Employee Engagement: The Next Frontier of Compensation Performance Goals

Employee engagement and its flip side—burnout—are issues receiving national attention. Many companies expect that remote work will remain at high levels in the post-pandemic world, and surveys show that most employees whose jobs are able to be performed remotely want to incorporate some degree of remote work into their schedules on a more permanent basis.

That said, workers dislike the blurring of the work-life boundary that the past year and telework have generated. Employers are thus trying to balance encouraging employees to dial back the amount of time they spend doing work with preserving connectivity and motivation. For example, Citigroup recently announced that after the pandemic it expects to adopt a hybrid work schedule with only three days per week in the office for most employees and that it now bans internal video meetings on Fridays as part of an effort to “reset” working practices. It is clear that employee engagement is of utmost importance to effective human capital management.

Indeed, investors are expressing increased interest in companies’ employee engagement efforts. This focus is warranted because a disengaged workforce can lower productivity, lead to higher turnover, and ultimately affect a company’s profitability. Just as compensation committees began to tie executive compensation to diversity and inclusion metrics when investors asked for more information about company workforce diversity, the same trajectory should be expected with employee engagement: as investor focus moves in that direction, so too will executive compensation performance goals.

Currently, the absence of set market practices in linking executive pay to employee engagement goals and the repeal of the Section 162(m) qualified performance-based exception offer companies flexibility to tailor unique performance goals to their own employee populations.

To incorporate employee engagement performance goals into executive incentive-based compensation programs, compensation committees and management can employ the following practical how-to tips:

• Assess. Consider your company’s current employee engagement measurement practices. Do you measure employee engagement? Do you have confidence in the accuracy of the results? Identify any weaknesses in or areas of improvement for accurately measuring various aspects of employee engagement.
• Organize. Consider your organization’s structure when assessing or establishing employee engagement goals. Is there a straightforward reporting structure below the top level of management? Should engagement goals apply only to those employees within the direct reporting line of the executive? Or, given your company’s particular business goals, would it be helpful to incentivize cross-departmental employee engagement measures? 
• Track and align progress. Consider the most appropriate goals. For a company with an established practice of measuring employee engagement, it may be motivating to tie payout to year-over-year improvement. Alternatively, payout could be tied to the achievement of specific employee engagement goals.
• Start small. It is common for performance-based bonus programs or awards to be grounded in multiple performance metrics, such as revenue; earnings before interest, taxes, depreciation, and amortization; free cash flow; and total shareholder return. Consider proportionally reducing the percentages of payout applicable to each existing metric and adding employee engagement goals as a metric with a relatively low weight. Testing the waters with a new metric is simply prudent.

A compensation committee considering adopting employee engagement metrics should bear in mind the corporate governance implications of doing so in consultation with outside counsel. Below are some areas of impact boards should keep in mind:

• Plan and contractual limits. To the extent that any of the compensation elements related to employee engagement performance goals are granted pursuant to a shareholder-approved plan, counsel should analyze whether there are any limits to the types of performance goals allowed and ensure that employee engagement goals are permitted. It is also important to consider whether any employment agreements mandate specific performance goals other than employee engagement goals.
• Internal coordination. Setting employee engagement performance goals will require coordination between the compensation committee and the human resources department to make sure everyone is rowing in the same direction.
• Overlap with review processes. On a similar note, an employee engagement assessment may overlap with elements of an existing performance review process, including upward or 360 reviews. It will be important to clearly identify which elements of performance will be relevant to compensation specifically. 
• The current report. Will the new performance goals require the filing of a current report? 
• Periodic reporting and proxy disclosure. How will the performance goals be disclosed in next year’s proxy statement? Will these goals fit into the company’s human capital management strategy, as this may be reported in the company’s annual report? Will they align with the company’s compensation philosophy?

Similarly, unintended consequences and litigation risks should be thought through prior to implementation. There may be collateral litigation risk, for example. Any time a company creates and compiles new metrics, there will be a paper trail at risk of discovery in future litigation. That should not stop a company from moving forward, but it does mean companies should review engagement data with care and follow up with employees and managers where appropriate to address areas of concern.

Adding an employee engagement component to executive compensation is a creative way for companies to monitor employee well-being and emphasize the importance of the broader workforce to the company’s overall strategy and performance. Doing so would be responsive to the desires of younger generations of employees to derive meaning from their work and, further, aligns the interests of the executive team with those of middle management who are faced with the day-to-day challenges of fostering employee engagement. We expect that employee engagement goals will be the next frontier in executive compensation performance metrics as much as diversity, equity, and inclusion metrics have come to be.

Robin Melman is a partner at Baker Botts. Her practice focuses on executive compensation issues and all matters considered by compensation committees. Christina Andersen is a special counsel at Baker Botts. Her practice focuses on advising clients on employment matters, including hiring and promotion practices, company culture, and diversity and inclusion.