EXECUTIVE INCENTIVE SCHEMES
This is the 3rd post in a 3-part series that focuses on furthering the discussion between business leaders around:
- Developing lead and lag indicators that will assist the business in preventing and controlling the risk of a significant event, and be consistent with assessing the impact on health & safety when making changes to the business.
- Moving away from using lost time injury (LTI) data as a measure of a business’ health & safety performance and introducing a new framework for reporting injuries and illnesses that will assist the business in its pursuit to prevent harm and provide a comparable measure of health & safety performance across businesses and industry.
- Improving the linkages between executive remuneration (and executive incentive schemes) and organisational health & safety performance.
BACKGROUND
Roughly every year, since 2009, Citi Research releases a report Safety Spotlight on injury and fatality data across Australia’s ASX100 companies, plus a few extra companies that are no longer in the top 100, but because Citi Research has data from their previous year’s reporting, they include them in the list of companies. Their most recent report was published in September 2016 (the 2016 report), provided insight how executives are remunerated in relation to organisational health and safety performance.
Citi Research stated that it will continue to monitor company reporting of more severe injuries and incidents, and identify the metrics used in remuneration incentives, on the broad basis that ‘what gets measured (and incentivised) get’s managed’. The intent is to establish whether there is a correlation between remuneration incentives and a focus on more material safety risks.
In addition to the 2016 report, research was conducted by Hopkins & Maslen in 2015 into the effect of bonuses on safety, particularly for a sample of companies operating in hazardous industries. The aim of their research was to answer three questions through case studies:
- Do incentive schemes work as intended? Are humans primarily driven by financial incentives or rather motivated by other rewards?
- Do financial rewards motivate the intended behaviour or do they have unintended consequences?
- Are the right indicators being used?
A brief summary of Hopkins & Maslan’s research was provided in a 2015 report by Safe Work Australia, Implications for Leading Safe and Healthy Work, which also outlined suggestions to improve the linkages between incentive schemes and health & safety performance.
WHY BUSINESS LEADERS SHOULD READ THIS POST
Given cultural change is fostered through the influence of climate and an organisation’s safety climate is shaped by management’s policies, behaviours, attitudes and decisions, this provides a compelling argument for close attention to the structure and content of those incentives used to motivate boards and senior managers. As suggested above, ‘what get’s measured (and incentivised) get’s managed’.
Clarifying targets
The 2016 report outlined that in 2014, Citi Research investigated whether and how a suite of 32 ‘higher risk’ companies included safety criteria in CEO remuneration incentive schemes and found that 28 of the 32 companies did include a mention of safety, and a few were more explicit about how fatalities were treated; however, often the criteria, and performance assessment against them, were not clearly disclosed.
In the 2016 report, 81 companies in the sample of 128, specified safety was a part of executive remuneration. However, only 31 of the 81 companies detailed safety performance targets in their remuneration plans (i.e. Rem Report) and that lagging injury measures (usually LTIFR and/or TRIFR) were most frequently used to assess safety performance. See my post #4 on the ineffectiveness of measuring aggregate injury data such as LTIFR and TRIFR.
Six companies included process safety / major hazard risk in FY15 executive remuneration criteria, but generally a quantifiable target was not reported. See my post #3 on why businesses need to identify their catastrophic risks, specifically process safety risks.
Use of the fatality gateway
Interestingly, only four businesses included a ‘fatality gateway’, whereby incentives (or part thereof) are not paid if a fatality occurs during the performance period (e.g. some examples of the use of the fatality gateway in the 2016 report were: ‘should a workplace fatality occur, the safety portion of the STI is forgone’; ‘gateway condition: no work-related deaths’; ‘no fatality (gateway)’; and ‘in the event of a fatality, no award is made for the Safety KPIs’). Several more companies stated that their Board retains discretion to reduce incentive outcomes in the event of a fatality.
Short-term executive incentive structures potentially pose a strong disincentive to spending on health & safety
The SWA report found increasing attention to incentive schemes that focus on financial performance, or more specifically on cost reduction, with no countermanding incentive to ensure health & safety risks are managed effectively. The impact of these types of arrangements on senior management behaviour is claimed to have been implicated in numerous industrial disasters, such as the 2005 BP Texas City explosion.
Hopkins & Maslen found the following:
- In nearly all of their case studies, the CEOs received incentives that far exceeded their fixed pay. These comprised both a short-term incentive (annual bonus) and long-term incentive payment.
- Most annual bonus criteria tended to include a small percentage relating to safety performance.
- These typically focused on injury rates such as LTIFR or TRIFR, although in some cases the requirement for safety-related activity was evident.
- The safety criteria were subjectively applied in bonus calculations. In one example, Hopkins & Maslen noted a company that was assessed to have performed ‘marginally above target’ despite two workplace fatalities and an injury rate ‘well above target’. The exception was one organisation that applied the fatality gateway as a threshold criterion before the safety component of the bonus was paid
3. Long-term incentives were paid almost entirely on financial performance. Since these constituted the largest component of CEO remuneration, the composition was said to render safety performance “essentially irrelevant” to the achievement of the financial reward. Their impact on safety therefore needs “careful (re)consideration”.
Overall, Hopkins & Maslen found executive incentive structures to motivate a short-term orientation to organisational performance and to potentially pose a strong disincentive to spending on health & safety. The findings are consistent with prior research that suggests organisations are often forced to choose between health & safety and profit, and health & safety actions are shaped by managers’ beliefs as to what is required to ensure the organisation’s future success.
Two recent examples of where CEOs have, or have not, received their bonuses are Dreamworld and BHP. While the investigation is still open into the Dreamworld tragedy which claimed four lives, the former CEO of Dreamworld, Deborah Thomas, has long term performance rights valued at $336,000, even though she was at the helm of the company when the tragic incident occurred. Noteably, before the tragedy, Ardent was performing well financially; revenue was up 11 per cent to $687.6 million — including $107.6 million from its theme parks division, where visitor numbers were up 13.2 per cent to more than 2.4 million. Conversely, Andrew Mackenzie, CEO of BHP, received neither his short- nor long-term incentive payments in 2016 after BHP reported a record-breaking loss of $8.3 billion in 2016 (the biggest loss in its 132 -ear history) – a year that also saw the human and environmental tragedy at its joint-venture iron ore operations in Brazil that resulted in the loss of 19 lives.
Going forward
Designers of performance management and internal control systems need to critically examine the potential to motivate both intended AND unintended behaviours, and to consider possible ways to prevent or mitigate any foreseeable behaviours or consequences that are unwanted or counter-productive.
Hopkins & Maslen suggest some possible ways to balance the potential for people to prioritise short-term gain (a bonus), over long-time effects (catastrophic incidents):
- Delay payment of bonus for some years.
- Identify indicators of current safety management.
- Identify management actions to reduce catastrophic risk.
- Reward incentives to reduce catastrophic risk.
The book outlines several incentive schemes in more or less detail with their pros and cons.
The SWA report suggests that relevant health & safety information for organisational leaders can be extracted from the organisation’s health & safety performance data set and incorporated into holistic management and communication and reporting tools, such as Kaplan and Norton’s ‘balanced scorecard’.
Ultimately, the extent to which KPIs succeed in driving desired changes in performance will hinge onthe degree of alignment between:
- the performance measure (KPI),
- the behaviour that measure motivates (intended and/or unintended), and
- the organisation’s goal/s.
Thanks for reading!
