ThinkTWENTY20

In an article posted on the Bloomberg Law page March 14, 2022, Lydia Beyoud writes that executive pay is usually tied to meeting key financial metrics, such as profit margins or return on equity for shareholders. “Now, companies are calculating portions of executive pay by factoring in goals such as carbon footprint reduction, employee wellness and retention, and supporting human rights.”

Beyoud points out that, in 2021, a quarter of U.S. companies included some form of environmental or social metric as part of their executive incentive plans, up from 16% in 2019, according to a study by proxy advisory firm Glass Lewis & Co.

The ESG link to executive compensation isn’t just about good optics, said Gregg Passin, senior partner and executive compensation leader at human resources consulting firm Mercer LLC. A company’s ability to address sustainability, workplace diversity and other ESG factors could determine whether it remains “a going concern” in the years to come, he said.

Institutional investors see executive pay as a concrete way to deal with ESG issues. The SEC could add to that pressure. The agency is working on “pay-versus-performance” rules that would require companies to disclose ties between executive pay and their financial results, with one commissioner suggesting that ESG metrics should be included as well.

According to Passin, shareholders see benefits to such incentives. But some are concerned that ESG goals are too amorphous to measure, or could be engineered for executives to win easy payouts. “That’s one reason why companies shouldn’t rush to adopt ESG pay metrics just to show they are engaged on important issues,” Passin said. “Companies need to have well-established goals and strategies for priorities like workplace diversity before they start linking them to executive pay.”

Beyoud notes that some investors do want companies to be more transparent about what goes into ESG metrics and how executive performance is measured against them.

Investors are right to cast a critical eye over adding ESG metrics to executive pay plans, said Witold Henisz, founder of the ESG Analytics Lab and professor of management at the Wharton School at the University of Pennsylvania. “The challenge is (that) the data we have are, frankly, bad. It’s really easy to reward the wrong thing because we can measure it,” Henisz said adding that “some metrics, such as carbon emissions, worker safety, or the number of women or minorities on boards, are relatively easy to measure and link to executive incentives. Others, like corporate tax avoidance or employee well-being, are more difficult.”

“If companies are required to or choose to disclose ESG-related performance criteria, consideration should be given to how the public might perceive not achieving those goals,” said Robin Melman, a partner at Baker Botts LLP specializing in executive compensation.

For more on who is doing what, and with what success, please see Executive Pay Tied to ESG Goals Grows as Investors Demand Action (bloomberglaw.com).