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26 September 20236 minute read

Linking executive compensation to D&I metrics in the wake of SFFA: Action steps for public companies to consider

Anti-ESG sentiment has been on the rise – shareholder proposals questioning the wisdom of ESG initiatives, including those designed to foster diversity and inclusion (D&I), have more than doubled within the past three years. Additionally, some stakeholders are bringing litigation aiming to curtail corporate D&I initiatives, including shareholder derivative claims for breach of fiduciary duty, classic assertions of reverse discrimination, securities fraud claims, and claims that specific corporate policies violate state and federal anti-discrimination statutes.

This trend has seemingly increased in the wake of the Supreme Court’s decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College (SFFA), in which the Court held that the admissions policies of two universities impermissibly considered race in violation of the Equal Protection Clause of the Fourteenth Amendment. As a result of SFFA and the broader uptick in anti-D&I litigation and shareholder activism, a variety of stakeholders are more intensely scrutinizing corporate D&I policies and practices, including those that tie executive compensation to the achievement of D&I objectives.

This particularly impacts a practice that has become increasingly commonplace in recent years in public companies: the incorporation of D&I metrics into evaluation of performance-based executive compensation. A majority of the S&P 500 companies have incorporated D&I metrics into their executive compensation programs.

As the anti-D&I movement continues to gain steam post-SFFA, companies should expect increased attention on these practices and programs. Since SFFA, at least one shareholder has sued a corporation for securities fraud premised in part on allegations related to executive compensation plans that included achievement of D&I goals, purportedly at the expense of shareholder value.

In light of these developments, there are several steps that public companies may wish to consider related to executive compensation policies and initiatives that incorporate D&I metrics.

Perform a holistic evaluation of D&I programs and compensation plans

Companies should consider undertaking a comprehensive assessment of their D&I policies, programs, and initiatives and how they relate to employee compensation programs, including executive compensation. The assessment could evaluate whether those initiatives might be viewed as requiring executives to enforce quotas or implement programs that do not offer equal opportunity to all groups as a component of their compensation.

Additionally, companies should ensure that their internal policies, programs, and procedures in this area are consistent with their public disclosures, do not implicate numerical quotas or protected characteristics (as discussed below), and remain relevant and beneficial to the company’s business as a whole.

Ensure that D&I-related performance metrics are measurable, adequately disclosed, and tailored to the company’s business

Although large institutional investors generally have not come out as “for” or “against” ESG metrics in executive compensation performance goals, including those measuring progress toward D&I goals, they have stated that when companies do include such metrics, they should be appropriately tailored to the individual business, adequately disclosed, and measurable. For example, one of the largest institutional investors has previously noted that “[i]f used, ESG metrics need to be tied to strategy, quantifiable, sufficiently challenging and incentivize behavior that is clearly articulated in companies’ disclosure.”[1]

While it does not currently appear that any large institutional investors have changed their policies as a result of SFFA, many institutional investors revisit their policies toward the end of a calendar year. Accordingly, companies may see changes to those policies in advance of the 2024 proxy season.

Avoid executive compensation performance metrics involving quotas or programs with access based on protected characteristics

Among the key themes to emerge from US litigation related to D&I policies and practices is that efforts to advance D&I through quotas or by providing specific benefits only to certain groups increases litigation risk. Claims that certain D&I programs and practices are discriminatory have had some success when the plaintiff could show that the company was implementing programs based on protected characteristics to the exclusion of those who do not have those characteristics.

As an example, a corporate grant program offering resources to help minority-owned small businesses, allegedly requiring an explicit racial qualification to assess eligibility, was revised to include eligibility for all company employees after the company was sued and reached a settlement with the plaintiffs.

Accordingly, companies should consider evaluating each of their D&I-related goals in performance-based compensation plans, and any related disclosures, to assess whether they could be viewed as enforcing a quota or not offering equal opportunity to all groups. When setting performance goals for compensation awards, the compensation committee of the company’s board of directors may wish to ensure and reaffirm that any D&I metrics used as performance goals are aspirational and that achievement of these performance goals is not based on attaining specific quotas.  For example, performance goals that require executives to take a leadership role in supporting training and education focused on workplace culture would likely generate less litigation risk than goals requiring a company to have a certain number or percentage of employees within a protected class. The board could also document how the D&I metrics are tied to the company’s goals generally.

Going forward

Please reach out to the authors or your DLA Piper relationship attorney if you have questions about how SFFA and other recent trends in ESG litigation and shareholder activism may impact your D&I initiatives or executive compensation programs.

[1] See Engaging with State Street Global Advisors from the Harvard Law School Forum on Corporate Governance.