The Advisors' Blog

This recent 9-page paper from Stanford’s Rock Center for Corporate Governance looks at where practices stand for climate metrics in executive pay programs – and where they might be going. I blogged last month that “ESG” metrics, on the whole, are improving in the midst of pushback. In a similar vein, this paper says that setting climate goals and incorporating them into pay programs is a journey. Here’s an excerpt:

Most companies acknowledge that it takes time to learn how to break down multi-year targets into one-year goals. Through repeated effort, they learn how efficiency programs, sourcing programs, and technology translate into emission reductions. To many, the process is analogous to continuous improvement programs for capital efficiency. It also takes time to get the largest suppliers on board and to educate smaller suppliers on how they can reduce their carbon footprint.

And:

Companies express very different experiences in the implementation of programs and creating buy in. For most, adopting climate targets and tying these to compensation is a multi-year (even decade-long) process. Companies newer to the effort will be faced with shorter timelines but have the benefit of learning from those who have gone before them. Companies phase the implementation, first adopting metrics to test their use and calculation before tying metrics to compensation. They also start at the top, adding climate goals to senior executive bonuses before rolling out to larger populations.

The underlying climate progress that the programs are intended to incentivize also takes time:

While some companies aim to realize straight-line reductions (for example, 3 percent annual decreases in absolute terms), others are on a “hockey-stick” trajectory. Targets for the first five to seven years focus on the transition to renewable energy and gross energy reductions in production and supply. Beyond this, there is general acknowledgement that technological innovation (outside the company) is going to be required for companies to achieve their long-term pledges.

The paper gives practical suggestions on overcoming resistance to pay changes, board committee oversight practices, why this topic matters in the first place, and more. Here are recommended “best practices” for integrating climate goals into compensation:

1. Leadership and organizational commitment. A company’s commitment to decarbonization is most effective when leadership (CEO, senior executive team, and board) genuinely embraces climate goals. This includes prioritizing decarbonization so it is not seen as secondary to strategic and financial objectives but integral to them. Climate-related goals are tied to strategy, embedded in budgets, and ultimately made part of culture. The reasons that the organization has committed to climate goals should be clearly and consistently articulated to divisional leaders and within functional groups to overcome resistance, remove inertia, and convince employees of the financial, organizational, and environmental necessity of decarbonization.

2. Metrics and reporting. Climate objectives should be few in number, low in redundancy, and largely quantifiable. We found that the most successful companies adopt science-based targets because of their demonstrable link to net-zero emission goals. Long-term targets are broken down into clearly achievable milestones, which map to quarterly, annual, and multi-year budgets and are supported by granular plans for capital allocation and procurement. Companies should be prepared to invest up front in systems for raw data collection and analytical processes, and entrust the reporting process to a small team of experts to ensure consistency and accuracy. Continuous improvement generally decreases cost and increase reliability over time. Ultimately, reported metrics should be audited to ensure accuracy and reliability.

3. Compensation. Climate programs are most effective when goals are added to executive and senior-manager compensation contracts to fully align the organization with its commitments. While many companies use the annual bonus program to do so, the most successful companies also embed climate in the longterm incentive program (LTIP) to match the timing of goals and compensation payouts. Annual targets in support of long-term goals are then reinforced through the annual incentive program. The achievement of annual goals gives executives and employees confidence that long-term objectives will be met. The rewards for meeting climate pledges should constitute a material part of at-risk compensation to encourage performance. Transparent reporting of interim and long-term targets allows the board and shareholders to monitor progress and hold the company accountable.

– Liz Dunshee