Paying for net zero

Majority of European companies are adopting carbon targets in executive pay, but quality of implementation needs to improve new research from LBS and PwC shows

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Companies are increasingly using carbon targets as part of executive pay outcomes, a joint study by researchers at the Leadership Institute at London Business School (LBS) and PwC UK finds. The study, which analyses the carbon targets at 50 of the top major European companies, shows they have been included by nearly four out of five companies. The report reviews the quality of the implementation of ESG targets in executive pay in the STOXX Europe 50 constituents, with a particular focus on climate targets in pay, to see whether they can be included in an effective way that also meets investor expectations. Analysis shows that the vast majority (78%) of companies have now adopted some measure of carbon target in executive pay.

Almost all companies analysed say carbon is considered in executive pay, but there is a wide spectrum of approaches for how it has been adopted. At one end of the spectrum, carbon is just one item on a list to consider as part of a basket of qualitative ESG measures, while at the other end, carbon can be a separately weighted quantitative component of the incentive plan tied directly into strategy. However, only 14% of companies meet investor expectations that targets should be significant, measurable and transparent. The most common problems were a failure to disclose targets transparently and the lack of a clearly explained link to the trajectory of long-term net zero goals. Moreover, pay-outs on carbon targets disclosed in 2022 were high, averaging 86% of the maximum available, with over half paying out at 100%.

The report shows that 71% of companies subject to engagement by the investor climate group Climate Action 100+ (14 companies) have carbon targets in pay compared with 50% of companies outside this group (36 companies). Carbon targets also play a bigger role in incentives at Climate Action 100+ companies, with a median 13% weighting in the bonus as compared with 6% for companies outside the group. This suggests that investor engagement on climate is also influencing how companies design their pay plans.

Tom Gosling, Executive Fellow at LBS’s Leadership Institute, feels that the “momentum to include climate targets in pay is unstoppable. But if it’s not done well, there’s a risk that the practice just results in more pay not more climate action. Current levels of pay-out don’t seem consistent with the slow progress we’re making on climate change.”

“At the moment most companies aren’t meeting investor expectations for meaningful, objective, and transparent climate pay metrics. But there are some potential quick wins, in particular improving transparency about future climate targets and clearly explaining the link to the trajectory of longer-term net zero commitments.

“At the same time investors need to be careful not to be too prescriptive – climate targets in pay are not a panacea, and companies may have non-climate priorities that are more deserving of a place in pay plans,” adds Tom.