European Companies are Adopting ESG into Pay Plans with Surprising Efficiency, Driven by Sustained Investor Pressure

| Edna Twumwaa Frimpong

This post appeared as part of our contribution to Insightia’s inaugural compensation report. Please read the full report here:

Pressure on companies to implement ESG Key Performance Indicators (KPIs) in executive compensation structures is mounting and investors are increasingly looking for boards to showcase how these targets are set in meaningful ways.

ESG metrics are no longer considered a “nice-to-have” in compensation plans but are expected to form a primary element of company strategy. However, companies must also balance the line between
addressing ESG and maximizing shareholder returns and long-term value creation, while avoiding “greenwashing” – selectively using ESG metrics that obscure the true impact of their business on the environment or society.

THE PERCENTAGE OF COMPANIES INCORPORATING ESG METRICS IN EXECUTIVE COMPENSATION PLANS HAS INCREASED FROM 15% IN 2008 TO 46% IN 2021.

To understand this trend, we have explored how companies in certain parts of Europe and Australia have incorporated ESG metrics in compensation plans from 2008 to 2022.
Our findings suggest that the number of companies that have introduced ESG performance metrics in pay plans has increased significantly. The percentage of European and Australian companies incorporating ESG metrics in executive compensation plans has increased from 15% in 2008 to 46% in 2021. In 2022, 50% of companies in our sample are expected to implement ESG KPIs. Looking specifically at our European sample, we analyze a growth from 7% to 44% within the same span of years, which is also
expected to increase to 48% in 2022. In Diligent’s 2021 report titled Aligned Pay, People, and
Performance, which surveyed 1,914 Europe-headquartered companies, we found that issuers are more likely to incorporate social metrics in compensation structures than their environmental and governance counterparts, and this holds true in our latest analyses. The percentage of European companies incorporating social metrics into their pay plans averages 32%. In comparison, 31% and 17% of companies surveyed incorporated environmental- and governance-related metrics, respectively.

France leads the charge

Approximately 82% of France-headquartered companies in the dataset incorporated at least one ESG-related metric into their compensation plans, according to their 2021 registration documentation. In 2022, the percentage of companies with ESG-related metrics in compensation plans is expected to
rise to 88%, according to Insightia data. France’s neighbors have made less progress with their ESG uptake, with only 22% of Germany-headquartered companies having established ESG-related metrics in their compensation plans. 53% of companies headquartered in the U.K. have also included ESG
related metrics in their compensation plans for 2021, which is expected to increase to 60% in 2022.
Within our European sample, France-headquartered companies represented the highest percentage of companies incorporating environmental- and social-related metrics in compensation plans in 2021 and this trend is likely to continue into 2022. Approximately 48% of companies based in France
have implemented environmental-related metrics in their compensation structures and this is likely to increase to 68% in 2022. In 2021, 73% of companies in France incorporated social-related metrics, which is expected to climb to 77% in 2022.

Italian companies have showed the highest implementation rate for the governance metrics, with 26% of companies including such measures in 2021 remuneration reports. However, in 2022, the highest percentage of companies having governance-related metrics in place would be from the Benelux region at 25%. Australia is seemingly ahead of the trend also, with 52% of surveyed companies having incorporated ESG-related metrics in their compensation plans in 2021 and 59% expected to have done so in 2022, according to Insightia data. weight of ESG metrics in compensation plans currently stands
at 11% and 10% for Australia- and Europe-based companies, respectively.

ESG uptake concentrated in premium indexes

Examining ESG uptake by index, France again ranks top with CAC 40 index constituents featuring the highest implementation of ESG-related metrics in compensation plans. Approximately 89% of CAC 40-listed companies had ESGrelated metrics in their compensation plans in 2021 and this is expected to climb to 94% in 2022. Australia’s ASX 100 follows closely in second place at 73% implementation.

ESG METRICS ARE MORE PREVALENT IN THE SHORT-TERM INCENTIVE (STI) COMPONENT OF VARIABLE COMPENSATION, RELATIVE TO LONGTERM INCENTIVES (LTI)

Again, we find that France’s premium index leads with the incorporation of environmental and social metrics, respectively. Approximately 63% and 76% of companies in the index implemented environmental-and social-related metrics in their compensation plans, respectively, according to 2021
remuneration reports. Netherlands’ AEX leads with the incorporation of governance-related metrics in compensation plans at 43% in 2021. More than 65% of FTSE 100 companies established ESG KPIs in their remuneration structures in 2021 which is expected to grow to 72%, with 58% and 45% having established social and environmental-related metrics, respectively. Throughout 2022, these are expected to have increased to 62% and 52%, respectively.

A short-term focus

Diligent data suggest that ESG metrics are more prevalent in the short-term incentive (STI) component of variable compensation, relative to long-term incentives (LTI). More than 40% of companies analyzed had ESG metrics in their shortterm incentive plans’ (STIP) annual bonuses in 2021, which is expected to grow to 47% in 2022. Of companies surveyed, 17% had ESG metrics implemented in their long-term incentive plans (LTIP), which is expected to grow to 19% in the coming year. Interestingly, the average
weight given to ESG-related KPIs in LTIPs is higher than in STIPs, carrying a weighting of 9% and 13% in STIPs and LTIPs, respectively.

Thinking long-term

As ESG dominates engagements between issuers and investors, companies are being asked to demonstrate how boards protect and manage stakeholder interests. Boards should be strategic in thinking about how they include ESG metrics in their overall strategy to help address the
opportunities and risks associated with it. Boards would be wise to monitor the market and understand
that their ESG metrics may need to rapidly evolve to keep up with developments. For companies that have yet to take that first step, they must make every effort to understand their market and lay the foundation for eventual ESG inclusion in compensation plans.

About the Author

Edna Twumwaa Frimpong

Edna Twumwaa Frimpong

Director of International Research

Edna Frimpong is an experienced research analyst with a demonstrated history of working in the information technology and services industry. In her role with the Diligent Institute, Edna oversees and directs corporate governance research projects and partnerships internationally, outside the US. She joined Diligent Institute in 2021 after six years with CGLytics  -- a corporate governance analytics firm based in Amsterdam, The Netherlands, acquired by Diligent -- where she served as Head of Research for the EMEA region. Previously, Edna held research positions at firms including Sustainanalytics and Carnomise.  She received her Master's Degree in Finance and Law from the Duisenberg School of Finance in Amsterdam, and her Bachelor's Degree in Administration, Insurance and Risk Management from the University of Ghana.