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ESG and Executive Pay: A Perpetual Discussion

Sustainability goals are now widely considered on par with more traditional KPIs and are slowly becoming standardized as external pressures continue to push corporations to tie non-financial measures to executive pay; however, this hasn’t always been the case, clearly. So how did we get here, how are these initiatives performing today, and what are some reasonable future expectations of tying ESG to executive compensation over the long-term?

The 1950s-1990s

In 1953, the term “Corporate Social Responsibility” (or “CSR”) was coined by an American economist and educator, Howard Bowen; however, the ideals contained within this concept seemed to go dormant until the early 1990s when other American professors (Donna J. Wood and Archie B. Carroll) brought it back to light. Through their various publications, CSR was given a new framework for assessing impacts and outcomes of corporate social responsibility programs.

From that point onward, many organizations began adopting these concepts and rolling out their own initiatives focusing on ideals such as health and safety, energy conservation, recycling, waste management, etc. Decades later, terms such as “sustainability” evolved from, and expanded on, early CSR programs and have quickly become ingrained into the identity and corporate strategy of many companies.

The State of ESG Today

Now that companies have been faced with addressing fundamental shifts in the business environment for the last decade, that is, a stronger focus on environmental, social and governance (“ESG”) issues, the only apparent thing left to do was to figure out how to tie sustainability goals to executive compensation programs. For many, this move showed the public just how serious companies are when it comes to addressing both stakeholder and broader public sentiments.

However, concerns have been raised regarding the right approach to incorporation and whether including ESG measures within annual or long-term incentive programs are just another way to pad executive pockets via subjective measures. In response, some companies have moved away from more qualitative metrics to a more quantitative approach that seem to be more in line with investor expectations. Regardless of the different angles companies are taking to “get it right”, the right question being asked today is whether tying executive pay to ESG goals improves a company’s sustainability and financial performance or not.

For certain industries, like manufacturing for example, it makes sense to focus goals aimed at reducing a company’s carbon footprint. However, when it comes to “do these measures payoff”, it’s not clear that ESG-related pay has either a positive or negative impact on a company’s financial performance, at least in the short-term. That isn’t to say that sustainability goals shouldn’t be considered. They should – companies have a responsibility to not only care for their shareholders but the communities in which they are a part and have a significant impact on.

Reasonable Expectations in a Changing World

So what can we expect as time goes on? The obvious answer is that ESG isn’t going away. From 2010 to 2020, the number of companies employing ESG metrics in executive pay programs have risen by over 5,600%. While only about 15% of US companies utilize ESG metrics within their executive compensation programs, the exponential growth rate we have witnessed over the last decade is sure to continue. Given the trajectory of where the world is headed from an environmental and social perspective, it is likely that more and more board members and investors are jumping onboard because they are viewing these initiatives through a telescopic lens. That is to say that returns, if any, are more likely to be seen over the long haul, and at the very least, incorporating such measures will lead to more economically sound businesses in the future.

Contact NFPCC for Expert Guidance On Your ESG Strategy
If you need help determining whether ESG metrics should be included in your executive compensation programs, don’t hesitate to contact us, and we will be happy to assist.

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