A new trend amongst Dutch multinationals: some executive remunerations are now based on meeting sustainability targets. But the criteria are not always clear.
Paint and chemical producer AkzoNobel was the first to introduce a new system of performance related pay last April, when it announced its executive bonuses would be based on sustainable criteria. The 600 top managers at the company now have to take into consideration whether they have done enough to reduce greenhouse gas emissions and whether they have developed more innovative, environmentally friendly products than the competition. If they fail to do so, their remuneration is reduced.
Akzo was the first company to openly connect its sustainable performance to its bonuses and several Dutch multinationals have already followed suit. Chemical manufacturer DSM, postal company TNT and energy giant Shell all announced they are adopting similar policies.
Is there a green revolution going on concerning the rewards for executives? Have managers in the Netherlands all realised more environmentally and customer friendly policies pay off? And are they trying to push their companies in this direction by not only taking profits into account, but also their contributions to people and planet? Or is this just a convenient way to keep handing out bonuses to managers when economic times are rough? Those who produce less may not meet their profit targets, but they also emit less carbon dioxide.
'A new perverted system'
Rob Bauer, a professor of Institutional Investors at Maastricht University, is extremely sceptical of this development. "I fear one perverted system is being replaced with another," he said. First, executives were stimulated to focus on profit development and share value. Now, Bauer said, companies risk focusing exclusively on carbon emissions, losing sight of all other aspects.
AkzoNobel does not run that risk, its director of sustainability André Veneman argued. Bonuses at the paint-maker are not based exclusively on sustainability criteria, financial goals still determine half the performance related pay. Sustainable goals settle the other 50 percent. Performance is rated based on the position the company gets on the Dow Jones Sustainability Index. This listing ranks companies based on 90 social and environmental criteria. Out of 80 chemical companies investigated, AkzoNobel has been in the top-3 over the last couple of years.
AkzoNobel's last annual report shows the third place is sufficient for managers to get 100 percent of their conditionally granted stock options. If AkzoNobel comes second or first, the bonus can rise as high as 125 or 150 percent. If financial goals are not met, like in the current crisis, that part of the bonus can be compensated by meeting the sustainability target over a three-year period.
"I understand this system from a manager's perspective," Bauer said. "This is a very good way for them to make money. But why would the supervisory board ever approve it?"
Criteria that make sense
It is not clear what the sustainability bonuses at Shell and DSM will look like. Like Akzo, Shell will use the Dow Jones Sustainability Index as its guideline. This is not without controversy. Claudia Kruse, a sustainability expert at APG, the company that manages the investments of the Netherlands' largest pension fund, has her doubts when it comes to the index.
Shell currently uses criteria such as reducing work accidents. Those make sense, Kruse said, because they are relevant to employees and the production process. "I am afraid the new criteria will be little more than a list of items to be ticked off and that targets will be selected that those outside of the company will have a hard time checking or finding out how challenging it is to meet them."
Carola van Lamoen of asset management firm Robeco has similar concerns. It is essential for companies to choose goals that are relevant. A carmaker should focus on safety and energy efficiency, she said, while a foodproducer has to look at its impact on local communities and biodiversity. "And the goals have to be measurable, and ambitious," Van Lamoen added.
A major transition
Akzo's Veneman said the 90 criteria listed by the Dow Jones Sustainability Index can certainly be measured. The results are also checked by an external accountant, KPMG. But those arguments did not convince professor Bauer: "CO2 emissions can be measured, but what about reputation benefits?"
The new policies at Akzo and DSM are in line with an advice drafted earlier this year by VBDO, an association of investors and shareholders who want to encourage companies to look at their sustainable development. It has called on Dutch companies to base at least 60 percent of their remuneration on long term goals and at least one third on sustainability targets.
Veneman agrees with this. "We have to operate more sustainable, there is no alternative," he said. According to him, the world market is going through a major transition. Billions of people are aspiring to a western consumption pattern, while the climate is warming up, nature is shrinking and biodiversity is diminishing. Veneman predicts a shortage of sweet water, oil and all sorts of other commodities.
Companies that can offer solutions will have the competitive advantage, he said. New products have to be better for the environment than those offered by competitors, Veneman said. "So we can demand a higher price for them." This is why Akzo is working on a car paint without solvents for its line of 'eco-premium' products. These currently account for 20 percent of revenue, 30 percent being the target for 2015. Linking the bonuses to sustainability goals only fits this strategy, according to Veneman.
Lead to the abyss
Rob van Tilburg of DHV consultancy firm agrees. According to him, sustainability targets only have a chance to be met if they are connected to remuneration. "Linking them leads to action," Van Tilburg said. It is also a way for a company to show investors it is seriously preparing itself for the future scarcity of all sorts of commodities and when emitting CO2 will become an expensive thing to do.
According to Edmond Logger, who works for Hay Group consultancy, US and UK companies have not taken the lead on this issue because they are entirely driven by shareholder value. "They don't know any other perspective," he said. Dutch companies, on the other hand, realise there are other important interests: clients, employees, and the environment. In recent years, Netherlands-based companies tended to adopt the Anglosaxon business model, but Lodger said this may change. "I suspect the economic crisis has made them realise that model can lead to the abyss and that building a specific image and identity can be better for the company."
He believes companies in other countries could soon follow, naming McDonalds as an example: the fast-food chain has related remuneration bonuses to what managers do to counter obesity.