Aligning Pay With Purpose: ESG-Linked Compensation and ESG Decoupling

Can linking CEO pay to sustainability goals prevent greenwashing?

Yasser Eliwa, Ahmed Saleh, and Ahmed Hassan Ahmed examine the relationship between ESG-linked executive compensation and « ESG decoupling » in « Aligning Pay With Purpose: ESG-Linked Compensation and ESG Decoupling ».

Using a dataset of 36,055 firm-year observations across 40 countries (2005–2023), the authors analyse how tying pay to ESG performance affects the gap between ESG commitments and action.

Their results include:

• Firms that tie executive pay to ESG targets exhibit significantly less ESG decoupling. Said otherwise, linking CEO incentives to sustainability goals reduces the gap between what companies publicly commit to and what they actually achieve.
• Companies with ESG pay incentives and an active CSR or sustainability committee see an even greater alignment between their ESG disclosures and observed performance.
• The impact of ESG-tied compensation is observed with varying strength in both developed and developing markets and in industries facing high ESG controversies.
• ESG-linked pay clearly curbs greenwashing but may slightly increase brownwashing, the tendency to downplay or underreport positive ESG performance relative to actual achievements.
• The negative link between ESG-linked pay and decoupling holds even after accounting for potential endogeneity, and extensive checks confirm these results aren’t due to reverse causality or selection bias.

This study suggests corporate boards and management can leverage ESG incentives, alongside strong internal oversight, to build stakeholder trust and enhance accountability for sustainability results.

Policymakers may consider encouraging internal governance mechanisms like aligning pay with ESG metrics and mandating oversight committees as a complement to disclosure rules in order to foster more credible ESG performance.

However, this study has limitations: it uses a binary measure of ESG-linked pay and does not capture differences in the quality or rigour of ESG targets in compensation contracts.