By Iris Yu
It was January and I was in Starbucks, hesitating about whether to use a plastic straw. After all, I was always troubled by its non-biodegradability. Several minutes later, as I was walking out the door without a straw, I got a timely news tweet: Starbucks CEO Kevin Johnson earned a portion of his 2021 bonus for reducing plastic straws and methane emissions of daily operations. This bonus represents ten percent of his annual bonus tied to environmental contributions, including efforts to “eliminate plastic straws” and “reduce farm-grade methane”.[i]
Is it a suitable metric to base CEO pay by the use of plastic straws and methane gas? It seems I am not the only person with such a concern. In 2022, Starbucks failed to win shareholders’ support for its executive bonus from the previous year, in part, by offering Johnson a $50 million retention bonus. This gives us a glimpse into some investors’ attitude towards transparency of environmental, social and governance (ESG) compensation for executives.[ii] It seems investors are waiting for standard metrics enforced by regulators to improve such transparency.
As corporate social responsibility (CSR) becomes more mainstream, companies are increasingly tying executive compensation to ESG performance. Proponents of responsible investing seem to appreciate the decision. They make use of this decision to predict changes of how investment targets lie in cyclical markets and try to calculate possible portfolio changes. Investors, however, aren’t placing all their trust in combining executive salaries with ESG performance. There are three main reasons why investors object to linking executive compensation to ESG.
First, investors wonder whether such linkages will actually work for the company. Many shareholders are skeptical that executive bonuses can incentivize companies to improve ESG performance, and investors are frustrated by large bonuses with little accountability. In 2021, a record number of S&P 500 companies failed to win investor support for bonuses.[iii] ESG compensation rules are often ambiguous. If ESG compensation replaces bonus targets tied to share price performance, many executives could use their positions to insulate bonuses in a volatile stock market. Such insulated bonuses may spark a slew of corruption incidents which further aggravate the income imbalance within the company, thereby causing a series of problems, such as employee dissatisfaction.
Second, investors suspect companies may not truly believe in the value of ESG and simply promote these efforts due to the dividend of tying executive pay to ESG performance. Quite a few companies have adopted this trendy measure to keep up with other companies in their business environment – especially in European countries that are often considered “ESG sensitive.” For example, according to a PwC survey of 400 businesses that recently experienced economic stress, companies with clear ESG policies are able to access more flexible financing options. Almost 68 percent of UK businesses say they can access better financing options with stronger ESG credentials.[iv] Therefore, many companies will follow suit in this case, linking executive compensation to ESG performance in order to gain investors’ trust – even if companies may not really believe in the value of ESG.
Finally, it can be difficult to ensure that the data companies provide is fair. As Anywhere Sikochi from the Harvard Business School said, “When companies are more specific about the impact of their ESG policies, the disclosures tend to stir disagreement among the raters.”[v] Fair data helps investors compare different portfolios of companies in the absence of relatively consistent regulatory checks. Companies may provide incomplete data because they receive better ESG scores from external rating agencies, which are based on follow-up results from ESG compensation adopters and rely heavily on corporate reporting in calculating ESG scores. Such results may lead to many companies using ESG rating scores to mislead investors, resulting in unintended investment behaviors.
An objection to including strong ESG metrics raised by some scholars is that investors do not actually care about the relationship between executive compensation and ESG performance, since transparency can only satisfy investors in the short term. This is because large institution shareholders are passively held while smaller shareholders are largely incapable of forcing change.[vi] Savers buy wealth management products mechanically without worrying too much about what’s in the index. As Tom Gosling, executive researcher at the London Business School’s Centre for Corporate Governance, says, “one of my big fears about this sort of stampede towards including ESG targets in executive pay is that it’s likely just to lead to more pay and not more ESG.”[vii] Truly, it seems investors don’t care if their investments are going somewhere ‘responsible’. Because investors are unlikely to materially change behavior based on proper ESG performance, effective regulatory measures are needed to find out whether company executives are actually fulfilling social responsibilities, or just getting bonus compensation.
In all, while ESG compensation models may be used by some companies, there should be increased transparency between executive compensation and ESG performance investors, regulators, and activists. More recently, the SEC is working on a “compensation and performance” rule that would require companies to disclose the relationship between executive compensation and a company’s financial performance. Submissions should also include the company’s ESG metrics, said Monique C. Winkler, Regional Director of the SEC’s San Francisco Regional Office. “When executives withhold material facts from investors, as we allege in our complaint, the SEC will take action against companies and individuals to ensure we maintain fair and open markets.” The boards of companies pursuing ESG performance need to pause a little and give themselves some time to reflect over and over again: has CSR become the green mist that hangs over their heads? Are they just doing things that treat the symptoms rather than the root causes? These are the questions that every ESG participant should consider.
Iris Yu is a first-year MPA-PNP student at NYU Wagner, specializing in Social Impact, Innovation, and Investment (Si3). She is a self-identified ESG enthusiast.
[i] Temple-West, P. (2022, February 20). US companies add environmental and social targets to executive bonuses. Financial Times. https://www.ft.com/content/86102111-3361-43e6-8e86-3dc6dfe7bb6f.
[ii] Lucas, A. (2021, March 18). Starbucks shareholders vote against executive pay plan. CNBC. https://www.cnbc.com/2021/03/18/starbucks-shareholders-vote-against-executive-pay-plan.html.
[iii] Haddon, H. (2021, March 17). Starbucks Shareholders Reject Executive Pay Proposal. WSJ. https://www.wsj.com/articles/starbucks-shareholders-reject-executive-pay-proposal-11616020313?mod=business_lead_pos11.
[iv] PricewaterhouseCoopers. (n.d.). ESG ‘Bandwagon’ or Brave New World? – 550 businesses and investors weigh into the conversation. PwC. https://www.pwc.co.uk/press-room/press-releases/ESG-bandwagon-or-brave-new-world-550-businesses-and-investors-weigh-into-the-conversation.html.
[v] What Does an ESG Score Really Say About a Company? (2021, July 21). HBS Working Knowledge. https://hbswk.hbs.edu/item/what-does-an-esg-score-really-say-about-a-company.
[vi] Rajgopal, S. (2021, April 29). Are Companies Tying CEO Pay To ESG Because It’s Not Linked To Performance? Forbes. https://www.forbes.com/sites/shivaramrajgopal/2021/04/29/are-companies-tying-ceo-pay-to-esg-because-its-not-linked-to-performance/?sh=44bbc8776cdb.
[vii] Does linking ESG performance to executive pay actually make a difference? | Greenbiz. (n.d.). https://www.greenbiz.com/article/does-linking-esg-performance-executive-pay-actually-make-difference.