ESG Incentives in Executive Compensation

Introduction

When it comes to environmental, social, and governance (ESG) reporting, governance tends to take a back seat to the more public-facing topics of environmental and social impact. However, corporate governance plays a key role in business because it affects the implementation of ESG incentives, shareholders' rights, the composition of the board, how corporate performance is measured, and executive compensation. 

The board of directors, usually through the executive committee, manages executives’ compensation and incentives. American corporations have been using equity-based compensation as a long-term incentive for executives since the 1950’s. These incentives are two-fold—to retain talent and to ensure that the executives are acting in the best interests of the company. Boards of directors have, more recently, begun providing compensation incentives to executives based on targeted ESG metrics. Willis Towers Watson found that, as of 2020, 51% of S&P 500 companies used some form of ESG metrics in their executive compensation plans (Newbury & Delves, 2020). By providing incentives based on ESG metrics, companies are signaling what is most important and increasing the likelihood of achieving their ESG goals.

This article discusses executive compensation disclosure requirements of the Securities and Exchange Commission (SEC), Global Reporting Initiative (GRI), and World Economic Forum (WEF); mentions where companies are making these disclosures; and presents examples of companies reporting about ESG incentives surrounding executive compensation.

Disclosure Requirements

The SEC, GRI, and WEF each have guidance around executive compensation disclosures. While adhering to the GRI and WEF standards is optional, all three of these bodies are seeking disclosure of similar information regarding executive compensation, showing that this is an important topic with well-defined criteria.

Securities and Exchange Commission

Companies are required by the SEC to “discuss the compensation awarded to, earned by, or paid to the named executive officers.” According to the Code of Federal Regulations, this disclosure should include:

1. The objectives of the registrant's compensation programs; 
2. What the compensation program is designed to reward;
3. Each element of compensation;
4. Why the registrant chooses to pay each element

In response to these requirements, companies are disclosing the details of executive compensation and metrics of performance evaluation. These disclosures provide stakeholders with insights into the incentives motivating company executives. 

Global Reporting Intiative

In addition to reporting compensation policies, the GRI also advises companies to include more specifics around ESG topics than the SEC requires. The GRI suggests the reporting organization to “describe how the remuneration policies for members of the highest governance body and senior executives relate to their objectives and performance in relation to the management of the organization’s impacts on the economy, environment, and people” (GRI 2: Disclosure 2-19, emphasis added). When companies report how performance criteria relate to ESG objectives, they provide useful information to stakeholders about how and to what extent the company is encouraging senior leaders to make progress in those areas.

World Economic Forum

In its 2020 publication Measuring Stakeholder Capitalism Report, the WEF mentioned additional disclosures beyond what the SEC and GRI have published. Similar to the GRI, the WEF requires disclosures on how compensation practices relate to “senior executives’ objectives for economic, environmental, and social topics…as connected to the company’s stated purpose, strategy, and long-term value” (p. 24). The WEF wants disclosures on not only whether companies are paying executives to achieve ESG benchmarks, but also how those objectives are connected to the company’s strategy.

The WEF also published its rationale for this standard: “[t]he incentives provided to board members and senior executives, and the way they are structured, can significantly reinforce or impede long-term value creation” (Measuring Stakeholder Capitalism, p. 53). By carefully establishing executive compensation systems, companies can impact long-term financial and non-financial results. 

Disclosure in Practice

In accordance with SEC regulations, companies must include extensive executive compensation disclosures in 10-K filings. Companies also disclose extensive executive compensation statistics in Proxy Statements and ESG reports. Some companies designate a page or section to explain their ESG compensation policies, while others blend ESG compensation in sustainability discussions or simply reference their Proxy Statements. The ESG frameworks referenced in the reports also vary from company to company. The following sections will provide examples of companies disclosing ESG incentives in executive compensation.

Alcoa

Alcoa, one of the world’s ten largest producers of aluminum, includes ESG metrics in its executive compensation structure. The company published details of its executive compensation structure in its March 2022 Proxy Statement and ESG report. Non-financial performance metrics comprised 30% of 2021’s annual incentive compensation at Alcoa, split between safety and diversity. By rewarding executives based on safety and diversity, Alcoa shows how important those things are to the company. For more information, see Alcoa’s 2022 Proxy Statement, pages 51-55 and Alcoa’s 2021 Sustainability Report, pages 88-89.

Alcoa Incentive Compensation Plan

remove

add

Alcoa’s 2021 Sustainability Report provides the following summary of the non-financial metrics included in its incentive compensation plan.

In 2021, we again linked 30 percent of our annual Incentive Compensation plan to non-financial metrics focused on safety and inclusion and diversity. The two inclusion and diversity objectives (percentage of underrepresented employee hires and percentage of global women) exceeded our internal goals. The results for safety were partially met based on having zero fatal injuries, but we did experience three serious injuries during the year.

2021 Sustainability Report

Additional Detail From 2022 Proxy Statement

remove

add

The chart below provides more detail on Alcoa’s non-financial performance metrics. It includes the metric category, name, weight, performance measures, and the level of achievement. The achievement percentage is on a scale of 0-200%. The footnotes provide additional information about each of the metrics.

Alcoa's 2022 Proxy Statement

Chevron

Chevron, a multinational energy company, includes environmental metrics in the annual incentive component of its executive compensation package. According to its April 2022 Proxy Statement, 10% of the annual incentive plan was allocated to “energy transition,” which is a plan to invest $10 billion to reduce carbon intensity of existing business and to build lower carbon business in the future. The filing continues, “[t]his important addition responds to investor input and reinforces Chevron’s focus on advancing a lower carbon future. This new category will have a 10% weighting and will measure Chevron’s progress in the areas of [Greenhouse Gas] management, renewable energy and carbon offsets, and low-carbon technologies.” (Chevron’s 2022 Proxy Statement) 

Like Alcoa, Chevron also included employee safety metrics in its executive compensation package. By rewarding executives for progress toward lower carbon emissions and greater safety in the workplace, Chevron is positioning itself to make meaningful improvements.

For more information, see Chevron’s April 2022 Proxy Statement, pages 50-53.

Chipotle Mexican Grill

ESG accounted for 10% of Chipotle’s annual incentive plan for executives, as found in its 2022 Proxy Statement. The ESG component included the following metrics: purchasing organic, local, and/or regeneratively grown/raised food; maintaining racial and gender pay equity; and publishing the Scope 3 emissions report. Chipotle awarded the max bonus to its executives for the ESG portion of compensation, showing that the company is exceeding its goals in these areas.

For more information, see Chipotle’s 2022 Proxy Statement, pages 62-65 and Chipotle’s 2021 Sustainability Report, page 13.

Disclosures in Proxy Statements: Nike and Qualtrics

remove

add

While Chipotle does not specify quantitative ESG targets in its bonus plan, it does disclose the following ESG metrics and achievements in its Proxy Statement as components of the bonus plan.

Chipotle’s 2022 Proxy Statement, pp. 64-65

Intel incorporated two ESG metrics in its executive compensation calculation. The ESG incentive bonus accounts for up to 7% of its annual cash bonus plan. These two metrics, environmental sustainability and diversity and inclusion, cover climate, energy, water, and working environment goals. The progress of achieving these goals is measured in Intel’s “balanced scoreboard,” and Intel reported that it had achieved all goals related to ESG in 2021 according to its 2022 Proxy Statement. 

For more information, see Intel’s 2022 Proxy Statement, pages 77-79.

Starbucks

In its Proxy Statement, Starbucks reported that it rewarded 20% of cash incentive bonus for ESG goals—10% for sustainability goals and 10% for inclusion and diversity goals. In addition to the cash bonus, the vesting of performance-based awards to company leaders is impacted, in part, by achievement of inclusion and diversity goals. “People” and “Planet” are two other categories in Starbucks’s ESG report. In these sections of the report, Starbucks discusses its goals in detail and its progress in achieving those goals. The topics in the report range from supporting refugees to reducing single-use plastic. 

For more information, see Starbucks’s 2022 Proxy Statement, pages 62-76 and Starbucks’s 2021 Sustainability Report, page 45.

Starbucks People And Planet Goals

remove

add

The following table comes from Starbucks’ 2022 Proxy Statement. It explains the goals under the “People” and “Planet” elements of executive compensation. The company also adds its rationale for setting these goals.

Starbucks 2022 Proxy Statement, p. 65

Conclusion

Although environmental and social topics may receive more attention in ESG discussions, proper governance policies are essential to keep a company’s operations aligned with its ESG goals. By linking compensation to ESG performance, executives can be held accountable for ESG initiatives of interest to stakeholders. The ESG disclosure requirements also encourage companies to establish goals and metrics to discover ways for improvement. 

Resources Consulted

Newbury, Robert & Delves, Don. Willis Towers Watson. “New research finds progress on the use of ESG incentive metrics”. Mar 27, 2020

Code of Federal Regulations: 17 CFR § 229.402

Global Reporting Initiative (GRI): GRI 2: Disclosure 2-19: Remuneration Policies

World Economic Forum, “Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation”. Sep 2021