Canadian companies are taking a longer-term view in how they incorporate sustainability objectives in their executive compensation programs. The number of S&P/TSX 60 companies with an environmental, social and governance (ESG) performance metric in their long-term incentive (LTI) plan more than doubled to 15% in 2023 from 7% in 2022.
While the inclusion of ESG in annual incentives is a majority practice (followed by 78% of S&P/TSX 60 companies), the emergence of ESG in LTIs underscores how progress on sustainability objectives is increasingly considered a driver of long-term value creation. Building accountability for sustainability goals through executive compensation is increasingly recognized as a tangible feature of good governance and a powerful signal to a company’s stakeholders.
Focus on the “E.” Eighty-nine percent of companies with ESG in their LTI plans include a climate-related performance metric. The most common performance metric is a variation on greenhouse gas emission reduction, with a range of approaches, including absolute emissions reductions, reduced emissions intensity and infrastructure development required to support eventual emissions reductions.
Scorecard approach. A scorecard of three to five performance metrics within performance share unit (PSU) plans is becoming more common. These scorecards are similar to the approach used in many annual incentive plans and tend to emphasize both climate and workforce diversity objectives. Female leadership representation is a common metric in North America.
Lighter initial weightings. Eighty-nine percent of the companies incorporate ESG as a weighted performance metric, with an average 14% weighting within their PSU plan or a 7% weighting in the overall LTI plan offering. While this may appear low, the median LTI award is three to four times greater than a Canadian executive’s target annual incentive. As such, a 7% LTI weighting is comparable to a 20% to 30% weighting within an annual bonus plan, which we consider material.
Modifiers. Twenty-two percent of companies use ESG performance to modify overall PSU outcomes. As examples, a large power utility combines its weighted climate metric with a +/– 5% inclusion and diversity modifier, while a large life insurer uses a modifier of +/– 10% using an ESG scorecard. Modifiers help link overall company and ESG performance such that progress on sustainability goals (or a lack thereof) can improve (or reduce) overall payouts otherwise tied to share price or financial performance.
An alternative approach. The statistics above exclude Canada’s big banks, all of which incorporate a different approach to linking ESG performance with long-term executive compensation. Each of these organizations adjusts the overall quantum of the annual LTI award based on prior-year performance on ESG and other measures of company performance. This is a way to further incorporate ESG within executive compensation without the challenge of setting longer-term performance metrics and targets.
North America has materially lower prevalence of ESG in LTI plans compared with Europe (46%), the U.K. (37%) and Asia Pacific (28%).
The global pace of adoption, coupled with the importance of sustainability to the strategies of Canadian companies, suggests a likely future prevalence of 30% to 40% among Canadian companies over the medium term.
Note: Data capture 2022 proxy disclosures with the exception of Canada using 2023 proxy disclosures to date.
Long-term sustainability objectives involve a good deal of uncertainty, which presents challenges in establishing suitable performance metrics and targets. Uncertainty, however, is a common feature of any long-term performance measure. We recommend the following approach:
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