ESG-linked pay, PRI session

I was at an investment conference debating extra-financial linked (Environment Social Governance) pay.

A blog summary is at the PRI:

”….The case for ESG-linked pay

We heard some strong arguments for why ESG factors should be incorporated into pay. Firstly, executive remuneration is a matter of concern for investors when the levels of pay don’t correlate with corporate performance or value generated in the long-term. This is not uncommon, given that incentive plans don’t often work as intended. Secondly, there is evidence to suggest that ESG factors result in positive financial returns and hence portfolio performance. Given that the market doesn’t account for these factors adequately (Alex Edmans work) it would be sub-optimal not to consider them in incentive plans to help deliver long-term sustainable performance….”

In the overall debate, I’ve referenced the Purposeful Company work several times.

This argues (amongst other matters) for a large amount of long dated restricted stock plus incentives around material intangibles (strategy and extra-financial) - this is broadly the position I argued.

Of recent note:

The PwC study looking at EPS / Sharebuy backs and incentive pay.

A Caroline Flammer study suggesting CSR linked pay leads to increase in firm value, long term orientation and social, environmental initiatives and Green innovations.

This study examines the integration of corporate social responsibility (CSR) criteria in executive compensation, a relatively recent practice in corporate governance. We construct a novel database of CSR contracting and document that CSR contracting has become more prevalent over time. We further find that the adoption of CSR contracting leads to i) an increase in long-term orientation; ii) an increase in firm value; iii) an increase in social and environmental initiatives; iv) a reduction in emissions; and v) an increase in green innovations. These findings are consistent with our theoretical arguments predicting that CSR contracting helps direct management’s attention to stakeholders that are less salient but financially material to the firm in the long run, thereby enhancing corporate governance.

SSRN link for Flammer

Purposeful Company: Exec Pay Report

BEIS / PWC report.

PRI blog here.

Are Energy Executives Rewarded For Luck?

In an influential paper, Bertrand and Mullainathan (2001) show that energy executives are rewarded for high oil prices, which they term pay-for-luck. Almost twenty years later, performance-based pay as a portion of executive compensation has nearly doubled; total executive compensation has also nearly doubled; and new disclosure laws and tax rules have changed the regulatory landscape. In this paper, we examine whether their results and their interpretation continue to hold in this changing environment. We find that executive compensation at U.S. oil and gas companies is still closely tied to oil prices, indicating that executives continue to be rewarded for luck despite the increased availability of more sophisticated compensation mechanisms. This finding is robust to including time-varying controls for the firms' scale of operations, and it holds not only for total executive compensation but also for several of the separate individuals components of compensation, including bonuses. Moreover, we show there is less pay-for-luck in better-governed companies, and that pay-for-luck is asymmetric – rising with increasing oil prices more than it falls with decreasing oil prices. These patterns are more consistent with rent extraction by executives than with maximizing shareholder value.

Are Energy Executives Rewarded For Luck? Lucas W. Davis, Catherine Hausman (2018)

Link to paper here.