How to tie ESG goals to executive compensation

How to tie ESG goals to executive compensation

How to tie ESG goals to executive compensation

Tuesday February 13 2024

Using ESG metrics for performance management is important because it focuses the attention of executives on important parameters that may have been sidelined. PHOTO | SHUTTERSTOCK

The world is leaning toward sustainable businesses and organisations are responding by reviewing their operations to be considered responsible. There is room for all businesses to truly embrace the concept of ‘doing well by doing good’ and incorporating Environmental, Social, and Governance (ESG) principles if they truly want to thrive, with a view to recognising various stakeholders and not only shareholders.

Under the social component of ESG, which delves into the impact an organisation has on people issues relating to employee training, compensation, diversity and inclusion, health and safety standards are of important consideration. For companies that need to drive sustainability in their businesses, executive compensation can be used as a tool to achieve this.

Read: What does ESG mean to your company’s board?

Using ESG metrics for performance management is important because it focuses the attention of executives on important parameters that may have been sidelined.

It also promotes the satisfaction of various stakeholders, including happier employees, supportive regulators and government representatives, as well as shareholders who can take pride in being a part of the business.

In addition, incorporating ESG into executive performance metrics and compensation provides incentives for management to drive the strategy of the business.

How can this be achieved?

An effective compensation and incentive package needs to be linked to company’s vision, strategy, culture, and business models. It goes without saying that neglecting to implement an effective compensation plan will have a negative impact on overall performance, productivity, and revenue.

One way of measuring performance is using a balanced scorecard, which may be expanded to include ESG parameters since it is important to keep track of and measure progress towards ESG goals.

Some companies prefer focusing on trying to achieve several critical ESG issues with a few essential Key Performance Indicators (KPIs), whereas others may take more of a general holistic approach including metrics such as diversity and inclusion, employee welfare and supply chain issues to their ESG agenda.

A carefully constructed and transparently disclosed scorecard will allow organisations to track such benchmarks and ensure a fair balance to achieve between metrics to not overcomplicate the process and end up with some measures being disregarded instead.

This would subsequently lead to cascading the ESG KPIs, in addition to other elements of the balanced scorecard, to all employees in the organisation. There is no one-size-fits-all metric that can be applied to all companies or all industries. Taking time to understand how company-defined ESG goals are achievable, measurable, and aligned with corporate strategy is important to maintain the sustainability of such KPIs over the long term. This also provides time to build the necessary employee buy-in.

Incentivisation plans should be careful not to factor in short-sighted strategies, which can lead to the emergence of problems at some later point. Instead, companies must be strategic and develop ESG goals with an eye towards long-term success.

The clarity of strategic direction as well as tactical and operational performance measures will help establish policies such as gender diversity and equal pay policies, corporate social responsibility policies, in addition to other human capital policies.

The corporate world is therefore at a crossroads, where companies and leaders are debating their fiduciary responsibilities, while society is demanding that businesses be held accountable to a wider constituency.

Read: Bulk of firms yet to adopt ESG reporting

Of course, corporate leaders must recognize that measuring the full impact of ESG performance goals in compensation is more challenging than measuring the impact of traditional operating or financial metrics.

ESG issues have become of strategic importance and the board of directors and other strategic stakeholders must take the responsibility for steering the businesses they lead in the right direction. They can start by ensuring ESG parameters are incorporated into the KPIs of executive management, so they are held accountable for driving the ESG strategy of the business.

Collaboration and communication are essential in helping build a sense of acceptance for all stakeholders concerned.

The author is a senior manager in the tax consulting team at PwC Kenya.

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