Executive Bonuses in Britain Increasingly Hinge on ESG Targets

(Bloomberg) -- A growing number of executives in Britain are finding that their pay packages rely on how well they perform on environmental, social and governance metrics.

Almost half the annual bonus plans awarded to executives at the biggest U.K. firms now include an ESG component, up from about a third a year ago, according to Alvarez & Marsal, which reviewed the most recent annual reports of FTSE 100 members. When it comes to long-term incentive plans, a third are now tied to ESG, doubling from a year ago, the consultancy found.

The development comes as shareholders bring their power to bear, with anxiety around climate change turbo-charging investor activism and forcing companies to adapt. There’s also evidence that FTSE 100 firms are now better at producing ESG strategies that are measurable, which makes it easier for stakeholders to hold executives accountable.

“If you step back, let’s say two years, and you talked about using ESG metrics to shareholders, they were pretty skeptical as to whether they were robust and whether they were actually fairly easy targets for executives to hit,” Nic Stratford, a managing director for executive compensation services at the consultancy, said in an interview. 

To make room on the executives’ “score card,” conventional yardsticks for measuring performance such as earnings per share that focus on shareholder returns are playing a smaller role. Such gauges were used in 5% fewer bonus plans, the study found.

To be sure, a company’s bottom line ultimately still plays the biggest role in determining an executive’s pay, with the “most highly prevalent” measure of performance being profit, the survey found. What’s more, the impact of ESG on bonuses remains moderate, with a median weighting of around 10%. The figure for incentive plans is only slightly higher, at 15%.

“It’s unlikely to ever get to more than a third,” and many firms are likely to keep the level below 25%, Stratford said. 

The increased focus on ESG means board committees that set executive pay need to become more knowledgeable about how to choose ESG targets and to measure and report to shareholders on the progress in achieving the goals, the analysis also found.

“Obviously reputation is a very important part of this,” said Jeremy Orbell, a managing director at Alvarez & Marsal. “Companies do worry about their reputation, particularly large, high-profile companies in the FTSE 100, and we know that reputation does have an impact on shareholder returns.”

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