A central feature of any pay policy is an agreement on the ‘yardstick’: the instrument to measure firm’s value creation by combining financial and non-financial performance.
Many CEOs are rewarded for mainly short-term financial targets. Yet share- and stakeholders rarely want short-term financial success if it comes at the cost of long term value. For this to change, performance yardsticks must also change.
We are developing a database of firm-level social and environmental monetised impacts. This database will allow us to assess the ‘net societal value added’ of firms by netting financial impact with the financial value of social and environmental impacts (both positive and negative). This results in a more truthful measure of firm sustainable value creation for all stakeholders to which compensation may be tied. Once finished, this approach of monetising firm impacts has several useful features. The direct measurement of net societal value creation spurs CEOs to act with societal interests in mind. Similarly, direct measurement implies that decompositions of financial and various aspects of non-financial value should be possible. This offers CEOs and stakeholders the tools to assess where firm behavior should be directed. Relatedly, given that all impacts are expressed in the same units of account, trade-offs between various stakeholder interests become transparent and comparable. Taken together, the role of this impact yardstick then becomes severalfold: it incentivizes the right behavior but can also be analysed to guide strategic decisions and supports fairness in firm behavior by rationalising the trade-offs between various stakeholder interests.

Firms increasingly recognize that share- and stakeholders expect that firm behavior keeps societal interests in mind. As a result, firms attempt to act purposeful and to engage with stake- and shareholders on material societal interests. This engagement may be bilateral, in the public debate, at the AGMs and through disclosures. Parallel to such efforts by firms, there is a widespread concern that talk is cheap. Actual decisions may deviate from stated objectives, and many of the disclosures and other touchpoints for engagement may be heavily skewed to paint the firm in a more favorable (often: greener) light.
We are developing an AI-powered tool to assess the extent to which firm attitudes, attention and actions align. This assessment of alignment or conviction should help us to better understand whether companies focus on the right issues and whether they are able to translate their focus on the right topics into concrete actions to drive long-term societal value creation.
With respect to pay, such tracking of intentions, actions and progress is important as well. Companies should align purpose, performance and pay. Measuring the extent to which purpose is embedded in firm priorities and outlooks can facilitate monitoring and a quantification of the relation between purpose and pay. Likewise, measuring firm attitudes, attention and actions and the outside perception of those attitudes, attention and actions may serve as a proxy and/or a leading indicator for performance. ‘Impact’ may be a slow-moving variable. Pivoting to a green business model takes time, and the effects of that will only become apparent after an implementation lag. Until the pivot is finalized, there still is a need to track progress. The conviction barometers may be one tool to track firm attitudes, attention and actions.

Whilst many stakeholders as well as shareholders agree that firms should focus on long-term outcomes, few offer a view on what this ‘long term’ is and why they feel that their view of the ‘long term’ is appropriate. Is 5 years the long term or 10? If it is 10, why?
In terms of compensation policy, the appropriate long-term may be the term at which different measures of firm outcomes converge. Shareholders may be willing to forego short term cash profits in return for future gains that result from current period investments. This expectation of future profits is discounted into asset valuations, but at some point, such expectations should materialise for the foregone short-term cash profits to be worthwhile to the investor. Likewise, material non-financial issues affect future firm performance (human capital, climate risks, etc.), but it takes time for such issues to affect the firm’s bottom line.
For compensation policy, the optimal long-term may be at the nexus between current and future costs and benefits for shareholders and stakeholders. A measure of CEO performance is ‘fair’ if it has had sufficient time to ‘absorb’ all relevant financial and non-financial costs and benefits. In this research project, we aim to estimate this term: how long does it take for accounting and share-based performance to align and how long does it take for non-financials to be appropriately accounted for in profits and valuations.

Whilst many stakeholders, boards and shareholders will agree that compensation policy can be improved, there is less agreement on what this change should constitute. This may be partially attributed to the fact that evidence on the efficacy of new models for rewarding CEOs is scarce. The resulting paradox is that willingness to change is low, and no new observational data becomes available.
We’re finding a way out of this problem by running online, laboratory and within-firm experiments. This allows us to test potential new compensation models so that we can arrive at evidence-based compensation policy that drives the right behavior by CEOs. We take a broad approach to this experimental redesign of remuneration and consider factors beyond the classical principal-agent approach, including leadership style, personality traits, teamwork and culture.

This research is supported by the Goldschmeding Foundation. The Goldschmeding Foundation for People, Work and Economy is working towards a better world in which People, Work and the Economy are well-balanced and reinforce each other, based on the conviction that a better world is reached when people serve each other’s interests. 

To this end the Foundation uses the donations that it receives, its network and its expertise to support excellent scientific research as well as innovative field projects that contribute to establishing an Inclusive Labour market and a Circular and Humane Economy.

Although many organisations and stakeholders recognise that changes to executive pay are sorely needed, coordinating on a joint push toward a new equilibrium is difficult. Many organisations and stakeholders prefer not to be the first and/or only mover. Many organisations and stakeholders don’t necessarily agree on the direction and magnitude of the push towards a new equilibrium. In short, there are (temporary) organisational and governance frictions that hinder the development and adoption of a new remuneration model across the board. In an effort to reduce such governance frictions, Reward Value is coordinating the development of a set of Principles for Responsible Remuneration (PRR). These principles are developed jointly with stakeholders. This co-creation allows for the process to be part of the solution of achieving agreement on the direction of change. Upon agreement of the PRR, the PRR may become a touchpoint for meaningful engagement about and governance of executive pay.

Companies are bound by various requirements for their reporting on remuneration, both through legislation and regulations and through (self) regulation in the form of governance codes. Companies are generally compliant with such requirements, but despite such compliance, concerns remain about the extent to which shareholders and stakeholders can successfully monitor companies’ remuneration policies. This is partly the result of the fact that remuneration reporting is often not standardised, companies have a relatively large amount of freedom to define broad standards at their own discretion, and only rarely offer extensive and substantive substantiation for the choices made in the remuneration policy. Concerns about the “quality of transparency” are the result. To help companies design their remuneration reporting in such a way that the expectations of stakeholders and shareholders can be met, we propose to develop a guidelines document for high-quality remuneration reporting. In such a document we not only map out what the best practices are now, but especially how they can be improved. By sketching such an ‘ideal type’ of remuneration reporting, we hope to encourage market parties to make their own remuneration reporting more transparent, for example by standardisation and by offering more substantive explanation of choices in remuneration.