By Jessica Tasman-Jones
This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards
Executives who meet their targets for environmental, social and governance criteria are increasingly being rewarded by long-term incentive plans (LTIPs) rather than bonuses.
Eighty-six per cent of FTSE 100 companies include ESG in incentive plans, such as LTIPs and annual bonuses, according to an analysis by PwC completed during the 2022 season of annual meetings.
Almost three quarters (72 per cent) of FTSE 100 groups use their bonus scheme to reward executives who hit ESG performance targets. This compares with about half that incorporate ESG targets into LTIPs, says PwC.
At present, though, ESG targets are more likely to be added to LTIPs than to bonuses, the researchers found.
Phillippa O’Connor, PwC reward and employment leader, attributes the trend to the rapid rise of environmental performance targets. This year’s PwC analysis found that environmental targets surpassed social goals, such as workplace diversity or improving health and safety, as the most common ESG factor in LTIPs.
In FTSE 100 companies, social goals are twice as likely to be rewarded in annual bonuses than in LTIPs, according to the PwC analysis. Environmental factors, however, tend to appear in either part of the pay package which, O’Connor says, reflects the fact that projects such as decarbonisation take longer to achieve.
Most FTSE 100 companies have ESG as part of their incentive plans and O’Connor expects attention to be focused on the balance of rewards between bonuses and LTIPs.
Many ESG targets are likely to take longer than even the most extensive LTIP performance periods, according to a recent KPMG report. This may cause boards to set shorter-term aims to be reached along the way, KPMG said.
The UK is one of the countries leading the way in adopting ESG in LTIPs but the trend is global, according to an executive incentives study by the Global Governance and Executive Compensation Group, an umbrella organisation of experts.
Making progress on ESG measures is often a long-term proposition, the group’s report says. Traditionally, strategic and qualitative measures have been rewarded in short-term incentive plans but this is beginning to change, it says.
“We expect more companies to adopt ESG measures in the long term over time as they potentially get more comfortable with using and assessing performance on ESG-based measures,” says Brian Bueno, ESG leader at Farient Advisors,a corporate governance consultancy.
Bueno says, however, that LTIPs have drawbacks –they lack the flexibility of short-term variable compensation plans.
Tom Gosling, executive fellow at London Business School, says there is less room for manoeuvre in an LTIP.
“In a world where ESG priorities are shifting rapidly and also measurement approaches and targets maturing, LTIPs can create problems: targets may no longer seem as relevant two years into the plan as they did at the outset,” Gosling says.
LTIPs have a reputation for transparency, with targets disclosed ahead of time rather than retrospectively. That makes them popular with investors, he says.
In addition, while metrics used for annual bonuses are commercially sensitive, there is no reason why ESG targets cannot be disclosed in advance, Gosling says.
EOS, Federated Hermes’ stewardship service provider, prefers remuneration to be aligned with long-term strategy.
“Where metrics and targets are used in incentive pay, they should reflect strategic goals rather than focus attention on total shareholder return, stock price appreciation or earnings per share,” says Velika Talyarkhan, associate director for engagement at EOS.
Targets that are more subjective, such as strategic goals, pay out at a higher level than financial measures, such as share price or profit and sales growth, according to a research paper on CEO pay published last year by the UK Department for Business, Energy and Industrial Strategy.
It is important that performance targets lead to more ESG, not simply more pay for executives, Gosling says.
“It can be difficult to define ESG goals precisely as ESG is multifaceted. Indeed attempts to become overspecific can result in hitting the target but missing the point,” he says.
One example Gosling gives is that a company may hit diversity targets for senior management in the short term but still make no progress on developing an inclusive culture.
This article is based on a piece written by Neanda Salvaterra for Agenda.