In recent years, the integration of environmental, social, and governance (ESG) factors into business practices has become increasingly important for sustainable value creation and key for corporate long-term success. Management remuneration is a critical means through which companies can influence organisational behaviour and performance –investors, regulators and other stakeholders are clear that aligning management remuneration with ESG objectives is a must for listed companies from a German perspective.
Our study sheds light on the multifaceted relationship between ESG-related criteria and management remuneration. We explore the following questions:
- Which types of ESG-related criteria do we see in management remuneration in listed companies?
- How are ESG-related criteria utilised? In short-term or long-term incentives (or both)? As a standalone criterion or as a multiplier?
Our findings are accompanied by an outline of the legal landscape and an overview of the expectations of proxy advisors, shareholders and other stakeholders.
Is it mandatory for German companies to include ESG factors in management remuneration, or is it more of a guideline? We explore the complex legal landscape and the 'comply or explain' approach, highlighting how many firms are adapting to investor expectations despite the legal ambiguity.
Legal landscape
Arguments continue as to whether or not it is mandatory under the law to include sustainability aspects as a factor in management remuneration in Germany. Changes to the German Stock Corporation Act (as part of the implementation of the EU’s Second Shareholder Rights Directive or SRD II) suggest that, at a minimum, ESG factors need to be taken into account. On the other hand,
based on the explanatory notes of the legislative draft, it can be argued that there is no strict obligation under the law.
Sustainability-related obligations are also included in the German Corporate Governance Code (GCGC). The principles of the GCGC state that the remuneration structure of listed companies must be oriented towards the company’s sustainable and long-term development, with “sustainability” referring to both environmental (ecological) and social goals. However, the GCGC only requires a ‘comply or explain’ approach, meaning deviations from the recommendations are legally permissible but must be disclosed in the declaration of conformity.
Despite the opaqueness of the laws, over recent years many listed companies have started to integrate ESG-related criteria into their business strategy and management remuneration in order to meet the growing demands and expectations of society and (supposedly) investors.
Expectations by proxy advisors and other stakeholders
Some institutional investors and proxy advisors have made a specific commitment to consider sustainability-related criteria. For example, Allianz Global Investors expects large companies in developed markets to include ESG-related criteria in their remuneration structure and will generally vote against the approval of remuneration policies that do not include ESG-related criteria; from 2025 they will also apply this rule to smaller companies in developed markets.
Proxinvest also recommends that performance-related board remuneration should include at least one ESG-related performance component, whilst Union Invest expects ESG-related criteria to be explicitly included in long-term variable remuneration. Ethos advocates that the annual bonus and long-term equity plans of the management board should take into account how well the company performs on environmental and social issues.
ISS and Glass Lewis are more differentiated when it comes to ESG-related criteria: they state that sustainability targets are generally to be supported but also emphasise that these must not interfere with the requirements for general corporate success. Therefore, the individual circumstances of the company must be considered if ESG-related criteria are set.
