How Carbon Reductions are Currently Factored into Executive Pay
As a fundamental driver of change to achieve global Net Zero by 2050 goals, As You Sow has begun to analyze the specifics of whether and how companies include greenhouse gas (GHG) emissions reduction targets as separate, explicit metrics in their executive compensation plans. Investors believe that linking climate performance and greenhouse gas (GHG) emission reduction targets to executive pay is a critical way for corporate boards of directors to incentivize companies to stay on track to achieve short, medium, and long-term emission reduction goals.
While our analysis is ongoing, we thought it useful to report initial findings as to where companies are in the process of bringing climate change metrics into pay packages and/or improving current climate-related metrics. We focused on disclosures made in the proxy statements of 48 mostly large carbon emitters. The key takeaways from our initial research are:
· Few of the companies surveyed make the attainment of specific GHG reduction targets an explicit element of executive pay.
· Some companies refer generally to attaining long-term GHG reduction goals, but with limited details by which to measure attainment, and more state that one element of executive pay is the attainment of sustainability, environmental, or operational safety goals, without providing sufficient details as to particular measures or relative weights between the various components.
· Universally, GHG reductions appear to count for a very small portion of total executive compensation, even among companies that make more specific disclosures.
The tide appears to be turning, however, based on the considerable pressure from shareholders for more and better disclosure. As indicated below, several of the proxy statements we examined for the 2021 annual meetings indicate that their company has adopted new policies for future years.
For example, in response to a shareholder proposal by As You Sow, Valero Energy announced in March 2021 that, for long-term incentive pay (LTIP) awards, the company would use a new “Energy Transition Performance Measure.” According to the Form 8-K announcing this change, the performance measure could increase or decrease LTIP payout by up to 25% based on total shareholder return relative to peers, based on: (1) Valero’s annual progress in achieving its publicly announced greenhouse gas (GHG) emissions offset/reduction target, and (2) the percentage of Valero’s growth capital expenditures deployed for low-carbon initiatives versus an annual target. The capital expenditures for this component must meet or exceed a minimum return on invested capital (ROIC).
Turning then to the specifics:
Typically, an executive’s pay package includes a base salary plus two forms of “incentive pay” that are intended to align executives’ interests with shareholders’ interests:
(1) "long-term incentive pay" (LTIP – options and restricted stock that are paid out over a three- to four-year period), which is usually 60%-70% of total executive pay, and
(2) the annual bonus (typically cash), which is generally 15%-20% of total executive pay.
Of the two forms of incentive pay, a link between carbon emission reductions and LTIP is more significant than a link to an annual bonus, as the LTIP makes up a significantly larger portion of executive pay.
We note that while a few companies may be creating incentives that directly link success in achieving GHG related reduction targets to executive compensation, as the examples below indicate, there is still a long way to go.
Few of the companies surveyed make the attainment of specific GHG reduction targets an explicit element that counts as a fixed percentage of executive pay. We have, however, identified companies whose links are more explicit than most other companies. The following observations are compiled from disclosures that companies made in their most recent proxy statements (companies listed in alphabetical order).
We identified four of the 48 companies analyzed that made explicit links between a fixed percentage of executive pay and achieving specific goals for GHG emission reductions.
AES – links 5% of annual incentive pay for “decarbonization” consistent with GHG reduction goals and identifies target; 5% for “strategic capital initiatives” citing a target ”$1B through clean energy or 3rd party Fluence EV [an energy storage joint venture] of $750M. “
Ameren – awards 10% of Performance Share Units in LTIP based on “pre-established goals related to the total MW tied to renewable generation and energy storage additions. This measure includes MW associated with new wind, solar, biomass, landfill gas and energy storage added to Ameren’s generation portfolio over the three-year period.”
Marathon Petroleum – assigns “greenhouse gas intensity” as a factor for 5% of annual incentive compensation (which is 17% of target CEO pay) = 0.85% of total pay.
Southern Company – ties 10% of CEO LTIP pay to achieving specific megawatt reductions each year, either by adding zero-carbon megawatts and by eliminating coal or gas steam megawatts, with specific targets set for each year. The 100% payout target is set based on the trajectory needed to meet Southern’s 2020 goal of a 50% GHG reduction by 2040. There is a 150% payout stretch goal, which is set about 60% higher than the target three-year net MW change goal, meaning that there is more challenging to reach the maximum payout for the 2020-2022 performance period. The threshold for 2020-2022 is set to the garget for the 2019-2021 goal, so there is no payout if the target for the 2019-2021 performance period is not reached.
The following companies cite generalized links to attaining long-term GHG reduction goals, but with limited details. Some state that one element of executive pay is the attainment of larger environmental, sustainability, or climate-related goals. Others make statements linking pay to the attainment of operational and strategic goals or “environmental, health, and safety” goals, which may be climate-related.
American Electric Power – has LTIP metrics including “non-emitting generating capacity growth,” which “includes nuclear, hydro, wind, solar, energy efficiency, demand response, and storage capacity owned or contracted by the Company as a percentage of AEP’s total owned and contracted generating capacity. This performance factor measures the increase in the Company’s non-GHG emitting generation capacity as a percentage of total generation capacity from January 1, 2020 to December 31, 2022.”
Chevron – links 15% of an annual award to “environment, health and safety” factors, and one factor is “greenhouse gas management,” i.e., whether Chevron is “on track to achieve oil, gas, flaring, and methane intensity reductions.” With a total of three EHS factors, GHG reduction is perhaps 5% of total annual incentive pay (which overall is 14% of target CEO pay) = 0.7% of total pay.
Duke Energy – added annual bonus metrics in 2021 that focus on reducing the carbon footprint from electricity generation by at least 50% by 2030 and achieving net-zero emissions from electricity generation by 2050; the compensation plan includes a nuclear reliability objective and a renewable availability metric to measure the efficiency of Duke’s generation assets.
Lockheed Martin Corp. – has an annual incentive plan that includes “strategic and operational performance assessments” of executives, including diversity and sustainability, the latter defined by reference to 14 elements, none of which is related to climate, apart from “energy management.”
Raytheon Technologies Corp. – will, starting in 2021, incorporate in its annual bonus plan a “scorecard with objectives,” one of which will be ‘Sustainability & Safety’” and account for 10% of annual target bonus. The proxy does not specify the elements of the “Sustainability & Safety” metric.
GHG reductions appear to count for a very small portion of total executive compensation, even among companies that make more specific disclosures.
As indicated above, most of the companies surveyed include GHG reduction goals or environmental goals as a very small percentage of an executive’s annual bonus, which is generally targeted at 15% to 20% of total executive pay. We identified only two companies (Southern and Ameren) that make emission reductions an element of an executive’s long-term incentive pay.
As You Sow is continuing research on climate links to executive compensation, and we would be interested in hearing of other companies, including non-S&P 500 companies with credible linkage that may incentivize change. It is critical that boards of directors find a way to incentivize executives to focus on the long-term. Investors nearly universally agree that the most important long-term issue is climate. It is past time to focus compensation practices on the most important issue to incentivize climate action.