Linking a portion of executive compensation to ESG principles is becoming a mainstream governance practice. According to the study “Linking Executive Compensation to ESG Performance”, the percentage of S&P 500 companies that have adopted ESG performance measures is increasing at a steady pace – from 66% in 2020 to 73% in 2021.
One finding of the survey is that the application of ESG-based incentive compensation goals is not an isolated activity, but reflects the practice of the vast majority of S&P 500 companies. “For example, some companies are moving from including ESG measures as part of the often-qualitative individual performance section of the annual incentive plan to incorporating ESG performance as a more quantitative modifier of the company’s overall financial performance rating, which is more aligned with investors’ preferences and expectations. Other companies are expanding the scope of those whose compensation is affected by ESG measures beyond the C-suite, reflecting that achieving ESG goals requires the collective effort of the employee base more widely”, the report says.
Companies are also embracing different approaches to factoring ESG into executive pay and are continuing to refine their ESG measures as they expand their reach. The most accepted approach is the use of DEI (diversity, equity and inclusion) related goals, which increased from 35% in 2020 to 51% in 2021. In addition, a growing portion of S&P 500 companies are linking carbon footprint and emissions reduction targets for executive compensation (from 10% in 2020 to 19% in 2021).
According to the survey, two primary motivating factors for incorporating ESG measures into executive compensation are: to emphasize to investors the priority a company places on its ESG initiatives and to support satisfaction of the company’s ESG commitments.
Companies can link executive compensation to ESG successfully; however, they will need to go beyond simply “following the trend.” For that reason, The Conference Board suggests some actions organizations will need to take:
- Identifying goals that are material, durable, and auditable.
- Assessing whether what the firm’s peers are doing in this area is instructive.
- Deciding whether to make performance measures absolute or relative to the market, and quantitative or qualitative.
- Determining the scope of those whose compensation is affected by ESG goals.
- Considering timing and assessing whether the ESG goal is appropriate for the annual or long-term incentive plan.
- Ensuring the type of metric reflects the firm’s corporate culture.
- Carefully considering the reaction of various stakeholder groups.
- Reevaluating goals periodically to ensure that the ESG measures are still relevant and effective.
Source: The Conference Board