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.