In recent years, Environmental, Social, and Governance (ESG) metrics have become important factors in determining executive compensation as companies, investors, and regulators aim to align executives’ interests with broader societal goals. But are these metrics effective in generating incentives for executives to improve ESG performance, or are they merely symbolic, allowing companies to appear socially responsible without driving real change?
In a recent paper, we tackle these questions by analyzing a novel dataset that provides comprehensive information on executive compensation in Europe. The data set covers 674 executives from 73 large, listed firms spanning the years 2013 to 2020. It is unique in that it includes both (1) the ex-ante design of performance-linked pay contracts – such as the number and weight of various performance metrics – and (2) ex post data on realized performance and actual payout. This level of detail goes beyond that of prior studies and thus provides a more granular look at how firms structure ESG-linked compensation and whether these structures can influence executive behavior.
The Rise of ESG Metrics in Executive Compensation
ESG metrics are part of a growing movement toward responsible capitalism (shareholder welfare maximization), where companies are expected to pursue goals beyond profitability. These metrics, often tied to factors such as emissions reduction, workforce diversity, or product safety, are seen as ways to ensure that corporate leaders are held accountable for their company’s impact on society and the environment.
In our study, we show that 60 percent of European executives had at least one ESG criterion embedded in their short-term incentive (STI) plans by 2020. However, the actual ex ante weight of ESG metrics within executive compensation packages is minimal. On average, ESG metrics account for less than 5 percent of total performance-linked pay. This low weighting raises doubts about whether these metrics give executives material incentives to strive for desirable ESG outcomes.
Binding vs. Discretionary ESG Metrics
A key aspect of our study is the distinction between “binding” and “discretionary” ESG metrics. Binding metrics enter the executive pay package with a predetermined weight at the beginning of the fiscal year, providing clear and reliable goals for executives. In theory, binding metrics create strong incentives for executives to focus on specific ESG outcomes.
Discretionary ESG metrics are more flexible. Supervisory boards or compensation committees can adjust the weight or significance of these metrics at the end of the fiscal year (i.e., ex post) at their discretion, which introduces uncertainty about how much an executive’s ESG performance will affect their pay. As a result, executives may feel less pressure to prioritize these goals throughout the year, knowing that the actual payout tied to ESG performance can be adjusted later.
Our study finds that discretionary ESG metrics are particularly common in industries like financial services, where ESG factors may not directly affect business outcomes in the same way they do in industries with greater impacts on the environment. In contrast, industries with large environmental footprints, such as energy and utilities, tend to use more binding ESG metrics with greater weight, aligning executive incentives more closely with sustainable outcomes.
Can ESG Compensation Drive Real Change?
One of the central findings of our study is that, despite the increased prevalence of ESG-linked compensation, these metrics contribute very little to the overall variability of – or risk to – executive pay. In practice, non-ESG performance metrics, such as financial results or stock price performance, continue to dominate the calculation of executive bonuses.
Executives are exposed to pay risk if their remuneration is not fixed but contingent on performance, i.e. if the executive is exposed to fluctuations in pay from one year to the next. Our study reveals that binding non-ESG metrics account for 87 percent of this pay risk as measured by variation in executives’ short-term incentive pay. This means that executives’ financial incentives are overwhelmingly tied to traditional business metrics rather than ESG outcomes. In stark contrast, binding ESG metrics account for only 1 percent of the total variation in pay. This tiny contribution suggests that ESG performance metrics are largely symbolic. Even if we focus only on the subset of executives with at least one ESG metric in their compensation contract, these metrics still contribute far less to overall pay variability than their non-ESG counterparts.
Moreover, our study enables us to highlight another issue: ESG metrics tend to be less volatile than non-ESG metrics. We find that overall pay varies less for executives whose pay depends more on ESG factors. This lack of variability may indicate that ESG goals are less ambitious than traditional financial targets, further diminishing their potential to drive meaningful change.
Greenwashing or Authentic Commitment?
Our findings raise concerns that ESG-linked compensation may be more about optics than actual change, especially in industries and companies under heavy public scrutiny. Large companies, particularly those in the financial sector, often include a multitude of mostly discretionary ESG metrics in their compensation plans but fail to assign them meaningful weights. This suggests that for many firms, the inclusion of ESG metrics may be a form of “greenwashing” — a way to signal commitment to sustainability without creating real incentives for substantive improvements.
In contrast, firms in sectors where ESG performance is closely tied to financial outcomes, such as energy, utilities, and manufacturing, tend to use binding ESG metrics with more substantial weights. In these industries, improving ESG performance is often linked to reducing costs (e.g., through energy efficiency) or avoiding regulatory penalties (e.g., emissions targets), giving executives stronger financial reasons to prioritize sustainability goals.
Moreover, our analysis revealed an unexpected trend: Specialized positions like chief human resource officers (CHROs) and chief technology officers (CTOs) often lack relevant metrics. CHROs are no more likely than CEOs to have workforce-related metrics, while CTOs frequently have fewer environmental metrics than their CEOs. This suggests that firms may focus on ESG metrics for their most visible executives, potentially as a greenwashing strategy.
Implications for Policy and Practice
For ESG metrics to meaningfully influence executive behavior, they must carry enough weight in compensation packages to create real incentives. As it stands, ESG metrics are too often relegated to the background, with minimal impact on executive pay. Increasing the weight of binding ESG metrics and reducing the reliance on discretionary measures could help ensure that ESG-linked pay is not just symbolic.
Looking ahead, regulatory and investor or proxy adviser pressure may play a critical role in pushing companies to design more robust ESG-linked compensation schemes.
While ESG-linked compensation is becoming more common, its actual influence on executive incentives remains limited. For ESG metrics to drive real corporate change, they must move from being a side note in compensation plans to playing a central role in how executives are evaluated and rewarded. Without this shift, ESG-linked pay risks remaining all hat and no cattle – offering the appearance of progress without delivering the incentives necessary to achieve it.
This post comes to us from professors Matthias Efing at HEC Paris and Patrick Kampkoetter at the University of Tuebingen and PhD students Stefanie Ehmann and Raphael Moritz at the University of Tuebingen. It is based on their recent paper “All Hat and No Cattle? ESG Incentives in Executive Compensation” available here.