Almost half of FTSE100 companies have pegged executive rewards to their ESG objectives in a bid to address broader societal concerns, finds Andrew Holt.
There is no doubt that environmental, social or corporate governance (ESG) issues are the zeitgeist of our age. But the interesting thing is how investors are seeking to embrace all aspects of the E, the S, and G to be focused not only on the financial side of things but also non-financial ones.
Companies have clearly got the message on this in the white heat of the annual general meeting (AGM) season with many going on the front foot to address ESG issues to outmanoeuvre any potential investor revolts.
This is evident by the fact that almost half of FTSE100 companies have linked executive pay to their ESG objectives, in a strong part, because investors are demanding that companies adopt non-financial aims in the annual general meeting season.
Now just over a third have an ESG measure in their bonus plans, with an average weighting of 15% of this payout linked to these goals, according to a report from London Business School and PwC. About one in five FTSE100 members include such targets in their long-term incentive plans.
Interestingly, nearly half of ESG measures used in judging CEO pay are not deemed ‘material’ to shareholder value.
The favoured factor for determining bonuses was based on social goals such as diversity and employee engagement, while for long-term incentives it was the environment.
Shift in concerns
Providing further evidence of a real change in approach, the report also revealed that ESG targets were shifting from traditional areas such as employee engagement and risk towards newer and broader concerns around the environment, sustainability and diversity.
An issue expressed regularly in the pages of portfolio institutional and highlighted in the report is that investors are increasingly demanding that company management build in ESG targets to pay agreements, with companies’ behaviour towards such non-financial goals set to be a focus in this year’s AGMs, which are likely to be sparky affairs for those not ESG committed.
On this, there has been a move by many companies to hold investor days specifically dedicated to their ESG plans.
This trend unpicks some traditional metrics with a link to shareholder value which have been used as a commitment to ESG, these have been the likes of health and safety issues and employee engagement, which it seems are being supplemented with metrics that address broader societal concerns, such as the climate, inclusion and diversity.
It is also consistent with boards taking a broader view of their responsibilities to stakeholders – which is a requirement under the UK Corporate Governance Code and the Companies Act.
The study also assessed the ESG targets used in pay against the Sustainability Accounting Standards Board (SASB) Materiality Map, which identifies the ESG factors that are material for each industry.
This framework has robust academic support, with research showing that companies that focus on its material dimensions reap the benefits of ESG in terms of enhanced shareholder returns. Around 55% of the measures used by FTSE100 companies were found to be material to the framework.
And though there is much momentum behind adoption of ESG targets in pay, the study strikes some important notes of caution.
It says the difficulty of translating ESG goals into targets in a holistic and reliable way leads to many potential unintended consequences.
Furthermore, ESG targets may undermine intrinsic motivation, and lead to companies focusing on only the ESG targets in the pay plan, at the expense of other important ESG issues.
The challenge here being that investors, in the main, want companies to be fully committed to non-material ESG issues but also want to see a good return on their investment.
An issue Tom Gosling, executive fellow at London Business School’s Centre for Corporate Governance, identifies. “It’s striking that nearly half of the ESG measures being used in pay aren’t deemed material to shareholders by the benchmark SASB framework. This may in part reflect SASB not being up to date with the latest ESG concerns,” he said.
And he added: “But it will be interesting to see how this plays out over time as most investors are making it clear they expect companies’ ESG activities to focus on the areas that contribute to long-term shareholder value. The increased focus on integrating ESG considerations into company strategy and operations is welcome. But this doesn’t mean we should automatically include ESG targets in pay.
“There are lots of practical difficulties, and scope for unintended consequences, in linking pay to ESG. And there’s a risk that more ESG targets simply results in more pay, due to the difficulty of knowing how stretching these targets are.”