Tying executive pay to ESG raises lots of questions

'How do you measure your progress? A lot of these metrics are actually qualitative in nature'

Tying executive pay to ESG raises lots of questions

Tying executive pay to environmental, social and governance (ESG) performance is now an established practice across Canada and the United States.

But there are still many questions involved, according to one expert.

Currently, about 70% of publicly traded companies have this practice, Bertrand Malsch, professor and corporate reporting expert at Smith School of Business, Queen's University in Ontario, told HRD.

Upon first glance, this is a good thing, he said, because companies are trying to align individual behaviours with ESG goals.

“You want to set up a compensation package that makes sure that executives’ actions are aligned with the firm’s strategies, which is to be more ESG-friendly.”

Currently, 67% of companies in the TSX60 index and 80% of CEC40 companies (which have been identified by Climate Engagement Canada for being among the country’s top carbon emitters) disclose the use of one or more ESG metrics in these compensation plans.

Signal

A deeper look into the matter, however, raises the question of whether this tactic actually works. For one, this move can be merely an attempt to make the outside world think that the corporation is actually concerned about ESG matters, Malsch said.

“It doesn't cost a lot of money… to make that statement. But is it more than a signal now?” he said, adding that currently, “there are huge pressures from stakeholders for companies to be more ESG friendly.”

He added that “this is a good opportunity for ‘window dressing,’” – meaning presenting something better than it actually is.

The “S” in ESG is becoming increasingly critical as people and organizations become more conscious about how the social aspect of doing business will impact their future, according to a previous report.

Metrics

Malsch also questions the metrics that companies use to measure ESG performance.

“These ESG metrics are difficult to define, especially the social. When you look at what ‘social’ covers, it actually ranges from human rights policy to data privacy to well-being at work. So it covers things which are extremely different. So it's not clear what is actually captured.

“There is a question here about what are we trying to measure? [Employers say] ‘I will give you an extra bonus or extra money if you achieve this target in terms of social achievements,’ for instance. What does this mean? How do you measure that? How do you measure your progress? A lot of these metrics are actually qualitative in nature.”

Tying executive pay to ESG also creates a possibility of “guaranteed bonds for executives, because they have a lot of control over the narrative,” said Malsch.

“They have a lot of control over the information and they have a lot of control over the definition of targets. If you're an executive, you're really happy about that. Because they're easy to achieve, because they're hard to define, they're hard to measure from the outside. And they're hard to quantify."

Malsch also raised a question on whether achieving “E” and “G” targets actually improves a company’s performance.

Nine in 10 (90%) of company executives said their ESG spending led to moderate or significant financial returns, and most of them (66%) saw this happening within three years, according to a previous Infosys report.

When setting up ESG targets, it’s best for employers to set realistic goals, said Malsch.

“For every business, the key word here is humility… to be realistic. I'm more suspicious about companies who pretend that they're doing great on every level. I don't think this is realistic.”

Employers must also be transparent in how they are measuring ESG progress. This will help not just the employer, but also other employers in their ESG practice, he said.

Best practices

To be successful in their ESG campaign, employers must ensure that CEOs do not have too much power. 

“You want to make sure that competition committee members are independent. You want to make sure that they have access to enough information, that they have access to independent consultants when they look for advice or benchmarking,” said Malsch.

But listing the "best practices" that actually work is still a challenge these days, he said.

“What will allow us to gain knowledge is [if] companies will be transparent, will disclose more information, will be more sincere. Because right now, that's not necessarily the case. 

"If we want to learn collectively, if we really want to develop these best practices, we need to get a better understanding about how all this works.”

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