Climate-Focused Executive Compensation: Driving Sustainable Leadership

Climate-focused executive compensation aligns executive actions with long-term sustainability.
30 April 2024
Climate-focused executive compensation

With climate change impacting business stability and profitability, increasingly more companies are integrating environmental objectives into their executive compensation strategies. This approach, known as climate-focused executive compensation, aligns executive actions with long-term sustainability — and may prove crucial for maintaining investor confidence and enhancing company valuations.

Recent news, including a report from Wall Street Journal and As You Sow’s Pay for Climate Performance report, highlight developments in a trend towards linking executive pay directly to greenhouse gas (GHG) emission reduction targets. Kobe Steel’s recent integration of ESG indices into executive pay also emphasises this strategic shift.

In 2024, over half of the S&P 500 companies now include such metrics, a figure which has doubled in just two years. This rise is driven by a greater recognition that sustainable practices are vital not just ethically, but also for long-term financial health. And yet, despite this, findings from As You Sow show that many large US companies still struggle to connect executive compensation with climate metrics effectively.

What are the best strategies for effective climate-focused executive compensation?

For climate-focused executive compensation to be effective, it must be supported by robust, scientific metrics. Speaking with the Wall Street Journal, Danielle Fugere, President and Chief Counsel of As You Sow, suggests that at least 5% of executives’ total performance shares should be linked to specific climate achievements to ensure they have a substantial impact. The specificity of these metrics should align with a company’s core operations and strategic objectives. Energy companies, for example, might focus on significantly reducing their emissions while consumer goods companies might instead concentrate on sustainable sourcing practices.

Current compensation models face challenges such as using qualitative metrics that allow too much discretion for compensation committees or opting for complex, non-transparent metrics that are difficult to track. Plus, many companies fail to include critical metrics in long-term incentive plans, which diminishes their potential impact.

To drive meaningful emissions reductions, companies should establish clear, measurable GHG reduction targets, linked to compensation and which cover all time frames. Quantitative metrics should be prioritised in order to minimise discretion in pay and ensure transparency. 

How can executive compensation packages of the future effectively link to climate?

Different sectors have varying levels of success when it comes to effectively incorporating climate metrics into executive compensation schemes. Technology and consumer goods companies may achieve higher net-zero targets, but often score lower overall due to the indirect impact of emissions on their business models. Alternatively, those industries like the energy sector — which directly involves emissions in its operations — often show more promise when effective climate metrics are applied.

Transitioning to compensation structures that robustly incorporate climate metrics poses challenges, but it also offers significant opportunities; this strategic shift may prove crucial for companies that plan to align business strategies with environmental sustainability demands. 
Some companies like Dow and Trane Technologies have made notable progress by tying significant portions of CEO pay to climate targets, yet the overall landscape shows a need for much stricter alignment to ensure that executive incentives truly drive the ambitious climate action needed to meet global targets. As more companies adopt and refine these practices, climate-focused executive compensation will play a crucial role in aligning business strategies with the urgent demands of environmental stewardship.

30 April 2024