Executive Bonuses for Making the CO2 Cut

As climate change and greenhouse gas emissions move to the forefront of corporate awareness, leading U.S. businesses are starting to tie the non-financial performance of their companies to their compensation metrics, according to a 2008 study of S&P 500 companies.

Data found in the Carbon Disclosures Project (CDP) Report 2008 on the S&P 500, which asked companies on that index to report and measure their greenhouse gas emissions, shows that 93 of 321 respondents -- or nearly 29 percent -- have begun building environmental responsibility and climate awareness into executive incentives.

One of those companies is Xcel Energy Corp., an electricity and natural gas company serving more than 5 million customers in Colorado, Michigan, Minnesota, New Mexico, North Dakota, South Dakota, Texas and Wisconsin.

Xcel "believes strongly in providing long-term incentive opportunities that deliver awards upon the achievement of specific performance goals linked to the success of the company and its long-term strategy in the core utility business," said Xcel Spokeswoman Patti Nystuen. "These include financial and environmental goals."

Seventy-five percent of Xcel's award incentives have a performance-based vesting schedule based on earnings per share growth. The remaining 25 percent of Xcel's awarded incentives are performance-based, relating to their environmental strategy, such as decreases in emissions.

"In 2007, payouts of annual incentive awards for the NEOs (Named Executive Officers) and all executive officers, including those reporting to the CEO, were determined entirely by attainment of corporate goals, which included targeted earnings per share, an environmental metric related to carbon dioxide emissions, and safety," Nystuen said.

Xcel measures emissions intensity by the amount of emissions per megawatt hour for certain emissions including nitrogen oxide, sulfur dioxide and carbon dioxide. Their emissions reduction targets are 2 pounds per megawatt hour (lbs/MWh) for nitrogen oxide, 2.9 lbs/MWh for sulfur dioxide, and 1,379 lbs/MWh for carbon dioxide. Performance against these environmental targets is measured annually at the end of each fiscal year.

Driving Green Incentives

The Carbon Disclosure Project's Global 500 2008 Report (which sends questionnaires to the 500 largest global companies) notes that half of the responding companies in the utilities sector have incentives for managers tied to meeting environmental goals.

The CDP's Global 500 Report further states that the utilities sector has the highest number of respondents that incorporate meeting carbon targets with management remuneration. The report proposes that "this partly reflects the fact that improved efficiency leads to direct financial savings for the company as well as having a beneficial impact on emissions."

There are a number of reasons why companies have started to link incentives to meeting environmental targets, specifically CO2 reduction. Investors increasingly see climate change as a material issue for companies and require information on corporate strategy and understanding of risk and opportunity associated with climate change to inform their investment decisions.

"First, measurable reductions in carbon footprint are increasingly part of performance evaluations as companies recognize a cost of carbon in their businesses," said Neil Braun, CEO the CarbonNeutral Company. "Second, some companies have successfully differentiated their products and services through environmental performance that grows the top line, which is reflected in performance evaluations."

The CarbonNeutral Company has worked with nearly 200 carbon-offset projects across six continents and with more than 300 corporate clients.

"Our clients report substantial economic savings achieved by putting a real cost of carbon on the P/L and assigning specific reduction targets to line management," said Braun.  "Many of our clients also report significant top line growth driven by product and service differentiation through an integrated carbon reduction plan. "

Executives in the U.S. are also going to have to respond to coming regulatory changes regarding CO2 reductions.

"There is also an increase in regulatory systems -- in the U.K., Australia and likely to be in the USA under the new administration," said Joanna Lee, CDP spokeswoman. "As a result, increased numbers of companies will be required to measure and report their emissions. Barack Obama has indicated his support for a cap-and-trade system both during his campaign and following his election and we anticipate there will be a USA federal scheme."

Braun agreed.

"There is both a quantifiable cost of carbon and a quantifiable benefit of being carbon neutral so there will be increased carbon budgeting in the U.S.," Braun said. "All signs are that one way or another there will be legislation that imposes a cost of carbon, and the reality is that, even without a regulatory cost of carbon, business travel, electricity and manufacturing processes can be made more efficient by applying a carbon budgeting discipline. And, as U.S. businesses see European case studies of top line growth achieved through a well-integrated carbon management strategy, there will be growing interest on the revenue side too."

Which Way Will They Go?

The current financial crisis seems to be pushing companies in two apparently contradictory directions. Some shareholders are demanding both increased transparency regarding corporate governance and executive compensation, as well as increased corporate responsibility for reducing carbon footprints. At the same time, companies are working to turn any profit at all.

Making a profit and reducing CO2 emissions, however, are not inherently at odds with each other.

"The current financial crisis is going to bring increased focus to corporate governance issues, including the linkage between executive pay and performance," Braun said. "The impact of climate change on business, the legal risk resulting from emissions, and the economic risks and rewards relating to effective carbon management are going to increasingly be on the agenda of corporate boards."

Yet one executive pay expert, Jesse Fried, a University of California law professor and co-author of "Pay without Performance: the Unfulfilled Promise of Executive Compensation," suggests that pay for CEOs and other executives should stay focused on their fiduciary duties.

"I think that pay should be tied to long-term shareholder value, not Environmental, Social and Governance (ESG) performance," Fried explained. "For-profit corporations are created by shareholders to serve their financial interests. The problem in publicly traded for-profit corporations is that the boards and managers appointed by shareholders often seek to serve their own interests rather than shareholders'".

Fried suggested instead working to align managers' interests with those of shareholders while also acknowledging that all citizens have a stake in corporations' environmental conduct.  

"But these concerns are best addressed through regulations of all businesses and non-profit organizations," Fried said. "Trying to use pay arrangements in publicly traded for-profit corporations to address environmental concerns seems overly narrow  -- why just these corporations? -- and can potentially increase agency costs to the extent managers use environmental performance to justify higher pay even when they do a poor job for shareholders."

Anne Moore Odell is a freelance writer based in Brattleboro, Vt.