The Green Gold Rush: why ESG pay is the new executive bonus
Incentivizing Environmental, Social, and Governance (ESG) achievements aligns executive compensation with long-term sustainable business practices and goals. This approach is becoming increasingly important for companies aiming to foster sustainable growth, enhance stakeholder trust, and attract socially responsible investors.
By linking executive pay to ESG performance, organizations not only drive positive impact but also signal to the market that they are committed to long-term value creation, rather than short-term financial gain alone. It is said that an overwhelming 87% of CEOs support the incorporation of ESG metrics into the regular reporting practices of corporations and that 71% of chief executives take personal responsibility for ensuring their company's ESG strategies align with their customers' values
"We don't inherit the earth from our ancestors, we borrow it from our children."
- Native American proverb
Lining up Incentives to Long-Term Goals
Supporting long-term sustainability: Reducing carbon emissions, improving labor conditions, or increasing diversity and inclusion, often require strategic investments that don’t yield immediate returns. Tying compensation to ESG metrics encourages executives to prioritize initiatives that benefit the company and society in the long run, thus fostering sustainability.
Shift from short-term profit focus: Traditional compensation models, which primarily reward short-term financial performance (e.g., quarterly earnings), may encourage behaviors that focus on immediate gains at the expense of sustainability. By linking compensation to ESG criteria, executives are incentivized to take a broader view of value creation—one that integrates social and environmental considerations into the business strategy.
Types of ESG Metrics to Incorporate
Environmental Metrics:
- Waste reduction and recycling programs
- Energy efficiency and renewable energy adoption
- Sustainable sourcing and supply chain practices
- Reduction in carbon emissions
Social Metrics:
- Community engagement and philanthropy
- Health and safety performance
- Employee diversity, equity, and inclusion (DEI) efforts
- Workforce development and fair wages
Governance Metrics:
- Board diversity and independence
- Transparency and anti-corruption measures
- Ethical business practices and compliance with regulations
- Shareholder rights and stakeholder engagement
Strengthening stakeholder trust: Linking executive compensation to ESG results reassures stakeholders—including customers, regulators, employees and investors—that the company is committed to responsible and ethical business practices. This strengthens the company’s reputation and builds trust across the stakeholder spectrum. 59% indicate that a company's failure to address ESG issues would likely lead them to vote against its executive pay agreement.
ESG and Stakeholder Value
Enhancing employee satisfaction and retention: Employees, particularly millennials and Gen Z, are placing increasing importance on working for companies with strong ESG credentials. By tying executive pay to ESG targets, organizations send a clear message to their workforce that their values and contributions to sustainability are recognized and rewarded.
Attracting responsible investors: Institutional investors, including those managing ESG-focused funds, are increasingly looking at how companies manage their environmental, social, and governance risks and opportunities. A significant 79% of investors consider how a company handles ESG risks and opportunities as crucial in their investment choices, with 76% using a company's ESG risk and opportunity profile to filter out potential investments. Companies that prioritize ESG considerations are more likely to attract these investors, which can result in better access to capital and more favorable financing terms. By the year 2025, it is projected that ESG-mandated assets may represent half of all professionally managed investments, totaling around $35 trillion.
Designing ESG-Based Compensation Plans
Short-term incentive plans (STIPs): For quicker ESG achievements, such as implementing a new employee health and safety initiative or launching a sustainable product line, short-term incentive plans (annual bonuses) can reward executives for meeting specific, time-sensitive ESG goals.
Long-term incentive plans (LTIPs): These are often used to reward executives for long-term value creation. ESG goals can be integrated into LTIPs by setting measurable ESG targets over a multi-year period. For example, reducing a company’s carbon footprint by a set percentage or improving employee diversity over a 3-5 year horizon could be key metrics tied to LTIPs.
Scorecards and weighted performance: A balanced scorecard approach can be used to assign different weights to various ESG factors. For example, environmental goals could make up 40% of an executive’s performance assessment, social factors 30%, and governance 30%. Adjusting these weights to reflect the company’s values and priorities helps ensure that ESG targets are aligned with the business’s strategic objectives.
Transparency and Accountability
Clear and measurable targets: To avoid “greenwashing” (when a company makes misleading claims about its environmental practices) or vague ESG goals, it’s important to set clear, measurable, and verifiable targets. For example, rather than stating a general goal like “improve environmental impact,” set a specific target like “reduce carbon emissions by 30% over the next 5 years.”
Regular reporting and communication: It’s essential for companies to regularly report on ESG progress, ensuring transparency and accountability. This can be done through annual sustainability reports, updates to investors, or public-facing dashboards. Executives should be held accountable for both the progress and outcomes related to ESG targets. Currently, 90% of S&P 500 companies release ESG reports.
Independent assessments: Independent third-party audits or assessments can help ensure that the company is meeting its ESG goals and provide objective data that can be used to evaluate executive performance. This reduces the risk of bias and enhances credibility.
Benefits of Aligning Executive Compensation with ESG
Increased stakeholder value: A focus on ESG can result in long-term value creation that benefits not only shareholders but also other stakeholders, such as employees, customers, and communities. By prioritizing ESG in executive compensation, companies can enhance their overall reputation and stakeholder loyalty.
Better risk management: Companies that integrate ESG into their strategy tend to have better risk management practices. This can protect the business from regulatory fines, environmental disasters, and reputational damage—risks that can harm long-term financial performance.
Improved innovation and competitive advantage: Focusing on ESG issues often sparks innovation, such as developing sustainable products, implementing efficient processes, or exploring new markets. This can provide companies with a competitive edge and new growth opportunities.
Challenges and Considerations
Defining meaningful and actionable ESG targets: Some companies may struggle with defining ESG goals that are both ambitious and achievable. It’s important to choose goals that are aligned with the company’s capabilities and industry standards.
Balancing ESG with financial performance: Some critics argue that focusing too much on ESG may detract from financial performance. To avoid this, it’s important to balance short-term financial targets with long-term sustainability goals, ensuring that they are complementary rather than conflicting.
Complexity of measurement: Measuring ESG performance can be challenging because it involves both quantitative and qualitative data, which can be subjective. Companies need robust data collection and reporting systems to track progress and ensure transparency.
The primary challenge for global investors in ESG investments is the inconsistency in scores from different ESG rating providers, as indicated by 25% of them.
72% of European asset owners who receive ESG reports from managers desire standardized reports, yet only 18% are currently able to implement this.
North American investors, in a higher proportion, emphasize the need for unified global standards (51%), the creation of ESG reporting guidelines (53%), and the disclosure of ESG risk factors (53%).
In 2021, 37% of market issuers and institutional investors worldwide said the main problem with increasing ESG (Environmental, Social, and Governance) investments was not having enough skilled people.
More than 10 years ago, Alcoa became one of the first companies to link executive pay to sustainability performance when it announced that 20% of executive cash compensation would be tied to its safety, environmental stewardship, and diversity goals.
Apple announced that it plans to increase or decrease executive bonuses by up to 10% depending on progress toward its ESG targets. Although the tech giant didn’t specify which metrics would be used, it recently unveiled a net-zero commitment.
Unilever, National Grid, Pepsi Co and many other major corporations have established similar plans. Nestlé has also connected executive pay to sustainability outcomes. The company has emphasized goals like reducing its environmental footprint, improving nutrition, and advancing human rights and labor standards. Executives are incentivized with performance-based pay linked to progress in achieving these objectives. Nestlé’s bonus structure includes targets on reducing plastic waste, improving water efficiency, and achieving better nutrition outcomes through product reformulations. Executives receive performance bonuses based on meeting these sustainability goals.
World-leading food company Danone links 20% of its executives’ annual variable compensation to its social, societal, and environmental targets.
Microsoft has made strides in linking its executive compensation to its sustainability and carbon reduction goals. The company has committed to becoming carbon negative by 2030 and has tied executive bonuses to specific environmental performance metrics. Microsoft's compensation framework includes sustainability metrics such as reducing the company’s carbon footprint, transitioning to renewable energy, and managing water use. Executives are eligible for performance bonuses based on their success in meeting these targets.
Most investors (institutional and more and more retail) are requiring from their asset managers to invest in ESG related products or in ESG-focused companies. 89% of investors when making investment decisions are considering ESG criteria. 88% of institutional investors surveyed express the belief that asset managers should take a more active role in creating new ESG-focused products.
Incentivizing ESG achievements through executive compensation is a powerful way to ensure that leaders are accountable for fostering sustainable, ethical business practices. This approach aligns the interests of executives with long-term goals that benefit both the company and society. As the global business landscape increasingly values sustainability, companies that lead in this area will likely see stronger financial returns, enhanced stakeholder trust, and a more resilient, purpose-driven business model.
Victor Hamoush is a consulting partner at Brandywine Insights and has more than 25 years of experience in the financial services industry in Paris, London, Beirut and Abu Dhabi. He is a strategy consultant for the World Bank and a founding partner of Axley Bankers M.E, a boutique consulting firm, focusing on strategy, asset management and ESG.
Discuss Further
Read more at -
Harvard Law School Forum on Corporate Governance - addressing two fundamental shifts - an intensified focus on ESG and a multistakeholder form of capitalism
PwC Insghts on Sustainability
Odgers Berndtson Leadership Series examining the most effective strategies boards can implement to align ESG goals with executive compensation -
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