Linking executive pay to ESG and climate objectives

During the 26^th U.N. Climate Change Conference in Glasgow, known as COP26, discussions focused on setting net-zero emission targets for 2050 to tackle the economic impact of climate change. As organizations increasingly move toward adopting net-zero business models, they are realizing the importance of including climate transition metrics in management systems, corporate disclosures and compensation plans.

Willis Towers Watson’s recently released Executive Compensation Guidebook for Climate Transition, published in partnership with the Climate Governance Initiative (CGI) to promulgate the climate governance principles of the World Economic Forum, includes strategies and practical advice on linking climate metrics to executive compensation. Below are some key takeaways from the guidebook.

• Investors will drive movement. Linking executive compensation and a company’s climate objectives requires buy-in from various stakeholders, especially investors and the board of directors. Investors expect board members not only to drive the adoption of a credible climate transition strategy but also to ensure that strategy is embedded across all key management processes, including enterprise risk management, strategic planning, innovation, capital investment and human capital.
• Boards are responding to investor demand for action on climate transition. The following actions can help the board ensure engagement of all key stakeholders in linking climate strategy to executive compensation:
  1. Align climate priorities with business strategy.
  2. Tie climate goals to the net-zero vision.
  3. Select the right metrics that are specific to the strategy and vision.
  4. Design fit-for-purpose incentives.
  5. Tell a consistent story with the company’s many public disclosures.
  6. Evolve the plan and learning over time.
• Both short- and long-term key performance indicators are needed. While over the past few years we have seen an increase in the prevalence of environmental, social and governance metrics in executive incentives, Willis Towers Watson research shows that more companies have environmental measures in their annual incentive plans than in their long-term incentive plans. Good design principles support the need for both short- and long-term incentives; while short-term plans recognize management’s efforts in achieving milestones related to climate transition, long-term incentives should reward the achievement of key outcomes aligned to long-term targets. Much remains to be done to tie forward-looking incentive goals to a company’s specific climate strategy.

Going forward

To meet net-zero emission targets, companies must begin to take action now and consider the following steps:

• Continuously monitor and update how they measure climate goals to commit to change.
• Consider tailoring climate metrics and transition strategies to their company or industry.
• Avoid judgment-based or ambiguous climate metrics and goals. Rather, choose objectives that are science-based, clear, appropriately stretched, transparent and consistent.
• Provide detailed disclosures that tell their story of how executive compensation drives climate transition.

Authors

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Kenneth Kuk

Senior Director, Work and Rewards

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Michael Siu

Senior Director, Work and Rewards (New York)

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Hannah Summers

Director, Executive Compensation and Board Advisory - Climate and ESG

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Jamie Teo

Director, Executive Compensation and Board Advisory (Seattle)

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