October 30, 2023 Executive Compensation ESG & Human Capital Management Articles

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The State of ESG Goal-Setting Exploring the Gap Between Prevalence and Public Disclosure

The following information in this article is intended to provide market context on ESG goal-setting practices and our thinking on key drivers of these market trends. This information may be a helpful resource for companies evaluating their own disclosure practices regarding ESG metrics in incentives.

ESG metrics are increasingly prevalent in incentives, but disclosure has not kept pace.

In recent years, the prevalence of ESG metrics in executive compensation design has expanded. 72% of the S&P 500 companies include ESG metrics in their incentive plans, up from 70% last year and 57% the prior year. The implementation of ESG metrics has also shifted over time towards more formalized, weighted inclusion in plans such as discrete weighted goals and modifiers, away from discretionary measurement approaches.  

Fig. 1. Year-over-Year Metric Structure: Weighted approaches includes discrete weighted, scorecard, and modifier structures – Data provided by ESGauge

Although the use of ESG incentive metrics is maturing, public disclosure regarding specific metric goals in incentives is still limited. Companies employ a range of disclosure strategies that vary based on the type of metric, its structure in programs, and whether the metric goal is measured quantitatively or qualitatively. Most companies do not disclose ESG-related goals in proxies. Among those that do, disclosure practices range from providing full details on the leverage of a specific ESG metric (i.e., threshold, target, and max performance goals) to limited disclosure of performance highlights against specific metrics achieved during the year.     

According to our research, most companies with ESG metrics in their incentive plans (67%) do not disclose any detail on specific performance goals for their ESG metrics. Of these companies without detailed disclosure, 53% reveal key performance highlights achieved during the year in lieu of specific goals, while the other 47% do not provide any specific information on ESG-related goals or performance.

Of the 33% of companies that disclose specific ESG metric goals, practice is split between disclosing full details on the leverage of a specific ESG-related goal vs. disclosing some part of the leverage curve (e.g., target, threshold, max, or some subset of the three). Companies that disclose full details on the leverage of a specific ESG-related goal usually employ a quantitative goal. This disclosure may follow practice, as many companies do not assess ESG in a fully formulaic way and may allow for a degree of discretion in assessing performance around a ‘target’ goal.

Not surprisingly, details on ESG metrics and goals are most commonly disclosed at companies that have a discrete, weighted component of their incentive plan tied to ESG metrics. 77% of companies with this design for ESG disclose either full or partial details on the quantitative goals and performance. However, only 26% of companies have a discrete, weighted metric tied to ESG, so this remains minority practice.

Metrics included in scorecard, modifier, and discretionary structures in incentives are less likely to have associated goal disclosure than weighted individual metrics because these structures are more commonly measured with more judgement and discretion applied. Again, not surprisingly, the more qualitative the measurement framework the less detail that is provided. Companies that employ ESG metrics in a discretionary format only disclose any information about goals 6% of the time, while companies that employ ESG metrics in a scorecard or modifier format disclose information on goals 19% and 16%, respectively.

Fig. 2. Goal Leverage Disclosure Prevalence in S&P5001 & Performance Disclosure Amongst Companies with
No Goal Disclosure – Data provided by ESGauge

1 Source: The four categories of goal leverage disclosure are defined as the following: (i) Full Disclosure–discloses threshold, target and maximum goals; (ii) Target Only–discloses only target (neither threshold nor maximum goals); (iii) Other–discloses threshold, target and/or maximum goals alone or in combination, while not classified as Full Disclosure or Target Only; (iv) No Disclosure– does not disclose any threshold, target or maximum goals.

Fig. 3. Goal Leverage Disclosure per Metric Structure by Company – Data provided by ESGauge

Why is there a lack of goal-setting disclosure?

Shareholders and other constituents might want more detail around ESG goals in incentive plans. However, companies might limit goal-setting disclosure for three main reasons:

1. Manage Social & Legal Risk

Detailed public disclosure of ESG goals carries significant social and/or legal risk. For instance, underperformance on publicly disclosed diversity, equity, and inclusion (DE&I) goals may lead to external and/or cultural backlash. Sensitive to external signaling, many companies are “greenhushing” and erring on the side of caution when it comes to what information they disclose. The recent Supreme Court decision on Affirmative Action in higher education has further sparked concerns about disclosing ESG goals given the increased litigation risk associated with DE&I politicization. Companies value flexibility as they manage social/legal risks while focusing on advancing their ESG agenda and meeting shareholder and customer expectations.  

2. Limited Performance Measurement Capabilities

Due to increasing external shareholder pressures over the last few years, many companies quickly adopted ESG into their incentive plans before they had the measurement and tracking capabilities to assess performance quantitatively or set explicit improvement objectives. Some companies are still in the process of defining success (i.e., what is “good” performance), and learning how to evaluate performance most effectively with limited ESG market data. It is difficult to develop performance measurement systems for qualitative objectives and discretionary evaluation; consequently, the absence of a good measurement system will make it hard to define tangible goals.

3.Desire to Maintain Flexibility

Many companies are still in the process of determining which ESG goals are most important to their overall business and may not be prepared to publicly commit to key performance goals. Given the dynamic nature of ESG issues, companies can benefit from maintaining flexibility in which metrics they choose to focus on each year. In addition, even with clear goals and commitments, companies may hesitate to define success by just one or two metrics. Many companies, for example, are genuinely more concerned about creating a culture of inclusion that supports a diverse workforce, rather than just measuring diversity directly, and such assessments do not always lend themselves to explicit, quantitative goals.

In addition to the above factors, the SEC’s disclosure requirements allow limited disclosure in some contexts. For instance, qualitative goals don’t require disclosure unless the metrics are material to the company’s compensation policies and decisions, and companies may limit disclosure of internally managed metrics that may cause the company “competitive harm”.  

We are hearing reports that shareholders are questioning the commitment to ESG due to limited disclosure. There is a suspicion that ESG metrics in incentives are meant as a form of ‘greenwashing’ and/or are just another qualitative goal that may be used to drive pay without a clear performance link. This growing demand for more detail may push companies toward more explicit measures, goals, and disclosure over time.

However, given the factors outlined above, we anticipate that the pace of change toward more detailed and explicit goals and objectives may continue to be muted, especially considering concerns over the politicization of ESG in the U.S. In our experience, a lack of goal-setting disclosure does not necessarily indicate a lack of rigor in a company’s ESG metric goals. Rather, companies have often set meaningful goals internally that are intended to drive performance against specific ESG objectives. Companies will be challenged with the need to continue telling their story on ESG compellingly, even if they are not moving toward more explicit objectives in their incentive plans.

As always, linking ESG objectives and achievements back to the fundamental business rationale (why we are doing this in the first place) is always the strongest starting point for expressing and maintaining a company’s commitment to ESG, regardless of how this is implemented in incentives.

View the full article as it was originally published.

John Borneman

Matthew Mazzoni

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