A well-designed executive compensation plan can be an important accelerant to help drive climate transition. However, including climate metrics and objectives in your compensation program requires buy-in from various stakeholders, especially investors and the board of directors. These are some of the key takeaways from our recent webcast introducing our Executive Compensation Guidebook for Climate Transition, published in conjunction with the Climate Governance Initiative (CGI), a project in collaboration with the World Economic Forum.
The webcasts, held on November 11, 2021, shared highlights from the guidebook on how companies can align climate transition priorities with executive compensation plans, followed by panel discussions featuring leading remuneration committee members and investors. Participants over the two webcasts included:
There's been a positive evolution in the sense that in the past targets tended to be too soft and untransparent. They were largely seen as box-checking exercises, and critics flatly called them out as greenwashing. But given the criticality of climate crisis, more and more companies and investors are realizing the importance of including climate transition metrics both in management systems, corporate disclosures and compensation plans alike.
Additionally, other stakeholders, including customers and employees, have joined the discussion and are voting with their feet by favoring companies that take climate transition seriously. Customers are more willing to buy products and services from companies that set meaningful targets for climate transition. In an increasingly competitive labor market, including climate transition in corporate purpose can help attract the best talent. How a company addresses climate transition has to be part of a hiring strategy.
And once employees are on board, employers will need to continue to listen to employees. Climate transition strategy must be part of the culture.
But now many corporations are also realizing their role in addressing climate transition. We also heard recently at COP26 that, at a minimum, it's essential to set net-zero targets for 2050, but the reality is that 2050 is not enough. Short-term targets need to be taken immediately in order to meet 2050, so investors are going to look at a range of targets, including pay. Investors are going to want to see very concrete evidence of climate targets being tied to short-term incentives.
Investors may be the most important of all the stakeholders because they have a number of vital levers to pull if they are unsatisfied with a company’s climate transition strategy. Among the actions at their disposal are say-on-pay votes in jurisdictions where applicable, say-on-climate votes in certain cases, and re-election of board members. In cases where investors are not satisfied with a company’s climate transition plans, they would be inclined to vote for certain directors to step down.
Investors are also calling for enhanced disclosures of climate-related metrics linked to science-based targets. There is also stronger emphasis on the prospective transparency of metrics and targets, particularly when linked to compensation.
Boards of directors recognize the importance of acting on climate transition, including incorporating climate metrics in pay. Boards are responding to investor demand for action on climate transition. They know that failure to respond might place them at risk of a breach of fiduciary duty, which actually ties in very neatly with some work that CGI published recently on directors duties and disclosure obligations.
Boards may ask, “Should we be paying people to do what's right? Shouldn't they just do what's right anyway?” Though it’s safe to assume that most people come to work with the intention of doing what is right, we are in a code-red situation, so we can’t simply hope that those intentions are going to be enough. We need to advance changes that spur action, including positive incentives for people to strive to reach net zero.
The board’s governance role is to work with management each step of the way and ensure engagement of all key stakeholder groups by:
It is important for all board members to be climate literate and for at least some board members to be climate experts. This is an interdisciplinary challenge, and it is important that the board is equipped to provide adequate climate stewardship.
While over the past few years, we have seen an increase in the prevalence of ESG metrics in executive incentives, there is still room for improvement in the adoption rate of climate metrics in the U.S. Based on our latest research of U.S. S&P 500 companies and the top 350 European companies, more companies have environmental measures in their annual incentive plans compared to their long-term incentive plans.
It is also important to note the regional differences; adoption of climate metrics is more prevalent in Europe than US – particularly for long-term incentive plans (see the graphic below from the guidebook).
Good design principles would suggest the need for both short- and long-term incentives; while short-term plans recognize management’s efforts in achieving climate-transition related milestones, long-term incentives should reward the achievement of key outcomes and long-term targets.
There are inevitably going to be winners and losers. But rather than thinking of winners and losers in terms of industries, it's the first movers that embrace this issue and engage on the transformation journey who will be the winners.
To sum up, consider the following to advance your organization’s journey toward net zero:
| Title | File Type | File Size |
|---|---|---|
| Executive Compensation Guidebook for Climate Transition | 7.7 MB | |
| Executive Compensation Guidebook for Climate Transition – 2023 Addendum | 1.4 MB |
