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Should ESG performance and executive compensation be linked?

© Shutterstock / Robert KneschkePost Thumbnail

One question is coming up more and more often – are companies serious about Environmental, Social, Governance (ESG) if they don’t link performance to compensation?

There’s an inflection point coming and those wanting to be seen as taking more than just token ESG action must find new ways to be credible. Remuneration could soon become a litmus test for whether or not a company or institution is seen as taking the ESG agenda seriously enough.

As pressure increases to report on non-traditional performance metrics, aligning compensation with ESG performance seems an obvious step to take. In the end, executive pay frameworks usually determine priorities in decision making, and if financial return trumps sustainability, then necessary actions may not be taken.

The focus needs to be right, ensuring that companies are taking action where they will have the most impact, but there are now a growing number of companies committing to link ESG action to compensation, and this is a conversation that is only going to get louder.

Are Traditional executive compensation frameworks outdated?

Yasmin Zarabi, head of ESG and general counsel at Parsable, a provider of SAAS services to digitally connect workers, says: “With global sustainable investment now topping $30 trillion, there is mounting pressure on the boardroom, c-suite and nearly every company to prioritise ESG and sustainability initiatives.

Adding to this pressure is a younger generation of workers who want to work for companies that have ethical standards. Consumers, too, are flexing their purchasing power and buying from companies who take ESG into account across their organisation and value chain.”

Salesfore introduce ESG goals

Earlier this year, Salesforce announced it would tie executive pay to diversity, equity and inclusion, as well as its sustainability and ESG goals moving forward.

Mastercard’s ESG targets

MasterCard recently took a further step from linking executive pay to ESG performance, announcing recently that all employee bonuses will be linked to meeting ESG goals. For MasterCard, the core ESG criteria it has selected on which to focus are carbon neutrality, financial inclusion and gender pay parity.

Chief executive Michael Miebach said: “While our global efforts go much broader and deeper, we’re tying compensation to emissions, financial inclusion and the gender pay gap because we have a substantial impact in these areas and because they closely align with our vision.”

UBS sustainable development objectives

The call for linked compensation is having an impact in the financial sector too. Multinational investment bank UBS recently said it was linking pay for all group executive boards (GEB) and group CEOs to explicit sustainability objectives connected to its net-zero plans.

BlackRock ESG Criteria

Meanwhile, the world’s largest asset manager, BlackRock, has updated its 2022 global principles to reflect that ESG criteria in executive compensation programmes should now align with a company’s strategy and business model, and be as detailed as other financial and operational targets for the company.

ESG targets being driven by business stakeholders

There is increasing pressure from all stakeholders to take significant, credible action on ESG targets and not simply due to growing social pressure to act.

There is increasing evidence in the academic literature that sustainability has a positive impact on the bottom line and shareholder value. There is also an increasing gap between strong and poor performers.

ESG performance focus could lead to increased shareholder returns

A 2022 report from Deloitte reported that ‘between 2013 and 2020, companies with consistently high ESG performance tended to score 2.6x higher on total shareholder return than medium ESG performers.’

Achieving that higher performance will require increased transparency and accountability across the business.

Zarabi adds: “ESG can’t just be lip service. Executives should be held accountable to ensure their companies are doing everything possible to make a real and measurable impact.”

Could ESG KPI’s work?

Without clear leadership from the top, however, this won’t happen. And one way to ensure that everyone in the business understands the importance of sustainability performance and ESG targets is to include KPIs that mean failing to incorporate sustainability into decision making means an impact on pay.

There is a difference between long-term and short-term incentives, and the decision as to whether to include ESG KPIs on basic salary, bonuses or a combination of the two will be made in connection with the specifics of an industry or operator.

While the identification of relevant ESG measures will need to include relevancy and impact on the business, and questions around measurement timelines and measurement/data issues may need to be resolved, failing to take action on compensation may soon look like a failure in governance.

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