Pursuing sustainability environmental, social and governance (ESG), or just climate change control goals, is more than just ‘the right thing to do’; many also consider it to be essential for long-term profit success. As Larry Fink of BlackRock put it: “Profits are in no way inconsistent with purpose – in fact, profits and purpose are inextricably linked.”
Wherever you stand on the long-running controversy over climate change, there are certain hard facts that cannot be refuted. For example, NASA has observed that sea levels across the planet have risen by about 20 centimeters in the last century. Such changes have implications.
Companies have begun to address the risks that observable facts such as this give rise to, and have started to think pragmatically about what counter measures are needed to protect their assets from potential negative consequences in the future, whether this is through insuring their assets against those risks, or taking the risks into consideration when making any longer-term plans. Companies may also be taking action because not doing so actually poses a reputational risk.
This is an issue that concerns everyone, in every walk of life, and that also influences the speed and depth of change because organisations are made of people (consumers, employees, investors, regulatory bodies, etc.). A new Eurobarometer survey recently showed that European citizens believe climate change is the single most serious problem the world faces: 93% of people surveyed consider climate change to be a serious problem, with 78% of those considering it to be very serious.
Also, nine out of 10 Europeans (90%) agree that greenhouse gas emissions should be reduced to a minimum, while offsetting remaining emissions to make the EU climate-neutral by 2050. Close to nine in 10 Europeans (87%) think it is important that the EU sets ambitious targets to increase renewable energy use, and the same percentage believes it is important that the EU provides support for improving energy efficiency.
According to a report issued by Science Based Targets on 338 large multinationals, those 338 collectively reduced their emissions by 25% between 2015 and 2019. That looks like a degree of progress, but it seems that neither investors nor wider society consider it to be enough.
For instance, during the 2018 AGM season, Shell investors rebelled over the company’s executive pay, as they came under pressure to take stronger action on climate change. Institutional Shareholder Services (ISS) did urge shareholders to reject the pay award because of the company’s poor performance on sustainable development targets, and while the CEO pay package for 2017 did gain enough support to be approved, more than 25% of shareholders voted against Shell’s remuneration report1.
But this year, having been ordered by a Dutch Court to reduce its CO2 emissions by 45% by 2030, Shell has been forced to recognise how rapidly the world has changed2. It is the first time that such a CO2 reduction obligation has been imposed on an enterprise by a court, setting a historical precedent. The ruling accepts that Shell alone cannot solve the world’s CO2 emissions problem but, in simple terms, ‘they can do their bit’.
ExxonMobil also received a major shock this year when activist hedge fund investor Engine No. 1, with a stock ownership of 0.02%, scored a victory for the climate change movement by wresting three of the twelve board seats and gaining the support of BlackRock, Vanguard and State Street3.
However, it is not only oil companies which have been feeling the pressure. Investors and proxy advisors turned the 2021 AGMs into a referendum on sustainability, and along the way they scored big real-world victories, despite the odds being stacked against them. Activist investors won majority support for some major resolutions (including pushing General Electric to craft a carbon neutrality plan, and asking American Express to conduct public-facing research on its diversity and inclusion efforts) and pushed forward other important issues.
ISS’ report “Climate & Voting: 2020 Review and Global Trends” concluded that over the past five years, proposals requesting companies undertake climate risk analyses have been trending down over time as requests for climate transition plans have been trending up. This reflects the desire of many shareholders and other stakeholders to move beyond disclosure and to see real changes in a company’s strategy in response to the climate change threat.
Investor expectations and regulatory requirements around ESG disclosures, and climate in particular, are expected to continue to grow. Results of a survey of 133 investors around the world, carried out by ISS ESG in 2021, show that climate is the single most commonly shared ESG engagement priority.
It is now becoming more common for investors to ask companies to provide concrete targets for CO2 emission reductions, because they do not want to find themselves in a similar situation to ExxonMobil or Shell. Investors are also now much more likely to closely monitor companies’ strategies and results.
In order to meet investors’ expectations and to drive change, companies have started to introduce the reduction of greenhouse CO2 emissions, along with other ESG priorities, as a measure in their variable remuneration systems.
According to 2020 annual remuneration reports, 51% of the companies in the S&P 500 have already integrated ESG measures into their annual variable systems, with a weight between 15% and 20% of the total annual variable remuneration.
More than two-thirds of top European companies use at least one E, S or G metric in their executive incentive plans.
According to Willis Towers Watson’s Global Executive Compensation Analysis Team (GECAT) ESG 2020 report, more than two-thirds (68%) of top European companies use at least one E, S or G metric in their executive incentive plans. This represents a 5% increase on the previous year and we expect this upward trend to continue. The year-on-year increase in prevalence is observed across all ESG categories, although most significantly (around 10%) in the environmental and broader governance categories.
At its AGM this year, Telefónica approved a new five-year incentive plan (2021-2025) which will link the remuneration of 809 senior managers to the achievement of various climate-related goals, including the decarbonisation of the company. In order for any incentive to be paid, it will be necessary to reach a certain level of reduction of scope 1 and 2 emissions in line with the scenario of the Paris Agreement and the objective set by the company of net zero emissions for 2025 in its four main markets.
On 17 June, Rolls Royce launched its report Leading the Transition to Net Zero Carbon, which sets out its short-term actions aimed at achieving net zero by 2050 at the latest. The company has also introduced short-term targets linked to its executive remuneration, in order to accelerate the take-up of sustainable fuels, which have a key role to play in the decarbonisation of some of its markets, especially long-haul aviation.
Three years after it created its CSR and food transition index, Carrefour is both raising its targets and setting itself some new ones in order to confirm and bolster its commitment to supporting sustainable fishing, combating deforestation, promoting good nutrition and health, sourcing locally produced goods and reducing the use of packaging. To help reach these targets, performance criteria have been incorporated into the pay of group managers. Starting in 2019, 25% of managers' pay was based on the CSR index as part of a long-term incentive. Since 2021, the CSR index has been incorporated into the variable remuneration of all group entity employees, as well as into the remuneration of integrated country managers.
The consequences of climate change are becoming an ever more pressing and material issue for society and the business community alike, and large organisations bear a responsibility to reduce their CO2 emissions. Companies have a pivotal role to play in slowing down climate change, and many existing company targets may not yet be ambitious enough.
Alignment of executive compensation plans, and inclusion of specific KPIs within those plans, would help focus management’s efforts towards these goals. It also sends a clear signal to investors, employees and customers that a company is taking climate change seriously. As the examples of Telefónica, Rolls Royce and Carrefour show, it is possible for companies to use their remuneration systems to drive the necessary changes with the support of their investors.
Because “what gets measured gets done”.
1. Shell investors revolt over pay and maintain pressure over climate change
2. "Monumental Victory": Shell Oil ordered to limit emissions in historic climate court case
3. Engine No. 1 extends gains with a third seat on Exxon board
