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The sun sets at wind farm in McCook, Texas, during a heat wave on July 20, 2022. Chipotle is tying executive compensation to ESG metrics, which can be seen as an easy way to boost pay.Delcia Lopez/The Associated Press

Gus Carlson is a U.S.-based columnist for The Globe and Mail.

As virtue signals go, environmental, social and governance (ESG) initiatives are a popular and noisy bandwagon that companies are jumping aboard to show how much their brands care about things that often have little or nothing to do with their bottom-line business success.

An increasing number of companies are even taking the window dressing of doing good to an absurd and sometimes reckless level by tying executive compensation to leadership’s performance on these feel-good metrics. More than 70 per cent of Fortune 500 companies now have baked – or are considering baking – some ESG elements into their executive-compensation formulas.

Chipotle Mexican Grill, the popular California-based fast-food chain, has become the poster child for this practice, announcing recently that ESG goals such as buying more from local farmers, upping composting efforts at its locations and raising diversity and inclusion hiring quotas will impact up to 15 per cent of CEO pay this year.

Shareholders should be suspicious at the very least, and probably outraged. Corporate boards, whose compensation committees determine how executives are measured and paid, have become notoriously lazy in holding senior management accountable for achieving the metrics that actually matter to the financial health of a company.

Now, the insidious creep of social soft sciences into the hard mechanics of running a successful business has changed the calculation of what’s important and given boards a new set of measurement metrics that often have little or no relevance to the success or failure of the business. And while boards fiddle with these nice-to-haves, the companies they oversee could burn for not achieving the must-haves.

The dangers of tying executive compensation to ESG go well beyond the obvious optics. For one, it gives boards more latitude in rewarding poor performance, something many have become quite good at in modern times. Think of the Walt Disney Company’s disastrous marriage to former CEO Bob Chapek, for example, which cut the company’s market valuation in half. Under an ESG compensation model, an executive can still get juicy bonuses for hitting ESG goals – which, let’s face it, are easier to achieve – while missing the meaningful financial and operational ones.

There is also the real concern that the material impact of ESG metrics on executive compensation – in Chipotle’s case, up to 15 per cent – will cause senior management to be distracted from the real task at hand and funnel resources, people and time to non-relevant areas of focus.

Under a compensation plan heavily weighted to ESG, who, other than the CEO, benefits if a company tanks on its financial metrics but hits a home run on ESG?

Ultimately, winning on ESG metrics while losing on financial and operational ones is a pyrrhic victory. The plus-side may sound good in marketing propaganda, but the downside won’t give a company the foundation to create jobs, pay competitive wages, salaries and benefits for employees, innovate for customers or reward investors for the risks they take buying its stock.

To be clear, there is no suggestion ESG initiatives don’t have a place. Doing good is a noble aspiration, and increasingly companies use their efforts on ESG to polish their reputations and suggest that they are pursuing a higher purpose for the common good. Social halos have become big selling points, especially for consumer brands.

But, as a recent Conference Board study suggests, any ESG metrics used to measure executive performance must be directly relevant to the successful operation of the business and achievement of the word do-gooders hate the most – profitability. That is, after all, the reason companies are in business.

Aligning the two sets of metrics and ensuring they are properly weighted within a company’s ecosystem is critical. Jumping on the ESG bandwagon because it’s popular is the wrong strategic move – if the metrics don’t fit, companies shouldn’t try to make them fit. Any misalignment can generate unintended consequences.

Boards, in particular, should pay close attention to the alignment issue. It’s easy to drink the ESG Kool-Aid. Everybody’s doing it. But directors are paid handsomely for bringing their experience and a critical eye to the strategic table. They need to have the guts to say doing good doesn’t always jibe with doing well, and that’s okay.

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