ESG & Incentive Plans: Considerations for Moving Forward Cautiously
I blogged last month about global trends relating to incorporation of ESG metrics into incentive plans. In another study, FW Cook examined use of ESG measures in annual and long-term incentive plans among US-listed companies with market caps greater than $25 billion – data was based on proxy statements filed as of July 2020. They found 56% of the companies used one or more ESG measures in their incentive plans, which sounds like a lot, but the study also cautions companies to be mindful of potential unintended consequences.
The last thing anyone wants is to charge forward, set ESG targets, fall short of achieving targets and then face the challenge of explaining that to investors and other stakeholders. As many comp committees continue discussions about whether to incorporate ESG measures into incentive plans, commentary to the study lists the following questions for consideration:
Is it feasible to set reasonable targets and make meaningful progress on the chosen initiatives within the time frames typically used for measuring performance in incentive programs (i.e., one year for annual incentives and three years for long-term performance awards)?
Are they prepared to communicate such targets internally to the employee population and externally to shareholders in the proxy statement? If not, are they prepared to defend their decision to reward executives for progress on ESG initiatives without providing transparency as to the specificity and robustness of the goals?
Is there a recognized standard for measurement of progress on the ESG initiatives, and if not, can the company track progress in a quantifiable manner?
Will they create outsized risk of embarrassment if they disclose underperformance, and could the risk of embarrassment lead management to make non-ideal short-term decisions that might impair the longer-term objectives?
Is it appropriate to compensate executives for achievement of ESG initiatives, particularly if financial performance and shareholder returns are below expectations?
A Corporate Board Member article also included commentary from the study’s authors saying ‘this is an area where we encourage companies to walk before they run.’ The article includes a helpful chart with possible stepping stones for incorporating ESG metrics into incentive plans.
-Lynn Jokela, CompensationStandards.com March 3, 2021
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