- Apple is adding an executive bonus metric in 2021 measuring ESG performance.
- Last year, Apple opposed a shareholder measure that asked for a substantially similar compensation change and the shareholder is targeting Alphabet this year.
- Apple is ranked among leaders in corporate ESG, but labor and human rights issues at partners have been a continued source of concern, as well as workforce diversity.
- Social responsibility as a factor in executive pay is becoming more common, though it is still the exception at major corporations, but a 2020 marked by civil unrest and a pandemic accelerated focus.
Apple senior executives are measured on key financial goals when it comes to being awarded among the market's most lucrative pay packages, such as sales, earnings and valuation growth. Now, for the first time, executives at the stock market's largest company are also going to have a portion of their millions in cash bonus pay linked directly to factors reflecting a fast-changing world of capitalism: environmental, social and governance (ESG) metrics.
In 2021, Apple is adding an ESG "bonus modifier" to its cash incentive program which can swing the total bonus payout by 10% — executing on ESG goals can increase the bonus by 10%, while failing to hit ESG targets could cost Apple's top brass a bonus reduction of the same amount.
The new executive compensation measure revealed in Apple's recent 2021 proxy — shareholders have to approve executive compensation plans each year — comes after years of pressure from activist shareholders. In fact, just last year Apple opposed a proxy measure filed by shareholder Zevin Asset Management — which received 12% support from the company's stockholders — that asked for executive compensation to be linked to ESG. Apple argued to shareholders there was no need to narrowly link pay to ESG since its corporate mission already included ESG goals foundationally.
What changed in one year? A lot.
For starters, activist shareholders say it is common practice among corporations to resist any resolution introduced at annual meetings, even in cases where the companies are moving in a similar direction — if at a slower pace — and when they are ready will do an about-face.
"The general posture with companies toward proposals is oppose in every instance," said Pat Tomaino, director of socially responsible investing at Zevin Asset Management, which authored the ESG compensation proposal last year. The Apple shareholder said that this posture is even more likely to be the case when the issue is executive pay. "Companies desire to have a free hand with executive compensation and we see it across the marketplace. The relationship between the compensation committee and the CEO is guarded very closely."
To its credit, Tomaino said Apple reached out to him after his measure's defeat at the 2020 meeting and provided him with an indication that change was coming. He said throughout the process Apple was eager to understand what the shareholder was asking. "I don't think of shareholder resolutions as adversarial. They wanted to understand what we wanted and i never doubted they were going in good faith to compensation consultants to study and understand whether it made sense. They could have chosen to do nothing."
The past year was no ordinary year either.
After a 2020 that included civil unrest in the U.S., the Black Lives matter movement, and a pandemic that showed the financial fragility and health risks across many communities and workers, there is more pressure on companies to focus on ESG themes, such as diversity, equity and inclusion, and labor policy. "For better or worse, this year the world is a lot different than it was last proxy season," said Jannice Koors, senior managing director at Pearl Meyer, an executive compensation consultant. "Diversity, equity and inclusion is taking up a lot more bandwidth in boardrooms."
Apple declined to comment to CNBC beyond citing the proxy language.
"It will enter into the discussion more," said Courtney Yu, head of research for executive compensation consulting firm Equilar. "What happened over the course of the past year and summer has helped supercharge lots of these processes and put direct focus on how companies are looking at diversity ... and just their contribution to society in general."
An analysis by JUST Capital, which ranks corporations on ESG (Apple is No. 3 overall, behind tech peers Microsoft and Nvidia), found that in recent years among the Russell 1000 universe of companies about 20% have linked executive pay to ESG goals. That is consistent with other surveys showing between 10% and 20% of companies have some executive pay tied to ESG key performance indicators. Most are of the magnitude of the new Apple 10% swing factor in bonus pay, according to a Pearl Meyer survey from last summer. Roughly 25% of the firms that said they have an ESG pay component indicated it was less than 5%; 67% indicated it was 5% to 10%.
Executive compensation and ESG experts say the data on companies that have incorporated ESG into pay can be misleading, though, and overstate the trend's influence when the details are not considered. A significant percentage of the existing ESG compensation plans are in industries where they have been mandated for a long time due to safety concerns, such as in oil drilling, mining and other industrial operations where the risk of an accident is an immediate material and legal risk to the company.
Or as Koors put it, "Old ESG versus emerging ESG. Emerging ESG is different."
If 15% of S&P 500 companies have incentive plans with an ESG component, that includes many with the "old" ESG, according to Gregg Passin, senior partner and Mercer's U.S. executive solutions Leader. "It will be much bigger this year and in future years," he said. A small number of companies included diversity, equity and inclusion as a metric in prior years. "We expect many more this year," he added.
The majority of companies that have an ESG pay metric use a bonus modifier like Apple. It allows companies to still rely on core financial metrics, such as sales and profit, as the most influential payout measures, while bringing in newer metrics — which also may be harder to measure — on the edges.
"Is it enough? Ten percent of a bonus doesn't strike me as being a massive swing factor," said Martin Whittaker, CEO of JUST Capital.
Apple's top executives received bonuses in 2020 that were 179% of the target payout opportunity, according to its proxy.
"It's laudable it is in there at all, and it puts Apple in a minority. That's leadership. ... If we only have 20% of companies tying compensation to ESG, that tells you there is lots of room for intelligent incentive packages that will drive performance even better," Whittaker said.
Using a modifier takes the pressure off in the goal-setting process and reflects the imprecision that still exists in ESG. "Companies can't just dive into the deep end of the pool right off the bat," Koors said (her firm does not work with Apple specifically). "The question for them is, 'How do we start to introduce these measures in a way where we don't end up regretting it. You don't necessarily want to be the first one out. You can tell the pioneers by the ones that have arrows in their backs. But lots want to be a fast follower."
Pearl Meyer expects more companies will be adopting ESG metrics in incentive plans — in its summer survey the number of companies that said they were looking at adding an ESG pay metric this year (9%) more than doubled over those that said they already had one (6%). "Given the data we've seen, this is still the early adopter phase," Koors said.
Which ESG metrics, and how many, to incorporate, remains a challenging question. "That everything is important should be signalled, but on the flip side, if everything is important than nothing is important," Koors said.
Mercer's Passin recommends no more than a handful of executive compensation metrics in total, and only one or two tied to ESG, though companies can have multiple factors considered within each category.
"What are we measuring? That's the bigger problem," says Whittaker.
Climate is an area in which metrics are maturing, such as reductions in carbon emissions across multiple well-defined scopes of emissions types. But not all ESG metrics are as easy to define. "The issue is there has been no generally accepted standard set of ESG metrics," Whittaker said.
In the Equilar 500, roughly 20% of the companies tie compensation to some kind of diversity metric, "and even there, it is very broad," Yu said.
There are quantitative measurements for gender pay gap or ethnic pay gap analysis, but there is no "monolithic approach," says Koors.
The issues should not deter companies from thinking about senior executive incentive plans, though, because they drive behavior and performance throughout an organization. "You need everyone in the boat all rowing in the same direction and the more companies that make a plan like this, it can cascade down through the entire management."
"It's typically the first step companies take, the bonus modifier," Tomaino said. "Companies typically do not reorient a whole portion of equity incentive around ESG, but take an existing part of the cash bonus plan."
Even in taking its first step, Tomaino said Apple has done more than other companies that insert basic language into a proxy saying it is at the discretion of the company's compensation committee to set targets for pay, and that could include ESG performance.
Apple's move is better than a blanket statement, but "it gives them a ton of wiggle room," Whittaker said. "Sometimes getting started is the hardest thing. We expect to see a lot more shareholder pressure on executive compensation."
More shareholder measures are coming soon, and targeting Apple peers among the market's dominant tech firms. Tomaino said Zevin Asset Management will again introduce a measure at Alphabet for this year's meeting.
"Impact investors can now point to Apple and I think it is a powerful example," Tomaino said. "Our argument is there is no better way to send a signal that it is mission critical than putting a portion of executive compensation at risk. I wouldn't say Apple went from zero to 60. Apple went from zero to 30."
An Alphabet spokeswoman told CNBC in an email that in "assessing the individual performance of our executive officers, the Leadership Development and Compensation Committee considers their performance against a number of strategic goals, including those related to sustainability and diversity."
Tomaino described Alphabet's approach to similar resolutions introduced over the past three years as "less transparent" than Apple.
"It is harder to tell if they are considering a change and their contention to us is that within each executive performance review there are certain basic sustainability issues on the table. Our contention is we want ESG aimed at senior officers and need more on what the mechanism is. And we have not been able to understand it over the past three years," Tomaino said.
For Apple, the proof that the ESG metric matters won't come until next year. That is because companies do not actually detail their compensation awards and how they arrived at those awards until the following year's proxy.
"We have to wait and see how serious they are about using this tool now that they have it," Tomaino said.
Investors will be looking at the discussion in next year's compensation section of the Apple proxy and how executive payouts moved up or down in respect to ESG. "That's what we get with any other financial and we are already pushing on Apple to outline what investors would want to see."
"No one telegraphs this in advance," Koors said.
Apple has increased transparency on climate and raw materials relative to conservation, and investors want to see that metric-approach in supply chain risks and with diversity and inclusion. As examples, that can include recruiting at historically Black colleges and universities, and employee participation in affinity groups.
"The labor issues in their supply chain are a big issue, as is progress on diversity in engineering," Tomaino said. "Tim Cook has described these issues as mission critical and ESG is financially relevant right now and into the long term. It is time for Apple to put their money where their mouth is ... a warts and all analysis. My message is consistent to companies: as an investor I don't want to substitute my judgment for their own or micromanage. They tell me which are the most relevant factors for them and how to get there."
Companies should be less concerned about looking bad and more focused on how to improve, but that worry is in the air.
"What does scare companies is having to report on it, if it is metric you have to disclose and talk about how you did next year," Passin said. "It takes the brave company to be serious about this and put it in, in a real way."
But Passin does think we will start seeing purpose-driven compensation more tied to a multi-stakeholder view of a corporation.
Moving ESG into long-term incentive plans rather than just the annual cash bonus ultimately is appropriate, he said, and it is a conversation that Mercer is starting to have with clients. "But it is not going to be fast," Passin said. "Holding executives accountable, just like with EPS and revenue, you need to be able to measure it. Metrics are not magic. You need a strategy on how to achieve it and how to build facts and end goals. Many companies are not ready yet."
Some critics of executive compensation are focused on the disparity between CEO pay and median worker income — Apple CEO Tim Cook makes 256 times the median Apple employee pay of roughly $58,000. And they say as long as CEOs are paid enormous sums, factoring ESG into that pay does not solve the larger problem. But Tomaino and other ESG experts said while wage disparity is among the bigger ESG issues, shareholders shouldn't view it as overriding the broader ESG-linked compensation discussion.
"It is the most profitable company in the world and the simple reality is high-pay decision makers should not be sheltered, isolated and unaccountable from what happens on the ground," Tomaino said. "CEO to worker median pay ratio is one metric of how divorced a leader is from what's happening on the ground, but it doesn't tell the whole story. At Apple, imagine the gap between Tim Cook and not just the Apple software engineer but those who shuffle in and out of supply chain factories."
"If the company proves that the goals they set were rigorous such that the 10% modifier plus or minus doesn't always end up being positive, if we see examples where they set goals and they were not layups and money was taken away, then give them credit for it," Koors said.
Apple's example will draw this into more peer conversations, but it may not see quick traction across the broader market given that so many companies are dealing with financial pressures caused by Covid-19. "The lingering effects which aren't going away any time soon may keep executives focused on financials," Equilar's Yu said. "Time will tell how impactful it is but any time a big name like Apple is saying that they are going to put more of a focus on ESG it can make some waves."