ESG-based compensation grows in popularity

Almost two thirds (60 per cent) of companies around the world are applying ESG targets to share-based employee compensation.

However, only 18 per cent of companies are applying ESG targets to both short- and long-term incentive plans, according to a survey by the Global Equity Organization.

An increasing number of shareholders are beginning to ask companies to make ESG a part of their business strategy. As a result, companies are making more granular, targeted ESG-based compensation plans, said Jason Kroft, partner at Miller Thopson.

“Shareholders and stakeholders want to see how the strategies, policies and procedures related to ESG are built into how companies reward and incentivize their employees. Some businesses are doing this proactively, and others… being their shareholders, are making proposals, being active and requiring action,” he said.

ESG important to shareholders

Shareholders’ desire for incorporating more ESG targets comes, in part, from the growing awareness of ESG issues and the impact businesses can make, particularly when it comes to the environment and workplace safety and security. As this awareness continues, it is becoming more of a norm for shareholders to use their shares to affect the issues that are important to them, Kroft said.

“Every business is different and finds itself in a different place on this journey around ESG, but very few businesses could say they are immune from the scrutiny and opportunity presented by being aligned on ESG goals.”

While integrating ESG targets into share-based compensation is in the early stages, at its core, aligning business activities with ESG goals and measuring this is part of performance is being adopted by more employers, he said.

“It's early days, but people are starting to say… ‘In addition to doing your job in the way it was previously formulated, you now have to do these other big picture things that the company cares about.’ However, how you demonstrate that you've done them and how the company measures them is still a work in progress.”

ESG and share-based compensation

Employers are increasingly moving from mentioning ESG factors in short-term incentive plans toward share-based compensation plans that are tied to ESG goals, which are typically longer-term goals, said Sean McAleese, partner at Davies Ward Phillips & Vineberg.

“It's difficult to use a short-term vehicle, like a STIP of some kind, to measure the ESG progress by a company, because those are longer-term goals, more structural in nature and [involve] quite fundamental changes, so it takes quite a bit of time to see change and to measure that change,” McAleese said.

Share-based compensation plans are longer-term, which also benefits companies because they serve as a retention incentive for employees to continue with the employer for longer and to invest further in and exercise options, he said.

“The longer-term nature of share-based compensation plans fits quite well with the approach to measuring ESG and recognizing that it is a longer-term goal.”

Building clear criteria into ESG-based compensation

In the future, McAleese foresees the number of companies deliberately building clear and measurable ESG criteria into their incentive systems, while also making these more sustainable in the long term. These measurement criteria will also likely become less vague and more sophisticated when it comes to aspects such as diversity or safety statistics or the environment in the workplace, he said.

“I think you will continue to see the integration of ESG values grow, and I think these values will become more important, especially as we’re starting to see more investors paying attention to that,” McAleese said.

For Kroft, the future of ESG will become more “holistically and comprehensively” addressed by employers, becoming a corporate principle that will become part of everyone’s toolkit — regardless of what department they’re in.

“ESG is not going to be housed by the risk management team or the compliance team, it’s going to become something everyone has to consider and part of the DNA of good businesses. I think over time, ESG principles are going to become more common, comprehensive, and holistic, and we're not going to actually have to reward people for meeting ESG targets separately from other things because it is going to be just part of being good at your job and doing your job,” he said.