As companies across the globe strive to demonstrate their commitment to ESG principles, a new trend is emerging that raises concerns about the sincerity of these efforts. Investors are warning that executives are manipulating ESG metrics to inflate their bonuses, undermining the true purpose of ESG reporting. A scheme beyond Greenwashing and ESG.

Greenwashing and ESG: The 2024 ESG Trends

The following three insights suggest a rising trend in the company’s alignment and the executives’ commitment to ESG aspects. However, upon closer examination of these indicators, it becomes apparent that this alignment and commitment may face challenges.
75% of S&P 500 companies have disclosed that ESG metrics contributed to executives’ pay (Source: ESGauge).
More than half of all S&P 500 companies include diversity and inclusion components in executives’ pay. Almost half of these companies also include environmental metrics in bonuses, up from a quarter in 2020 (Source: Semler Brossy).
Since 2015, profitability and business-related pay factors have declined at global companies, while ESG factors have increased (Source: ISS ESG).
A recent Financial Times article describes a worrying pattern of “fluffy ESG metrics” that are being exploited by top executives to boost their own financial gains. These metrics, which measure a company’s sustainability and ethical practices, are manipulated to create the illusion of strong ESG performance.

Paulo Andrade de Oliveira, the founder of Alma Mundus, a global sustainability consultancy, warns against this deceptive practice of what he named “ESG Gamification.”

He emphasizes that “ESG indicators cherry-picking for executive bonus inflation is a narrow and short-term approach that may misrepresent not only non-financial (ESG) but also financial performance”.

This manipulation not only undermines investor trust but also detracts from the efforts companies are making to improve their ESG practices.

Greenwashing and ESG: The Context of ESG Compensation

According to the ISS ESG Global Executive Compensation Analytics dataset, ESG is becoming more critical in determining executive pay.
Per cent of metrics used to determine executive pay plans, according to company filings from 2015, 2019, and 2022
Source: Financial Times / ISS ESG Global Executive Compensation Analytics dataset
Note: 13,500 global companies are included in this dataset
ESG indicators are invaluable tools for investors who want to assess a company’s long-term prospects beyond just financial performance. They are meant to provide a comprehensive view of a company’s impact on the environment, society, and its ability to govern itself ethically. However, some executives are using these indicators as a mere tool for personal financial gain, resulting in a distortion of both non-financial and financial performance.
Diversity and Inclusion remain a top ESG metric, based on the number of S&P 500 companies with metrics across different ESG categories.
Number of S&P 500 companies with ESG metrics
Source: Financial Times / Semler Brossy

Key Concepts

Gamification is the integration of game elements into non-game contexts, and it can yield both positive and negative outcomes. While gamification is often linked to engaging activities and positive results, it can also encompass manipulative actions and questionable outcomes. This article specifically focuses on the latter aspect.

Greenwashing involves misleading consumers by falsely portraying a company’s products, activities, or policies as more eco-friendly than they really are. This is achieved through tactics like vague environmental claims, unsupported or exaggerated statements, or concealing negative environmental effects.

Greenwashing and ESG: The American Express Case 

ESG considerations in executive pay allow executives to receive additional compensation when equity pay falls short, as stated by Lucian Bebchuk, the director of Harvard Law School’s corporate governance program and co-author of the research. This additional compensation is still received even when equity pay is performing well.
The research conducted by Harvard professors highlights that American Express allocated 15% of executives’ annual bonuses to recognize achievements in diversity, talent, and culture. However, the specifics of how these achievements are measured and met remain unclear. The researchers noted a lack of quantitative targets and questioned whether any increase, even if it included just one woman, would be deemed sufficient.
In 2022, American Express CEO Stephen Squeri received the maximum allowable annual bonus, amounting to $10.3 million. This represents an increase from his $8 million bonus in 2021. Furthermore, Squeri’s total compensation for 2022 nearly doubled to $48 million compared to his previous year’s pay. It should be noted that this significant increase occurred despite a decline in the company’s total shareholder return in that same period.

Greenwashing and ESG: The ESG Indicators Challenges

One of the key concerns highlighted by investors is the lack of consistency and standardized reporting in the ESG space. Companies often have the freedom to choose which metrics to disclose and how to measure them, leading to inconsistencies and difficulties in comparability. This lack of transparency provides a perfect opportunity for executives to manipulate the data to their advantage.
Another issue is the lack of independent verification of ESG reporting. Without an external audit process to ensure the accuracy and integrity of the reported metrics, there is a higher risk of manipulation. Investors call for greater accountability and rigorous oversight to prevent these deceptive practices.
The manipulation of ESG metrics for personal gain not only poses ethical concerns but also has real financial implications. Investors rely on these indicators to make informed decisions about the companies they invest in. When executives game the system, investors are left with an inaccurate assessment of a company’s true sustainability and ethical practices. This can lead to misallocated investments and negative financial outcomes.

Greenwashing and ESG: A Plan To Action

To address this issue, investors are urging companies to adopt a more rigorous and standardized approach to ESG reporting. This includes:

1) Establishing clear and consistent metrics
2) Ensuring independent verification of reported data
3) Implementing robust accountability measures

By doing so, companies can restore investor confidence and ensure that ESG reporting remains a credible tool for assessing their long-term viability.

It is also essential for investors to take an active role in holding companies accountable. They can advocate for stricter ESG reporting standards, engage in dialogue with company management to address concerns, and vote against excessive executive compensation packages linked to manipulated ESG metrics. By exerting their influence, investors can pressure companies to prioritize genuine and meaningful sustainability practices.

Furthermore, regulators play a crucial role in ensuring the integrity of ESG reporting. They should provide clear guidelines and enforce compliance to prevent manipulative practices. Close collaboration between regulators and industry stakeholders is necessary to address the loopholes that allow executives to game the system.
ESG reporting is a valuable tool for companies and investors alike to promote sustainable and responsible business practices. However, the recent trend of executives gaming these metrics for personal financial gain threatens to undermine the credibility and effectiveness of ESG reporting.
All stakeholders must come together to address this issue and restore integrity to ESG reporting. Only through transparent and responsible practices can the true impact of companies’ sustainability efforts be accurately measured, and investors’ trust be restored.

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