The Push for “Rigorous and Quantifiable” ESG Metrics

Companies will soon move away from broad, qualitative ESG scorecards and weighted measures to a select number of quantifiable metrics that have a clear impact on strategy, according to Farient Advisors. As regulatory agencies across the globe require more standardized and robust disclosure of ESG achievements, companies will be expected to set forth more rigorous goals and reporting with verifiable data.

Farient’s 2023 Stakeholder Incentives report (a newer term that seems to be a synonym for ESG metrics) highlights the importance of integrating investor preferences with broader public interests in order to identify the ESG measures that are “strategic differentiators for which companies are willing to pay.”

The firm examined evolving investor guidance and proxy advisor preferences to conclude that increased rigor in ESG practices and transparency will be required to sustain shareholder support on executive pay.

Many global investors have beefed up their guidance in 2023 related to ESG in compensation.  While most do not require that ESG metrics be tied to pay, many have specific guidance if ESG measures are used. Vanguard updated its guidance to further emphasize metrics should be rigorous, tied to long-term objectives or material risks and include adequate disclosures that would paint a full picture of how the goals translate to shareholder value.  Blackrock issued additional commentary last month for U.S. companies outlining principles for compensation committees. Both discussed their case-by-case approach for assessing compensation plans and BlackRock provided case studies from the 2022 voting season in which they voted for or against compensation.  Key principles include:

• Build resiliency in plans by balancing retention and motivation. Acknowledging the use of discretion and special awards over the past few years, Blackrock expects future plans to deliver reasonable outcomes across a variety of economic and market conditions without committee intervention. They define plans as resilient [when providing] “sufficient retentive impact without intervention when market conditions are difficult, motivate appropriate risk behavior by executives, reward performance when conditions are more favorable and adequately reflect the financial performance that shareholders are experiencing.”
  
  
• Align the “how” of pay and strategy. Blackrock has long maintained that a significant portion of pay be tied to goal achievement over an extended period. The investors looks for companies to explain how the compensation program encourages long-term financial value creation throughout the performance period. They suggest that companies articulate how metrics are selected and how the committee considered the goal-setting process in relation to the business.
  
  
• Balance flexibility. While recognizing situations that warrant committee discretion and adjustments, Blackrock also maintains that “pay program outcomes should reflect dynamics both within and beyond the executives’ control” and seek clear disclosure around these special circumstances.