The Advisors' Blog

Late last month, the Vanguard Investment Stewardship team shared a new update about the asset manager’s approach to ESG metrics in compensation plans. This update follows earlier guidance from May 2022.

Vanguard implies that it’s time for more detail because it’s seeing a growing number of U.K. and European companies implementing ESG metrics. However, the insights & suggestions appear to be relevant to all portfolio companies, including U.S. companies.

Vanguard still doesn’t expect companies to use ESG metrics and recognizes there’s no one-size-fits-all approach to executive pay. But if a company does use ESG metrics, those metrics should be transparent, rigorous & well-planned – it’s not a place to “test-and-learn.”

The update explains that pay-for-performance alignment continues to drive Vanguard funds’ say-on-pay votes. The stewardship team gives these examples that may cause concerns & impact voting decisions:

1. The introduction of ESG metrics that are not clearly aligned to company strategy.

2. The inclusion of ESG metrics that are not linked to a financially material risk or opportunity, even where targets are quantifiable or clearly disclosed.

3. The introduction of ESG metrics without the disclosure of comprehensive definitions.

4. Increased weightings placed on ESG metrics or replacing financial metrics with ESG metrics without a disclosed compelling rationale.

5. Year-over-year optimum achievement of ESG targets. This may raise concerns over the rigor of plan design, including the level of rigor in the established ESG targets. This concern may be exacerbated when ESG metrics are not quantifiable or clearly aligned to a company’s annual reporting.

VIS also suggests these “best practices” (see the full 4-page update for more detail on what each of these mean):

1. Focus on materiality

2. Alignment to appropriate time horizons

3. Robust disclosure

4. Stretch targets

5. Use of underpins or modifiers where appropriate

6. Thoughtful approach to external indexes

Lastly, the update shares a few questions that Investment Stewardship reps may ask about ESG metrics during engagements.

– Liz Dunshee