Executives follow the money. If your strategy points one way and your remuneration another, people will follow the money.
Why does ESG matter?
The ESG concept is rooted in an ethical and moral responsibility to stakeholders. Businesses not only have a responsibility to act in a manner that does not negatively impact the environment and society but also actively improve the situation. Embracing these practices demonstrates the business’s commitment to sustainable and responsible operations that enhance the world in which they operate.
From an investor’s perspective, companies with robust ESG initiatives present safer long-term investments. Such companies are less susceptible to regulatory scrutiny, legal penalties, customer boycotts and loss of employee confidence. By identifying and prioritizing key ESG considerations, these companies mitigate potential risks.
From the executive’s perspective, embracing ESG represents an opportunity to transparently demonstrate how they are effectively managing risks and governance practices. It allows executives to showcase their commitment to sustainable business practices and responsible corporate governance, thereby enhancing investor confidence in the company’s long-term viability and performance.
ESG & Remuneration
As businesses integrate ESG into their strategies, it’s a natural progression to incorporate these objectives into executive pay. The rationale behind this approach is that strategic initiatives must emanate from the top leadership. When executive remuneration incentivises behaviours that are aligned with the company’s ESG goals, then the business stands to benefit.
Executives (and employees) follow the money. If your strategy points one way and your remuneration another, people will follow the money.
There are various ways ESG objectives can be incorporated into executive pay. ESG goals may be included and assessed as part of a broader performance scorecard used for either individual performance and/or company performance. ESG may also be used to adjust the financial performance rating, the overall rating, or the payout. They may be used in the short term incentive plan (STIP) and/or long term incentive plan (LTIP).
Khokhela’s view is that G should NOT be incentivised. Good governance is not negotiable and something to be rewarded. If good governance is not implemented properly, disciplinary action should be taken.
E and S should be included using specific (often quantitative) metrics. Once E and S factors have been included in the remuneration structure, the RemCo needs to monitor & adapt these factors when appropriate to ensure they are achieving the objectives.
Before incorporating ESG into executive pay.
ESG targets should seamlessly align with the broader business objectives to maximize their impact and address the unique risks inherent in each business. Often comparing with other companies in the same industries can assist in confirming the objectives. This is not to say all companies in the same industries should all have the same ESG goals.
Conducting a comprehensive cost-benefit analysis is crucial to understand the financial implications of implementing the strategy.
A recent Business Day podcast delved into the topic of ESG Integration, emphasizing the importance of considering context rather than solely relying on ESG rankings provided by rating platforms. While ESG rankings provide insight into interventions and commitments, they often lack deeper context regarding the risks companies face and how executives identify them. Additionally, these rankings do not offer detailed information on where executives prioritise their efforts. As ESG reporting requirements continue to evolve, it is becoming evident that investors should take a more thorough look at a company’s ESG strategy to gain a comprehensive understanding of its approach.
Incorporating ESG targets into executive pay requires careful consideration of potential trade-offs and unintended consequences. It should be viewed as a cultural shift rather than just a compliance requirement, with a focus on maximizing positive impact across all aspects of the business.