Last week, the fast-casual restaurant chain Chipotle Mexican Grill announced a new policy that ties executive compensation in part to environmental, social and governance (ESG) metrics.
Going forward, 10 percent of the annual incentive bonuses for corporate officers — essentially, anyone with day-to-day responsibility for running the company — will be tied to the company’s progress toward achieving such goals as improving diversity, creating more opportunities for advancement amid Chipotle’s lower ranks and increasing the organic, local and regeneratively produced food served in its restaurants.
Chipotle is the latest company to spice up its executive pay packages to include social and environmental goals. In January, Apple announced it will incorporate ESG metrics into the annual cash incentives for company execs, using a formula to either decrease or increase bonus payouts by up to 10 percent.
The goal, per the company’s proxy statement: "to further motivate Apple’s executive team to meet exceptionally high standards of values-driven leadership in addition to delivering strong financial results."
What in the name of fringe benefits is going on?
Linking executive bonuses to sustainability metrics is making waves. But is it making a difference?
At long last, companies and their largest investors are recognizing that climate change, diversity and other sustainability issues represent risks to profits and productivity, and that companies that proactively manage these risks are better run and thus more attractive investments.
And where investors go, corporate boards of directors quickly follow in the form of carrots and sticks for a company’s top brass.
The trend to link ESG metrics to executive pay is a departure from traditional compensation packages, which have relied almost entirely on financial measures — earnings per share, revenue growth and other factors. Now, nonfinancial metrics are being folded into the mix, with a strong emphasis on climate change and diversity and equity issues.
The trend is just ramping up, especially in Europe, where the main focus is on climate change. U.S. companies are still mostly at the starting gate. A 2020 analysis of company public disclosures by Willis Towers Watson found that while about 11 percent of the top 350 European companies have linked greenhouse gas emissions to their executive incentive plans, only 2 percent of U.S. S&P 500 companies have done so, as Willis’ Nidia Martínez and Ryan Resch wrote recently on GreenBiz.
But a few U.S. companies have stepped up. In 2019, Clorox set a goal to tie executive compensation awards to elements of its ESG goals for members of its executive committee, including for the chair and CEO, although it hasn't yet announced details on how it will do this, according to Andrea Rudert, its associate director for ESG stakeholder engagement. Starting this year, McDonald’s is linking executive bonuses to increased hiring of "women and historically underrepresented groups." At Starbucks, compensation for top execs is tied to corporate diversity, with the goal of having at least 30 percent of corporate workers who identify as Black, Indigenous or people of color by 2025.
Moving the needle
Will all these incentives change anything? In theory, yes. In practice — well, it’s hard to tell. There’s no clear data that companies with sustainability-related executive comp packages perform better in either ESG or financial metrics. One reason is that it’s early days, with many of these policies just kicking in.
Adding sustainability into the mix still can move the needle. Whereas most financial metrics are short-term, with a strong emphasis on quarterly or annual performance, most sustainability metrics are by their nature longer-term. And while many of these metrics can be tracked on a quarterly basis, progress in sustainability usually plays out over years. To the extent that ESG metrics lead the C-suite to think longer-term, they could be a positive influence.
Moreover, linking executive pay to sustainability can send an important signal through the company, its industry and the corporate world in general that these issues are vital to business success. And to the extent that these early adopters create a bandwagon, social and environmental metrics will increasingly will become an expectation of investors. In many sectors, they already are.
Initiating such measures does present some challenges, such as identifying metrics material to the company and its sector, creating stretch goals that demonstrate real progress and establishing time periods that engender meaningful change. And there’s disagreement among large institutional shareholders about which ESG metrics should take preeminence. But these are all surmountable, as the first wave of leadership companies is showing.
One good resource: The Aspen Institute recently published a white paper, Modern Principles of Sensible and Effective Pay, designed "to advance fresh thinking in boardrooms about executive compensation given new market priorities, shifting public attitudes towards equity, fairness and the role of business, and fundamental changes in the role of the CEO and executive teams."
In the end, the question remains: Are these executive compensation plans making a difference or are they a check-the-box activity that’s more symbolic than substantive? As I said, there’s no clear evidence either way.
And what, if anything, does all this have to do with the much bigger issue of skyrocketing executive pay relative to those further down the corporate ladder? After all, for the millions living paycheck-to-paycheck, the relatively modest compensation adjustments of those at the top are, at best, laughable. In 2019, the ratio of CEO-to-typical-worker compensation in the United States was 320-to-1, up fivefold from 61-to-1 in 1989, according to the nonpartisan Economic Policy Institute. It’s no secret that the rich keep getting richer while the poor stay poor.
To the extent that executive compensation is also determined in part by reducing the earnings gap between those at the top and bottom, we’ll begin to see a fairer and more just economy, one that could provide a multitude of sustainability benefits to both people and the planet.