Incentivizing Climate Action: Exec Pay Increasingly Tied to GHG Emissions

The Securities and Exchange Commission (SEC) missed its own April 2023 deadline to issue a final rule on climate change disclosure. The rule, originally proposed in March 2022, would require publicly listed companies to disclose greater information around their climate risks including annual data on their greenhouse gas (GHG) emissions, and how they manage those risks. The Washington Post, citing a former SEC commissioner, reported the final rule might not arrive until sometime this fall.

While the rule has received pushback from certain companies and industry groups, as Farient detailed last year, companies have long faced mounting pressure from investors and other stakeholders to disclose information on their climate risks and emissions. For instance, investors such as BlackRock and State Street Global Advisors have policies that require their portfolio companies to disclose climate risks and related information under the Taskforce for Climate-Related Financial Disclosures (TCFD), a reporting standard which influenced the creation of SEC’s own climate rule. Other ESG reporting standards (e.g., Global Reporting Initiative and Sustainability Accounting Standards Board) have also encouraged this type of climate and GHG emissions reporting, which many companies have adopted.

“Say on Climate” initiatives have also seen companies pressured by shareholders to submit annual non-binding advisory resolutions on their climate transition plans.

A combination of factors—new regulations, investor pressure, and shifting stakeholder and customer expectations—have worked together to compel companies to adopt environmental sustainability goals into their broader business strategies. Sustainability measures are increasingly tied to specific climate goals, such as net zero “science-based” emissions targets, which are aimed at limiting global warming to 1.5°C above pre-industrial levels.

 

Executive Incentives Tied to Climate Targets

Companies are tying executive incentives to environmental performance metrics in order to align their compensation programs with their corporate and sustainability strategies. According to the Farient/GECN report “2023 Global Trends in Stakeholder Incentives: The Staying Power of ESG,” globally, the use of environmental measures in incentives among large companies has increased from 30% in 2020 to 50% today, with significant increases made across certain regions and industries.

For instance, Europe leads in its use of environmental measures, with 82% of companies in the region now using such measures. And while the U.S. lags other markets, environmental measures are now used by nearly one-third of companies, up from 8% in 2020.

Other findings from Farient’s report include:

• The Energy sector continues to lead in the use of environmental measures in incentives, with 79% prevalence, which has not changed much from prior years
• Companies in the Health Care and Financials sector significantly increased their use of environmental metrics, with more than 40% prevalence in the latest year
• Of those companies using environmental measures in incentives, about half (52%) are focusing on GHG emissions
• Outside of GHG emissions, companies are using environmental measures tied to improvements in air quality, land management, environmental incidents management, and water conservation

Source: 2023 Global Trends in Stakeholder Incentives: The Staying Power of ESG

 

Source: 2023 Global Trends in Stakeholder Incentives: The Staying Power of ESG

 

Proxies in 2023 have revealed additional companies tying executive incentives to environmental targets. And some companies that were already using environmental-based incentives are refining existing goals to be more quantitative and are using more objective performance targets (i.e., that don’t rely on subjective reviews by management or the Compensation Committee).

One such company refining its environmental incentive targets is Chipotle, which changed the ESG component of its short-term incentive (STI) plan to incorporate more quantitative measures. In addition to switching ESG from a 10% weighted measure to a modifier that can modify the STI payout +/- 10%, the company changed its environmental metric. In FY 2021, the environmental goal was to “publish our Scope 3 emissions by December 31, 2021,” and in FY 2022, the goal was enhanced to “Reduce Scope 1 and 2 GHG emissions by end of year 2022.” The company improved the objectivity and rigor of its incentive measure and actually achieved a 13% GHG emission reduction in 2022.

 

Source: Chipotle 2023 Proxy Statement

 

Farient Point of View

Environmental issues will undoubtedly remain of paramount importance to society, and thus, to regulators and certain investors. Regulations intended to curb climate change likely will become more stringent as governments around the world aim to curtail emissions in keeping with the 2015 Paris Agreement. As such, the use of incentive measures tied to reaching environmental and climate goals, particularly those relating to GHG emissions, will continue to increase.

While we expect companies to continue to refine their metrics and goals, the work to be done is daunting. Measuring long-term environmental targets under the one-year and three-year time horizons typical of incentive awards remains a challenge. Why? Because a balance must be struck between rigor and what is achievable. In addition, the challenge is compounded by pressure to align performance with shareholder and stakeholder expectations. Some stakeholders who want to see companies act on climate will equally disapprove of companies that make false promises on sustainability efforts or pay out incentives to executives for underperformance on climate initiatives.

Finally, we anticipate some expansion in the types of environmental metrics on which companies focus. Working groups such as the Taskforce on Nature-related Financial Disclosures (TNFD), which address land use, ocean and freshwater management, and biodiversity, have started to gain traction among policymakers and investors, with key stakeholders beginning to develop quantifiable metrics to measure progress.

By Brian Bueno

 

About Brian Bueno

ESG Practice Leader, Farient Advisors/GECN Group, New York

New York
(646) 626-6929
brian.bueno@farient.com

Brian Bueno is the ESG Leader at Farient Advisors. In this role, Brian guides the firm’s strategy, research, and analysis on environmental, social, and corporate governance (ESG) matters. Brian focuses on the ESG landscape and its intersection with executive compensation and incentives in order to assist clients in understanding stakeholder considerations and developing and implementing appropriate programs that help create stakeholder value.

Prior to re-joining Farient in 2022, Brian was vice president and product manager at Institutional Shareholder Services (ISS), a leading proxy advisory firm, where he led the development of solutions that assist institutional investors evaluate executive compensation and related areas at their portfolio companies across global markets. Additionally, at ISS’s Corporate Solutions arm, Brian led the creation and management of product platforms that allow companies to benchmark themselves across executive compensation and ESG topics.

Prior to joining ISS in 2015, Brian worked at Farient where he managed the development and delivery of Farient’s Performance Alignment Reports and associated research, including analyses on executive pay definitions and financial performance metrics and their link to shareholder value. At Farient, Brian also worked with clients across various industries, including energy, industrials, banking, and insurance. And before Farient, Brian held a market research role involved in identifying opportunities and risks in particular industries and communicating findings to clients and media.

Brian holds a BS from the University of Southern California’s (USC) Marshall School of Business with a triple concentration in finance, marketing, and entrepreneurship.

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