January 18, 2024 Incentivising ESG
In January 2023 our article “Where next for ESG reporting” highlighted the increasing prominence of environmental, social and governance concerns within organisations. Our particular area of focus at that time was a new initiative by the Financial Reporting Council (FRC) which looked towards developing ESG systems and reporting models which were “forward looking and fit for purpose.”
One year on and the recognition of ESG as an intrinsic element of company culture and outlook has not diminished. So much so that research by The Conference Board and ESGAUGE and reported on The Harvard Law School website has revealed that 75.8% of S&P 500 companies now integrate ESG performance metrics into their CEO and Senior Executive incentive plans.
Further analysis reveals a direct correlation between company size and ESG metrics; with 83.6% of larger Russell 3000 companies (annual revenue exceeding $50 billion) adopting this incentive compared with just 23.8% of those with revenue below $100 million. Nevertheless, the increasing use of ESG metrics has led the researchers to conclude that: “Companies have crossed the Rubicon in integrating environmental, social & governance (ESG) performance into their executive incentive plans.”
Perhaps more importantly, the way in which organisations are using ESG metrics has matured. This has resulted in far more targeted performance areas which vary according to the business sector and model. For example, energy and utility companies are far more likely to focus on environmental metrics than IT companies. And whilst human capital management metrics such as diversity, health & safety, or employee engagement are fairly universal, environmental metrics such as carbon footprint and emission reductions have become increasingly prevalent as companies in all sectors identify their potential impact on the landscape.
That being said, organisations are also moving towards a more integrated outlook with ESG metrics moving from stand-alone performance pay generators to being used as modifiers, perhaps overlaying a performance target and outcome which is first calculated on more ‘traditional’ financial lines.
That approach is reflected in an FRC review from October 2023 which cautioned that ESG data should not be treated just as part of an annual reporting cycle but rather should be integrated in regular processes and embedded in the company’s culture. That report urged companies to be clear on three key elements of ESG data capture; namely motive, method, and meaning. In that way executives are far more likely to focus on what is relevant to their company and its stakeholders and to produce information which is targeted and inciteful.