Rethinking Executive Incentives Can Boost ESG Performance
Changing the incentive structure can help companies run more ethically in the long term.
Anytime the economy hits a downturn, it’s a familiar story: Companies cut expenses through layoffs, and top executives get bonuses for keeping stock prices up. Today, this arguably hurts employees more than it used to. Even before the pandemic, 17% of adults could not pay their bills, and 24% skipped medical care because they didn’t have the money. And given the bruising, consistent rise in income inequality, the average employee lives paycheck to paycheck.
Meanwhile, in 2021 the average ratio of CEO pay to worker pay among S&P 500 companies was 324-to-1, and during the pandemic, 20 CEOs furloughed workers while maintaining a CEO-to-worker pay ratio greater than 1,000-to-1. Their collective total compensation could have covered the wages of over 30,000 of their employees. Yet this has become standard practice: CEOs have used the actions of fellow executives as cover to pay themselves obscene amounts, reduce employee benefits, and send jobs offshore.
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Nonetheless, some companies are already trying to do better by their workers. Early in the pandemic, from March to May 2020, 259 U.S. companies suspended share buyback programs. Costco raised its minimum wage from $15 to $16 an hour and further upped it to $17 in 2021. Target, CVS Health, Walgreens, and others also increased minimum wages. Yet more tools are needed to guide and motivate the vast majority of CEOs to decisively protect employees during future crises.
The existing incentive structure for executives rewards them when things go right without motivating them to minimize the chance that things will go wrong. A new federal pay-versus-performance rule that went into effect Oct. 11 begins to address this by mandating that companies provide details on executive renumeration and financial performance from the past five years. Companies also have to disclose the performance measures that are linked to leaders’ compensation. Yet the new rule does not tie executive pay to employee wages in downturns.
Rethinking Executive Incentives With Parity Pills
A parity pill — a term of my own — is a clause in a company’s governing documents that would automatically redistribute executives’ pay in the event of a business downturn, to avert layoffs or augment the salaries of the lowest-paid workers.