Case Study: Incorporating ESG Metrics into Executive Compensation

Discussions on environmental, social, and governance (“ESG”) topics are not new to companies in the energy sector. While oil and gas companies may have previously been considered ESG laggards, this perception has changed over the years; in fact, many oil and gas companies were the first to incorporate ESG metrics in their compensation plans (albeit typically limited to measurable health and safety or operational measures). In December 2018, Royal Dutch Shell PLC (“Shell”), the British-Dutch oil and gas company, went a step beyond health and safety compliance when it announced it would incorporate carbon reduction metrics into its executive incentive plan.

This article examines the process Shell undertook in implementing these metrics, and the role shareholders played throughout.

Shell’s Carbon Reduction Goals & Executive Compensation Timeline
Source: Hugessen Consulting

As illustrated by the timeline, Shell engaged with shareholders throughout the process of establishing carbon goals and incorporating those goals into the executive incentive plans. Although some shareholder resolutions received relatively low support (~5%), they still put the pressure on Shell by emphasizing their focus on ESG.

The response following Shell’s announcement that it would incorporate ESG metrics into incentive plans was somewhat surprising: ShareAction, a registered charity that promotes responsible investment, recommended voting against Shell’s compensation plan. This recommendation was driven by the fact that Shell’s 10% climate measure is outweighed in the Company’s compensation program by volume growth measures, which are achieved by increased fossil fuel output. While the introduction of a climate measure was a positive signal to shareholders, ShareAction argued that ultimately executives are still incentivized to “chase higher levels of … output” to the detriment of the climate and Shell’s long-term value. While it may initially appear as though the shareholder community was criticizing the very plan it had requested, in fact it was critiquing the effectiveness of the stated metrics. Given the media coverage of Shell’s initial announcement, it is no surprise that shareholders continued to follow the story closely and took this opportunity to signal their expectations to the market.

Shell’s approach to tying carbon reduction to executive compensation may still be a work in progress, but it has had a trickle-down effect throughout the oil and gas industry:

We expect that shareholders will be energized by these examples of “first movers,” and will continue to put forward resolutions and engage with companies on ESG topics. Furthermore, while not publicly disclosed, we recognize that these case studies appear at almost every industry boardroom table and are top of mind for companies when they consider implementation in their organization.

Although ESG metrics have become more prevalent in compensation plans over the past few years,[5] there will surely be bumps in the road as companies attempt to answer the questions that come with the development of any performance-based compensation program: What metrics make sense? What is the appropriate weighting? Should they be part of the short-term or long-term compensation program? What should the leverage opportunity look like – and what happens if the goal is not met? Shell was one of the first to tackle these questions under the watchful gaze of its shareholders and the broader investor community. We expect more examples to be disclosed in the near term; in particular, we will see how shareholders react to new ESG measures and their view of alignment with performance, integration with the company’s corporate strategy, and the degree of transparency in the short-term and long-term metrics. There will certainly be more learnings to come from each company’s unique path in incorporating ESG metrics in their executive compensation programs.

Article Sources:

[1] Reuters: “Chevron ties executive pay to methane and flaring reduction targets

[2] The resolution was developed in partnership with Follow This, and is intended to be presented at the FY2020 AGM

[3] Wall Street Journal: “BP Agrees to Draft Climate Change Shareholder Resolution

[4] CBC: “Canadian oil giants emphasize climate change and diversity as they compete for investment

[5] Hugessen Consulting: “Integrating ESG considerations into Executive Compensation Governance

Timeline Sources:

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

The Rise of Impact Investing: COVID-19 and the Evolution of RI

2020 feels different. Year over year responsible investing (RI) has gained momentum, but 2020 feels like a tipping point. It feels like the notion of “tipping point” has been used countless times to describe the state of the market, but 2020 feels different than other years.

The COVID-19 pandemic has devastated society and the economy as we know it, creating the “perfect storm” of environmental, social and governance (ESG) issues. This has accelerated both the need and importance for investors to take action. As we look forward to an economic recovery, we need to not only think about how to rebuild, but how to rebuild better.

Resilience Rules

The COVID-19 pandemic has provided the world with an opportunity to pause and an opportunity for investors to reflect on RI’s path forward. Undoubtedly, the stakes have changed over the past 6 months. The term “resilience” comes to mind when describing what investors should look for as they assess the ESG factors associated with investee companies – the capacity to recover quickly following difficulties and the ability to adapt – a fitting term for the current times.

The examination of ESG factors (particularly “E”) has historically focused on compliance and efficiency. While these are in their own right important concepts, there is a sense now that it isn’t good enough for companies to reduce costs through maximizing efficiency or to simply operate within the confines of their legal license to operate. Instead, the narrative of “building back better” will drive a shift in thinking towards resiliency and purpose. Take the oil and gas industry as an example.

There is little doubt of the impact that companies in this industry are facing and will continue to face going forward. Growth in renewable energy technologies continues to be strong, leading to a decline in prices. At the same time, the pandemic has very likely had a permanent impact on the demand for fossil fuels, meaning we may have seen peak demand for fossil fuels come and go in 2019.[1] The result is an altered supply and demand dynamic for oil and gas companies to grapple with. Mix in a commitment by the Canadian government to legislate net zero emissions by 2050 and to set more ambitious 2030 emissions targets (with a touch of more stringent regulation of course), and you get a scenario where the oil and gas industry needs to step up.[2] The good news is that this is already happening. However, while some of the largest players have made significant progress in improving their efficiency, they are now focused on positioning themselves at the forefront of the transition to a low carbon economy, including ambitious targets to cut oil and gas production and major organizational restructuring – a clear shift from efficiency to resiliency.[3]

Continuing with this train of thought, the most significant issues that we are facing today, including the climate crisis, systemic racism and the COVID-19 recovery process will not only require companies to become more resilient, but that they operate in a manner that is positively impacting the environment and society. For investors, it will be imperative to invest in companies who are on the right side of change, and not on the wrong side of it. These companies are not only resilient but will also be well positioned to meet changing consumer expectations and preferences. If investors do this, they can achieve the popular goal of “doing well by doing good”.

The Importance of Impact Investing – the “New” Kid on the Block?

Change, by definition, is difficult. As outlined in a recent report published by the Future Fit Foundation, our economy is not currently built to accommodate the concept of “purpose”.[4] Perhaps this is best captured in a quote by environmentalist Paul Hawken:

“We have an economy where we steal the future, sell it in the present, and call it GDP.” – Paul Hawken

Enter impact investing. As investors, we have the opportunity to allocate capital towards businesses that are demonstrating resilience and purpose; who are positioned to do well by doing good through achieving strong financial returns while positively impacting the environment and society. Investing with impact in mind will be a key concept for ensuring that the environment, society, businesses and our economy flourish. While impact investing isn’t without its challenges, such as defining and measuring impact, this is no reason to avoid it. Fortunately, the United Nations Sustainable Development Goals (UN SDGs) provide a holistic framework that can be leveraged by companies and investors to map their activities to areas that address global systemic challenges including climate change, inequality and poverty. These goals may have never been more important than they are today.

As an asset manager, we have been thinking quite a bit about impact investing and the SDGs, leading to the development and launch of the CI MSCI World ESG Impact ETF and the CI MSCI World ESG Impact Fund last year. Investing in companies that are contributing to positive environmental and social impact is increasingly becoming commonplace for investors that incorporate ESG factors into their investment decision-making process. This trend is likely to continue (and accelerate) as we enter a COVID-19 recovery process and continue to feel the impacts of systemic issues like racism and climate change. The transformation of RI into just “investing” has been a topic of debate in recent memory. With current events sparking a change in the way in which investors think about and approach RI, 2020 could be remembered as a year where we take a big step forward in the evolution of RI. While impact investing is certainly not a new concept, it’s positioned now to be the “new” kid on the block – the “new” RI.






RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.