ESG – Why and how could companies think about including ESG metrics in executive compensation plans?

ESG is a growing characteristic of executive remuneration plans, with 58% of FTSE 100 companies including these metrics in their reward packages – up from 45% in 2020. According to a 2021 PwC Survey amongst Corporate Directors, 94% support the inclusion of non-financial targets in executive compensation plans. But aside from this, why should companies consider linking executive remuneration to ESG, and how can this be achieved?

One consideration for companies could be the growing trend of ethical investing. In a survey by Finder 77% of British investors are likely to invest ethically, accounting for 23 million adults in the UK. With a potential market size of this scale, it seems to make more sense to include at least one ESG measure than it does not to include any, especially as this number is likely to grow in the future. As remuneration strategies are voted for by shareholders, it is also important that these strategies reflect the investors’ ESG priorities. Furthermore, with the consideration of ethical investment, there is a high chance that these thoughts will begin to spill into consumer habits, leaving companies that fail to adapt being overlooked in favour of their competitors.

Another factor to consider is the UK Corporate Governance Code, which states that remuneration policies should be designed to support strategy and long-term sustainable success. With this, there are likely to be long-term benefits for the environment, society and the economy, ensuring the best conditions for the company to flourish in the long run. The UK Corporate Governance Code also obligates premium listed companies to be transparent, in turn encouraging them to be mindful of ESG metrics in remuneration strategies.

So how can ESG metrics be implemented into executive remuneration plans? As is with most corporate practices, practice, initially, is likely to be laid by large corporations and will trickle down into mid-market businesses in due course. However, an initial starting point could be to outline the ESG practices already taking place within the company but structuring reward schemes to provide that a percentage of the maximum award will vest only upon the achievement of improvements in said practices. Another way to include ESG targets could be through research into competitors in similar industries and applying similar practices to those. That said, it is important that incentive plan measures and targets are tailored to the requirements of each company and are not selected by reference to what appears to be most popular in the market.

MM&K is developing its expertise on this topic.  The GECN, of which MM&K is a member, carries out global research into the use companies are making of ESG measures and targets in their executive incentive plans. The 2022 report on the latest findings of that research will be available later in the autumn.

For more information, please contact George Edwards.

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