The Advisors' Blog

I blogged a few weeks ago about Pay Governance findings that ESG metrics aren’t leading to the executive windfalls that some had feared. A new Willis Towers Watson memo also defends the “new kid on the block” – pointing out that the challenges & drawbacks of ESG metrics are not all that different from those associated with financial & operational metrics.

If you take it as fact that financial & operational metrics are a good thing (not everybody does), then here are some “lessons learned” that WTW suggests can also be applied to the ESG context:

1. Establish more consistent disclosure requirements. Consistent disclosure will improve transparency and accountability, allowing stakeholders to make more informed decisions. For example, this may involve the consistent adoption of the Task Force on Climate-Related Financial Disclosure standards, or more consistent Human Capital Report disclosures.

2. Improve external standards. Over time, with enhanced disclosures, companies and investors can develop better external standards. For example, the ability of organizations such as Institutional Shareholder Services (ISS) and Glass Lewis (GL) to develop and deploy compensation plan assessment models only exists because of robust disclosure that has evolved over time. We would expect to see the rapid development of external ESG standards once enhanced, consistent disclosure requirements are in place.

3. Compile a set of precedents. Similar to how companies learned to understand the pitfalls of using certain financial and operating metrics by trial and error (e.g., don’t measure working capital or cash flow at a point in time because it drives poor timing decisions at year end), companies will learn how to adjust incentives when encountering pitfalls with certain ESG metrics as they gain experience with those metrics.

4. Apply appropriate weighting to ESG metrics. A relatively small weight (e.g., 15-20%) should be applied to ESG incentive metrics to properly signal the importance of the metric while not disproportionately weighting these metrics. We see a similar approach taken with financial metrics such as revenue and working capital, which are typically weighted less than 25% of the total incentive.

5. Ensure ESG results are measurable, actionable and tied to business strategy. Similar to financial metrics, it is important and possible to make sure ESG metrics are linked to business strategy, can be acted upon by participants and are measurable. For example, goals tied to achieving greater leadership diversity may work best when an incentive plan is geared towards a limited population of senior leaders. And climate-related goals could be disaggregated such that all participants understand how their actions can contribute to the successful execution of the strategy, much like financial metrics such as EPS are broken down via value driver analyses.

If you’re among the 60% of S&P 500 companies that have already added ESG metrics and are looking to take the next step – or among the large number of companies that are still in the “consideration” stage – make sure to visit our checklist on “ESG as an Executive Compensation Performance Component” for step-by-step practical guidance – as well as the other resources in our “Sustainability Metrics” Practice Area.

This is also a hot topic that we’ll be covering at our virtual “Proxy Disclosure & Executive Compensation Conferences” – which are available for a discounted rate only until the end of this week! Register today for the best price. Check out the agendas – 18 sessions over 3 days. Join us for expert insights October 12-14th!

And tack on our “1st Annual Practical ESG Conference” for even more valuable information about ESG programs, risks & opportunities that could affect this new form of metrics. The Conferences can be bundled together for a discounted rate. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.

– Liz Dunshee