Executive Compensation: An Analysis Identifies ESG Leaders and Laggards

Understanding what distinguishes corporate leaders from laggards in the environmental, social, and governance (ESG) realm provides important guidance on emerging best practices for boards.

In this fast-moving arena, Farient Advisors identified a small group of companies who stand out as leaders in incorporating stakeholder measures into their executive compensation plans. Conversely, many companies are falling behind because they are either reluctant to engage in stakeholder issues or their efforts are insufficient to encourage real progress.

What makes a leader or laggard in stakeholder incentive design? What measures should directors and management teams consider in their incentive plans?

From Promise to Fulfillment

Data disclosure is often considered the first step in accountability and external monitoring. ESG-focused investors and activists continue to call for greater transparency from companies on an array of topics, ranging from workforce ethnic diversity to the impact of their operations on natural habitats. Some 74 percent of global companies and 56 percent of U.S. S&P 500 companies now incorporate stakeholder measures into their executive incentive plans. By including such measures, companies and their boards aim to:

• Communicate priorities on stakeholder issues throughout an organization and externally
• Provide focus for incentive participants to drive performance on important ESG issues
• Build accountability and oversight mechanisms on these issues

As detailed in the Farient/Global Governance and Executive Compensation (GECN) Group research 2023 Global Trends in Stakeholder Incentives: The Staying Power of ESG, stakeholder measures are typically:

• Included in short-term incentive (STI) rather than long-term incentive (LTI) plans
• Used as weighted metrics or as part of a weighted scorecard
• Measured on a qualitative basis or by using a mix of qualitative and quantitative assessments
• Focused primarily on social and environmental measures

Leading companies, which make up a small percentage of the U.S. market, are creative, vocal, and clear in disclosing their stakeholder incentive designs. On the other end, laggards’ use of stakeholder incentive measures lack effort in design, lack rigor in goal setting, or communicate only vague commitments to ESG, indicating a board or management team that does not make sustainability a priority.

The Leaders

With ESG developments moving at rapid pace, best practices and trends are quick to change. Nevertheless, the characteristics of leaders reflect their effort under current conditions to drive positive progress on environmental and social issues. Listed below are emerging best practices from leaders in stakeholder measures and common incentive design characteristics.

Although some industries have a greater prevalence or a longer history of using stakeholder measures, the standout companies can be found across sectors. Examples of companies which have demonstrated leadership in their use of stakeholder incentive measures and goals, and notable features of each incentive system, are detailed below.

Recommendations for Boards

Wherever companies are on their ESG journey, key considerations for compensation committees include the following:

• Start with the company’s ESG strategy. Think holistically about the company’s ESG strategy—how it ties into the broader business strategy and mission, what measures are important, what goals are to be achieved, and how (if at all) incentives can help the company make progress on the company’s stakeholder short- and long-term objectives.
• Engage shareholders and stakeholders. Shareholder engagement with a focus on ESG can help companies gather specific feedback on areas for improvement. In addition, this feedback should be reported to the board to enhance their understanding of the issues.
• Benchmark performance against peers. Benchmarking can help to identify where the company stands relative to the market, where it stands out, and where it needs improvement. The growing wealth of comparable data also can assist companies in identifying goals.
• Think about desired outcomes. In setting goals, think about what the end result should look like and where the company should be in the long-term. Then work backwards to identify the short-term inputs needed to achieve those goals, such as investing in new technology that reduces emissions or hiring a diversity officer. The incentive plan could be designed using output goals (i.e., outcomes), inputs, or a mix of both.
• Strive for greater transparency. The company should tell its story and explain where it currently stands on sustainability issues, why it is using stakeholder measures in its incentives, why it chose the metrics and goals it did, and where it plans to be in the future. Greater transparency in this area can strengthen the company’s messaging on ESG commitments.

Any approach taken by boards should be thoughtful, consider the company’s broader strategy as it relates to stakeholders, and show a commitment to measures which prove progress is being made.

 

By Brian Bueno

Brian Bueno is ESG leader at Farient Advisors.

An abridged version of this article originally appeared in Directorship magazine, Fall, 2022. (Membership required to access.)

 

About Farient Advisors 

Farient Advisors LLC is an independent premier executive compensation, performance, and corporate governance consultancy. Farient provides a full array of services, linking business strategy to compensation through a tailored, analytically rigorous, and collaborative approach. Farient has locations in Los Angeles, New York, Louisville, and Dallas and works with clients globally through its partnership in the Global Governance and Executive Compensation Group (GECN). Farient is a certified diverse company and is recognized by the Women’s Business Enterprise National Council.