As the ESG landscape continues to heat up, with investors and the SEC signaling heightened focus on human capital as well as sustainability and climate disclosure, a useful new piece from Semler Brossy exhorts us to “move cautiously” even as we embrace the new paradigm.
The article notes, consistent with what we are seeing at the Center, that the move to link ESG metrics, particularly D&I metrics, to pay seems to be driven more by companies themselves than by mainstream investors. Linking human capital metrics to pay may be a way to ensure that companies don’t fall short of public D&I goals or may be deemed necessary from an external optics perspective long before investors start demanding it. On the other hand, investor demand for human capital disclosures may make it difficult for companies not to create a link with pay, since once disclosed, expectations will be raised for improvement on year-to-year achievement.
The article makes the excellent point that “compensation real estate” is limited. Adding ESG metrics to the pie takes up space that could be devoted to other metrics, so prioritization based on company objectives is critical. In addition, boards should consider the following when it comes to ESG metrics:
- Consider the Risks. Companies need to consider the possibility that they will fail to hit public targets, or, even worse, that financials may suffer in the short-term if metrics are not well-balanced. Semler suggests “walking before you run”: track metrics for a period before incorporating them into compensation, or start with qualitative goals before moving to more quantitative ones. Consider, too, that it will be difficult to withdraw an ESG metric once instated.
- Deliberate Process. We are entering a period of experimentation when it comes to ESG metrics, and there will likely be no awards for first place. If boards are uncertain about the best way to incentivize progress on ESG metrics, using a scorecard approach first and then moving to hard metrics may be wise. Similarly, companies may start with metrics in the annual plan before moving to a long-term approach (or both).
Although we have not yet seen a strong push from mainstream investors to link ESG metrics and pay, it seems inevitable that if the current focus on increasing disclosure continues, a widespread change in metrics is not far behind. Additionally, companies in certain sectors may find that expectations are higher regarding ESG metrics tied to pay (such as the energy sector being expected to tie pay to carbon footprint reductions or retail being asked to consider sustainability and human rights in pay plans). Now is the time to prepare and lay the groundwork so that decisions about metrics never have to be made in a hurry
