With Environmental, Social and Governance (ESG) metrics increasingly being linked to executive pay, we ask: how well is this working?
We have looked at how 50 of the largest European companies are paying CEOs to deliver on the transition to net zero. We cover the effectiveness of current action, and share recommendations for boards as they consider how to link pay to net zero.
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Executive pay, net zero and investor expectations
Our analysis shows that while most large European companies are including carbon targets in executive pay, they almost always fall short of what investors are looking for.
A balance needs to be struck. ESG targets linked to pay can’t be seen by investors as the only indicator of a company’s commitments to ESG priorities. But at the same time, they need to be executed to a meaningful and high standard.
Our report tackles:
- How have large European companies implemented carbon targets in pay? Have the biggest emitters moved further on putting carbon into executive pay?
- How well have companies met investor expectations on implementing carbon targets in pay?
We also look at some of the challenges and complexities of including carbon targets in pay, including:
- What are some of the challenges when linking pay to carbon targets?
- Are carbon targets always relevant? Or will alternative approaches work better for some companies?
The response from high and low carbon emitters
With high emitting companies subject to the most intense investor engagement on carbon reduction, our analysis splits companies into ‘CA100+’ and ‘non-CA100+’, to distinguish high and low carbon emitters respectively (as identified by the organisation Climate Action 100+).
Key findings
- Almost all companies at least reference that carbon is considered in executive pay, but there is a wide spectrum of approaches for how it has been adopted.
- The levels of maturity of carbon reduction strategies are quite similar across CA100+ companies and non-CA100+ companies, with 68% of companies using SBTi approved carbon reduction plans.
- CA100+ companies have, in general, targeted a slower pace for reaching net zero than non-CA100+ companies.
- 71% of CA100+ companies translate carbon strategy into an explicit carbon measure in executive pay with a separate weighting (compared to 50% of non-CA100+ companies). We define this as a ‘Basic’ approach. However, only 64% of CA100+ companies have an explicit carbon measure worth 10% or more of the incentive (vs 25% of the non-CA100+ companies). We classify this higher weighting as ‘Better’
For companies with a separately weighted carbon measure
- CA100+ companies include a significantly higher weighting for carbon measures in pay plans.
- Carbon targets are generally measurable, with 90% of CA100+ company carbon targets being measurable (vs 94% of non-CA100+ companies).
- Overall, fewer than half of companies disclose targets prospectively. Many investors view prospective disclosure as a critical component in building trust and accountability.
- 80% of CA100+ companies that have an explicit carbon measure in pay have, at the very least, a loose statement linking this carbon measure to their long-term company plan (vs 72% of non-CA100+ companies). By contrast, only 10% of CA100+ companies provide a more comprehensive link (e.g. supported by numbers) compared with 11% of non-CA100+ companies.
- Payouts on carbon targets last year averaged 86% of maximum with over half paying out at 100%. This compared with typical average incentive pay-outs on other measures of around 75% over a number of years.
Carbon is not like other executive pay metrics
With value-related targets (e.g. revenue, profit), it’s a general rule that ‘more is better’. With carbon, ‘less is better’ will be the norm, which creates a number of knotty issues:
- What about acquisitions and disposals?
- What if company A can produce at a lower carbon intensity than company B, then shouldn’t we accept A’s emissions growing if it is taking production from B?
- How do we deal with hard-to-measure Scope 3 that isn’t in management’s line of sight?
- When should we consider that regulation has overtaken the need for pay targets?
Looking to the future
- There is growing momentum from investors and companies to tackle the carbon transition – carbon commitments are now widespread, and this is increasingly being reflected in carbon targets in pay.
- Our assessment showed that only 14% of companies have targets that are significant, measurable, transparent, and with a disclosed link to strategy. But there are easy wins for improved targets, most notably around prospective transparency of targets and a clearly explained link to longer-term carbon goals.
- But the goalposts are likely to move. ‘Best’ practice remains some way into the future and investor expectations will likely become more, rather than less, demanding.
- Linking executive pay to climate goals is not a panacea: executive pay targets cannot overcome the fundamental economics that carbon is not properly priced. But done well it can, in the right circumstances, reinforce executive accountability to meet short-term targets towards long-term climate goals.
- If we think executive pay is part of the solution, there needs to be more ambition to implement carbon targets robustly and effectively, using the power of incentives to support the push for net zero.
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