib­il­ity (CSR) indic­at­ors. In oth­er words: if the CSR indic­at­ors are good dur­ing the year, their end-of-year bonuses will be good too. 

In the­ory, the applic­a­tion of these “CSR con­tracts” is a way of integ­rat­ing envir­on­ment­al con­cerns into busi­ness mod­els by pla­cing them on the same level as fin­an­cial tar­gets, and thus encour­aging respons­ible decision-mak­ing by exec­ut­ives. How­ever, even if this meth­od is presen­ted as an effect­ive way of achiev­ing extra-fin­an­cial object­ives, until recently there was a lack of con­crete ana­lys­is on the subject. 

Patri­cia Crifo, a pro­fess­or of eco­nom­ics at École Poly­tech­nique (IP Par­is), recently looked into this ques­tion by study­ing a pan­el of the world’s largest com­pan­ies, recently pub­lish­ing her research in an art­icle on the sub­ject: “Cor­por­ate Social Respons­ib­il­ity and Gov­ernance: The Role of Exec­ut­ive Com­pens­a­tion”¹. In this sur­vey, she and her col­leagues ques­tion the effect­ive­ness of CSR con­tracts. They note that this type of con­tract, which cer­tainly makes it pos­sible to improve extra-fin­an­cial per­form­ance, can also some­times res­ult in an increase in costs and a drop in the per­form­ance of the com­pan­ies that put them in place.

In your study, you show an increase in the applic­a­tion of CSR con­tracts by com­pan­ies. What do we know about their frequency? 

Patri­cia Crifo. For sev­er­al years, the num­ber of agree­ments described as “CSR con­tracts” has clearly been on the rise. In prin­ciple, the aim of CSR con­tracts is to encour­age man­agers to take bet­ter account of the com­pany’s long-term per­form­ance. This is a trend that can be observed through­out the world.

Out of a pan­el of nearly 4,000 com­pan­ies in 40 coun­tries, 20% have imple­men­ted this type of con­tract between 2010 and 2016. These coun­tries are mainly in Europe (30%), North Amer­ica (27%) and Asia-Pacific (37%). In terms of activ­ity, they are mainly posi­tioned in the man­u­fac­tur­ing and fin­an­cial sec­tors (26%). 

Look­ing at this base of 4,000 com­pan­ies, we can see that the trend has been clearly upwards over the last 10 years. The fig­ures show that we have gone from about ten com­pan­ies in 2010 to more than 750 in 2018 that are adopt­ing these exec­ut­ive com­pens­a­tion pro­grammes. In France, if we focus on the CAC40, we would have gone from 10% in 2006 to more than 70% at the end of 2015.

How do these CSR con­tracts come into prac­tise with­in companies? 

There are many examples. In May 2020, the Suez Group announced a com­mit­ment to assess the envir­on­ment­al impact of its activ­it­ies, and to integ­rate biod­iversity into the company’s decision-mak­ing pro­cesses, includ­ing exec­ut­ive pay­outs. Deutsche Bank announced in Decem­ber 2020 that it had set annu­al growth tar­gets for its envir­on­ment­al, social and good gov­ernance (ESG) activ­it­ies, and plans to link this to exec­ut­ive pay from 2021. Apple announced in Janu­ary 2021 that they will alter exec­ut­ive bonuses depend­ing on their actions towards the company’s social and envir­on­ment­al val­ues (the policy change will affect up to 10% of the vari­able part of compensation). 

Your work shows that the impact of these CSR con­tracts depends on the company’s gov­ernance mod­el. What have you noticed? 

Our ana­lyses show that these con­tracts do not always work as inten­ded. In com­pan­ies whose gov­ernance is mainly share­hold­er-ori­ented, they have very little incent­ive. This is because they only bring a rel­at­ive gain in terms of CSR per­form­ance and even tend to have a neg­at­ive impact on fin­an­cial per­form­ance. On the oth­er hand, for com­pan­ies whose gov­ernance is ori­ented towards a lar­ger num­ber of stake­hold­ers, CSR con­tracts are effect­ive in improv­ing the com­pany’s extra-fin­an­cial performance.

CSR con­tracts are there­fore not always effect­ive in achiev­ing the com­pany’s object­ives. How do you explain this phenomenon? 

Indeed, for com­pan­ies with a gov­ernance mod­el focused on the cre­ation of share­hold­er value, these mech­an­isms are not suf­fi­cient to improve per­form­ance, wheth­er fin­an­cial or extra-fin­an­cial. They do not work towards res­ol­u­tions where there may be con­flict­ing object­ives and where the interests of all (man­agers and share­hold­ers, in par­tic­u­lar) need to be aligned in the cre­ation of value for the company.

A large body of lit­er­at­ure now recog­nises that big fin­an­cial incent­ives can dis­tort mana­geri­al effort or encour­age excess­ive short-ter­mism. Stock options and bonuses both increase with volat­il­ity and encour­age risk-tak­ing, without neces­sar­ily align­ing with the long-term interests of shareholders. 

Poli­cy­makers have recently reacted. Some coun­tries, such as France and the United States, have passed laws requir­ing com­pan­ies to hold “say on pay” votes at share­hold­er meet­ings, to dis­close CEO-to-employ­ee pay ratios, or to lim­it bonuses. 

The intro­duc­tion of incent­ives to think long-term or on CSR per­form­ance via CSR con­tracts is anoth­er way to coun­ter­act short-ter­mism. For example, the 2019 Pact law in France encour­ages com­pan­ies to com­mu­nic­ate about this. How­ever, this must be accom­pan­ied by a gov­ernance mod­el that focuses on cre­at­ing value for all stake­hold­ers, not just share­hold­ers. In oth­er words, the com­pany’s gov­ernance must be con­sist­ent with the incent­ives offered to managers.