“Red Flags” for Board Directors on Tying Pay to ESG

As tying ESG metrics to pay becomes increasingly prevalent (almost 80% of the S&P 500), some interesting thought pieces have emerged as to how and where they should be applied. A new Conference Board piece directed at board members instructs them not only what questions to ask management, but “what to look for” in management’s answers and even “red flags” in management’s response. A review of the questions may prove instructive:

• What is the goal? The article states that management should be able to explain why including ESG metrics is necessary, how it relates to the overall ESG initiative, and why the benefits outweigh the costs. The authors suggest that “boards ought to be wary”  if management’s proposed goals don’t align with ESG strategy or if they are pushing ESG metrics because it’s “what investors want.” Although large investors do advocate for ESG disclosure, they do not always support management being paid for progress on ESG goals.
  
  
• How deep should it go? Given the board’s role in overseeing human capital risks, the article warns against pushing ESG metrics too far down in the organization. The board should be made aware of which levels of employees can actually influence ESG performance.
  
  
• What is the plan design? There are generally four types of ESG metrics in use: individual performance (49%), strategy scorecard (48%), stand-alone metric (24%) and modifier (6%). The article advises the board to ensure management has considered whether the metrics should be annual or long-term, absolute or relative, quantitative or qualitative, and how various stakeholders will react. If goals are too vague, qualitative or discretionary, the company may be moving too quickly.
  
  
• How to communicate? The article exhorts boards to ask management about a comprehensive communications plan to investors, employees and the media, especially regarding how ambitious and achievable the goals are. It notes that “boards should be wary” if management seems unprepared to “deal with skepticism” or is too optimistic about stakeholder reactions.

As boards are increasingly told that they must prioritize oversight of human capital, talent and ESG risks, these types of questions are becoming more common in board meetings and management should be prepared with answers.