Dr Timothy King from the Kent Business School at the University of Kent comments on the news that Shell will link executive pay to carbon reduction targets, arguing this is a welcome move as shareholders’ increasingly recognise the importance of corporate social responsibility within business operations.
The traditional view of ‘optimal’ executive compensation contracts is that they should help align the objectives of executives/managers with outside shareholders.
However, this traditional view says little about other stakeholders. But this is very important. Indeed, in few industries are environmental, social and governance (ESG) concerns of greater significance to policy makers, regulators and the future of society. The 2010 the BP Deepwater Horizon oil spill serves to highlight the potential environmental damage if safeguards are not probably adhered too. Indeed, shareholders pressure on executives to deliver share price related performance targets can create a culture that puts safety and ESG concerns second to corporate profits.
However in recent years, ESG has been increasingly on the agenda of investors and policy makers. For instance, many investors are starting to actively consider the current and future impacts of climate change and carbon emissions and constructing portfolios that emphasize the importance of renewable clean energy, for the long-term financial performance of their portfolios. As highlighted in a paper titled: ‘Shareholder Activism and Equity Price Reactions’ in Economics Letters, corporate social responsibility (CSR) performance, which is shown to have real economically important impact on stock returns and risk.
Shell should be commended on their decision to link executive to ESG performance; notably carbon emissions. However, executive pay structure is complex and different components of pay may present executives with conflicting targets. The structure and transparency of the pay-setting process is therefore of paramount importance if the ultimate objective is to deliver sustainability in firm performance; but most importantly deliver reductions in carbon emissions and increasing momentum to delivering clean, renewable energy in the future. One could argue, international policy makers should reaffirm their commitments and increase pressure on the energy sector to link executive pay to delivering specific environment, social and governance objectives. The future of the world is at stake.