More Companies Use DE&I as Executive Compensation Metric

​Diversity, equity and inclusion (DE&I) objectives figure into an increasing number of executive pay programs. But these programs typically are annual bonuses rather than long-term incentives, which lessens their impact.

"In the 12-month period to Sept. 30, 2018, 51 companies in the S&P 500 included a diversity metric in their compensation program," according to Glass Lewis, a governance solutions firm, in its Racial & Ethnic Diversity in the Boardroom report. "In the 12-month period to Feb. 1, 2021, that number had nearly doubled to 99 companies." 

Aalap Shah, managing director of Pearl Meyer, a compensation advisory firm in New York City, said, "There's been a significant uptick in incentive plans tied to diversity and incentive goals. Larger companies are leading the way."

But he noted that "the actual impact on pay is not that significant" because most of the incentives are in annual programs rather than long-term incentives, such as stock options.

"A metric like diversity belongs in long-term programs more than short-term incentives," Shah said. If included in long-term incentives, concentrated DE&I efforts could be made in incremental steps over three, five or even 10 years, rather than "one-and-done" quick fixes that may not last.

Large Companies Linking Executive Pay to DE&I

Starbucks and McDonald's are two of the few companies to create long-term incentive programs around DE&I. In October 2020, Starbucks announced it would for the first time link executive compensation with success in achieving the company's environmental, social and governance (ESG) goals.

"The changes to the annual bonus plan created a more direct tie between executive compensation and the goal of creating a more inclusive and diverse company," Starbucks noted. The company was "increasing the individual performance factor from 30 to 50 percent of the overall payout calculation, with the goal of holding senior leaders individually accountable to drive inclusion and sustainability."

Starbucks is one of the few companies to create a long-term incentive program for the U.S.-based senior leadership team. Executives are collectively accountable for three-year representation targets focused on increasing Black, Indigenous and Latino representation in managerial positions in the corporate sector. If targets are met or exceeded, payout increases by 10 percent. There will be an automatic 5 percent reduction to payout if growth is 0 to 5 percent, and 10 percent reduction to payout if growth is negative.

McDonald's aims to increase the number of women in leadership roles—senior director and above—from 37 percent to 45 percent globally by the end of 2025, with a goal of reaching gender parity by the end of 2030. The company also is setting goals for increasing representation of historically underrepresented groups in leadership roles—senior director and above in the U.S.—from 29 percent to 35 percent by the end of 2025.

For the company's target incentive program, executives will be measured on metrics related to championing the company's core values, improving diversity representation for women and underrepresented groups, and creating a strong culture of inclusion among employees. The 2021 short-term incentive program metrics will be operating income growth (42.5 percent), systemwide sales growth (42.5 percent) and human capital metrics (15 percent).

Benefit of Tying Pay to DE&I

"Based on empirical evidence, we expect that over the long term, diversity and inclusion will lead to better financial performance and investment returns, thus justifying the higher CEO pay," said Simiso Nzima, head of corporate governance for the California Public Employees' Retirement System in Sacramento, Calif. "This is about pay for performance and long-term investment returns."

He added, "It is therefore important to include diversity, equity and inclusion metrics as part of performance evaluation at every leadership level in a company since we know that what gets measured gets managed."

"Increasingly, we see consumer behaviors being shaped by companies' public ESG commitment, and ESG-focused companies are also better equipped to highlight their purpose, giving them an advantage in attracting and retaining new-generation talent," said Kenneth Kuk, senior director, executive compensation with Willis Towers Watson in Washington, D.C.

"Keep in mind that DE&I is not only an HR priority. It's a boardroom priority, and by extension it's a top executive mandate," he said.

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Most Firms Aren't Yet Linking Pay to DE&I

While more firms are tying executive pay to DE&I, the practice is "still relatively uncommon," according to Glass Lewis.

"Most companies agree that diversity is important to their long-term success but find it difficult to include it in incentive plans," Glass Lewis stated in its report. The firm attributes the reluctance to join the trend to several factors:

• Some companies found it difficult to measure performance and disclose achievement in brief with data that in some cases is considered sensitive.
• Others do not include DE&I in their incentive plans because it is something that is always expected to be considered by all executives, not something to specifically incentivize.
• Several organizations cited the stigma associated with using a quota as the reason for avoiding quantifiable metrics.

As for those fearing claims of reverse discrimination, Shah dismissed this concern, saying companies "wouldn't overcorrect on diversity."

He said, "There's a swell of interest in having companies more accountable to diversity. Now institutional shareholders are moving the needle."