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Article | Executive Pay Memo North America

Use of ESG metrics in executive incentive plans expanding

By Don Delves , Robert Newbury and Eleanor Blakeslee | January 4, 2022

Our 2021 global ESG report examines how ESG metrics play an increasingly important role in executive compensation incentive programs.
Executive Compensation

While the majority of United States companies now include environmental, social and governance (ESG) measures as part of their executive compensation incentive programs, they are now poised to expand and refine the use of ESG incentive metrics in the coming year. Stakeholders have been steadfast in their desire for companies to address key ESG issues, most prominently environmental and sustainability (E&S), people and human resources (HR) and inclusion and diversity (I&D).

Key takeaways

  • Refining ESG in 2022. Many organizations in the U.S. are poised to refine the use of ESG incentive metrics in their compensation plans in 2022.
  • Increased use. HR metrics, employee health and safety, and inclusion and diversity are ESG metrics that have seen notable increases in use.
  • Enhancing DEI. Inclusion and diversity is the area where most companies are considering adding or enhancing an ESG measure.

Responding to stakeholder concerns, many companies have recently announced goals tied to achieving various ESG initiatives, such as net-zero carbon emission commitments or I&D recruitment goals. Companies have increasingly incorporated ESG-related measures tied to these goals as part of their incentive programs, signaling increased importance and consequences of these initiatives as part of broader efforts related to risk management, brand value enhancement, and recruiting and retention.

According to Willis Towers Watson’s recently published “2021 Global ESG report,” (please see link below to download the report) the use of ESG metrics within incentive plans for S&P 500 companies is increasing. In fact, we are seeing measured increases across all ESG categories, but the increases are especially notable in HR metrics, which increased nine percentage points since last year, employee health and safety (up five percentage points), and inclusion and diversity (up four percentage points).

The study also found that most companies use several stand-alone ESG metrics or combine them as part of ESG or broader bundles. Only 5% of companies use a single (stand-alone) ESG metric. To the extent a distinct weight of ESG metrics could be determined (i.e., it is comprised of the stand-alone ESG metrics as well as the pure ESG bundles), 17% is the median overall ESG weighting within annual incentive programs.

Drilling a bit deeper into some of the key ESG issues emerging this year:

  • Environmental and sustainability: Two-thirds (66%) of companies using environmental metrics do so quantitatively. Of these, 51% are stand-alone metrics, while the remaining are split relatively evenly between an ESG bundle or broad bundle. Although energy, materials and utilities companies have incorporated E&S metrics for several years, increases are occurring across most industries. Metrics like emissions, incidents and waste have goals that can be defined, are understandable and easily measured.
  • People and HR: People and HR metrics are the most prevalent of the six ESG categories of companies, with 40% of companies having a people and HR goal. Nearly three-quarters are classified as being part of broad metric bundles. Most (66%) fall within individual performance. These types of goals are often different depending on the role of an executive. For instance, if one is responsible for HR activities, they may have a people and HR goal. Only 13% of companies with people and HR metrics are measuring them quantitatively. People and HR metrics, such as talent management, engagement, leadership and culture are more commonly determined in a subjective manner.
  • Inclusion and diversity: One in five companies (19%) with an inclusion and diversity metric are measuring it quantitatively. Nearly half (46%) set objectives at the corporate or business unit level and the majority (56%) set them at the individual performance level. Like people and HR goals, I&D usage is most frequently disclosed as part of ESG or broader metric bundles with performance assessed qualitatively. Over half (55%) of inclusion and diversity goals are stated simply as “inclusion and diversity” and do not give any additional details, inviting calls for increased transparency.

People and HR metrics are the most prevalent of the six ESG categories within incentive plans for S&P 500 companies, with 60% of companies having a people and HR goal.

We anticipate continued focus and increased use of ESG metrics by companies in the year ahead. There are 57 companies that have already indicated they will be adding at least one new or amended ESG metric to their annual or long-term incentive programs or increase the total ESG weighting of their existing program this year or early next year.

Inclusion and diversity is the area where most companies are considering adding or enhancing an ESG measure — usually in the form of a stand-alone metric or modifier — followed by environmental metrics. We expect several more companies will reveal new or enhanced ESG metric use when the full picture of 2021 actions are disclosed in 2022.

A version of this article appeared in Workspan Daily on December 16, 2021. All rights reserved, reprinted with permission.

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Managing Director, Executive Compensation and Board Advisory

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