Companies are increasingly looking to ensure that their boardrooms reflect the makeup of their customers, and society as a whole. Yet the push for ethnic and gender diversity is not limited to the boardroom. Diversity-related goals and considerations have started to enter the conversation as compensation committees develop their executive pay programs. Although still relatively rare, we have observed a number of companies in a variety of sectors include diversity considerations when determining payouts.

But even when you know that diversity is a key indicator, determining how to measure performance in this area remains tricky. In most cases, companies include diversity as a subjective consideration when assessing individual performance, or as a portion of a discretionary component of an incentive plan, rather than a weighted, quantitative metric. Usually, there is no clear disclosure of what specific diversity goals or achievements were considered, just a brief sentence or two stating that it was a factor in the outcome. Perhaps that’s understandable – diversity performance isn’t necessarily quantifiable and, even when you can measure it, gathering that information can present other problems. As a result, for many companies, achievement is determined subjectively based on internal benchmarks and goals.

Glass Lewis recognizes the value of including environmental and social factors, including those related to diversity, in executive compensation structures – and the difficulty of measuring them. As such, we tend to view discretionary assessments of these areas with less skepticism than we would for financial or operational performance. That said, we understand that investors have valid concerns about reliance on ‘soft’ or ‘squishy’ targets.

Whether companies choose to assess diversity performance on a discretionary basis or as part of a formal metric, our focus is on the level of disclosure provided, and alignment with outcomes. A soft goal reviewed by a judicious board can give better outcomes than a poorly structured weighted metric. It is the board’s responsibility to make sure that either structure works. Investors have expressed wide ranges of preferences on this topic as well; a recurring theme is to ensure that the goals included are challenging and do not reflect de facto guaranteed payouts.

Because diversity goals are set subjectively based on organization-specific factors, with exact considerations generally undisclosed, it is often difficult to assess just how stretching or rigorous they are. In our observation, when diversity is assessed on a discretionary basis and/or as part of the overall consideration of an executive’s individual performance, they pay out at target level or higher. As such, where specific targets are absent, we look for non-boilerplate explanatory disclosure that provides context as to the performance assessment and ultimate award outcome.

Companies Including Diversity in Executive Compensation

When diversity is included in executive compensation, it is typically a component of the short-term incentive (STI) plan. In many cases, companies have made it clear that diversity is a consideration without necessarily providing specific details. For example, see Archer-Daniels-Midland Company (ADM), whose STI plan is determined through a bonus pool, with one quarter of payouts based on individual performance including a consideration of “advancement against our Diversity and Inclusion goals” (Form DEF14A filed March 25, 2020). This approach is in line with most companies that have taken the step to include diversity in their compensation program.

However, there are certain companies that have gone above the norm by including diversity as a weighted metric. Edison International (EIX) includes “Diversity, People & Culture” as a 10% weighted metric under its short-term incentive plan (Form DEF14A filed March 13, 2020). Rather than simply stating that the outcome is determined subjectively, Edison lists a tangible goal under the metric, specifically increasing the diversity of executive and leadership populations. Edison also discloses the actual result, an increase of 1.6%, noting that the goal was met. This level of disclosure is relatively good, but not common practice for most companies.

While diversity goals are typically included under a company’s STI plan, we have also seen instances where they are included in long-term incentive (LTI) plans. For example, Prudential Financial, Inc. (PRU) included employee diversity as a modifier for its performance-based LTIs in the 2018-2020 performance cycle. Under this plan, payouts could increase or decrease by as much as 10% depending on the change in the representation of diverse persons in senior management (Form DEF 4A filed March 28, 2019).

It’s unclear whether Prudential will retain diversity goals for future LTI cycles, but it appears Starbucks Corporation (SBUX) is following their lead. In the second-wave coffee giant’s Form DEF 14A filing on January 22, 2021, they disclosed that they will hold senior leadership collectively accountable for meeting a three-year representation target under their FY2021 long-term incentive plan. The target focuses on improving in Black, Indigenous and LatinX representation at the manager level and above by more than 5% by 2023. Like at Prudential, payouts can be modified upward or downward by as much as 10% based on performance against this goal.

Time will tell how long-term diversity performance ultimately impacts payouts in the cases of Prudential and Starbucks, but the inclusion of diversity considerations is a trend that appears to be growing. Rather than simply stating that they value diversity, more and more companies are taking steps to tie some portion of compensation to advancing it. Just how to measure diversity remains an open question, but it is being measured – and what gets measured, gets managed.

For more information on Glass Lewis’ approach to executive compensation and ESG issues, including diversity and inclusion, contact:

GROW@glasslewis.com (Institutional Investors) | ENGAGE@glasslewis.com (Public Companies)