How to make green incentives pay

Hello from Miami. I’m here at the iConnections Global Alts conference to moderate a panel on impact investing.

And it is a good time to talk about impact because sustainable investing overall has had a difficult few months. Our colleagues on the climate team dug into the Morningstar numbers for sustainable investing in 2023. Climate-focused funds attracted $37.8bn of new investor money in 2023, compared with a record $151bn in 2021, they reported. Last year was the weakest for net inflows since 2019, when interest in green investments intensified.

At least one climate-focused investor is forging ahead. You’ve most likely heard of Tom Steyer as a billionaire financier who briefly ran for president in the 2020 US election. Recently. he returned to investing to focus specifically on climate solutions. I talked to Steyer about his efforts and a key feature of his firm’s investment thesis. Please read on.

ESG in executive pay: Beyond the ‘fluff’

In 2018, Marathon Petroleum agreed to pay a $335,000 fine for a diesel spill that leaked into a river on the border between Indiana and Illinois. That year, the petroleum company paid its chief executive the full portion of his bonus that was tied to environmental performance. Although this portion comprised just 5 per cent of his annual bonus, it underscores how environmental components of executive bonuses can look dubious. (Marathon did not respond to a request for comment on Friday.)

Adding environmental, social or governance (ESG) provisions to executive pay has been a growing trend. Three-quarters of S&P 500 companies have disclosed that ESG metrics contributed to executives’ pay in 2023, up from two-thirds of companies in 2021. 

The use of environmental metrics in pay has increased significantly in North America, according to a January 24 report from Willis Towers Watson. Over the past three years, use of environmental metrics rose from 12 per cent to 44 per cent of constituents of the US benchmark S&P 500 index (and rose similarly among big Canadian companies too). Carbon emissions reduction was by far the most commonly used metric, the firm said.

But the use of these criteria is increasingly drawing fire from asset managers. “Oftentimes they are very subjective, fluffy and easily gamed,” State Street told me last year.

The Marathon pay example was highlighted in a new report on executive pay from Galvanize Climate Solutions, a new asset manager where billionaire US investor Tom Steyer is co-executive chair.

In 2019, Steyer launched a presidential campaign as a Democrat. After his investing career, Steyer threw tens of millions of dollars to Democratic candidates who prioritised climate change. In 2015, Steyer challenged Republican megadonor David Koch in a climate change debate at the Aspen Ideas Festival in Colorado.

Last year, Steyer went back into investing by founding Galvanize Climate Solutions, a $1bn investment firm that funds companies positioned to lead the climate transition. Rather than shrug off ESG in bonus plans as rather gimmicky, Galvanize wants companies to seriously ramp up climate goals tied to executive pay. Part of its strategy for its global equities fund is to demand companies incorporate rigorous climate criteria into bonus plans.

“People do what they get paid to do,” Steyer told me in an interview at Galvanize Climate’s New York office last week. “If these are supposedly your real corporate goals, but they are not part of the compensation package then it is really hard to say that they are your corporate goals.”

A big reason for the need for climate criteria in pay is that investors have relatively little information about how companies are decarbonising. Corporate sustainability reports offer some clues, but these reports are generally opaque to investors and the public.

“By requiring companies to institute long-term incentives tied to granular climate plans, investors can be assured that management teams have appropriate operational and capital allocation programmes in place to drive greenhouse gas reductions,” Galvanize said. The report was co-authored with Stanford’s Graduate School of Business.

Being more rigorous about climate goals was increasingly important as a way to ward off expensive litigation, said Galvanize. 

ESG disputes were cited as the top litigation risk to companies in 2024, up from second place in 2023, according to a report published by Baker McKenzie last week. The law firm surveyed 600 senior legal officers at companies globally with annual revenue of more than $500mn. And within ESG, climate change litigation was the top response, the firm’s survey said.

There were a handful of companies that properly incorporated climate goals into bonuses, Galvanize said, citing French multinational Schneider Electric, for example, as a leader on this front. Last year, the company said 25 per cent of chief executive Peter Herweck’s long-term bonus pay would hinge on scoring highly on certain climate scores such as those issued by the Carbon Disclosure Project or the Dow Jones Sustainability index.

Apparel giant Nike was another top performer on ESG in pay, Steyer said (despite high-profile controversy over the treatment of workers in its supply chain). Nike has tied executive bonuses to improving diversity, equity and inclusion (DEI) among its employees. Mars was also applauded by Galvanize. The US snacks and pet food company revamped its pay programme for its top 300 executives, who have a piece of their bonuses linked to emissions reduction goals. Mars has given emissions targets the same weighting as conventional profit-related goals in bonus calculations. 

Galvanize has not yet disclosed which companies it has invested in (the fund will be required to make certain regulatory disclosures in the weeks ahead).

By tying climate to investing, Galvanize is forging into a difficult sector in the investing ecosystem. Jeff Ubben, another well-known, climate-focused investor, wound down his Inclusive Capital fund last year. Engine No. 1, the small hedge fund that won three board seats at ExxonMobil, sold its exchange-traded fund business last year and has dropped its activist investing activities following its campaign against the oil major.

But Steyer said there were other, lesser-known investors profiting in the climate space. “We believe these companies’ profitability is going to be driven by this,” Steyer said, referring to the energy transition. Galvanize, he said, aimed to separate “what is real” from the “hype”.

Smart reads

• The World Bank, Citigroup and the Plastic Collective have launched a $100mn bond to combat waste, with repayments partly determined by the sale of plastic and carbon offset credits, I report with Harriet Clarflet.

• Also, my favourite ESG sceptic, Stuart Kirk writes that “we are all hypocrites on corporate governance”.