Innovations in Sustainable Finance

Innovations in Sustainable Finance #6: ESG Incentives and the Zone of Discretion with Tom Gosling

Jun 26, 2023

Tom Gosling, ESG compensation expert, discusses the effectiveness of linking executive pay to ESG targets, the challenges of setting effective ESG targets, and the benefits and risks of delegating ESG responsibilities on the board. He also explores the broader role of ESG incentives and sustainable investing, emphasizing the need for policy changes.

55:42

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Episode guests

Tom Gosling

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Quick takeaways

Linking executive pay to ESG targets is becoming more prevalent, with approximately 90 percent of companies now adopting this practice.

Well-designed ESG targets in executive pay enhance accountability and drive positive change when they align with the company's strategy and prioritize material ESG issues.

ESG incentives and sustainable investing cannot solely fix mispriced externalities or replace comprehensive policy frameworks, but they can create an environment for policy change by demonstrating investor demand.

Deep dives

The Increase in Linking Executive Pay to ESG Targets

Over the past few years, there has been a significant rise in the practice of linking executive pay to ESG targets. In 2021, 37 out of the FTSE 100 companies had ESG in their annual bonus, with an average weight of 15 percent. This practice has since increased, with approximately 90 percent of companies now linking executive pay to ESG targets. This trend reflects the growing expectation for businesses to adopt stakeholder-oriented and environmentally conscious approaches. Targets have expanded beyond traditional measures to include climate change and diversity and inclusion, with a shift towards long-term incentive plans along with annual bonuses.

Introduction

2min

Linking Executive Pay to ESG Targets

6min

Effective ESG Targets in Executive Pay Plans

33min

Challenges and Modest Expectations of Linking ESG Targets to Pay

3min

Exploring the Concept of Delegating ESG Responsibilities on the Board

3min

The Role of ESG Incentives and Sustainable Investing

8min

Did you know that most large European corporations compensate executives for reaching ESG targets? Is that a good thing, and how should this be done?

I discuss these fascinating questions with Tom Gosling, perhaps the world's most experienced expert regarding ESG compensation. I learned a lot in this episode! Some (but not all) of my favorite insights:

Even if ESG targets contribute to long-term shareholder value, it can make sense to incentivize middle managers on ESG because they are usually incentivized on annual targets.
ESG incentives can work when they are aligned with overall strategy, focus on one central ESG issue, and are monitored by a knowledgeable anchor investor
There is no way to fix the economic incentives given by the market and regulation with managerial incentives.

Tom has written about this topic a lot, as you can see on his homepage. Here are some direct links to documents mentioned during the podcast:

Paying for net zero assesses the quality of climate targets in large European companies. Spoiler alert: it’s not great.

Paying well by paying for good is a report produced in collaboration with PwC looking at whether executive pay should be linked to ESG targets, and if so how. The follow-up paper Paying for good for all looks at practice and attitudes globally and extends the analysis to consider alignment of broader company-wide reward strategy with ESG.

Executive Pay and ESG Performance is an excellent summary of the first report in blog format.

And here two of the recent papers that Tom mentions:

Say on ESG: The Adoption of Say-on-Pay Laws, ESG Contracting, and Firm ESG Performance

Executive Compensation Tied to ESG Performance: International Evidence

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