5 Steps for Tying Executive Compensation to Sustainability

The final link in the chain of improving corporate accountability for sustainability is to tie improvements to compensation. How should these incentives be designed? What implementation steps should you take? How can you overcome the challenges that deter executives and directors from changing how company incentives have traditionally been designed?

The challenges are easy to identify. The number of possible sustainability improvement goals grows by the day, which makes it increasingly hard to know which to pursue: sourcing resources more wisely, managing waste and CO2 emissions responsibly, acting as a good citizen, celebrating diversity among workers, and so on.

Plus, the years-long efforts to realize payoffs from most environmental, social and governance initiatives rarely fit typical annual or three-year incentive time frames.

Perhaps most significantly, directors and management teams remain reluctant to base incentives on sustainability results that will show up in the financials. Why, they ask, should we squeeze nonfinancial sustainability measures onto the limited real estate of executive incentive plans if they’re going to boost returns or profits that are already measured in those plans?

Here’s how to design sustainability incentives that address these challenges:

REEXAMINE THE CONTEXT. Analyze the business case for your initiative. In addition to any direct financial results, will the initiative contribute to intangible, off-balance-sheet assets like brand and reputation enhancement? Will it signal to your workers and investors that you are committed to sustainability? Sustainability incentives are the most powerful when they tap into strategic opportunities that promise a good return.

Many companies’ license to operate depends on operating sustainably no matter the immediate effect on revenues — whether for extractive industries whose methods risk harming the environment or tech companies whose presence contributes to increasing the cost of living in local communities. These kinds of contexts, regardless of strategy, demand that sustainability results figure strongly into companies’ future success.

CLARIFY THE ORGANIZATIONAL SCOPE. Examine how broadly sustainability incentives should be applied — companywide or by business unit, team or individual. Are you making a major shift toward more responsible products across the entire company — in a total transformation of your business? Or are you merely addressing a niche market by focusing on sustainable sourcing in a single product line? Do you want to refashion incentives for executives in that niche business or for all of your managers?

QUANTIFY THE DURATION. Should the initiative be addressed with annual incentives, long-term incentives (typically a three-year time frame) or very-long-term incentives (perhaps five or seven years)? If benefits will not be realized for even longer periods, consider requiring higher stock-ownership levels with a decade-long holding restriction. Are these changes incremental or transformational?

CONSIDER THE MEANS AND THE ENDS. Is how your company gets to its results as important as achieving those results? If unintended consequences are to be avoided, you may need to link awards to the milestones or behaviors you expect of executives, in addition to the final results.

STRUCTURE THE INCENTIVES. Once you’ve clarified the context, scope, time horizon and means versus ends, you will have isolated the specific sustainability goals that are relevant for your incentive plans. The final task is to determine what your incentives will be, in particular whether you need to move beyond traditional targets and time frames.

Copyright 2019 Harvard Business School Publishing Corp. Distributed by The New York Times Syndicate.