ESG Metrics in Incentive Plans – the Debate Continues

As companies continue to embrace ESG matters as an integral part of their business strategy, they are grappling with how and where to measure ESG goals and outcomes and how best to hold themselves accountable for their ESG results in rewarding for overall performance. 

The 2021 Global ESG Report indicates that 60% of S&P 500 companies have integrated some ESG metrics into their 2020 incentive plans, which is a 12% increase from the previous year. 98% of these include metrics in the short-term incentive plan; less than 10% with metrics in the long-term incentive. 

Yet not all stakeholders are convinced that ESG metrics belong in incentive plans. For instance, large investors like BlackRock, State Street and Vanguard – while supportive of ESG as a way to drive long-term value creation - refer to themselves as “agnostic” on the use of ESG metrics in incentive plans. And there are critics, as outlined in research from a Harvard study, who voiced concerns about the lack of transparency in the weighting of ESG metrics, the propensity to create vague and easily achievable goals and skepticism that the metrics will result in inflated payouts to the C-suite without providing long-term value to stakeholders.

While the use of ESG metrics is still in its initial stages and will evolve over time and through lessons learned, Willis Towers Watson “debunks the myths” around ESG goals and offers suggestions to ensure your ESG metrics in incentive plans will reinforce your pay and performance philosophy and align with your business goals.

• Critically, the article notes that financial and operational metrics often share the same challenges as ESG metrics. For example, financial metrics are not always comparable across companies and setting performance ranges is difficult, especially in today’s uncertainty. Similar challenges will exist for establishing ESG metrics. Other challenges often raised regarding ESG metrics (that they reflect the performance of a small number of people, that they don’t cover the full scope of issues) can be equally applied to financial metrics.
  
  
• Use available data and informed judgment to select initial ESG metrics and set goals; refine your approach as needed based on relevant internal and external environments.
  
  
• Use multiple ESG metrics across both short-term and long-term incentives as often a single metric will not clearly reflect the health of an organization in a particular area.
  
  
• Clearly communicate how ESG metrics align to goals and how incentives align with the corporate strategy and why incentives may need to change.