ESG measures increasingly used to calculate executive pay

Environment, social and governance (ESG) measures are increasingly used to determine executive pay, with nearly half of the UK's 100 largest listed companies now doing so.

That is according to a new report from PricewaterhouseCoopers (PwC), which reveals how 45% of FTSE 100 firms currently have an ESG metric in either their annual bonus targets or long-term incentive plans (LTIPs).

Although one-third of companies currently use traditional ESG metrics relating to employees, such as health and safety, the report highlights how 28% now use measures for newer concerns, such as climate change and social issues related to inclusion and diversity.

“We’re seeing an explosion in interest from investors and companies in linking executive pay to ESG targets,” said Phillippa O’Connor, reward and employment leader at PwC.

“This is now feeding into practice, and very soon we’ll be in a situation where a majority of large companies have ESG targets in pay.”

The new research – which was carried out with support from the London Business School’s Centre for Corporate Governance – involved reviews of ESG targets disclosed in the pay plans of FTSE 100 companies’ annual reports from last year.

It also assessed the ESG targets used in pay against the Sustainability Accounting Standards Board (SASB) Materiality Map, finding that around 55% of the measures used by FTSE 100 companies are material to the framework.

This is important as research has shown that companies that focus on material dimensions reap the benefits of ESG in terms of enhanced shareholder returns.

Despite the momentum around linking ESG targets to pay, the researchers warned that the difficulty of translating goals into targets in a holistic and reliable way leads to many potential unintended consequences.

Furthermore, ESG targets may undermine intrinsic motivation, and lead to companies focusing on only the metrics in pay plans, at the expense of other important issues.

“The increased focus on integrating ESG considerations into company strategy and operations is welcome, but this doesn’t mean we should automatically include ESG targets in pay,” said Tom Gosling, executive fellow at London Business School’s Centre for Corporate Governance.

“There are lots of practical difficulties, and scope for unintended consequences, in linking pay to ESG. And there’s a risk that more ESG targets simply results in more pay, due to the difficulty of knowing how stretching these targets are.”

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