‘It would be unusual for an Australian listed company to not have some portion of its incentives linked to ESG Plus measures.’ So says Michael Robinson, a director of Guerdon Associates in Australia, in a recent report – titled '2021 and beyond: Global executive incentive trends' – looking at ESG-linked, performance-based pay across the US, Canada, continental Europe, the UK, Australia and Singapore.
For its research, Guerdon uses its own term – ESG Plus – explaining: ‘While we acknowledge that ESG is the most frequently used moniker for interests that extend beyond ‘shareholders’, it does not capture the full breadth of non-financial performance, which also includes customer and community measures. As a result, we developed a framework called ESG Plus to refer to environmental, social, governance, customer and community performance, separate from financial performance, for this body of work.’
Incentive packages differ ‘significantly’ across regions when it comes to ESG Plus metrics, note the authors – and Australia leads: 81 percent of companies in the ASX 100 use these measures in executive incentives. This is followed by the UK at 72 percent (of the FTSE 100) and continental Europe at 66 percent (CAC 40, DAX 30, SMI 20). The US is bottom of the list of regions studied, at just 56 percent (of the S&P 100).
Robinson spoke to IR Magazine about what has been driving the adoption of ESG measures in Australian companies.
‘Australia has an unusual regulatory regime known as the two-strikes law,’ he explains. ‘This requires a company that has received more than 25 percent of votes against the non-binding remuneration report resolution, two years in a row, to submit a resolution that all board directors stand again for election. This appears to have made board directors in Australia more responsive to investor concerns on pay matters than in other countries.’
He cites a range of other factors that have all pushed companies to bring ESG closer to executive pay. Australia’s securities regulator and financial services regulator require companies to explicitly consider climate risks, he says, adding that the country’s regulatory regime ‘provides ready means for activist investors to lodge their own ESG resolutions.’ There are also significant penalties – including jail time – for board directors at companies with poor safety outcomes ‘even at large companies where the board is very far removed,’ he notes.
Climate change is another big driver for a number of factors, explains Robinson. Australia’s unique flora and fauna are at risk and there is a ‘very concerning’ high rate of extinction, he says, adding: ‘Australia also has a high proportion of mining and energy companies that, by their nature, damage the environment. In addition, they do this on land that often has features of significant symbolic cultural significance to the first Australians, who require their lands to be protected.’
Rio Tinto’s destruction of an ancient sacred Indigenous site in Australia last year, which eventually – and after months of investor pressure – cost its CEO his position, is perhaps the most high-profile failure to protect such sites in recent years.
Another factor is the country’s investment climate, which consists of a relatively heavy concentration of long-term investors, as a result of having the fourth-largest pool of pension funds in the world, explains Robinson. ‘As these investors have to hold, they are more concerned with long-term existential threats like climate change and the impact on asset values 10-30 years from now,’ he says.
Moving on from health and safety
Australia’s ESG drive might have grown out of the country’s unique relationship with climate change and the health and safety concerns at big miners, but it has now moved on to cover a far broader range of issues. And because almost all larger companies have policies in place that allow boards to forfeit unvested executive remuneration, investors expect action if something happens, says Robinson.
‘To make it easier, and fairer, to meet investor and executive expectations, companies have framed ESG policies that management must comply with to avoid forfeitures,’ he explains. ‘So it has moved beyond safety, compliance and environmental concerns to include staff engagement, customer loyalty and reputation in the community. Penalties are applied[there’s your typo sorted!] to take pay away from executives when a company fails in its values, such as when bullying or sexual harassment is discovered to have occurred, or there is insufficient diversity in executive ranks.’
Some of the benefits for companies in tying their executive pay to ESG metrics include employees and customers – particularly younger generations, says Robinson – becoming more engaged and loyal, as well as more productive on the employee side. ‘Risk assurance systems also improve,’ he adds. ‘Consequently, extreme events with significant financial, reputational and other impacts become less frequent and less severe – and so company value improves.’
It’s not all positives, of course. Robinson says the main drawback is that a company’s short-term focus can become diluted as ESG considerations take up more space. ‘In addition, capital expenditure is typically larger to address systemic ESG issues that may not have a pay-off as quickly or as directly as other areas of focus,’ he says.
What does it exist for?
Measures of ESG performance are becoming more sophisticated, says Robinson. To date, he says these have been mostly confined to annual compensation and forfeiture, but boards are increasingly considering the longer-term impact of ESG factors on company value and reputation – something that will result in a shifting focus toward more ESG performance being tied to longer-term incentives.
Just because most big companies in Australia tie ESG metrics to executive compensation, it doesn’t mean they do it well, notes Robinson.
But those that do always relate it back to the company’s purpose, he adds: ‘What does it exist for? In all cases [these companies] do not exist to make profits. They exist for other purposes. And when you think of these other purposes, ESG must always be in the mix of tools to deliver on that purpose.’