More companies are linking executive pay to environmental, social and governance (ESG) performance. But few see it as critical to sustainability goals, revealed a new study.
According to the report, carried out by The Conference Board with Semler Brossy and ESG data analytics firm ESGAUGE, large US companies are increasingly linking executive compensation to some form of ESG performance; with the share growing from 66% in 2020 to 73% in 2021.
At the same time, just a minority of polled corporate executives said including ESG performance goals in executive pay is very important in achieving their ESG goals. Most view such measures as being of medium importance. This indicates that incorporating ESG measures into compensation is just part of companies’ broader efforts to achieve their objectives.
TYING EXEC PAY TO ESG PERFORMANCE
Large companies are increasingly tying executive compensation to ESG performance. The share of S&P 500 companies linking executive compensation to some form of ESG performance grew from 66% in 2020 to 73% in 2021. The increase, in part, can be attributed to demands from external stakeholders.
There are large increases in companies incorporating DE&I and carbon-related performance goals. Companies increasing Diversity, equity & inclusion goals in the S&P 500, jumped to 51% in 2021 from 35% in 2020. Companies increasing carbon footprint and emission reduction goals went up from 10% in 2020 to 19% in 2022.
Large disparities exist among business sectors. Companies in the utilities sector (100%) and energy sector (90%) are most likely to tie executive pay to ESG performance. But only 55% in the consumer discretionary and IT sectors would tie executive pay to ESG performance.
COMPENSATION APPROACHES USED TO LINK ESG
Organisations are most commonly tying executive compensation to human capital management goals (64%). This is followed by governance performance goals (38%) and least frequently to environmental goals (25%). Many companies are taking a variety of approaches in tying executive compensation to ESG performance. Additionally many often do not set specific numerical goals. For example:
- Around half (49%) of S&P 500 companies use Individual performance assessment for factoring ESG goals in executive pay. In this approach, ESG is considered part of an executive’s individual performance rating. This is usually a discretionary assessment by the company’s compensation committee.
- Business strategy scorecard is used by 48%. In this approach, ESG goals are included and assessed as part of a broader scorecard of ESG or non-financial business priorities.
- Standalone ESG metric is used by 24%. In this approach, ESG is incorporated through specific (often quantitative) metrics.
- Modifier metric is used by 6%. In this approach, ESG can be used to adjust the financial performance rating, the overall rating, or the payout under a plan..
Despite the long-term nature of ESG performance goals, most companies incorporate them into executives’ annual incentive plans. Annual incentive plans are used by 97% in the S&P 500 that have incorporated ESG into executive compensation. Long-term incentive plans are used by 12% companies. Additionally 30% of companies claimed that ESG performance is already covered by existing performance measures.
REASONS FOR ADOPTING ESG MEASURES
To understand the opportunities and challenges that companies have in implementing ESG performance goals in executive compensation programme, The Conference Board convened a roundtable with executives in compensation and ESG. Participants said the top reason to link executive pay to ESG performance goals is signalling ESG as a priority, followed by responding to investor expectations. The top two reasons for not tying executive compensation to ESG is the challenge of defining specific goals, followed by skepticism about their effectiveness.
The main reasons for adopting ESG performance measures include:
- Signalling ESG as a priority: cited by 90% of roundtable participants.
- Responding to investor expectations: 67%.
- Achieving ESG commitments your firm made: 56%.
The top reasons for not adopting ESG measures, include:
- Difficulty in defining specific goals: 50% of roundtable participants.
- Concerns about measuring/reporting performance: 35%
- Skepticism about effectiveness in driving performance: 30%
OPPORTUNITIES & CHALLENGES
The study includes various trends and lessons learned, relating to companies tying executive pay to ESG performance. In addition to the analysis showing an overall increase in the adoption of such goals, some ESG topics have gained considerably more traction than others. For example, from 2020 to 2021, the share of S&P 500 companies incorporating diversity, equity and inclusion (DE&I) goals in executive compensation grew from 35% to 51%. Additionally carbon footprint and emission goals nearly doubled, increasing from 10% to 19%.
“Companies should consider using ESG operating goals for one to two years before including them in compensation,” said Merel Spierings, author of the report and Researcher at The Conference Board ESG Center. “That allows time to see if those goals are truly relevant for the business and develop strong buy-in from management and employees. It is especially important for companies to both validate and broadly communicate ESG goals before rolling them out as part of compensation plans for a broader management or employee base.”
COMPELLING BUSINESS RATIONALE
“Compensation committees and senior executives will want to carefully consider whether they have a compelling business rationale for adopting, adjusting, or expanding the use of ESG goals in executive compensation,” noted Blair Jones, Managing Director of Semler Brossy. “The ESG component of executive compensation should do more than send a signal to investors or other stakeholders about the importance of ESG; it should help drive the company’s business strategy and ESG programme.”
Only a minority of companies believe including ESG performance goals in executive pay is highly important in achieving ESG objectives:
- Low importance: 17%
- Medium importance: 67%
- High importance: 17%
“It takes time to develop and compile reliable, meaningful data that companies can use to measure and report actual performance against ESG goals,” said Umesh Chandra Tiwari, Executive Director of ESGAUGE. “They can start by putting together a steering committee with representatives from various functions who are engaged in the company’s strategy and can understand and access the data needed to measure and report on ESG performance.”
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