Feet to the Fire: How Should Companies Tie Executive Compensation to Climate Targets?

Abstract

In recent years, many companies have made voluntary pledges to reduce their carbon footprint. In this Closer Look, we examine how some companies institutionalize their climate commitments through executive compensation contracts. We find considerable variation in the choices they make, the structure of their programs, method of implementation, and ongoing support at the board and executive levels. Based on these learnings, we identify best practices for companies serious about demonstrating their commitment to climate objectives to shareholders.

We ask:

• Why do so few companies include climate metrics in their bonus plans?
• What are the impediments to doing so, and how can they be overcome?
• Are commitments to carbon reduction driven by industry and market pressure, or commitment of the CEO and board?
• How realistic are the assumptions that underlie corporate projections for carbon reduction?
• How can outside investors determine whether a company will meet its objectives?

Keywords: Corporate governance, CEO compensation, climate change, reporting, carbon reduction, annual bonus, key performance indicators, long-term incentive programs, board of directors