Boards and CEOs are increasingly incorporating financial incentives to achieve corporate sustainability goals. Research indicates that a significant number of corporate directors believe sustainability should be fully or partially integrated into executive performance metrics and compensation. However, despite this growing focus, many environmental, social, and governance (ESG) initiatives fail to produce meaningful progress due to poorly designed incentive schemes.

Key Barriers to Success

Designing effective sustainability incentives is complex due to the varying expectations of stakeholders, the intricacies of sustainability initiatives, and challenges in measurement. Several barriers hinder the success of these initiatives:

1. Generic KPIs: Many companies use one-size-fits-all key performance indicators (KPIs) that fail to address specific job functions, making it difficult to drive behavior changes. Tailored KPIs, which are linked to the roles of key individuals, are crucial for making an impact.

2. Overreliance on Qualitative Metrics: Relying on subjective measures, such as progress toward a net-zero roadmap, leads to minimal accountability. Qualitative metrics are often vague and open to interpretation, reducing their effectiveness.

3. Strategic Disconnect: Sustainability metrics often lack a clear connection to financial or strategic materiality, leading to lower prioritization by leadership.

4. Short Timelines: Many companies limit sustainability incentives to annual performance bonuses, neglecting the long-term commitments required for meaningful change. Long-term sustainability goals should span three to five years to allow for substantial progress.

5. Low Weight: Sustainability incentives often account for a small portion (10%-20%) of the total incentive pool, making it less likely to drive substantial behavioral changes.

6. Limited Coverage: Sustainability incentives are frequently restricted to top executives, excluding key operational roles that are critical for implementing sustainable practices in areas such as supply chains, facilities, and sales.

Addressing the Challenges

The pressure to integrate sustainability into performance incentives is intensifying, driven by regulators, investors, and external rating agencies. Properly structured performance incentives can lead to real change. Companies with well-integrated sustainability incentives have seen notable improvements in climate-related performance.

Seven Priorities for Effective Sustainability Incentives

1. Use Material and Measurable Metrics: Incentive schemes should be based on clear, quantifiable metrics aligned with the company’s strategic direction. Examples include sales from sustainable product lines or specific reductions in environmental impact.

2. Develop Tailored Incentives: Sustainability-linked compensation should extend beyond top executives to senior leadership and middle management. Tailor metrics to each individual’s scope of influence, with short-term incentives focusing on tactical goals and long-term incentives addressing strategic outcomes.

3. Raise the Stakes: Sustainability incentives must be financially significant—at least 20% of the variable compensation. This ensures sustainability is viewed as a strategic priority and motivates meaningful change.

4. Keep It Simple and Transparent: The incentive scheme should be easy to understand and the link between actions and rewards clear. A simple approach, such as a sustainability multiplier that adjusts the incentive based on predefined sustainability metrics, can make the system more effective.

5. Consider Unintended Consequences: Sustainability incentives may create competing priorities. For example, incentivizing energy-efficient machinery might conflict with traditional financial metrics, requiring a reassessment of established KPIs.

6. Consider Nonfinancial Incentives: Nonfinancial rewards, such as internal recognition or access to training programs, can be powerful motivators and applied to a broader group of employees. Recognition as a “climate champion” can inspire action and foster a culture of sustainability.

7. Review and Update Regularly: Sustainability incentives should be continuously assessed and updated in response to changing stakeholder expectations, regulatory developments, and market conditions. Regular reviews ensure that the incentives remain relevant and effective over time.

Conclusion

As the pressure to meet sustainability goals intensifies, aligning executive and employee incentives with environmental, social, and governance (ESG) objectives is crucial. To ensure that sustainability efforts yield tangible results, companies must move beyond generic and short-term incentives and adopt a more strategic, tailored approach. By focusing on clear, measurable metrics, extending incentives to a broader group of employees, and ensuring the financial and nonfinancial rewards are significant, companies can foster a culture of sustainability across all levels of the organization.

Regular review and adaptation of these incentive structures will help companies stay ahead of regulatory demands and market expectations, driving continuous progress toward their sustainability objectives. When structured correctly, performance incentives not only align company goals with sustainability but also create a powerful tool for change, paving the way for long-term success in a rapidly evolving business landscape.