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Environmental, social and governance (ESG) issues may seem like a hot, new topic, and in many ways it is. Companies all over the world are increasingly focused on their performance in various ESG measures and discussing them with their boards, investors and other stakeholders.
While ESG is a rapidly expanding area of interest, a surprisingly large number of companies have been taking environmental, social and governance measures very seriously for quite some time.
More than half (52%) of S&P 500 companies include at least one ESG metric factoring into the design of executive incentive plans. This is based on data from annual proxy statements filed in 2020 and reflecting pay practices in 2019. The percentage for 2018 was 51%. This high level of uptake indicates that ESG measures are reasonably well incorporated into executive incentive plan design, at least to some degree. Based on the events of 2020, we expect this trend to continue and possibly grow significantly.
The ‘S’ Is All About Human Capital
While 52% of S&P 500 companies have an ESG measure impacting design in their executive incentives, 49% have an “S” or social measure. While some companies also have an environmental (12%) or governance (18%) measure, almost all companies that incorporate ESG in incentive plans include an “S” measure.
Human capital measures are used at most companies under the “S” category. However, we have also included customer service in the “S” category.
Once we remove the customer service measures from the social category, we see that 45% of the S&P 500 companies incorporate a human capital measure in their executive incentives. This is significant and indicates a high level of interest in and support for key human capital initiatives in many large organizations.
The key types of human capital measures included in executive incentives are as follows:
- Succession Planning and Talent Development: 23% (of S&P 500)
- Employee Health and Safety: 17%
- Inclusion and Diversity: 17%
- Employee Engagement: 11% (increased from prior year)
- Culture: 9% (increased from prior year)
How Is ESG Included in Incentives?
For companies that include ESG measures as a weighted component in their executive incentive plans, those are typically accounting for 15-20% of the total incentive award, when all ESG measures are totaled (many companies incorporate more than one type.) Companies employ several different methods of incorporating these measures within plan design. About 23% of the S&P 500 incorporate ESG measures in the individual portion of the executives’ incentive award. Another 20% employ a weighted component of the total incentive. And 17% incorporate ESG measures as a qualitative component of the incentive award (e.g. an unweighted component to a broader weighted category, like a strategic or scorecard portion to overall plan design.)
Most companies use ESG measures to directly affect the determination of initial payouts as part of the incentive award plan design. However, 13% of companies use a modifier to the assessed payout level of other non-ESG measures, or to the entire award payout itself.
Almost all (51% of the 52% total) companies with ESG in their incentive plans incorporate the measures in their annual incentive plans. Only 3% of the S&P 500 incorporate ESG into their long-term incentive plans. We expect the prevalence of ESG in long-term incentive plans to increase over time. This is because many ESG measures are long-term in nature and take several years to improve.
Virtually every major industry classification has significant usage of ESG measures in executive incentives. Consumer Discretionary is the lowest at 25%. Energy and Utility companies are the highest, with ESG incentive prevalence at or near 90%. Most other industries are in the 40% to 60% range. So, the prevalence of ESG measures is common in the executive incentive plans among all sectors of larger companies.
For companies that are considering how to incorporate ESG measures into their management and governance processes, we find this data to be encouraging. It clearly indicates that there are a significant number of companies that already have experience using various ESG measures. There are many examples of incentive plans that incorporate ESG in various ways. So, companies have much to learn from each other’s experience.
The data also indicates where there is room for many more companies to incorporate various ESG and other non-financial measures into executive incentive plans. With all the emphasis on the importance of human capital in 2020, we expect to see the prevalence of these measures in incentives increase, and particularly the prevalence of inclusion and diversity measures. We also expect to see greater emphasis on environmental measures by many companies.
The prevalence of human capital measures in incentives is particularly instructive for disclosure. As companies begin to report relevant and material human capital information to shareholders and other stakeholders (as now required by the SEC), they can look to what measures are already included in incentive plans as a place to start.
Clearly, if a human capital measure is important enough to pay for in an incentive plan, it is probably relevant and material information to shareholders and investors.
About the Authors
Don Delves is a North America practice leader, executive compensation at Willis Towers Watson.
Erik Nelson is a director, global executive compensation analysis team at Willis Towers Watson.