The final link in the chain of improving corporate accountability for sustainability is to tie improvements to pay. In our last article, we explained that companies should use incentives to motivate executives to tap big strategic opportunities related to environmental, social, and governance (ESG) goals.
Now we want to describe how these incentives should be designed. What implementation steps do you take? And how can you overcome the challenges that deter executives and directors from changing how company incentives have traditionally been designed?
The challenges are easy enough to identify. For one, the number of possible sustainability improvement goals grows by the day, which makes it increasingly hard to know which to pursue: sourcing resources more wisely, managing waste and CO2 emissions responsibly, acting as a good citizen, celebrating diversity among workers, and so on. For another, the years-long efforts to realize payoffs from most ESG initiatives rarely fit typical annual or three-year incentive timeframes. That’s particularly true when you’re working to achieve indirect or intangible payoffs such as burnishing your brand and reputation. Results can build over decades.
Perhaps the most significant challenge is that directors and management teams remain reluctant to base incentives on sustainability results that will show up in the financials. Why, they ask, should we squeeze nonfinancial sustainability measures onto the limited real estate of executive incentive plans if they’re going to boost returns or profits that are already measured in those plans? They don’t consider it appropriate to cut back the weighting of incentives based on standard measures of revenue, profit, and returns while increasing the weighting of less traditional and often nonfinancial ones.
Our experience suggests that there are five steps to designing sustainability incentives that effectively address these challenges. When taken in sequence, the steps allow boards and management teams to create incentives that signal their commitment to sustainability. Well-designed incentives can respond to internal and external stakeholders’ priorities as well as reinforce that sustainability efforts can have both financial and nonfinancial results. The steps are:
- Reexamine the context. Confirm that your company’s situation calls for explicit sustainability measures.
- Clarify the organizational scope. Determine which parts of the organization the incentives should apply to.
- Quantify the duration. Decide on the time horizon of your initiative, which will affect how your incentives are structured.
- Consider the means and the ends. Do the processes and behaviors used to achieve your ESG goals matter as much as, more than, or less than the results?
- Structure the incentives. Integrate the relevant metrics and payouts in designing your plan.
Now let’s look at each step in turn.