Should companies tie worker pay to green goals?

June 4, 2012, 6:09 PM UTC

An Alcoa production plant in Goose Creek, South Carolina.

FORTUNE — There’s no easy way to run a green mine. Harvesting metal from the ground disrupts the environment, even when that metal is gathered relatively close to the surface, which is the case with aluminum.

Yet Alcoa (AA), one of the world’s biggest miners of aluminum ore bauxite, has set ambitious green goals for itself. In 2010, the company said that it would cut its carbon emissions from its refining and smelting businesses by 35% over the following 20 years, compared to the amount it emitted in 2005. Also in 2010, Alcoa created a new chief sustainability officer position for Kevin Anton, who was formerly CFO of one of the company’s business units. Alcoa connects 20% of Anton’s pay to his progress in advancing the company’s green goals.

Most companies don’t tie employee compensation directly to environmental goals. That’s including the firms that tend to be ahead of the curve on corporate responsibility, says Jennifer Wagner, a principal at consulting firm Mercer’s Human Capital business.

Part of the trouble, perhaps, with moving green initiatives off of the backburner and into people’s salaries is in nailing down specific, measurable targets for sustainability. “It’s not like financial reporting,” says Wagner. When it comes to sustainability, “There really aren’t standards about the best way to track things.”

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Green goals aside, companies must set very specific goals for incentive-based pay to work at all. According to a 2006 U.S. Merit Systems Protection Board report to Congress about how to implement incentive-based pay, “Organizations must be very careful when deciding what to measure and reward, because they are quite likely to get what they measure — which may or may not be what they really want.”

Alcoa doesn’t have a numbers problem, Anton insists. “We’ve got mature processes and we’ve got a great historical database of performance, so we have the confidence to know that our metrics work.” Every year, Anton and other Alcoa employees are evaluated on their ability to reach their carbon footprint, greenhouse gas emissions, and other environmental goals they have set for 2020 and 2030.

Anton and other C-Suite members aren’t the only Alcoa employees whose salaries are tied to sustainability. In fact, the practice goes fairly deep into the organization, Anton says. Even staffers in charge of medium-sized departments have part of their salaries tied to green goals, as well as goals involving workplace safety and diversity.

The company’s green goals fold into a larger pay-for-performance culture at the mining giant. Alcoa has had an incentive based pay system for as long as Anton remembers, and he believes it’s effective. “The key here is you want to get alignment with your employees, you set aggressive targets, and you make sure those targets line up with where you want to take the organization.”

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But then there’s the question of whether incentive-based pay is ever the best solution for a company. Coupling pay with certain goals too tightly can force employees to focus on specifics in lieu of the larger picture, says Michael Beer, a professor of business administration at Harvard Business School.

“An incentive is a carrot, but it works like a stick,” he says. The risk in incentives is that employees will act out of fear that their pay will be docked, which creates a negative instead of positive rewards system. A positive rewards system, Beer says, would require leaders at a company to outline clear goals and then communicate how meeting those goals could result in an increased chance for a promotion or stock options.

“You want to get the compensation to them in a way that’s a recognition of their engagement with the company,” Beer says. “That’s the value of stock options, that’s the value of profit sharing — those are loosely coupled ways in which we remind people they are part of this community. It’s just a whole different psychology.”

Sprint (S), for example, uses a loosely coupled reward system. The company does not tie executive pay directly to its environmental projects, but corporate responsibility communications officer Marci VerBrugge-Rhind wrote in an email that some of its departments use sustainability as one of many different elements it considers when it adjusts its staffers’ salaries. And Sprint CEO Dan Hesse has been vocal about how he hopes Sprint’s green initiatives will distinguish the company from its fierce telecom industry competitors.

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Increasingly, companies are getting on board with green movements. “I don’t think it’s a fad at all,” says Mercer’s Wagner. “I think more boards and more investors are starting to ask about risks beyond financial risks. We’ve seen more and more companies issuing voluntary sustainability reports,” she says.

Yet there is still some confusion among corporations, shareholders, and consumers about what sustainability truly means. Alcoa’s incentive pay approach is one attempt to set aggressive goals for a player in one of the most historically un-green industries. The question is whether or not employees at companies that use this method truly support a green mentality, or, as Beer fears, narrow in on the numbers and wind up missing the forest for the trees. Or, in Alcoa’s case, missing the mine for the bauxite.