Embedding climate-related metrics in executive remuneration

As organisations face growing pressure to integrate climate-related objectives into their core strategies and deliver on climate commitments, aligning executive remuneration with climate-related metrics is gaining momentum.

As highlighted in the recent report from the Investor Group on Climate Change (IGCC) and Climate Action 100+, aligning executive remuneration with climate goals is a critical lever for driving meaningful action. For directors, this presents both the challenge and an opportunity to ensure that remuneration frameworks support the transition to a low-emissions economy alongside long-term value creation.

Executive incentives have long been used to drive financial performance, but their alignment with non-financial metrics, particularly climate targets, is still evolving. Incentivising climate-related outcomes through executive pay is a powerful governance tool, helping companies manage climate risks and capture opportunities.

Globally, companies are increasingly aligning long-term incentives (LTIs) with climate performance, though progress varies by region. The IGCC report found that 54 per cent of ASX200 companies now link executive remuneration to climate outcomes (up from 10 per cent in 2020). Nearly half (47 per cent) of ASX200 companies have incorporated climate-related metrics in short-term incentives (STIs) and 11 per cent in LTIs. In Europe, 80 per cent of companies now incorporate environmental and climate metrics in executive incentive plans.

While major financial institutions like Barclays and NatWest have recently removed climate targets from their annual bonus schemes, they’ve opted instead to integrate these metrics into LTIs that assess performance over multiple years. This shift reflects a broader trend of reevaluating the structure of climate-related incentives to better align with long-term sustainability goals.

In contrast, US multinational confectionary and food company Mars has demonstrated the effectiveness of linking executive pay directly to sustainability outcomes. Mars has achieved a 16 per cent reduction in total emissions since 2015, attributing this success to making sustainability goals as critical as financial targets in executive performance evaluations. By tying 20 per cent of overall executive remuneration to sustainability objectives, Mars emphasises environmental accountability alongside financial performance.

These contrasting approaches highlight the importance of carefully designing remuneration frameworks that genuinely incentivise climate action. While integrating climate metrics into LTIs can align executive incentives with long-term sustainability, it's crucial that these metrics are robust, transparent and directly tied to measurable outcomes. Boards must also ensure that such structures do not inadvertently dilute the emphasis on immediate climate actions.

In New Zealand, although linking non-financial metrics with remuneration is still in its early stages and is seen most frequently in health and safety-related measures, there is growing recognition of its importance. The 2024 Forsyth Barr Carbon and ESG ratings report found that 36 of the 61 NZX listed companies assessed linked remuneration to sustainability performance, however only six were linked as part of LTIs.

As regulatory and investor expectations continue to evolve, directors can use executive remuneration as a tool to drive both environmental sustainability and long-term shareholder value. The challenge for boards is to design remuneration frameworks that are both ambitious and achievable, fostering a culture of accountability and long-term value creation.

Chapter Zero NZ has produced a guide to incorporating environmental, social, governance and climate-related factors into employee incentive schemes. Starting with a clear set of principles, the guide emphasises the importance of setting measurable, industry-specific metrics aligned with the company’s climate transition strategy and balancing short-term and long-term incentives. Alongside discussion of the role of incentives in influencing behaviour, and trends and processes in management incentive schemes, the guide also includes a step-by-step process for effectively embedding non-financial and climate metrics and targets into incentive plans.

Executive incentives are a powerful governance mechanism for driving accountability and the remuneration committee’s role is essential to getting the right design and the right outcomes. For directors, the key takeaway is the necessity of a balanced approach. Incentive schemes should be structured to promote both short-term progress and long-term commitments to climate goals.

Considerations for directors:

• How can your executive/management incentive scheme (short-term and long-term) include non-financial and climate measures?
• Are the agreed measures and targets the right ones to incentivise action and not promote perverse incentives or drive unintended consequences?
• Are the metrics measurable, significant, congruent and material?
• Have you tracked the progress against your chosen measures over time and considered whether the incentives are providing the appropriate return on investment?
• What monitoring is in place to ensure incentives don’t lead to greenwashing?

 

*  AI assisted