More City workers face bonus cuts for failing to meet environmental, social and governance goals, but recruiters and employment lawyers warn that unless such schemes are well designed, staff could be left frustrated at pay cuts for supposed ESG failures.
“Before, bonuses were all very much about:’you delivered this much in revenue and you get X amount’,” a City recruiter who asked to remain anonymous said. out the answer.
“But with ESG, you have to show the employees how the system will be monitored and measured. Is it fair? Have they defined what ESG stands for? Who is auditing this? What is the data used to measure it?
Compensation has become a useful tool for companies to drive deliberate planning and action over ESG goals among senior managers. But the challenge around the architecture of such schemes could end up frustrating well-intentioned executives.
“If it is badly managed, it could create a sour taste in the mouth,” the recruiter said.
ESG investing has exploded in popularity during the pandemic. Critics have warned of the increased risk of greenwashing, and climate activists continue to push the financial sector to move faster towards net zero.
READEurazeo’s first female CEO Virginie Morgon on why she’s pulling’all the levers’ on ESG
Pay has emerged as a critical battleground for spurring firmer action.
A discussion paper on diversity and inclusion in the City, which included a proposal to link pay to metrics on diversity and inclusion, was published last year by the Bank of England, the Financial Conduct Authority, and the Prudential Regulation Authority.
Leading diversity campaigners such as Diary of a Black Man on Wall Street author J Derek Penn and Equality Group chief executive Hephzi Pemberton have argued that pay and bonuses should be linked to diversity and inclusion targets.
READ ‘Salomon sister’ Anne Clarke Wolff: Inclusivity will matter when’a trader loses $ 500k’ because they can’t keep a diverse team
And now the pace is picking up with action on the ground — FTSE-listed asset manager Schroders announced in April that it was tying fund manager and analyst remuneration to sustainability goals.
Analysis of the first 50 directors’ remuneration reports published by FTSE 350 companies this year show that 58% of bonus plans now include an ESG element, according to consultancy Alvarez & Marsal. The firm’s April report also found that 33% of share plan awards included ESG metrics in 2021, up from 17% the year before.
In April, Mastercard said it is expanding efforts to link executive bonuses to its ESG targets.
Picking metrics is’no easy task’
Introducing such measures is not without challenges, however.
When firms use financial rewards to incentivise staff, “there’s almost invariably unintended consequences of the behavior you’re driving to reach that outcome”, according to BDBF employment lawyer Tom McLaughlin.
“If you had a bonus linked to a carbon footprint, employees might feel pressure to reduce their air travel to meet that part of the target, but that could be harmful to long-term goals when face-time [with clients] is important, ”he said.
“It is something that employers have to keep under close review to see if it is working as intended. Employers need to not feel shame in reviewing and changing these arrangements if they are not working in the way it is intended.”
According to a 2021 Willis Towers Watson report based on a survey of 168 board members and senior executives, four in five companies are planning to tweak ESG measures in executive pay plans over the next three years.
“Selecting the right ESG metrics is no easy task,” the report said. “Most board members find it challenging to narrow down the discussion on suitable ESG metrics out of hundreds of options.”
More than half of those surveyed said that target setting was one of the most important challenges they faced when considering how to include ESG metrics in executive incentive plans.
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Twenty-eight percent said there was “unclear or insufficient” market practice and a further 23% said they preferred to wait and see how industry adoption unfolds before adding their own sustainability goals.
“The social agenda is quite varied and wide-reaching,” said Jeremy Orbell, managing director in Alvarez & Marsal’s executive compensation team in London. “Deciding what the areas of focus should be is quite complicated. Should you focus on something like diversity and make that a single metric that you focus on? Or should you try and broaden it out and look at a whole basket of indicators? ”
Orbell cites volunteer days as an example — a benefit some companies have that allows employees to take additional days off to volunteer at a charity in their community, for example.
“It’s a useful indicator, but if you focus on one thing like that, if you just pluck that out of the social agenda and that’s what we’re going to focus on, is that too narrow?” He added. almost an obsession with tracking one thing at the expense of everything else? ”
Crunch time for compensation
However, pressure continues to mount on companies to make sure staff take action on ESG by hitting them in the pocket.
The move to link ESG metrics to compensation “has accelerated a lot” in the last year and will continue to do so in 2022, Orbell said.
In 2021, a PwC report found that 45% of FTSE 100 companies had an ESG target in their annual bonus scheme, long-term incentive plan, or both.
The most common elements were social, focusing on diversity, employee engagement, and health and safety, and more companies are introducing environmental metrics.
READSchroders ties staff comp to ESG goals — here’s how this will impact pay
More than half of ESG measures in bonuses are output measures with a quantifiable goal, PwC’s research found.
Tying pay to ESG metrics is the future, according to Claire Skinner, a partner at executive search firm Heidrick & Struggles.
“In the flurry of commitments that have been made around ESG, people have come up with these bold statements and now they’re very much in the how of the execution of those goals and plans, and as we all know what gets measured gets done , ”She said.“ Therefore linking to executive compensation is increasing. ”
Paris-headquartered € 31bn private equity firm Eurazeo links 15% of all of its partners’ and managing directors’ bonuses to ESG targets, indicating how serious the firm is about sustainability, chief executive Virginie Morgon says.
“If you don’t meet” [the goals]then you don’t get that part [of the bonus]”Morgon told Financial News.
Tough action
Dangling financial carrots remains the only way to incentivise progress, according to some campaigners.
Anne Clarke Wolff, the founder and chief executive of women-owned investment bank Independence Point Advisors, told a FN panel in March that Wall Street will only change if there are “very clear incentives and penalties”.
“The moment at which a trader loses $ 500,000 because they can’t retain 80% of the diverse people who have been added to their team, or more importantly, the moment when a leader puts forward a woman on the most important transaction and sees a $ 500,000 benefit, ”Clarke Wolff said.
READTie banker pay to diversity, says author of Diary of a Black Man on Wall Street
J Derek Penn has called for the sector to tie diversity goals to compensation if it wants to improve.
“The most effective [method] Is to tie compensation to diversity and people-of-colour retention. Not enough firms are doing it. Money is our currency, and quite frankly, the only effective ones that I’ve seen is when diversity has been tied to compensation, ”he said.
But not everyone agrees. Some are more optimistic. When asked if financial incentives were the only way to push employees in the City to work towards sustainability-linked goals, Morgon said financial levers “are not magical”.
“You need to pull all the levers you can,” she said. “We’re all different. It is also about awakening people to what is happening now.”
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