Sustainability issues have become mainstream in the boardroom and one area receiving specific attention is the link between sustainability performance and executive compensation. 

A recent announcement from Deutsche Bank that the company is establishing this link follows the path of many other companies that have done so in 2020 (even in the midst of the pandemic), such as Siemens, Shell, PayPal, Danone, Unilever, amongst others.

The challenge of running a sustainable company has taken centre stage among shareholders. The dilemma, however, is determining what aspects of sustainability, or ESG performance, should have priority — and should be linked to pay incentives. 

With such strong board-level and investor focus on the topic, many have asked about the link between ESG and shareholder value. For example, a recent report from Glass Lewis notes that several global companies had “suffered massive blows to shareholder wealth as a result of significant environmental, social, and/or governance-related issues.” With environmental, social, and governance (ESG) issues increasingly viewed as material contributors to shareholder value, there is growing support for factoring performance on ESG measures into CEO compensation.

The key question becomes: which ESGs metrics to establish? There are many tools in place that help to identify those measures (SASB and its materiality map being one of the most noticeable) but what seems to be missing in most cases is the clear understanding of the strategic dimension. ESGs metrics to be set must not be a sort of “cherry-picking” exercise where companies selected those where they “look good”. Also, as mentioned in a previous message the World Economic Forum released last September a report (“Measuring Stakeholder Capitalism: Toward Common Metrics and Consistent Reporting of Sustainable Value Creation”) proposing a set of ESG metrics that companies can report on, regardless of their industry or region. 

A better approach is to have bonuses depend largely on executives’ success in tapping big strategic opportunities related to sustainability. By treating it strategically, the change brings the work of advancing sustainability from the periphery of the business to its heart. Which means that the ESG metrics chosen as inputs in setting CEO pay must be directly relevant to the company’s activities, those that constitute the source of competitive advantage. Firms must ask which ESG factors are material in driving value for their shareholders with a view on the long term as well as the near term. A key challenge for many firms will be to ensure that the ESG goals linked to executive pay are closely aligned to long-term profitability and shareholder value.

In this context, there are relevant questions that should be asked in order to understand whether the right ESGs are in place. A recent ICGN report highlights some of them:
 

• What are the top three environmental, social, or governance considerations of your company?
• (How) have you engaged with key stakeholders to determine these? Who are the key stakeholders? Where is the process documented? How often is this consultation repeated?
• Can you define opportunities for balancing long-term value creation, short-term strategic agility, and the building of stakeholder ecosystems all at the same time?
• How do the company’s mission and its board-level narrative on sustainability issues get translated into robust governance of these issues, a clear strategy, risk (and opportunity) management as well as metrics and KPIs?
• Do you have a long-term incentive plan in place? What are the relevant ESG-related performance metrics and gateways for these? 
• How do you entice ownership of environmental, social, and governance issues in company governance and among directors, executives, and employees?
• How are these issues integrated into the compensation packages of executives and others?

Have a great and impactful week!

Nuno Moreira da Cruz
Executive Director 
Center for Responsible Business and Leadership

This article refers to edition #75 of the "Have a Great and Impactful Week" Newsletter.
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