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Environmental, social, and governance (ESG) considerations have evolved from being peripheral concerns to integral components of corporate strategies. A notable shift is underway as businesses increasingly intertwine ESG performance with executive compensation. It’s an emerging trend in 2024, but will companies actually make it part of their business strategy? Here’s what we know so far.
The Evolution of ESG in Compensation Plans
Linking ESG performance to executive compensation is a recent phenomenon gaining momentum. Just a decade ago, this connection was uncommon. However, according to a recent study of more than 4,000 companies by IESE Business School Professor of Accounting and Control Gaizka Ormazabal, it's now a standard practice in over 30% of global companies.
For the top companies in the United States, more than 73% have linked executive compensation to ESG performance as of 2021, according to research conducted by The Conference Board, a member-driven think tank. More specifically, diversity, equity & inclusion (DEI) goals have taken center stage, surging from 35% to 51% in just a year. While carbon footprint and emission reduction goals have also seen a notable increase, from 10% to 19%.
Navigating Challenges and Building Credibility With ESG Goals
Companies have found various ways to connect executive compensation to company ESG goals, including individual performance assessments, business strategy scorecards, standalone ESG metrics, and more. Yet, many companies remain skeptical about its potential effectiveness.
Only 17% of corporate executives view ESG performance goals in executive pay as highly important for achieving ESG objectives and investors' support for ESG-based pay is not uniform, reflecting a disparity in priorities across sectors. Opponents cite concerns about standardization, transparency, and goal rigor when tying ESG to executive income.
There are also wide-ranging disparities across different business sectors; utilities and energy companies leading adoption, while other sectors, like IT and consumer discretionary, lag behind.
Ormazabal advises against blindly following the crowd. "Do not do this because everybody is doing it," he emphasizes. "Do this if you have a clear idea of why you want to: because you are concerned that ESG risks may affect you in the future; because you have a certain type of stakeholder that is pushing really hard for this; or because you have made a commitment and you want this commitment to be credible."
Conclusion
It’s predicted businesses will continue to grapple with the integration of ESG into executive compensation throughout the year. Companies must carefully assess the motivations behind this alignment. Balancing the pursuit of sustainability with the intricacies of executive rewards is a journey that demands strategic foresight, clear goals, and a commitment to authenticity. The evolution of ESG in compensation plans reflects a broader commitment to responsible business practices, and as executives navigate this landscape, the impact on corporate culture and societal expectations remains a critical consideration.
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