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Should companies consider including ESG metrics in their incentive plans?

As ESG continues to grow, should companies consider including ESG metrics in their incentive plans?

In 1988 Bill Ford said, “Creating a strong business and building a better world are not conflicting goals – they are both essential ingredients for long-term success”. Fast forward 34 years and this quote is even more relevant now than it was then. ESG is not a new concept, it is evergreen it has been around for decades and shows no signs of slowing down.

What has changed is the focus on ESG – stakeholders want to know what organisations are doing and the impact that they have on the environment and society. Calls for enhanced disclosure regarding non-financial information. Along with the calls for better disclosure we are seeing an increased focus on accountability both corporate and executive accountability. This brings us to the link between ESG performance measures and executive remuneration, when the execs and key decision-makers have their skin in the game and are incentivised to think in a multidimen- sional way, to really look at and consider the company’s future sustainability, that is when it gets exciting.

When done correctly remuneration should align pay metrics to the company’s performance and ongoing value creation. Value, as we know, means more than just financial numbers, and therefore, it makes sense that as part of the incentive structure that non-financial metrics (ESG) should be included. There are arguments for and against including ESG performance measures into pay – some of the ideas are that executive remuneration is complex enough without adding a new dimension; and that if it is not done correctly, there could be unforeseen consequences [Like pay padding, accusations of greenwashing, reputational issues and execs who have no line of sight over their key performance indicators].

However, for those of us who believe that it is a good way to drive impact – there is the view that rewarding non-financial performance is a good way to balance the short-term financial focus of most compensation plans, encourage and promote long-term thinking, show a clear commitment by the organisation to ESG, focus on areas that need improvement, to drive the sustainability agenda. Either way, if we look at the global and the South African landscape, the majority of listed companies have some link to ESG in their remuneration. Since it is gaining such momentum, this is something that companies need to consider and evaluate. It is a way to close the loop between strategy, disclosure, and accountability.

This brings a health warning, when you start fiddling with the pay of the most senior people in the organisa- tion, best you get it right because if it’s not done correctly, it can backfire, not only on those individuals but on the entire business. Having implemented a number of these and followed the emerging best practice internationally, we have developed a methodology that works well because there are quite a few things to consider when you design the compensation plan and if you already have ESG metrics in the compensation plan it may be time to relook at it and evaluate whether the metrics are the best metrics to drive value and positive impact.

When considering whether to include ESG performance measures there are a few considerations like:

  • Such as whether you link the performance to a rating agency, choose a standalone measure or a scorecard;
  • Which metrics do you select?
  • What process has been followed in selecting the metrics? Such as purpose-driven, linked to material issues or strategy or another approach?
  • How many metrics do you select? Adding too many creates a whole new set of issues, and too few have their own set of complications.
  • Which time horizon do you place them, so they go into the STi or the LTI? Along with that, what weighting to give them?
  • How to measure and monitor the issues, and then how to report and articulate your messaging to stakeholders.

The focus from investors on ESG and on remuneration shows no signs of going away. This is putting pressure back on the remuneration committees to re-look at their remuneration approach around ESG. Is this something that your organisation is facing? We would love to hear your view and thoughts on how your remuneration commit- tee handles this.

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