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Article | Executive Pay Memo – Western Europe

ESG Metrics in European Executive Incentive Plans

Organizations in Europe increase their use of ESG metrics in STI and LTI plans.

By Judith Schoenthal , Hannah Summers and Stephanie Schmelter | April 4, 2023

WTW's 2022 global report found that Europe continues to lead the way in the use of Environmental, Social and Governance (ESG) metrics in executive incentive plans. 90% of companies in the major European markets now use ESG metrics in their incentive systems, an increase of 11 percentage points over the prior year.
Executive Compensation|ESG and Sustainability
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For the third year in a row WTW has conducted a global study on the use of ESG metrics in executive incentive plans in top European and North American companies. For Europe the analysis is based on public disclosures of 326 companies listed in the top indices of nine European countries: Belgium (BEL 20), France (CAC 40), Germany (DAX 40), Ireland (ISEQ), Italy (MIB 40), Netherlands (AEX), Spain (IBEX 35), Switzerland (SMI) and United Kingdom (FTSE 100).

Significant increase in the use of ESG metrics overall – in both STI plans and LTI plans

European companies have significantly increased the use of ESG metrics as many companies introduced new ESG metrics, especially in LTI plans, where prevalence rose to 44% – an increase of 16 percentage points versus prior year.

Three bar charts outlining ESG metrics in STI and LTI plans. In the first chart, all plans have 75% ESG metrics in 2019, 79% in 2020, and 90% in 2021. In the second chart, STI plans have 72% ESG metrics in 2019, 75% in 2020, and 85% in 2021. In the last chart, LTI plans have 21% ESG metrics in 2019, 28% in 2020, and 44% in 2021.
Figure 1: ESG metrics in executive incentive plans

Prevalence of ESG metrics in executive incentive plans expressed as % of all companies in the European sample commentary: Increasing prevalence across European companies in both STI and LTI plans over recent years

The use of ESG metrics has increased in all individual countries included in the study. France and Germany now have the highest prevalence of ESG metrics across the region, with 100% and 98% of companies in their top index using ESG metrics overall. It should be noted that the increases are influenced not only by changing practice but also by the level of disclosure in each country. While pay disclosure regimes in France and the UK already showed a high degree of transparency in prior years, disclosure quality in countries like Belgium and Germany has significantly improved as information around performance metrics and how they are implemented into incentive plans are detailed in disclosures to a greater extent. France (70%) and Italy (65%) are the countries with the highest prevalence rates of ESG metrics in LTI schemes, whereas for Switzerland (20%), Ireland (26%) and Belgium (25%), prevalence is significantly lower. However, prevalence growth rates are high for ESG metrics in LTI across all European countries.

Companies in the energy and materials industries are leading the way

While the use of ESG metrics has increased in all industries throughout Europe, the energy and materials sectors have the highest prevalence, with 100% of companies having ESG metrics in place in one or both incentive plans. This is also true when looking at just LTI plans. In contrast, companies in the healthcare sector tend to reflect their ESG strategies mostly through ESG metrics in STI plans. Overall, companies in the healthcare, IT and financial services industries have the lowest prevalence of ESG metrics. Nevertheless, even in these sectors prevalence levels for ESG metrics in one or both incentive plans are still high, approaching 85%.

Environmental metrics and inclusion and diversity metrics are key drivers in the increase of ESG metrics

The use of incentive metrics has substantially increased in all three categories of E, S, and G. Metrics in the social category, such as HR-related measures (e.g., employee engagement, succession / talent management, culture, leadership or training and development) have long been in use in STI plans and remain the most common overall. The ESG metrics with the highest increase in prevalence rates are environmental metrics (up 26 percentage points versus prior year), and social metrics, specifically metrics related to inclusion and diversity (up 24 percentage points versus prior year). This finding is in line with the perceived trend in society towards a heightened environmental and I&D awareness. The reduction of carbon emissions was the single metric most frequently implemented in the latest financial year.

In addition, a growing proportion of companies (now 45%) combine measures based on multiple ESG areas in their incentive plans.

An infographic sharing the percentage of ESG metrics included in their plans by category. In the first graphic, it shows 17% of companies have at least one ESG category in their plans. In the second graphic, it shows 35% of companies have at least two ESG categories in their plans. In the last graphic, it show that 45% of companies have all three ESG categories in their plans.
Figure 2: Combination of ESG categories in executive incentive plans

Prevalence and combination of ESG categories in executive incentive plans expressed as % of all companies that have at least one ESG metric in place commentary to which the majority of companies with ESG metrics in place use a combination of several ESG categories.

The way that ESG metrics are incorporated into incentive plans varies between STI and LTI

ESG metrics are incorporated into incentive systems in diverse ways -- as standalone KPIs bearing a specific weight in the incentive outcome, as part of a pure ESG bundle, or as broad bundles of qualitative metrics or modifiers. In most incentive plans, ESG metrics are implemented as a standalone KPI with a respective weighting into the payout formula. However, standalone ESG metrics are more prevalent in LTI than in STI plans; we suspect a driver of this is the culture of more quantifiable metrics with defined payout curves (and therefore less subjectivity) and greater prospective disclosure of metrics in LTI verses. In contrast, it is more common to incorporate ESG metrics into STI plans as part of a broader bundle of qualitative metrics that contain a mix of ESG and non-ESG metrics.

Our study reveals that local differences also exist in the approach to incorporating ESG metrics into incentives. To add to the observation above that ESG metrics are most prevalent in LTI plans in Italy and France, those are also the two countries where ESG metrics are most often incorporated as standalone metrics. Conversely, in countries like Switzerland or Belgium, ESG metrics typically form part of a broad bundle of measures.

The median overall weighting of ESG metrics in incentive plans is 20%, based on those metrics with disclosed weightings.

Why Europe is ahead of the US

There is a significant gap between ESG metric prevalence levels in the US and Europe: 69% of S&P 500 companies versus 90% of top European companies. The gap is even more dramatic when we focus on LTI plans: 8% of S&P 500 companies versus 44% of top European companies. One reason for this is that the remuneration regulatory frameworks in Europe tend to focus more directly on sustainability issues. In contrast to the US, in all nine European countries included in our analysis, local law and/or corporate governance codes reference ‘sustainability’ in some way, requiring remuneration committees or boards to consider how remuneration for senior executives drives sustainable outcomes and value.  Further, recent changes to reporting and disclosure requirements and guidelines in Europe have fuelled the implementation of ESG metrics in incentive schemes. Of these regulatory developments, the most important are:

  • the Corporate Sustainability Reporting Directive (CSRD) that will require EU companies to report along the European Sustainability Reporting Standards in the course of 2025. The CSRD scope is broad, applying to all ESG aspects (as opposed to climate only, like the below).
  • the Task Force on Climate-related Financial Disclosures (TCFD) is the current regulatory basis, mandated in multiple markets already, for climate-related disclosures. The framework is based around four pillars: Governance, Strategy, Risk Management and Metrics & Targets. 
  • the International Sustainability Standards Board (ISSB)’s climate standards builds on the TCFD with great granularity (final drafts expected in mid-2023). The UK has indicated it will be adopted as the future regulatory basis for climate requirements in the UK (superseding the TCFD).

In addition, it seems the push from investors to implement ESG metrics in incentive schemes is more pronounced in Europe than in North America. However – as WTW’s annual investor outreach exercise showed – some contradictory perspectives exist with regards to ESG in the shareholder community. While some investors emphasize that it is critical to reflect ESG performance in incentives and even push for incorporating ESG metrics with 50% weighting in LTI plans, others express some concerns with regards to "greenwashing." It may take some time for any clear investor consensus across Europe, and indeed globally, to emerge with respect to incorporating ESG metrics into executive remuneration. However, there continues to be an expectation that, where ESG metrics exist, targets should be rigorously defined, as quantifiable as possible, measurable, have direct alignment with the company’s overarching sustainability strategy, and disclosure should clearly explain why the metrics used are material for the business.

If you are interested in learning more about regulatory developments around ESG and its implications for HR, including incentives, culture, and skills, please look out for one of our next Executive Pay Memos.

In a nutshell

Our latest ESG report shows that companies in Europe – driven by regulatory and investor factors as well as their own evolving business strategies - are moving rapidly towards an increased focus on environmental, social and governance topics in their executive remuneration arrangements. This trend is present in all countries and all industries we analyzed. While the use of ESG metrics has increased throughout all incentive plan types and in all areas of E, S and G, the most striking growth in prevalence was within LTI plans and in the categories of environmental and inclusion and diversity metrics. We expect the trend of introducing environmental metrics to strongly continue this year.

Access our complimentary report to learn more about the detailed results of WTW's latest Global Report.

Contacts

Judith Schoenthal
Director, Global Executive Compensation Analysis Team (GECAT) Europe
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Director, Climate Practice & Executive Compensation and Board Advisory – WTW
Transition Plan Taskforce member
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Stephanie Schmelter
Director, Executive Compensation and Board Advisory Germany/Austria
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