ESG Incentives and Executives
Posted by Ira T. Kay, Mike Kesner, and
Joadi Oglesby, Pay Governance LLC, on Tuesday, May 24, 2022
Early indications are that the inclusion of environmental, social, and
governance (ESG) metrics in corporate incentive plans—primarily annual
incentives currently—is becoming common, with 69% of S&P 500 companies (207 of
301) reporting the inclusion of such metrics in their 2022 proxies.  If
this level of inclusion holds for all of 2022, it would represent a significant
increase from 2021 when 52% of the S&P 500 reported ESG metrics. It is apparent
that large corporations and their executives have undertaken a good faith effort
in using incentives to address ESG issues at the company level, with possible
beneficial societal implications.
This unprecedented movement in incentive metric usage—much faster even than the
relative total shareholder return (TSR) transition—is caused by many factors:
from boards’/executives’ desire to help improve the social footprint of their
companies and society to responding to shareholder pressures. This shift is
viewed by most audiences as a positive response from the corporate sector, but
it has its critics and challenges: measuring real impact; interpreting limited
data; navigating the lack of uniform measurement standards; choosing metrics;
setting goals; and balancing shareholder, societal, and employee priorities,
among others. Most, but not all, companies that have added ESG metrics to an
incentive plan have included them in a holistic/qualitative scorecard that may
include a combination of quantifiable and qualitative goals. There are many
valid reasons for this including measurement difficulty, litigation risk, and
motivational challenges. There are several companies that have purely
quantitative goals, and there is governmental, institutional, proxy advisor, and
media pressure to adopt this approach.
Bebchuk/Tallarita (BT),  major
critics of the ESG/stakeholder movement, have challenged the suitability and
utility of incorporating these metrics/goals into corporate incentive plans. BT
raised several valid criticisms/questions of the ESG/stakeholder incentive
movement,  including
the narrowness of the metrics, the limited use of quantitative metrics, and the possibility
that executives are implementing these metrics to improve their incentive
payouts at the expense of shareholders. Their view is that ESG metrics will
likely not improve the desired corporate and societal goals and might
distract the executives from focusing on shareholder value.
Gosling, another expert in this field, agrees with the BT view: “One of my big
fears about this sort of stampede towards including ESG targets in executive
pay is that it’s likely just to lead to more pay and not more ESG. ”
However, despite these criticisms, the ESG incentive metrics movement has
significant, and arguably irreversible, momentum to
address the private and public issues due to substantial pressure on large
corporations to move rapidly into ESG/stakeholder incentive commitments.
Therefore, it is essential that this movement be based upon financial and
economic validity and facts.
important criticism from BT remains empirically unresolved: “it is difficult
if not impossible for outside observers to assess whether this use provides
valuable incentives or rather merely lines CEO’s pockets with
performance-insensitive pay.” They worry that these incentives will motivate
executives to increase their pay without benefiting other stakeholders and
“indeed might dilute executives’ incentives to deliver value to shareholders.”
Pay Governance has conducted unique research to try to address this issue. We
find the usage of ESG metrics, thus far, does not appear to have significantly
diluted other incentives or distracted executives from creating shareholder as
well as stakeholder value.
Here are the hypotheses we thought should be tested:
Is the ESG
payout multiplier in incentive plans higher than the payout multiplier for
If there is
validity to the criticism that ESG metrics are a distraction and being added
to increase executive pay, there would be some indication that ESG metrics
are in fact diluting attention from creating shareholder value relative to
It is also
too early in the ESG incentive movement to test whether they have a positive
impact on TSR or other performance metrics.
can test whether the ESG incentive payouts are higher than the payouts for
conclusions can be drawn from companies that use a weighted ESG factor versus
We note that
77% of companies with an explicit ESG metric use a “weighted” structure
versus 24% of companies with an unweighted modifier (the total adds to 101%,
as one company uses a weighted metric and modifier).
See below for
additional information regarding weighted metrics and modifiers.
Are there any
indications that Compensation Committees may be hesitant to provide payouts
above or below target based upon the achievement of ESG metrics if such
metrics are measured based on a combination of quantitative and qualitative
goals and/or when financial and operational goals are not attained?
utilized the following methodology to test for the answers:
Scanned 100 S&P
500 companies’ proxies using ESGAUGE to identify companies with ESG metrics
that provided clear disclosure of both the financial and ESG metrics
included in their annual incentive plan, even if the ESG metrics were part of
a holistic scorecard of other strategic metrics.
data into two different groups based on the method used to include ESG in the
incentive plan: either a weighted ESG factor, which reduces the weight of the
financial metrics, or a modifier that is used to increase or decrease the
2021 payouts for:
payout after incorporating the ESG impact
We found 62 large companies that met these criteria.
Here are our key findings:
ESG reduced the
overall payout at 75% of the companies using a weighted metric, (Figure 1)
with the median reduction equal to 9%. (Figure
ESG-weighted metric companies (56%) used a 20% weighting or less. (Figure 2)
cases, the company used a scorecard approach and did not provide sufficient
detail to determine the portion of the weighted metric attributable to ESG;
in those cases, we included the entire weighting.
Many of the
companies with a >20% weighting included ESG and other strategic metrics.
companies that incorporated ESG metrics as part of a modifier, 33% increased
payouts and the remaining 67% had no effect or reduced payouts. (Figure 3)
impact on payouts for companies using a modifier on the financial performance
metrics ranged from +35% to -14% and averaged +2%. (Figure 4)
indicate that the compensation committee members are acting conservatively in
setting and scoring ESG goals—thus the narrow band around target for most
ranked the 48 companies from largest (negative) impact to smallest (positive).
ESG movement has made substantial progress in encouraging U.S. companies to
incorporate ESG metrics into their incentive plans. It is early in this process,
and we need to wait for information about the impact of these corporate programs
on companies’ long-term performance and sustainability as well as the effect on
societal problems. However, it does appear that the ESG incentive criticism,
that executives are using these metrics inappropriately to increase their
compensation, is not empirically supported.
Data provided by ESGAUGE.
Lucian A. Bebchuk
and Roberto Tallarita. “The Perils and Questionable Promise of ESG-Based
Compensation.” Journal of Corporation Law. March 4, 2022.
Ira Kay. “The
Perils and Promise of ESG-Based Compensation: A Response to Bebchuk and
Tallarita.” Harvard Law School Forum on Corporate Governance. April 27, 2022.
CJ Clouse. “Does Linking ESG Performance to Executive Pay Actually Make a
Difference?” GreenBiz. February 2, 2022.
Harvard Law School Forum
on Corporate Governance
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