Executive remuneration is being linked to benchmarks

Many companies already incorporate environmental, social, and governance (ESG) metrics into executive pay structures.

However, a recent report by professional services company PwC on the practices and remuneration trends for executives found that while it was clear that the incorporation of ESGinspired measures into executive pay structures has become much more common, it was not clear if this had been done in a meaningful way that will drive real change.

Without linking remuneration to achievement of ESG targets, targets won’t be achieved, said Tracey Davies, executive director of shareholder activism organisation Just Share.

“We know that financial reward is a strong motivation for performance. It is self-evident that unless the achievement of non-financial metrics is directly linked to executive remuneration, executives will not prioritise them. Unfortunately, what we do see happening are that those targets that are linked to remuneration are either very easy to achieve or they are not defined in sufficient detail to enable executives to be held to account,” Davies said.

They were also seeing instances, she said, where even when targets were not met, remuneration committees will decide that this was due to circumstances beyond executives’ control and the benefit is given.

Without regulating these issues and properly linking the achievement of these targets to remuneration, the incentives to succeed get diluted.

The recently launched Sanlam ESG Barometer, an assessment of how SA companies are changing their businesses to deliver improved ESG outcomes, looked at the extent to which senior executives’ incentives were affected by the achievement of ESG targets.

Survey participants had to indicate the share of executives variable pay (their bonuses) that was affected by ESG factors.

According to the report, compiled in partnership with Intellidex and Business Day, 60% of companies said that between 10% and 30% of executives’ variable pay is affected by ESG targets. At the bottom end, 5% of companies had no link between executives’ variable pay and the achievement of ESG targets, while at the top end about 7% of companies said that 50% or more of variable pay was linked to ESG factors.

SA institutional investors were still very far from holding executives accountable, for example by voting against them if they don’t achieve or prioritise ESG targets, said Davies. “In jurisdictions that SA corporates compare themselves to in terms of ESG progress, we see litigation by groups of shareholders, often working with NGOs, against directors in their personal capacity for failing to prioritise or achieve ESG targets.”

To make it possible for investors to hold companies accountable there first needed to be transparent disclosure when incorporating ESG into incentive structures, the PwC report said.

“Investors expect full and transparent disclosure of the relevant detail behind the disclosed metric or modifier, and as per the JSE’s most recent sustainability disclosure guidance, an organisation should describe the performance metrics and targets it uses to measure, monitor, and manage its sustainability impacts, risks and opportunities, and its performance against these metrics and targets,” the report said.

It suggests some minimum guidelines for what should be illustrated in a company’s ESG reporting including that the metrics used to measure performance and methodologies used to calculate performance had to be clearly illustrated.

In addition, reporting should disclose the period of time over which performance is measured, any milestones or interim targets, any amendments to the metrics or targets and the reasons for these changes, including, where possible, any restated comparative figures.

The company and individual performance against these targets and metrics should also be clearly shown. The degree to which ESG metrics should be incorporated into executive pay structures is not formally defined or regulated.

In its report, PwC said ESG targets had to be calibrated appropriately. “ESG issues could quite easily be calibrated in a way that results in higher payouts. Boards should ensure shareholders trust ESG targets and their calibration. At the top end, payouts must require truly exceptional ESG changes to be delivered.”

According to Davies, the achievement of ESG targets also usually applies to short-term pay incentives rather than longterm incentives and that was where the biggest problem lies.

“There are very few meaningful ESG targets that can be achieved in one or even three to four years - a lot of these targets, especially those related to climate-change adaptation and mitigation, relate to outcomes that can only be measured quite far in the future.”

Given the average executive’s tenure at a company will be much shorter than the time required for the achievement of meaningful targets, achievement should also be linked to longterm incentives like retirement benefits, she said.