Corporate Governance

Shearman & Sterling LLP ESG Continues to Find its Way into Incentive Compensation Plans | 24 1 See Hester Peirce, "Rethinking Global ESG Metrics," Views – the Eurofi Magazine, page 208 (April 2021). (Also available at https://www.sec.gov/news/public-statement/rethinking-global-esg-metrics). Regulatory Activities In March of 2021, the SEC requested public input on climate change disclosure and tasked the staff with evaluating SEC disclosure rules related to climate change. The SEC received more than 550 unique comment letters in response, and three out of every four letters was in support of mandatory climate disclosure rules. SEC Chair Gary Gensler subsequently announced that the staff is developing a mandatory climate risk disclosure rule for the SEC's consideration by the end of the year, emphasizing that investors are looking for "consistent, comparable, and decision-useful" disclosures in this regard. In addition, the removal of the "performance-based compensation" exemption from Section 162(m) of the tax code provides companies with greater latitude to use qualitative performance metrics and to implement a bonus "modifier," which enables the company to increase the payable bonus as a result of a subjective determination, such as a commitment to the company's ESG principles. 3 The Challenge of Metrics Boards looking to incorporate ESG metrics into incentive compensation plans are faced with the dual challenge of choosing appropriate metrics and appropriately measuring success. Although there is a movement toward establishing a global set of standards for reporting ESG metrics — as is the case with financial reporting — there is an ongoing debate as to whether a global set of ESG standards is, in fact, beneficial. For example, in April of 2021, SEC Commissioner Hester Peirce argued that a "global reliance on a centrally determined set of metrics could undermine the very people-centered objectives of the ESG movement by displacing the insights of the people making and consuming products and services." 1 Further, for any individual issuer, the chosen set of global standards required to be reported on may not align with the long-term business strategy of the issuer and, therefore, may not be appropriate as an incentive compensation metric. As issuers continue to grapple with how best to incorporate ESG metrics in their incentive compensation programs, most provide for a qualitative review and include the metrics as part of an overall review of individual performance. Regardless of how the ESG metrics are utilized, they should come coupled with transparent disclosure to investors as to how and why the metrics were chosen, weighted and evaluated.

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