ESG ratings, executive pay-for-performance sensitivity and within-firm pay gap

Could a push for sustainability actually widen the pay gap between CEOs and employees?

Xinze Li, Xi Wang, Zuoxiang Zhao, and Qiuyun Zhao ask whether a company’s ESG rating influences its internal pay inequality in « ESG ratings, executive pay-for-performance sensitivity and within-firm pay gap ».

They use data from Chinese-listed firms (2017–2021) and various statistical tests to control for external factors to show that:

• Companies with higher ESG ratings tend to have a significantly wider pay gap between executives and ordinary employees.
• Even after controlling for various factors, the ESG-driven pay gap persists, indicating a likely cause-and-effect relationship.
• When ESG scores improve, executives’ compensation becomes more tightly tied to company performance, so as the firm prospers, executives reap disproportionately larger rewards than employees.
• Not all ESG components are equal: governance is the main driver of this effect, likely because strong governance aligns leaders’ interests closely with performance, inadvertently boosting executive pay relative to employee pay.
• The pay-gap widening effect of ESG is more pronounced in non-state-owned and larger companies, where top managers have more latitude in pay settings.
• Traditional industries and highly competitive sectors see a stronger ESG effect on pay gaps.

This article shows high ESG scores is not a guarantee of fair treatment for employees: linking ESG incentives to fair pay practices may help prevent exacerbating inequality.

Achieving a strong rating, especially via governance improvements, should be paired with dedicated policies to make sure internal inequality and income distribution remain under control.

Regarding the article’s limitations, the data only captures an overall executive-to-employee pay gap and does not distinguish between employee skill levels or roles.

Besides, as the authors mention, sustainability improvements might attract more job seekers, which could widen pay gaps, but a lack of hiring data left this possibility unexamined.