Executive compensation
ESG metrics are set to transform compensation packages for CEOs.
US companies had made an explicit link between executive pay and achieving environmental emission reductions – and then only linking reduction targets to long-term pay.
1/5
The number of companies in the Russell 1000 Index that reported all three ESG governance data points in 2022, up from 1/10 in 2020.
JUST Capital 18% JUST Capital 26
The percentage of companies in 2022 that disclosed all three data points, up from 7% in 2020.
Gosling, for his part, has similar concerns. “Of course, we should put ESG targets in pay, but actually I think there are some real unintended consequences underlying it all as well,” he says. Of these, the academic identifies several categories that these risks fall into, the first of which is capturing and measuring the actual metrics involved. After all, measuring the full impact of ESG goals in compensation is a greater challenge than the impact of traditional or financial metrics. How, for example, to measure carbon reduction when there are so many different methodologies – and when global emissions can’t easily be compared with those of individual companies? From there, Gosling highlights another risk: “that you can hit the target and miss the point”. As an example, he emphasises the multifaceted problems facing diversity targets. Appointing more gender- diverse and ethnic-minority candidates onto a board is all well and good – but does that mean much if they all went to private school?
There is the danger that, by implementing superficial board diversity, people become less concerned with promoting an inclusive culture across the company. The third risk Gosling highlights involves distorting incentives – and placing them above other targets such as innovation and development. “The obvious example of this was around the diesel mechanism put in place in the European car industry to make diesel engines look cleaner than in fact they were.”
The final risk is “more pay and not more ESG” as a result of putative environmental targets. Omens agrees, pointing out the real concern of “greenwashing” that a lack of clarity over processes can cause. To put it differently, companies can set a percentage of pay related to ESG targets – without ever delineating the
strategy and goal the company is attempting to meet. “If you don’t understand why the pay metric is there,” Allen adds, “then of course you’re always going to question it.”
Wages of creation?
Regardless of the risks, ESG metrics seem destined to transform compensation packages on both sides of the Atlantic. But can they really change the planet? “What gets measured gets managed,” is how Omens puts it. Ensuring, therefore, that goals are meaningful, and are disclosed fully, is essential to ensuring ESG pay compensations make an impact. A Harvard study suggests that using ESG goals for one to two years before including them in compensation packages could help counter these worries, as it would give companies time to measure and report relevant ESG data. Walton, for her part, is keen to emphasise that if emissions are tied to financial metrics and executives are held accountable, the planet really could benefit. Even so, poor implementation by companies remains an issue, which risks doing nothing except making wealthy executives even richer. Multinationals, therefore, will need to justify the inclusion of ESG in compensation packages – and its role in achieving something practical for the planet. “We’ve got to be really modest and realistic about
what it’s going to achieve,” suggests Gosling. CEOs are, after all, always going to prioritise what is best for the shareholders long term, and ESG policies will unlikely be unable to counter these embedded economic incentives. But with the right measures, ESG can help nudge executives in the right direction to focus on important issues and the longer-term horizon of sustainability. It is too early, Walton says, to tell which companies are incorporating these metrics in the right way. “But in theory,” she adds, “if you put in a good quality metric with a tie to a substantial amount of pay, I can see this being a good accountability measure.” ●
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