Challenges and opportunities for ESG-linked pay in 2022

Last week Ras Berglund and I spoke at the ESOP Centre’s 2022 Share Schemes Symposium about the growing impact of ESG on executive remuneration. We were joined on the panel by Jeremy Edwards from Baker McKenzie. It was a lively, in person session in which we discussed the topical issues facing organisations when it comes to ESG and pay.

Some of the headline points discussed include:

ESG-linked pay has shot to prominence in a short space of time – why now?

• Likely explanations include a renewed focus on good corporate governance and behaviour in recent years, of which a balanced and appropriate executive pay package is a key part. Combined with the increasingly acute array of societal issues we are all exposed to (climate change, societal inequality, supply chain ethics, cyber-security threats and so on), it is hard for companies to eschew responsibility for playing their role in finding solutions. Tying ESG to pay is a clear way to signal they are trying to do this.

Does it work?

• Paying people to do things is usually a good way to get those things done. But why pick out ESG ends as something to remunerate separately when there are multiple other strands to the day job?
• Possible reasons include the communicative function it holds for the broader organisation and stakeholders. It is also fair to acknowledge that embedding certain “new” ESG concepts into business as usual represents a novel challenge for which executives can legitimately be rewarded.
• However, there may be equally effective ways to achieve the same goals that don’t rely on financial reward (the carrot) or the downward adjustment of pay outcomes for ESG failures (the stick).

How should firms choose ESG targets?

• The golden rule here is ensuring targets are aligned with corporate strategy. This cannot be a tick-box exercise; at best, pursuing arbitrary ESG ends becomes futile but at worst choosing the wrong targets can be a harmful distraction from other things that need to be done.

Which metrics should firms choose?

• Investors like clear, quantifiable metrics which enable them to hold executives to account (and remove the ability for them to “mark their own homework”). However such metrics should be approached with care – the narrower the metric, the narrower the scope of the problem they may be able to address. Firms’ real aims in this space are often broad, complex, and qualitative (for instance, establishing a more inclusive working environment). Pursuing one strand of such aims in isolation - for example, a more diverse board - may “hit the target, but miss the point”.

Who needs to think about all this?

• While listed companies have been the traditional home of ESG-linked pay, it is creeping onto other agendas too.
• Large private companies recently became subject to disclose in line with the Taskforce for Climate Related Financial disclosures (on a comply or explain basis), the guidance to which requires users to “consider describing whether and how related performance metrics are incorporated into remuneration policies”.
• We are also seeing increasing interest from asset managers in tying ESG to carry and other remuneration arrangements. Only this week Schroders announced it would tie its compensation to ESG goals. So this is no longer the preserve of the listed space.