• Monday, April 22, 2024
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Incorporating ESG in executive compensations

Incorporating ESG in executive compensations

A significant size of the world’s capital is now leaning toward sustainable businesses and corporations are responding by reviewing their operations to be considered responsible. In some instances, some of these organisations have been accused of green-washing (an act that entails just acting for the sake of it and not substantially). The road to the goal may indeed, therefore, start off in a crooked manner but there is room for all businesses to truly embrace Environmental, Social, and Governance (ESG) principles if they truly want to thrive. For companies that need to drive sustainability in their businesses, Executive Compensation can be used as a tool to achieve this.

What is ESG and its parameters?
ESG is an acronym that represents Environmental, Social, and Governance. It is a sustainability framework that considers a broader view to recognizing various stakeholders and not only shareholders. Each acronym has a stakeholder focus group and parameters that are subsumed within it, providing insights into the key considerations in question.

In the Environmental component of ESG, the stakeholder focus is the Community or Environment in which the business is conducted. The parameters to be considered here are reduction in carbon emissions, oil spillage, management of resources such as water, energy, waste, replenishment of resources used by a business, and an overall reduction in carbon footprint. The Social component of ESG has Employees and the Society has key stakeholders. Issues relating to employee training, compensation, diversity and inclusion, health and safety standards are of important consideration here. The Governance aspect of ESG has Company Officers as key stakeholders and deals with issues such as transparency, accountability and reporting, anti-bribery & corruption and other governance policies, procedures, and controls that serve as a guide to carrying activities in a company.

Why is incorporating ESG into compensation important for organisations?
It has been said often that what is not measured, never gets done. It is one thing to appreciate what ESG seeks to achieve and another to ensure ESG parameters are measured in a business. Using ESG metrics for performance management is important because it focuses the attention of executives on the very important ESG parameters that may have been sidelined. It also promotes the satisfaction of various stakeholders, including happier employees, supportive regulators, and government representatives, as well as shareholders who can take pride in being a part of the business. Other reasons why ESG should be incorporated into performance measures and executive compensation include improved business operations which could lead to business expansion and reduction in costs such as government/regulator fines and vandalism of property by aggrieved community members. Overall, incorporating ESG into executive performance metrics and compensations provides the incentives for management to drive the strategy of the business while aligning with sustainability principles and ESG parameters.

How can ESG be incorporated into Executive compensation?
Since ESG is a stakeholder-centric framework, all relevant stakeholders or their representatives must be consulted/considered in order to achieve an acceptable outcome. The process may commence by conducting an analysis of current ESG practices within the business using parameters under the ESG framework. This should be done with a view to identifying the areas of strength and those that require some level of improvement. Upon analysing the results gleaned from the assessment conducted, it may be useful to hold strategy sessions where board members and representatives of shareholders, together with executive management share thoughts on the strategic direction of the business and how ESG principles can be incorporated into the strategy. This collaboration in process will help in building a sense of acceptance for all stakeholders concerned.

Upon acceptance and agreement of the new strategic direction for the business, all parties involved should proceed further to deliberate on how the balanced scorecard would be expanded to include parameters around ESG parameters. This would, subsequently, lead to cascading the ESG Key Performance Indicators (KPIs), in addition to other elements of the balanced scorecard, to the other employees in the organisation. It is the achievement or otherwise of these ESG KPIs, depending on the weight attached to them per time, that will determine how executive compensation is affected. It is, therefore, the duty of the Board to approve the relevant ESG parameters in the balanced scorecard as well as determine the weight to be assigned to them.
The clarity of strategic direction as well as tactical and operational performance measures will provide the clarity required to establish policies such as diversity and non-discrimination policies, equal pay policies, and corporate social responsibility policies, in addition to other human capital policies.

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Implications for Nigerian Companies
The Nigerian Climate Change Act became law in November 2021, this indicates the pulse of the Government regarding issues of sustainability. In demonstrating its commitment to global sustainability, the Financial Reporting Council of Nigeria (FRCN) through the Nigerian Code of Corporate Governance (NCCG) 2018 (Principle 26.3) has also mandated companies to report in their Annual Reports, the extent of compliance with their sustainability policies. For companies with a proactive approach to prioritising ESG concerns, you can find clear evidence of their sustainability practices. Consider multinationals like Coca Cola and Dangote, a cursory view of their annual reports indicates their prioritisation of sustainability and ESG practices. Other multinationals like Unilever, even go as far as incorporating sustainability into their purpose – To make sustainable living commonplace (Unilever’s purpose).
In the coming years, it is expected that ESG would speedily evolve from being a nice-to-have to a must-have and possibly even codified by national laws to ensure adequate compliance. Nigerian companies are, therefore, urged to consider taking a proactive approach to prioritising ESG in their dealings so as to prevent getting caught up in the web of the past. These companies should consider measuring ESG compliance in the short term or long run; correspondingly, executive compensation attached to the achievement of ESG KPIs should also be utilised as short or long-term incentives to drive action.

What are the next steps?
ESG issues have become of strategic importance as it is no longer enough to just be in business, companies must now do business in an ethical manner. A significant portion of global capital is being channeled into businesses that have demonstrated their commitment to ESG and sustainability issues. It is not enough to expect Executive Management to toe the line. The board of directors and other strategic stakeholders must take the responsibility for steering the businesses they lead towards the right direction and they can start by ensuring ESG parameters are incorporated into the KPIs of executive management, so they are held accountable for driving the ESG strategy of the business.

How PwC can help
To have a deeper discussion about how the topic might impact your business, please contact your engagement partners or members of PwC’s People and Organisation (Sustainability) team