Professionals see evolving ESG links to executive compensation
Amid growing investor pressure for companies to link executive compensation – at least to some degree – to ESG factors, there remains widespread uncertainty about how boards should approach the issue. But the outline of best practice is beginning to emerge, according to professionals.
The connections between ESG and compensation ‘are evolving in real time,’ Wendy Cassity, executive vice president and chief legal officer with Nuance Communications, told the audience during a panel at the Corporate Secretary Forum – Governance Priorities in 2021.
Fellow panelist Jonas Kron, chief advocacy officer with Trillium Asset Management, agreed. He added that it will take time to reach a ‘new normal’ around this approach to executive compensation and noted that a company’s size and industry greatly affect the extent to which ESG issues such as climate change are relevant.
He also outlined some thoughts on how boards can address executive compensation in this new context. For example, he said they should consider whether pay is being linked to a material ESG issue. Although there is room for qualitative links, investors will be looking for more quantitative ties and meaningful weights. ‘We want it to be something that’s not just a rounding error,’ Kron said.
He was reluctant to specify a figure that would meet this standard but said Trillium has seen some cases where 30 percent of short-term incentive plans are linked to ESG factors, a level he thought would be meaningful. In addition, Kron said: ‘The ESG factors need to be separate and distinct.’
Trillium would also like to see targets set for executives as ‘stretch goals’ that would help drive change at the company rather than set ‘a low bar that’s there for PR purposes.’
Speaking during the same session, Todd Krauser, managing director at FW Cook, outlined commonalities that are emerging from his discussions with boards. Although most are focused on short-term incentives, greater attention will be paid to long-term incentives in time, he said.
In terms of weighted metrics, 30 percent is probably higher than most companies are aiming for, with 10 percent to 15 percent more common, Krauser commented. Another approach is to use ESG factors as a modifier in executive compensation, he added. This involves tying incentives to the company’s financial performance but modifying them either positively or negatively based on performance in relation to ESG metrics. This signifies the importance of ESG issues without carving out a weighting separate from financial goals, Krauser said.
Boards are also using more of a broad scorecard metric approach for ESG issues, he noted. This may be inconsistent with how some investors prefer to view ESG as a separate pillar, but it helps boards take a variety of factors into consideration as they look to ESG and other non-financial elements of strategic and operational goals, according to Krauser. He added that it lends itself to committees discussing compensation discussion and analysis in terms of aligning pay and performance.
As did his fellow panelists, Krauser described the consideration of ESG factors in executive compensation as very much an evolving process.
Partners of the Corporate Secretary Forum – Governance Priorities in 2021