June 5, 2020

ESG executive incentive compensation and CSR performance

SRI, CSR, GRI, ESG; Stakeholders, B-Corps, 3BL - what should one think of this acronym soup? Today, people assume that what is good for people and sustainable for the planet is also good for risk management and sustainable for long-term shareholder return. Everyone, from large institutional investors to retirees, knows that smart money is invested in socially responsible business practices. Performance-based compensation for executives plays an important role. And "ESG" has emerged as the leading framework for this.

In Switzerland, 30% of public companies already have some form of ESG component in their bonus plans, with ESG indicators accounting for between 10% and 33% of short-term variable compensation. In Germany, 21% of listed companies do so. In the US, less than 10% of the 100 largest companies still use ESG measures in their executive bonus plans.

In our work and discussions with companies, we see that most ESG bonus plans are poorly designed, which can sometimes be one reason why they produce such mixed results. What is lacking for management purposes is a practical framework for alternative ways of measuring ESG performance for the purpose of executive compensation. Based on his essay on the topic "Better Bonus Plans for ESG" by Obermatt CEO Dr. Hermann J. Stern, he discusses such a framework in this German podcast, covering the four alternatives for performance-based compensation for ESG purposes:

  1. ESG targets: Concrete targets for activities, projects and ESG outcomes that the company has set as its goal.
  2. Relative ESG performance: Measuring performance against competitors, based on ESG metrics that the company considers relevant.
  3. ESG rating agencies: Agencies that publicly assess the ESG performance of companies, such as LSEG, S&P Trucost and RobecoSam, Sustainalytics, ISS ESG, MSCI ESG, Vigeo Eiris and EcoVadis.
  4. ESG performance evaluations: Internal or independent performance assessment by means of expert opinions based on objective and subjective facts available internally and externally.

Which of these methods are most likely to be used in practice? Management consultants know from experience that it is not always the most sensible solution that prevails, but ultimately the one that gives the majority an advantage. This is why ESG targets are most often used in executive compensation plans. Relative ESG performance and ESG ratings, on the other hand, are both external benchmarks that seem to elude management control. However, this apparent lack of management control dissolves upon closer examination, as we show in the German podcast.

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