Criteria such as the environment, social aspects and good corporate governance (ESG) are becoming increasingly important factors for management boards, supervisory boards and managing directors. Ultimately, entire business models may have to be transformed with a focus on climate protection in response to the European Green Deal. A study conducted by the Union Investment fund management company in collaboration with the Sustainable Governance Lab at the University of Giessen found that, as a consequence, almost all DAX-40 companies have made sustainability targets an integral factor in their management board remuneration.
Regulatory pressure increasing
Such moves represent a response to the increasing regulatory pressure resulting from the Act Implementing the Second Shareholders’ Rights Directive (ARUG II), for example: This act stipulates that the executive board remuneration structure at stock companies has to be oriented on the company’s sustainable and long-term development. The German Corporate Governance Code also references this. Pursuant to the EU Disclosure Regulation, which came into force in March last year, the financial sector now has to establish transparency regarding the extent to which remuneration policy is harmonized with sustainability risk handling. As of January 2023, the German Supply Chain Act will also apply across all sectors, making social standards as well as occupational safety and environmental protection focal issues for employers with more than 3000 employees. From 2024 onward, the limit will decrease to just 1,000 employees.
ESG risks lead to less favorable financing conditions
Employees, customers, investors and regulatory authorities are also increasingly interested in the positioning of companies with regard to environmental protection, CO2, social standards and compliance. The German Federal Financial Supervisory Authority (BaFin) has published a fact sheet describing examples of sustainability risks. The fact sheet also provides financial institutions with guidance on how to deal with such risks. One consequence is that non-sustainable products, purchasing or production conditions may lead to less favorable financing conditions.
Against this background, employers are increasingly considering how to integrate incentives to encourage sustainable action into their remuneration systems. Fortunately, the legislator provides employers with plenty of freedom to do so. Both the fixed and variable remuneration components can be oriented on sustainability targets. The criteria for selecting the requirements can be as follows: Do they match the overall business strategy? Are they compatible with the interests of the key stakeholders? Do they serve as an incentive for the management? Are the requirements for the management reliably reconciled with those of the employees? Do the economic incentives match the compliance and integrity measures, such as the implementation of the Supply Chain Act? The German Sustainability Code provides further ideas and approaches for creating sustainable incentive systems.
Measurability and practicability
In particular, linking variable remuneration to ESG targets requires realistic targets that can be measured via external or internal metrics. These could include specific targets for CO2 reduction by saving energy for heating, cooling or in production or even a larger proportion of electric vehicles in the company fleet. When taking the first steps toward ESG, the concept development, implementation and participation in training courses covering ESG aspects can also be rewarded. It may even make sense to first define a target pool for the remuneration system. This can be used to determine specific annual targets for the individual business units. These can then be broken down and applied to their managers and individual employees.
Nevertheless, sustainable business was and remains difficult to classify. Although Brussels has set the first standards with the EU taxonomy, many questions still require answers. For example, the Standard Driving Sustainable Change from the University of Witten/Herdecke provides guidelines for enabling mid-sized manufacturers, service providers and retailers to effectively measure ESG-compliant activity.
Involve the works council
Regardless of how employers intend to structure their remuneration model, the works council always has a right of co-determination with regard to wage structures. Ideally, this enables HR managers to kill two birds with one stone, because involving employee representatives often creates greater acceptance among the workforce.
Remuneration systems should not chase every trend. People paid part of their remuneration in bitcoin are unlikely to be overly happy given the bitcoin slump and the uncertain forecasts. As recently as last fall, such models seemed attractive and innovative in view of the rising rates. Yet linking ESG criteria and remuneration represents a long-term development in response to investor and consumer demands together with the increasingly strict regulatory requirements. That is why HR managers need to act now. Working in coordination with their sustainability, legal and compliance, colleagues, they need to develop suitable concepts in line with the company’s ESG goals. By creating incentives to engage in sustainability, ‘Green HR’ can help pave the way towards the transformation into a climate-neutral economy.