ESG Metrics and Executive Compensation – What to Consider to Do It Right

Environmental, social and governance (ESG), sustainability and corporate responsibility matters touch every area of a business, and the breadth of related metrics is expansive. Most organizations have done some work in this realm. But many find the amount of change, data and transparency needed to be overwhelming. Each aspect of an ESG program is complex, and organizations seeking to make progress may struggle with how to implement it effectively. One trend we see increasing is organizations linking performance in ESG metrics to executive compensation. This strategy is one way for businesses to show ESG is being prioritized and aligned with business goals – but this conversation is not without nuance.

Recently, several organizations – including Chipotle, Apple, McDonald’s, and many more – have announced executive variable compensation will be linked to performance in ESG key performance indicators (KPIs). These metrics vary and span multiple facets of ESG programs including meeting carbon emissions targets, reducing natural resource consumption, achieving gender pay parity, 3rd party human rights and meeting diversity goals.

Making a public announcement to hold the company to account for key targets can be a step in the right direction – so long as that direction is to make a tangible impact on ESG matters, not a public relations greenwashing endeavor. By aligning with KPIs and providing quantitative results, key stakeholder will have more insight into how the company and leadership is tracking against these goals.

Financial motivators can certainly be a force for change, but as a PwC notes, “There’s a risk of hitting the target but missing the point. An example might be a bank that focuses on reducing its own carbon footprint when the biggest effect it could have on reducing emissions is through changing its approach to financing companies that emit carbon. There’s a risk of distorting incentives. Research shows that incentivizing pro-social goals can undermine intrinsic motivation…”

Tying financial incentives to ESG performance is one way to hold corporations accountable for certain metrics, but it is also important to continue looking at the full picture. ESG touches virtually all business units and focusing on a few metrics can make a difference – but it can also narrow the scope of focus and be detrimental to the overall ESG efforts.

Prioritizing ESG efforts is good for business. As the public, investors and employees continue to pay attention to how the businesses they interact with do business, this trend will remain. Not only that, but upcoming regulatory requirements for disclosure mean ESG will become a standard part of business operations.

Many companies have already recognized that beyond being the right thing to do, making strides towards a robust, transparent ESG program with measurable progress provides sustainable business practices. Linking ESG metrics to compensation is one of many ways large organizations can measure and make progress on these initiatives. So long as the end goal (a long-term plan to continuously improve on ESG-related outcomes) is not lost, and the connection to compensation is made with that in mind (and not perceived as greenwashing).

As disclosure requirements are codified into law, organizations will need to abide by more standard KPIs for disclosure and regular audits to report on progress. Reporting standardization will help to limit companies from reporting on misleading or unverifiable ESG metrics. Though ESG disclosures are currently voluntary for many companies, all organizations need to prepare for the future now by leading versus spending more on how to catch up later

Because what gets measured, gets improved, efforts to tie compensation to ESG KPIs are likely to make a positive impact overall on corporate culture, people and the environment – and shed further light on the importance of ESG as a whole.

The conversation about ESG will continue to be prominent as public awareness and upcoming regulations will keep these important issues top-of-mind.

To learn more, check out our latest webinar, “Exploring the Future of ESG

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