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E-MailBlair Jones is Managing Director at Semler Brossy Consulting Group. This post is based on her Semler Brossy memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).
Eager to give greater attention to stakeholders beyond investors, corporate boards have been adding environmental, social and governance (ESG) issues to their agenda. Prompted by institutional investors and proxy advisors—and from other stakeholder groups— they’ve begun considering translating those concerns into their executive pay packages. At Semler Brossy, we’ve seen a dramatic increase in client inquiries on this challenge.
Linking ESG metrics to executive pay is a powerful way to drive change, but compensation is a sensitive instrument, so we urge caution. Compensation real estate is limited. Each new metric may dampen the emphasis on existing metrics. It is important to balance all incentive metrics to gain the most powerful effect. Companies can be most effective with ESG metrics starting with just the most relevant issues for them and their industry or sector, rather than trying to address all ESG elements.
Companies can assess a number of worthy goals against the company’s specific strategy for customers, employees and other stakeholders. Where can you make the biggest impact or where do you have the biggest gaps? What metrics best drive competitive advantage? Are you looking to limit a major risk or capture a big opportunity?
As with any other new metric, ESG metrics should be crafted to reflect the company’s context and ESG priorities—and to complement the existing pay incentives. The company should also test a metric before including it in compensation, to reveal unintended consequences or the possibility of gaming. Rather than a single decision, new pay metrics involve a process that begins with elevating certain issues internally and externally. No need to know everything at once; boards can move from incorporating metrics in a general scorecard to more specific incentives as they better understand the dynamics of certain issues.
The board’s commitment is critical—this must not be a short-term publicity exercise. ESG goals almost always require multi-year efforts. There’s also a signaling component: While adding the metric to your incentives may send a positive message, taking it away or diluting it later will do the opposite.
Compensation isn’t the only tool for ESG. For at least some issues, organizations might do better with reinforcing the importance of the metrics through who gets promoted or cultural shifts, rather than new pay incentives. But the urgency of ESG makes it a natural addition to many company’s pay packages over time. If done well, it can help the company and society thrive in the long term.
