Risk & Economy » CFOs miss out on ESG-tied compensation

CFOs miss out on ESG-tied compensation

Only six percent have their compensation linked to ESG performance

CFOs play an integral role in a company’s ESG strategy but only a small minority have financial incentives tied to their company’s progress.

Finance is only really beginning to play a “much more central role” in businesses’ ESG strategies, says John Mennel, managing director of Monitor Deloitte’s strategy practice.

“Finance started off as mostly reporting to having a much greater role in measuring and driving return of investment (ROI), internal investment decisions, and external financing decisions,” he says. “I think you’ll see that number go up.”

Regulators have globally put forward a proposal to accelerate this. In Europe, the EU has proposed mandating the inclusion of ESG issues into executive pay under the Sustainable Corporate Governance initiative.

Currently, 75 percent of CFOs say their job is impacted by ESG, but only 6 percent of finance has compensation tied to ESG performance, according to a report by Deloitte. This is compared to 45 percent of executive and strategy who have their compensation linked.

ESG-linked compensation is becoming an increasing popular tool for corporates looking to progress their journey. Sustainability targets are now routinely acknowledged alongside traditional key performance indicators (KPIs).

“It goes back to what’s measured is managed,” says Mennel. “If companies believe their purpose is important, […] and important driver of value, then they, their boards and their investors will want to see it linked to compensation.”

Paul Herman, CEO at HIP investor, says the benefit of tying pay to these factors can “focus the mind” of C-Suite professionals. “[It can] improve market value, reduce future risk, and align the whole firm on how it actually succeeds: with prioritising people, planet, and trust factors.”

According to PWC, nearly half of the FTSE 100 companies set measurable ESG targets for their CEOs and have begun to introduce ESG targets in executive compensation packages. Companies including Deutsche Bank, Volkswagen and Apply have also announced ESG linked executive pay. But there is still a long way to go.

One reason for the current low percentage of finance compensation linked to ESG, according to Mennel, is there are functions other than finance which are currently seen as better value drivers for companies.

Deloitte’s survey found ‘talent impacts’ was the greatest driver of value: 79 percent said purpose supports talent recruitment, engagement, and retention.

In comparison, only 17 percent agreed purpose enhances access to capital, despite the increase in investor expectations related to ESG.

“We’re seeing [purpose and ESG] become a much more central issue to investor relations and we’re seeing companies, for example, issuing sustainability bonds that are bringing down their overall cost of capital and so finance’s role is becoming much more central,” says Mennel.

“Finance has a huge role in bringing purpose into investment decisions [and] are progressively being integrated into customer relationship management (CRM) frameworks.”

Moreover, the scope of ESG is becoming “more expansive” as reporting becomes statutory, and investors ask for more granular information placing a greater focus on the finance team, he adds.

Compensation risks

Including ESG metrics in executive pay packages is a tangible way to single out companies which have strong ESG rhetoric but are failing enact relevant strategies. But there is a fine balance for businesses looking to introduce ESG linked compensation.

The biggest risk, arguably, is that incentives could become distorted. For example, a bank could focus on reducing its own carbon footprint, when in fact the biggest effect it could have on reducing emissions is through changing its approach to financing companies which emit carbon.

There is also a calibration risk. It is well known businesses set targets which they know they will hit, protecting themselves against any reputational fallout missing the targets may incur. There is a misconception that ESG targets should be used to drive CEOs to undertake operations which they would not were the incentive not there.

But pay does not drive strategy, it follows it. Once ESG factors are integrated into broader corporate goals, linking them to pay can be a natural next step.

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