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Mar 30, 2021

Making it meaningful: How European companies are linking ESG and executive pay

Europe is leading other regions in connecting strategy, ESG and pay

Many European companies already incorporate ESG metrics into executive pay. In a study of 365 issuers from major indexes in continental Europe and the UK, 68 percent have at least one ESG metric in their incentive plans, according to Willis Towers Watson.

But companies are under pressure to go further. Investors want to see stronger links between ESG, strategy and pay. In particular, they are pushing for significant metrics on key sustainability topics, like climate change and diversity. 

If you go back four years, firms with ESG metrics in executive pay tended to be from certain industries, explains Peter Reilly, a senior director at FTI Consulting. He highlights the energy and materials sectors, where you could find compensation linked to measures like emissions or health and safety.

That picture has changed significantly, however, and today there are new announcements almost every week, adds Reilly. ‘There is a market-wide trend because, increasingly, every listed company either recognizes internally that this is key to its business strategy and risk, or it’s being told that by its largest investors,’ he says.

Pressure points

External pressure is playing a key role in reshaping pay packages across Europe. Investors, regulators, proxy advisers and reporting bodies are nudging firms – with varying levels of force – toward more integration between ESG and compensation.

At a regional level, the Shareholder Rights Directive II has mandated say-on-pay votes across the continent. While some countries already gave shareholders a vote on pay, others have seen a big rise in scrutiny. The directive also calls for investors to analyze corporate performance through an ESG lens, increasing expectations that pay and sustainability should be integrated.

National corporate governance codes are playing their part, too. For example, the updated French code says ESG measures should be included in executive compensation. ‘If you look at EU markets, the French market is taking a lead,’ says Aniel Mahabier, chief executive at CGLytics.

Further pressure is being exerted by investor groups. Last November the UK’s Investment Association, which represents more than 250 members with around £8.5 tn ($11.8 tn) in assets under management, adjusted its ‘principles for remuneration’ to be clearer on expectations around non-financial performance metrics.

‘ESG measures should be material to the business and quantifiable,’ states the association in the principles. ‘In each case, the link to strategy and method of performance measurement should be clearly explained.’

At Amundi, Europe’s largest asset manager, expectations around ESG and compensation continue to evolve. In 2020 it asked companies to include ESG metrics in their LTIP and voted against those that did not. This year it is going further and calling for climate performance measures in sectors with heavy exposure to global warming.

‘We really want top management’s compensation to be linked to the climate strategy,’ says Caroline Le Meaux, head of ESG engagement at Amundi. ‘We will vote against any viable items if there are no climate-related KPIs. And, for all sectors, we still have ESG KPI requirements for variable compensation.’

This is an extract of an article from the Spring 2021 issue of IR Magazine.