ESG Materiality | Analyzing the Growing Role of ESG Factors in Executive Compensation

by Katherine Collins of Putnam, 8/29/23

In a potentially positive trend for investors, the number of companies incorporating ESG metrics in their executive compensation plans has been growing.

In a new research paper, Management Incentive Compensation: Trends, Observations, and Value to Fundamental Research, we explore the importance of assessing management incentives, the characteristics that can inform incentive plan analysis, trends in how compensation plans have evolved over time, and considerations of emerging issues.

Understanding corporate incentive pay structures helps investors to assess the alignment of management compensation with shareholder and stakeholder interests and to better understand motivations that drive management decision-making. In our research, we highlight a number of individual company examples to bring these issues to life within a specific context. By examining the structures of long-term and short-term incentive plans, we believe that investors can gain insights into strategic priorities that drive long-term financial performance.

Our research conclusions note the following points:

  • Management incentive compensation has evolved over time.
    It has become more performance-based. In 2020, 94% of S&P 500 companies utilized performance-based share plans. It involves more metrics today, going beyond total shareholder return and incorporating more ESG metrics. The level of CEO compensation has also grown, with the average realized pay of CEOs reaching $25 million in 2020. This represents an 8% compound annual growth rate over 11 years.
  • Putnam's analysis focuses on understanding the structure and composition of incentive plans.
    Effective plan structures have relatively longer time horizons, a performance basis, reasonable compensation levels, and clear, consistent terms, in Putnam's view. Performance metrics that are well composed are business-relevant, appropriately ambitious, and financially material.
  • Business-relevant ESG metrics in incentive plans can potentially be additive when done in a way that emphasizes key attributes of relevance, additionality, specificity, and ambition. The number of companies in the S&P 500 Index that use ESG metrics in incentive compensation plans has more than doubled over the past decade. Companies held in Putnam's sustainable portfolios are also incorporating ESG-linked compensation plans more often than in the past. We highlight some examples in the paper.
  • Improving governance and incentive data can help us better understand the motivations of executives and top-level management.
    There is growing data available on average CEO pay relative to median worker pay, on broader employee ownership models, and on the effectiveness of stock-based compensation models. We are interested in new ways of assessing stakeholder alignment and new approaches that foster strong long-term performance, some of which are featured in the report.