Investors approve executive pay that incentivises global warming

If shareholders are serious about pressing for net-zero alignment, they need to call for a reset

Natasha Landell-Mills, head of stewardship, Sarasin & Partners


Natasha Landell-Mills, head of stewardship, Sarasin & Partners

Executive pay polarises opinion. In the face of the climate emergency, however, we have an opportunity to unite behind a simple proposition. Executives should be rewarded for creating value in a way that is aligned with a stable climate. This requires a fundamental reset in pay.

It isn’t hard to see why we need to fix remuneration, especially at carbon-intensive businesses. We keep paying executives for activities that contribute to global warming.

In 2022 we saw Exxon’s crude oil production rise 6%. We rewarded the CEO with increases in bonuses and long-term incentive plans (LTIPs) of 88%. In the airline industry, International Consolidated Airlines Group’s (owner of British Airways among others) emissions rose 43% in 2022, and bonuses rose from nothing to £1.4m, pushing the CEO’s total package up over 130% compared to the previous year.

This is not to say boards are doing nothing. It is just that action to date amounts to tinkering around the margins; rather like rearranging the deck chairs as the Titanic sinks.

A review of 35 oil and gas companies’ executive pay by Carbon Tracker in 2022 reaffirms the point. Not only is pay still normally tied to production growth, but many have increased incentives to grow production. This is even true for the companies that have explicitly pledged to align with the Paris Agreement goals. BP, for instance, has promised emissions reductions of 20-30% by 2030, but 30% of executive pay is tied to production growth. Only around 10% could be described as transition-positive.

What Carbon Tracker found for oil and gas is repeated across most sectors, and especially carbon-heavy industries. Among the top 50 listed European companies, for instance, a recent study by PWC and London Business School found that while 78% had some form of carbon target linked to pay, this is normally added as a metric among many.

With performance targets in carbon-intensive sectors still pointing executives towards increasing emissions, we can hardly blame them for following the incentives we set. Investors not only approve these pay packages in most jurisdictions, but they also vote for members of the remuneration committees that draw them up. If shareholders are serious about pressing for net-zero alignment, they need to call for a reset and start using their votes to hold boards to account.

Best practice

What might climate-safe pay look like? One possibility borrows from the banking sector.

Following the financial crisis of 2007/2008, global prudential regulators were clear that they needed to shift executive incentives away from short-term metrics to an over-riding focus on longer-term capital health. The goal was to discourage risk taking at the expense of financial stability and social wellbeing.

In keeping with guidance from the Financial Stability Board, the UK has promoted key reforms for bankers’ compensation. A capital adequacy ‘underpin’ has been adopted by several banks to ensure that executives do not receive performance-related pay unless capital adequacy tests are met.

In addition, boards are required to implement malus and clawback mechanisms (the former deals with awards that have yet to vest, the latter where vesting has occurred) for variable pay awarded in the past that later turns out to have come from imprudent activity. These measures seek to elevate prudent capital management to the top of executives’ priority list to reinforce banks’ financial stability.

The logic for taking a similar prudential approach for climate risk management is compelling. Rewarding executives for short-term financial gains, achieved by contributing to global warming, puts society at risk. By inserting net zero underpins and/or climate malus and clawback provisions, incentives for climate harm would be neutralised.

This approach could be implemented quickly by inserting them into existing pay schemes, avoiding cumbersome renegotiations of existing performance metrics.

Importantly, responsibility for assessing whether the conditions for the net zero underpin, malus or clawback were met would sit with remuneration committees. Shareholders unhappy with the assessments could vote against remuneration-related resolutions and/or against remuneration committee directors. For the largest – and systemically important – carbon emitters, governments could vet adherence.

The climate is boiling yet we keep rewarding executives for activities that make it worse. If we were prepared to mandate prudence in banks following the financial crisis, we should be prepared to do the same for carbon-intensive companies in the face of the climate crisis.

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