As the ESG landscape continues to heat up, with investors and the SEC signaling heightened focus on human capital as well as sustainability and climate disclosure, a useful new piece from Semler Brossy exhorts us to “move cautiously” even as we embrace the new paradigm.
The article notes, consistent with what we are seeing at the Center, that the move to link ESG metrics, particularly D&I metrics, to pay seems to be driven more by companies themselves than by mainstream investors. Linking human capital metrics to pay may be a way to ensure that companies don’t fall short of public D&I goals or may be deemed necessary from an external optics perspective long before investors start demanding it. On the other hand, investor demand for human capital disclosures may make it difficult for companies not to create a link with pay, since once disclosed, expectations will be raised for improvement on year-to-year achievement.
- Consider the Risks. Companies need to consider the possibility that they will fail to hit public targets, or, even worse, that financials may suffer in the short-term if metrics are not well-balanced. Semler suggests “walking before you run”: track metrics for a period before incorporating them into compensation, or start with qualitative goals before moving to more quantitative ones. Consider, too, that it will be difficult to withdraw an ESG metric once instated.
- Deliberate Process. We are entering a period of experimentation when it comes to ESG metrics, and there will likely be no awards for first place. If boards are uncertain about the best way to incentivize progress on ESG metrics, using a scorecard approach first and then moving to hard metrics may be wise. Similarly, companies may start with metrics in the annual plan before moving to a long-term approach (or both).