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UK executive pay increasingly linked to ESG targets

Author: ICAEW Insights

Published: 17 Jan 2023

The UK’s top companies are increasingly including ESG corporate goals in executive pay plans, suggesting investor pressure for greater ESG disclosure is taking effect, new research shows.

The use of environmental, social and governance (ESG) metrics in UK executive pay plans has grown to 89%, up from 81% according to research by WTW, a US advisory and broking company.

The occurrence of ESG-linked goals appears in both short-term and long-term payment plans in the UK. According to the study, 85% of UK plc tied their short-term pay packages to at least one ESG measure, up from 79% the previous year.

The proportion of companies that used at least one ESG measure in their long-term pay plan rose from 24% to 37% in the past year. This trend is set to continue, if not accelerate in the next few years, the research suggests.

Sarah Reay, Climate Change Executive, ICAEW, says: “While it’s encouraging to see an increase in incentive plans including ESG metrics, there is some way to go in matching the addition of measures in long-term plans with those in the short-term plans. We hope that by including social and environmental measures as part of executive remuneration, this will accelerate action on emissions reduction, close the gap on social inequalities and improve the health and wellbeing of people and the planet.”

Reay said ESG-linked incentive plans are one lever an organisation can use as part of its overall sustainability strategy. “We expect this to become the norm in the coming years,” she added.

Differences between Europe and America

Europe leads the way in the use of ESG incentive metrics. A substantial 90% of European companies, including those in the UK, now include at least one ESG metric in their executive pay plans – an increase from 79% in the prior year. The highest adopters are Germany (98%) and France (100%).

In contrast, in the US, the use of ESG metrics in long-term incentive plans remains uncommon, increasing from 5% to 8% year on year.

The prevalence of environmental metrics almost doubled worldwide year on year, rising from 22% to 40%. Significant regional disparities in the use of climate and environmental metrics remain but WTW said it expected adoption to increase globally as institutional investors and regulators step up pressure.

ESG metrics are incorporated into incentive systems in a variety of ways, including underpins – weighted key performance indicators that stipulate a threshold or basic level of performance required – and modifiers, which allow modifications to the incentive pay-out. Some use quantitative measures while others use judgement-based ones.

Social metrics are most frequently used in pay plans among the three ESG categories. The use of environmental metrics is highly disparate, ranging from 25% of companies in the US to almost two-thirds of companies in Europe and the UK.

Energy and utilities companies continue to see the highest use of ESG metrics, followed by the materials industry. Despite a 9% increase from the prior year, IT remains the industry with the lowest prevalence of ESG incentive metrics.

Richard Belfield, executive compensation and board advisory practice leader at WTW, said: “Pressure from institutional investors, proxy advisers, employees and other market stakeholders is reshaping the envelope. Companies are beginning to focus on a stronger link between their executive compensation plans and ESG priorities, particularly with respect to climate change and environmental measures, inclusion and diversity matters, and overall human capital governance.”

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