We continue to post resources in our “Sustainability Metrics” Practice Area that can help you navigate the best way to link ESG goals to executive pay. Caution and careful planning are key — especially since some people criticize ESG metrics as being a cover for under-performance on stock price.
The latest instructive memo comes from Aon. Among other things, it includes a framework to analyze whether your company is ready to add non-financial metrics to your executive pay plans. Here’s an excerpt:
Compensation committees currently determining when and how to design ESG-based incentives will need to focus more on impact and readiness of potential metrics and rely less on competitive practice compared to other areas of the executive compensation structure.
As the use of ESG metrics in compensation plans evolves, we expect this aspect of incentive design to take two to three years before there are truly competitive norms and a strong understanding of investor and investor advisor standards. For now, the decision on when to implement should be based on degree of readiness, the nature of the ESG metrics, and the size and time frame needed to cover the performance gap.
Aon looks at adding ESG metrics in terms of a spectrum of “readiness.” Companies that are further along on the “readiness spectrum” will be able to add multiple quantitative incentives, with greater weights, to the long-term plan. Meanwhile, companies that are closer to the “exploration” stage should focus on short-term plans and adding one metric at a time, likely qualitative in nature — or even just focus on disclosure of ESG progress for another year. Here are the indicators that show a company is pretty advanced in its readiness:
– Several key metrics have been identified and disclosed for more than a year. Quantitative understanding of success or failure known
– Metrics have a range of performance associated with them and clear timeframes
– Additional metrics have been explored and either added or eliminated from consideration
– Relative importance/priorities established
– Internal teams working on metric definitions and goals have initial findings and an on-going agenda
– Key milestones and timeframes to achieve goals are mapped for all multi-year goals
– Systems for assessing progress and reporting to leadership and the board have been tested
– Back or future testing completed
– Risk assessments completed and communicated to the board
-Liz Dunshee, CompensationStandards.com June 1, 2021
