There's a push for executive pay to be linked to ESG. Should this be done, and if so how?
Environmental, Social and Governance (ESG) issues now sit at the heart of good business practice, and for some companies have become a central strategic pillar. As a result, many companies around the world are linking executive pay to ESG goals - whether reducing emissions, customer welfare or workforce diversity.
The focus of business, investors and society on ESG does seem to point to the importance of paying executives based on ESG performance. But this may not always be the right answer, and simplistically adding the wrong ESG metric into executive incentives can be unproductive, and worse, counterproductive. ESG measures can also be very hard to calibrate - and setting long term targets that both demand stretching performance and yet are achievable is challenging.
Most companies and remuneration committees want to do the right thing - but find themselves navigating complex and competing pressures as they look to motivate their senior leaders to deliver on ESG goals.
To help, we have collaborated with the Centre for Corporate Governance at the London Business School in this groundbreaking report which sets out the academic evidence around ESG in pay, when companies should consider the link to pay (and when not) - together with a framework for creating a good, effective and enduring ESG performance measure.
There is no right answer - but we hope this cutting edge thinking will greatly assist companies and remuneration committees as ESG in pay becomes normal practice in the coming years.
We have also taken a deep dive into current practice in the UK - examining the 45% of FTSE 100 companies with some form of ESG linkage in executive pay.
Almost half of FTSE 100 companies now incorporate an ESG measure into their Executive Incentive Plans (45%)
Prevalence and type of ESG measure varies considerably between sectors - and between the bonus and LTIP
The graph shows the usage of E, S, and G measures in annual bonuses by sector. For each sector we show both the percentage of companies within that sector using an ESG measure as well as the number of companies this represents. For example, 100% of the Energy sector use ESG metrics – but this refers to two companies
Data Sources: We reviewed the public disclosures of FTSE 100 companies released in 2020. Annual bonus targets are published in detail at the end of the year to which the bonus relates. Therefore, data for annual bonus targets relates to targets operated in the 2019 or for March or later year ends, the 2019/20 financial year.
The graph shows the usage of E, S, and G measures in LTIPs by sector. For each sector we show both the percentage of companies within that sector using an ESG measure as well as the number of companies this represents. For example, 50% of the telecommunications sector use ESG metrics – but this refers to one company.