We are seeing an increase in the use of ESG-based incentives at companies, i.e., tying in financial executive compensation to non-financial metrics that are rooted or based on ESG factors. These ESG factors can range from "E" elements (e.g., energy efficiency), to "S" factors (e.g., employee satisfaction) or "G" aspects (e.g., data security), or any combination of such E-S-G elements. Accordingly, financial compensation packages are becoming increasingly complex (as they are tied to the traditional financial metrics, such as quarterly sales turnover or the company's share price, in addition to these emerging ESG factors).
For companies considering adopting or modifying their incentive packages to incorporate ESG factors, prudence and caution are essential to ensuring that such incentives will in fact motivate the right kind of behaviour and achieve the intended result (i.e., in the case of energy efficiency, that will in fact result in a positive environmental effect for the company) without causing any unintended adverse consequences. In addition to incentivizing the wrong behaviour, according to Pricewaterhouse Coopers LLP ("PwC"), other things that can go wrong if inadequate consideration is given when designing the incentive package include the following (among others):
- "Setting the wrong targets"
- "Sending the wrong signal to the executive team, or to investors"
- "Creating just another entitlement"
- "Losing the goal in translation"
Accordingly, as PwC suggests, "for those that have made recent changes to their executive compensation plans to account for ESG metrics: continue to monitor developments and expect an evolution in how those goals are being defined and utilized" and "[f]or those who haven’t added ESG metrics yet: consider when the company will be ready, and start to lay the groundwork with the executive team."
If the metrics or targets relate to areas that shareholders or employees assumed were non-negotiable, the compensation committee risks creating an almost guaranteed bonus. Shareholders are wary of incentive pay for something executives should be doing in any case.