Trending: Linking Executive Compensation to ESG Performance

Resonance began in 2022 meeting with sustainability leaders from across the country as part of our Sustainable Impact Roundtable series.

From these deep conversations, insights related to breakpoint change, and emerging challenges have been discussed, among other topics like SCOPE emissions reductions, biodiversity loss and commitments, just transitions, partnerships, and value chains, among others. We have plans to convene through 2023 given the positive feedback from participants, and top of the list of challenges going into the new year continues to include focus on ESG.

As most in this space understand, the conversation around corporate citizenship has often moved from responsibility to accountability, particularly with frameworks like ESG that emerged in the investment market. 

We see daily that investors, regulators, and consumers are stepping up demands for corporations to move beyond a rhetoric of sustainability that existed a decade ago, and instead develop quantifiable strategies that integrate ESG performance goals into decision making and business operations. 

A Strategy for Environmental and Social Progress

In response, companies are creating incentives to drive ESG progress internally. One strategy that is gaining in popularity is linking executive compensation to ESG performance and impact. 

From 2020-2021, the percentage of S&P 500 companies that linked executive pay to ESG performance rose from 66% to 73%. Much of that increase can be traced to social metrics, (i.e., diversity, equity and inclusion objectives); at the same time the share of these companies that tied pay to carbon footprint/emissions reduction metrics also rose, nearly doubling from 10% in 2020 to 19% in 2021.  
Linking Executive Compensation to ESG Performance, a report published in October by The Conference Board, a global, non-profit business membership and research group organization, offers a deep dive into these incentive programs. The report was produced as part of a collaboration among The Conference Board; ESGAUGE, an ESG data analytics firm; and Semler Brossy, a leading independent executive pay and performance consulting firm.

The report draws on a roundtable conversation, “ESG Performance Metrics in Incentive Plans,” that included 120 compensation, ESG, sustainability, and governance executives from 72 firms. Discussion topics included: trends in executive compensation incentive programs; the opportunities and challenges of ESG performance incentive plans; evaluations of ESG measures; and the future outlook for executive incentive programs.

Among the key takeaways:

• Linking executive compensation to ESG performance sends a strong message to shareholders and other constituents that ESG is a priority. It can also help ensure that ESG goals will be met.
• Good communication is fundamental to ESG success. Companies need to make a strong bottom-line business case for incorporating or adjusting ESG-related goals and successfully communicate this to investors.
• Companies should not rush to define ESG metrics; rather, ESG operating goals should be in place for at least a year or two before companies tie ESG progress to compensation. There is no one-size fits all metric that can be applied to all companies or all industries. Taking time to understand how company-defined ESG goals are achievable, measurable and aligned with corporate strategy is important. It also provides time to build employee buy in.
• Incentivization plans should be careful not to incentive short-sighted strategies, which can lead to more problems later on; instead, companies must be strategic and develop ESG goals with an eye toward long-term success.
• Corporate leaders must recognize that measuring the full impact of ESG performance goals in compensation is more challenging than measuring the impact of traditional operating or financial metrics. While progress toward ESG goals aimed at increasing diversity/access or decreasing a carbon footprints, for example, are easily quantified other kinds of ESG metrics can be more difficult to understand.

Leading Companies Lead the Way

In 2021, leading corporations like Apple and fast-food giants Chipotle and McDonald’s announced plans to tie executive compensation to ESG performance to support and accelerate progress toward ambitious, long-term ESG goals. 

Chipotle’s ESG targets include emissions reduction (to support the company’s goal of slashing emissions in half by 2030) and increased sustainable food sourcing. The plan considers nearly every aspect of its restaurants and supply chains – from transportation and warehousing to food sourcing, packaging, and waste. Performance toward these goals can affect incentive bonuses for senior managers up to 15 percent.

In the case of McDonald’s, the company also linked 15% of executive bonuses to meeting global diversity and inclusion targets. These metrics include: 35% of senior management from underrepresented groups by 2025, up from 29% currently; and an increase in women in senior roles (from 37% to 50% by 2030).

In 2020, Apple announced an ambitious goal of achieving a 100 percent carbon neutral supply chain by 2030. The plan calls for a reduction in emissions by 75%, with the remaining 25% reached through carbon removal solutions or offset projects such as restoring habitats.  Up to 10% of executive bonuses are tied to ESG progress. 

Moving Beyond the C-Suite

All of these incentive programs target executives and senior managers. But moving the ESG needle requires a commitment from every employee at every level of an organization. And that commitment must also extend to its customers. 

To incentivize ESG performance throughout an organization, companies should build ESG goals into all aspects of operations – from greening supply chains (sourcing solutions, low-carbon product production and design, recycled packaging) to improving global logistics networks (transportation modes, distribution centers, etc.) and beyond. ESG factors can be built into professional development through employee review and promotion practices. 

Empowering employees to help identify social and environmental priorities and design practices in support of these priorities will encourage ESG support.

Last month, an article in Forbes magazine looked at the role corporate ESG commitment can play in boosting employee satisfaction in their jobs, especially if they “feel included and supported in ESG matters when they are part of the policymaking and not just when they hear it from the top down.” One way to do that the piece suggests is to appoint internal ESG ambassadors.

But closing the loop on sustainable operations also involves participation from customers. For example, for companies to phase out single use plastics, they must be able to recover packaging from the marketplace so the plastic can be reprocessed and reused. But to do that they must figure out how to motivate customers to return the used packaging.

And that will take a whole new kind of incentive.