Managerial incentives for ESG in the financial services industry: direct and indirect association between ESG and executive compensation

Abstract

PurposeThis study investigates the empirical association between environmental, social and corporate governance (ESG) performance and top executive compensation in the US financial services industry. Considering that financial firms can inflict systemic shocks across the economy, it has been argued that they must conduct ethical and sustainable business in accordance with ESG principles. This study examines whether ESG efforts are beneficial to managers.Design/methodology/approachThe authors use CEO compensation and ESG performance ratings data for all US financial firms (SIC 6000–6799) from 2015 to 2019. Employing fixed effects regressions, the authors test whether lagged ESG performance is related to CEO compensation, after controlling for other firm characteristics such as size, financial performance, leverage and CEO stock ownership.FindingsThe authors find that lagged ESG ratings are strongly associated with all forms of compensation. An increase of one standard deviation in the composite ESG rating is associated with a 14%–16% increase in the total pay. Among the three ESG pillars, only S (social) and G (governance) exhibit persistent and significant associations with both short- and long-term executive pay. The authors also document the significant moderating effects of ESG on the relationships among firm performance, size, leverage, ownership and executive pay, identifying how ESG is associated with compensation.Originality/valueThe authors conclude that managers receive ESG incentives implicitly and explicitly. The novel finding of direct and indirect associations between ESG and top executive compensation contributes to the growing ESG literature on the financial sector and ongoing debate about the explicit inclusion of ESG targets in compensation design.

From profits to purpose: ESG practices, CEO compensation and institutional ownership

“…Additionally, it is emphasized that firms incorporating ESG metrics in executive compensation tend to attract a higher level of engagement and financial commitment from institutional investors, reflecting a congruence with shareholder interests. Similarly, Lee et al (2023) found that ESG performance ratings are strongly associated with all forms of compensation in US financial firms. Among the three ESG pillars, only social and governance exhibit persistent and significant associations with both short-and long-term executive pay.…”

Addressing environment, social and governance (ESG) investment in China: Does board composition and financing decision matter?

“…Executive salaries, bonuses, and other kinds of annual remuneration are significant factors in corporate governance and executive decision-making [ 51 ]. Our research shows a negative relationship between annual compensation and ESG investment; hence, we reject H8 .…”

Guest editorial: A short review of the role of ESG activities in business and research

“…The four papers accepted for the special issue analyze the relationship between corporate governance characteristics and ESG activities. Lee et al (2024) examine the link between ESG performance and top executive compensation in the USA financial services industry. The results reveal that an increase in ESG performance, and specifically social and governance performance indicators, is positively related to an increase in CEO compensation.…”

“…Rahman and Wu (2024) call for further investigation of the role of ESG performance and disclosure (and separate pillars) in M&A deals, as it has been observed that involvement in ESG activities significantly effects the relation between ESG strategy and corporate performance in the context of M&A activities. Lee et al (2024) call for further analysis of the effect of different economic conditions on the relationship between involvement in ESG activities and executive compensation schemes. Future research can also investigate whether explicit ESG incentives for CEOs serve to increase their own compensation or serve stakeholders' interests.…”

“…Lee et al . (2024) examine the link between ESG performance and top executive compensation in the USA financial services industry.…”