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In the run up to the peak of the 2022 AGM season, the link between executive remuneration and ESG targets has increasingly come under the spotlight. On 22 February 2022, Allianz Global Investors (AllianzGI), a German asset manager which supervises approximately €565bn in assets under management, several amendments to its 2022 voting policy. Alongside an expectation that companies in both the UK and US will disclose a diversity approach that goes beyond gender, European large caps are also encouraged to incorporate ESG key performance indicators (KPIs) into their executive remuneration policies, with AllianzGI threatening to vote against the policies of companies that fail to do so during 2023.

The link between ESG criteria and executive remuneration has also been addressed by the Pensions and Lifetime Savings Association (PLSA), which pension schemes for over 30 million savers based in the UK. On 23 February 2022, PLSA published its Stewardship and Voting Guidelines for 2022. Among other things, the guidelines ‘the increased consideration of remuneration through the lens of ESG factors,’ with PLSA stating that it ‘would like to see more packages linked to clear targets for performance against achieving a company’s ambitions to meet climate goals’.

Calls for issuers to link ESG metrics to executive remuneration have been on the agenda for some time. In March 2021, Cevian Capital, one of Europe’s largest activist investors, a statement arguing that ‘significant, measurable and transparent ESG targets should form part of senior management compensation plans for all European public companies’. The Swedish investment firm urged ‘European public companies to start, or accelerate, the development of such ESG targets for integration into compensation plans to be put to shareholder vote at AGMs in 2022’.

In November 2021, the UK’s largest asset manager, Legal and General Investment Management (LGIM) announced in its annual letter to the chairs of company remuneration committees that it is to stop providing almost all of its direct feedback to issuers in relation to executive remuneration. This is after the asset manager found that the feedback that it provided to companies was usually ignored. According to the letter, issuers wishing to consult on remuneration will instead be directed to LGIM’s policy documents on the subject, except in exceptional cases. Despite a less direct approach, LGIM’s clearly addresses ESG metrics in executive remuneration:

‘Companies that are exposed to high levels of environmental, social or governance (ESG) risk should include relevant and clearly measurable targets that focus management on mitigating these risks.

LGIM expects ESG topics to be incorporated into the strategy of the business, the delivery of which should inform how the business operates and its purpose. Where ESG metrics are included as part of the long-term incentive, we would not expect this to be weighted more than one-third of the total award. For those companies in high-risk sectors, where the health and safety of employees is key, we would expect a health and safety modifier to be introduced to the annual bonus and/or long-term incentive. LGIM expects to see awards reduced by at least 20% or more if there have been fatalities. ESG metrics should be meaningful, measurable, aligned to the company’s strategy and subject to third-party verification.’

Nevertheless, various institutional advisors in the investment space are becoming increasingly vocal with regards to the normalisation of this linking of executive pay packets to ESG concerns, with a particular focus on specific markets. In December 2021, leading proxy advisory firm, Institutional Shareholder Services (ISS), in its 2022 voting policy update for continental Europe that ‘financial and non-financial conditions, including ESG criteria, are relevant as long as they reward an effective performance in line with the purpose, strategy, and objectives adopted by the company’. More recently, proxy adviser Glass Lewis the monitoring of ESG related company data in an effort to better inform investors ahead of shareholder meetings. This an ESG Targets and Alignments Score for companies, outlining whether they link executive compensation to specific ESG areas, including sustainability and climate change. In related research on 25 February 2022, it found that of the US$6.96bn paid out to S&P 500 chief executives during 2021, approximately US$600m (8.6%) was tied to E&S performance, including US$515m from short-term incentives and US$83m from long-term incentives.

Voting trends for 2021

Alongside AllianzGI’s amendments to its voting policy, the asset manager outlined how it voted during 2021, stating that at 68% of 10,190 shareholder meetings it voted against, withheld or abstained from at least one resolution, and it opposed 21% of all resolutions globally. The US proved to be the most contentious market, with AllianzGI voting against 40% of resolutions. On the other hand, the UK was the market where dissent was the lowest, the asset manager opposing only 4% of resolutions overall. Unsurprisingly, remuneration received the highest levels of opposition, AllianzGI voting against 20% and 84% of UK and US remuneration agenda items respectively.

According to Market Tracker data, the 2021 AGM season saw 53 FTSE 350 executive remuneration resolutions (36 remuneration reports and 17 remuneration policies), receive significant no votes (resolutions that receive at least 20% of shareholder votes cast against). Of the 53, the average level of investor opposition was 32.5% (33.2% for remuneration reports and 31.0% for remuneration policies).

So far during the 2022 AGM season, there have been ten FTSE 350 executive remuneration resolutions that received significant no votes (seven remuneration reports and three remuneration policies). Average investor opposition for the ten resolutions was 33.9% (34.3% for remuneration reports and 32.8% for remuneration policies). Market Tracker will be releasing a report later this month, which looks at key issues for companies during the 2022 AGM season, with a particular focus on voting and executive remuneration.

With the 2022 AGM season to begin in earnest this month, it will be interesting if investor dissent is even more prevalent this year, as well as whether any of the dissent will be due to the failure to link executive pay to ESG criteria.

How are companies approaching this?

Companies are mindful of the increased pressure to align executive remuneration with ESG targets. Market Tracker notes that a number of companies have addressed this in their 2021 Annual Report. Darktrace, a new entrant to the FTSE 350 in 2021, stated that the connection between ESG metrics and remuneration is on the agenda for consideration in 2022, yet fell short of committing to a defined plan of action:

The Committee has determined that for FY2022 it is appropriate to base the annual bonus on revenue metrics which are key to evaluating top line growth and business  performance. The Committee will consider during the course of FY2022 the likely timing for the introduction of additional financial measures into the bonus scheme as well as how and when ESG metrics might be included in our incentive schemes.

Watches of Switzerland also acknowledged the need to make progress in this area, confirming that the remuneration committee would address the matter in the upcoming review of the company’s remuneration policy. Some assurances were given in relation to ESG being factored into bonus and incentives, although no specifics were identified.

‘The Committee is also mindful of Environmental, Social and Governance (ESG) issues and the importance of linking executive pay to ESG goals. It is an area that is being reviewed more broadly and as the Company develops its strategy more fully in this area, the Committee intends to review the current incentive framework to determine how to better link Executive Director remuneration with ESG performance. This is an area that will also be considered as part of the Committee’s review of the Remuneration Policy next year. In the meantime, for future bonus and LTIP awards the Committee intends to review ESG factors as part of its holistic assessment of the overall appropriateness of pay outcomes.’

Genus was one of a few companies we reviewed that had committed to a link between executive pay and ESG targets. The animal genetic improvement company, which operates in the controversial field of genetic modification, also noted the potential impact of its sector on wider environmental and sustainability concerns.

The Annual Bonus will continue to be assessed through key financial metrics (adjusted profit before tax and generation of free cash flow), alongside a number of identified strategic measures that have been set for each Executive, including targets specifically linked to environmental, social and governance (‘ESG’) metrics. Just under one-third of the strategic element will be assessed against environmental and sustainability targets for the business, recognising the importance of this topic for wider society, but particularly acknowledging the role that our sector can play in this area.

More detail on individual FTSE 350 annual reports can be found in our Market Tracker transaction database, which contains summaries and deal documents on over 7,500 public company transactions (a subscription to Lexis®PSL is required).