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Blue-chips shift to ESG metrics to reward top executives

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A growing number of blue-chip US companies are using environmental and social factors to decide bonuses for top executives, but investors are worried the metrics are being gamed to increase payouts.

Three-quarters of S&P 500 companies have disclosed that environmental, social and governance metrics contributed to executives’ pay, up from two-thirds of companies in 2021, according to data from The Conference Board and Esgauge, an ESG data analytics firm.

Among them are American Express, Dow and Southwest Airlines.

More than half of all S&P 500 companies have diversity and inclusion components in executives’ pay, according to Semler Brossy, a consultancy. Almost half of these businesses included environmental metrics as part of bonuses, up from a quarter of companies in 2020.

Since 2015, pay factors tied to profitability and business matters have declined at more than 13,000 global companies, while environmental and social pay factors have surged, according to ISS ESG, a division of Institutional Shareholder Services.

Now some of these determinants of executive pay are coming under fire from asset managers.

“We are sceptical of ESG metrics being used in compensation,” said Ben Colton, head of stewardship at State Street Global Advisors, which manages $3.79tn. “Oftentimes they are very subjective, fluffy and easily gamed.”

At Southwest, chief executive Robert Jordan’s pay increased 76 per cent to $5.3mn last year even though the airline angered passengers by cancelling more than 16,700 flights during the holiday season.

Southwest, in a regulatory filing earlier this year, said the December cancellations negatively affected executives’ bonuses, but added: “With respect to ESG initiatives, including DEI and sustainability, the [board] determined that the company performed above target-level expectations.” DEI stands for diversity, equity and inclusion.

The pay plans at Southwest have drawn fire from Strive Asset Management, a conservative-leaning firm that has criticised ESG investing principles.

Strive was co-founded by Vivek Ramaswamy, now running as a Republican in the 2024 US presidential primary. In a letter this week to Southwest it said: “There is no easier way to cut the company’s carbon footprint than to ground thousands of flights.”

Southwest did not respond to requests for comment.

Other asset managers support companies including ESG metrics in remuneration. UK-based Legal & General Investment Management has said that beginning in 2025, it wants to see net zero carbon emissions targets linked to long-term executive pay.

“We have taken a stance that ‘employee engagement’ is a poor submetric inside of ESG that some people are using that we think is troubling,” said John Hoeppner, head of US stewardship at LGIM. “We have frankly never seen a company ever score under median for employee engagement. These things can be gamed.”

About 190 executives at S&P 500 companies have an employee engagement pay metric, the Esgauge data shows.

Unlike financial metrics tied to earnings or share price performance, it is almost impossible for outsiders to tell if ESG pay metrics are worthwhile “or merely line CEOs’ pockets with performance-insensitive pay”, two Harvard researchers said in a January 2023 paper.

ESG in pay “enables executives to obtain extra compensation when equity pay is not rewarding”, Lucian Bebchuk, the director of the corporate governance programme at Harvard Law School and co-author of the research, said in an interview. “But they are happy to get extra compensation also when equity pay is rewarding.”

Credit card company American Express paid 15 per cent of executives’ annual bonuses for diversity, talent and culture achievements. But it is unclear how those achievements are met, the Harvard professors said in their research. “It is unclear whether there was a quantitative target or whether any increase (even of only one woman) would suffice.”

Chief executive Stephen Squeri earned the maximum annual bonus allowed by the company for 2022: $10.3mn, which was up from $8mn in 2021. Squeri’s total 2022 pay nearly doubled to $48mn from what he was paid in 2021 even as the company’s total shareholder return declined last year.

American Express declined to comment.

At chemical company Dow, executive pay ESG metrics include a “customer experience index”, which measures prospective customer sentiment, as well as workforce diversity. The diversity factor “does not disclose the relevant starting points at the beginning of the year”, the Harvard professors said in their paper.

ESG metrics comprised 20 per cent of executives’ annual bonuses at Dow. CEO Jim Fitterling earned a $3.5mn annual bonus for 2022, down from $5mn in 2021.

In a statement, Dow said its executive pay programme “is in line with market practice” and that it added “quantifiable ESG metrics” in 2020. The company said its 2022 sustainability report “provides the most recent quantitative and qualitative information supporting performance against our targets”.

Real estate company CBRE disclosed that chief executive Robert Sulentic did not meet the targeted financial objective that accounted for half of his annual bonus last year.

But he overachieved on five strategic goals that included boosting “employee engagement” and improving diversity, CBRE said. Excluding a one-time equity award, Sulentic’s pay increased by one-third to $18.4mn. The company disclosed that its total shareholder return declined last year.

CBRE and did not respond to requests for comment.

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