In Defense of ESG Metrics in Incentive Plans

The Center recently reported on a study by Lucian Bebchuk and Roberto Tallarita (hereafter referred to as BT) that cast doubt on the advisability of including ESG metrics in executive incentives. That study has prompted Ira Kay, a recognized thought leader in executive compensation and a founder of compensation consulting firm Pay Governance, to offer a rebuttal.  Kay’s view is that executives and boards incorporate stakeholder interests into business strategies in response to investor pressures and because addressing such interests is “essential to [company] survival and success.”  His rebuttal, also published in the Harvard Law Blog, observes the following:

• ESG metrics reflect the sincere interest of boards and executives in making “progress on these important economic and social matters.”  This belief contrasts with the view of BT that company focus on stakeholders is “largely a rhetorical public relations move rather than a harbinger of meaningful change.”
  
  
• In contrast to BT’s conclusion that company focus on ESG is potentially harmful to shareholders, Kay offers that addressing stakeholder concerns can increase company growth and profitability, improve corporate image, and reduce risk.
  
  
• BT question the commitment to ESG given that company disclosures of metrics “are vague” or “leave full discretion to the compensation committee.” Kay acknowledges that many companies have “qualitative and holistic” ESG incentive metrics due to the difficulty of setting quantitative ESG goals in the early stages. However, in view of pressure from shareholders, companies should (and are already) prepare for quantitative ESG metrics and goals that align with business strategy.
  
  
• BT note the limited nature of stakeholder interests that are reflected in the current use of ESG metrics, thereby favoring certain stakeholders over others.   Kay suggests that while this is true, the areas included as incentive objectives, such as DEI, are areas which companies believe are important and where their efforts can make a difference.  
  
  
• BT claims that corporate leaders “have strong incentives to enhance shareholder value but little incentive” to benefit other stakeholders.  Kay’s response is that while ESG weights are “modest,” including such metrics in incentives “provides internal and external signaling” of the importance companies place on making progress in responding to significant employee, director, customer, and investor support for the role of corporations in addressing ESG issues.

In contrast to BT’s conclusion that company focus on ESG is not helpful, Kay’s more optimistic contention is that, while imperfect to address ESG issues, inclusion of ESG metrics in business plans and incentives has the potential to provide economic benefits to companies, shareholders, and society.