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.