Monthly Archives: November 2022

Glass Lewis 2023 Policies Guidelines – ESG Initiatives

Brianna Castro is Senior Director of North American Research; Courteney Keatinge is Senior Director of Environmental, Social & Governance Research; and Maria Vu is Senior Director of Compensation Research at Glass, Lewis & Co. This post is based on their Glass Lewis memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) both by Lucian A. Bebchuk and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.; and Stakeholder Capitalism in the Time of Covid (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita.

Guidelines Introduction

Shareholders are playing an increasingly important role at many companies by engaging in meetings and discussions with the board and management. When this engagement is unsuccessful, shareholders may submit their own proposals at the companies’ annual meetings. While shareholder resolutions are relatively common in some countries like the United States, Japan and Canada, in other markets shareholder proposals are rare. Additionally, securities regulations in nearly all countries define and limit the nature and type of allowable shareholder proposals including submission ownership thresholds. For example, in the United States, shareholders currently need only own 1% or $2,000 of a company’s shares to submit a proposal for inclusion on a company’s ballot. However, American issuers are able to exclude shareholder proposals for many defined reasons, such as when the proposal relates to a company’s ordinary business operations. In other countries such as Japan, however, shareholder proposals are not bound by such content restrictions. Additionally, whereas in the U.S. and Canada the vast majority of shareholder proposals are precatory (i.e. requesting an action), such proposals are binding in most other countries. Binding votes in the U.S. are most often presented in the form of a bylaw amendment, thereby incorporating the proponent’s “ask” in the company’s governing documents.

Glass Lewis believes binding proposals should be subject to heightened scrutiny since they do not allow the board latitude in implementation to ensure consistency with existing corporate governance provisions. Nonetheless, Glass Lewis will recommend supporting well-crafted, binding shareholder proposals that increase shareholder value or protect and enhance important shareholder rights.

We recognize that shareholder initiatives are not just limited to shareholder proposals. For example, in some markets, shareholders may submit countermotions (e.g., Germany) and/or may solicit votes against management proposals, most commonly the ratification of board acts.

While the types and nature of shareholder initiatives vary significantly across markets, Glass Lewis approaches such initiatives in the same manner, regardless of a company’s domicile. Glass Lewis generally believes decisions regarding day-to-day management and policy decisions, including those related to social, environmental or political issues, are best left to management and the board as they in almost all cases have more and better information about company strategy and risk exposure. However, when there is a clear link between the subject of a shareholder proposal and value enhancement or risk mitigation, Glass Lewis will recommend in favor of such proposal where the company has inadequately addressed the issue. We strongly believe that shareholders should not attempt to micromanage a company, its businesses or its executives through the shareholder initiative process. Rather, we believe shareholders should use their influence to push for governance structures that protect shareholders and promote director accountability. Shareholders should then vote into place a trustworthy and qualified board of directors, who can make informed decisions that are in the best interests of the business and its owners. These directors can then be held accountable for management and policy decisions through board elections.

Glass Lewis evaluates all shareholder proposals on a case-by-case basis. However, we generally recommend shareholders support proposals on certain issues such as those calling for the elimination or prior shareholder approval of antitakeover devices such as poison pills and classified boards. Additionally, we generally recommend shareholders support proposals that are likely to increase or protect shareholder value, those that promote the furtherance of shareholder rights, those that promote director accountability and those that seek to improve compensation practices, especially those promoting a closer link between compensation and performance as well as those that promote more and better disclosure of relevant risk factors where such disclosure is lacking or inadequate.

Summary of Changes for 2023

Glass Lewis evaluates these guidelines on an ongoing basis and formally updates them on an annual basis. This year we’ve made noteworthy revisions in the following areas, which are summarized below but discussed in greater detail in the relevant sections of this document:

Board Accountability for Climate Related Issues

We have included a new discussion on director accountability for climate related issues. In particular, we believe that clear and comprehensive disclosure regarding climate risks, including how they are being mitigated and overseen, should be provided by those companies whose own GHG emissions represent a financially material risk, such as those companies identified by groups including Climate Action 100+.

Accordingly, for companies with material exposure to climate risk stemming from their own operations, we believe they should provide thorough climate-related disclosures in line with the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”). We also believe the boards of these companies should have explicit and clearly defined oversight responsibilities for climate-related issues. As such, in instances where we find either of these disclosures to be absent or significantly lacking, we may recommend voting against responsible directors.

Disclosure of Shareholder Proponents

We have included a new discussion regarding our approach to disclosure of shareholder proponents at U.S. companies. Given the growing number of and focus on shareholder-submitted proposals, we believe that companies should provide clear disclosure in their proxy statements concerning the identity of the proponent (or lead proponent if multiple proponents have submitted a proposal) of any shareholder resolutions that may be going to a vote. If such disclosure is not provided, we will generally recommend voting against the governance committee chair.

Racial Equity Audits

We have codified our approach to proposals requesting that companies undertake racial equity or civil rights audits. When analyzing these resolutions, Glass Lewis will assess: (i) the nature of the company’s operations; (ii) the level of disclosure provided by the company and its peers on its internal and external stakeholder impacts and the steps it is taking to mitigate any attendant risks; and (iii) any relevant controversies, fines, or lawsuits. After taking into account these company-specific factors, we will generally recommend in favor of well-crafted proposals requesting that companies undertake a racial or civil rights-related audit when we believe that doing so could help the target company identify and mitigate potentially significant risks.

Retirement Benefits and Severance

We have updated our approach to proposals requesting that companies adopt a policy whereby shareholders must approve severance payments exceeding 2.99 times the amount of the executive’s base salary plus bonus. Although we are generally supportive of these policies, we have updated our guidelines to reflect that we may recommend shareholders vote against these proposals in instances where companies have adopted policies whereby they will seek shareholder approval for any cash severance payments exceeding 2.99 times the sum of an executives’ salary and bonus.

Link to the full report can be found here.

Open Letter to Directors and Activists Regarding Amendments to Advance Notice Bylaws

Andrew Freedman, and Ron Berenblat are Partners and Dorothy Sluszka is an Associate at Olshan Frome Wolosky LLP. This post is based on their Olshan memorandum.

We want to draw attention to a concerning corporate governance trend that directly impacts directors of public companies and shareholders with director representation on public company boards. As you are likely aware, the U.S. Securities and Exchange Commission adopted new rules regarding the use of “universal proxy cards” for contested director elections, which went into effect on August 31, 2022. In response to this, a large number of public companies have been amending the advance notice provisions under their bylaws to conform the timing and notification requirements of their shareholder nomination procedures to those of the new universal proxy card rules. Unfortunately, however, many of these bylaw amendments we are seeing go well beyond the provisions that would be needed to address the new universal proxy regime. Rather, company counsel have been using this opportunity to expand their advance notice bylaws with an array of so-called “disclosure enhancements” that make the process for a shareholder to nominate directors unnecessarily cumbersome and costly.


Communicating with the SEC When Your Organization Suffers a Cybersecurity Incident

Haimavathi Marlier and Michael Birnbaum are Partners at Morrison & Foerster LLP. This post is based on their Morrison & Foerster memorandum.

If there was ever doubt before, the Securities and Exchange Commission (SEC) has made clear—through two proposed rules related to cybersecurity, enforcement actions, public statements, and a beefed up “Crypto Assets and Cyber Unit” within the Division of Enforcement—that it expects public companies and registered entities to promptly assess the materiality of cybersecurity incidents and make swift disclosures of material incidents. In particular, if adopted, the SEC’s proposed cybersecurity disclosure rule for public companies states that issuers will have to disclose, via Form 8-K, material cybersecurity incidents, including any impact on business operations, within four business days of their determination that the incident is material.[1] And, if adopted, the SEC’s proposed cybersecurity risk management rules for registered investment advisers (RIAs), registered funds, and closed-end companies state that these registrants must report “significant cybersecurity incidents” to the SEC within 48 hours of discovery.[2] Final action on these rules is expected in April 2023.[3]

As it determines the materiality of a cybersecurity incident, an organization must also decide whether to report the incident to the SEC in advance of any public disclosure and whether to cooperate with any ensuing SEC inquiry or investigation. On the one hand, proactive reporting of likely material cybersecurity incidents can build goodwill with the SEC and make clear from the outset that the organization is thoroughly investigating the incident. On the other hand, informing of the SEC of immaterial incidents could expose the organization to expense, business disruption, and unwanted SEC scrutiny, particularly into the organization’s cybersecurity-related internal controls.

Here are four considerations in-house counsel should keep in mind in determining whether to proactively inform the SEC about a cybersecurity incident before making a formal public disclosure.


Understanding the Role of ESG and Stakeholder Governance Within the Framework of Fiduciary Duties

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Adam O. EmmerichKevin S. SchwartzSabastian V. Niles and Anna M. D’Ginto. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders? (discussed on the Forum here), both by Lucian A. Bebchuk and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr; and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita.

Over the past decade, investors, companies, and commentators have increasingly accepted and adopted stakeholder governance as the way to pursue the proper purpose of the corporation and have embraced consideration of environmental, social and governance (ESG) issues in corporate decision-making toward that end. But an emerging movement opposed to any consideration, at all, of ESG factors threatens to erase the gains that have been made over the past ten years and revert to the outdated view that the purpose of a company is solely to maximize short-term shareholder profits.

This debate is playing out very publicly, with politicians at the highest levels of state and federal government publicly staking out positions on ESG and the extent to which it should (or should not) be considered by asset managers; through regulation and law; and in boardrooms across the country and around the world. At one extreme, critics of ESG are dismissing any consideration of the long-term impact of environmental or social risk on a company as “woke” capitalism, to be condemned, if not outlawed. (See Bloomberg, Populist House Republicans Picking a Fight With US Business Over ‘Woke Capitalism’ (Nov. 27, 2022).) At the same time, attacks from the other end of the spectrum condemn board consideration of ESG in a stakeholder governance model as insufficiently prescriptive. Yet neither view, attempting to politicize the role of companies and their boards, grapples adequately with the real meaning of ESG and stakeholder governance and the role of these concepts in the decision-making process of corporate boards and management.

ESG, properly understood, is not a monolithic concept, but rather refers to the panoply of risks and policies that a company must carefully balance in seeking to achieve long-term, sustainable value. To be sure, political action may be necessary to meaningfully confront climate change and other environmental and social challenges to the long-term success of the U.S. economy and global prosperity. But separate and apart from that political will — and all the debate that should properly surround it — it remains incumbent upon and entirely within the purview of each board of directors to look beyond short-term shareholder profits and seek sustainable long-term value creation, taking into account all stakeholders, including those implicated by ESG matters. With this in mind, we write to correct recent misinformation about stakeholder governance and ESG, and to explain how the consideration of ESG, properly understood, as well as other stakeholder factors, is entirely consistent with the fiduciary duties owed by the board and management to the company and to shareholders, and indeed required if board and management are to act prudently.


The Attack on Share Buybacks

Harry DeAngelo is Professor Emeritus of Finance and Business Economics & Kenneth King Stonier Chair in Business Administration at the University of Southern California Marshall School of Business. This post is based on his recent paper. Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows by Jesse M. Fried and Charles C.Y. Wang (discussed on the Forum here); and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay by Jesse M. Fried (discussed on the Forum here).

Corporate share buybacks are under attack, mainly from the political left (e.g., Senators Bernie Sanders, Chuck Schumer, and Elizabeth Warren and President Joe Biden), but also to some degree from the right (e.g., Senator Marco Rubio).  Critics decry the large sums distributed to shareholders via buybacks because that cash could have been used to fund greater investment and, especially, investment that would make workers better off.  They typically portray buybacks as an opportunistic way for managers to bolster their own pay by artificially inflating stock prices and EPS, leaving their firms starved for cash that could have funded larger investment outlays and provided higher wages and ancillary benefits for workers.  The proposed “remedy” is to impose higher taxes on buybacks, and possibly to allow a firm to repurchase its shares only if it makes investments that satisfy specific worker-friendly criteria (to be spelled out in federal legislation).


The Rise of Rule 10b5-1 Enforcement and How Companies Can Mitigate Risk of DOJ and SEC Actions

Jina Choi, Edward A. Imperatore, and Brian K. Kidd are Partners at Morrison & Foerster LLP. This post is based on their Morrison & Foerster memorandum. Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation (discussed on the Forum here) by Jesse M. Fried. 

The U.S. Department of Justice (DOJ) and Securities and Exchange Commission (SEC) have recently intensified their scrutiny of insider trading under Rule 10b5-1 trading plans. The emerging trend of enforcement investigations and actions in this area shows that regulators and prosecutors are keen to hold executives accountable for insider trading. Companies and executives should adopt best practices to mitigate the risk that trading pursuant to a Rule 10b5-1 plan could result in an insider trading investigation.

Key Takeaways:

  • The SEC and DOJ are increasingly using data analytics to identify and initiate investigations of suspicious trading under Rule 10b5-1 plans, which are intended to shield companies and executives from insider trading allegations by letting them schedule transactions in advance;
  • Rule 10b5-1 plans, standing alone, cannot insulate corporate executives and employees from insider trading liability;
  • Insiders cannot possess material nonpublic information (MNPI) when they put a Rule 10b5-1 plan in place; otherwise, the plan will not serve as an affirmative defense to an allegation of insider trading;
  • The SEC has proposed amendments to the rules for Rule 10b5-1 plans, including a “cooling-off” period of at least 120 days between enacting the plan and when trading pursuant to the plan can begin;
  • The SEC’s view of information that constitutes MNPI may be expanding, and what is considered material will be assessed with hindsight; and
  • Companies should consider adopting the following for Rule 10b5-1 plans:
    • Institute a Cooling-off Period: Companies and executives should consider a “cooling-off” period between enacting the plan and when trades begin under the plan. Although no such restriction is currently in place, the SEC has proposed a period of at least 120 days, which would span an entire quarter, meaning that no trading could occur under a Rule 10b5-1 plan adopted in a particular quarter until after that quarter’s financial results are released. Adopting a cooling-off period designed to delay trading under a Rule 10b5-1 plan until after quarterly earnings are publicly announced can support an argument that the plan was created in good faith.
    • Ensure Robust Internal Controls: Companies should ensure that they have robust internal controls that are consistent with SEC rules and enforcement developments. They should look closely at their insider trading policy, enforcement of trading windows for enactment of Rule 10b5-1 plans, and review modifications to Rule 10b5-1 plans. Because the SEC has proposed heightened disclosure requirements for Rule 10b5-1 planned trades, companies may also want to prepare for possible disclosure of executive plans.
    • No Overlapping Plans: The SEC’s proposed rules prohibit “overlapping” Rule 10b5-1 trading plans. The SEC explained that, under the current rules, an insider can exploit Rule 10b5-1 plans by using them to establish multiple pre-existing hedged trading arrangements that temporally overlap and are timed to occur around dates on which the the issuer is likely to disclose earnings or other material information. An insider may decide later which trades to execute and which to cancel under the plans after the insider  becomes aware of MNPI but before the MNPI is made public. Under the proposed amendment, the affirmative defense would not be available for any trades by a trader who has established multiple overlapping trading arrangements for open market purchases or sales of the same class of securities. Companies should understand how directors and officers are using these plans and consider adopting a policy of prohibiting multiple overlapping plans.


Trends in E&S Proposals in the 2022 Proxy Season

Daniel Litowitz and Lara Aryani are Partners at Shearman & Sterling LLP. This post is based on a Shearman & Sterling piece by Mr. Litowitz, Ms. Aryani, George Casey, William Kim and Lucas Wherry and is part of the 20th Annual Corporate Governance Survey publication of Shearman & Sterling LLP. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions (discussed on the Forum here) by Scott Hirst.


2022 has seen yet another record-setting proxy season,[1] with Russell 3000 companies fielding 813 shareholder proposals filed as of mid-July, 2022, representing approximately a 3% increase from 2021. Companies in the S&P 500 experienced a slightly higher year-over- year increase, receiving 642 proposals this season, representing a 5% increase from 2021. While the number of compensation-related proposals received by Russell 3000 companies remained generally consistent with 2021 and governance proposals decreased by approximately 15% in 2022, environmental and social (E&S)-related proposals continued their upward trend, with a record 471 E&S proposals submitted in 2022, a 15% increase over 2021. The number of E&S proposals continues to represent a majority of all shareholder proposals received by Russell 3000 companies, comprising 58% of proposals in 2022 compared to 51% in 2021.

Source: “Shareholder Voting Trends (2018-2022),” The Conference Board, and management-socialproposals.

In 2022, there was a significant increase in the number of E&S proposals that were put to a vote in comparison with 2021 (from 47% to 59%). This was likely partly an effect of Staff Legal Bulletin No. 14L, issued by the Securities and Exchanges Commission (SEC) in July 2021, which made it harder for companies to exclude E&S proposals from proxy statements under the ordinary business exclusion pursuant to Rule 14a-8(i)(7) or the economic relevance exclusion pursuant to Rule 14a-8(i)(5).[2]


The Unicorn Puzzle

Rüdiger Fahlenbrach is Swiss Finance Institute professor at Ecole Polytechnique Fédérale de Lausanne (EPFL) College of Management. This post is based on a recent paper by Professor Fahlenbrach, Professor René M. Stulz, Daria Davydova, and Leandro Sanz.

Unicorns are private companies with pro forma valuations of at least $1 billion. In our paper “The Unicorn Puzzle,” recently posted on SSRN and available here, we investigate the puzzle of why controlling shareholders of certain startups find the unicorn status more valuable than being a public firm and the closely related question of why the number of unicorns increased so much recently. Our key findings are that unicorns differ from other VC-funded firms in that they rely more on organizational capital as well as network effects and the internet. Unicorn status enables startups to access new sources of capital. With this capital, they can invest more in organizational intangible assets with less expropriation risk than if they were public. As a result, they are more likely to capture the economies of scale that make their business model valuable.

We create a new unicorn database. Our sample consists of 639 U.S. unicorns. We have 427 active unicorns at the end of our sample period and observe 212 unicorn exits. Our sample covers all U.S. unicorns since the beginning of the 2000s until the end of the third quarter of 2021. We document the evolution of the number of unicorns and find that the number increases at an accelerating pace over our sample period. Even though 2021 has the highest number of unicorn exits, unicorn births outpace exits and the number of unicorns in existence increases in 2021. The increase is surprising because one would have expected the high valuations of 2021 to represent a unique opportunity for startups to enter public markets rather than seek to attain unicorn status.

Unicorns have reached a size that is much larger than the size of the typical IPO firm. To evaluate why founders find it valuable for their startups to stay private even though they have a much larger size than the typical IPO, we assess how the benefits and costs of being public may differ for unicorns from those of other startups. Since the unicorn phenomenon is a new phenomenon that did not exist before the 2000s, it has to be that either (1) the net benefit of being public (benefit minus cost of being public) became negative for many existing firms with private valuations of $1 billion or more, or (2) a new type of firms emerged for which the net benefit of being public is negative even at private valuations exceeding $1 billion. We show that both forces are at play. Funding has become increasingly available for firms with a valuation of at least $1 billion, which has decreased the funding and liquidity benefits of being public for these firms. In addition, a new type of firm that relies more on organizational capital and network effects has emerged. These firms are highly valuable if they succeed at capturing the benefits associated with the organizational capital and network effects that are central to their business plan, but they may not succeed in their efforts to build sufficient organizational capital and create network effects if they have to do so as public firms. These two effects constitute our proposed explanation for the unicorn phenomenon.


The corporate director’s guide to overseeing deals

Maria Castañón Moats is Leader, Paul DeNicola is Principal, and Colin Wittmer is Deals Leader at PricewaterhouseCoopers LLP. This post is based on their PwC memorandum.


The deal volume in 2021 reached levels not seen in recent years, a trend that continued into the first part of 2022. But since then, the markets have shifted.

With rising inflation rates, geopolitical uncertainty, continued supply chain interruptions, and a lingering pandemic, deal volume began to slow significantly as 2022 progressed.

A period of economic contraction will certainly influence transactions. This flows through inflationary, and borrowing rate pressure, real wage challenges, consumer spending variability, and other factors. The markets in 2022 still have an abundance of capital for both corporate and private equity (PE) to fund deals. As market volatility stifles IPO activity, alternative sources of capital (including from PE) become more appealing.

Some of the same forces creating market uncertainty also are driving dealmaking imperatives. Whether a company needs to transform its capabilities, supply chains, or go-to-market approach, the market is impatient and one of the fastest ways to accelerate transformation is through M&A.

Navigating this rapidly-evolving market presents a challenge for any business leader. But in any environment, a well-tailored deals strategy will open opportunities. And the current environment still poses a fiercely competitive deals marketplace as companies look to unlock value in new ways.

Overseeing deals and your company’s portfolio strategy

Having a focused deals strategy is critical to success. Along with organic growth through increased sales and new products and services, growth can also come through acquisitions, mergers, joint ventures, and other deals. What’s critical for the board is understanding the ins and outs of the deal, and how various transactions a company has done or wants to do are tied together in a portfolio strategy.


Linking Executive Compensation to ESG Performance

Merel Spierings is a Researcher for the ESG Center at The Conference Board. This post is based on her Conference Board memorandum, in partnership with ESG analytics firm ESGAUGE and compensation advisory firm Semler Brossy. Related research from the Program on Corporate Governance includes The Perils and Questionable Promise of ESG-Based Compensation (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; Paying for Long-Term Performance (discussed on the Forum here); Pay without Performance: The Unfulfilled Promise of Executive Compensation; and Executive Compensation as an Agency Problem, all by Lucian Bebchuk and Jesse M. Fried.


As companies address two fundamental and related shifts—the intensified focus on environmental,
social & governance (ESG) issues driven by investors, employees, consumers, business partners, ESG rating agencies, and regulators, [1] and the shift to a multistakeholder form of capitalism [2] —corporate boards are not only incorporating nonfinancial matters into discussions of company strategy and business plans, but also increasingly considering ESG performance measures in incentive plans. At the same time, there are concerns about the benefits of incorporating ESG measures into compensation, the risks of doing so (e.g., rewarding the wrong behaviors, setting inadequate targets, and creating guaranteed bonuses), and challenges in providing investors with what they view as sufficient transparency and specificity in ESG-based pay plans. These concerns have now been compounded by skepticism about whether ESG can actually drive financial performance for companies and investors alike. [3]

Insights for What’s Ahead

  • The vast majority of S&P 500 companies are now tying executive compensation to some form of ESG performance—growing from 66 percent in 2020 to 73 percent in 2021. The most significant increase was found in companies’ use of diversity, equity & inclusion (DEI) goals, rising from 35 percent in 2020 to 51 percent in 2021, as investors and other stakeholders continue to focus on diversity—making it a priority for companies as well. And as a result of the ever-growing attention to climate change, the share of S&P 500 companies that tied carbon footprint and emission reduction goals to executive pay also grew considerably, from 10 percent in 2020 to 19 percent in 2021.
  • Companies are embracing different approaches to factoring ESG into executive pay and are continuing to refine their ESG measures as they expand their reach. For example, some companies are moving from including ESG measures as part of the often-qualitative individual performance section of the annual incentive plan to incorporating ESG performance as a more quantitative modifier of the company’s overall financial performance rating, which is more aligned with investors’ preferences and expectations. Other companies are expanding the scope of those whose compensation is affected by ESG measures beyond the C-suite, reflecting that achieving ESG goals requires the collective effort of the employee base more widely.
  • Leading reasons companies are incorporating ESG measures into executive compensation, according to a poll of roundtable participants, are to signal that ESG is a priority, to respond to investor expectations, and to achieve ESG commitments the firm has made. While these are valid reasons, they also raise concerns. For example, some large institutional investors are skeptical about tying compensation to ESG measures, especially if there is not a strong business case for doing so and if the ESG goals are not sufficiently challenging or specific. Further, there are other less costly and disruptive ways of signaling ESG is a priority, including building ESG factors into professional development, succession, and promotion practices. Companies can also convey or achieve their commitment to ESG by enhancing disclosure on ESG performance.
  • Companies should consider using ESG operating goals for one to two years before including them in compensation. That allows time to see if those goals are truly relevant for the business, develop strong management and employee buy-in, and address any kinks in measurement methodology and reporting. It is especially important for companies to take time to validate and socialize ESG goals before rolling them out as part of compensation plans for a broader management or employee base.
  • It takes time to develop and compile reliable, meaningful data that can be used to measure and report actual performance against ESG goals. Companies can start by putting together a steering committee with representatives from various functions (e.g., compensation, finance, sustainability) who are engaged in the company’s strategy, and understand and have access to the data needed to measure and report on ESG performance.
  • Companies can link executive compensation to ESG successfully; however, they will need to go beyond simply “following the trend.” Actions companies will need to take include 1) identifying goals that are material, durable, and auditable, 2) assessing whether what the firm’s peers are doing in this area is instructive, 3) deciding whether to make performance measures absolute or relative to the market, and quantitative or qualitative, 4) determining the scope of those whose compensation is affected by ESG goals, 5) considering timing and assessing whether the ESG goal is appropriate for the annual or long-term incentive plan, 6) ensuring the type of metric reflects the firm’s corporate culture, 7) carefully considering the reaction of various stakeholder groups, and 8) reevaluating goals periodically to ensure that the ESG measures are still relevant and effective.
  • Companies will need to explain why including or adjusting ESG goals in compensation programs makes business sense and will “move the needle” on the firm’s performance and impact. Investors will want to understand how modifying the company’s compensation is necessary to achieve the firm’s financial, operating, and ESG goals—and whether the goals are sufficiently challenging to put compensation “at risk.” Those covered by the compensation programs will want to understand why a portion of their compensation is now linked to ESG goals. In some cases, the rationale may be obvious, such as when a company includes compliance-related goals in the wake of a widespread compliance failure. In other cases, boards and senior management will want to carefully consider whether they have a compelling narrative for adopting or adjusting such goals, especially as most companies say that including ESG measures in executive compensation is no more than “medium important” to their overall ESG efforts.
  • Measuring the full impact of including ESG performance goals in compensation is more challenging than measuring the impact of traditional operating or financial metrics. Companies should consider what they are trying to achieve by including ESG measures in compensation programs: is it to improve the firm’s ESG performance, to enhance its operating and financial performance, to signal that ESG (or a specific ESG metric) is a priority, to have a meaningful impact on society and the environment, or some combination of all four? If companies are actually seeking to have a broader impact on society and the environment, they may want to give serious consideration to how, if at all, they are incentivizing executives to work collaboratively with others in the industry and across the firm’s value chain—because making a measurable difference may require collective action.


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