Corporate Governance

Corporate Governance and Exec Compensation 2021

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Shearman & Sterling LLP ESG Continues to Find its Way into Incentive Compensation Plans | 26 ACTION ITEMS FOR INCORPORATING ESG METRICS The following is a list of action items for companies looking to incorporate ESG metrics into their incentive compensation programs: Identify the Appropriate Metrics Consider a task force comprising different stakeholders within the organization that can appropriately determine ESG metrics that reflect the company's strategy and key risks and promote value creation. 2 The DOL's Rules on ESG Investing for ERISA Plans – The Pendulum Swings Again In December 2020, the Department of Labor (DOL) published a final rule with respect to ESG investing in the ERISA context. Purporting to reflect the DOL's long-standing position that ERISA fiduciaries may not sacrifice investment returns in order to promote social, environmental or other policy goals, the rule provided that ESG factors may be considered only to the extent they present material economic risks or opportunities. The rule was not without controversy, as evidenced by the over 8,000 comment letters sent to the DOL following the initial release of the proposed rule. Reflecting the long-standing back and forth between Republican and Democrat administrations as to the role of ESG considerations in ERISA investing, the Biden administration announced it would not enforce the rule and, on October 13, 2021, the DOL promulgated a new proposed rule. The proposed rule addresses concerns that the previous rule put fiduciaries at risk if they considered ESG factors in their financial evaluation of plan investments. Therefore, the proposed rule eliminates the requirement that fiduciaries only consider "pecuniary factors" in making investment decisions and allows fiduciaries to consider any factor that is material to the risk- return analysis. Therefore, the proposal would allow fiduciaries to consider ESG factors, including climate change-related factors. Set Goals With a lack of historical context by which to measure ESG progress, consider providing the compensation committee with discretion to determine how executives have performed with respect to the company's ESG goals. Although companies may decide to measure success against targets set by third parties, such as SASB, these external targets may not be appropriate for every individual company. Also, determine whether goals should be annual or long-term. As shown in the Survey data, most ESG metrics are tied to annual incentive plans, reflecting the long-held belief that long-term goals should relate to financial and shareholder return metrics. 4 Ensure a Line of Sight between Executive Actions and Performance Incentive compensation metrics are without value if employees do not have the ability within their job function to impact the desired outcome. For example, while improved safety may be an important goal for an organization, it is likely the controller has little ability to effect change in this regard and his or her attention should be directed toward other goals of the company. 3 Review Your Executive Officer Scorecards As discussed, unlike financial metrics, ESG performance cannot be boiled down to numbers on a spreadsheet and requires a subjective analysis. Therefore, when evaluating the overall performance of the company's executive officers, the board should include relevant ESG metrics on its scorecards. 5 Engage with Shareholders As part of a company's regular calendar on shareholder engagement, the company should discuss with key shareholders the inclusion of ESG metrics into its incentive compensation programs. Companies should seek to emphasize that these metrics are not divorced from the interests of shareholders but are, in fact, value drivers. 1

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