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Article | Executive Pay Memo North America

Next frontier in executive compensation

Environmental measures in incentives

Governance Advisory Services |Executive Compensation
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By Don Delves and Jessica Yu | June 24, 2021

Climate risk and emissions measures are likely to become more common in executive incentives over the next two to three years.

Perhaps the most significant ongoing change in executive compensation is the inclusion of non-financial environmental, social and governance (ESG) measures in incentive plans. In particular, the last two to three years have seen a steady increase in the use of environmental and social measures, most notably diversity, equity and inclusion (DEI) measures. DEI measures and factors are increasing most rapidly (about 3%-4% per year). Environmental and climate measures are also increasing at a steady rate (about 2%-3% per year).

Willis Towers Watson has been tracking ESG factors and measures in executive incentive plans in the S&P 500 (and other global indices), as disclosed in annual proxy statements for three years. The 2019 data disclosed in 2020 proxies revealed the following:

   2020 review of proxy statements, covering fiscal 2019 compensation practices. pp = percentage point change over fiscal 2018 compensation practices
Figure 1. FY2019 ESG data with overall comparison to prior year

2020 review of proxy statements, covering fiscal 2019 compensation practices.
*pp = percentage point change over fiscal 2018 compensation practices.

Movement in E Measures

In 2020, environmental measures increased to 15%, according to 2021 proxy statements. The following chart shows the breakout of the different categories of environmental measures:

15% of S&P 500 companies use an environmental & sustainability metric in one of their incentive plans.
Figure 2. Different categories of environmental measures

Overall prevalence is based on 432 S&P 500 companies which filed in the time period of October 2020 to June 2021. Prevalence for each category is based on S&P 500 companies that have an environmental and sustainability metric in either STI or LTI plans. Some companies have metrics which fall into multiple categories.

The use of environmental measures in incentive plans is concentrated in the energy, utility and materials sectors, as shown in the following chart. This shows the percentage of companies in each sector (within the S&P 500) that disclosed the use of environmental measures in their incentive plans, as well as the type of measure used.

Percentage of companies in each industry with environmental measures in incentive plans
Figure 3. Percentage of companies in each industry with environmental measures in incentive plans

Data is based on 432 S&P 500 companies which filed in the time period of October 2020 to June 2021, of which 63 disclosed environmental measures in their incentive plans. Prevalence for each category includes all companies in the sample group which include an environmental and sustainability metric within either the STI or LTI plan, measured as a percentage of the applicable industry group. If a company has metrics in both the STI and LTI plan, it has only been counted once, based on the most specific metric (i.e., if a company has an Individual Performance metric in their STI plan but a weighted metric in their LTI plan, it has been counted as a weighted metric).

In addition to this increase of 3% from 2019 to 2020, another 2% of companies disclosed new environmental incentive measures for 2021, according to their proxy filings. As a result, the “E” for the S&P 500 for 2021 will be about 17%.

Movement in DEI Measures

DEI measures in incentive plans have also increased steadily, and at a slightly faster rate than environmental measures. The prevalence of DEI measures in S&P 500 companies has increased as follows:

  • 2019: 16.6%
  • 2020: 20.4%
  • 2021: 23% (anticipated)

While the percentage changes in both categories may seem small, they represent a much more substantial change in corporate purpose, investor preference and board governance. For each company that includes an ESG factor in its executive incentive plans, there are many more companies that are engaging in better measurement, discussing and considering these measures with their boards, and disclosing data to investors. Most companies spend months, if not years, studying, monitoring, testing and tracking various ESG measures before including them in incentive plans.

When we poll our senior executive compensation consultants, who advise several hundred board compensation committees, we find a significant majority of U.S. boards are having more thorough and in-depth discussions about DEI than in the past. This is true across virtually all industries and includes more in-depth data analysis, identifying problem areas and tracking progress over time.

Conversely, environmental and climate issues are common topics for boards in certain industries but have not yet risen to the level of DEI issues across industries. This is the opposite in the United Kingdom, Western Europe and parts of Asia, where environmental and climate issues are at the forefront. This is borne out by the data, which shows the following breakout of ESG measures in incentive plans in various markets:

ESG in various markets
Figure 4. ESG in various markets

Data based on Willis Towers Watson’s proprietary research using public disclosures. S&P 500 results were as of November 2020, and Europe results were as of June 2020. Major indices included in this research are BEL 20, OMX Copenhagen 25, CAC 40, DAX 30, FTSE 100, ISEQ 20, MIB 40, AEX 25, IBEX 35, OMX Stockholm 30 and SMI 20.

Climate risk and emissions measures seem to be the next frontier in executive incentives and are likely to become more common over the next two to three years. What we have learned from engaging with board members in roundtable discussions and other forums is that there is a wide variance of what environmental and climate risk factors are most important to companies in different industries, and even within industries.

While many companies have made net-zero-by-2050 commitments in regard to greenhouse gas (GHG) emissions, those commitments are vastly more difficult for, say, a heavy manufacturing company than a global consulting firm. And GHG emissions, while a global concern, may not be as critical to a given company as reducing other pollutants or waste.

In addition, companies and boards tend to distinguish between the risks posed by climate change on the company and its assets, and the risks of what the company’s activities are doing to the environment.

GHG emissions fall in the second category but are often less pressing than the very real near-term risks in the first category. Companies must pay attention to both.

None of this, of course, lessens the importance of financial and stock performance. It just underscores the “both-and” corporate world in which we live, where companies and boards are accountable for serving multiple stakeholders, including our environment.

A version of this article appeared in Workspan Daily on June 17, 2021. All rights reserved, reprinted with permission.

Authors

Managing Director, Executive Compensation Practice Leader - North America (Chicago)

Sr. Associate, Global Executive Compensation Analysis Team (GECAT)

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