TOKYO -- A growing number of Japanese firms are rethinking how they compensate their top executives. In addition to the usual focus on financial performance, companies are keen to look at other factors that investors care about, such as environmental and social responsibility.
In investing, the term "environmental, social and governance" (ESG) refers to standards that socially conscious investors use to screen investments. Environmental factors are how a company treats the natural environment. Social criteria are a company's relationships with employees, suppliers, customers and communities. Governance is about the company's leadership, executive pay, internal practices and shareholders' rights.
Earlier this year, Kyoto-based Omron, a pioneer in electronic ticket gates and automated teller machines, introduced a compensation program that takes into account executives' efforts toward ESG and reflects them in their paychecks.
The company will ask an outside party to review the leadership team's performance of after three years, the end of the current mid-term management plan that runs through March 2021, and determine compensation accordingly.
Alongside sales, earnings per share and return on equity, social responsibility will be factored into executives' performance-based compensation, which could increase their total package by as much as 200%, depending on performance.
Omron, which makes everything from face recognition systems for digital cameras to blood-pressure meters, lists "sustainable corporate value growth" as a key goal. The outside party will calculate just how much Omron's corporate value is enhanced, and compensate the whole team accordingly.
Meanwhile, cosmetics company Shiseido looks at peers in the industry to determine benchmarks for business results when deciding how much to pay executives. In its annual report, the company refers to the results of cosmetics companies L'Oreal of France and Estee Lauder of the U.S., among others, in describing how it determines executive compensation.
If Shiseido's operating profit grows more slowly than that of its competitors, the upper limit on the number of stock options for which executives are eligible will be lower. If the results are better than those of peers, more stock options could be on the table.
Shiseido's rare disclosure of the names of rival companies that it compares itself to is part of efforts to be a globally competitive brand. "We have to compete with leading global players, including for recruits," said a company representative. "We wanted to make it clear to investors that we do not determine compensation just by internal measurements."
Temporary staffing company Persol Holdings has introduced a new evaluation system that executives use to set numerical targets in three categories -- brand awareness, employee satisfaction and risk management. Their success in reaching the targets is the basis for compensation.
Previously, companies were typically keen to introduce stock options and similar perks as a major incentives for senior executives. Better business performance could benefit executives as well. But companies can no longer pursue only their own interests. They are instead expected to respond to environmental, social and governance issues.
Open dialogue with investors
The next step should be to increase communication with investors.
"In the U.S. and Europe, executive compensation has become a major topic of discussion between companies and investors," said Chisato Haganuma, chief equity strategist at Mitsubishi UFJ Morgan Stanley Securities. A key tool to further dialogue is disclosure of companies' relevant information.
Companies are obliged to disclose only select information, such as total compensation amount, the names of executives paid 100 million yen ($900,000) or more, and their paid amounts. A survey by the Japan Association of Corporate Directors last year suggested 89% of 19 institutional investors found the information disclosed about executive compensation to be insufficient.
"Disclosing the policies and design of its own compensation scheme could be an effective tool for a company to advertise its growth potential and social contribution," said Naohiko Abe, head of the Japan unit of Pay Governance, a compensation-specialized consultancy. "Companies are increasingly expected to be willing to make a move." A system to evaluate how the compensation program functions could help.