CEP Magazine (September 2022)
Incentive plans for corporate executives have been linked to financial metrics for many years. Adding environmental, social, and governance (ESG) metrics to these compensation plans is a more recent development—especially over the last 10 years—as companies increasingly want ESG goals to be taken seriously by the senior management team.
Principles for Responsible Investment (PRI) has since at least 2012 opined that factoring ESG goals into compensation plans has more positive than negative effects. More recently, in its June 2021 article, PRI stated:
In our view, if structured appropriately and implemented effectively, ESG-linked pay could: increase firm value; rebalance the excessive emphasis on short-term performance targets in typical remuneration packages, which run contrary to long-term financial and sustainability objectives; and create better accountability on sustainability-related performance across management.[1]
There are, however, strong opinions on this type of incentivization of ESG goals. As noted by Rhonda Brauer, president of RLB Governance LLC, “In an ideal world, I think that ESG metrics would not be needed in executive compensation plans, because the related goals would be so well integrated into a company’s overall strategy that they would already be impacting the more typical financial goals that are already in comp plans” and that “having ESG goals would seem to be another way to pay executives more for just doing their day jobs.”
But, recognizing that executives are human, incentives can have a powerful effect. The key might be in those last few words from Brauer. Incentives for just “doing their job” are inappropriate, whereas incentives for “excelling at their job” in connection with metrics that align with the organization’s current priorities are an excellent way of encouraging strong performance in the areas of greatest importance.
As Brauer points out, “Executives tell me that having ESG metrics is definitely changing their behavior in positive ways, for example, linking part of their pay to greenhouse gas emission reductions or to having more diverse workforces at all levels. If that’s true, then that’s good enough for me.” Likewise, it’s good enough for me, too.
1 “ESG-linked pay: Recommendations for investors,” Principles for Responsible Investment, June 17, 2021, https://www.unpri.org/executive-pay/esg-linked-pay-recommendations-for-investors/7864.article.
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