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Linking executive pay to ESG performance – does it have an impact?

If your organisation has recently set new Environmental, Social and Governance (ESG) goals, you’ll need to develop a clear strategy to help you achieve them. This can involve a range of methods, starting with accurate data and reporting.

One interesting method that some companies are trialling is linking executive pay to ESG target performance.

Companies can tie executive pay to Environmental, Social, and Governance (ESG) goals by including ESG performance targets, metrics and objectives as part of the executive’s performance-based compensation, such as bonuses or equity awards.

According to a recent survey by the London Business School and PWC, around 45% of FTSE 100 executives now have their remuneration linked to ESG performance. What’s more, 78% of board members and executives agree that strong ESG performance contributes to organisational value and financial performance.

Similar studies in the US have made corresponding findings, including leading brands and companies such as Apple, Chipotle, McDonald’s, Clorox, Starbucks and National Grid in the UK. The survey goes on to say decision-making by top level management is expected to take ESG into greater consideration.

But does it actually work?

There is thinking that linking ESG performance to executive pay could be an effective way of incentivising firms to improve their commitment to sustainability.

Research published by the Standard Graduate School of Business in the US noted that when companies build specific metrics into executive remuneration packages, they are able to make progress in achieving these benchmarks.

The study by Shira Cohen, Igor Kadach, Gaizka Ormazabal and Stefan J. Reichelstein states:

“For instance, we find that when firms include emission-specific metrics in their executive compensation packages, they also achieve a subsequent decrease in their CO2 emissions,”

The research also noted, however, that ESG pay initiatives don’t appear to have much of an impact (if any) on financial performance. There are plenty of other benefits, but these can sometimes be difficult to quantify. Researchers state:

“Most consumers, investors, and the general public believe that some of these ESG variables reflect a common good for society that is not reflected on its own in profitability measures.”

Steering clear of ‘greenwashing’

However, the Standard Graduate School of Business study also flagged up the need for clear and specific ESG metrics. Without them, businesses aiming to link ESG performance to high-level pay may face potential pitfalls to navigate.

For example, such measures could encourage short-term thinking and greenwashing. There’s the risk that any such initiative could be simply labelled a PR move, designed solely to improve the company’s reputation as a responsible organisation with customers and stakeholders.

If your company needs help sourcing executive level talent, our expert team here at Bailey Montagu are right by your side. Get in touch to discuss your requirements and start your search.

Andrew Linger