Investor body asks EU to mandate ESG-linked remuneration

The PRI says a legal requirement to tie pay to sustainability goals would help reconcile long-term and short-term goals

An influential investor body is urging European lawmakers to mandate sustainability-linked pay at companies.

The UN-backed Principles for Responsible Investment (PRI), which represents $121trn of assets under management globally, today published recommendations on how the EU should expand its sustainable finance rules after this summer’s elections.

It suggests that companies should be required to link executive remuneration with environmental, social and governance objectives.  

“If structured appropriately and implemented effectively, sustainability-linked pay can rebalance the emphasis on short-term performance targets in typical remuneration packages, which may run contrary to long-term financial and sustainability objectives,” it said.

The EU is currently negotiating the Corporate Sustainability Due Diligence Directive (CS3D), which would require firms to develop pay policies to support their climate objectives. But it’s looking increasingly unlikely that the law will make it through the final stages of the legislative process.

Even if it does, the PRI said that “focusing on climate change disregards the importance for remuneration packages to incentivise performance on the most material sustainability factors, which may not always be climate change”.

If CS3D makes it into law, the PRI wants the next European Commission to update it to allow directors to select the most material environmental, social and governance factors for their business when establishing remuneration targets.

It also called for additional guidance to help companies understand how to use these targets to drive meaningful sustainability progress, and how to “exercise and report on their use of discretion to ensure pay is adjusted where targets have been met as a result of external factors outside the control of executives”.

Back in 2018, the original group that advised the European Commission on its sustainable finance agenda told the EU to introduce rules ensuring that “remuneration policies and individual executive employment contracts are consistent with the long term, including sustainability goals”.

While many of the group’s suggestions – including the EU Taxonomy and the Sustainable Finance Disclosures Regulation – have since become legislation, the proposal on pay was not taken forward.  

Regardless, a study of more than 4,000 listed companies, published in the Journal of Accounting Research last year, showed that the uptake of ESG-linked executive pay policies had leapt from 3% in 2010 to 38% in 2021.

Only 16% of US companies in the sample had adopted the practice, compared with more than half in key European markets.

The research also found that institutional investors were more likely to increase their holdings in firms with ESG-linked pay policies.

While the study concluded that introducing such policies couldn’t be linked to any uptick in financial performance, it said it could be shown to contribute to progress on sustainability goals.