Environmental, Social, and Governance (ESG) criteria are becoming ever more important in the realm of business management and corporate strategy. IESE Business School’s Professor Gaizka Ormazabal delves into the growing trend of companies linking ESG performance with executive compensation.
Environmental, Social, and Governance (ESG) performance is becoming a cornerstone of corporate planning. These criteria gauge a company’s dedication to making a positive societal and environmental impact.
The shift towards ESG performance measures represents a transformation in standard focus on financial performance.
As companies strive for greater sustainability, the concept of linking executive pay to ESG performance has emerged as a compelling strategy. This approach incentivizes executives and managers to prioritize long-term sustainability goals, rather than short-term financial gains.
Gaizka Ormazabal, Professor of Accounting and Control at IESE Business School in Barcelona, illuminates this evolving trend. He co-wrote the paper “Executive Compensation Tied to ESG Performance: International Evidence.” The paper studied nearly 4,400 companies in 21 countries to understand how ESG metrics are integrated into compensation plans.
Professor Ormazabal’s research reveals that, in 2021, 38% of companies tied compensation to ESG goals. This is a vast increase from just 1% in 2011.
This practice is particularly common in regions with stringent regulations, such as the EU. In the EU, 60% of companies included ESG metrics in their compensation contracts. Meanwhile, in the US, only 16.5% of companies considered ESG performance in relation to compensation.
The study shows that firms adopting ESG-linked compensation do see improvements in their ESG performance. Although the study notes no immediate financial gains or boosts in stock prices from implementing ESG pay, the longer-term implications for embedding sustainable practices within business operations are clear.
Companies prioritizing ESG performance are better positioned to attract and retain talent, secure financing from environmentally conscious investors, and build brand loyalty with customers who value sustainability.
Reducing Carbon Footprint: A manufacturing company could tie a portion of CEO compensation to achieving a specific annual reduction in carbon emissions. This could be measured through metrics like energy consumption per unit produced.
Improving Diversity, Equity, and Inclusion (DE&I): A tech company might incentivize its leadership team based on progress in closing the gender pay gap or increasing the representation of minorities in leadership positions.
Enhancing Supply Chain Sustainability: A retail giant could link executive bonuses to sourcing a certain percentage of materials from certified sustainable suppliers. This demonstrates a commitment to ethical labor practices and environmental responsibility throughout the value chain.
The decision to link executive compensation to ESG performance is not one business leaders should take lightly. Professor Ormazabal cautions against adopting this approach to compensation without a reason.
“Do not do this because everybody is doing it,” Professor Ormazabal stresses, “Do this if you have a clear idea of why you want to. Either because you are concerned about how ESG risks may affect you in the future. Because you have a certain type of stakeholder that is pushing really hard for this. Or because you have made a commitment and you want this commitment to be credible. If you cannot classify yourself in either of these three buckets, then it might not be a good idea.” (01:44)
In light of Professor Ormazabal’s advice, businesses should adopt a strategic mindset rather than blindly following a trend. Organizations should link ESG performance and compensation with a clear understanding of the specific outcomes they aim to achieve.
The importance of integrating Environmental, Social, and Governance performance continues to rise. While linking ESG metrics to executive compensation is a notable strategy, it’s just one of the myriad ways organizations are advancing their sustainability agendas.
If you’re looking for a school where they practice what they preach, IESE Business School is a leader in promoting sustainable business practices. The school integrates sustainability into its study programs and even measures its own carbon footprint, aiming for continuous reduction. Their Institute for Sustainability Leadership conducts research and fosters dialogue among business, academic, and community leaders to create solutions for a more sustainable future.
Over the past decade, IESE has implemented a comprehensive range of measures aimed at enhancing sustainability. The school achieved an 80% reduction in CO2 emissions per square meter in that time.
IESE’s master’s degree curriculum is grounded in a general management approach, emphasizing ethical leadership and responsibility. Choosing to study at IESE means joining a community passionate about making a difference.
To delve deeper into what IESE Business School has to offer, explore IESE’s school profile and read our articles based on interviews with IESE alumni.
