The Advisors' Blog

This blog features wisdom from respected compensation consultants and lawyers

December 6, 2018

Pay-for-Performance: ESG Edition

Liz Dunshee

This Pearl Meyer survey says that at this point, it’s not very common to incorporate ESG goals into incentive plans. But a shift is underway. Companies are no longer bound by the constraints of Section 162(m) – and shareholder interest in the corporate risks posed by climate change & human capital issues is greater than ever.

In fact, Shell announced just a few days ago that it would link pay to carbon reduction targets for as many as 1300 high-level employees, following shareholder engagement on the topic (also see this BBC article). Other comp committees should also start exploring whether using ESG metrics would benefit their company.

If your compensation committee is considering going down this path, Pearl Meyer’s Jim Heim proposes this process:

1. Evaluate the overall compensation philosophy to confirm it continues to send the right signals to shareholders, employees and potential candidates about the type and level of performance on which the company is focused and how results will be reflected in compensation. ESG measures may have a role to play as companies evolve their performance priorities over time.

2. Assess the prevalence of incentive compensation design practices among peers and the broader market. If sector-relevant companies are clearly shifting their incentive designs to include consideration of ESG measures, they may merit closer investigation (as would be the case for any shift in peer practice). Peer practices may also provide specific examples of how such a shift may be implemented.

3. Incorporate ESG goals into pay-for-performance assessments. While such assessments typically focus on financial categories of performance, investors have indicated that they have found positive correlations between sustainability or “good governance” ratings and shareholder value creation in certain sectors. Companies considering implementation of ESG performance measures may wish to supplement traditional pay-for-performance assessments with an examination of whether there is in fact such a relationship between ESG and shareholder value creation among their peers.

For more on this topic, check out the resources in our “Sustainability Metrics” Practice Area – including the transcript from our recent webcast – “The Evolving Compensation Committee.”