In theory, integrating ESG criteria into executive compensation should ensure that corporate governance actively supports sustainability and ethical goals. However, the practical effectiveness of this approach remains questionable.
Non-Binding ESG Criteria
A joint study by HEC Paris and the University of Tübingen analyzed data from 674 executives across 73 major European companies between 2013 and 2020. The study examined detailed compensation contracts, including objectives, performance indicators, and actual payouts. The researchers assessed the weight of ESG criteria relative to other performance measures and the impact of ESG achievements on compensation across various sectors and executive roles.
While 60% of executive compensation plans in Europe included ESG indicators, most of these were non-binding.
The findings revealed that while 60% of executive compensation plans in Europe included ESG indicators (as of 2020), most of these were non-binding. Strict and enforceable ESG criteria accounted for only about 5% of short-term incentive calculations by the end of the study period. This minimal weighting is likely insufficient to motivate substantial behavioral or strategic shifts among executives.
Sector-Specific Disparities in ESG Implementation
A sectoral analysis showed that industries with significant environmental footprints—such as energy and heavy industries—assign greater importance to ESG criteria in executive compensation. This emphasis may be driven by the financial implications of rising energy costs and carbon emissions, making ESG performance financially beneficial in these sectors.
Conversely, ESG criteria in the financial sector often remain purely discretionary. The lack of material ESG performance targets in the financial sector may be due to ESG initiatives yielding fewer immediate, financial benefits than in heavy, energy-reliant industries. At the same time, the financial sector faces intense scrutiny from investors, regulators, and the public, creating pressure to appear committed to ESG goals without necessarily delivering tangible outcomes.
Misalignment with Executive Responsibilities
Another striking observation was the disconnect between ESG criteria and specific managerial responsibilities. For instance, one might expect production technology managers to have more environmental criteria or human resources (HR) managers to be evaluated on employee well-being. However, the data showed that ESG criteria were not more prevalent for these specialists than for CEOs or CFOs. This suggests that companies are more focused on incorporating ESG metrics into the compensation of highly visible executives rather than aligning them with roles where ESG impact could be most effectively driven.
Risk of Greenwashing
ESG-linked compensation can serve different purposes depending on the industry context. In sectors where ESG improvements align with financial performance, companies use material ESG incentives. In other industries without an obvious link between ESG and financial performance, ESG-linked pay remains immaterial and may function as a response to external pressures from investors, regulators, or the public. This practice risks devolving into greenwashing—presenting a socially responsible image without producing meaningful results.
The Call for Transparency and Tailored ESG Metrics
To counter greenwashing, a more transparent and genuine approach to ESG-linked compensation is crucial. Clearer communication about how ESG criteria influence executive behavior—and whether they foster real progress—would empower stakeholders, including investors, employees, regulators, and the public, to hold companies accountable. Aligning ESG indicators with specific managerial responsibilities and granting them substantial weight in compensation structures could transform ambitious corporate statements into concrete commitments that benefit both society and the environment.
Future Outlook
Ultimately, the tendency of companies to publicly emphasize ESG-linked compensation while failing to meaningfully implement it is unlikely to bring about change. For ESG-linked executive compensation to be effective, companies must go beyond symbolic gestures. This means creating enforceable, role-specific ESG objectives with substantial influence on pay, supported by transparent reporting and accountability mechanisms. Only then can businesses ensure that their sustainability ambitions translate into real-world progress.
One remaining question is how governments can ensure that companies design meaningful, material ESG incentives for their executives. Regulation of compensation packages can fall short of this objective, as there is no one-size-fits-all solution that suits all firms equally well. A more promising approach would be to make firms internalize negative externalities on society or the environment through Pigouvian taxes or market solutions like carbon permit trading. If weak ESG performance entails financial loss for companies, they are more likely to set appropriate ESG objectives for their executives.
