Could a New Approach to Linking Executive Pay and Climate Goals be a Game Changer?

ESG (environmental, social and governance) and DEI (diversity, equity and inclusion) programs may have come under fire lately, but that’s not stopping top-earning companies from linking the outcomes to executive compensation. The practice of linking DEI metrics to compensation among S&P 500 and Russell 3,000 companies increased by at least 20 percentage points over the last two years, according to the nonpartisan think tank The Conference Board. Likewise, the use of climate metrics by Russell 3,000 firms increased by 100 percent between 2021 and 2023, and it more than doubled among S&P 500 companies in the same period, from a quarter of firms to just over half.

Of course, how companies are integrating and measuring the metrics varies. TriplePundit spoke with Monica Batchelder, chief sustainability officer at the software and technology company Hewlett Packard Enterprise (HPE), about the company’s unique, strategic approach to implementing key performance indicators (KPIs) based on climate action. 

“Linking ESG metrics to executive compensation isn’t necessarily new,” she said. “It’s a growing trend, probably for like the last five years.”

Going beyond Scopes 1 and 2 to make a real difference

When HPE began instituting a climate-based management model, most of the companies that adopted ESG metrics for executive compensation focused more on social and human capital, like workforce diversity and talent retention, than environmental measures, Batchelder said. Those that did include the climate and environment were more centered on operational emissions, with eyes on Scopes 1 and 2.

“The problem with that is that for most companies the vast majority of your carbon emissions, your climate footprint, is linked to your Scope 3 emissions, which are outside of your direct control,” Batchelder said. “Our Scope 1 and 2 emissions are less than 3 percent of our total carbon footprint. So we didn’t feel it was a credible sort of strategy to link our carbon footprint to that. We wanted to go broader.”

A three-year plan for knowledge-based action

In order to do so, HPE took a three-part approach, rolling the process out over a span of three years. It used the first year to understand what needed to be done by giving executives the foundational knowledge for the action they would need to take, Batchelder said. Vice presidents and above were given training to develop this knowledge base, and completing the training served as their metric for that first year. Ninety-six percent of them did so. The second year was used to develop action plans, and 100 percent of the executives met the metric.

“Every member of HPE’s executive committee was tasked with evaluating how their team-specific remits could reduce the company's carbon intensity,” Batchelder said. “My team could have given each business unit a plan to execute, but our thinking was that having them self-develop their own plans and KPIs with our guidance actually caused them to do the mental gymnastics, so to speak, to figure out how to not just set a goal but actually operationalize it and put an action plan together … The approach [that we've taken] is unique in that every member of our executive committee is responsible for their specific contribution, as opposed to our overall climate targets as a company.”

HPE is currently in year three of the rollout, which means the executive teams will see their variable compensation tied to the KPIs in their action plans this year. Instead of measuring their performance-based pay by numbers, it will be based on how well executives execute their action plans. By looking at the metrics this way, leaders can’t rely on growth or chance to get them to their goals, Batchelder said. 

Can this strategy work for other businesses?

While shareholder expectations might influence linking ESG metrics to executive compensation, implementing this strategy is not correlated with increased profits, according to a 2023 study in the Journal of Accounting Research. Although this could potentially have a negative effect on the long-term inclusion of such KPIs, it’s not a given. After all, stakeholders’ expectations for corporate climate action are on the rise. But can HPE’s model be expanded to other companies and industries? That depends.

“There are certain industries where we have a better handle on the sort of maturity and evolution of our corporate carbon footprint, to the point that our executives feel confident tying their compensation to that and seeing their efforts reflected in the calculations that we report each year,” Batchelder explained. But, “in some industries … corporate carbon footprints are evolving in maturity, and that varies based on industry, as well. And it is challenging to tie executive compensation to metrics that continue to get re-baselined, and evolve, and that executives may not feel confident with.”

A stake in the game increases the likelihood of success

“Localized accountability ensures that all of our leaders are focused on the most impactful actions that they can take within their own domain, and it makes a strategy more actionable to them,” Batchelder said. “Because if you are just to say, ‘I’m going to link your compensation to a 50 percent reduction in emissions,’ that doesn’t mean anything. I don’t know how to action that if I’m an executive. I’m not a climate expert.”

Since emissions reductions are not linear the way other KPIs are, the action plans promote multi-year effort, she said. This is especially important considering the focus on Scope 3 emissions throughout the value chain versus the more easily controlled — and minimal in comparison — carbon footprint of the company’s facilities alone. 

The overall success of HPE’s strategy won’t be evident until the end of the fiscal year in October, but it appears to be a solid approach that’s motivating executives toward measurable outcomes by giving them ownership of the process.

“What was really important to us was that every executive in our company had skin in the game and also saw their unique role and ability to influence their climate KPIs,” Batchelder said. “Too often in this space inaction is a result of not understanding what you can do or feeling like the task of what needs to be done is too daunting for you to be able to make an impact on it.”