45% of FTSE 100 firms use ESG to calculate pay

Research by PricewaterhouseCoopers (PWC) and London Business School has revealed environmental, social and governance (ESG) measures have reached widespread adoption in the setting of executive pay.

Data from The paying well by paying for good report found the measures were now being used in approaching half (45%) of all FTSE 100 companies’ pay strategies.

The most common use of ESG indicators was to calculate either annual bonuses or long-term incentive plans (LTIPs), according to the study.

Just over one-third (37%) of organisations polled reported using such a measure in their bonus plans, with an average weighting of 15%. Meanwhile nearly one in five (19%) said they included them in their LTIP with an average weighting of 16%.

Responding to the findings, Phillippa O’Connor, reward and employment leader at PWC, said: “What we’re seeing is an explosion in interest from investors and companies alike in linking executive pay to ESG targets.”

She added: “This is now feeding into practice, and very soon we’ll be in a situation where a majority of large companies have ESG targets in pay.”

But as well as revealing increased use of ESG measures, the report also discovered that their usage was changing too.

Nearly a third of companies questioned now use much more updated indicators – such as those concerned with the environment, climate change, or social issues – rather than those which are less current, and refer instead to health and safety, employee engagement, governance and risk management. In fact, a greater percentage now refer to these newer metrics rather than the older ones (28% vs 26%).

O’Connor said: “Traditional metrics with a direct link to shareholder value, like health and safety and employee engagement, are being supplemented with metrics that address broader societal concerns, such as climate and inclusion and diversity. This is consistent with boards taking a broader view of their responsibilities to stakeholders, as required by the UK Corporate Governance Code and the Companies Act.”

Significantly though, PWC also identified that too fervent linking of pay to ESG could result in unintended consequences. It found over-playing ESG targets could undermine intrinsic motivation, and could lead to companies focusing only on them in the pay plan, at the expense of other issues.

Tom Gosling, executive fellow at London Business School’s Centre for Corporate Governance, welcomed the increased focus on integrating ESG considerations, but warned related targets should not automatically be linked to pay.

He added: “There are lots of practical difficulties linking pay to ESG. And there’s a risk that more ESG targets simply result in more pay, due to the difficulty of knowing how stretching these targets are.”