Report: 45% of UK businesses linking executive pay to ESG targets

The most common approach to making the link is via annual bonuses

PwC’s report on the findings, entitled ‘paying well by paying for good’ and supported by the London Business School, reveals that this approach has become far more common in recent months. Indeed, a similar study by Vlerick Business School in 2019 found that just 6% of UK firms had made this move.

The report reveals that, of the FTSE100 businesses now linking executive pay to ESG targets, most make the link within their bonus plan. The average executive in this cohort stands to see their bonus reduced by 15% if KPIs are not met.

A less popular approach, adopted by around one-fifth of firms, is embedding ESG links in long-term incentive plan (LTIP) rates.

Across both approaches, the energy sector was named as the lead adopter. Other sectors with above-average levels of adoption include real estate, utilities and telecoms.

Drivers of these trends, the report states, are numerous. They include legally binding net-zero targets in markets like the UK; changing regulation, like Streamlined Energy and Carbon Reporting (SECR) and the UK Corporate Governance Code and the Companies Act; and changing demands among investors, consumers and staff.

While there is a lot of momentum behind the adoption of ESG targets in pay, the study strikes some notes of caution. It reveals that only 55% of the measures adopted by the businesses assessed are in keeping with the Sustainability Accounting Standards Board (SASB) Materiality Map – a tool designed to identify the most material ESG issues for each sector. Without alignment, the report cautions, businesses risk failing to address the issues most prominent to them and, therefore, being accused of ESG-washing.

Moreover, the report warns that many firms are not translating ESG goals into targets relating to pay in a holistic way. In many cases, only a handful of goals are covered, and uptake has proven better for goals relating to health and safety and employee engagement than to broader environmental and social issues. Less than one-third of companies (28%) assessed have links to climate change, inclusion or diversity.

“It’s striking that nearly half of the ESG measures being used in pay aren’t deemed material to shareholders by the benchmark SASB framework,” the London Business School’s Centre for Corporate Governance’s Tom Gosling said.

“This may in part reflect SASB not being up to date with the latest ESG concerns. But it will be interesting to see how this plays out over time as most investors are making it clear they expect companies’ ESG activities to focus on the areas that contribute to long-term shareholder value. 

“The increased focus on integrating ESG considerations into company strategy and operations is welcome. But this doesn’t mean we should automatically include ESG targets in pay. There are lots of practical difficulties, and scope for unintended consequences, in linking pay to ESG. And there’s a risk that more ESG targets simply result in more pay, due to the difficulty of knowing how stretching these targets are.”

Case studies to date

The new report does not specifically name companies with ESG links in executive pay.

However, edie has covered several company announcements regarding the adoption or expansion of such links in recent months. Initial adoption has been confirmed by the likes of Apple, BMW and Kingfisher, while Shell, having trialled this approach with 150 members of staff, recently expanded this to more than 16,000.

One of the most recent announcements in this field came from US-based food-to-go giant Chipotle. Earlier this month, the business moved to tie 10% of the annual incentive bonus for all executive officers to progress towards new ESG goals. Goals include developing a baseline for Scope 3 (indirect) emissions; increasing the sourcing of meat and produce from local, organic and regenerative farms; maintaining equal pay and improving diversity and inclusion for more senior roles.

Changes at Chipotle will come into effect this financial year. The firm’s chief corporate affairs and food safety officer Laurie Schalow said that the move “ensures our leaders continue to set the right example for our more than 88,000 employees while fulfilling our mission to drive change and cultivate a better world.”

Sarah George

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