- Katica Roy
Yes or No: Compensating Executives for Hitting Their Diversity Goals?
Welcome to my weekly Q&A feature. (Scroll down to find the Q&A.)
If this is your first time here, welcome. I spend a fair amount of time speaking at events and conferences. At the end of my presentations, I leave space for audience members to ask questions—tough questions, brave questions, you name it. The level of candor and curiosity always inspires me, and I want to share that sentiment with you. Each week I pick one question that I believe others would find most instructive and publish my response to it here.
The purpose of this weekly tradition is transparency and inclusion.
Transparency: a behind-the-scenes look at my day-to-day.
Inclusion: bringing others along on the journey.
Executive Compensation x DEI Goals
Should companies tie executive pay to DEI targets?
(Curious about something? Ask your question here for a chance to have it answered in an upcoming edition of Brave Souls®.)
Whether or not companies should tie executive pay to DEI targets seems to be irrelevant. They already are.
Salesforce became the latest high-profile company to link executive pay to DEI goals. As of February 2022, a portion of Salesforce’s executive variable pay for those at the executive VP and above level will be determined by four ESG measures—such as increasing the percentage of underrepresented employees in the US and abroad.
Salesforce, with its 29,000 employees scattered around the world, added its name to the growing list of companies that link executive compensation to diversity targets. McDonald’s, Starbucks, Microsoft, and Alcoa are among the others that practice this type of pay-for-performance.
Before we determine the justification of such initiatives (it’s more nuanced than you might think), we need to explore the environment in which these initiatives are taking place.
Re-Aligning Incentives: From Shareholder To Stakeholder Capitalism
Capitalism is transforming from profit maximization to sustainable value creation. The Business Roundtable’s meeting in 2019 largely kicked off this transformation and triggered a flurry of activity around measurement and change management for the emerging stakeholder capitalist system.
The World Economic Forum, for its part, published a comprehensive set of common metrics that companies can report on to ascertain their commitment to a more equitable world.
These metrics extend across the four pillars of stakeholder capitalism, which WEF defines as:
Principles of governance
In corporate speak, we call these four pillars “ESG,” with diversity, equity, and inclusion falling under the People pillar. Stakeholder capitalism metrics like these are a step in the right direction.
However, they also leave us hanging. For one, they imply voluntary compliance*—i.e. no regulatory teeth. And for another, they lack the intersectional lens—i.e. no data disaggregation beyond one protected class.
Amongst this backdrop, companies are electing to report on (non-financial) ESG metrics of their choice and connect these non-financial metrics to executive compensation. The keyword here is “electing.” It’s largely voluntary.
Mercer estimates that 27% of S&P 500 companies currently link executive compensation to DEI metrics.
So what constitutes a “DEI metric?” you might ask. And what percent of executive pay depends on hitting those metrics? Those details remain dubious. Which brings us to the more multifaceted part of this conversation…
Beware Of The Subtext: Not All Comp Programs Created Equally
Synchronizing executive pay with performance is not new, but it is nuanced—especially when it comes to DEI performance. Here’s what I mean:
Sandbagging: Are companies deliberately setting low or easily achievable diversity targets?
Performative metrics: Are the DEI targets simply forward-facing manifestations of what the company was already planning to undertake? Performative diversity compensation doesn’t bode well at a time when the CEO to unskilled worker pay ratio is 354:1.
Size of compensation: What percentage of executive pay is linked to DEI goals? 10 to 20% seems to be the sweet spot for many companies. Below 5% of a short-term incentive plan seems ineffective at catalyzing meaningful change.
Time horizon: Are DEI goals linked to short-term incentive plans like the annual bonus, or long-term incentive plans, which hold more weight as a percent of total compensation? The latter is more conducive to sustainable value creation vis-à-vis DEI.
Types of metrics: What metrics are you using? And how are you measuring them? For DEI metrics to be meaningful, they need to go beyond employee representation and account for equity of opportunity, equity of pay, and equity of performance. They also must be disaggregated by gender PLUS race/ethnicity PLUS age.
Tyranny of the metrics: The wrong metrics can undermine progress. One study found that companies seeking to increase the representation of women in leadership overpaid high-potential women in an effort to meet their DEI targets. It came at the sacrifice of women in all other ranks who continued to experience inequity.
Linking executive compensation to DEI targets can be an effective way to signal to stakeholders that a company cares about equity in the workplace. And since DEI isn’t a light switch you can flip on or off, it will take time to create and sustain equitable work environments.
As such, we need to continue monitoring this space to ensure the companies that do tie executive compensation to DEI targets can maintain their level of progress in the long run.
As we head into proxy season, we can expect to see more evidence of companies compensating their executives for hitting diversity targets, especially as 60% of investors plan to factor board and workforce diversity into their 2022 investment decisions.
*Voluntary diversity reporting in the US may soon come to an end. The SEC is exploring avenues to mandate human capital disclosures. Abroad, many countries already mandate reporting around companies’ diversity, equity, and inclusion metrics.
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© 2022 Katica Roy™, Inc.