Companies face enhanced pressures to engage in environmental, social and governance (ESG) activities. To improve their ESG performance, organisations increasingly include ESG metrics in incentive compensation arrangements. Although this practice has gained significant traction in recent years, evidence of its effectiveness is limited and conflicting. Therefore, by analysing a sample of UK-listed firms from 2016 to 2022, this study empirically examines the determinants of ESG-linked compensation and, more importantly, evaluates its effects on ESG performance and firm outcomes. The study reveals that well-governed firms and those with an ESG committee are significantly more likely to adopt ESG-linked compensation.
Secondly, ESG-linked compensation has a positive and statistically significant relationship with ESG performance. More specifically, ESG-linked compensation is positively associated with the social and, to a lesser degree, environmental pillars of ESG scores but has no association with ESG controversies. These results demonstrate that ESG-linked compensation is an effective incentive and alignment mechanism that motivates managers to pursue proactive ESG initiatives, consistent with the assumptions under agency theory. Surprisingly, the results reveal that ESG-linked compensation has an insignificant relationship with firm performance and firm value.
Together, the findings suggest that ESG-linked compensation effectively improves ESG performance without impacting firm outcomes.
Keywords
- Executive compensation
- Corporate governance
- ESG-linked compensation
- ESG performance
06 91΄σΙρ 2024