What should boards do to ensure ESG accountability?
This article was originally posted on NACD BoardTalk.
Long before the pandemic, US companies were addressing and grappling with environmental, social, and governance (ESG) issues and the impact of climate change on their businesses. In addition, the Black Lives Matter and #MeToo movements have brought issues of diversity, equity, and inclusion (DE&I) front and center for organizations, and the Great Resignation and war for talent have highlighted the need for companies to strengthen their employee value propositions and more fully monitor their human capital.
Research for Mercer’s latest iteration of the Global Talent Trends study covering attitudes on workplace issues continues to show that employees who thrive want and expect to work at companies that make a positive mark on society.
As ESG imperatives have become more widely discussed, organizations have started considering how best to hold themselves accountable. One way to accomplish this is to tie leaders’ compensation to positive ESG outcomes, but few US companies have done this—until now.
In 2021, Mercer research found that for the first time, more than 50 percent of S&P 500 companies included ESG metrics of some type in their incentive compensation programs for top executives. So far in 2022, Mercer’s research on companies that have released proxy statements suggests this statistic could rise to close to 70 percent of S&P 500 companies (with many smaller companies doing this as well).
So, what should boards do to hold their organizations—and themselves—appropriately accountable through incentive compensation? Following these four steps will help directors form the right approach for their organizations:
2. Strategy and Culture
The ESG metrics themselvesESG metrics will differ by company and need to be tied to the overall ESG strategy. Note that it’s impossible to capture all sustainability, DE&I and human capital management metrics in your incentive plans. The board must work with management to determine the most critical metrics and how to demonstrate success.
GoalsOnce metrics are decided, setting actual goals comes next. Goals can be set and articulated qualitatively, allowing the board a degree of discretion, or quantitatively, setting specific threshold, target and maximum goals and related payouts. Our research shows that most public companies use qualitative goals with human capital and DE&I-related measures, but quantitative goals with sustainability and environmental measures.
WeightingHow prominent should ESG be in the incentive compensation schema? ESG metrics tend to be weighted from 5 percent to no more than 10 percent of total incentive opportunity, but we expect that to increase modestly over time.
TimeframeWill the ESG metrics be in the company’s annual short-term incentive plan or in the long-term incentive plan, measuring results over a three- or four-year period? While ESG accomplishments are typically longer-term in nature, most companies use their short-term plan to reward ESG performance. However, we are seeing some companies using their long-term incentive plans to measure ESG and DE&I and expect that trend to continue as companies become more familiar with ESG metrics.