Closing the Gap Between Purpose and Pay
Incentivizing ESG through Executive Compensation
Up until recently, conversations about sustainability have been largely focused on the actions of an organization to do business without negatively impacting society and/or the environment overall. Instead, one of the primary goals of having a sustainable organization is to make a positive impact by considering various environmental, economic, and social factors when making important business decisions and then monitoring the impacts. None of this is exactly new. What is coming up more frequently, however, is what this all means for executive compensation.
Today, there are higher expectations and increased scrutiny among an organization’s key stakeholders. But it’s not just about the leaders or investors creating pressure to prioritize ESG and communicate progress made regularly. Ever since the Great Resignation, we have seen that more employees and job candidates are also prioritizing their employment decisions on an organization’s mission, vision, purpose, ESG goals, and culture. As such, this prioritization of sustainability is not limited to a select few, but rather found at each level of the organization.
What is the Gap Between Purpose and Pay?
While no one is disputing the importance of demonstrating the impact of a sustainable business model, many organizations are ignoring one of the most powerful motivators for their leaders … money, and specifically, executive compensation. As such, a gap has widened over recent years between an organization’s purpose and its executives’ pay. The reasons for this are varied. First, organizations, while out of the pandemic’s survival mode, still tend to look more at the short-term rather than the long-term—a necessary component to ESG. Further, compensation incentives have historically been based on shorter-term performances, while sustainability impacts generally have more aspirational longer-term impacts.
Other challenges include the facts that ESG regulation is still evolving, metrics are often difficult to be implemented, and best practices remain limited. These are all in direct opposition to the clear certainty required in determining executive compensation. Simply, they’re not as black and white as an organized spreadsheet with neat columns and set formulas. This creates a disconnect between what type of performance actually gets rewarded monetarily versus what the organization communicates is their priority (i.e., ESG). It appears that it is time for a realignment.
Five Questions to Get Started
Despite the challenges, we’re already seeing this shift occurring. Today, more organizations are beginning to incorporate ESG performance measures not only into organizational strategy and business plans, but also into their executive compensation plans. In fact, according to a recent survey, 73% of S&P 500 companies in 2021 were tying executive compensation to ESG performance, which was up from 66% in 2020.
The primary reasons to include ESG measures into executive compensation include demonstrating that ESG is a priority, responding adequately to investors, and achieving goals faster. However, many are unsure about where to begin. To that end, Harvard Business Review has identified five questions to serve as a helpful starting point for organizations to develop sustainable executive compensation plans. According to the article, the following questions should be considered –
1. What is the goal?
What does the organization aim to achieve with its compensation plan? How do these objectives link to the corporation’s purpose and strategy?
2. Which metrics matter?
On which topics does the organization invite its stakeholders to measure its progress? What financial, social, and environmental impact does it expect to make by prioritizing these topics?
3. How do you weight the incentives and over what timeframe?
Once materiality is assessed, it’s important to determine priorities — or the weighting — of incentive scheme metrics to drive the right behaviors. To make an impact, compensation plans need to be tied to clear KPIs and be financially meaningful to participants.
4. What are the targets?
For incentivization purposes, sustainability KPIs must be measurable and typically set with reference to external standards or international treaties.
5. How will you show progress?
The goal should be to offer investors, customers, employees, and a range of other stakeholders a transparent and accessible articulation of the coordinated efforts an organization has made to improve sustainability.
Best Practices to Close the Gap
Organizations may want to get started quickly but should take their time before jumping into this approach. Proper planning includes using ESG operating goals for a few years before including them in compensation. In this way, they can determine if the goals are relevant for the business and if they are measurable prior to becoming an integral part of compensation plans. Additionally, putting together an advisory board or committee from various impacted departments to engage in the strategy, metrics, and plan can be extremely beneficial in considering what the organization is attempting to achieve with this approach. Organizations should also be prepared to explain why linking ESG with compensation makes good business sense. Investors and other key stakeholders will want to know how it will actually move the needle when measuring the effectiveness of ESG initiatives and how it will drive financial performance.
There is no doubt there are many compelling business reasons for organizations to accelerate the transition to sustainable business models by aligning this priority with executive compensation metrics. By taking it slowly and being intentional about why it is being done, real progress can be made. Simply, it will begin to close the gap between purpose and pay.
At The Win Woman, we focus on Environmental, Social, and Governance strategic development and policies for organizations of all sizes and funding opportunities for nonprofits. We work with boards and C-Suite executives to help develop the right solutions for their specific situation in their specific industry. For more information, please contact us.
Until next time, keep Building Your BADASSERY!
