The Advisors' Blog

I recently blogged about ESG “overperformance” — specifically, a research paper alleging that ESG targets are set at low enough levels that executives “reap their rewards even if ESG performance is not particularly strong.” The paper seemed to justify investor concerns about the lack of rigor and transparency surrounding these goals.

At the end of last month, a group of professors released a new research paper. Even though this paper was focused on companies in Europe — where ESG incentives seem to be farther along — it similarly concluded that they are often “largely discretionary, carry immaterial weights in payout calculations, and contribute little to executive pay risk” and focused on the companies’ “most visible executives.” They allege that this isn’t just a pay issue — and that it could be greenwashing — or at least evidence of greenwashing. They suggest that “[f]irms might engage in such “greenwashing” of executive pay if meaningful (that is effective) ESG incentives would conflict with shareholder value maximization but, at the same time, firms face public pressure by third parties (governments, customers, some investor groups, proxy advisors, etc.) to become more ESG-friendly.”

This approach to ESG metrics isn’t across the board for the European companies in this dataset, however. They found that this was common in financial firms and large companies, while companies in sectors with a large environmental footprint are more likely to employ “binding ESG metrics with significant weights, which have potential to influence incentives.”

Here in the US, it seems that companies are beginning to shift in this direction. The latest Semler Brossy report on ESG incentives has this to say:

Companies appear to be shifting their focus from adoption to refinement of ESG metrics, with prevalence in annual incentive plans (AIPs) and long-term incentive plans (LTIPs) remaining relatively consistent since FY2021 as companies continue to prioritize the use of short-term ESG goals. However, companies continue to adjust existing plans away from discretionary incentives and towards weighted metrics. In FY2023, 87% of companies with ESG metrics in incentives reported using weighted metrics, up from 72% in FY2021.

Most prominent shifts in metric structure were i) discretionary to scorecard (+6 companies year over year) and ii) scorecard to discrete weighted (+17 companies year-over-year), which is the typical path companies take as ESG metrics become more prominent in their programs.

– Meredith Ervine