In the last few years, companies have begun to use non-financial metrics more often in CEO pay packages. In 2021, 52 percent of S&P 500 companies reported including ESG metrics in compensation while 69 percent said they will be included in 2022 compensation packages.
Investors and investor-led climate initiatives are helping to drive adoption of climate-related CEO incentives. The CA100+ Net Zero Benchmark defines the climate-related expectations from 700 signatory investors and asset managers with $68 trillion in assets under managing. It says companies should establish executive compensation incentives aligned with short-, medium- and long-term science-based GHG reduction goals.
A new report and scorecard, Pay for Climate Performance, last year looked into how the 47 largest emitting companies in the United States are incorporating climate metrics into CEO pay packages. It identified the best practices needed to create quality climate links, to ensure they help ensure accountability for emissions reduction:
Use a quantitative emissions reduction metric that is 1.5oC-aligned across all scopes, not less specific and less rigorous targets. Many CEOs have made net-zero-by-2050 pledges, but these executives likely will not be leading their companies when the pledges come due. Executives must be held accountable now for accomplishing the short- and medium-term GHG emissions reductions needed for credible climate transition plans. This includes ensuring investments and business changes occur that will achieve 2050 targets when executives are still at the company.
Disclose quantitative metrics and targets. Multiple companies include “reduce emissions” as a climate “metric” without defining specific targets for what sort of a reduction is required for a bonus. Others use “progress towards” or “demonstrate leadership to” emissions reduction without defining target levels. Others point to milestones achieved without setting measurable targets. None of this is adequate. Retrospective milestone reflections that support current awards are not the same as setting targets for the future and measuring performance against those targets. Climate-related metrics disclosure should match best-practice financial metrics disclosure.
Disclose the CEO payout for achieving targets. To assess the likely financial impact of an incentive, investors must be able to determine how much an executive will receive a climate metric is achieved. This requires a metric with pay weighting that spells out. pay percentages associated with specific achievement levels.
Tie quantitative emissions reduction metrics to enough CEO pay to incentivize performance. When a climate incentive is dwarfed by financial performance metrics, executives are not likely to prioritize emissions reductions. Future As You Sow reports will look more closely at this subject and also consider which kind of conflicting financial metrics may incentivize CEOs to take action that increases emissions.
When assessing the quality of the compensation and climate link, investors must concurrently consider the quality of a company’s climate transition plan and its alignment with CEO pay. Investors should pay particular attention to compensation design and the rigor of climate metrics to determine if a company is effectively incentivizing the emissions reduction needed.
Rosanna Landis Weaver
Director of Wage Justice & Executive Pay, As You Sow
Melissa Walton
Executive Compensation & Say on Climate Associate, As You Sow