The Investment Association (IA) has published an updated version of its Principles of Remuneration setting out its members' expectations for executive pay for 2023. They reflect developments in market practice and investor expectations, including, notably, linking pay to ESG targets.
The IA highlights an increasing trend for companies to incorporate ESG performance metrics into variable executive pay. They say where companies do this, the rationale should be robust and clearly explained to investors, and the ESG metrics should be quantifiable and linked to the company’s strategy. Where companies have incorporated climate-related risks and opportunities into strategies, they say the risks and opportunities should be reflected in remuneration structures and, if that has been planned but not yet started, companies should explain how it will be done in future years.
In his annual letter to remuneration committee chairs, Andrew Ninian, the IA’s Director, of Stewardship and Corporate Governance, says there has been a marked increase in the number of companies recognising the importance of ESG. He talks about their ‘journey’ and the ultimate goal, namely, sustainable long-term financial health.
In the last couple of years we’ve noticed companies are definitely incorporating ESG metrics into their performance criteria. So, let’s hear more about that. Lynette Jacobs is a Rewards specialist and earlier she joined me from Manchester to discuss this. I started by asking how the performance conditions are chosen and HR’s role:
Lynette Jacobs: “So the performance conditions will be chosen in practice by the remuneration committee of your company. That said, you may be asked to have some contribution into the discussions about what those performance targets should be the, the ESG ones, and to the extent you're not actually invited to contribute to the determination of the performance targets, given that certainly the social ones - so we've got ESG, environmental, social and governance - social will include matters such as, for example, diversity, so increasing the proportion of either female and/or BME people in senior leadership roles within the company, employee engagement, it could also be customer experience, depending on the type of business you're in. So those are things that, as HR, you may well be able to influence either in terms of the communications that go out to employees in relation to those performance targets, and/or in your work with your employees, the people who you work with on a day to day basis, in helping them to understand how to improve their performance in relation to those targets and therefore the company as a whole.”
Joe Glavina: “In his letter Andrew Ninian says that he wants ESG to align with the company’s strategy. What’s he getting at with that comment?”
Lynette Jacobs: “That ESG performance targets should only be there if that matches the company's strategy. It's not meant to be a box ticking exercise, which I think he said either this year or last year, Andrew Ninian has certainly spoken about this. What we can see is ESG is very much a developing area for everybody, for businesses, for countries, for the world as a whole, and we can see that happening in the same way as companies are applying ESG targets to their incentive arrangements. Therefore, because it's a developing area, they started off much more in short term incentive arrangements, and they're still more prevalent in short term incentive arrangements, probably because that reflects the way the company is developing it so you can only see it on a short term basis, and gradually it's moving more into long term incentive arrangements - I think about 30% of FTSE 350 companies have them as part of their long term incentive arrangements. That what Andrew means, don't put something in if you're just doing a box ticking exercise. It should match and parallel the company's strategy on ESG generally. If the company's strategy on ESG isn't fully developed, it doesn't make sense, therefore, to start sticking all kinds of, whether it's E or S or G targets into its incentive programmes.”
Joe Glavina: “Can I just come back to HR’s role, Lynette? So, you’re saying it’s around the communication piece and checking for alignment with the strategy, rather than any direct involvement with targets?”
Lynette Jacobs: “Yes, so again, as I said previously, HR isn't necessarily going to be involved in the determination of what performance targets are going to be there, but HR will be involved in the dissemination of the plans to participants, so whether it's short term incentive arrangements, so annual bonus arrangements, or long term incentive arrangements, so principally in long term incentive plans that may only apply to a smaller population of your company's employees. Whether it's an environmental, a social or a governance target that's being included, make sure that the people who are participating in the relevant plan are aware of what those targets are, and make sure that it is referred to them and that they understand how they can influence it. For example, looking at Tesco, in the last year Tesco has introduced ESG performance targets now into its long term incentive plan arrangement. I understand it's 25% of the target as a whole, of which is it's divided on an equal third basis. So, from the E, the environmental, they've got carbon reduction and then for social they've got two, so they’ve got food waste and they've got increasing the representation of minority groups in the leadership of the company. They're all good things and, with the food waste, that can be promoted and Tesco, obviously, is looking to do it from the company's perspective, but that's something that employees will identify with and will understand - they can understand how to deal with it so it doesn't happen. Then equally, it'll be key to employees hearts, one would imagine, the fact of increasing representation of minorities in the leadership role. So, set it out so employees can see it. Employees will also identify with that and will appreciate that that's the way your business is going and those are the goals that your business has.”
Joe Glavina: “In his letter, Andrew Ninian says he wants to give companies clarity on members’ expectations on executive pay that notwithstanding the importance of ESG, the priority has to be financial performance. Is that right?”
Lynette Jacobs: “Yes, as I said, now on Tesco, 25% of their of their performance targets for their long term incentive plan are now ESG based. That means therefore, that 75%, the majority of those, will be financial based. So whether that's earnings per share, total shareholder return, other financial performance measures, and as important as ESG is to the Investment Association and to its members, they are still looking for financial performance and even if the 25% ESG performance targets are met in full, if a company's financial performance isn't doing that well the investors will not be looking for large pay-outs, or pay-outs, under the relevant incentive arrangements.”
Lynette and the team has put together a detailed analysis piece which deals with the role HR professionals can play in shaping and delivering their organisations’ ESG strategy, and helping address the skills gap in the process. That’s ‘How HR can shape and deliver the ESG agenda’ – that is currently available from the Out-Law website and we’ve put a link to it in the transcript of this programme. We have also put a link to the Investment Association’s Principles of Remuneration.
- Link to Investment Association publishes updated Principles of Remuneration for 2023
- Link to Outlaw article: ‘How HR can shape and deliver the ESG agenda’