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The future of reward and the rise of ESG

Reading Time: 7 minutes

The impact of the pandemic on the workplace has been far reaching, and many issues related to the ‘future of work’ have been accelerated. This combined with the rising importance of Environmental, Social and Corporate Governance (ESG) has driven enduring decisions for business leaders.

Human Resources Practice Lead and Reward specialist, Toby Burton, speaks with Roger Fairhead, Group Reward Director at Legal & General on the future of reward and the rise of ESG in 2021 and beyond.

TB: Roger, what was the biggest reward challenge you faced across 2020 and coming into 2021?

RF: Different organisations have had different reward challenges depending on the sector they are in. Clearly there are some that have had very real and immediate reward issues as their business model effectively stopped. How do you keep people going? Do you continue to pay? Do you lay them off? Do you keep them on furlough? Can you even afford the part payments on furlough?

The short-term executive reward challenges have been around the concept of appropriateness of executive pay across 2020 and 2021, particularly some of the formulaic outcomes for bonuses and long-term incentive plans.

Share vesting for example, the quantum issue around executive pay, is in much sharper focus this year. However, the real challenge for reward is going to come over the next five years. How will an organisation’s business model change in terms of how people work, whether they are working in the office or not in the office, in addition to the hours of work and the days that they might work?

It’s going to drive a new focus that is far more output orientated rather than input orientated.

The problem with reward in its very traditional sense, is that it’s mostly input-related. We still apply time-based pay; if you work for 35 hours a week you get a certain rate. So, what does that mean when people are working from home and you cannot monitor hours in quite the same way yet employees are still producing the same or greater output? Does it matter that they have produced all the output in 20 hours, but you are still paying them for notionally 35 hours?

Ultimately, we are going to have to find better measures of productivity to reward people than our current reward structures enable.

The concept of base pay – what will that actually mean in 2025?

The short-term issues of 2020, will pale into insignificance in 2021 because they are about tweaks and adjusting pay. Where there might be an excessive pay outcome for some, that is not deemed appropriate in the circumstances. At the other end of the pay scale, how do we keep people earning an income throughout this very difficult period?  The exciting longer-term piece is about a whole new concept of rewarding output which will come over the next three to five years.

TB: Do you actually see a world where a ‘big corporate’ would remove time-based pay and attach a set of outputs to a job that are then rewarded?

RF: Yes, I do think that this will happen and the most progressive companies will do it. We do have some precedence for that at the moment with contractors and gig workers. There is an element of time-based pay because that’s still appropriate, but it’s not measured by hours per week, it is by length of contract and delivering specific tasks or projects. So, the basic models are already there, we just do not use them for permanent employees at the moment.

Tech firms are looking far into the future already, so they have been able to look at their employee workforce in that way.

However, some of the larger consultancy firms will have a real opportunity as ‘people heavy’ business models drive workforce and pay innovation first. There are no barriers to any company in any industry.

TB: How is the rise in ESG impacting Legal & General and its well-known views on stakeholder capitalism?

RF: ESG is a relatively new term, but actually when you look at what it encompasses, many companies have been focussed on the elements under a different banner for some time now.

At Legal & General, we have always done a lot in the ‘S’ and the ‘G’ part, but on the ‘S’ itself, inclusive capitalism has absolutely been a focus at Legal & General. The concept that huge funds can invest on behalf of pension policyholders for genuinely good social reasons, as well as good investment reasons is positive. Doing good things for good reasons has a natural long-term outlook to it, which is exactly what pension policyholders want, so everyone can benefit from that sort of sensible long-term decision making.

The risk with the social element of ESG is that corporates might ride the political wave and then move on, thinking – ‘We’ve done our bit now’. Organisations need to do so much more because that is what drives public understanding, and it can be a force for good. Organisations need to think ‘What can we do to change that issue?’

Companies have the power through their workforce to make huge changes for the good in society.

As some have done during the past year – could call centres have been used to speak to lonely people during lockdown when call volumes dropped? I don’t think we have yet seen the full power of ‘Social’ in quite the way that we could and should. Organisations, through the collective focus of their people, have the power to change the world.

TB: How is ESG being measured at Legal & General at the moment?

RF: From the beginning of 2021 we agreed ESG performance measures in both the bonus plan, and the long-term incentive plan for executive directors and senior executives. As mentioned earlier, interestingly we have always had the ‘S’ and ‘G’ aspects within the business. We just never really particularly called it out; it was embedded in the personal objectives of employees.

We put the ‘E’ in because of the strong desire to have ESG together, but we had to think carefully about which environmental performance targets to include in the reward plans. Part of the issue is that most of the specific environmental targets that we have set out and committed to are much longer term than any of our reward plans.

Our long-term incentive plan has a three to five year performance period, but our environmental targets are 30 years, so how do you incorporate that in a meaningful way?

Executives are (and already have been) fully committed to these environmental targets – without them being included in their incentives, but the grouping of ESG together will perhaps act as an accelerator. It is important that remuneration committees are able to look at progress against ESG targets and ask; ‘Has that progress been good enough in all the circumstances? Could more have been done?’ This encourages better, quality conversations right at the top of the business. Putting ESG in reward structures makes it front and centre of everything that the company and the executives are talking about -this is a positive change.

TB: How do you measure the ‘S’ in 2021?

RF: It is difficult to measure the ‘S’ element as it has to be a subjective measurement of progress in an ever-changing world, but again how do you make that meaningful? The onus is on the non-executives holding the executives to account; and they absolutely do! It is not always useful to set very specific targets, it’s more about the challenge of; ‘What are you going to do about ‘S’ this year? And the next three to five years? What is it that you are committing to? Do you think you can do it, and could you do more?’ Strong, independent NEDS can make that conversation happen and drive change.

TB: And do you think these targets should sit below board as well into the senior leadership teams?

RF: Absolutely yes, it needs to go all the way through the organisation. I am a big advocate of target cascading; a chief executive can’t change this on their own.

It is the might of the workforce that will make the biggest change, so it’s no good just having targets at the top, you have got to cascade all the way though the organisation to make the most positive change.

Otherwise, it becomes a PR campaign, rather than having a sustained impact that is driven throughout the year by the entire workforce. This should apply to all targets. Even employees at the lowest level in an organisation can be focussed on asking themselves the question, ‘What is it that I can do in my job that will make the most difference? That is absolutely critical.

Everyone can make a direct or indirect contribution to environmental matters. The key aspect is to bring the focus to the employee that environmental issues matter. It’s about getting employees to think about ESG in a different way to drive different outcomes. Cumulatively they will make a huge difference and that is the opportunity.

TB: How is the ESG conversation playing out with shareholders?

RF: I think it’s about having the conversations up-front or signalling an intent with shareholders. At L&G we did this as early as 2019 when we started talking about ESG, and in 2020 we then committed to have specific ESG targets in both our bonus and our long-term incentive plans. We then continued to consult with shareholders and take soundings about what those specific ESG targets might be, and then in 2021 we embedded them. So, these are definitely long-term conversations.

We have also said that our annual ESG targets may change, potentially each year, as we get better at measuring impact and progress.

Naturally we want to continue that conversation with shareholders. ESG is constantly evolving, and if we are seeing good practice elsewhere, we may wish to adopt it.

If you build trust with your shareholders as a remuneration committee and as a board (which includes the executives as well), then shareholders will trust more and give more permission to exercise discretion, which ultimately results in better outcomes.

TB: Will we see a rise in discretion given the fluidity of some of these targets?

RF: Yes, absolutely – I think that is inevitable. For discretion to work properly shareholders have to have trust; they have to be clear on the direction that they are going rather than specific rules, and put their faith in the non-executive directors to allow the remuneration committee to make that discretion. Discretion will be an increasing feature in the future, and rightly so.

TB: What advice you would give to emerging reward leaders?

RF: Huge change in the workplace and the workforce creates an opportunity to invent new approaches to reward. The broader longer-term approach is likely to be that pay needs to be more focussed on output rather than input. ‘Time-based input’ is already an ageing concept, and COVID (and the change to the working environment as a result of COVID) has highlighted the need to have a much more flexible workforce – both in terms of location and quantum.

In terms of any advice I might be able to give to emerging reward leaders, it is such an exciting landscape now, and will be in the future. I think it’s about keeping reward in proper perspective. While reward might not rank number one in our hierarchy of needs, if organisations are way off kilter with reward, almost nothing else will matter.

Reward can be a blunt tool, but it is a powerful tool to drive big directional change, to steer organisations on the right path.

For at least the next ten years we will be dominated by change in the workplace and the workforce. Reward leaders are uniquely placed to make that positive change happen.

TB: Roger, thank you so much, great to have your input and openness.