Corporate Governance

Shearman & Sterling LLP 23 | ESG Continues to Find its Way into Incentive Compensation Plans Although COVID-19 and its impact on business operations brought its own challenges to issuers' incentive compensation programs, a review of 2020 proxies showed no slowdown in the incorporation of ESG metrics into plan design. Traditional incentive compensation metrics, namely quantitative shareholder return and financial and operational metrics, still dominate but, increasingly, qualitative "social" factors, such as diversity and pay equity, are playing a meaningful role in executives' take- home incentive pay. In the Top 100 Companies, 15 have announced in their 2020 CD&As that incentive compensation for 2021 will include new ESG metrics. The move toward ESG metrics is both a response to stakeholder pressures and a growing recognition that these factors are important to long-term shareholder value. This article discusses the forces leading companies to adopt ESG metrics, analyzes how those companies are incorporating ESG metrics into their incentive compensation programs and discusses the challenges of establishing meaningful metrics. THE FORCES OF CHANGE A number of forces have led to the increased use of ESG metrics in incentive compensation plans. These include: Institutional Investor Focus on Sustainability In January of 2020, Larry Fink, Chairman and CEO of BlackRock, noted in his letter to CEOs that failure to focus on the needs of a broad range of stakeholders will ultimately damage long-term profitability. In his 2021 letter, Mr. Fink reiterated this position and called for a single global standard with respect to sustainability disclosures. Survey data shows that asset managers agree that a focus on ESG brings financial benefits. According to the 2020 RBC Global Asset Management (RBC GAM) Responsible Investing Survey, 75% of institutional investors in Canada, Asia, the United States and the United Kingdom apply ESG principles to investment decisions, with a 26% increase in Asia. In addition, 43% of the respondents said they believe ESG-integrated portfolios are likely to perform best, which is a 14% increase from 2019. Notably, the United States lags behind its peers, as only 28% of U.S. institutional investors polled held this view. 1 Shifting Views of the Role of the Corporation In August of 2019, more than 180 CEOs signed onto a Business Roundtable statement that, for the first time, expanded the view that corporations exist principally to serve their shareholders to say that corporations should commit to serving the interests of all stakeholders, including shareholders, customers, employees, suppliers and communities. The Business Roundtable's position undoubtably reflects increasing public, investor and employee pressure on companies to focus not only on advancing profits, but to also contribute to solving societal problems such as income inequality and environmental sustainability. The incorporation of ESG into incentive compensation plans is a key measure that observers will use to track whether the signatories' companies are honoring this new philosophy. 2 ESG Continues to Find its Way into Incentive Compensation Plans Matthew H. Behrens & Annie P. Anderson Insights

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