The Advisors' Blog

The DOJ and SEC have been very clear that they want to make bad actors pay for unethical behavior. This Farient Advisors blog discusses the flip-side: how companies can pay good actors for ethical behavior. After all, an ounce of prevention is worth a pound of cure. Here’s an excerpt:

Overall, about 10% of large cap S&P 500 companies incorporate E&C measures in their executive compensation programs. These measures are most used in highly regulated sectors such as financials (50% prevalence), health care (33% prevalence), and energy (25% prevalence). While most large-cap companies have E&C programs, they may not be considered such a key part of their corporate or sustainability strategy that they are sufficiently material as a component of incentive compensation.

The blog goes on to note that there’s a lot of variability in how companies incentivize culture, and some approaches may be less effective than others:

E&C measures vary from those that promote compliance versus others that penalize for violations. Edison International will cut short-term incentive award payouts for executives in the event of any major non-compliance event at the company. Interestingly, Signature Bank reported using a measure for maintaining a “culture of high ethical standards” as part of its strategic priorities in its 2022 incentive plan, just months before it collapsed in the wave of bank failures that followed the downfall of SVB.

E&C measures are typically used qualitatively in STI plans usually as part of a broader scorecard and using both upward and downward payout leverage. About one-fifth (21%) of companies using an E&C measure apply only downward payout leverage — i.e., the measure will only shift payouts downward and cannot increase them. While 68% of companies use E&C measures with upward and downward payout leverage, the measures are typically part of a scorecard that includes other metrics, and it is unlikely that the E&C measures individually are providing much (if any) upward leverage.

The notion of compliance metrics hasn’t escaped the regulators, who also have some ideas about what that could look like. About a year ago, the DOJ adopted a policy that says prosecutors may give credit to companies that provide incentives to promote compliance. Here’s an excerpt from the DOJ’s memo:

Affirmative incentives include, for example, the use of compliance metrics and benchmarks in compensation calculations and the use of performance reviews that measure and reward compliance-promoting behavior, both as to the employee and any subordinates whom they supervise. When effectively implemented, such provisions incentivize executives and employees to engage in and promote compliant behavior and emphasize the corporation’s commitment to its compliance programs and its culture.

Despite that carrot, and despite the underlying business benefits of promoting ethics & compliance, governance-related compensation metrics that would support those goals tend to get less attention than newer flavors of metrics for environmental & social goals. Maybe that’s because ethics seems like a difficult thing to quantify. If you’re looking to overcome that hurdle, check out Farient’s blog for a chart with specific examples of metrics and other good info.

– Liz Dunshee