Executive compensation is evolving beyond traditional financial benchmarks. As sustainability moves to the forefront of corporate strategy, companies are increasingly aligning leadership incentives with ESG goals. According to the ISS Executive Compensation Analytics (ECA) database, the share of firms integrating ESG metrics into executive performance reviews rose from just 3% in 2010 to over 30% in 20211. This shift signals a growing recognition that executive compensations are intrinsically linked to environmental and social accountability.

The Evolving Landscape of ESG-Linked Executive Compensation The integration of ESG principles into executive remuneration frameworks has gained significant momentum worldwide. IESE Business School highlights that “the percentage of listed firms incorporating ESG performance into pay structures rose sharply from just 1% in 2011 to 38% by 20212, reflecting mounting alignment with the ESG-linked compensation. Hence, enhancing corporate accountability”.

However, adoption patterns vary by geography. ESG-linked pay is more prevalent in jurisdictions with stronger sustainability mandates and disclosure requirements. In the European Union, over 60% of companies have integrated ESG metrics into executive compensation. In contrast, only about 16.5% of U.S. firms have done so. Sector-wise, industries with significant environmental or social footprint such as energy, utilities and mining are more likely to embed ESG measures in remuneration frameworks2.

Companies adopt ESG-linked pay for multiple strategic reasons: •To align executive incentives with long-term stakeholder value. •To mitigate ESG-related risks and enhance corporate resilience. •To signal a serious commitment to sustainability goals. • To respond to rising institutional investor pressure for ESG integration.

The Four Key Dimensions of ESG Remuneration As companies like Apple, McDonald’s, and Shell adopt ESG-linked executive compensation, it’s essential to understand the key design principles behind these initiatives3. Here are the four dimensions that leaders need to consider when integrating ESG measures into pay structures:

1.Internal and External Targets: oInternal targets are about setting goals within the company, like increasing diversity or investing in sustainable technologies. These are more about the processes that lead to broader societal outcomes. oExternal targets focus on measurable outcomes, such as the total emissions reduced or improvements in employee engagement scores.

While both are important, external (output) targets are increasingly in demand, as they are easier to measure and more impactful in terms of societal benefits. Example: Shell uses both internal measures (like increasing biofuel use) and external goals (like net carbon reduction targets) to link executive pay to energy transition goals3.

2.Individual KPIs and Scorecards: oTo measure progress, companies must track and disclose performance across a range of ESG priorities. A well-constructed scorecard with clear Key Performance Indicators (KPIs) ensures transparency. oThis multidimensional approach ensures that companies address diverse ESG issues, from environmental impact to social goals like diversity and employee welfare.

Example: Unilever’s sustainable living plan has been in use for over a decade, with a scorecard that tracks their sustainability priorities and influences 25% of their long-term incentive plan3.

3.Long-Term Incentive Plans (LTIP) vs. Annual Bonus: o LTIPs are well-suited for environmental goals, which often take years to show measurable results. o Annual bonuses, on the other hand, can address short-term ESG targets like health and safety or gender pay equity, which can be tracked over a single year. Example: BP (British Petroleum) incorporates ESG targets in both its annual bonuses (15% on safety and emissions reduction) and LTIP (40% on renewables and energy transition goals)3.

4.Underpins and Scale Targets: oSome metrics serve as a baseline, if these standards aren’t met, bonuses are reduced. Health and safety are often examples of “table stakes” metrics that executives must meet, but don’t necessarily result in extra rewards. oFor more transformational goals, such as emissions reductions, performance scales should be established. This means executives can earn rewards based on exceeding specific targets, but only if minimum standards are met.

Example: BT Group plc has established “underpins” to its restricted share plan, ensuring no ESG-related reputational damage. Legal & General, another investor, has set minimum ESG target requirements to qualify for rewards3.

Global Trends in ESG-Linked Executive Compensation An increasing number of companies globally are aligning executive compensation with Environmental, Social, and Governance (ESG) goals. Driven by investor expectations, regulatory pressure, and evolving governance norms, businesses are recognizing that long-term value creation is tied to sustainability and responsible practices.

According to a 2024 study by KPMG, 78% of the 375 publicly listed companies, encompassing the largest 25 by market capitalization from each of the 15 countries, including Australia, Austria, Belgium, Canada, China, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, the United Kingdom (UK), and the United States (US), link executive compensation to sustainability performance4.

Europe Leads the Way In countries like France, Germany, and the UK, 81% of companies tie CEO pay to ESG goals, significantly higher than in the U.S., where only 44% of companies follow suit5.

This highlights Europe’s more advanced approach to integrating sustainability and governance into corporate strategies. 1.Key Focus Areas Driving Compensation Decisions Climate change and a company’s own workforce are the main ESG themes shaping sustainability-linked compensation targets. These focus areas help define performance metrics that ensure leaders are incentivized to address critical challenges such as emissions reduction, gender equality, and employee well-being5.

2.The Importance of Materiality Materiality is crucial in linking ESG to compensation. A strong 88% of global companies align their ESG targets with issues that directly impact their business operations and long-term value, ensuring their sustainability goals are relevant and impactful5. The Role of Regulators and Investors

European regulators and investors are accelerating the move toward ESG-linked executive compensation: •The EU’s Shareholder Rights Directive II recommends using ESG criteria to assess director performance where appropriate6. •The UK Corporate Governance Code calls for pay structures that support long-term, sustainable success6. •Investor groups, such as the UK’s Investment Association, advocate for clear, measurable ESG KPIs tied to company strategy6.

Timeframe Breakdown: Short-Term vs. Long-Term Incentives KPMG’s report shows that 37% of companies use both short- and long-term incentives tied to ESG metrics, while 40% focus on short-term targets, and 23% on long-term incentives7.

As ESG-linked executive compensation becomes more prevalent across industries, it is clear that aligning financial incentives with sustainability is not just a trend but a necessary step toward fostering long-term business success, corporate responsibility, and resilience in an ever-evolving global landscape.

India Catching Up in ESG-Linked Executive Compensation As global trends push Environmental, Social, and Governance (ESG) metrics to the forefront of corporate performance evaluation, companies across the Asia Pacific (APAC) are increasingly integrating these considerations into executive pay. While European firms lead this movement with 94% incorporating ESG into incentive plans, India is making deliberate strides forward8.

According to a 2024 study by WTW (Willis Towers Watson) conducted on the top 50 listed firms in India by market capitalization, 56% of the companies that disclosed executive incentive metrics incorporated ESG factors into their executive pay programmes, reflecting steady progress amid evolving disclosure standards in the region8.

Among India’s leading companies embracing this shift is ITC Limited, a diversified conglomerate known for its strong sustainability agenda and stakeholder-focused governance. Its remuneration policy serves as a compelling case study in aligning executive compensation with ESG priorities.

Case Study: ITC Limited – ESG Metrics Driving Executive Pay in India Among the Indian corporate leaders embracing the shift toward ESG-linked incentives is ITC Limited, a diversified corporation widely recognised for its sustainability agenda and stakeholder-centric governance. ITC’s remuneration policy stands out as a compelling example of how executive rewards can be aligned with long-term ESG goals.

As detailed in ITC’s 2023-24 ESG Factbook10, the company incorporates quantifiable ESG performance indicators into executive incentive frameworks. Key highlights include: These metrics are incorporated into executive performance scorecards and reviewed by both the Nomination & Remuneration Committee and Sustainability Committees, ensuring accountability and pay-for-performance alignment. This structure directly ties incentive payouts to ESG outcomes as part of ITC’s broader Sustainability 2.0 strategy.

1. Greenhouse Gas (GHG) Emissions •Achieved 50% reduction in specific GHG emissions (Scope 1 & 2) compared to FY2018- 19 baseline10;p2. •100% of purchased grid electricity is sourced from renewable energy10;p2.

2.** Water Stewardship** •Cumulatively developed 1,630,000 acres under watershed development as of FY 2023-24, progressing toward the 2,200,000-acre target by 203010;p4. •Achieved 40% reduction in specific water consumption compared to FY2018-1910;p3.

1. Solid Waste Management • 99.9% of packaging is recyclable, reusable, or compostable10;p4.

From Boardroom to ESG Score: Why Executive Pay Matters A landmark empirical study titled “Advancing Understanding of ESG Score and Executive Compensation Relationships in the Indian Context” by Ranjitha Ajay, Surendranath Rakesh Jory, and K.P. Syamraj (2024) offers robust evidence that higher ESG performance is positively associated with higher executive compensation, particularly in business group-affiliated and environmentally sensitive firms. Some of the key highlights of the study are mentioned below:

•Governance and social factors drive executive pay decisions, highlighting the rising importance of governance in ensuring sustained corporate value11;p5.

•Regulatory frameworks, such as the Companies Act of 2013, which mandates 2% CSR spending for qualifying firms, reinforce the accountability mechanisms that support ESG-linked compensation11;p5.

•Firms with strong ESG scores and high executive pay tend to outperform in market valuations, especially those affiliated with business groups and operating in environmentally sensitive sectors, suggesting investor confidence in sustainable leadership. These findings are supported by rigorous methodologies, including instrumental variable analysis and propensity score matching11;p5.

ESG Regulation and Compensation: The Indian Policy Landscape India’s ESG disclosure landscape has undergone a significant transformation over the past decade, driven largely by regulatory momentum. The Securities and Exchange Board of India (SEBI) has played a pivotal role in this evolution. In 2015, SEBI introduced the Business Responsibility Report (BRR) for the top 500 listed companies, initiating formal ESG-related disclosure requirements. This framework was substantially enhanced in 2021 with the rollout of the Business Responsibility and Sustainability Report (BRSR), which mandates comprehensive ESG disclosures from the top 1,000 listed entities, aligned with global reporting standards. While SEBI does not prescribe ESG-linked executive pay, the BRSR framework provides the necessary foundation for companies to integrate sustainability considerations into performance management systems. By encouraging structured, comparable, and transparent ESG reporting, these regulations enable companies to align executive incentives with long-term sustainability goals and stakeholder expectations.

Why This Matters •Business Group Affiliation Matters: Firms affiliated with business groups show a stronger positive relationship between ESG scores and executive pay than standalone firms11;p5. •Market Valuation Alignment: Companies with high ESG scores and high executive compensation are associated with higher firm valuations, suggesting market approval of ESG-integrated leadership incentives11;p5.

As ESG metrics gain traction in shaping leadership incentives, the reliability and relevance of India-specific, BRSR-aligned disclosures will be instrumental in defining the next phase of corporate accountability and long-term resilience.

Key Challenges in ESG-Linked Executive Compensation As ESG-linked executive compensation becomes increasingly common, companies face several significant challenges in effectively integrating sustainability metrics into pay structures. •Greenwashing Risk: Companies may use ESG-linked compensation to create an illusion of sustainability without driving genuine progress, often by adopting vague or superficial ESG targets that prioritize image over impact.

•Lack of Standardized and Measurable ESG Metrics: The absence of clear, consistent, and comparable ESG performance indicators hampers the ability to accurately measure and reward true sustainability achievements, weakening the effectiveness of compensation programs.

• Misalignment with Long-Term Sustainability Goals: Short-term financial pressures and shareholder expectations can conflict with broader ESG objectives, resulting in compensation structures that fail to incentivize meaningful, long-term, sustainable change.

To mitigate these risks, companies must ensure that their ESG metrics are material, measurable, and aligned with long-term sustainability goals. Transparent reporting and a genuine commitment to sustainability are essential to making ESG-linked executive compensation a driver of real change, rather than merely a branding exercise.

Conclusion To achieve meaningful ESG performance, commitment must extend beyond executives to every level of the organization and its customers. Integrating ESG goals into daily operations, such as supply chains and employee development, ensures sustainability is ingrained in company culture. Involving employees in identifying and addressing ESG priorities boosts engagement and job satisfaction, especially when they are part of the decision-making process.

Customer participation is also crucial, particularly in initiatives like reducing plastic waste. By incentivizing customers to return packaging for reuse, companies can create a closed-loop system that supports sustainability efforts. Fostering a culture of shared responsibility across employees and customers will drive long-term ESG success.

References 1.https://doi.org/10.1111/1475-679X.12481 2.https://www.iese.edu/insight/articles/esg-linked-executive-pay/ 3.https://www.pwc.com/gx/en/issues/esg/exec-pay-and-esg.html 4.https://kpmg.com/xx/en/media/press-releases/2025/03/kpmg-international-report-finds-growing-link-between-sustainability-and-executive-pay. 5.https://www.esgtoday.com/eu-companies-nearly-twice-as-likely-as-u-s-to-link-executive-pay-to-esg-goals-kpmg-report/ 6.https://www.tandfonline.com/doi/full/10.1080/14735970.2023.2253888#d1e143 7.https://www.rinnovabili.net/business/esg/esg-goals-and-ceo-pay-europe-leads-us-lags-behind/ 8.https://www.wtwco.com/en-in/news/2025/01/close-to-three-quarters-of-the-top-50-listed-companies-in-apac-markets-continue-to-adopt-esg-metrics 9.https://www.wtwco.com/en-gb/news/2024/12/european-companies-refine-their-approach-to-esg-metrics-in-executive-pay-programmes-wtw-study-finds? 10.https://www.itcportal.com/itc-esg-factbook.pdf 11.https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4520081 12.https://www.resonanceglobal.com/blog/trending-linking-executive-compensation-to-esg-metrics 13.https://www.sciencedirect.com/science/article/abs/pii/S1044028324000656

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