Perhaps you noticed that PracticalESG.com hasn’t talked much about ESG-based compensation developments. One of our other resources – CompensationStandards.com and The Advisors’ Blog – focuses on executive compensation practices and updates. That is our repository for the latest information and analysis of trends in using ESG metrics in executive compensation programs, and executive compensation disclosure issues.
At the same time, we know that PracticalESG.com readers may also be interested, so today I am borrowing excerpts from a couple of Liz’s posts there. The full articles are available at CompensationStandards.com on a membership basis – along with Lynn & Borges’s “Executive Compensation Disclosure Treatise” and an array of other tools, information and our ever-popular Q&A Forums. If you work with compensation committees or you’re involved with designing, advising and reporting on executive compensation, check out that site and email email@example.com to sign up.
ESG Metrics: Unmitigated Boon to Management?
The first article covers a study from Harvard Law profs Lucian Bebchuck & Roberto Tallarita that provides empirical analysis to highlight flaws of ESG-linked compensation. They identify these two primary limitations:
1. ESG metrics commonly attempt to tie CEO pay to limited dimensions of the welfare of a limited subset of stakeholders. Therefore, even if these pay arrangements were to provide a meaningful incentive to improve the given dimensions, the economics of multitasking indicates that the use of these metrics could well ultimately hurt, not serve, aggregate stakeholder welfare. They risk distorting CEO incentives.
2. ESG compensation poses the danger of creating vague, opaque, and easy-to-manipulate compensation components, which can be exploited by self-interested CEOs to inflate their payoffs, with little or no accountability for actual performance.
The professors are skeptical that ESG pay programs could evolve enough to overcome these problems, even if designed with an eye towards being clear, objective, comprehensive, transparent and standardized. Their current conclusion is that:
Shareholders and those who care about stakeholder welfare should not support maintaining or expanding current practices for using ESG metrics. Existing practices and their expansion should not be regarded as a positive development for those who are concerned about stakeholder protection. They serve the interests of executives but not those of shareholders or stakeholders.
Companies that are resisting the push to incorporate ESG metrics in pay programs may want to add some of these talking points to their engagements and proxy statements.
European Companies & Investors Continue to Push Forward
In the second article, Liz points out that a growing number of commentators are taking issue with the concept of using ESG metrics in executive pay plans. They say the risks outweigh the benefits, and that there are better ways to encourage sustainable, long-term performance.
Yet, those red flags aren’t deterring some investors. Particularly in Europe, asset managers & owners continue to urge companies to add non-financial targets to pay programs. To counter the shortcomings of discretionary ESG factors, the investors typically want these metrics to be measurable, transparent and linked to publicly disclosed E&S pledges.
A number of companies are responding to these investor preferences by tying pay to ESG goals. UBS – which is headquartered in Switzerland and a foreign issuer here – is one of the latest. In the GRI-aligned sustainability report that it recently published, it shared details (pg. 33) of a new compensation scorecard that includes quantitative & qualitative ESG metrics. The company’s compensation plan also includes group metrics based on climate & people goals that are tied to corporate strategic initiatives.
Although the jury is out on whether ESG metrics will deliver the right kind of progress on corporate environmental & social goals, it’s worth keeping an eye on European ESG trends & practices – because they often make their way to the US.
What About DEI?
Diversity, equity and inclusion (DEI) metrics are arguably the most common ESG metric in executive compensation programs. Our upcoming free DEI Workshop Series is intended to help DEI and ESG practitioners collect and use data about diverse workforces, equitable policies, and inclusive cultures that frequently form the basis for these compensation metrics. Of course, you will get much more out of the workshops than that, so register today.