Sustainability Comes to Equity Compensation

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Sustainability Comes to Equity Compensation

• Athanasia Karananou, Investor Engagements, United
  NationsPrinciples of Responsible Investing
  Initiative (UK)
• Fred Whittlesey, Principal Consultant,
  Compensation Venture Group, SPCA Certified B
  Corporation (US)
• Brit Wittman, Director, Executive and Equity
  CompensationIntel Corporation (US)

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Discussion Topics

• What is sustainability?
• The global movement
• Executive compensation meets ESG
• Equity compensation and stakeholders
• The United Nations PRI
• Intels Compensation Programs
• Conscious Compensation in startups

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What is Sustainability?
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What is Sustainability?

• Conscious Capitalism
• ESG (environment, social, governance)
• CSR (corporate social responsibility)
• Responsible Investing
• Social Impact
• Triple Bottom Line

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Is Anyone Taking This Seriously?

• You know about ISS
• What about ISS SRI?
• You know about the FASB
• What about the SASB?
• You know about ISSs EPSC
• What about GIIRS?
• RobecoSAM Sustainability?
• Dow Jones Sustainability Index?

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Is Anyone Taking This Seriously?

• socially responsible investors have dual
  objectives financial and social. Socially
  responsible investors invest for economic gain,
  as do all investors, but they also require that
  the companies in which they invest conduct their
  business in a socially and environmentally
  responsible manner.
• In voting their shares, socially responsible
  institutional shareholders are concerned not only
  with sustainable economic returns to shareholders
  and good corporate governance but also with the
  ethical behavior of corporations and the social
  and environmental impact of their actions.
• Generally, we take as our frame of reference
  policies that have been developed by groups such
  as the Interfaith Center on Corporate
  Responsibility, the General Board of Pension and
  Health Benefits of the United Methodist Church,
  Domini Social Investments, and other leading
  church shareholders and socially responsible
  mutual fund companies. Additionally, we
  incorporate the active ownership and investment
  philosophies of leading globally recognized
  initiatives such as the United Nations
  Environment Programme Finance Initiative (UNEP
  FI), the United Nations Principles for
  Responsible Investment (UNPRI), the United
  Nations Global Compact, and environmental and
  social European Union Directives.
• Source Institutional Shareholder Services (ISS)
  2015 SRI Proxy Voting Guidelines

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Is Anyone Taking This Seriously?

• Socially responsible shareholder resolutions are
  receiving a great deal more attention from
  institutional shareholders today than in the
  past. In addition to moral and ethical
  considerations intrinsic to many of these
  proposals, there is a growing recognition of
  their potential impact on the economic
  performance of the company. Among the reasons for
  this change are
• The number and variety of shareholder resolutions
  on social and environmental issues has increased
• Many of the sponsors and supporters of these
  resolutions are large institutional shareholders
  with significant holdings, and therefore, greater
  direct influence on the outcomes
• The proposals are more sophisticated better
  written, more focused, and more sensitive to the
  feasibility of implementation
• Investors now understand that a companys
  response to social and environmental issues can
  have serious economic consequences for the
  company and its shareholders.
• Source Institutional Shareholder Services (ISS)
  2015 SRI Proxy Voting Guidelines

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The PRI at a glance

• Launched in April 2006 at the NYSE, the
  Principles for Responsible Investment has

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The PRI The six principles
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This is about being a better investor
Performance not philanthropy
risk managementnot breach of fiduciary duty
The high-sustainability companies dramatically
outperformed the low-sustainability ones in terms
of both stock market and accounting
measures Harvard Business School
As we note above, the links between ESG factors
and financial performance are increasingly being
recognised. On that basis, integrating ESG
considerations into an investment analysis so as
to more reliably predict financial performance is
clearly permissible and is arguably required in
all jurisdictions. Freshfields Bruckhaus Deringer
Returns not sacrifice
DIVERSE APPROACHESnot just excluding unethical
investments
There are positive, strongly statistically
returns associated with going long good corporate
governance firms and shorting those with poor
governance. Yale School of Management
We believe that ESG analysis should be built
into the investment processes of every serious
investor and into the corporate strategy of every
company that cares about shareholder
value. Deutsche Bank
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An inevitable agenda gathering momentum
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The Signatories

• The current 1,359 signatories include
• Asset owners
• BP Pension Fund (UK)
• BT Pension Scheme (UK)
• Harvard University Endowment (US)
• Marks Spencer Pension Scheme (UK)
• Pension Fund City of Zurich (CH)
• Petros (BR)
• Skandia (SW)
• University of California (US)

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The Signatories

• The current 1,359 signatories include
• Investment Managers
• ABN AMRO Bank NV (NL)
• Allianz Global Investors (DE)
• BayernInvest Kapitalverwaltungsgesellschaft mbH
  (DE)
• BNP Paribas Investment Partners (FR)
• ING Investment Management (NL)
• JP Morgan Asset Management (US)
• The Vanguard Group (US)
• UBS Global Asset Management (UK)

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The Signatories

• The current 1,359 signatories include
• Professional Service Partners
• Aon Hewitt (UK)
• Bloomberg LP (US)
• Glass, Lewis, Co LLC (US)
• GMI Ratings (US)
• Institutional Shareholder Services-ISS (US)
• McGraw Hill Financial (US)
• Mercer Investments (CA)
• MSCI (US)
• Thomson Reuters (US)
• Towers Watson (US)

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How the PRI supports signatories
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Investor engagements collaborative investor
initiatives
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Should ESG issues be linked to pay?

• Opportunities
• Aligning pay and long-term strategy sustained
  shareholder value
• Long-term thinking is rewarded
• ESG value drivers risks new business
  opportunities cost savings

• Challenges
• Lack of universal standards for companies and
  consultants
• Risk of creating perverse incentives vs. holistic
  approach
• Different performance metrics to compete
  complexity

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PRI initiative Integration of ESG issues into
executive pay

• Recommendations for companies
• Adopt a clear process for identifying appropriate
  ESG metrics to be linked to pay
• Link these appropriate ESG metrics to reward
  systems in a way that they form a meaningful
  component of the overall remuneration framework
• Endeavour to clearly and concisely disclose the
  rationale, method and challenges presented by the
  incorporation of ESG metrics into executive pay

PRI Guidance to help investors engage in dialogue
with companies on how to integrate ESG issues
into executive pay in a meaningful way (2012)
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Executive compensation meets ESG

• Review of 84 companies in utilities and
  extractives

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Executive compensation meets ESG

• Investors also asked
• What is the proportion of incentives awarded for
  ESG performance?
• Approx. 10
• In determining payouts, are factors considered
  retrospectively or are they preset at the
  beginning of the performance cycle?
• Fewer than half of executive pay plans are based
  on pre-set targets
• Are ESG factors incorporated into the measurement
  of corporate goals and/or individual objectives?
  
• Far more likely to be measured relative to
  corporate-level targets
• Are ESG factors a precondition for a portion of
  the incentive award to vest? Can ESG factors
  reduce awards otherwise earned? 
• Yes, but rarely

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Executive compensation meets ESG

• Type of ESG issues linked to pay by sector

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Executive compensation meets ESG

• Are companies linking the right issues?
• Safety was by far the most prevalent ESG factor
  
• Safety is a key issue for the industry. However,
  no other ESG factor was employed by almost half
  of companies reviewed. Is there excessive focus
  on just one issue?
• Climate (i.e. carbon emissions) was the least
  prevalent ESG factor
• This was despite many references to climate
  related issues as a material risk by the
  companies own sustainability reporting. Is there
  a disconnect between companies own reporting and
  selecting appropriate issues to link to pay?
• Approximately 30 use integrated ESG metrics
• While the use of integrated ESG scorecard factors
  addresses a broad range of ESG performance in
  some cases, these factors typically lack
  transparency, specificity, or disclosed
  performance metrics, thereby diluting their
  incentive value

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Executive compensation meets ESG

• What will investors be asking going forward?
• Investors will be encouraging companies that do
  not incorporate ESG issues into executive pay to
  consider doing so, or explain why not appropriate
  
• For companies that do incorporate ESG factors,
  investors will expect disclosure of clear
  targets, performance against targets and link to
  pay-outs, as well as discussion of material
  issues and progress towards goals
• Given the long-term nature of ESG issues,
  investors will be inviting more companies to
  incorporate ESG factors into LTIPs or even
  moving away from traditional structures but
  ensuring an appropriate long-term time horizon
• Investors will also expect any discretionary
  power of the compensation committee to be applied
  for downward adjustments to account for unusual
  events or unintended consequences, and that
  awards are subject to claw-back provisions

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Executive Compensation Meets ESG

• Not a new issue Equity Residential 2011
  shareholder proposal (3.7 yes)
• RESOLVED That the shareholders of Equity
  Residential (Equity or Company) request the
  Boards Compensation Committee, when setting
  senior executive compensation, include
  sustainability as one of the performance measures
  for senior executives under the Companys annual
  and/or long-term incentive plans. Sustainability
  is defined as how environmental, social and
  financial considerations are integrated into
  corporate strategy over the long term.
•  
• British utility company National Grid announced
  last year it would partly base executive
  compensation on meeting targets for reducing
  carbon emissions. In addition, Xcel Energy in its
  2009 proxy statement discloses that certain
  annual incentive payments are dependent on green
  house gas emission reductions alongside the
  weight given to meeting earnings per share
  targets. Also, Intel Corporation calculates every
  employees annual bonus based on the firms
  performance on measures that include energy
  efficiency, completion of renewable energy and
  clean energy projects, and the companys
  reputation for environmental leadership.

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Executive Pay and Shareholders

• How do companies protect shareholders through
  executive pay design?
• Burn rate/value transfer limitation
• Vesting schedules
• Performance conditions
• Stock ownership guidelines
• Clawbacks

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Equity Compensation and Stakeholders

• Long history of shareholder-focused
  concernsassuming these affect shareholder value
• Dilution
• Executive pay
• Board independence
• Share plan design

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Equity Compensation and Stakeholders
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Intels Compensation Programs

• Annual Cash Incentive all employees (currently
  107k) participate in program
• Payout is based half on financial metrics and
  half on operational metrics
• Operational metrics change annually but have/do
  include
• Environmental/sustainability goals (energy
  consumption carbon-footprint reduction
  recycling)
• Conflict-free sourcing
• Employee population diversity and inclusion

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Intels Compensation Programs

• Stock Program Summary Employee Perspective
• Virtually all (98) employees participate
  annually
• For Exec Population (top 350) equity is
• 60 performance-based RSUs rTSR to basket of 15
  high-performing peers 3-year cycle more
  leverage up than down (but w/threshold max)
• 40 time-based RSUs quarterly vesting over 3
  years
• This population also has holding requirements
  (total share, not per grant)
• Broad-based population equity is exclusively
  time-based RSUs, vesting annually over 4 years
• Additionally, Intel has a Qualified Stock
  Purchase Plan with high participation worldwide

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Intels Compensation Programs

• Stock Program Summary Stockholder perspective
• Annual dilution commitment of lt2 currently
  running closer to 1
• Return to shareholders every 2 years for
  authorization approval

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Conscious Compensation in Startups

• Linked to concepts of Conscious Capitalism
• Parallel thinking with strategy for investors,
  customers, suppliers, governance, and staffing
• Contrary to the legacy startup model of pay

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How Would Sustainable Equity Look?

• All-employee participation
• Dynamic dilution measurement, not burn
• An equity grant size ratio (vs. CEO)
• Longer vesting schedules
• Required holding periods
• ESG performance measures for all
• Other ideas?

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Contact Information

• Athanasia KarananouUnited NationsPrinciples for
  Responsible Investmentathanasia.karananou_at_unpri.o
  rg
• Fred WhittleseyCompensation Venture Group,
  SPCfred_at_compensationventuregroup.com
• Brit WittmanIntel Corporationbrit.wittman_at_intel.
  com