Amid a cacophony of articles suggesting new approaches for companies considering tying ESG metrics to executive pay, a recent Alex Edmans
blog post in the
Wall Street Journal takes a contrarian view. Professor Edmans, a frequent writer on the topics of finance and executive compensation, has long held that executives should be compensated in long-term shares that can’t be sold for 5-7 years and a proportion of which must be held beyond departure. His latest article addresses the efficacy of “short-term” metrics in general and ESG metrics in particular, noting that “nonfinancial” doesn’t always mean “long-term,” and that paying executives for targets encourages them ONLY to hit those specific targets – whether overall performance is benefited or not. In Edmans’ view, ESG metrics are even more susceptible to this phenomenon as they are multi-faceted, so that incentive plans are faced with the choice of CEOs focusing on only a couple of measures and ignoring all others, or chasing so many measures at once that the plan loses all motivational effect.
Separately, Edmans raises the question of whether performance on ESG measures in fact correlates to long-term corporate performance, noting that there is a dearth of research connecting the two (this may be partly related to the significant divergence of ESG ratings among rating agencies). However, while it may be true that we lack data to show a strong correlation between ESG metrics and financial performance (other than where those ESG metrics are material to the business), Edmans misses the point that many companies consider ESG issues such as climate and diversity to be integral to how they do business and sustain their brand in the long term, and may therefore be willing to pay executives for achievement in those areas separate from immediate impact on performance.
Edmans’ suggested solution, the use of long-term pay plans (meaning RSU grants that must be held for 5-7 years or past departure from the company) which have been shown to improve both financial performance and ESG performance over time, is an interesting one given the recent focus by
CII and others on eliminating performance-based incentives in favor of static salaries and RSU grants. Edmans is careful to note that companies should still set and publicly disclose ESG goals along with progress against those goals, arguing that the reputational and intrinsic motivation for a CEO to hit those goals makes financial incentive unnecessary. Although most companies are not likely to follow this advice given the current environment, not to mention the strong support enjoyed by performance-based plans among mainstream investors, the article adds to the growing number of voices questioning whether the pay-for-performance model is still effective.
