ESG in Incentives: Evolving Your Approach

FW Cook discusses “phase two” of how companies incorporate ESG objectives into incentive design in its new 2023 ESG report. They indicate that 75% of the Top 250 companies put ESG measures into their plans, but only a quarter are disclosing quantitative performance measurement.  As pressure mounts for companies to increase transparency and rigor of ESG performance goals and communicate the link to how these goals impact the long-term business objectives, organizations need to carefully weigh how this is done in order to avoid unintended consequences. Noting the political backlash of ESG by some - as well as the criticisms of many mainstream investors for “soft” and “subjective” goals, it is prudent for companies to review their incentive plans for 2024 to determine if the plan design needs to evolve.

FW Cook highlight some key factors to consider when evaluating the appropriateness of ESG measures in compensation or changes to how these measures are currently included:

• Shareholder engagement. What are the expectations of your large investors? Has the topic of linking ESG to incentives previously been discussed? Is pushback anticipated? How have you previously communicated to investors about ESG measures and the materiality to the business?
  
  
• Balancing multiple stakeholder perspectives. Understanding that not all stakeholders have similar views about the implications of an ESG measure, what are the implications of including a measure or not and what financial measure is de-emphasized? Can a measure already in place be removed?
  
  
• Disclosure. Can the goal be quantitatively measured? Will increased transparency raise concerns over the level of achievement? What criticism would be expected if goal attainment is not disclosed clearly?
  
  
• Status of current processes. How are ESG measures monitored today? Does the governance structure assign responsibilities to a designated committee or across multiple committees?
  
  
• Signaling of importance. Does an ESG measure need to be formally included in incentive to signal the value to the organization? Can ESG be effectively measured and disclosed outside of compensation? Does inclusion of one measure imply lack of importance of others?
  
  
• Measurement of ESG goals. If it is determined a goal should be included, how it will be incorporated (as a modifier, weighted measure, or part of a corporate or individual strategic objective.)? Should goals be measured quantitatively or qualitatively? Should they be set at the corporate or business unit level for visibility?
  
  
• Goal setting challenges. Companies need to determine if they are measuring outcomes or activities and inputs, something that is particularly difficult with DEI and climate goals. Setting targets can be difficult, especially for goals with a long-term horizon. And companies risk criticism for setting goals too low or underachieving on commitments.

The full report contains prevalence of different ESG measures by category and industry as well as data on how achievements are measured.