More Companies are Linking Executive Pay to ESG Performance

Large US companies are increasingly linking executive compensation to some form of ESG performance, with the share growing from 66 percent in 2020 to 73 percent in 2021. At the same time, just a minority of polled corporate executives say including ESG (environmental, social, and governance) performance goals in executive pay is very important in achieving their ESG goals.  Most view such measures as being of medium importance, which indicates that incorporating ESG measures into compensation is just part of companies’ broader efforts to achieve their objectives.

The findings come from a new report by The Conference Board, produced in collaboration with Semler Brossy and ESG data analytics firm ESGAUGE. The study includes various trends—and highlights lessons learned—relating to companies tying executive pay to ESG performance.

In addition to the analysis showing an overall increase in the adoption of such goals, some ESG topics have gained considerably more traction than others: From 2020 to 2021, the share of S&P 500 companies incorporating DE&I (diversity, equity and inclusion) goals in executive compensation grew from 35 percent to 51 percent. And carbon footprint and emission goals nearly doubled, increasing from 10 percent to 19 percent.

To understand the opportunities and challenges companies have in implementing ESG performance goals in executive compensation programs, The Conference Board convened a roundtable with executives in compensation, ESG, governance, and sustainability. Participants said the top reason to link executive pay to ESG performance goals is signaling ESG as a priority, followed by responding to investor expectations. The top two reasons for not tying executive compensation to ESG is the challenge of defining specific goals, followed by skepticism about their effectiveness.

“Companies should consider using ESG operating goals for one to two years before including them in compensation,” said Merel Spierings, author of the report and Researcher at The Conference Board Governance & Sustainability Center. “That allows time to see if those goals are truly relevant for the business and develop strong buy-in from management and employees. It is especially important for companies to both validate and broadly communicate ESG goals before rolling them out as part of compensation plans for a broader management or employee base.”

The report offers the following findings and insights:

1. By Area
   • Large companies are increasingly tying executive compensation to ESG performance:
     • The share of S&P 500 companies linking executive compensation to some form of ESG performance grew from 66 percent in 2020 to 73 percent in 2021.
     • The increase, in part, can be attributed to demands from external stakeholders.
   • Companies are most commonly tying executive compensation to human capital management goals, and least frequently to environmental goals:
     • Human Capital Management goals: present in 64 percent of S&P 500 companies
     • Social performance goals (e.g., human rights and product quality/safety): present in 39 percent
     • Governance performance goals: present in 38 percent
     • Environmental performance goals: present in 25 percent
   • Large increases: companies that incorporate DE&I and carbon-related performance goals:
     • Diversity, equity & inclusion goals: In the S&P 500, the share increased from 35 percent in 2020 to 51 percent in 2021.
     • Carbon footprint and emission reduction goals: increased from 10 percent in 2020 to 19 percent in 2021.

     
     

2. By Business Sector
   • Large disparities exist among business sectors:
     • Most frequent adopters: Companies in the utilities sector (100%) and energy sector (90%) are most likely to tie executive pay to ESG performance.
     • Less frequent adopters: Only 55 percent in the consumer discretionary and IT sectors.

   
   

3. By Approach
   • Companies are taking a variety of approaches in tying executive compensation to ESG performance–and often do not set specific numerical goals:
     • Individual performance assessment:49 percent of S&P 500 companies use this approach for factoring ESG goals in executive pay.
       • In this approach, ESG is considered part of an executive’s individual performance rating, which is a discretionary assessment by the company’s compensation committee.
     • Business strategy scorecard: used by 48 percent
       In this approach, ESG goals are included and assessed as part of a broader scorecard of ESG or non-financial business priorities.
   • Standalone ESG metric: used by 24 percent
     • In this approach, ESG is incorporated through specific (often quantitative) metrics.
   • Modifier metric: used by 6 percent
     • In this approach, ESG can be used to adjust the financial performance rating, the overall rating, or the payout under a plan.

   Note: Some companies use multiple approaches, which explains why the sum of the percentages exceeds 100 percent.

4. Despite the long-term nature of ESG performance goals, most companies incorporate them into executives ’ annual incentive plans:
   • Annual incentive plan: Used by 97 percent in the S&P 500 that have incorporated ESG into executive compensation.
   • Long-term incentive plan: used by 12 percent companies.
5. Incentives, Disincentives, and Views on Importance
   

   The insights below come from a recent Governance & Sustainability Center roundtable with executives in compensation, ESG, governance, and sustainability. Participants discussed lessons learned and the road ahead in linking executive compensation to ESG.

   • Incentives: top reasons for adopting ESG performance measures:
     • Signaling ESG as a priority: cited by 90 percent of roundtable participants
     • Responding to investor expectations: cited by 67 percent
     • Achieving ESG commitments your firm made: cited by 56 percent
   • Disincentives: top reasons for not adopting ESG measures:
     • Difficulty in defining specific goals: cited by 50 percent of roundtable participants
     • Concerns about measuring/reporting performance: cited 35 percent
     • Skepticism about effectiveness in driving performance: cited by 30 percent
     • ESG performance is already covered by existing performance measures: cited by 30 percent

     “Compensation committees and senior executives will want to carefully consider whether they have a compelling business rationale for adopting, adjusting, or expanding the use of ESG goals in executive compensation,” said Blair Jones, Managing Director of Semler Brossy. “The ESG component of executive compensation should do more than send a signal to investors or other stakeholders about the importance of ESG; it should help drive the company’s business strategy and ESG program.”

     

   • Only a minority of companies believe including ESG performance goals in executive pay is highly important in achieving ESG objectives:
     • Low importance: 17 percent
     • Medium importance: 67 percent
     • High importance: 17 percent

     “It takes time to develop and compile reliable, meaningful data that companies can use to measure and report actual performance against ESG goals,” said Umesh Chandra Tiwari, Executive Director of ESGAUGE. “They can start by putting together a steering committee with representatives from various functions who are engaged in the company ’s strategy and can understand and access the data needed to measure and report on ESG performance.”