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.
We’ve speculated with some podcast participants about the insurance market that might develop in the wake of the Dodd-Frank clawback listing standards. As this Latham alert reminds us, “companies are not permitted to indemnify or insure any person against losses under the SEC Clawback Rules, nor are they permitted to directly or indirectly pay or reimburse any person for any premiums for third-party insurance policies that such person may elect to purchase to fund such person’s potential obligations under the SEC Clawback Rules.” However, insurance coverage may be purchased and funded by an individual executive, who must pay their own premiums out of pocket.
This Woodruff Sawyer blog discusses the key features of those policies in their current form:
Limits: As of this writing, primary insurers are offering relatively low limits, ranging from $500,000 to $1 million for each individual executive at a company. Higher limits will require additional carriers to participate on an excess basis. The amount of excess limit available will depend, in part, on interest in this type of insurance over time. We should also expect carriers to impose a per-company cap, at least in the near or medium term, depending on how many executives at any one company decide to purchase this insurance.
Simplified Application Process: The application process for this insurance should generally be streamlined. Insurers will review the company’s public filings and disclosures. This will often include evaluating the company’s compensation clawback policy, governance practices, any recent material weaknesses in internal controls over financial reporting, and any existing legal or regulatory disputes that might impact the company’s risk profile. Because the underwriting process relies heavily on publicly available information, there should be minimal administrative burden placed on the executive during the application phase.
Coverage for Compensation Repayment and Defense Costs: This insurance can cover both the compensation amounts an executive must repay and the defense costs associated with compensation clawback claims. As previously mentioned, compensation repayment can range from cash bonuses to equity awards based on the company hitting several metrics. This makes the insurance attractive not just for executives whose compensation is performance-based, but for all executives.
No Duty to Defend: One distinct feature of current forms of this insurance is they are not “duty-to-defend” policies. This means the policyholder (i.e., the executive) retains the right to select their own counsel rather than being constrained to the insurer’s panel of attorneys. This is important for executives who value autonomy and wish to retain counsel familiar with their individual circumstances in addition to having deep industry expertise.
The blog also notes that coverage is not limited to financial restatements and may also apply to non-financial triggers that companies may include in voluntary clawback policies. But it also notes that coverage won’t cover every scenario — for example, coverage won’t be available if an executive is found guilty of fraud or if reimbursement is prohibited by law.
Yesterday, ISS announced that for companies with annual meetings between February 1, 2025 and September 15, 2025, its peer group review & submission window will open at 9:00 AM ET on Monday, November 11, and close at 8:00 PM ET on Friday, November 22. Submissions should reflect peer companies used by the submitting company for pay-setting for the fiscal year ending prior to the company’s next upcoming annual meeting (so for your 2025 annual meeting, this would mean peers used for the 2024 fiscal year).
As a reminder, these submissions are requested semi-annually and are just one input for ISS’s own peer group construction methodology. Companies are under no obligation to participate. If you have made no changes to your previously disclosed comp peers or do not wish to provide this information in advance, you don’t need to do so. When no peers are submitted, the proxy-disclosed peers from the company’s last proxy filing will automatically be factored into ISS’ peer group construction process.
In February of 2023, Corp Fin released a number of PvP CDIs, including this Question 128D.11:
Question: Can the Company-Selected Measure included in the Pay Versus Performance table required by Item 402(v)(1) be measured over a multi-year period that includes the applicable fiscal year as the final year, similar to the use of multi-year measurement periods for calculating total shareholder return under Item 402(v)(2)(iv), as long as such performance period is used consistently for all years in the table?
Answer: No. Under Item 402(v)(2)(vi), the Company-Selected Measure is the measure which in the registrant’s assessment represents the most important financial performance measure (that is not otherwise required to be disclosed in the table) used by the registrant to link compensation actually paid to the registrant’s named executive officers, for the most recently completed fiscal year, to company performance. [February 10, 2023]
At the time, this CDI came as a surprise to some and, in those cases, required companies to pivot and change their CSM at the last minute. A PvP comment letter posted on EDGAR last week clarifies Corp Fin’s position on this further. This CDI is not only intended to limit the use of a metric with a multi-year measurement period, but also a metric with a measurement period that spans “across” multiple years, even if it doesn’t exceed one year. In the comment, the Disclosure Review Program staff took issue with a CSM with year-long measurement periods that start and end in September. Here’s a snippet from the company’s response:
[T]he Company originally interpreted Regulation S-K Compliance and Disclosure Interpretation 128D.11 to prohibit the use of a Company-Selected Measure with a measurement period that exceeded one year. In reaching this conclusion, the Company took note of the analogy in the interpretation to Company TSR, which will ultimately be measured over a period of five years. The Company thanks the Staff for clarifying that Regulation S-K Compliance and Disclosure Interpretation 128D.11 prohibits the use of a Company-Selected Measure with a measurement period that spans “across” multiple years, even if the measurement period does not exceed one year. The Company will ensure that, going forward, its disclosed Company-Selected Measure will not span across multiple years.