The Interplay Between Board and CEO Compensation With an ESG-focus

Abstract

ESG has become increasingly important for a company's performance as more legal requirements are needed, and awareness has increased from investors and consumers. Furthermore, is transparency in compensation plans and the art of getting rid of short-term incentives key factors in avoiding future financial crises. Hence, this paper empirically studies the interplay between CEO- and board compensation with an ESG focus. We model three models to gain an understanding of the determinants and the relationship between board compensation, CEO compensation, and ESG rating. Based on a sample of 475 companies from the S&P 500 Index in the years 2017-2021 (2,287 observations), we find significant evidence for the fat cat problem, mutual backscratching theory, and resource dependence theory. These findings align with previous research (Lin et al., 2013; Lin & Lin, 2014; Brick et al., 2006). However, more importantly, we find significant evidence of the fact that the ESG perspective can challenge these theories. The environmental factor is significant in explaining both CEOand board compensation, implying that including ESG measures in the pay-for-performance can help align the CEO's and the board's interests. We argue that companies use ESG as a window-dressing strategy to attract investors. Moreover, we suggest that future research investigate how to include social and governance measures in the compensation plans, as those measures have the most significant impact on ESG ratings but are insignificant in the current compensation plans.