Brian Niccol earned $17.2 million as CEO of
Chipotle Mexican Grill
last year, but some of his pay had nothing to do with burrito sales.
Niccol earned a $2.1 million bonus partly because Chipotle (ticker: CMG) met some of its goals in environmental, social, and governance (ESG) areas, including sourcing local produce and advancing a diverse workforce. A spokesperson for Chipotle said the compensation plan “sets the right example” for the company’s more than 100,000 employees.
Chipotle isn’t alone in tying pay to ESG targets. Over 60% of
S&P 500
companies included ESG measures in executive pay last year, up from 19% in 2019, according to proxy advisory firm Glass Lewis. Utilities and fossil fuel companies—facing some of the steepest risks to revenue as the world moves to cleaner energy—are most likely to include ESG factors in pay, followed by consumer-facing brands and financial institutions.
What’s unclear is the impact of ESG-related bonuses. Proponents say that aligning CEO compensation more closely to ESG targets will incentivize companies to take action in areas like workforce diversity or cutting emissions. Critics worry that ESG bonus criteria are often vague or too easy to hit—providing another way to increase executive compensation without having much impact on the bottom line, people, or the planet.
“Companies are using it to send a signal to investors and others that certain ESG issues matter to the management,” says Paul Washington, executive director of the Conference Board’s ESG Center. “I think they are serious about this, but my main concern is that it may not be effective.”
Many ESG targets in compensation plans are ambiguous and subjective. For example, companies might set “cutting carbon emissions” as a goal without specifying the percentage of cuts or whether they include “Scope-3” emissions, which are comprehensive measures covering a product’s environmental toll across its life cycle, from production to consumption.
According to proxy advisory firm ISS, only 13% of S&P 500 companies have specific ESG objectives in compensation plans, and just 7% also disclose information on the weighting criteria. “The majority of companies are being pretty vague about it,” says Joe Arns, executive director of ISS’s ESG rating branch.
Even when ESG targets are specific, there often isn’t enough context about their real-world impact, according to Harvard Law School professor Lucian Bebchuk. Such compensation components could be used by CEOs to inflate pay “with little or no accountability for actual performance,” he wrote in a 2022 paper.
Investors seem to agree the criteria should be toughened. According to ISS’s 2021 Global Benchmark Policy Survey, more than 50% of investors believe ESG goals should be used in executive pay only when they are “specific and measurable.”
Companies sometimes set ESG bonus targets for “dealing with low-hanging fruit,” says Rosanna Landis Weaver, a program manager at shareholder advocacy group As You Sow, which pushes for stricter criteria.
Take
Dominion Energy
(D), an electric utility. As part of its executive incentive plan in 2021, the company set a goal for 95% of employees to participate in a town hall about sustainability initiatives. That didn’t impress Weaver. “Everybody should be having these town halls, this isn’t what we should be paying extra for,” she says.
Dominion CEO Robert Blue received nearly $7 million in compensation in 2021, including a $1.75 million bonus partially thanks to meeting ESG goals. The company was rated above-average among peers by MSCI’s ESG ratings unit, partly due to its effort in water management. Dominion didn’t respond to a request for comment.
According to a recent report from consulting firm PwC, executives at Europe’s 50 largest companies received 86% of the maximum payouts for meeting carbon-emission targets last year, higher than the average payout rate of 75% for other performance measures. “Have these companies really done so well on climate?” the PwC authors ask. “This seems difficult to square with the consensus that overall progress on climate change is insufficient.”
Another concern: Companies are inclined to use “off the shelf” ESG metrics like board diversity and carbon emissions, even though they might not be material for their core business, according to the Conference Board’s Washington. He expects to see more company-specific ESG targets in compensation plans as firms assess the impact of hitting the goals on their business.
Linking ESG work to annual CEO bonuses could also lead to shortsighted decisions that aren’t the best approach in the long run. “If companies change to more efficient lightbulbs, they can get quick reductions in energy bills, but some of the other work requires planning and time, and it might not pay off in a day or two,” says Melissa Walton, a research associate at As You Sow.
Institutional investors generally favor adding ESG criteria to bonuses, says ISS’s Arns. “At this stage, simply having it in an incentive plan is a big step forward,” he says.
Whether it’s getting CEOs to push further into ESG, or simply giving them a pay bump for doing so anyway, has yet to be determined.
Write to Evie Liu at evie.liu@barrons.com
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