Tying executive compensation to sustainability performance

Growth and sustainability are often caught in a paradox for businesses. Blockchain technology creates new business models and improves existing processes yet comes at the expense of extreme energy utilisation. Similarly, while e-commerce can increase merchandise volume and value (along with convenient home deliveries), it is accompanied by significant amounts of packaging and a carbon footprint that raises eyebrows. It certainly seems that growth often comes at the expense of sustainability.

What are some possible courses of action that can reconcile the seemingly divergent objectives between growth and sustainability? An interesting proposition raised is have more corporations link sustainability performance to executive compensation. The theory is that doing so will direct both objectives towards convergence, so that neither performance nor sustainability come at the expense of the other but will generally move in tandem and be aligned.

“Between 2019 and 2020, there’s been a doubling of large companies using climate pay targets. Shell in 2018 announced that its executive compensation would be tied to short-term carbon emissions targets and in the years that followed, their greenhouse gas emissions have progressively decreased. Tying ESG scorecards to executive compensation can be uncomfortable, but it is a method to try to truly be committed to sustainability goals”, says Betul Genc, country manager, Singapore of The Adecco Group.

Willis Towers Watson also reported that more than half of the companies on the S&P 500 use ESG metrics as part of their executive compensation framework. Even Apple followed suit, announcing in January 2021 an added metric affecting the annual bonuses of executives by up to 10 per cent, based on ESG performance. When we put money where our mouths are, there will be a more immediate and visible commitment to sustainability outcomes than to kick the can down the road. Realistically, this approach will face resistance as it is both the carrot and the stick!

A key benefit of an executive compensation model that incorporates ESG metrics is that it should focus more attention on sustainable investments and technologies as we collectively transit to a low-carbon economy. Decision makers will also be compelled to invest in (and implement) performance-based efforts using data-driven decisions. As the adage goes, what gets measured gets done.

“Companies are increasingly building sustainability considerations into their digital infrastructure and business processes to aid their ESG reporting, as well as for timely monitoring, decision-making and even intervention to meet sustainability targets. Some sectors leverage data analytics and sensors technology for energy and manpower optimization. The tech sector is also starting to use machine learning and AI for operations to improve cooling efficiency that can yield up to 40 per cent reduction in energy consumption and carbon emissions.” says Howie Lau, managing partner at NCS group.

Moreover, decision-making for sustainability will naturally be more tangible than mere posturing and token efforts. So organisations aiming to be net carbon-neutral quicker may choose more productive efforts over those that will garner more press coverage. For example, new climatech solutions such as direct air capture technology are exciting but capturing CO2 straight from the atmosphere is still extremely inefficient (and expensive) as our atmosphere only has 0.04 percent of CO2. Instead, organisations may choose to deploy an older solution in the interim by capturing carbon directly from a factory or coal power plant smokestack that may be more productive, as this is where 35 per cent of CO2 is emitted. Such an approach will provide sufficient time for emerging climatech to mature, scale and be cost-effective for mass adoption that will accelerate our collective efforts.

That said, these models are not without challenges and criticisms. Some ESG metrics are more easily measured (and understood) than others, like CO2 equivalent emissions. For instance, a single number could signify the impact of greenhouse gases, and even be translated into a carbon cost (such as rising carbon taxes) because of the well-established relationship between emissions and climate change. Others however have more complex cause-and-effect relationships, like measuring impact on biodiversity and habitat which is much harder to quantify. Hence leaders need to be cognizant that what we’re currently able to measure are just

a few slices of the entire cake. Extra care should be taken when implementing ESG-based executive compensation or it can result in distorted incentives, prioritizing the pursuit and performance of certain quantifiable metrics while ignoring the others which may have hard to- quantify dimensions.

Tying executive compensation to sustainability outcomes is not a panacea for our climate woes, but it’s a good start. Corporations showing the will and committed leadership that manages both performance and sustainability will benefit all stakeholders and should be duly recognised. In the long run, we must view ESG beyond a compliance checklist to meet, such that it becomes a goal that is pursued out of conviction, which finally permeates company corporate culture. Earth is after all everyone’s problem to care for.

Ryan Lim is founding partner of QED Consulting and Su-Yen Wong is chairperson, Singapore

Institute of Directors.

A version of this article was originally published in The Business Times on Aug 22, 2022.