The greening of Schneider Electric started in 2005. The French electrical equipment group announced it would review its “social and environment performance” and set up a “planet and society barometer”. In 2008 it even rebranded itself in lurid green. “If you measure it, it happens,” Jean-Pascal Tricoire explained to Les Echos, the French business newspaper, in 2007, a year after taking over as chief executive.
Tricoire’s own pay packet also has an increasingly green tinge. In recent years, his bonuses and long-term share grants have been tied to goals based on the barometer or its successor programme — such as reducing carbon dioxide emissions — plus the group’s performance on environmental, social and governance measures across a range of external indices. In 2020, a fifth of Tricoire’s total incentive pay — some €1.6m, including the value of shares from his long-term incentive plan — was due to his efforts to hit such targets.
As climate change has advanced up the boardroom agenda, so, inexorably, it has started to find its way into the incentives of senior executives. That has raised questions, not only about the clarity and solidity of the underlying goals and the ease with which chief executives might hit them, but about the purpose and effectiveness of monetary rewards as a way of changing corporate behaviour.
For now absolute numbers of companies using climate targets to calculate chief executives’ bonuses and long-term incentives remain low: just 24 companies in the FTSE 100, and only 20 in the S&P 500, according to ISS ESG, the responsible investment arm of proxy adviser Institutional Shareholder Services. But from a low base, the number of companies using climate pay targets more than doubled between 2019 and 2020.
A survey by Deloitte in September 2021 suggested a further 24 per cent of companies polled expected to link their long-term incentive plans for executives to net zero or climate measures over the next two years. “We have not seen that sort of increase since TSR became the measure in vogue” in the early 2000s, says Phillippa O’Connor, a partner at PwC, who advises companies on executive rewards, referring to total shareholder return, the metric of choice for tying executives’ incentives to financial performance.
The push to integrate climate goals, and wider ESG targets, into pay plans has been led by consumer companies such as Unilever. Investors have also intensified the pressure on oil and gas groups such as Royal Dutch Shell to follow suit. According to ISS ESG, 39 per cent of energy companies in the world’s biggest indices had incorporated climate targets into their chief executives’ pay by last year, the highest proportion of any sector. Harlan Zimmerman, senior partner at Cevian Capital, an activist investment group, sees the introduction of targeted pay as a “forcing mechanism” to change mindsets about climate change.
Others are more sceptical. Alex Edmans, a finance professor at London Business School (LBS), favours paying chief executives with shares that they must hold after they leave to nudge them to take decisions in the longer-term interests of the company. “When you [set specific goals], you get this problem of hitting the target but missing the point,” he says.
When earnings per share growth was popular as an executive goal, for instance, bonus-hunting managers tended to fixate on short-term expansion. Research also shows that when too many targets are added to incentive schemes, executives start to concentrate on the most obvious opportunities for reward — almost always financial growth, which carries the biggest weight in pay plans. Yet investors continue to add new items to their wish list of targets. Other studies have also suggested executives receive more generous payouts on non-financial targets than they do when judged on precise financial achievements, perhaps because they are often harder to measure and more subjective.
Climate targets also face an obvious snag not shared with shorter-term strategic goals. Companies’ environmental goals often have an understandably long horizon — 2030, 2040, or even 2050 — but chief executives’ tenure is much shorter. An S&P 500 chief executive holds office, on average, for less than 10 years. “Like everything to do with executive remuneration, it isn’t easy to get this right,” says Edward Mason of Generation Investment Management, the sustainability-focused fund company with $36bn of assets under management. “There are risks of perverse incentives and easy remuneration that investors should be on the lookout for.”
Some red flags are already flapping, according to pay analysts and investors. One is a concentration on tactical, short-term targets, such as operational efficiency, rather than more strategic, long-term goals such as emissions reductions.
A second danger signal is a focus mainly on vaguer discretionary measures of progress, such as “improving sustainability” sometimes mixed with other qualitative goals.
A third is the lack of transparency. “A lot of targets we are seeing are still quite vague,” says Tom Gosling, an executive fellow in the finance department at LBS, “and about ‘making progress towards [a goal]’, as opposed to pinning yourself to a final number.” Honeywell, for instance, has committed to become carbon neutral by 2035 in its core activities, yet progress towards these commitments is not linked in detail to its executive pay plan.
The US industrial group paid its chief executive Darius Adamczyk an annual bonus of $2.5m for 2020, of which 20 per cent was based on the remuneration committee’s assessment of a raft of goals including driving “a robust ESG programme”.
ASML, the Netherlands-based semiconductor equipment group whose shares are quoted on Nasdaq, has promised to cut its direct and indirect greenhouse gas emissions from operations to zero by 2025 as part of the “climate and energy” criteria for executive bonuses. It benchmarks itself against other semiconductor companies in the Dow Jones Sustainability Index. But it refuses to reveal actual targets and achievement levels, saying they are “commercially or strategically sensitive”.
Angeli Benham, senior global ESG manager at Legal & General Investment Management, which has $1.8tn of assets under management globally, is typical of many in calling for climate goals to be “meaningful, material, and measurable”. The two largest elements of performance pay are the annual bonus, and long-term incentive plan (LTIP), which typically runs for three years. The level of enthusiasm within boards to attach more conditions to their chief executives’ incentives varies. ISS ESG measured the highest impact of climate factors in pay at companies in the French and German benchmark indices, and the lowest in Asia and the US.
Not one of the attempts by US investors to tie executive pay to ESG measures attracted significant support at this year’s annual meetings, according to Glass Lewis, another proxy adviser. It registered a drop in shareholder support for ESG targets in pay to 12 per cent, on average, compared with 17 per cent last year and 22 per cent in 2019.
Glass Lewis itself recommended support for just one proposal this year: that General Motors should report if and how the carmaker had met pay criteria laid down by Climate Action 100+, a network of investor organisations. Lila Holzman, from the lobby group As You Sow, told GM’s board meeting that shareholders wanted chief executive Mary Barra and her team “to focus their actions on achieving Paris-aligned goals during these next critical years when it matters, not some day in the future”.
Her plea to embed climate change performance measures in executive pay fell on deaf ears. Defending itself in the proxy statement issued to shareholders ahead of its annual meeting, GM said it had taken its sustainability performance into account in setting pay since 2017 and added that it had “highlighted our executives’ key 2020 ESG achievements” with a leaf symbol in its performance highlights. Even though Glass Lewis judged the GM proposal “not to be overly burdensome”, given the carmaker’s existing commitments to climate goals, it was rejected with only 16.3 per cent of GM shares voting in favour.
The GM case highlights that every company is different when it comes to tying climate targets to pay, making a blanket approach unworkable. But successfully adopting bespoke plans is arduous and complicated. For instance, NatWest, the UK-based bank, has set conditions on its issue of stock to Alison Rose, chief executive, that include reducing carbon emissions from its direct operational footprint and increasing funding for clients’ climate and sustainable finance initiatives.
Helen Cook, NatWest’s chief human resources officer, told a recent Deloitte webinar that introducing climate conditions into executive pay was “a new frontier”. She said she and her team “probably had 10 iterations of conversations around climate before we got our first climate measures”. They had to revisit those at least twice after the bank’s remuneration committee had discussed them, “because people were trying to define and to discern what was measurable and importantly what is auditable”.
While an increasing number of businesses are linking executive pay to the delivery of Environmental, Social and Governance (ESG) targets, an analysis of the climate plans of large, high-emitting firms in the US have found that most are not using this approach to drive decarbonisation.
Shareholder organisation As You Sow has this week (https://www.asyousow.org/reports/2022-pay-for-climate-performance) of the links between executive pay and ESG at 47 of the largest listed companies in high-carbon sectors in the US.
More than half of these companies (25 of the 47) have not explicitly linked any kind of climate-related action or target to the remuneration for their chief executive. Of the firms which do make this link, only six link compensation to a quantitative (time-bound, numerical) climate goal. Only one firm, Xcel Energy, links compensation to a quantitative target to reduce absolute emissions.
The analysis concludes that none of the companies is “adequately” reflecting the need to align with a 1.5C temperature pathway in its CEO pay approaches.
This suggests that many firms are prioritising other parts of the ESG agenda in links to executive pay, even when climate is a more material issue. In 2021, more than half (52%) of the S&P 500 companies reported linking ESG metrics to CEO compensation. This proportion is likely to increase again, beyond
the 60% mark, for 2022.
As You Sow noted that it was challenging to assess which firms were linking CEO pay to climate targets due to a lack of joined-up disclosures. Poor transparency meant it had to conclude that many firms were making “ineffective” links. For example, the difference in pay could be negligible, and/or the climate target unambitious. Another issue could be that the incentive plan could only be short-term.
The organisation is warning that investors are likely to push the companies that they back for more information on this topic and for a strengthened approach in the coming years.
The US Securities and Exchange Commission (SEC) has notably proposed new mandates to standardise climate reporting, with a particular focus on indirect (Scope 3) emissions and climate risk. On the global stage, IFRS’ pending ISSB Climate Disclosure Standard will have the same and more extensive impact.
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