As investors increasingly push for executive pay to be tied to climate targets, real progress depends on using the right metrics to track performance, says the Canadian Climate Institute (CCI).
“It’s a simple, yet powerful idea: if a company underperforms on its emissions targets, executives receive less pay,” writes Arthur Zhang, a research associate with the CCI’s 440 Megatonnes project. But when companies choose unambitious metrics to evaluate performance, “climate-linked compensation risks being reduced to a box-ticking exercise.”
The trend of companies leveraging executive pay to align management practices and their climate goals is increasingly apparent in the TSX60, the index of Canada’s top 60 largest corporations, writes Zhang. As of 2022, a noteworthy 39 companies, more than half of the index, had adopted the approach—a significant increase from the nine that did so in 2019. The shift can be attributed, at least in part, to a growing number of businesses embracing net-zero emissions targets.
But simply tying executive pay to climate targets won’t have much effect if those targets are not ambitious, if the metrics used to mark progress are poor, or if incentives are weak. As it stands now, “it’s unlikely top executives will immediately take a big hit in their pay if their companies fall short” of environmental, social, governance (ESG) goals, the Globe and Mail reports.
Zhang points out that a lack of transparency, in particular, undermines the impact of performance pay. Metrics that track progress must be clearly defined to ensure accountability, but only 18 of the 39 TSX60 companies have explicitly published their emissions metrics, he says. The rest “only indicate that some undisclosed climate-related measures are considered when determining executive compensation.”
The weighting of those metrics—the impact of climate performance on executive pay—is also important, Zhang adds. But only 12 of the TSX60 companies have published that information. Among them, weightings range between 3.6% to 12% and are typically found in short-term incentive plans used to assess compensation for annual incentives.
Furthermore, two-thirds of the companies that tie executive pay to performance link pay to broader ESG goals. That makes it hard to ascertain what determines the outcome unless exact metrics and weights are identified.
“Without more information, it is difficult to discern whether the proper elements of effective climate-linked executive compensation are in place,” Zhang writes. “The metrics used to evaluate climate performance and the financial incentives in place both need to be ambitious enough to align executive performance with a company’s broader climate goals.”
