Be it presentations, business reports, or regulatory documents, you can’t get far in the corporate world without seeing a 1.5-degree-aligned emission reduction target. 

These goals are proffered by organizations and businesses of every size, aiming to limit global temperatures to those agreed upon in the Paris Agreement. 

Yet, each business does so with varying degrees of precision and effectiveness. Now, NGOs, investors, and activists are calling for a different way of ensuring emissions are reduced — by tying the pay of top bosses and CEOs to a company’s climate performance. 

“For many companies, executive remuneration can and should function as an accountability tool for climate performance,” says Danielle Fugere, President and Chief Counsel of As You Sow, a nonprofit chartering corporate social responsibility. “By tying executive remuneration to climate performance, companies hold current leadership accountable to achieving crucial emissions reductions year over year, while management is incentivized to do so.”

ACHIEVING EMISSIONS REDUCTION

When executed effectively, executive remuneration schemes would see top bosses financially compensated for achieving emissions reduction targets across all scopes of their business. That means reducing the company’s direct emissions (like fuel used to power a company’s equipment) and the indirect emissions resulting from business activities (waste disposal, employee travel, and long-term impacts of goods or services rendered). 

“For companies with material climate risks, tying remuneration to climate performance sends a credible signal to investors that the company is committed to its transition plan, all while creating an additional accountability mechanism for the board and shareholders alike,” says Peter Taylor, corporate program director at IIGCC, the Institutional Investors Group on Climate Change. 

“Delivering a credible transition plan will provide resilience against the physical risks of climate change, help navigate transition risks, and create new opportunities for growth and value creation. Executives should be incentivized to achieve this.”

Jacqueline Jackson is head of Responsible Risk Investment for the London Pension Collective Investment Vehicle. Her job is to develop strategies that help mitigate the financial risk caused by environmental and socioeconomic factors. For Jackson, tying executive performance to climate risk is a responsible approach for businesses, as it can lead to better risk management and reduced exposure to climate-related risk.

“By promoting sustainable practices, companies may also enhance their long-term resilience and potential for growth. Investors can benefit from improved company performance, reduced reputational risks, and enhanced shareholder value in the long run. However, it is still important to carefully consider the design of executive pay structures to avoid unintended consequences or any type of short-termism that might arise if not properly implemented,” she says. 

THERE’S A CHALLENGE

Yet CEOs’ excessive bonuses are a constant source of public fury, and many may wonder if they should receive top-ups to their paychecks. Even for those in the know, linking executive remuneration to climate is an idea with criticisms. CEOs tend to stay in a job for around five years, which might make it hard to deliver on long-term transitions; plus, they may be unfairly rewarded for short-term emissions reductions beyond their control — like the drop in emissions seen during the pandemic. 

Taylor says, “We would argue that remuneration committees should retain explicit climate-related discretion to amend outcomes. This discretion should be exercised diligently and clearly disclosed in line with the Investment Association’s Principles of Remuneration.” 

In countries like Japan, additional problems have arisen. “Remuneration linked to sustainability is not treated as a tax-deductible cost,” says Yasunori Takeuchi, CEO of Corporate Action Japan, a shareholder advocacy organization. “It is viewed as different from remuneration linked to financial performance.” Takeuchi adds that although a Corporate Governance Code was introduced in the country in 2015 — which outlines things like ESG goals and a company’s core values — “the process deciding executive remuneration is not transparent and fair, and the independence of the committee members are also questioned in some cases.” 

To combat this, an international community of investors is advocating for regulation on executive remuneration frameworks and new disclosure and taxation rules. Describing investor activist work as an ongoing process, Takeuchi says, “There is a strong need to establish standard rules for climate-related disclosure. Because it is not possible to check and monitor climate-related progress without appropriate disclosure.”

With so many factors at play, questions may be raised over whether linking executive pay to climate performance is worth the fanfare. According to those like Fugere, the answer is a resounding yes. She explains, “Some suggest this is a political exercise, but it is necessary risk mitigation.” Although she adds a caveat, “but the metrics matter.”

Jackson agrees, “Tying climate performance to executive pay is critical to addressing climate change and encouraging responsible corporate behavior. Non-financial factors should be and are as important as financial measures of success because, as we know and see all too often, social risks can very quickly materialize into financial costs.” 

However, throwing more money at top bosses is no environmental panacea. “Executive remuneration is only one tool in the box. It can play a valuable role in incentivizing transition plans, but we can’t put the cart before the horse: encouraging companies to set robust, Paris-aligned, and science-based targets through credible transition plans remains the priority,” says Taylor.

“Comprehensive climate strategies require engagement from all levels of an organization, effective governance, and a strong commitment to sustainable practices from the bottom up as well as from the top down,” adds Jackson. That might mean promoting a culture of sustainability throughout operations or recruiting junior employees with the right values rather than relying on financial incentives. “Diversity at the top will also be a critical factor if we hope to see genuine and effective action in the fight against climate change,” she adds.