Is CEO compensation out of control?

Case Study

There’s been increased discussion and debate about excessive remuneration for executives of global publicly traded companies. Public outrage at the inequality is active and loud. More and more shareholders are also beginning to take a stand against it, and some governments are attempting to limit it. It’s prompted us to ask: “At what point is a pay package too much?”.

What’s the concern?

Large pay packages are not an uncommon reward for strong and profitable leadership and not a problem per se. Over the years, however, the pay packages of chief executives have risen excessively, especially in Anglo-Saxon countries. Back in 2014, French economist Thomas Piketty wrote about it in Capital in the Twenty-First Century, a landmark study on global inequality. Piketty identified that extraordinarily high salaries – sometimes 300 times that of the average co-worker – are not aligned to the managers’ actual contribution to a company’s performance and are considered highly inequitable and unfair because every co-worker contributes to the success of a company.

The current discussion isn’t just about the significant cash base salary offered as incentive to attract and retain the best managerial talent – European CEOs often receive more than one million in cash per year – but also the other components in their salary packages. Following the global financial crisis in 2009, many felt that executives had been neglecting long-term value creation because there was no incentive to manage beyond their short-term financial targets. As a way of combating this short-term thinking, variable components of salary packages were increased.Remuneration began to include cash bonuses (often not linked to performance though), as well as benefits, stock awards and stock options. By providing a sense of ownership through these incentives, the intention was there would be more concern for long-term operability and profitability.

Say on pay

Many years already, Triodos publicly expresses its concern and voted against excessive compensation packages at annual general meetings. Nowadays there’s a growing number of shareholders also voting to reject CEO compensation packages. The tide is turning in regulation too. While the results of shareholder voting are not currently binding in most countries (apart from Switzerland), regulatory frameworks around the world are set to change. Last April, the European Parliament adopted a revision of the Shareholders’ Rights Directive, and the EU Member States have 24 months to transform it into law. The directive aims to create improved transparency on remuneration policy and actual amounts awarded to directors, and to create a stronger link between pay and performance. In a bid to tackle income inequalities, in 2012 France capped the salary of CEOs of majority state-owned companies at EUR 450,000. Companies publicly traded in the US are now required to disclose how the pay ratio of the CEO compares to the median of all employees in their regulatory filings, and the Dodd-Frank Law also requires companies to allow shareholders to approve or reject executive-pay policies. The UK is considering following suit.

What we think

Executive compensation should work in favour of a company’s long-term operability and profitability, and for the benefit of all stakeholders. It should incentivise managers to think long-term and to integrate sustainability considerations into daily operations.

When analysing companies for potential investment by our Socially Responsible Investment funds, Triodos has always favourably viewed companies’ whose CEO compensation was linked to financial and sustainability performance; for example with targets like reduced carbon emissions and improved worker safety statistics.

In 2016, we conducted a deep dive into remuneration practices of global companies in our investment portfolios, which resulted in a new approach to assessing executive compensation. We now consider our previous, controversy-based assessment too limiting, and will start to take four specific factors into account that together may indicate controversial remuneration:

  1. proportion of fixed to total remuneration
  2. existence of a claw-back provision (a special clause by which money already paid must be paid back under certain conditions)
  3. ratio between CEO remuneration and average employee remuneration
  4. ratio between CEO remuneration and the company’s performance (expressed in earnings before interest, tax, depreciation and amortization (EBITDA)) and/or stock price.
CEO remuneration
Tesla - benefit of the doubt

Preliminary results

In 2017, we excluded US computer tech company Oracle for its controversial remuneration practices. The company has a long history of excessive CEO remuneration, and there is no indication of substantial improvement in the future. Our results showed Oracle’s average total compensation during 2013 to 2016 amounted to USD 85 million, and there was persistent shareholder opposition of 54%, when more than 50% is rare. We also identified highly controversial practices against our four factors.

Another controversial company in this regard is electric carmaker Tesla. But unlike Oracle, we kept Tesla in our sustainable investment universe. We have given the company the benefit of the doubt, because currently only the fixed-variable remuneration ratio is clearly highly controversial. As of this year, Tesla is obliged to disclose another ratio, i.e. the one between CEO remuneration and average employee remuneration, enabling us to draw a firmer conclusion. Furthermore, we believe that the company’s choice for performance-based payment (and thus a low fixed-variable ratio) strongly reflects its early development stage and associated ambitions. Although we do not favour a prominent role for bonuses in executive remuneration, this development stage must be taken into account. In the meantime, in our contacts with the company and in our proxy voting activities, we will maintain our critical stand on the excessive aspects of Tesla’s remuneration practices.

To be continued

In the coming years, we will have a closer look at remuneration practices when assessing the sustainability performance of companies. Although we see some improvements, there is still a long way to go. Therefore, we will also continue to exercise our rights at shareholder meetings, and to engage with companies on the issue.

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