Incentivizing Safety: Does Linking CEO Bonuses to EHS Goals Work?

A company’s safety and environmental compliance and performance are critical to its long-term survival. One single catastrophic incident, such as the release of methylisocyanate gas from a Union Carbide plant in Bhopal, India in 1984 can take down even a global corporation. And, the same can happen to smaller companies and can result from smaller-scale disasters regularly enough to make wise employers cautious. But how to impress upon CEOs that these issues are as critical as production and profit?

One method, employed by more than 90% of companies in the energy and utilities sector, is to link CEO bonuses to environment, safety, and health (EHS) performance metrics. But does it work?

Playing the Percentages

One question that GMI Ratings looked at in its report Sustainability Metrics in Executive Pay was “How much of an executive’s compensation is linked to sustainability performance?” Most commonly, companies set aside a small percentage of executive bonuses (often just 5% to 10%) that is tied to a sustainability factor like worker safety or environmental performance. Where more than one sustainability factor is included in the reckoning—for example, in companies that use a “scorecard” of multiple factors—the percentage may go as high as one-quarter or one-third of the overall annual bonus.

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Another way of accounting for sustainability metrics is to calculate the bonus based on the business’s overall financial performance and then to use sustainability metrics as a “modifier” that can result in an adjustment, either up or down.
In either case, the overall effect of sustainability metrics on CEO compensation is generally small and limited to short-term incentives (annual bonuses) rather than long-term incentives such as stock options.

But is it enough to make a difference?

Bad Executive! No EHS Bonus for You!

Unfortunately, the answer may be “No.” An analysis performed by Bloomberg and published in October 2015 noted that, on average, only 12% of executive compensation at mining and energy companies is tied to EHS metrics. Regrettably, this didn’t have much of an impact on Massey Energy CEO Donald Blankenship’s compensation in 2010, when an explosion at the Upper Big Branch Mine in West Virginia killed 29 miners. Blankenship, who is now being tried on criminal charges relating to the accident, lost $150,000 in 2010 for “failing to meet safety goals,” but he still received a $669,000 bonus; only 10.5% of his bonus was tied to safety performance. For most of the other S&P 500 energy and mining companies that tied executive pay to safety in 2010, the percentage was even lower.

Clearly, 10.5% wasn’t enough to effectively focus Blankenship’s attention on worker safety. But was Blankenship an outlier?

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Signs say no. According to Bloomberg, there’s no identifiable correlation between linking executive pay to EHS factors and worker safety. Bloomberg noted that Chevron, which does not tie executive pay to measurable safety metrics, had a recordable incident rate in 2014 that was well below the industry average, while another company, Oneok, Inc., had a recordable incident rate nearly double the median despite linking 10% of executive pay to its reportable incident rate.

Greater Percentage, Greater Incentive?

Although the two 2010 disasters—Massey Energy and the Deepwater Horizon oil spill—resulted in energy companies increasing the direct link between executive pay and EHS metrics, it doesn’t appear that those links have yet reached a level that has a measurable effect on worker safety or environmental performance. Two suggestions have been offered as to how these incentives could be retooled to have greater impact:

• Increase the percentage of executive compensation that is linked to EHS metrics. Unfortunately, there’s no firm data right now on what percentage might be “enough.”
• Link EHS metrics with long-term compensation, not just short-term compensation.

With more companies using EHS metrics to encourage executives to be proactive in risk management, these answers should eventually come.

Need more information on how to get upper management to support your EHS efforts? You can find it at Safety.BLR.com®.