May 11, 2021
Linking ESG to Pay: Considerations for Incorporating into Long-Term Incentive Plans
– Lynn Jokela
Earlier this year, Liz blogged about trends among Fortune 200 companies linking diversity & inclusion metrics to executive pay. When we’ve seen reports of companies linking ESG metrics to pay, they’ve most often been incorporated within annual incentive plans. A recent Meridian memo discusses concerns with that approach and suggests it might be more appropriate to incorporate ESG metrics into long-term incentive plans.
The memo asserts one of the problems with including ESG metrics in annual incentive plans is that, in a short 12-month period, it’s often difficult for companies to make meaningful progress on certain ESG initiatives, such as D&I. Some companies might think it’s easier to link ESG metrics to short-term plans because they plan to assess progress qualitatively. As noted in the memo, meaningful progress on D&I can sometimes require more than a simple 12-month period. To help resolve concerns with trying to measure progress over a short timeframe, this excerpt provides considerations for companies to incorporate ESG metrics into LTIPs:
In a typical three-year LTI cycle, metrics do not change often but goals are reset every year based on past performance; such is the annual nature of our overlapping PSU designs. ESG initiatives are better suited to multi-year objectives that can only be measured by progress over that period. For example, companies could focus on an “S” goal this year, with a three-year plan in mind. Next year, while maintaining the “S” goal a priority, companies could set a new “E” or “G” goal with a three-year plan. This approach would allow organizations to focus on three critical areas over a multi-year period without having different, moving goals for the same metric. Further, there are countless ESG metrics to choose from and most companies want to limit the focus to just one to three items (inclusive of financial and stock price goals that likely will not be replaced). ESG as a broad category could represent a defined percentage of the LTI. This allows for ESG to be a fixture of compensation programs while maintaining flexibility in goal setting and performance measurement.