Linking Executive Compensation to ESG Performance
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Linking Executive Compensation to ESG Performance

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As companies address two fundamental and related shifts—the intensified focus on environmental, social & governance (ESG) issues driven by investors, employees, consumers, business partners, ESG rating agencies, and regulators,[1] and the shift to a multistakeholder form of capitalism[2]—corporate boards are not only incorporating nonfinancial matters into discussions of company strategy and business plans, but also increasingly considering ESG performance measures in incentive plans. At the same time, there are concerns about the benefits of incorporating ESG measures into compensation, the risks of doing so (e.g., rewarding the wrong behaviors, setting inadequate targets, and creating guaranteed bonuses), and challenges in providing investors with what they view as sufficient transparency and specificity in ESG-based pay plans. These concerns have now been compounded by skepticism about whether ESG can actually drive financial performance for companies and investors alike.[3]

As companies address two fundamental and related shifts—the intensified focus on environmental, social & governance (ESG) issues driven by investors, employees, consumers, business partners, ESG rating agencies, and regulators,[1] and the shift to a multistakeholder form of capitalism[2]—corporate boards are not only incorporating nonfinancial matters into discussions of company strategy and business plans, but also increasingly considering ESG performance measures in incentive plans. At the same time, there are concerns about the benefits of incorporating ESG measures into compensation, the risks of doing so (e.g., rewarding the wrong behaviors, setting inadequate targets, and creating guaranteed bonuses), and challenges in providing investors with what they view as sufficient transparency and specificity in ESG-based pay plans. These concerns have now been compounded by skepticism about whether ESG can actually drive financial performance for companies and investors alike.[3]

Insights for What’s Ahead

  • The vast majority of S&P 500 companies are now tying executive compensation to some form of ESG performance—growing from66 percent in 2020 to 73 percent in 2021.The most significant increase was found in companies’ use of diversity, equity & inclusion (DEI) goals, rising from 35 percent in 2020 to 51 percent in 2021, as investors and other stakeholders continue to focus on diversity—making it a priority for companies as well. And as a result of the ever-growing attention to climate change, the share of S&P 500 companies that tied carbon footprint and emission reduction goals to executive pay also grew considerably, from 10 percent in 2020 to 19 percent in 2021.
  • Companies are embracing different approaches to factoring ESG into executive pay and are continuing to refine their ESG measures as they expand their reach. For example, some companies a

Author

Merel Spierings

Merel Spierings Merel Spierings

Former Senior Researcher, Governance & Sustainabil…
The Conference Board

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