How to integrate ESG issues into executive pay: a review of utilities and extractives

Executive pay remains at the forefront of corporate governance discussions for the investment community.

Even post-financial crisis, high levels of executive pay, regardless of performance, continue to be the norm at many organisations, and are regularly reported in the media.

Linking environmental, social and governance (ESG) performance to pay can help hold executive management to account for the delivery of sustainable business goals. Executive pay should be aligned with performance and long-term strategy in order to protect and create value, but existing remuneration plans often do not promote sustainable value creation, which is in the interest of both companies and their investors. This lack of alignment is of concern for long-term investors, and presents opportunities for engagement to promote the consideration of ESG issues when setting pay.

This report highlights significant gaps in company practices and disclosure. Where ESG metrics are used, they often don’t reflect the issues that are identified as most material to performance, and many companies do not disclose the targets linked to those metrics. Developing transferable recommendations is challenging: companies argue that the complexity of business operations makes it difficult to identify either a set of ESG issues applicable to companies across the sector or a set of metrics sufficiently applicable across an entire company to be integrated into CEO pay.

These findings are a strong indication that the integration of ESG issues into executive pay is in its infancy, and further work on the issue is crucial.

About the project

Given the continuing intense scrutiny around executive pay, in 2012, along with Global Compact LEAD, we facilitated discussions between a diverse group of institutional investors and companies to explore the rationale, feasibility and effectiveness of including ESG factors in corporate executive pay plans to incentivise the delivery of long-term sustainable performance. The project resulted in a guide for investors and companies on how to integrate ESG issues into executive pay. It outlined recommendations around three key areas of discussion: how to identify the appropriate ESG metrics for each company, how to link these metrics to executive pay packages and how to provide high-quality disclosure on such practices. From 2013, we worked closely with the investor group to explore the issue in more depth via further company dialogue and commissioned research in the utility and extractive sectors.

These sectors are highly exposed to a range of ESG issues including companies’ license to operate, greenhouse gas (GHG) emissions and health and safety standards. Given such exposure, the integration of ESG metrics into executive pay was considered likely to be among the most robust, potentially shedding light on examples of good practice. In addition, based on an initial assessment, utility and extractive companies were perceived to be more advanced in their consideration of ESG issues in executive pay. Discussions with a select number of companies and the bespoke research on related practices of the top extractives and utilities around the world form the basis for this report, which complements our 2012 guide. It highlights key takeaways from the company dialogue, leading to additional points for engagement, and presents an overview of current practices in selecting ESG metrics and of levels of disclosure.