Companies increasingly are incorporating climate-related metrics into CEO pay packages. The effectiveness of CEO compensation as an accountability mechanism, however, hinges on at least three key factors.
Too often, where climate-related metrics exist, they
are predominantly qualitative, leaving significant and unwarranted discretion to compensation committees;
are non-transparent and use overly complex quantitative climate metrics that are difficult to understand and act upon; or
include insignificant metrics outside the long-term incentive plan that makes up the most substantial part of CEO pay.
Our upcoming report, Pay for Climate Performance: Linking CEO Compensation to Emissions Reduction, addresses these concerns and provides benchmarks for effective climate-related compensation. The report assesses 100 of the largest U.S. companies and found that most have yet to tie compensation to meaningful greenhouse gas (GHG) reductions. Just one company – Dow – has established a goal explicitly tied to achieving GHG reductions. None of the companies incentivizes GHG reductions aligned with achieving 1.5°C emissions reduction.
Similarly, the Climate Action 100+ investor network has adopted Benchmark expectations that CEO remuneration arrangements specifically incorporate climate change performance and achievement of emission reduction targets in determining performance-linked compensation. References to vague terms such as sustainability performance are insufficient.
To highlight the importance of linking executive compensation to sound climate metrics, As You Sow filed a proposal this year with several companies, including Cummins, a leading industrial vehicle component manufacturer which is one of the world’s largest corporate emitters. Despite acknowledging climate-related risks in its Form 10-K, Cummins does not adequately link its compensation package with its decarbonization commitments.
In CDP disclosures, Cummins states that its CEO pay package provides incentives for advancing Cummins’ PLANET 2050 goals, which are only partially related to reducing emissions. The compensation package does not describe a quantitative emissions-reduction incentive, though, nor a specified payout percentage. Furthermore, the company says that Return on Average Net Assets was the sole performance measure for its annual bonus payouts. In short, Cummins’ current compensation arrangements fail to provide a direct incentive for achieving emissions reductions even though the company says its uses pay arrangements to focus executive attention on achieving GHG reductions.
Tying executive compensation to 1.5°C-aligned emissions reductions can incentivize leadership to:
integrate climate risk management into company and value chain operations;
oversee capital allocations furthering the company’s GHG reduction goals; and
incorporate climate in the company’s value creation and risk management strategies.
This only happens if the packages are well constructed.
To help drive progress on climate change, investors should analyze CEO pay packages in detail, evaluating not only if pay packages are climate-aligned, but also the quality, robustness and rigor of the climate metrics. Shareholders should strongly oppose greenwashing that rewards CEOs for non-quantitative, vague or suboptimal climate metrics; insufficient incentives or rewards for ambivalent or immaterial emissions progress have little meaning.
Given the urgency of addressing climate change, we need to deploy every available strategy at our disposal, including incentive compensation, but these tools must be used effectively.
Abigail Paris
Climate & Energy Program Manager/ Decarbonization Lead, As You Sow