ESG reporting, ESG contracting, and executive compensation : international evidence

Abstract

This study examines the influence of environmental, social, and governance (ESG) reporting on the effect of integrating ESG criteria into executive compensation practices (ESG contracting) on executive compensation and corporate environmental performance. We exploit the staggered implementation of ESG mandates across countries as an exogenous shock that enhances firms’ ESG reporting practices. Our analysis demonstrates that firms domiciled in countries with (vs. without) ESG mandates are more likely to adopt ESG contracting practices and exhibit higher quality ESG reporting. We also find a significantly stronger negative association between ESG contracting and executive compensation in the post-ESG mandate period, compared with the pre-ESG mandate period. This effect is particularly pronounced for firms that show improvements in their ESG reporting quality and those that incorporate explicit ESG targets into the design of their ESG contracts. Additional analyses reveal that the negative relationship between ESG contracting and executive compensation is more pronounced for firms with strong corporate governance mechanisms, those operating in industries with substantial environmental impacts, and those domiciled in countries with higher regulatory effectiveness. Finally, we document that ESG reporting strengthens the relationship between ESG contracting and firms’ environmental performance in the post-ESG mandate period. Overall, our findings highlight the critical role of enhanced ESG reporting practices in bolstering the effectiveness of ESG contracting practices to achieve desired corporate outcomes.