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‘Creating a different mousetrap’: The risks of linking executive pay to ESG

As wages lag rising inflation, NEI Investments warns that rewarding executives for sustainable achievements risks creating perverse incentives and exacerbating inequality.

The trend for linking executive pay and compensation to ESG targets may have unintended consequences that investors need to address, the director of corporate engagement at Canada’s NEI Investments tells Responsible Investor.

More companies are doing it and more investors are pushing for it, which is a net positive,” says Jamie Bonham. “But are we still happy if an executive gets paid $30 million to meet those ESG targets? Do we have an opinion on whether the amount we pay an executive to perform against ESG criteria can become the ESG risk itself?” 

Bonham’s comments come as the topic of executive remuneration is rising up the agenda of investors, companies and regulators. With wage growth lagging, inflation soaring and CEO pay packages bounding back to pre-pandemic levels, it is expected to feature prominently during this year’s AGM season. 

NEI Investments has been engaging with a raft of US and Canadian banking giants regarding equitable compensation. Bonham admits, however, that the process can be challenging – and notes that investors partly have themselves to blame. 

“Investors said, ‘We want you to link your pay to our share returns.’ So companies did. I don’t think anyone had the current levels of compensation in mind when we supported the brilliant idea to link executive pay to share price. But quite clearly the concept, as it is currently understood, of pay for performance has engendered runaway compensation and that is our legacy to address.” 

NEI Investments has a cap and will vote against the pay package and possibly the compensation committee at a firm – regardless of performance or ESG metrics – where this is exceeded, Bonham says. “But we don’t want to vote against everyone.”  

He also warns that investors should be mindful that companies do not structure them in a way that has negative trickledown effects. 

“For example, if you have a lagging indicator like safety performance as a metric, it could have the perverse effect of people not being able/comfortable to report on incidents or to talk in a frank way about challenges as there will be this mindset and pressure that the metric has to be met in order for bonuses to be paid out.”  

Bonham says investors are increasingly becoming aware of the risks of linking ESG performance and compensation.

“I’ve heard others agree and express the need to be careful as we’re just building a different mousetrap, where the outcome ends up being the same for executives.

“Yes, remuneration is linked to ESG performance, but it’s still going to be exorbitant, and it is not going to deal with the systemic risks of growing inequality. It’s only going to make it worse, because now it is justified with the shine of ESG.”