© Institute of Directors in South Africa 2020

LINKING EXECUTIVE PAY TO ORGANISATIONAL PURPOSE REMUNERATION COMMITTEE GUIDANCE

Guidance for

Remuneration Committees

SPONSORED BY

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© Institute of Directors in South Africa 2020

Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

The Remuneration Committee Forum (the “Forum”) is constituted as a forum of the Institute of Directors in South Africa (“IoDSA”), and is sponsored by EY. The activities of the Forum have specific focus on the governance, accountability, role and duties of remuneration committee members.

The objective of the Forum is to serve as a platform for discussion and dissemination of guidance to

remuneration committee members either in the form of papers or events.

The current members of the Forum are:

Dr R Nienaber Independent (Chair)

Mr T Anderson Independent (Lead author)

Mr C Blair 21st Century

Mr D Couldridge Ninety One

Ms J Dixon IoDSA (Secretariat)

Mr L Grubb South African Reward Association (SARA)

Mr R Harraway Independent

Mr M Hopkins Bowman Gilfillan

Ms M Jialal-Dasrath Independent

Mr A Johnston Independent

Ms A Keke Independent

Mr P Koornhof Allan Gray

Ms E Kumalo Independent

Dr K Mohamed-Padayachee Independent

Ms P Natesan IoDSA

Mr B Olivier Vasdex

Mr M Pannell Korn Ferry

Mr C Schaefer EY

Ms S Tosh Standard Bank

Ms V Vandayar IoDSA

Mr M Westcott PE Corporate Services

This paper was first published in July 2020

Disclaimer

The information contained in this guidance note is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although every endeavour is made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. The view and opinions contained in this guidance note are merely guidelines for information purposes only, and as such no action should be taken without first obtaining appropriate professional advice. The IoDSA shall not be liable for any loss or damage whether direct, indirect, and consequential or otherwise which may be suffered, arising from any cause in connection with anything done or not done pursuant to the information presented herein. All copyright in this paper subsists with the IoDSA, and extracts of this paper may only be reproduced with acknowledgement to the Institute of Directors in South Africa.

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

Contents

INTRODUCTION ............................................................................................................................................... 4

BACKGROUND ................................................................................................................................................. 4

DEFINING PURPOSE ....................................................................................................................................... 5

THE PAYOFFS TO PURPOSE ..................................................................................................................... 6

HOW ARE ORGANISATIONS RESPONDING? ........................................................................................... 7

COMMENTARY ON THE ABOVE ................................................................................................................... 11

LINKING PURPOSE AND PAY - A PRAGMATIC APPROACH ..................................................................... 13

SUMMARY AND CONCLUSION ..................................................................................................................... 20

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

Introduction There is growing pressure on companies from asset owners, governments and society to state their

purpose, beyond making money for shareholders, and to build their strategies around this purpose. The

current focus by companies on short-term profitability, and the structuring of executive incentives to

achieve this, has disadvantaged stakeholders and threatened their own sustainability, ultimately to the

detriment of long-term shareholders as well. According to Glass Lewis1 “a number of global companies

have recently suffered massive blows to shareholder wealth as a result of significant environmental,

social and/or governance-related issues”.

The demands for business to be a force for good in society are growing. In a 2018 Millennial Study by

Deloitte2, millennial workers were asked what the primary purpose of businesses should be. 63% of them

responded “improving society” rather than “generating profit.” According to the 2020 Edelman Trust

Barometer3, the majority of respondents in every developed market do not believe they will be better off

in five years’ time, while 56% believe capitalism in its current form is doing more harm than good in the

world.

To be effective, purpose must be more than a slogan. It must be embedded in the organisation’s

strategies, policies, initiatives, metrics and incentives. The structure of remuneration, in particular, needs

to change. As long as executives continue to be rewarded for achieving financial goals only over a period

of time that is short in relation to their business cycle, there is little chance of meaningful progress. Pay

should be linked to the achievement of purpose over the long term.

Purpose is still a work in progress. There is insufficient consensus on how it should be defined, measured

and implemented. But the momentum for change is building and organisations will have no choice but to

adapt.

This paper is intended to inform readers of the latest thinking regarding purpose and to help organisations

put purpose at the centre of their strategies and link it to pay. Whilst much of the paper has been written

with reference to for-profit companies, it applies equally to all organisations including not -for-profit

companies and state-owned enterprises.

Background Companies were originally established with clear public purposes. They were usually private companies

owned by families and founders who managed them to achieve their purpose. It is only over the last half

century that purpose has come to be equated solely with profit.

This has come about because of the changing nature of ownership of corporations through the 20th

century. Over this period, ownership became increasingly dispersed in the hands of first individual and

then institutional shareholders. The professionals who manage these investments are typically judged

and rewarded each quarter on the basis of returns from the investments they manage and this gave rise

to the focus on quarterly performance. Shareholders have become distanced from the management of

the companies and the very concept of a shareholder has changed from one of owner, who had a direct

1 In depth: Linking Compensation to sustainability http://www.glasslewis.com/wp-content/uploads/2016/03/2016-In-Depth-Report-LINKING-COMPENSATION-TO-SUSTAINABILITY.pdf 2 Millennials disappointed in business, unprepared for Industry https://www2.deloitte.com/content/dam/Deloitte/global/Documents/About -Deloitte/gx-2018-millennial-survey-report.pdf 3 Edelman Trust Barometer: Global capitalism under fire, SA Government least trusted https://www.biznews.com/wef/2020/01/21/edelman-trust-barometer-capitalism-under-fire

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interest in the sustainability of the organisation, to one of investor whose primary interest was a quick

return on his investment or the investment he manages on behalf of other investors.

This prioritisation of short-term profitability and emphasis on share price growth as a primary indicator

for the value of an investment, often forces companies to cut back on long-term value creating

investments such as innovation, R&D, employee development and care for the environment. This has

disadvantaged the long-term interests of customers, employees, suppliers and communities. In a 2017

McKinsey research paper4 it was reported that 87% of executives feel pressured to demonstrate strong

financial performance within two years or less and 65% say that pressure to perform over the short term

has increased over the past five years. Short-term thinking is the norm and executives have been well

rewarded for delivering short-term results.

However, the impacts of this short-term thinking, particularly in the form of visible climate change, are

becoming difficult to ignore and even the most hardened climate denialists are starting to review their

positions. An example is BlackRock, an institutional investor with over $7 trillion in assets under

management. In his 2020 letter to CEOs,5 Larry Fink writes: “Climate change has become a defining

factor in companies’ long-term prospects. Last September, when millions of people took to the streets to

demand action on climate change, many of them emphasised the significant and lasting impact that it

will have on economic growth and prosperity – a risk that markets to date have been slower to reflect.

But awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of

finance”. Other institutional investors feel the same way and often exclude fossil fuel companies and

other polluters from their portfolios.

Throughout the world, society is becoming disillusioned with government, which is seen as populist and

partisan, and is increasingly looking to companies to address social, economic and environmental issues.

Larry Fink, in his 2019 letter to CEOs6, reports that 73% of employees say they want to change society

and two thirds of consumers identify themselves as belief -driven buyers. CEOs and boards are starting

to understand that their mandate has changed.

Defining Purpose In response to these pressures, organisations are starting to put purpose at the centre of their strategies.

This will lead to three fundamental shifts in the way business is conducted:

1. From a financial view of value to a broader view of value;

2. From a shareholder perspective to a stakeholder perspective; and

3. From a short-term orientation to a long-term orientation.

A company’s purpose is the reason for its existence and what it seeks to do. Purpose determines its

goals, objectives, values, and strategy and is embedded in its culture and practice. Underlying it is a set

of values and beliefs that establish the way it operates. Purposefu l companies contribute meaningfully

to human betterment and create long-term value for all their stakeholders, not only shareholders.

4 Measuring the economic impact of short-termism

https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/Long%20term%20Capitalism/Where%20companies%20with%20a%20long%20term%20view%20outperform%20their%20peers/MGI-Measuring-the-economic-impact-of-short-termism.ashx 5 A fundamental reshaping of finance https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter 6 Purpose and Profit: An Inextricable Link https://www.blackrock.com/americas-offshore/2019-larry-fink-ceo-letter

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The categories of stakeholders impacted by an organisation’s purpose typically include the following:

1. Employees: purposeful companies recognise there is a reciprocal human contract between

employees and themselves. Employees are not short-term inputs into the production process;

rather, they are partners in and members of the organisation. Purposeful companies develop

cultures based on trust and respect so that workplaces provide an opportunity for people to learn,

thrive and contribute;

2. Customers: purposeful companies view a customer not as a transactional source of revenue,

but as having a win-win mutual relationship centred on the long-term impact of a company’s

product or service on the customer’s wellbeing;

3. Suppliers: purposeful companies aim to create a similar long-term mutual relationship of fair

dealing. They pay their suppliers equitably and ensure that their relationship allows them to grow

and develop;

4. Wider society: purposeful companies recognise there is a mutuality of interest between society

and themselves. They act as responsible stewards for future generations, are good neighbours

in the communities in which they operate, cooperate with government and regulators and ensure

that their operations are sustainable. Purposeful companies consider how a company performs

as a steward of nature. They consider the impact the companies’ operations has on the

environment within which they operate and implement measures to protect the environment.

Executive pay should be based on the achievement of purpose, rather than just financial or operational

results. This will be a major shift, particularly from institutional shareholders who have spent decades

finding ways to align managerial interests with their own.

THE PAYOFFS TO PURPOSE

The pay-offs to purpose are increasingly measurable and include superior innovation, investment, R&D

and the recruitment and retention of engaged employees. Collectively, these lead to stronger accounting

and operational performance and ultimately higher stock returns over the longer term.

The CEO of BlackRock, in his 2019 letter to CEOs7, states that profits are entirely consistent with

purpose – in fact, profits and purpose are inextricably linked. Profits are essential if a company is to

effectively serve all of its stakeholders over time. Purpose guides culture, provides a framework for

consistent decision-making, and, ultimately, helps sustain long-term financial returns for the

shareholders of your company.

McKinsey has noted8 that shareholders and stakeholders do not compete in a zero-sum game. Quite

the opposite: building a strong connection with broad elements of society creates value. Compromising

the connections with stakeholders simply to achieve earnings targets, on the other hand, destroys valu e.

Companies that build environmental, social and governance (ESG) factors into their strategies –

including carbon emissions, energy usage and recycling, employee growth and development and

7 Purpose and Profit: An Inextricable Link https://www.blackrock.com/americas-offshore/2019-larry-fink-ceo-letter 8 Five Ways that ESG creates value https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-

insights/five-ways-that-esg-creates-value

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community relations, and strong governance – tend to produce more shareholder value over the long

term.

In a research article entitled Getting smart about governance and its link to financial performance9, Grant

Thornton describes the role that strong corporate governance plays in helping to shape a decision-

making environment that creates sustainable value. In a survey of over 2,300 FTSE 350-listed company

entries, they found that strong corporate governance is a robust indicator of consequential higher

performance across a wide range of financial measures.

HOW ARE ORGANISATIONS RESPONDING?

Companies are increasingly realising that an excessive focus on the short -term can threaten their

sustainability and are shortening their timeframes for value creation. Some South African examples are

given below:

9 https://www2.grantthornton.co.uk/rs/445-UIT-144/images/2019Q107-GetSmartGov3_Getting_smart_about_governance.pdf

Our definition of victory is to grow shareholder value sustainably .” – Sasol

“We aspire to drive shareholder returns in the top quartile of our peer group.” - Kumba

“Value means ‘sustainable profitability’. This refers not only to growing Nampak’s earnings, but also to securing the group’s sustainability more broadly, by creating value for all our stakeholders – customers, employees, authorities, investors, suppliers or society at large – in the short, medium and long term. By defining what value means to us, we align the company to a common purpose: we all understand what is required of us .” - Nampak

“That those charged with governance duties in all sectors be empowered to discharge these effectively.”– Institute of Directors in South Africa

“Our purpose is to make the country commercially competitive in a rapidly changing global context by lowering the cost of doing business in South Africa, enabling economic growth, and ensuring security of supply in providing ports, rail and pipeline infrastructure in a cost -effective manner. In principle, we interpret our mandate to have three key tenets: enabling competitive industry supply chains; exemplifying responsible corporate citizenship; and achieving commercial self-sustainability”. - Transnet

“

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

Other examples include those listed below. None of these mention shareholder value. The implicit

assumption is that shareholder value will flow from effective implementation of their purpose:

The broadening of business objectives to include purpose is also being addressed by institutional

investors, proxy advisers, think tanks and others:

1. BlackRock

In his 2019 letter to CEOs10 Larry Fink states: “It must begin with a clear embodiment of your

company’s purpose in your business model and corporate strategy. Purpose is not a mere tagline or

marketing campaign; it is a company’s fundamental reason for being – what it does every day to

create value for its stakeholders. Purpose is not the sole pursuit of profits but the animating force for

achieving them. When an organisation balances the obvious need for profits with an operating model

that is purpose-driven, all stakeholders end up winning. Employees are happier. Customers return

for more purchases. The community benefits. The environment is protected. And profit seekers and

shareholders are rewarded.”

2. British Academy

In two recent British Academy papers11, the following is stated: “Corporate purpose is the reason a corporation is created and exists, what it seeks to do and what it aspires to become. It reflects the contribution it wishes to make in furthering the interests of its customers, communities and societies and is the basis on which relations of trust are created in business. It is distinct from the consequential implications for the corporation's profitability and shareholder returns .”

10 https://www.blackrock.com/corporate/investor-relations/2019-larry-fink-ceo-letter 11 Reforming Business for the 21st Century https://www.thebritishacademy.ac.uk/sites/default/files/Reforming-Business-for-21st-

Century-British-Academy.pdf Principles for Purposeful Business https://www.thebritishacademy.ac.uk/sites/default/files/future-of-the-corporation-principles-purposeful-business.pdf

Nourishing families so they can flourish and thrive” - Kellogg

help people manage risk and recover from the hardship of unexpected loss ” - IAG (insurance company)

“That those charged with governance duties in all sectors be empowered to discharge these effectively.”– Institute of Directors in South Africa

“To make the property process simple, efficient, and stress free for people buying and selling a property” - REA Group (Real Estate)

“To conduct business and operations for the benefit of members as a whole while delivering long term value for its customers, the region and the communities it serves and

seeking positive outcomes for the environment and society” - Anglian Water (UK)

“Drive change to defeat diabetes and other serious chronic diseases ” - Novo Nordisk (healthcare company)

“

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3. Business Round Table (BRT)

The US BRT periodically issues its Principles of Corporate Governance. Each version issued since

1997 has endorsed principles of shareholder primacy, namely that corporations exist principally to

serve shareholders. In April 2019, the BRT issued an updated declaration ,12 signed by the CEOs of

181 of the largest American companies, which supersedes previous statements and outlines a

modern standard for corporate responsibility.

This BRT statement commits its signatories to:

deliver value to our customers by constantly meeting or exceeding their expectations;

invest in our employees through fair pay, training and development and through fostering

diversity and inclusion, dignity and respect;

deal fairly and ethically with our suppliers by building constructive partnerships with them;

support the communities in which we work by protecting the environment and embracing

sustainable practices across our businesses; and

generate long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate.

4. The Purposeful Company

In their Policy Report13, they state that the purpose of a company is its reason for being. Purpose operates on four major planes – a covenant with customers, a reciprocal human contract with employees, mutuality of interest between society and firm and the desire to contribute to human betterment.

5. Embankment Project on Inclusive Capitalism (EPIC)14

EPIC, a coalition between EY and thirty-one companies, asset managers and asset owners, with

approximately $30 trillion of assets under management, came together in pursuit of a single goal: to

identify and create new metrics to measure and demonstrate long-term value to financial markets.

They recognise that the ultimate goal of a for-profit company is to increase its long-term financial

value. However, they also recognise that this can only be achieved sustainably if measurable value

is also created for other stakeholders which they categorise into financial, human, consumer and

social value.

6. International Business Council (IBC) of the World Economic Forum

The IBC15 states that “society is best served by corporations that have aligned their goals to the

long‑term goals of society.” This report proposes a common, core set of metrics and recommended

disclosures for use by IBC members leading in the future to a generally accepted international

accounting standard.

12 Statement on the Purpose of a Corporation https://opportunity.businessroundtable.org/wp-content/uploads/2019/09/BRT-

Statement-on-the-Purpose-of-a-Corporation-with-Signatures-1.pdf 13 Purposeful Company (2017) Policy Report https://www.biginnovationcentre-purposeful-company.com/policy-report/ 14 https://www.ey.com/Publication/vwLUAssets/EY-the-embankment-project-for-inclusive-capitalism-report/$File/EY-the-embankment-

project-for-inclusive-capitalism-report.pdf 15 Compact for Responsive and Responsible Leadership http://www3.weforum.org/docs/WEF_IBC_ESG_Metrics_Discussion_Paper.pdf

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7. King IV Report on Corporate Governance™ for South Africa 201616 (King IVTM)

King IVTM states “directors owe their duties to the company and the company alone … the company

is represented by several interests and these include the interests of shareholders, employees,

consumers, the community and the environment. Thus, requiring directors to act in good faith in the

interest of the ‘company’ cannot nowadays mean other than a blend of these interests…”

8. Institutional Shareholder Services (ISS)

In their 2017 paper, Insights into value creation,17 ISS states that a company’s primary goal is to

maximise shareholder value. However, they also emphasise that ESG factors are important drivers

of this.

9. The Sustainability Accounting Standards Board (SASB)18

Although there is much environmental, social, governance (ESG) and sustainability information

already publicly disclosed, it can be difficult to identify and assess which information is most useful

for making financially-related decisions. In response, SASB has developed a complete set of 77

industry standards for sustainability reporting. SASB standards focus on financially material issues

to help businesses report on the sustainability topics that mat ter most to their investors.

10. Principles for Responsible Investment (PRI)

The PRI is a United Nations initiative. In their 2016 Integrating ESG Issues into Executive Pay19,

they note that companies should adopt a clear process for identifying appropriate ESG metrics that

have a clear link to the optimisation of shareholder value and are aligned with the company’s long -

term business strategy. These metrics should be forward looking, clear, attainable, replicable,

comparable and time-bound.

16 https://cdn.ymaws.com/www.iodsa.co.za/resource/collection/684B68A7-B768-465C-8214-E3A007F15A5A/IoDSA_King_IV_Report_-

_WebVersion.pdf 17 https://www.issgovernance.com/library/insights-into-value-creation-using-eva-to-measure-performance/ 18 https://www.sasb.org/standards-overview/ 19 https://www.unpri.org/esg-issues/governance-issues/executive-pay

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Commentary on the above There are significant differences in the way companies and commentators think about purpose and

how it should be expressed:

a) some state that long-term shareholder value is their ultimate objective and that other forms of

stakeholder value are drivers or enablers of this objective;

b) some feel that all forms of stakeholder value are of equal importance and each should be a

measureable objective; and

c) others are simply aspirational statements and give no detail as to how they will be achieved.

The first two of the above reveal fundamentally different ways to express purpose:

1. The first is to equate purpose with increasing the long-term financial value of the organisation

and to consider other forms of stakeholder value (that is, for employees, customers, suppliers and

the wider society) as drivers of this outcome. This view is strongly supported by institutional

investors who see their ultimate responsibility as managing and growing the funds entrusted to

them by investors. It is also supported by the IIRC, quoted in King IVTM, that states: “Long-term

financial performance depends on the efficient and productive management of resources not

currently measured by traditional accounting methodologies – human, intellectual, social and

relationship, and natural”;

2. The second considers all forms of stakeholder value as desired outcomes in their own right,

without any one having primacy over the others. This view leads to a number of difficulties as

described below.

Despite these different views, there is widespread recognition that value for shareholders can only be

achieved sustainably if the legitimate needs and expectations of all material stakeholders are al so

satisfied. Both approaches, however, give rise to a number of questions that have not yet been

satisfactorily answered:

1. How should the different forms of stakeholder value be expressed and measured to communicate

to stakeholders how a company is creating long-term value and positioning itself for the future?

This is important for investors when deciding how to allocate their capital. However, a review of

company integrated reports reveals:

a. some organisations state their purpose but have no clear strategy to achieve it or metrics to

monitor it. Their purpose statements are simply taglines;

b. other organisations discuss stakeholder value in detail but then measure it in terms of inputs

or outputs, rather than outcomes. The most common of these is to equate spend on training

with an increase in the value of human capital; and

c. very few organisations explain the link between the value created for individual stakeholder

groups and the achievement of their long-term purpose.

2. How should the interests and expectations of different stakeholder groupings be balanced and

how should conflicts be reconciled? For example, should a company:

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a. Invest in technology that increases revenue, profitability and competitiveness but leads to

job losses?

b. Spend money on recycling initiatives that reduce profitability and threaten jobs but protect

the environment?

c. Invest money in employee skills or better customer service or benefits for the community,

assuming it cannot do it all? How should it choose?

d. Pressurise/bully suppliers to reduce prices, potentially threatening their sustainability, to

improve shareholder returns?

e. Buy from local suppliers even if this results in higher costs and reduced competitiveness but

supports the local economy and employment opportunities?

f. Use labour intensive processes rather than automated ones to create jobs even if this leads

to lower productivity and profitability?

3. Most companies discuss these conflicts and tradeoffs anecdotally and make no attempt to

quantify them in their integrated reports. For example, a leading manufacturing company in their

2019 Integrated Report, stated: “In order to remain competitive we invest in the latest

technologies, reduce manufacturing complexity and rationalise outdated production facilities. Often

this leads to job losses which negatively impact human capital. While investments have a short -

term negative impact on financial capital, they have a long-term beneficial impact on this capital

stock. More efficient production facilities as well as products help mitigate negative impacts on

natural capital”.

4. Sasol, Kumba and NAMPAK appear to prioritise shareholders over other stakeholders. However,

an inspection of their integrated reports reveals a clear recognition by these companies that long -

term shareholder value can only be achieved if the needs of other stakeholders are also met. Their

purpose statements could be enhanced if they stated explicitly how much of other kinds of

stakeholder value they wish to create and explain the link between stakeholder value and long -

term shareholder value.

5. Even where organisations recognise the importance of satisfying stakeholder interests to achieve

their purpose, most continue to link executive pay primarily to financial outcomes. One

institutional investor commented as follows: “until the formulas for CEO compensation in the USA

change to reward them for more than earnings per share and stock price appreciation, we are

unlikely to take the Business Roundtable statement seriously.”

At present, shareholders hold the balance of power over other stakeholders. It is they who appoint and

remove the board and therefore influence the purpose and direction of companies. It is also they who

vote to approve or reject the structure of executive remuneration and what it is linked to. Until such

time as shareholders accept that their interests will be best served through the pursuit of purpose, they

are likely to tread warily.

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

Linking purpose and pay - a pragmatic

approach

To assist companies to reconcile the different approaches outlined above, the following pragmatic six

step process to implement purpose is proposed. For for-profit companies, this process focuses on

achieving two fundamentally important outcomes:

a) Growing the financial value of the company;

b) Meeting the needs of its material stakeholders, including shareholders, and linking executive pay to

these outcomes.

These two outcomes are both complementary and self-reinforcing: without growth, there will be nothing

for stakeholders to share in and without sharing, the growth is unlikely to be sustainable.

The six steps are:

Step 1: Defining the ultimate objective in clear and measureable terms;

Step 2: Identify the value drivers;

Step 3: Define metrics to measure the value drivers;

Step 4: Establish target levels of performance;

Step 5: Develop narrative statements; and

Step 6: Link short- and long-term executive remuneration to purpose related metrics.

For NPOs and SOEs, the above financial outcome would be replaced with one consistent with its

mandate or guiding objective.

STEP 1: DEFINING THE ULTIMATE OBJECTIVE

Achieving its purpose should be the guiding objective for all organisations. For for-profit companies,

this means increasing the value of the company over the longer term. A company that is growing

creates opportunities for all stakeholders to benefit, provided certain conditions are met. A company

that is failing or decreasing in value benefits nobody. Valuation can be measured in a number of ways -

market capitalisation, discounted cash flow or price-earnings multiple. In consultation with

management, the board would establish target levels of performance on an absolute and relative basis.

An increase in the value of the organisation, on its own, does not guarantee sustainability, particularly

over the short term. Management could achieve this objective by, for example, indiscriminate cost

cutting to increase profitability or buying back shares to increase earnings per share. Sustainable

increases in the value of the company can only happen if value is being created for the company’s

stakeholders who, in turn, create value for the company. It is the creation of stakeholder value that

ultimately drives the value of the organisation over time. This requires that companies identify their

stakeholders – shareholders, employees, customers and others – and establish the factors that are

important to them.

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

STEP 2: IDENTIFY THE VALUE CREATION DRIVERS

In this step, a company identifies the value expected by its stakeholders and categorises these into

financial, human, consumer and societal value to facilitate measurement. Thus, when a company

develops its employees or suppliers, it creates human value; when it reduces CO2 emissions or water

usage, it creates societal value; when it makes profits, it creates financial value. These four forms of

value are closely aligned to the six capitals and triple context.

Financial value: The value a company creates for stakeholders when it grows its revenues,

manages its working capital, costs and cash flows and earns a return on capital that exceeds

the cost of this capital;

Human value: The value a company creates for stakeholders when it develops people and

creates jobs, both inside the company and within its value chain;

Consumer value: The functional or emotional value a company creates for its stakeholders by

producing goods and services to meet customer needs; and

Societal value: The value created for stakeholders through the relationships between a

company and all other external stakeholders, including its environmental, social and economic

impacts.

It is through creating these forms of value that the company is able to inc rease its own value over time.

Many companies already do a good job of identifying their stakeholders and understanding their needs

and expectations. Where they often fall short, however, is in measuring stakeholder value and in

understanding the relationship between the different forms of stakeholder value and the value of the

organisation over time so that trade-offs can be made.

For example, to what degree does increases in the skills of different categories of employees increase

the value of the organisation and over what timeframe? What is the right amount of skills and at what

cost? Is there a point of diminishing returns where further investments in employee skills add no further

value to the value of the organisation? Is it better to create value for employees or for other

stakeholders? Or is there a balance between the value created for different stakeholders and, if so,

how should this balance be determined? King IV refers to “a blend” but gives no guidance as to how

this blend should be determined.

Answering these difficult questions requires deep knowledge of a company’s industry and competitors

as well as judgment informed by experience. There are a number of things the board and management

can do:

1. They can study the literature to understand how other stakeholders, legislators and academics are

addressing the subject. Useful references include: the Sustainability Accounting Standards Board

(SASB), the Global Reporting Initiative (GRI), the International Business Council of the World

Economic Forum (WEF), or the UN’s Sustainable Development Goals (SDGs) .

2. They can attempt to quantify the impacts of previous initiatives undertaken in the company – for

example, what was the result of the last drive to improve employee engagement or corporate

culture?

3. They can benchmark themselves against leading companies in their industry – for example, what

is our closest competitor achieving with respect to CO2 emissions or water usage and are there

recommended industry standards?

4. They can get the views of the stakeholders themselves through appropriate engagements.

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STEP 3: DEVELOP METRICS

The next step is to develop metrics for the different forms of value listed above. The metrics should

ideally be expressed as outcomes, rather than the more commonly found inputs or outputs. This

distinction is important. To illustrate, for an organisation that provides training:

Input: skills and finances required to develop the courses;

Output: number of courses developed, number of times the courses are run or number of

delegates attending the courses; and

Outcome: the degree to which attending the courses has resulted in an improvement in the

delegates’ or their companies’ performance as well as the value created for the other

stakeholders of the companies concerned – employees, customers, suppliers and communities.

Each step in this value chain can and should be measured. Internal measures of efficiency are

obviously important, but they do not reflect the achievement of the organisation’s purpose. Only

outcome metrics do this.

Examples of outcome metrics are given in Table 1 below .

STEP 4: ESTABLISH TARGET LEVELS OF PERFORMANCE

Short and long-term targets should be established for each metric. This often presents a problem for

boards and remuneration committees due to the information asymmetry between them and

management and management is able to set easily reachable targets and earn bonuses without having

added any real value. Setting targets for the selected metrics should be a rigorous process which

includes, for each metric:

Understanding the current level of performance as the baseline;

Developing a scale of performance for each metric to provide a road map for the future. This is

a two-step process:

Analysing the historic relationship between each metric and the ultimate objective to

decide how much of each kind of value should be created; and

Regardless of its contribution to the company, a minimum level of performance should

be required for each metric that is important to stakeholders. Companies are part of

society and it is expected that they should contribute to social initiatives such as

schools, small businesses or recycling initiatives, even if there is no immediate

payback;

Each metric should be benchmarked against similar industries from published information. This

will guide the setting of the company’s targets.

SABMiller followed a rigorous process in the above. For each of their ten “Sustainable Development Priorities”, they developed targets at five levels:

a) Minimum standard;

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

b) Progressing;

c) Developing leadership;

d) Best practice; and

e) Leading edge.

Each year, they reported their actual performance against these targets.

Coca Cola has a longer-term water usage objective of 1,7 litres per litre of Coca Cola produced,

down from today’s figure of 1,92 and 2,7 in 2004. The target of 1,7 is considered feasible with

current technology at a cost they believe is acceptable.

Better performance would be possible, but only at a significantly higher cost which would prejudice

the interests of other stakeholders. Setting targets for sustainability objectives is not straightforward

and there’s no “right” answer. It requires knowledge of the industry and judgment.

BHP Billiton, Shell and BP are also good examples of companies that link executive incentives to

their companies’ impacts on climate change

Value driver Metric description Target levels of performance

Threshold Target Stretch

Financial

Growth of revenues (%)

EPS growth (%)

Return on capital employed (%)

5%

8%

12%

7%

10%

13%

9%

12%

14%

Human

Retention of key employees (% turnover)

Employees meeting required skills (%)

Employee engagement rating (%)

Females in senior management ranks

(%)

6%

75%

65%

20%

5%

80%

75%

30%

4%

90%

85%

40%

Customer

Customer satisfaction ratings (%)

Key customer retention (%)

Innovation: revenues from new products

(%)

80%

70%

10%

85%

75%

12%

90%

80%

14%

Societal

Jobs created in supply chain (number)

Reduction of CO2 emissions (%)

Supplier diversity (% BEE procurement)

500

20%

12%

750

25%

15%

1 000

30%

18%

Table 1: Examples of outcome metrics and targets

STEP 5: DEVELOP NARRATIVE STATEMENTS

The company should develop narrative statements for each value driver and metric chosen. Narrative

statements bring rigour to the thought process and communicate to stakeholders the factors the

company considers important in its efforts to create sustainable value, for example:

Why the particular metric was chosen and how it contributes to the ultimate objective of

growing the value of the organisation over time;

The degree to which the chosen metric mitigates risk. The board should ask the question: “what

risks may arise if we do not focus on this metric?”

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

How trade-offs between the metrics will be made. This should help answer the question “is it

better to produce more human value or more societal value?”

Where the data to support the metric will be obtained and how the data will be validated to give

stakeholders confidence in its consistency and comparability;

On what basis targets were set; and

Which value drivers have been included in the company’s incentive schemes and which have

been omitted, with reasons for both.

STEP 6: LINK EXECUTIVE REMUNERATION TO PURPOSE RELATED METRICS

The final step is to link executive remuneration to the most important metrics and targets in its

strategy, examples of which are listed above. Because of the difficulty experienced by remuneration

committees in this regard, The Purposeful Company20, recommend the following:

Performance-based metrics, which are not easy to set or calibrate, should be deemphasised in

favour of long-term holdings of restricted shares by executives;

Where performance-based short-term incentives are used:

Executive remuneration should be linked to those few metrics that the board believes

will have the greatest impact. Too many will be a distraction. These may change

periodically to reflect the priorities of the board at that time;

Performance-based targets, where used, should be linked to a selection of the value

drivers in Table 1 at threshold, target and stretch levels;

Remuneration committees should set targets such that a minimum level of performance

is required in each of the defined stakeholder value categories;

Incentives should be capped to avoid excessive focus on easily achievable metrics, but

which have diminishing returns;

Short-term incentives may be paid in cash or shares with potential matching

arrangements if shares are selected (current trends for executives are a combination of

cash and shares specifically to align with longer term value creation).

As regards long term incentives, senior executives should be required to build a holding of

shares equal to at least twice their annual gross salary. This could be achieved through

signing-on awards, vested LTIs and the payment of short-term incentives in shares. Shares

should be released for sale on a phased basis over periods of not less than 5 - 7 years, with at

least half of the shareholding requirement applying for at least 2 - 3 years after leaving the

company. The block-release of shares should not be triggered by any defined event (for

example, retirement). This will strongly encourage long-term thinking with executives.

The following example illustrates how sustainability factors could be incorporated into short-term

incentives. Assume that the remuneration committee has determined that the maximum of the short -

20 Executive Remuneration Report http://www.biginnovationcentre-purposeful-company.com/wp-content/uploads/2017/11/feb-

26_tpc_exec-rem-final-report_v3-tg.pdf

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

term incentive for the CEO in a specific year, calculated as a multiple of annual guaranteed pay, is

R1,6 million.

The remuneration committee may further decide to link this incentive to performance against selected

metrics, appropriately weighted, drawn from Table 1. As shown in Table 2 below, four metrics have

been chosen, one each from the financial, human, customer and societal categories. The standards of

performance for incentive payment purposes, have been taken from Table 1 above.

Performance

metric Weight Maximum bonus

STI pay at different levels of

performance

33% of bonus paid

at threshold

100% of bonus

paid at stretch

EPS growth 40% R640 000 R211 200 R640 000

Employee

engagement 25% R400 000 R132 000 R400 000

Customer service

rating 20% R320 000 R105 600 R320 000

Reduced CO2

emissions 15% R240 000 R79 200 R240 000

Total bonus 100% R1 600 000 R528 000 R1 600 000

Table 2: Short-term incentive awards

The actual bonus paid for any level of performance would be a linear relationship between the

minimum and maximum bonus level in the Table 2. Thus, for the EPS metric:

Chart 1: EPS – Bonus Relationship

Reading off the graph, performance of 10,5% EPS growth would yield a bonus for that component of

the short-term incentive of 75% of the maximum of R640 000, or R480 000.

The following additional conditions would apply to the payment of short-term incentives:

1. No bonus would be paid for below-threshold performance;

30%40%50%60%70%80%90%

100%

8 9 10 11 12Pe

rce

nta

ge

of

ma

xim

um

b

on

us (

%)

EPS growth (%)

EPS - bonus relationship

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

2. The remuneration committee may decide to cap the bonus paid for certain elements at the stretch

level to avoid incentivising performance beyond the point of diminishing economic returns;

3. The payment of bonuses would be subject to qualifiers and/or modifiers:

a. Qualifiers: Two types of qualifier could apply:

i. If there is a fatal accident, the STI for execs could be reduced by a pre-stated percentage

or cancelled altogether;

ii. The four metrics in Table 2 should be seen as a package. Thus, qualifying for a bonus for

any one of the elements is conditional on achieving at least threshold performance in all

four elements. This will encourage execs to focus on all areas of performance;

b. Modifiers: the total quantum of STI award could be increased:

i. If EPS performance is above stretch and the performance for the other three elements is

simultaneously at target or higher. Again, this would encourage all-round performance;

4. The remuneration committee would retain a degree of discretion in the payment of short -term

incentives to guard against windfall gains due to unusual events or unintended consequences;

5. The remuneration committee would include malus and clawback provisions into the remuneration

policy. Malus refers to the partial or total forfeiting of unvested awards to enable the company to

cancel previously granted awards in cases of inter alia misstatement of results, fraud or

negligence. Clawback refers to the return of previously paid awards to executives for specified

reasons or triggers and may continue to apply for a period after an executive has left the

organisation.

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

Summary and conclusion

Focusing solely or excessively on the interests of short-term shareholders damages not only the

interests of a company’s other stakeholders, including its long-term shareholders, but also its

sustainability as an organisation. To address this, companies are increasingly being encouraged to

clarify their purpose and to build their strategies, policies, metrics and incentive schemes around this

purpose.

A company’s purpose should explicitly recognise and quantify the needs and expectations of all its

material stakeholders, including its shareholders. Many companies already do this to some degree –

they identify their key stakeholders and note the issues that are important to them. But purposeful

companies go further - they make the delivery of clearly defined stakeholder outcomes central to their

strategies so as to achieve their purpose. Thus:

1. They understand that growing the financial value of the company and providing value to

stakeholders are mutually reinforcing. Financially strong companies have the resources to provide

value to their stakeholders, and companies that provide value to their stakeholders are often

financially strong. Financially weak companies tend to cut corners on environmental, social and

other issues often considered “soft”;

2. They include in their strategy outcomes what they believe are important to the achievement of their

purpose, for example:

a. Growth in profits and returns (financial);

b. Improvement in employee engagement ratings (human);

c. Acquisition and retention of key customers (consumer); and

d. Jobs created in the value chain, including suppliers and customers (social) .

3. They identify metrics to measure each of these outcomes and they commit themselves to defined

levels of performance;

4. They link variable executive remuneration to the achievement of stated outcomes:

a. Long-term: executives build a significant shareholding in the company to align their interests

with the growth in value of the company. Shares vest over an extended period, often 5 -7 years,

which can extend into retirement;

b. Short-term: executives are awarded cash bonuses, convertible to shares, for the achievement

of defined outcomes in each of the four categories listed above – financial, human, consumer

and social.

Companies that do the above are giving more than lip-service to their stakeholders. Rather, they are

committing themselves to delivering clearly defined and measureable levels of value to their material

stakeholders and linking the remuneration of executives to their performance to these outcomes.

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Guidance for Remuneration Committees - Linking Executive Pay to Organisational Purpose

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