How Startups Can Boost ESG Goals Through Sustainability-Linked Compensation Structures

Due to the global flux of regulatory requirements, the environmental, social, and governance (ESG) factors for reporting have become increasingly complex. 

A UNPRI survey conducted across 90 countries revealed that there are already over 700 regulations requiring companies to report on at least some aspects of sustainability, demonstrating the seriousness of regulatory commitment to ESG.  

While listed companies are required by law to report on ESG metrics, companies that do not meet the threshold are increasingly incorporating ESG practices and reporting mechanisms into their strategy. This is an area of focus for startups in particular, as ESG metrics play an important role in investor decisions and oversight. According to Edelman’s survey of institutional investors, two-thirds of respondents wanted executive pay to be linked to ESG performance.  

ESG Regulations In India

In terms of adopting a reporting framework for sustainability, Business Responsibility Sustainability Reporting (BRSR) is one of the most progressive and comprehensive regulations in India.  It includes a detailed set of key performance indicators (KPIs) for businesses to report on per its nine principles. 

However, since BRSR is in its first year of mandatory implementation, there is little clarity on how businesses will establish progressive sustainability goals and demonstrate them through the BRSR report. Similarly, the regulator’s analysis of the submitted data is currently unknown. 

For instance, BRSR requires two years of data for provisions such as environmental impact assessment, energy and water consumption, air emissions and liquid discharge, and grievance redressal. However, there are no specific requirements for companies to demonstrate incremental progress across various parameters over time.  

Global Scenario: Executive Remuneration & ESG

Executive compensation is one of the important disclosures under BRSR’s Principle 5, but there are no qualitative criteria for linking it to sustainability targets. However, some regulators around the world have begun to discuss linking companies’ sustainability goals to traditional KPIs and executive remuneration. 

The US Securities and Exchange Commission (SEC) opened public comments on linking executive compensation to “performance metrics related to, for example, climate, diversity, and other company-specific ESG goals” in January 2022. 

In the EU, the Platform for Sustainable Finance (PSF), a group of experts tasked with assisting the European Commission with the EU Taxonomy Regulation, has stated that “having executive remuneration linked to ESG should be part of the EU taxonomy as it is a reflection of what is happening in the real economy.” 

Globally, the proportion of companies voluntarily linking executive pay to ESG is increasing rapidly. According to a London School of Business survey, 45% of the FTSE 100’s ESG targets are now linked to variable pay, with 37% including one in their bonus plans (with a typical weighting of 15%). 

India Inc. is seriously considering this, and according to a report in the Economic Times, leading companies like Tata, Marico, Vedanta, Welspun, and the RPG Group are leading the way in tying ESG performance to the Key Responsibility Areas (KRAs) of the top management.  

Ensuring Targetted ESG Disclosures 

To make ESG disclosures more focused on achieving global sustainability targets, companies must first define specific annual targets.  Defining sustainability targets must be done holistically and sectorally, while keeping the nature of business operations and industry in mind.  

Boards must clearly articulate their priorities in terms of environmental, governance, and social goals, as well as establish metrics. The weightage of the metrics for key management executives would be determined by their specific roles and responsibilities. A carrot and stick approach to these targets would be the best way to ensure consistent progress toward the goals.  

Linking executive pay to these targets, both in terms of annual bonuses and long-term incentive plans, will ensure that adequate thought in terms of overall strategy, the commitment of people, and resources is allocated to achieving these goals. Due to the lack of a baseline, companies could conduct pilots for the first few years to test the waters.  

Boards should also be aware of the possibility of under-reporting of certain metrics as a result of linking executive pay to them, and should plan for these complications. It is also necessary to consider which metrics should be associated with annual bonuses and which with long-term incentive plans. Above all, boards must be adaptable and willing to change strategy as needed. 

Startups Have A Clear Advantage

While some companies have taken progressive steps in this direction, regulatory oversight of executive pay has been a contentious issue that has elicited strong opposition. As a result, there are no tangible benefits or drawbacks to executives voluntarily strategising on sustainability goals with expected outcomes within defined timeframes.  

A regulatory push in the form of guidelines to operationalise ESG reporting requirements in India would go a long way toward ensuring that organisations implement ESG requirements by tying executive pay to sustainability outcomes. 

Given their technological capabilities, startups have a clear advantage over established listed companies and large multinationals. Furthermore, the comparatively simpler organisation and supply chains will make it easier for startups to implement sustainability principles as best practices.