October 6, 2021

NACD – DE&I Metrics in Executive Incentives: Diagnose the Issues, Measure Performance

By: Robin Ferracone

This article was originally published in NACD’s Directorship Magazine

The summer 2020 protests against racial injustice served as a harsh wake-up call. While we thought we had come a long way since the civil rights movement of the 1960s, corporate America suddenly realized that it had not come far enough, with gross and systemic discrimination still running rampant. Companies started asking themselves difficult questions, such as the following:

  • Where are we on the journey toward equality, equity, and belonging among our stakeholders, particularly our workforce, our suppliers, and the customers and communities we serve?
  • What people and processes are most recalcitrant toward achieving diversity, equity, and inclusion (DE&I) goals, and how large are the gaps in attitudes, behaviors, actions, and decision-making?
  • How should we go about systemically and permanently closing the gaps for better competitive outcomes and a more sustainable future?

As companies determine how to hold their employees accountable for addressing these issues, boards are wondering whether to start incorporating DE&I measures into executive incentive plans—and if so, how. To provide guidance, Farient analyzed the current practices of S&P 500 companies.

DE&I Metrics in Incentive Plans

There is no doubt that there is growing interest in incorporating DE&I metrics into incentive plans. According to S&P 500 proxy disclosures, about one in three companies are now incorporating DE&I measures or considerations into their incentive plans or awards. Furthermore, several companies are reporting that while their 2020 incentives did not include a DE&I metric, their 2021 incentives will.

The majority of companies using DE&I metrics are doing so in their short-term incentive (STI) plans. Only four of the S&P 500 companies—Altria Group, Consolidated Edison, Prudential Financial, and Starbucks Corp.—are putting DE&I incentives into their long-term incentive (LTI) plans. It is not hard to see why this is the case: companies are simply in the early stages of learning how to measure and manage DE&I-related issues. Below is a breakdown of the approaches to DE&I improvement used by the four aforementioned companies with DE&I metrics integrated into their long-term incentive plans:

  • Altria includes DE&I as part of a strategic scorecard in its cash LTI plan. The weighting is unknown.
  • Consolidated Edison will include DE&I in its LTI plan as a qualitative metric, starting in 2021; this is weighted at 5 percent.
  • Prudential Financial will include DE&I in its STI plan in 2021 and will include quantitative LTI measures beginning in 2023
    (as a weighted modifier with a range of plus or minus 10 percent). Metrics include the following:
    • Increase the diverse representation among the leaders in the top 600 US positions.
    • Increase representation of people of color in US positions one level below vice president by 8 percent.
    • Close the gap in the employee engagement scores of our Black employees relative to other employees.
  • Starbucks will include DE&I in its STI plan in 2021 and will begin using quantitative metrics in 2023 (as a weighted modifier with a range of plus or minus 10 percent). Metrics include the target of improving Black, Indigenous, and LatinX representation in the workforce by more than 5 percent by 2023.

Financial services firms and utilities are frontrunners in using DE&I metrics. Over half of companies in these two sectors tie their executive incentive payouts to DE&I considerations, compared to less than half of companies in all other sectors. This stands to reason. Financial services and utility companies have long been highly regulated and considered members of the communities in which they operate. These types of companies recognize the importance of reflecting community diversity in their employee base. However, financial services firms and utilities go about measuring DE&I differently from one another. Large financial institutions typically “look back” on DE&I performance as a mechanism for informing pay decisions, while utilities tend to “look forward,” integrating DE&I metrics into their incentive plans as a prospective mechanism for determining incentive payouts.

Diagnosing the Issues

Companies need to pinpoint and understand the many facets of diversity in order to identify and address core issues that work against DE&I. Key aspects of measurement include the following:

  • Representation: gender, ethnicity, and sexual preference of workers by level and unit or department compared to the general community population
  • Hiring: gender, ethnicity, and sexual preference of employee candidates by level and unit or department compared to the general community population
  • Promotions: promotion rates by gender, ethnicity, and sexual preference by level and unit or department
  • Performance ratings: performance ratings by gender, ethnicity, sexual preference, and age by level and unit or department
  • Pay: equal pay by gender, ethnicity, sexual preference, and age for equivalent jobs and performance by unit or department; equal pay by gender, ethnicity, and sexual preference by unit or department, regardless of jobs and performance ratings
  • Involuntary terminations: termination rate by gender, ethnicity, sexual preference, and age by level and unit or department
  • Voluntary terminations: termination rate by gender, ethnicity, sexual preference, and age by level and unit or department
  • Employee survey indicia: feelings of inclusion and belonging, reasons for joining the company, and reasons for terminating by gender, ethnicity, sexual preference, and age by level and unit or department
  • Supplier diversity: spending on women-owned and ethnically diverse suppliers as a percentage of total spending
  • Subconscious bias: indicia of subconscious bias by gender, ethnicity, sexual preference, and age by level and unit or department; percentage of the worker population that has undergone subconscious bias training

Measuring DE&I Performance for Incentives

Among those companies measuring DE&I performance prospectively (i.e., based on pre-determined goals), a slight majority measure DE&I performance qualitatively, while the remainder measure DE&I quantitatively. This is because numerous companies are still trying to find their DE&I bearings, diagnosing the core issues and determining how to define and measure performance. In this regard, many companies are trying to define the baseline from which they can measure improvement. As businesses gain experience in measuring DE&I performance, we expect to see an increasing number of them quantify and disclose their measurement mechanisms and goals in the future.

The most prevalent measure of DE&I success is representation (for example, what percentage of employees are women or people of color), typically at the senior-most levels of an organization, with 38 percent of S&P 500 companies that use DE&I metrics in incentive compensation employing this measure. Among the companies that measure representation are Alliant Energy Corp., Southern Co., and McDonald’s Corp. Alliant Energy places a 7.5 percent weighting on representation in their short-term incentive plan and calls out in their latest proxy disclosure the percentage of the workforce that must be composed of people of color and women by year-end. Southern Co. places a 6 percent weighting on “improving representation of minorities and women in leadership and across the organization,” among other diversity measures. McDonald’s, on the other hand, sets forth a scorecard, weighted at 15 percent, that suggests a variety of quantitative targets related to “championing the company’s values, improving diversity representation, and ensuring strong feelings of inclusion among employees.”

When DE&I measures are weighted, they tend to average about 10 percent of the total short-term incentive award. When they are part of a scorecard, which could include a variety of measures, the scorecard is weighted approximately 20 percent.

Improving the Opportunity for Success

Companies are becoming aware of the importance of taking their DE&I journeys within a foreseeable time frame and holding their entire organizations accountable, starting with those at the top. This undeniably involves changing the mind-set of an organization from “making the numbers” to a holistic leadership model. The incentive system can be a powerful tool in the toolbox for holding leaders accountable for real, measurable progress. In this regard, there are five definitive steps that management and the board can take:

  • Consider whether diversity should be targeted at the corporate, business unit, or individual level.
  • Diagnose the root causes of a lack of DE&I to ensure the company is attacking the right issues and establishing the right measures.
  • Pilot measures and goals to ensure the company can access credible data on a timely, recurring basis and to establish a baseline for goal-setting.
  • Start with this baseline and aim for improvement.
  • After initial experience with DE&I measures, use specific, measurable goals to the extent possible.

Most companies believe in the business case for diversity. The real work must now begin to achieve it.

Robin Ferracone Founder and Chief Executive Officer of Farient Advisors. She is the author of the book entitled, “Fair Pay Fair Play: Aligning Executive Performance and Pay” and is a frequent presenter for well-known organizations including Council of Institutional Investors, Society for Corporate Secretaries and Governance Professionals, the National Association of Corporate Directors (NACD), and The Conference Board, among others.