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ESG and corporate pay: A measure of intent

It is only reasonable that business leaders reap the benefits should they succeed but suffer penalties should they fail.


Activism used to be a word associated with the disgruntled fringes of society. Today, it is just as likely to be uttered in the boardroom. Corporate activism has become commonplace, which is just one reason many businesses are taking ESG policies more seriously.

Thanks in part to the pandemic’s impact on so many aspects of life, the business world is facing a renewed focus on the environment, and social issues around inequality and racism. Activism around movements such as Black Lives Matter has sent a stark message — people no longer will put up with the status quo.

Take the world’s biggest asset manager, BlackRock. Last January it announced that it would give the same weighting to ESG reporting as it has to traditional financial reporting, and that it would vote against those companies that failed to meet standards.

This policy became manifest when it was revealed that BlackRock had voted against shareholder resolutions around climate change 80 percent of the time in 2020. The company identified 244 companies making insufficient progress towards combating climate change. It took shareholder voting action against 43 of them and put the remainder "on watch." 

It is clear that this is more than being seen to be doing the right thing from an ethical standpoint. There is a business case to make ESG more accountable, with a growing emphasis on rigorous ESG reporting that’s numerically tied to executive remuneration.

Pay-related ESG policy is becoming more commonplace — law firm Macfarlanes recently researched FTSE 100 companies and revealed that 35 had disclosed that ESG factors had a tangible impact on executive pay. Of those, 23 had included these factors in executives’ short-term bonus awards, four had included them in their long-term incentive plan and eight had included them in both.

These findings are indicative of a broader shift towards a more concerted approach, with a growing number of companies embedding environmental targets into corporate culture and tying them more substantially to bonuses and long-term incentive schemes.

According to research across North America, Europe, Asia, Africa and the Middle East by Willis Towers Watson, four out of five (78 percent) companies are planning to change how they use their ESG measures in executive pay plans: 41 percent plan to introduce ESG measures into long-term incentive plans over the next three years, while 37 percent intend to introduce measures to annual incentive plans.

The latter is evident at tech giant Apple, which has adopted greater rigor around ESG targets. Starting this year, management annual bonuses will go up or down a not-insignificant 10 percent, depending on whether ESG-linked key performance indicators are met. The detail on those KPIs won’t be visible until next year but will focus on transparency on climate and raw materials relating to conservation, while investors will want to see metrics applied to supply chain risks and diversity and inclusion.

Meanwhile, according to PwC, 35 percent of FTSE 100 companies include an ESG performance measure as part of incentives for executives, 27 percent include an ESG measure in the annual bonus and 13 percent intend to use a measure in the long-term incentive plan.

From policy to practice

But aligning ESG with incentive plans is no easy matter. Willis Towers Watson noted that more than half (52 percent) of businesses deemed target setting to be among the greatest challenges, while 48 percent cited performance measurement identification and 47 percent cited performance measure definition.

So how do companies go about tying ESG performance to executive pay? The overriding advice is to align ESG targets with strategies and goals already woven into your business. Start simply, by measuring something already in place, and build out from there.

Setting targets is clearly a challenge. Some are more easily measurable on an annual basis, such as putting a diversity policy into place, or hitting employee wellbeing targets. From a pay perspective, these can be tied into annual bonuses. However, others are longer term and might have an ultimate outcome, such as cutting emissions entirely or reducing fossil fuel consumption across the business. These are the sorts of target that should be linked to longer-term incentives.

Rigor and transparency are essential. ESG targets need to be as measurable as financial targets, preferably using audited numbers — a language shareholders can identify with — based on established standards.

But many areas of ESG activity aren’t represented in easily reportable figures, don’t have generally accepted measurement criteria or defy clear definition.

Furthermore, the importance and prevalence of different areas of ESG activity varies from sector to sector and indeed from company to company. There is a huge risk that many companies will oversimplify their ESG reporting to just what can easily and consistently be measured, rather than what actually matters. 

What is needed is an objective, reliable system of scoring that can accurately, consistently assess how stakeholders perceive a company’s ESG credentials — and represent those credentials in a useful way. 

Clearly, major challenges are ahead if businesses are to truly incorporate ESG into corporate strategy and link it to remuneration. Businesses cannot afford to ignore mounting stakeholder pressure.

It is only reasonable that business leaders reap the benefits should they succeed but suffer penalties should they fail. By linking pay to ESG, performance itself becomes another, very significant measure — one of seriousness of intent.

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