Legitimate Leadership has long argued that organisations will only deliver on a stated intent to “serve” all their stakeholders if what they are measured and rewarded for is consistent with that intent. What this article outlines are some small but not insignificant shift in that direction.
BELOW IS OUR SUMMARY OF AN ARTICLE BY KENNY WHICH APPEARED IN THE HARVARD BUSINESS REVIEW.
On November 9, 2016, the shareholders of Australia’s largest company, and the world’s tenth largest bank, revolted. The Commonwealth Bank’s shareholders were reacting to the board’s annual Remuneration Report, which contained a recommendation that the CEO be granted a bonus based on what critics saw as “soft” measures – that is, non-financial measures and subjective measures.
Commonwealth Bank is among an increasing number of corporates internationally which are moving away from using only “hard” (financial) measures to decide on executive remuneration.
In the past 20 years most corporates went down the “hard” path forged largely by US corporations and global remuneration consultants. But they often now find themselves dissatisfied with the result.
For instance, the world’s largest mining company, BHP Billiton, now uses several key performance indicators (KPIs) to guide its executive compensation. These include financial metrics (such as attributable profit; underlying earnings before interest and taxation; and total shareholder return (share price and dividends which are assumed to be reinvested)), but also non-financial (but still objective) KPIs (namely total recorded injury frequency and greenhouse gas emissions).
But corporations are now taking a further step beyond objective metrics, which can be financial and non-financial, to include subjective measures — tagged as “soft.” For instance, the Commonwealth Bank restructured its evaluation system so that 75% of CEO incentives came from the bank’s total shareholder return (TSR) relative to a set peer group, and 25% from customer-satisfaction results, benchmarked against another peer group. Then, following an ethics scandal within its life insurance arm, the bank’s board took yet another step to include even more subjective measures. To help modify the bank’s culture to match its stated values, the bank’s remuneration committee and board recommended a change to the reward split to TSR 50%, customer satisfaction 25%, and people and community 25%. The latter was concerned with “measuring long-term progress in the areas of diversity and inclusion, sustainability, and culture”.
This proved to be a step too far for some shareholders, precipitating their revolt in November 2016.
One Australian analyst described the Commonwealth Bank’s move as “well-intentioned but not well designed”.
But the board of the bank has not backed away from the issue since the revolt. Indications are that it will rather provide shareholders with additional context and logic on the thorny issue of soft measures.
Boards around the world find themselves in a bind. But they don’t really know what to do instead. As a consequence, companies are firing off ad hoc responses rather than approaching performance measurement in a comprehensive way.
The author recommends a framework to boards and CEOs to develop a corporate performance scorecard. This produces both objective and subjective measures. It recognises, as company law dictates, that a board’s primary responsibility is to look after the best interests of the company — not only those of shareholders. It develops a corporate scorecard focused on the relationships that the company has with its stakeholders – including customers, employees, shareholders, and suppliers. It acknowledges that the relationship between the company and stakeholders is a two-way street and develops measures for these on both sides. It appreciates that the much-sought-after leading indicators are often soft, subjective measures. It implements a short list of KPIs recognising the cause-and-effect relationship between soft and hard measures.
A recent study by AMP Capital, a leading Australian investment company, observed that “incentives linked solely to financial metrics risk fuelling negative culture and conduct”. As a result, it noted, “companies are increasingly focusing on setting non-financial targets alongside financial targets”.