Every year, Hugessen Consulting conducts a review of the proxy circulars filed by the constituents of the S&P / TSX60 Index to report on trends in executive compensation and related governance practices among Canada’s largest and most influential companies.
This year, we expanded our focus on TSX60 issuers’ use of environmental, social and governance (“ESG”) metrics in executive compensation. This article provides a summary of our findings.
A full recording of Hugessen’s TSX60 Webinar on Emerging Trends in Executive Compensation and ESG can be found here.
As of the 2021 proxy season, approximately two-thirds of TSX60 companies have incorporated ESG metrics into their short- or long-term incentive plans (“STIP” and “LTIP”, respectively). Traditional health & safety metrics remain the most prevalent, followed by talent-related metrics (including diversity, equity and inclusion, or “DE&I”). Customer-focused metrics and environmental metrics were also observed.
The number of TSX60 companies using ESG metrics remained relatively steady year-over-year, despite the ever-growing interest and focus on ESG factors from stakeholders (which has only been amplified by the COVID-19 pandemic). However, the inclusion of ESG factors into compensation programs is not always a straightforward exercise. In general, the most effective measures will flow from a company’s ESG strategy (which remains in the nascent phase for many organizations). Over the next few years, we expect to see increasing prevalence and more diverse examples of how issuers incorporate ESG considerations into compensation plans.
To date, ESG metrics have been incorporated primarily in the STIP: 73% of TSX60 companies that incorporate ESG metrics do so in just the STIP, and 24% have ESG metrics in both the STIP and LTIP. Where ESG metrics are used in the STIP, the average weighting in the scorecard is 20%. As companies’ ESG strategies evolve, we expect to see an increased used of these metrics within LTIP given the longer-term nature of many of these metrics (i.e., especially those centered around environmental performance and DE&I initiatives).
Disclosure surrounding the specific measures and objectives underlying these ESG metrics tends to be lean. As companies explore the incorporation of ESG into incentives, some organizations are understandably allowing themselves leeway to fine-tune the program as their processes mature. Focus and growing interest are observed in the social (i.e., human capital) and environmental categories, which are further explored below.
Human Capital Factors
We observed 18 instances of TSX60 companies including talent or human capital related metrics within executive compensation programs, making them the second most common ESG metrics, after health & safety measures. The majority of talent-related measures are focused on employee engagement or investing in people. There are also 4 instances of TSX60 companies including DE&I measures in compensation plans.
Specific examples include:
None of these examples clearly define their DE&I metrics; this may indicate that these metrics remain highly subjective, or that companies are choosing not to disclose the specific measurement methodology. In contrast, many high-profile US companies introduced or announced plans to include specific quantifiable DE&I objectives into incentive plans during the 2021 proxy season (e.g., In January 2021, Starbucks announced that a portion of executive’s LTIP grant will be tied to a target of growing the chain’s diversity in managerial ranks over three years).
Within the TSX60, 11 out of 14 observations of environmental metrics were at companies in the extractive industries (e.g., Materials and Energy). Interestingly, of these 11 occurrences, two are within LTIP performance frameworks. These metrics tend to be geared towards environmental risk: examples include disaster avoidance, compliance to environmental assessments or industry benchmarks, and greenhouse gas (“GHG”) emissions reduction as a forward-looking metric.
Select examples include:
The following has been adapted from our US partner firm’s (Semler Brossy Consulting Group) series on 2021 ESG &Incentives. For additional information, see their most recent report here.
Semler Brossy found that 57% of companies in the S&P 500 include an ESG metric in either their annual or long-term incentive plan. DE&I is the most prevalent ESG metric ahead of more traditional metrics such as customer satisfaction and safety, with other human capital metrics (i.e., talent development and retention) also among the top five.
DE&I is at the intersection of two distinct trends: A growing focus on racial inequity brought to the forefront in 2020, and the increased attention on human capital management. DE&I prevalence in incentive programs among S&P 500 increased by 19% year-over-year for proxies filed between January and March of 2021 compared to 2020, as companies felt urgency to add DE&I metrics in response to the high degree of focus on racial inequity in the US.
Environmental measures continue to round out the bottom of the list, with 14% of companies including these metrics. These metrics’ prevalence is expected to continue to grow as investors call for net zero GHG emissions targets and integration of ESG in compensation.
Year-over-year, the most commonly added metrics were safety, customer satisfaction, and DE&I. Nearly all COVID-related safety additions were incorporated into individual components, implying that Boards considered the treatment of employees during the pandemic (i.e., employee health and safety) in a retrospective assessment of executive performance. As a result, the increased use of safety measures is not expected to be permanent.
High-performing Boards are taking action as they continue to navigate the changing ESG landscape. These are informed by our firm’s work with Boards through our Board Effectiveness practice. Recommended activities include:
Conclusion - What's Next?
Hugessen’s review of the TSX60 2021 proxy season sheds a light on the adoption of ESG into incentive plans. Moreover, we observe a refinement of metrics and increased disclosure of specific measurable objectives across ESG topics. TSX60 companies face ongoing shareholder pressure to incentivize ESG performance, particularly for those companies with significant exposure to climate-related risk. Moving forward, Boards must continue to monitor, manage, and oversee ESG. This will require identifying the specific issues most relevant to the organization, and establishing clear guidelines surrounding who “owns” ESG within the Board and its committees. Hugessen continues to work with Boards and management teams on the rapidly evolving topic of ESG strategy and its place in incentive plans.