Defining ESG: sustainability-linked remuneration schemes


Searching for sustainable companies has become a major market trend

Defining ESG: sustainability-linked remuneration schemes
June 28, 2021

Searching for sustainable companies has become a major market trend, boosted by greater corporate awareness of environmental, social and cultural issues reinforced by the COVID-19 health crisis caused.

It is increasingly clear that sustainability and the ESG principles (“environmental, social and corporate governance”) are a strategic cornerstone in most companies’ business because of their positive impact on employees, clients, investors and the company’s financial performance.

Employees and management prefer working for companies committed with society and the environment. Customers find companies focusing on sustainable development more appealing. And investors rely, e.g., on large fund managers to put pressure on companies to make specific environmental protection commitments, fight against climate change or ensure equal opportunity at all levels of society.

In this context, one of the strongest lines of action companies are developing to achieve sustainability is adapting their variable remuneration schemes. Until a few years ago, variable remuneration targets were only based on financial metrics like income, profit or the company’s stock market value. However, including ESG-related metrics is gaining significant ground in the last few months, and remuneration committees and other corporate decision-making bodies are facing a new challenge: redefining variable remuneration schemes based on these sustainability factors.

As entities increasingly include new sustainability factors, many companies, particularly large multinationals, have speeded up their ESG transformation, bringing together corporate objectives and employees’ actions through variable remuneration schemes. Some companies have modified the targets to receive bonuses, e.g., reducing CO2 emissions (Iberdrola); assessing customer satisfaction (Siemens Gamesa); eliminating single-use plastic (Inditex); creating sustainable value for shareholders (Repsol); and setting targets tied to sustainable financing (BBVA).

Of the three pillars of sustainable business management, the most commonly used in remuneration schemes so far are environmental objectives. However, there are increasingly relevant parameters related to social and corporate governance factors that (i) help assess companies’ relationship with their social context; and (ii) can significantly strengthen corporate values. Therefore, variable remuneration schemes are increasingly including, e.g., diversity and inclusion objectives, equal pay, disconnection policies or other social management aspects.

Implementing these remuneration policies and updating the existing ones is not easy, since there are several questions from a legal and corporate structure perspective. In particular, there are legal issues regarding:

  • The possibility of modifying remuneration policies unilaterally by the company, the need to follow the legal procedure for substantially modifying working conditions or entering into an agreement with the employee.
  • The need to establish social metrics before the start of the remuneration period. These social metrics should be as objective and attainable as possible and, particularly, within the employee’s effective scope of action.

    This poses the greatest legal challenge for these new policies, since the classic scheme based on reaching set targets (used for remunerations based, e.g., on sales, income or profit) will have to be replaced by the appropriate new social metrics (e.g., reducing CO2 emissions, closing the gender pay gap or promoting diversity).

    The starting point should be the remuneration policies that have been including, for several years now, targets more closely related to soft skills. To measure “S,” social criteria will include employee rotation ratios; results of employee satisfaction surveys to assess human resources management; number of internal and external training hours; or the number of projects or hours put into pro bono programs.

It seems that most Spanish companies will eventually have to face this new social reality (if they have not done so already). Adapting their remuneration policies to environmental, social and corporate governance aspects and implementing new policies including these variables will pose a major challenge, given the need to engage all employees in achieving a more sustainable company.

This will also require the help and involvement of different market operators, including legal advisors.

June 28, 2021