- Increased usage. Among S&P 500 companies, 76% reported in this year’s proxies that they incorporated at least one ESG metric in their executive incentive plans. This is an increase of seven percentage points from last year and 24 percentage points from two years ago.
- Growth is greatest in long-term incentive plans (LTI). ESG metrics are still more common in short-term incentive (STI) plans, but their use in long-term incentive (LTI) plans has nearly quadrupled in the past three years.
- Avoid “greenwashing.” As more companies implement ESG in executive pay, competitive pressure will drive many companies to include a broader range of ESG metrics and to be more transparent in their target setting and measurement.
More companies around the world — including North American organizations — are linking environmental, social and governance (ESG) measures to their executive pay programs, according to new research from WTW.
The study found that 76% of S&P 500 companies reported in this year’s proxies that they incorporated at least one ESG metric in their executive incentive plans, up from 69% the previous year and 52% three years ago.
The prevalence of ESG metrics within executive incentive plans continues to rise in Europe and Asia Pacific as well, increasing from 90% to 93% and from 63% to 77%, respectively.
Linking ESG metrics to executive pay can offer organizations a number of benefits, according to Ken Kuk, senior director of executive compensation and board advisory at WTW. He believes these metrics help ensure a more sustainable future where the company has a clear competitive advantage, a better and more transparent relationship with customers and employees, and a more robust framework to oversee and manage emerging risks.
For these benefits to be realized, alignment is important. “Total rewards and compensation professionals have an important role in aligning the organization toward such a future,” said Kuk, “and in ensuring connection between these business priorities and the employee experience.”
ESG Usage Across the Globe
While using ESG metrics in comp plans is gaining momentum in the United States, it is already common in Europe and Canada, Kuk said.
In Canada, four in five TSX 60 companies reported using at least one ESG metric in their executive incentive plans, an increase from 68% three years ago, according to the WTW study. By comparison, ESG prevalence sits at 93% across the constituents of nine major stock exchanges, including the FTSE 100. (The WTW study included a review of public disclosures from 1,146 companies listed in the S&P 500; TSX 60 in Canada; nine major European indices, including the FTSE 100; and the largest companies across seven markets in the Asia Pacific region.)
In Europe, more than 80% of companies use at least one human capital metric tied to their executive incentive plans.
In other parts of the world, comparing the use of ESG metrics may get lost in translation. For example, Kuk noted there is “a very wide range” of ESG practices across countries in the Asia Pacific region. “Australia, Japan and Singapore are far ahead of the other Asia Pacific markets we reviewed in terms of the use of ESG metrics in executive incentive plans and their thoroughness of executive compensation disclosures in general,” he said.
Short-Term vs. Long-Term Incentives
While the practice of tying pay to ESG is growing in both short-term incentive (STI) and long-term incentive (LTI) plans, most of the growth is happening in STI plans, the WTW study found. ESG metrics are more commonly found in STI plans, but the use of ESG metrics in LTI plans has nearly quadrupled in the past three years, according to WTW.
As ESG is built into more LTI and STI plans, compensation professionals will be challenged to navigate what is a very broad field that falls under the umbrella of ESG, said Hermann J. Stern, CEO of Obermatt, a financial research company in Zurich, Switzerland. Stern recently discussed these topics in a Journal of Total Rewards article, “ESG Metrics Expanding in Executive Compensation.”
“The selection of appropriate ESG metrics that are not only appropriate in representing a company's ESG priorities but that are also measurable is not that straightforward,” Stern said. “Together with the actual measurement and definition for target setting, there are many areas of potential pitfalls for companies and compensation professionals.”
Avoiding ‘Greenwashing’
It may be reassuring to see research that shows evidence of a continuing trend toward more ESG in compensation, said Stern. However, the question is not just whether ESG is included, he said, but how. “The selection of ESG metrics, and more importantly, the targets that are set show whether the effort is ‘greenwashing’ or represents real improvements,” Stern said.
As more companies implement ESG in executive pay, competitive pressure will drive many companies to include a broader range of ESG metrics and to be more transparent in their target setting and measurement.
But regardless of whether the impetus comes from investors or regulators, the fact that executives are being held accountable and motivated by issues to improve human capital and environmental issues is nonetheless “good to see,” said Stern.
WTW’s Kuk said compensation professionals should look for a greater focus in the quality of ESG metrics in the coming months, especially in light of market sensitivities about ESG as a business priority in the U.S. “We believe companies will focus on articulating a business case for why these priorities drive long-term sustainable value creation for investors and stakeholders,” Kuk said.
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