Executive Compensation With Socially Responsible Shareholders

Abstract

We study incentive provision by a socially responsible board. We show that managerial compensation uses measures of social performance such as ESG scores only when the board is more socially responsible than investors who set the stock price. Thus, ESG-based compensation and socially responsible investors are substitutes. When the board and investors have different social preferences, the compensation contract uses multiple performance measures. Otherwise, it only relies on the stock price. The firm's manager, who understands how social performance measures are constructed, will game the methodologies. Relying on multiple measures based on different methodologies can mitigate this inefficiency. This has normative implications for the regulation and harmonization of ESG ratings.

Keywords: corporate governance, corporate social responsibility, ESG measurement, ESG harmonization, executive compensation

JEL Classification: G30, M12