Shareholder resolutions requesting companies disclose plans to achieve net zero emissions by 2050 received increased support in the 2021 proxy season. While this is a positive development, companies must do more to cut emissions in half by 2030 to meet the Paris climate treaty goals. One lever in meeting 2050 net-zero pledges is linking executive compensation to hitting climate targets.

An Institutional Shareholder Services (ISS) survey last year found 86 percent of investors believe incorporating ESG metrics into executive compensation programs will appropriately incentivize executives. Of these investors, 52 percent support introducing “specific and measurable” ESG metrics into compensation programs and 34 percent say “when chosen well, even ESG-related metrics that are not financially measurable can be an effective way to incentivize positive outcomes that may be important for a company.” The important differentiator is not to simply have a link; it must be significant and easy to understand.

ESG metrics in executive compensation plans are now common. Willis Towers Watson reported in 2021 that 60 percent of S&P 500 companies incorporated ESG metrics in their incentive plans. Diversity, equity and inclusion and human capital management were the most likely, but less than 13 percent addressed the environment.

Environmental metrics can help executives focus their attention on emissions reduction, but the details are important. Weak goals suggest greenwashing and undermine investor and public confidence that companies really take problems seriously. Meaningful climate action through executive compensation arrangement can occur. Current ties to ESG targets are usually a miniscule part (in some cases less than 1 percent) of total executive compensation. Only a few companies tie explicit emissions reductions to pay and they quantitative goals are scant; vague language subject to board discretion is the norm.

As You Sow believes that best practices for incorporation would include:

• Linking emission reductions to long-term incentive pay (LTIP), not annual cash bonuses. LTIP is much bigger part of compensation (60 percent to 70 percent, compared with total bonus pay of 15 percent to 20 percent). Also, bonuses often include a variety of metrics with different weights.

• Making emissions reduction targets appropriate ‘stretch’ goals. This would further incentivize executives, with higher rewards for exceeding normal expectations or reductions the company already is likely to achieve.

• Making the emissions reduction targets explicit, specific and standalone metrics.

From 2018 to 2021, 32 shareholder resolutions proposed some type of ESG ties to executive pay. That number has significantly dropped in 2022, likely because many companies have incorporated some environmental metrics into executive pay. Yet adopting emissions reduction targets in executive compensation is still in the early stages. It is not clear if current practices will mean companies meet the net-zero goals we need. With pressure from shareholders for stronger metrics and better disclosure, more companies will adopt policies in the future. Whether this comes from resolutions or engagement, investors must develop clear guidelines for appropriate metrics that link emissions reductions to executive compensation to drive meaningful change.

Melissa Walton
Executive Compensation & Say on Climate Associate, As You Sow