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May 19, 2022

Investors expect senior management pay to be linked to ESG

But IR Magazine’s latest research shows only minority of companies doing so

Three in four investors expect senior management pay to be linked to ESG, according to the latest report on executive compensation by IR Magazine. But it is a practice that only a minority of companies undertake, with just 46 percent of boards linking executive pay to ESG metrics.

Linking pay to ESG is least common in North America, where just over a quarter of companies do so. And while comparatively fewer investors in North America expect this link, it is still the expectation of 62 percent of investors there.

A majority of companies in Asia tie a proportion of executive pay to the performance of ESG metrics, as do more than two thirds of European firms. But as high as 85 percent of European investors expect a link between management pay and ESG, making it the default assumption of investors in the region.

The number of companies linking executive pay to ESG rises with company size. Just over a third of boards at small-cap companies implement such a link when determining the executive compensation package. This rises to more than two thirds of boards at mega-caps.

'ESG risks'

Having a proportion of executive compensation tied to ESG is one way of counterbalancing other aspects of the package that could reward a short-term approach by management. In the report, fund managers frequently mention how practices such as linking executive pay to share performance can lead to short-termism, while one analyst explains that poorly structured compensation packages ‘may pose ESG risks if improvements are short-lived and are the result of exploiting other stakeholders.’

The proportion of executive pay tied to ESG metrics usually sits between 5 percent and 15 percent. Just over a quarter of companies that link executive compensation to ESG do so at a level higher than this, while one in five link less than 5 percent. The median range for ESG-linked compensation is 10 percent to 15 percent, although it is typically less than this at Asian and small-cap companies.

This matches the expectations of investors. The median range investors expect for ESG-linked pay is 10 percent to 15 percent of the executive compensation package. This is true for both the buy side and the sell side, as well as for investors in every region. While more than a third are satisfied with a rate lower than this, more than four in 10 have greater expectations: one in five investors expects more than 20 percent of the executive compensation package to be tied to ESG metrics.

The IR Magazine Executive Compensation report is based on a study of IR professionals and the investment community conducted in Q4 2021 and Q1 2022 and is available to IR Magazine Advanced subscribers. Click here to download the report.