Panel on ESG and executive remuneration

Guerdon Associates and CGI Glass Lewis hosted their 15th annual Remuneration and Governance Forum, this COVID time as a webinar, on the 23rd and 30th of March.

This article is the second of three that summaries the main sessions, focussing on ESG and executive remuneration.

Non-financial performance measures have become more common recently, in part being driven by regulation (see HERE).

The growth in these measures is not, however, without backlash. Notable protest votes have been associated with ESG/non-financial performance measures (E.g. AGL in 2020 for including climate metrics and Commonwealth Bank in 2016 for the adoption of ESG measures, although these voting results may have been due to reasons other that the measures).

The panel raised points to consider:

  • Performance measures increase the value of the company in the long run and minimise unintended consequences.
  • Performance measures must be verifiable. If boards and executives cannot track the performance of the company against the performance measures it is not going to effectively motivate the executives and not be effective at moving the company in the direction the board and executives want it to move. This is why quantitative measures have an advantage in motivating executives and also help explain outcomes to shareholders.
  • Returns may sometimes only be assessed over a long-term time frame with some only being realised 20 years in the future. Designing the performance measure capable of validly indicating progress to longer term realisation is a challenge.
  • Performance measures must be variable. Proxy advisors and institutional investors are not happy rewarding executives at maximum for day job performance measures that would be achieved regardless of their being on the scorecard. Gateways, modifiers and malus are ways to include “day job” measures in incentives.
  • The mechanism by which the performance measures impact outcomes should be considered carefully. Rather than burying a safety component as a small proportion of a scorecard, having it as a gateway or malus where an executive could lose all or part of their remuneration will increase its impact.
  • The weighting of the performance measures must be significant. If weighting is not suitably significant it is probably not worth including it at all. Consider what the top five issues should be that management should pay attention to and build the plans around that.
  • Ensure ESG/non-financial measures are right for your company. Checking the SASB framework will allow you to consider which measures may be right for your industry. There is no right approach and each company will need something different to execute its strategy and minimise its risk.
  • After implementation, review the plan to ensure it is working as intended and there aren’t any unintended side effects, for example a reduction in reporting of safety issues. Ensure your company’s culture encourages reporting of issues.
  • Before any vesting or award occurs ensure that the outcome of every performance measure and total outcome is considered. If your company has had its social license to operate threatened, it is warranted to consider using malus to reduce outcomes to nil.
  • Make sure the disclosure surrounding performance measures is good. Performance measures must be explained and linked back to strategy or risks so shareholders understand why the framework is built how it is. Shareholders need to understand why the performance measures are necessary for the performance of the company and not just a free kick for executives. This is particularly important if qualitative measures are being used where shareholders are less likely to understand the reasoning behind the outcomes and more likely to view the incentive as a free kick.

For additional information on the above, call Guerdon Associates on 02 9270 2900.

© Guerdon Associates 2024
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