Companies that include ESG metrics in their executive compensation schemes experience more tangible improvements in their CO2 emissions, research from the University of Mannheim, Business School reveals.

According to Professor Stefan Reichelstein, Director of the Mannheim Institute for Sustainable energy Studies and Professor of Business Administration at the University of Mannheim, Business School, including ESG criteria among key performance indicators for executives (referred to as “ESG pay”) is also associated with firms receiving more favourable ESG scores from external rating agencies.

The likelihood of firms adopting ESG pay for executives is more common in environmentally burdensome industries and countries with greater sensitivity to ESG-related issues, Reichelstein finds.

At the firm level, the proclivity to introduce ESG pay is associated with large firms that exhibit greater volatility, and increases if a company has already publicly issued environmental commitments.

“By including ESG metrics for activities subject to external costs in executive compensation schemes, owners can credibly convey to the firm’s stakeholders that management’s attention will be drawn to these external effects. In addition to improving the general corporate image, a firm commitment to be ‘ESG conscious’ may strengthen customer loyalty and make the firm’s equity shares more attractive for institutional investor groups,” says Reichelstein.

Though window-dressing activities, where firms don’t want to “walk the talk”, can be difficult to detect in the context of ESG pay, these findings indicate that the majority of ESG pay adopters are not merely engaging in window-dressing.

This research was based on a sample of 4,395 public firms from 21 countries taken from the ISS Executive Compensation Analytics database.