The economic downturn has put executive pay in the
shareholder spotlight, with investors increasingly demanding
that executive compensation be linked to corporate performance.
So far, however, the ongoing policy and public debate has
largely overlooked the extent to which companies should
consider linking remuneration not just to financial performance
but also to specific environmental, social and governance (ESG)
metrics and whether investors need to send stronger signals to
management to make this happen.
With responsible investment gaining media coverage,
companies will be well aware of the importance of addressing
their ESG risk.
Studies show that capital is likely to flow into companies
that can demonstrate transparency, compliance with bribery
legislation, management of environmental risk and other
factors. We also know what happens when CEOs are seen to be
running afoul of governance issues. There are the massive costs
associated with BP’s failure to address adequately
environmental, health and safety risks in connection with the
disastrous Gulf of Mexico oil spill. Similarly, weak leadership
at South African mining giant Lonmin has led to the breakdown
of employee relations, with the strike earlier this year
slashing its earnings, on top of the massive strikes two years
prior that made international news.
Back in 2012, during the so-called Shareholder Spring, when
shareholders began to question excessive executive pay, the
Principles for Responsible Investment (PRI), a United
Nations–supported group of institutional investors
that has committed to sustainability measures, developed some
guidance for integrating ESG issues into executive remuneration
decisions. These included: adopting a clear process for
identifying the appropriate ESG metrics to be linked to pay;
linking those metrics to reward systems so that they form a
meaningful component of the overall remuneration framework; and
disclosing the rationale, method and challenges presented by
the incorporation of ESG metrics into executive pay clearly and
New research from PRI covering the mining, energy and
utilities sectors, to be released September 25 at
PRI’s annual conference in Montreal, shows some
interesting statistics. A review of public filings for 84
companies in these sectors revealed that 83 percent of them
incorporate some type of ESG issue into compensation decisions,
as it is a growing trend in these industries. From a regional
standpoint, Australia is clearly leading the way, followed by
North America and Europe.
Yet whereas almost all companies incorporated ESG issues in
short-term compensation plans, just 16 percent of companies
tied these issues to long-term incentives.
Other key findings indicate that safety is by far the most
prevalent ESG issue employed by companies in the mining, energy
and utilities industries, whereas in those sectors, climate
change is the least prevalent. Other metrics cover
environmental issues such as pollution or water use, governance
factors such as board composition and diversity and social
metrics such as labor and community relations.
Finally, looking at compensation plans overall,
approximately 25 percent of the 84 companies reviewed allow for
board discretion in the determination of remuneration awards,
although more than half have clawback provisions.
The study shows that there remains significant work to be
done in developing long-term and rigorous approaches to
providing incentives for ESG performance through executive pay.
It also shows that the performance metrics used are often
opaque or ill-defined.
Certainly, there are challenges to doing this, including the
lack of a universal standard of reference for boards, top
management and remuneration consultants to assess relevant ESG
risks and opportunities. There is also the concern of creating
executive incentives in isolation, without promoting a holistic
approach toward sustainable performance. And there is the
potential for different performance factors to compete with one
another within compensation packages and remuneration reports
that are already lengthy and difficult to read.
Today’s complex sustainability challenges
present both risks and opportunities for companies. Our
preliminary research suggests the mining, energy and utilities
sectors are ahead of the curve, as they are already linking
their organizational ESG strategy with individual
But investors need to engage in a wider dialogue with these
companies to ensure that ESG issues constitute a meaningful
component of overall remuneration and that incentives are being
aligned with long-term strategic plans to ensure that senior
management is held accountable for sustainable performance and
the delivery of continued shareholder value and so that
investors are confident that stakeholders across the investment
chain are taking a long-term view.
Companies must also develop ESG criteria that are relevant
for their businesses and use more robust metrics that capture a
long-term view of ESG issues and regularly communicate these
processes to the wider stakeholder community, including
investors. Transparency is critical, as investors are more
likely to engage with boards that ensure senior management is
suitably rewarded for their ability to position the company to
meet sustainability challenges.
Fiona Reynolds, based in London, is the managing
director of the Principles for Responsible