ESG ambitions are not yet sufficiently reflected in executive remuneration

Edna Frimpong

Belgian listed companies are increasingly taking long-term value creation into account in their strategy  by making ESG criteria part of that strategy. However, the  executive pay criteria for those executives who have to implement the strategy  are not yet in step with this strategic trend, according to the Diligent 2022 Corporate Governance & Executive Pay Report. This is something to take into account for non-executives in the run-up to the AGM.

At more and more Belgian companies, non-financial ambitions are part of the strategy. This is in line with a shift that is taking place worldwide: from a short-term focus on profit optimization to a long-term vision on social value creation and impact. Performance criteria increasingly include non-financial criteria, such as sustainability goals and increased customer and employee satisfaction.

Remarkably, the use of these non-financial criteria is still limited when it comes to the remuneration of Belgian CEOs  and other top executives. The Diligent 2022 Corporate Governance & Executive Pay Report, co-authored by Diligent and consultancy PwC, shows that the financial key performance indicators (KPIs are dominant  in every single case in the executive remuneration of Belgian companies. On average, financial KPIs account for two thirds of the executive  remuneration of the listed companies in our study.

Remuneration does not match strategy

As a result,  executive remuneration does not coincide well with the non-financial ambitions of many companies. This applies to both short-term incentives (STI) and long-term incentives (LTI). Among LTIs, non-financial KPIs account for an average of only 14% of executive pay. On average, 86% of this part of the remuneration is determined on the basis of financial KPIs. With STIs, non-financial KPIs make up an average of 29% of the goals on which the reward is based - compared to an average weighting of 71% for financial KPIs.

Caption: Belgian companies include various non-financial KPIs in executive pay. These do not yet carry much weight when  the reward is determined.

Top 5 KPIs for Short Term Incentives

Diligent and PwC research shows that non-financial KPIs – and certainly ESG indicators – are used more often in STIs than in LTIs. One possible explanation is that it is more challenging to set relevant long-term ESG goals.  Most schools of thought  believe that short-term incentives usually present more flexibility for measuring individual performance goals.

In practice, companies will therefore initially choose to include more ESG factors in the STIs. The experience gained by linking achievable short-term goals to the STIs can then be used to improve the reward structure for short-term and long-term rewards. That is in many ways important. Where until a few years ago many stakeholders did not take the information on sustainable performance too seriously,  such information is now closely monitored. Stakeholders do not hesitate to call  organizations to account about the chosen sustainability goals and their translation into executive remuneration.

Payment structure in line with long-term goals

It is clear that many Belgian companies still have to take significant steps to align the remuneration of executives with the non-financial goals in the company's strategy. This requires the attention of executives and internal and external parties responsible for the remuneration policy. And not only the executives will  benefit. A well-considered remuneration policy also helps to better comply with laws and regulations. 

Since 2019, European companies have been required to prepare their remuneration reporting in line with the requirements of the European Shareholder Rights Directive (SRD II). This includes a comprehensive overview of the remuneration (and other benefits ) of executives. In addition, listed companies must explain how their remuneration structure aligns with the company's long-term goals.

Executives must focus on the long term 

Moreover, the legislator is not the only one who takes a critical look at the financial and non-financial goals that form the basis for executive remuneration. The global study Paying for good for all, published this year by PWC, shows that investors also encourage the inclusion of non-financial criteria in the companies they want to invest in.

Of the investors surveyed, 86 per cent want companies to include non-financial goals in executive pay. They expect that incorporating ESG factors into a company's strategy will improve its long-term financial performance and shareholder value.

The idea is that remuneration in line with that strategy helps executives focus on the non-financial factors that lead to long-term shareholder value, even if these are in conflict with short-term profit. This is definitely something to take into account for executives and non-executives involved in the remuneration policy at the annual shareholders meetings (AGMs). Executive  remuneration is definitely going to be on the agenda.

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Edna Frimpong
Edna Frimpong
Edna Frimpong is Head of International Research for the Diligent Institute, the governance think tank and research arm of Diligent Corporation. In her role, Edna leads corporate governance research projects and partnerships across the globe. She joined Diligent Institute after six years as Head of EMEA Research at CGLytics, the corporate governance analytics firm acquired by Diligent in 2018.