If the remaining two supermajors, BP pledged to align its business with the aims of the Paris Agreement and has begun linking some staff bonuses to its low-carbon progress, and Chevron plans to set targets and tie executive compensation and rank-and-file bonuses to carbon reductions.

Of the largest 308 companies in the 14 most carbon-intensive sectors tracked by TPI, fully 107 of them now link senior executive pay to climate performance (including Cenovus, Enbridge, Imperial Oil, Teck Resources, TransCanada – now TC Energy – and Suncor in Canada).

Despite political battles over climate change measures at the government level, the topic is moving to the top of corporate agendas. It’s becoming not just a public relations exercise but also about competing. Competing for investor capital that is increasingly attuned to the risks of the energy transition, not wanting to get stuck holding a bag of stranded assets. Competing for customers who are consciously choosing vendors whose policies dovetail with their own. Competing for talent looking to impact the world and help ensure the long-term sustainability of our society, and who will steadfastly not work for companies lagging behind critical megatrends.

Executives are increasingly aware of the importance of sustainability issues and have been for the last number of years. According to a 2016 survey by the UN and Accenture, 98% of executives believe sustainability is important to the future success of their businesses. The problem is, up until recently, few of them had their performance linked to sustainability metrics.

Of the largest 308 companies in the 14 most carbon-intensive sectors, 107 of them now link senior executive pay to climate performance.

For the last 30 years, executive compensation has been tied to financial targets and shareholder returns. Despite its popularity, compensating executives for total shareholder return is fundamentally unfair since so much of that return is beta (a measure of a stock’s volatility in relation to the market), which is something they can’t control, and alpha (the investment return over and above a benchmark index) is notoriously hard to find in certain sectors. CEOs will tell you they focus on what they can control: so why have boards been tying executive compensation to share performance, which management can’t control, and not to sustainability practices linked to surviving and thriving in the transition to a low carbon economy, which they can control?

Decades ago, when companies were facing issues with quality control in the manufacturing sector, boards of directors began to include quality metrics in compensation to focus executives on a key factor affecting the bottom line. CEOs embraced the idea because they like control, measurements and meeting targets. The same thinking should be deployed to address climate-related risks and harness climate-related opportunities.

Managing climate risk and opportunity

When it comes to management of climate risk and opportunity, businesses have many metrics from which to choose, but comparable metrics are not yet commonly deployed. Every business leaves a carbon footprint, so measures to reduce that footprint could be easily adopted (although it’s not always most relevant to a business case). Financial-services firms can allocate a percentage of capital to climate-friendly projects, such as renewable energy, climate-resilient infrastructure or sustainable agriculture. All companies could commit to zero-carbon energy targets. They could also commit to more climate-resilient infrastructure. Finding the right company-specific metrics to incentivize efficiency and sustainability over the medium to long term is key.

Doing so can bolster a company’s reputation among its stakeholders and generate political capital with government regulators (who can grant the company great freedom of movement, amend legislation and regulations or provide greater tax exemptions). Many climate-related measures can provide a return on investment through reduced energy consumption and waste over the medium to long term. And of increasing importance, they can avoid costs by proactively managing future climate risks and reducing “emergency” responses and spends.

It’s not only about downside risk. Companies can use compensation incentives to support the creation of new products and services to address urgent needs around the world, such as scarce water supplies, hunger and the need to support renewable fuels and clean electricity development.

As the World Economic Forum’s January 2019 publication on effective climate governance for boards sets out, monetary incentives for senior management teams should be tied to long-term organizational goals that contribute to resilience and prosperity over time. There is little to prevent linking climate-risk and opportunity-related factors to compensation schedules. There have already been significant advancements in linking corporate social responsibility (CSR) to executive compensation, and it’s worked.

Europe’s largest firms are already well on their way to incorporating climate change into executive compensation, according to the CDP, a global non-profit that measures sustainability impact. Looking at firms worth three quarters of European market capitalization, they found that 47% of companies reward senior management for managing climate topics, with one in four tying incentives to climate targets. For example, BNP Paribas aligns top managers’ compensation to climate-related indicators, such as financing renewable energy projects and carbon pollution targets (measured as carbon-equivalent per employee).

In Canada, the information is spottier, but major financial institutions are leading the way and beginning to incorporate the climate crisis into compensation schemes. For instance, RBC and TD’s senior executives have monetary rewards linked to environmental commitments and targets. And the Quebec pension fund La Caisse has linked compensation to climate targets across the organization. Although these are admittedly “small carrots” in the larger compensation picture, the carrots appear to be helping nudge towards alignment of corporate and climate-related goals.

Executive compensation can be an effective tool to spur innovation and rapid movement towards a low-carbon future and organizational stability in a climate-adjusted future. To actualize the urgent transition required, we’ll need to pull out all the tools the market has to offer, and fast.

Laura Zizzo is the founder and CEO of Mantle314, a climate risk management consulting firm.

The post Climate bonus: Is paying executives to address the climate crisis good business? appeared first on Corporate Knights.

What do they have in common? Both believe executives should be rewarded for driving environmental, social and governance (ESG) performance that protects and creates long-term shareholder value.

The good news is that more companies are listening and acting. Unfortunately, outcomes have been mixed.

Globally, investment research firm Sustainalytics found that 16 per cent of large publicly traded companies considered ESG performance in setting executive compensation in 2012, up from 13 per cent two years earlier. In Canada, according to my own research on sustainable pay, that number is much higher, with nearly 60 per cent of companies listed on the TSX 60 providing incentives to executives who hit non-financial performance targets in 2012.

According to Corporate Knights’ Best 50 ranking, that number rocketed to 80 per cent this year (up from 56 per cent in 2010). This points to the obvious conclusion that sustainable pay incentives are becoming increasingly important in corporate Canada.

But underlying these metrics is a less compelling story.

In “Sustainable Pay,” a study I published in March 2013, it was found that only 13 per cent of the TSX 60 companies formally set annual sustainability targets for executive performance. And none of the TSX companies (and few global companies) include ESG performance in their long-term incentive plans.

Boards and their compensation committees are not setting pre-determined performance hurdles for executives to achieve, and they are overlooking the value that sustainability risk and opportunity management can bring to the corporate bottom line over time.

Also, they are failing to grasp the significance of sustainability impacts on their company or resulting from their company, as well as how sustainability will be critical to creating or protecting value over the medium term. Instead, it appears companies are largely treating sustainability performance as an after-the-fact bonus for chief executives – just another way to pay executive teams.

Another observation, particularly in Canada, is that sustainability performance metrics tied to executive pay are primarily directed at compliance, risk mitigation and value protection – not value creation. Top metrics were focused on safety and spill prevention. Few considered the opportunity side of the sustainability equation related to innovation, new products and markets, cost savings or customer acquisition. On the other hand, some global best practices see companies rewarding executives for achieving green product growth targets.

Arguably, the Canadian TSX 60 results reflect an overweighting to the extractives sector, which is necessarily concerned with compliance and risk mitigation. But how are boards rewarding proactive investments in social licence to operate and in stakeholder relations? Forward-thinking measures such as these might realize greater long-term benefits for companies and shareholders alike.

Finally, where metrics exist at all, they are nearly always backward looking. I came across few examples of forward-looking (leading) measures that assure boards their managers are placing careful investments to generate future performance results.

What explains this? We know there is a lack of agreed upon guidance for executive sustainability compensation. We also know that “pay for performance” – whether financial or non-financial performance – is a recent governance trend. The most popular performance indicators continue to be profit and executive performance goals for short-term incentives and total shareholder return for long-term incentives.

Finally, it’s clear that peer normalization plays a very strong role in determining executive compensation. The practice of engaging compensation advisors to benchmark comparable companies results in copycat pay packages.

In my experience advising companies on sustainable compensation practices, I tend to come across the following limitations or constraints:

• The human resource managers who advise board compensation committees lack experience in setting sustainable pay metrics and are not familiar with the qualities of a good sustainable pay metric;

• Companies have not identified the ESG risks or opportunities material to their performance and thus lack an understanding of how sustainability practices can enhance shareholder value protection and creation;

• As the typical corporate strategy does not include relevant sustainability performance targets, ESG is not properly positioned in the corporate balanced scorecard and thus is usually sidelined by the compensation committee.

• Boards lack an understanding of stakeholder expectations and how sustainability mega-forces will affect their company, sector, value chain and region. They are ill equipped to determine top sustainability metrics that will enhance corporate prospects going forward.

So what does the future hold?

Sustainability think tanks like Corporate Knights will continue to rank companies on their sustainable pay practices, putting pressure on company boards to enhance their ESG compensation programs. With capital markets increasingly looking for rigorous ESG value protection and creation goals, expect more compensation packages to have clear, quantified and stretching ESG targets.

At the same time, global standards and guidelines on ESG pay will emerge and compel continuous improvement. ESG pay will then join excessive pay, referred to as quantum by investors, and equitable pay (vertical pay ratios) to create a triumvirate of non-financial pay issues for boards and their advisors to address.

In other words, expect sustainable pay to be on board agendas for many years to come.

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