Excessive remuneration of CEOs has received a great deal of criticism in recent years. However, public attention has been unable to turn the tide and as a result, rising executive pay is contributing to growing income and wealth inequality within countries. Lether: “This is concerning from an ethical point of view, but also because this growing inequality goes hand in hand with poverty and social tension. In our new paper we describe the origins of excessive CEO remuneration and our approach on this issue.” 

In one of its studies, the Economic Policy Institute notes that between 1978 and 2020 the remuneration of CEOs in the US has seen an average increase of no less than 1,300 percent, while for the average employee wage increases remained limited to 18 percent. On average, company leaders now earn 320 times as much, while in 1978 this was ‘only’ 27 times. Lether: “Ultimately, it is up to the shareholders of listed companies to address this. But as long as a company continues to produce good results, this subject gets very little attention.”

As Lether says, income inequality is an issue that Triodos Investment Management (Triodos IM) has been focusing on for several years already. The asset manager often votes against high remuneration packages. “Within a company you do things together; its result is the product of a group effort. That is also the philosophy within our company. From an economic perspective you could also wonder if the contribution of the CEO warrants extremely high remuneration. Could that money not be put to better use?”

A clear limit for the CEO

Extreme income differences have no place in the sustainable and fair society that Triodos IM is aiming for, says Lether. “The remuneration of the CEO is therefore one of the criteria we consider during our stock selection process. For smaller listed companies we apply a limit of EUR 2.5 million, while for the world's largest companies the size-adjusted limit may be as high as EUR 20 million per year. This approach adjusts for company size and is based on the average figures over the last five years.”

Lether admits that a limit can be a tricky thing. Because whether remuneration is excessive varies per company. “That is exactly the reason why shareholders do not set limits. But if they don’t do it, no one will. Exactly for that reason, we have set limits. Also because we hope that other parties will follow our example."

The limit is not just a wild guess. “Based on our in-house research, and based on what we find ethical, we know that a salary of between EUR 1 million and EUR 2.5 million - also as a five-year average and adjusted for company size - might be acceptable, says Lether. Triodos analysts have also assessed the portfolio and the benchmark. “Around 13 percent of the companies represented in the MSCI World Index exceed our remuneration limit. For our funds, this percentage is much lower, currently being around 7 percent of the holdings"*

Impact on investment policy

The remuneration limit in its new form was first used during the selection process early last year, says Fabian Meijs, investment analyst at Triodos IM. “The remuneration limit is included in our Minimum Standards. These are criteria that a company must meet to be eligible for investment.

The first step is that we apply the limit, adjusting for company size: specifically, we consider the market value, revenues, and number of employees of the company. The CEOs of large companies may then earn up to 8 times EUR 2.5 million, while for the CEOs of smaller companies the limit is much lower.

The next step is the assessment of the ‘pay ratio’: how much more does the CEO earn than the average employee? For this issue, Triodos analysts use a limit of 100 to 1. If a company fails to pass these hurdles, we thoroughly review its remuneration structure. Based on this analysis, we ultimately decide whether a company is eligible for inclusion in our portfolios”, says Meijs.

“This is why we rejected a company that we were looking to add to our portfolio in 2021 because of its positive impact. And there was one company that we removed from our portfolio because the CEO’s remuneration far exceeded our standards.”

Engagement on the remuneration structure

We engaged with seven companies represented in our sustainable investment portfolios.**

Meijs: “In such conversations, we discuss the whole remuneration structure, not just the level of remuneration. We were pleasantly surprised that companies are willing to engage on this subject.

Excessive remuneration is bad for society, but also for a company. Meijs: “It can demotivate staff, for instance, knowing that their boss earns so much more than them. But another issue is that bonuses may tempt a CEO to pursue short-sighted actions. Especially stock options forming part of remuneration packages may tempt CEOs to take much bigger risks, due to the potentially almost unlimited gains that can be made.

Triodos IM also advocates including ESG in criteria in remuneration packages. Meijs: “This has led one company we engaged with to include ESG criteria in its remuneration package for the first time. With all companies engagement is still ongoing.” 

Meijs notes that things are slowly improving in this area. “Companies still find it a difficult subject and indicate that in terms of remuneration they need to remain aligned with their peers. But increasingly often, other investors follow our example when voting at Annual General Meetings (AGMs), especially when it concerns golden handshakes - although still not as often as we would like. Things are moving inch by inch, but at least we are heading into the right direction.”