As COVID-19 tears through healthcare systems and the economy, determining KPIs for company and individual performance may not seem a priority. But it does matter. Executive Teams are in the eye of the storm. Survival is a priority. At the same time, at Board level Fidelio is seeing through both our Search and Evaluation assignments evidence of clear thinking on KPIs. These need to be set to ensure that as companies come out of this trough they can look to long-term and sustainable growth for both investors and stakeholders. A decade ago it was clear that incentives in Financial Services encouraged egregious mis-selling of products and promoted systemically dangerous risk-taking. To what extent is the current health and economic crisis a product of incentives that encouraged companies and politicians to favour lowest cost and shareholder profit at the expense of resilience and sustainability? To rebuild out of this crisis Boards will need to understand and implement incentives to promote a sustainable future. Much work was already underway – consider Financial Services where in the last decade accountability been substantially increased and the sense of bonus entitlement has been eroded. In response to the COVID-19 crisis, investment advisers are already warning Remuneration Committee Chairs that a dim view will be taken of management teams being paid bonuses when employees are being fired and government grants are being sought.
Driving Behaviour, Balancing Interests
Good behaviour is clearly a desirable outcome at both company and individual level but must surely be regarded as a bare minimum. More challenging is the interplay between the various ESG factors and how to identify KPIs and metrics at both enterprise and executive level that will balance the interests of shareholders, stakeholders and the planet, and contribute to a sustainable future.
Currently we see companies reporting upon a raft of measures from carbon emissions through health and safety to customer satisfaction. Most corporate governance codes are not explicit in mandating ESG metrics. The UK’s Code requires the following of the Board: “It should describe in the annual report how opportunities and risks to the future success of the business have been considered and addressed, the sustainability of the company’s business model and how its governance contributes to the delivery of its strategy”
Provision 1, UK Corporate Governance Code 2018
Complying with this kind of overarching principle increasingly requires meaningful reporting of performance indicators in a variety of areas, in addition to financial results.
The Link to Remuneration
KPI’s are especially relevant for Remuneration Committees which have the task of translating complexity at corporate level into appropriate compensation structures for individuals. Here again the UK Corporate Governance Code provides high-level guidance: “Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to company purpose and values, and be clearly linked to the successful delivery of the company’s long-term strategy.”
Principle P, UK Corporate Governance Code 2018
Choosing the Right KPIs
Relevant KPI’s clearly vary by sector: for example, in companies where safety of staff, contractors and customers is of particular concern such as aviation and mining, executive remuneration may be linked to fatality and severe injury statistics, with CEOs receiving a lower bonus if safety KPIs are not met. For companies with a heavy carbon or environmental footprint – automotive, fossil fuels, shipping, plastics – there is increasing expectation that remuneration should be linked to environmental KPIs, often aligned with the Paris Agreement. In the energy sector, for example, a leading Oil and Gas company has now tied remuneration to numerical targets for environmental goals including reduced carbon emissions. Yet when it comes to non-financial reporting most companies stay within their comfort zone. The most common metrics that companies and Boards like to share with investors relate to “soft” issues such as employee and customer satisfaction, and these are not always rigorously tracked. A perusal of annual reports for major firms also indicates that most share only superficial information on the mechanisms that drive remuneration. In many cases alignment of pay with ESG KPI’s is indirect, with the Remuneration Report simply stating that environmental and social factors are “taken into account” when deciding payouts. And some firms remain exclusively focused on financial measures, without any link to ESG factors at all.
Why All This Matters
At Fidelio we argue that the trend on corporate ESG KPIs was clear before COVID-19, leading to greater scrutiny, increased transparency, and more reporting. If we want to see companies that can pave the way back to sustainable value generation for both shareholders and stakeholders, Boards will need to continue the hard work on ESG KPIs. To rebuild confidence Boards will want to ensure a compelling corporate narrative and framework on the following:
What ESG issues are central to the company’s purpose?
How are these measured and reported on?
How do these translate into executive pay?
There is no one answer here: every company is different and faces a unique challenge in balancing potentially conflicting performance indicators for its business. A new focus on environmental and social goals shouldn’t compromise health and safety, for example, and no shareholder is going to be happy with an investment which fails to take due account of financial performance.
There are trade offs and tough calls in establishing robust and meaningful KPIs. But it matters because KPIs set direction and breed behaviours and never have we had greater need of companies that are resilient and doing right by society and investors.
Fidelio will continue to support Boards as they do the heavy lifting. This is not the time to shy away. Investors and Boards have not gotten it right in the past. This is an opportunity to learn and make substantial contribution to recovery in economic health that is so desperately needed the world over.
To learn more about how Fidelio can support your Board in its oversight of long-term value creation – through Search, Evaluation and Development – contact us here or email gkarrancumberlege@fideliopartners.com.
