Executive compensation and corporate sustainability: Evidence from ESG ratings (2024)

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Executive compensation and corporate sustainability: Evidence from ESG ratings (1)

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Heliyon. 2024 Jun 30; 10(12): e32943.

Published online 2024 Jun 13. doi:10.1016/j.heliyon.2024.e32943

PMCID: PMC11211889

PMID: 38948032

Chen Zhu,a,1,⁎⁎ Xue Liu,a Dong Chen,b, and Yuanyuan Yuec,1

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Abstract

Selecting A-share listed companies in Shanghai and Shenzhen, China, during the period of 2012–2021 as research subjects, this study examines the relationship and operational mechanisms between executive compensation and corporate ESG Ratings. It is found that executive compensation incentives can significantly enhance corporate ESG Ratings. This effect is achieved through promoting green innovation efficiency, enhancing environmental information disclosure, and improving financial performance. However, this positive impact weakens with an increase in management shareholding, but strengthens with a higher proportion of independent directors. When compensation exceeds appropriate levels, overcompensation leads to a decline in ESG Ratings. The significance of this study lies in revealing potential pathways for enhancing corporate sustainability through executive compensation incentives, while also emphasizing the importance of formulating appropriate compensation strategies.

Keywords: Compensation incentives, Corporate ESG ratings, Sustainable development

1. Introduction

In today's business environment, where corporate social responsibility and sustainable development are increasingly prioritized, the relationship between executive compensation incentive mechanisms and corporate sustainability has garnered widespread attention. Numerous studies demonstrate that linking executive compensation to a company's environmental, social, and governance (ESG) performance not only fosters positive actions towards sustainable development but also enhances long-term market value and financial performance. There is a positive correlation between executive compensation, sustainable compensation policies and carbon performance, with executive incentives playing a key role in driving companies to achieve their environmental goals [1]. Financial incentives for management have a significant positive impact on increasing firm value and earnings, with sustainability metrics playing a critical role in contributing to this impact [2].

Furthermore, innovation investment, a key driver for corporate sustainability, has been proven to have a significant impact on long-term financial sustainability through its interaction with executive compensation incentives [3]. Sizable executive compensation can incentivize management to act more proactively on climate and environmental issues, thereby improving firm financial performance [4].

These pieces of evidence suggest that carefully designed executive compensation incentive mechanisms can effectively promote corporate performance in environmental protection, social responsibility, and governance structures, thereby achieving the goals of corporate sustainable development. Therefore, the connection between executive compensation and corporate sustainability is complex and intimate, requiring the collective attention and in-depth discussion of corporations, policymakers, and researchers to achieve a more harmonious development of society, the environment, and the economy.

The concept of ESG was initially introduced by Goldman Sachs and other financial institutions in 2004, responding to the call of the United Nations Environment Program Financial Action Unit (UNEPFI). Over the past 19 years, the ESG concept has gained increasing prominence. As the market's attention gradually shifts toward ESG Ratings, companies are providing timely, relevant, and credible data to showcase their improved ESG Ratings. Financial analysts and investors utilize this information to facilitate capital flow towards sustainable corporate investments, addressing critical climate and sustainability challenges [5].

At a time when the ESG concept is becoming more prevalent, the market's focus on firm performance has gradually shifted to ESG performance, and the relationship between executive compensation and corporate ESG performance has begun to receive gradual attention. The concept of ESG pay has been introduced, and ESG pay is more common in firms with higher ESG ratings, and larger firms tend to be linked to ESG criteria [6]. Lagged ESG ratings are strongly associated with CEO compensation [7], and executive compensation also has an impact on ESG ratings [8,9].

In recent years, sustainability has emerged as a paramount concern in global development, amid the frequent occurrences of the COVID-19 pandemic, climate change, and income inequality issues. Since the introduction of the “peak carbon emissions and carbon neutrality” goals, the significance of Environmental, Social, and Governance (ESG) criteria has been escalating in China. This is attributed to its strong alignment with China's “dual carbon” strategy and goals for high-quality development. Consequently, there has been a growing emphasis on ESG considerations across various sectors of Chinese society, particularly in evaluating corporate ESG performance.

With an increasing number of companies in China intensifying their focus on ESG, the economic benefits and societal impacts associated with ESG will be further accentuated. This trend is conducive to enhancing corporate sustainable competitiveness and international image, while also facilitating the sustainable development of the Chinese economy, thus advancing the goals of “peak carbon emissions” and “carbon neutrality” at an earlier juncture.

As pivotal economic agents, corporations bear the responsibility of fostering societal progress towards sustainable objectives. This entails the construction of operational models that balance economic efficiency with sustainable development while simultaneously pursuing profit maximization. Therefore, the active embodiment of ESG principles becomes imperative in corporate practices.

To delve deeper into the role of executive compensation incentives in shaping corporate ESG performance and to elucidate potential transmission mechanisms, facilitating a greater consideration of ESG factors in future executive compensation design, thereby enhancing corporate ESG ratings, is essential.

This paper empirically examines the impact of executive compensation on corporate ESG performance of selected Chinese A-share companies listed in Shanghai and Shenzhen during the period of 2012–2021, and analyzes the impact of executive compensation on corporate ESG performance. Robustness and endogeneity tests are conducted to validate the findings. Additionally, the study explores the channels through which executive compensation affects corporate ESG Ratings, specifically examining the impact on green innovation efficiency, environmental information disclosure, and financial performance. Moreover, the study investigates the influence of executive compensation on ESG Ratings in relation to different levels of management shareholdings and independent director ratios. Lastly, the study explores the impact of executive overcompensation on corporate ESG Ratings.

The possible marginal contributions of this paper are as follows: first, it verifies the facilitating effect of executive compensation incentives on corporate ESG performance enhancement using Chinese data, which provides ideas for Chinese firms to enhance their ESG performance. Second, this paper reveals the incentive mechanism of executive compensation incentives on ESG performance of Chinese firms through green innovation efficiency, environmental information disclosure and financial performance, and explores the transmission path of executive compensation on corporate ESG performance. Finally, the findings of this paper provide a theoretical basis for Chinese firms to improve ESG performance by setting reasonable management compensation incentives, which is an important reference value for corporate compensation setting. The remainder of this paper is structured as follows. section 2 reviews the theoretical literature and presents the research hypotheses. Section 3 provides the data and research methodology. Sections 4, 5 discuss the empirical results and further analyze the impact of excess compensation on corporate ESG. Section 6 gives the conclusions of the study.

2. Literature review and research hypothesis

2.1. Executive compensation and corporate ESG ratings

Executive compensation encompasses various forms of compensation received by executives from the company, including direct or indirect, explicit or implicit, and monetary or non-monetary components. Currently, two predominant perspectives exist regarding the factors that influence executive compensation contracts: the "optimal contract theory" and the "management power theory." The "optimal contract theory," rooted in the principal's viewpoint, asserts that the principal can design an effective executive compensation contract to incentivize executives to work diligently while curbing the agent's self-interest. Thus, the executive compensation contract serves as a mechanism to mitigate the agency conflict between the principal and the agent [10,11]. In contrast, the "management power theory" is an agent-based theory. According to this perspective, rational managers are primarily motivated to maximize their own interests rather than the interests of the company and its shareholders. The inherent weaknesses of the board of directors, the managerial market, the control market, and the capital market allow managers to wield substantial influence over the formulation and implementation of executive compensation contracts, enabling them to seek personal gains by manipulating these contracts [12]. Consequently, executive compensation contracts themselves become part of the agency problem. Existing literature predominantly revolves around the "optimal contract theory" and the "management power theory," considering various factors such as the type of controlling shareholders [13], firm production [14], executive tenure [15], stock market performance [16], internal and external corporate governance environment [17], and the comparability of accounting information.

ESG Ratings is a measure of a firm's sustainability, and academic discussions on this topic can be broadly categorized into two aspects: economic consequences and influencing factors. Regarding economic consequences, the primary focus lies in examining the impact of ESG Ratings on various financial indicators such as financial performance, share price volatility, financing constraints, firm value, and firm efficiency. There is a positive correlation between ESG ratings and firms' financial performance, and this positive effect is stable in the long run [18]. During the COVID-19 pandemic, portfolios with higher ESG scores showed greater resilience [19]. Socially Responsible Investment (SRI) foundations adjust their portfolio weights based on a company's relative ESG rating [20].Companies with higher ESG ratings have lower debt financing costs and are more influential in stakeholder-oriented unsystematic equity setups [21].ESG ratings have a positive impact on listed companies' value and can significantly improve a firm's Tobin's Q [22]. Non-linear relationship between corporate ESG activities and corporate efficiency [23].

Additionally, ESG Ratings has been shown to have various positive effects, including the reduction of corporate risk, the enhancement of customer relationship stability, the inhibition of true surplus management activities, and the reduction of equity costs [[24], [25], [26]]. These positive impacts on firm operations and capital market performance can serve as motivators for firms to prioritize and improve their ESG Ratings. In terms of influencing factors, studies have been conducted to examine comprehensive ESG Ratings with regard to corporate organizational structure, industry heterogeneity, management characteristics, and company size. Companies with social responsibility committees exhibit higher ESG ratings [27]. Companies operating in sensitive industries such as tobacco, alcohol and polluting industries are motivated to improve their ESG ratings [28]. Materialism plays a role in shaping individual value systems, and companies led by materialistic CEOs tend to have lower CSR scores and fewer strengths, resulting in lower ESG ratings [29]. There is a significant positive correlation between firm size and ESG ratings, which can be explained by the concept of organizational legitimacy [30].

According to the theory of incentive compatibility and optimal contract theory, although both incentives and supervision can address the conflict of interest between the two parties in the principal-agent relationship, incentives hold greater advantages due to the associated costs incurred by supervision. An effective compensation contract, serving as an incentive mechanism, can mitigate the agency conflict between shareholders and executives, aligning the interests of both parties. Well-designed compensation contracts can satisfy both management participation constraints and incentive compatibility constraints, thus helping to mitigate the moral hazard problem of agents under information asymmetry [31]. Meanwhile, there has been increasing domestic and international attention to the Environmental, Social, and Governance (ESG) concept in recent years, making ESG ratings a mainstream evaluation criterion for publicly listed companies globally. ESG factors are playing an increasingly significant role in the operation and performance of enterprises, drawing heightened interest from stakeholders such as investors, consumers, employees, and regulatory bodies.

As the ESG development paradigm gains increasing prominence, a growing number of companies are incorporating ESG performance indicators into the evaluation systems for executive compensation [[32], [33], [34], [35], [36]]. Under such a compensation design, it can heighten the executives' focus on long-term sustainability, curb their short-term opportunistic behaviors to a certain extent, and thereby encourage executives to consider environmental, social, and governance (ESG) factors in investment and business operational decisions. This, in turn, aligns the incentives of executives with the sustainable development of the enterprise. Drawing on stakeholder theory, in scenarios where enterprises prioritize ESG institutional construction and ESG performance, compensation incentives can enhance the alignment of executives' decision-making with the values of stakeholders. This alignment facilitates the enterprises' strategic decision-making that adheres to the principles of sustainable development, based on a long-term value orientation. Consequently, executive compensation incentives are likely to improve a company's ESG performance.

Based on the preceding analysis, this paper proposes the following hypothesis.

Hypothesis 1

There exists a positive relationship between executive compensation and corporate ESG Ratings. Specifically, higher executive compensation is expected to be associated with better corporate ESG Ratings.

2.2. The mediating role of green innovation efficiency, environmental information disclosure and financial performance

2.2.1. Executive compensation, green innovation efficiency and corporate ESG ratings

In modern corporate management, executive compensation incentives are widely regarded as a key mechanism for driving innovation and enhancing a company's Environmental, Social, and Governance (ESG) performance. Theoretical and empirical research has revealed a logical framework where executive compensation incentives, by boosting corporate green innovation efficiency, positively impact the company's ESG rating.

Initially, executive compensation mechanisms, including but not limited to salary rewards and long-term equity incentives, aim to align executives' personal interests with the company's long-term goals. This mechanism stimulates executives' focus and investment in green innovation, as such innovation not only assists companies in addressing environmental challenges but also serves as a vital pathway to achieving sustainable development. Compensation incentives can promote green innovation activities within firms [37], and incorporating corporate social responsibility (CSR) criteria into executive compensation can improve firms' green innovation performance [38].

Furthermore, a company's green innovation efficiency, serving as a measure of its capability to develop and apply environmentally friendly innovative products and technologies, directly influences its ESG rating. The ESG rating reflects the company's performance in environmental protection, social responsibility, and governance structure, serving as a crucial basis for investors, consumers, and other stakeholders to evaluate the company's sustainable development capacity. Green innovation not only enhances the company's environmental performance but also fosters improvements in social responsibility and governance structure, thereby positively affecting its ESG rating [39,40].

In summary, executive compensation incentives, by fostering corporate green innovation activities, not only enhance the company's performance in environmental protection, social responsibility, and governance but also indirectly elevate its ESG rating. Executive compensation incentives can effectively balance managers' risks and returns associated with green technology innovation, potentially enhancing their willingness and capacity to undertake such innovation and associated risks. This, in turn, facilitates executives in making green technology innovation decisions that align with stakeholder value orientations, thereby reinforcing the driving effect of ESG performance on corporate green technology innovation.

This logical framework emphasizes the central role of executive compensation incentives in advancing corporate sustainable development strategies, while also highlighting green innovation as a key avenue for achieving high ESG ratings. Therefore, companies should thoroughly consider the importance of green innovation in enhancing their ESG rating when designing executive compensation incentive mechanisms, thus playing a proactive role in the global agenda for sustainable development.

2.2.2. Executive compensation, environmental information disclosure and corporate ESG ratings

In exploring the impact of executive compensation incentives on corporate environmental disclosure and its influence on corporate ESG ratings, literature indicates a complex mediating relationship between executive compensation mechanisms and corporate ESG ratings. There is a positive correlation between a firm's environmentally responsible performance and its executives' risk-taking incentives, suggesting that executive compensation structures can encourage better environmental performance, which in turn influences firm risk and investor perceptions [41]. Executive compensation is positively correlated with corporate climate and environmental issues, which in turn affects a firm's financial and market value performance, demonstrating how environmental disclosure can serve as a channel to link executive compensation incentives to firm performance [42].

Executive compensation has a U-shaped threshold effect on corporate environmental responsibility and the potential mediating role of environmental disclosure between executive compensation and corporate ESG ratings [43]. Executive compensation has a direct positive effect on firm value but no significant effect on GHG emissions disclosure, implying that the quality and extent of environmental disclosure may be a key factor influencing corporate ESG ratings [44].

Furthermore, active adherence to ESG principles is not only imperative for corporate sustainable development but also crucial for safeguarding stakeholder interests, leading to increased scrutiny of corporate ESG behavior by various stakeholders. The widespread stakeholder focus on ESG principles creates pressures on executives managing corporations. Executive compensation incentives can serve as compensation for the risks associated with their information disclosure, prompting executives to disclose more environmental information during operations to meet stakeholders’ demands and gain their recognition and support.

The aforementioned research collectively reveals the significant impact of executive compensation incentives on environmental disclosure and corporate ESG ratings, suggesting a potential pathway through enhancing the quality and transparency of environmental disclosure to optimize corporate ESG ratings.

2.2.3. Executive compensation, financial performance and corporate ESG ratings

High executive compensation provided by firms can serve as a motivating factor for executives to perform well. There are two key aspects to consider in this context. Firstly, high compensation levels, within reasonable limits, create a competitive environment among incumbent and potential executives, stimulating them to enhance firm performance [45]. Secondly, compensation tied to verifiable and direct mechanisms, such as corporate financial performance, can incentivize managers to exert more effort [46,47]. In China, the relationship between executive compensation and firm performance has already been established, indicating a significant and positive correlation. According to the theory of redundant resources, enterprises with superior financial performance provide more idle resources for increasing environmental protection investment and undertaking social responsibility. At the same time, the process of strengthening ESG construction itself also requires continuous resource investment in the early stage. When companies obtain better financial performance through executive compensation incentives, they provide a financial foundation and support for the fulfilment of ESG responsibilities. In enterprises with good financial performance, management and shareholders will be more willing to fulfil their environmental protection obligations and social responsibilities when their economic interests are satisfied. Therefore, remuneration motivates management to improve financial performance, which in turn enhances ESG Ratings.

When a company's financial performance is strong, both management and shareholders are more inclined to fulfill their environmental and social obligations, as their economic interests are already being satisfied. Consequently, compensation serves as a motivation for management to improve financial performance, subsequently enhancing corporate ESG Ratings.

Based on the above analysis, the following hypotheses are proposed in this paper.

Hypothesis 2

Green innovation efficiency, environmental information disclosure and financial performance play a mediating role in the relationship between executive compensation and corporate ESG Ratings. Specifically, executive compensation enhances corporate ESG Ratings by increasing the level of corporate green innovation efficiency, environmental information disclosure, and enhancing financial performance.

3. Study design

3.1. Sample and data sources

This study focuses on the inclusion of all A-share listed companies in the Shanghai and Shenzhen markets in China between 2012 and 2021 as the primary subject of investigation. A total of 40,766 initial observation samples were obtained from 5072 listed companies. To align with the research objectives, the following treatments were applied to the samples: (1) exclusion of samples from the financial, insurance, and capital market service industries, (2) exclusion of ST-labeled samples, (3) exclusion of samples with missing data, and (4) application of tailoring at the 1% and 99% levels for all continuous variables. Ultimately, 28,306 observation samples were obtained. All data were obtained from the CSMAR database, the Wind database and the CNRDS database.

3.2. Variable definition

3.2.1. Explanatory variable: ESG ratings of the firm (ESG)

In the current academic landscape, the evaluation of ESG Ratings primarily relies on ratings provided by third-party rating agencies such as MSCI, Bloomberg, FTSE Russell, as well as domestic agencies like HuaZheng, SynTao Green Finance, and Run Ling Global. In the benchmark regression model, considering factors such as the rapid update frequency, broad coverage, and suitability for the Chinese market, this study utilizes HuaZheng ESG ratings data as the measure for the dependent variable, namely corporate ESG Ratings (ESG). The Huazheng ESG ratings range from AAA to C, with nine levels in total. This article assigns a score of 1–9 to these ratings, with AAA corresponding to 9 points and C corresponding to 1 point.

3.2.2. Explanatory variables: executive compensation (Pay)

In this paper, executive compensation (Pay) is measured by taking the natural logarithm of the total cash compensation of the top three executives, as disclosed in the annual reports of listed companies.

3.2.3. Mediating variables

  • a.

    Green innovation efficiency (GIE)

Referring to the study of [48], green innovation performance is calculated from the CNRDS database, using the ratio of green innovation output and innovation input to measure green innovation efficiency. Restricted by the unavailability of green innovation input data for listed companies, this paper uses the company's annual R&D expenditures as an approximate proxy for green innovation input. The green innovation output of listed companies is measured by the natural logarithm of the total number of green invention, utility model and design patents filed by listed companies plus one.

  • b.

    Environmental information disclosure (EID)

Referring to the methodology of [49], the environmental disclosure was derived from the environmental research database in the CSMAR database. It consists of five dimensions of environmental management disclosure, environmental certification disclosure, environmental disclosure vehicle, environmental liability disclosure, and environmental performance and governance disclosure with a total of 25 indicators, 2 if one of them is disclosed and 0 otherwise for non-monetized information, and 2 for quantitative and qualitative description, 1 for qualitative description only, and 0 for non-description for monetized information. The 25 indicators were summed and logarithmically processed to obtain this variable.

  • c.

    Financial performance (ROE)

Referring to the study of [50], this paper selects the return on equity indicator to measure the financial performance of the enterprise (ROE), and the larger the indicator is, the better the operating efficiency of the enterprise is.

3.2.4. Control variables

Building upon prior research, this paper incorporates the following control variables: firm age (FirmAge), firm size (Size), gearing (Lev), dual position (Dual), board size (Board), firm growth (Growth), and firm value (TobinQ). Additionally, year effects and industry effects are accounted for as control variables. The detailed definitions and measurement methods of these variables can be found in Table 1.

Table 1

Variable definition table.

Variable NameVariable SymbolsVariable Definition
ESG RatingsESGHuaZheng ESG Rating Assignment, 1–9 points
Executive compensationPayln (total compensation of top three executives)
Green innovation efficiencyGIEln(number of green patent applications +1)/ln(R&D expenditures +1)
Environmental information disclosureEIDQuality of environmental disclosure
Financial performanceROEReturn on Equity
Company AgeFirmAgeln (current year - year of company establishment+1)
Company SizeSizeNatural logarithm of total assets at the end of the year
Gearing ratioLevRatio of total liabilities to total assets at the end of the year
Duality (Dual)Dual0-1variable, takes the value of 1 if the chairman and general manager are the same person, otherwise, it is 0
Board SizeBoardThe number of board members is taken as the natural logarithm
Company GrowthGrowthOperating income growth rate
Company ValuesTobinQTobin's Q at the end of the company's year

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3.3. Model setting

To investigate the relationship between executive overcompensation and corporate ESG Ratings, the following benchmark regression model is set in this paper:

ESGi,t=α0+α1Payi,t+Controlsi,t+λi+μt+εi,t

(1)

In order to further investigate the impact of changes in executive compensation on changes in corporate ESG performance, this paper constructs the following model:

ΔESGi,t=α0+α1ΔPayi,t1+Controlsi,t+λi+μt+εi,t

(2)

To examine whether executive compensation affects corporate ESG Ratings through mediating variables, the following mediating effect test model is constructed:

Mediatei,t=β0+β1Payi,t+Controlsi,t+λi+μt+εi,t

(3)

ESGi,t=γ0+γ1Payi,t+γ2Mediatei,t+Controlsi,t+λi+μt+εi,t

(4)

where the dependent variable ESGi,t represents the ESG Ratings of firm i in year t, while ΔESGi,t denotes the difference between the ESG performance of firm i in year t and that in year t1. The explanatory variable Payi,t represents the executive compensation received by firm i s executives in year t, and ΔPayi,t1 represents the change in executive compensation received by firm i's executives in year t1. The intercept term is denoted by α0 and Controlsi,t refers to the control variables. λi is the individual fixed effect, μt is the year fixed effect, and εi,t is the random error item. The coefficients α1 represents the effect of executive compensation on corporate ESG Ratings. If the coefficient α1>0 and statistically significant, it indicates that the executive overcompensation has a positive association with the ESG Ratings of the company, supporting research Hypothesis 1.

Mediatei,t represents the mediating variables, including social responsibility (CSR), internal control (IC), and financial performance (ROE). According to the three-step test for mediating effects, the mediation effects are examined as follows: in the first step, The impact of executive compensation on corporate ESG Ratings is significant, indicating that the coefficient α1 in model (1) reaches a significant level. In the second step, the impact of executive compensation on the mediating variables is significant, indicating that the coefficient β1 in model (2) reaches a significant level. In the third step, the simultaneous effects of executive compensation and mediating variables on corporate ESG Ratings are tested. In model (3), when the coefficient γ2 of the mediating variable is significant while the coefficient γ1 of executive compensation is not significant, the mediating variable fully mediates the relationship. When both the coefficient γ2 of the mediating variable and the coefficient γ1 of executive compensation are significant, the mediating variable partially mediates the relationship.

4. Empirical results and analysis

4.1. Descriptive statistics

Table 2 presents the descriptive statistics for the main variables. In terms of the ESG Ratings of firms (ESG), the sample exhibits a mean of 6.469 and a median of 6.000. These values suggest an overall favorable ESG Ratings among the firms. Furthermore, the standard deviation of ESG Ratings is 1.174, indicating a substantial variation in ESG Ratings levels across firms. Regarding executive compensation (Pay), the mean value is 14.467, with a minimum of 12.820 and a maximum of 16.404. These findings align with previous literature on the subject. Firm size (Size) demonstrates a mean value of 22.251 and a standard deviation of 1.299, implying significant differences in size across firms. The mean value of gearing (Lev) is 0.432, indicating a generally strong solvency among companies. For the variable Dual, the mean value is 0.282, and the standard deviation is 0.450, suggesting that the phenomenon of having the same person as the chairman and general manager is relatively common in supervisory companies. The mean value of Growth is 0.174, indicating that companies, on average, maintain a high level of revenue growth.

Table 2

Results of descriptive statistics of main variables.

Variable NameObservationsAverage valueMedianStandard deviationMinimum valueMaximum value
ESG283066.4696.0001.1743.0009.000
Pay2830614.46714.4410.69812.82016.404
FirmAge283062.9292.9960.3151.9463.526
Size2830622.25122.0691.29919.76926.263
Lev283060.4320.4230.2080.05800.918
Dual283060.2820.0000.4500.0001.000
Board283062.1212.1970.1991.6092.708
Growth283060.1740.1020.453−0.5942.966
TobinQ283062.1141.6391.4660.8499.648

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Note: All data were sourced from the CSMAR database and Wind databases.

Table 3 shows the correlation coefficients between the variables, and it can be seen that the correlation coefficient between Pay and ESG is 0.211,and presents a significance at 1% level. It indicates that there is a significant positive correlation between executive compensation Pay and corporate ESG performance.

Table 3

Pearson correlation coefficient.

Variables(1)(2)(3)(4)(5)(6)(7)(8)(9)
(1)ESG1.000
(2) Pay0.211a1.000
(3) FirmAge0.035a0.163a1.000
(4) Size0.371a0.443a0.158a1.000
(5) Lev0.049a0.083a0.169a0.475a1.000
(6) Dual−0.101a0.018a−0.103a−0.167a−0.121a1.000
(7) Board0.158a0.085a0.053a0.266a0.139a−0.181a1.000
(8) Growth−0.0050.038a−0.030a0.030a0.019a0.027a−0.017a1.000
(9) TobinQ−0.105a−0.074a−0.021a−0.406a−0.246a0.075a−0.135a0.057a1.000

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ap<0.01, **p<0.05, *p<0.1.

Table 4 shows the Variance Inflation Factor (VIF), it can be seen that the average VIF is 2.96, and the VIF of each variable is less than 2, which indicates that there is no significant problem of multicollinearity, and the results of this study can more reliably explain the effect of the independent variables on the dependent variable without being significantly affected by multicollinearity.

Table 4

Variance inflation factor (VIF).

VariableVIF1/VIF
Pay1.540.647293
FirmAge1.310.765663
Size2.180.458559
Lev1.480.67546
Dual1.080.923223
Board1.140.874119
Growth1.030.967158
TobinQ1.40.715402
Mean VIF2.96

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4.2. Baseline regression results

Table 5 presents the regression results, which have been adjusted using cluster-robust standard errors to address the issue of within-group correlation in the sample. We adjusted for clustering at the enterprise level using the cluster variable (firmid) to ensure the accuracy and robustness of the results. All standard errors in the table have been adjusted for clustering. column (1) presents only the regression results of executive compensation (Pay) and firms' ESG performance (ESG), column (2) reports the regression results controlling for industry and year, which show that the regression coefficients of executive compensation (Pay) are all significant at the 1% level. The regression results imply that there is a significant positive relationship between executive compensation and firms' ESG performance, indicating that the higher the compensation given to executives, the better the firms' ESG performance will be, controlling for other variables.

Table 5

Regression results of executive compensation and ESG Ratings.

(1)(2)(3)(4)
VariablesESGESGVariablesΔESGΔESG
Pay0.349***0.112***ΔPayt-10.009**0.009***
(37.628)(10.538)(2.507)(2.652)
FirmAge0.065***FirmAge−0.895**
(2.988)(-2.176)
Size0.371***Size0.093**
(53.771)(2.176)
Lev−1.013***Lev−0.323**
(-26.953)(-2.138)
Dual−0.073***Dual(0.036)
(-5.333)(-0.846)
Board0.251***Board(0.071)
(7.541)(-0.578)
Growth−0.051***Growth(0.014)
(-3.715)(-0.531)
TobinQ0.038***TobinQ0.012
(8.368)(0.867)
Constant1.414***−3.949***Constant(0.106)0.594
(10.563)(-23.520)(-0.188)(0.381)
FirmYESYESFirmYESYES
YearYESYESYearYESYES
Observations2830628306Observations75847584
R-squared0.0450.242R-squared0.0200.023

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Note: t-values are in parentheses, and ***, **, and * indicate statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively.

Columns (3) and (4) show the results of regressing the change in executive compensation (ΔPayt-1) in the previous year on the change in corporate ESG performance in the current year. The results show that the regression coefficients of the change in executive compensation (ΔPayt-1) in the previous year are significant at the 5% and 1% levels, respectively, and it appears that the change in executive compensation (ΔPayt-1) in the previous year significantly improves the change in corporate ESG performance in the current year. Hypothesis 1 is verified. Regarding the control variables, the regression coefficient of firm size (Size) is significantly positive at the 1% level, indicating that the larger the firm size, the more importance the firm attaches to ESG performance. The regression coefficient of Lev is significantly negative at the 1% level, indicating that the higher the corporate debt ratio, the worse the ESG performance of the firm. The regression coefficient of Dual is significantly negative at the 1% level, indicating that the ESG performance of enterprises with the same chairman and general manager is worse than that of enterprises with different chairmen and general managers, which may be due to the fact that the decision-making of this enterprise is mainly decided by a single person and lacks the necessary supervision, and will be under-invested in ESG. The regression coefficient of Board size (Board) is significantly positive at the 1% level, indicating that the larger the board size, the more complex the mutual monitoring among directors, and the better the ESG performance of the firm. The regression coefficient of firm growth (Growth) is significantly negative at the 1% level, indicating that firms with faster growth in operating income may devote more resources to the development of corporate performance and thus have poorer ESG performance. The regression coefficient of company value (TobinQ) is significantly positive at the 1% level, indicating that companies with higher company value have better ESG performance.

4.3. Robustness test

In the robustness test, this paper conducts a substitution of the explanatory variables by introducing the logarithm of the total annual salary of directors and supervisors (Pay1) and the corporate ESG Ratings score data provided by Bloomberg Consulting (ESG1) for the benchmark regression analysis. This substitution is carried out to ensure the reliability and robustness of the paper's findings.

As depicted in columns (1) and (2) of Table 6, the substitution of the explanatory and explanatory variables does not alter the positive correlation observed between executive compensation and corporate ESG Ratings. This outcome aligns with the results obtained in the previous study, thereby enhancing the consistency and robustness of the findings.

Table 6

Robustness test regression results.

(1)(2)
VariablesESG1ESG
Pay1.263***
(12.704)
Pay10.148***
(13.983)
FirmAge0.669***0.077***
(3.148)(3.555)
Size2.404***0.354***
(33.108)(50.090)
Lev−2.660***−0.989***
(-7.360)(-26.324)
Dual−0.078−0.064***
(-0.530)(-4.658)
Board0.3650.204***
(1.192)(6.126)
Growth−0.106−0.050***
(-0.784)(-3.684)
TobinQ0.241***0.039***
(5.007)(8.610)
Constant−55.022***−4.174***
(-30.761)(-24.928)
FirmYESYES
YearYESYES
Observations10,35920,903
R-squared0.5550.244

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Note: t-values are in parentheses, and ***, **, and * indicate statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively.

4.4. Endogeneity test

4.4.1. System GMM regression

Considering the possible endogeneity of the model, this paper uses a dynamic panel modelling system GMM model for the regression, which is set up as follows:

ESGi,t=δ0+δ1ESGi,t1+δ2Payi,t+Controlsi,t+λi+μt+εi,t

(5)

In equation (5), ESGi,t1 denotes ESG Ratings in the lagged period, and other variables have the same meaning as in equation (1).

The regression results are shown in Table 7. The regression coefficient for ESG Ratings in the lagged period is significantly positive, indicating that the company's ESG Ratings in the previous period has a significant positive impact on the company's ESG Ratings in the current period. Regression coefficients for executive compensation (Pay) are significantly positive at the 1% level regardless of whether control variables are introduced, indicating that the higher the executive compensation the higher the firm's ESG Ratings. Regression results remain robust after controlling for endogeneity using a system GMM model.

Table 7

System GMM regression.

(1)(2)
VARIABLESESGESG
L.ESG0.413***0.307***
(19.330)(16.337)
Pay0.662***0.150***
(10.371)(3.430)
FirmAge0.199***
(2.971)
Size0.412***
(14.999)
Lev−1.494***
(-10.206)
Dual−0.123***
(-2.703)
Board0.494***
(3.707)
Growth0.022
(1.148)
TobinQ0.026**
(2.372)
Constant−5.421***−7.544***
(-5.997)(-10.598)
AR(1)0.0000.000
AR(2)0.8560.143
Hansen J Test0.3680.427
Observations23,71323,713

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Note: t-values are in parentheses, and ***, **, and * indicate statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively.

4.4.2. PSM

In this paper, we employ the propensity score matching (PSM) method to analyze the relationship between executive compensation and corporate ESG Ratings. The methodology involves several steps. Firstly, we introduce a dummy variable, Pay_D, which takes a value of 1 if the executive pay (Pay) exceeds the sample median, indicating high executive pay, and 0 otherwise. Secondly, we select FirmAge, management shareholding (Mshare), gearing (Lev), dual position (Dual), board size (Board), firm growth (Growth), and firm value (TobinQ) as covariates. We estimate the propensity scores for the sample firms by conducting a Probit regression of the treatment variable Pay_D against the covariates. Next, we implement 1:1 nearest neighbor matching without replacement based on the propensity scores to create matched samples. The matching is guided by the principle of finding the closest untreated control observation to each treated observation. After ensuring balance between the treated and control groups through an equilibrium test, we perform regression tests on the matched samples. Table 8 shows the results of descriptive statistics based on Pay_D grouping.

Table 8

Descriptive statistics by Pay grouping.

Pay_D=1
VariableObsMeanStdDev.MinMax
ESG13,6806.6742691.20597939
FirmAge13,6802.9700190.3067291.945913.526361
Mshare13,3350.12780.35328020.17084
Size13,68022.720671.32467619.7687326.26294
Lev13,6800.4462790.2016150.057970.91821
Dual13,6800.2837720.45084401
Board13,6802.1332550.2011381.6094382.70805
Growth13,6800.187070.412892−0.5935592.96564
TobinQ13,6802.0241891.3696950.8493769.648229
Pay_D=0
VariableObsMeanStdDev.MinMax
ESG146266.2762891.10978639
FirmAge146262.8898310.3169251.945913.526361
Mshare142070.1408080.20075201.472875
Size1462621.811111.10711619.7687326.26294
Lev146260.418790.2123190.057970.91821
Dual146260.2806650.44933901
Board146262.1088520.1962931.6094382.70805
Growth146260.1624480.486763−0.5935592.96564
TobinQ146262.1985681.5461460.8493769.648229

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The results of this analysis are presented in Table 9. The regression coefficient for executive compensation (Pay) in the propensity score-matched sample is found to be significantly positive. This implies that even after applying propensity score matching, the results continue to support the hypothesis that executive compensation has a positive impact on corporate ESG Ratings.

Table 9

PSM regression.

(1)
VARIABLESESG
Pay0.083a
(7.223)
FirmAge−0.027
(-1.115)
Size0.355a
(46.149)
Lev−0.812a
(-19.422)
Dual−0.094a
(-5.914)
Board0.359a
(9.281)
Growth−0.019
(-1.168)
TobinQ0.038a
(7.546)
Constant−3.298a
(-17.944)
Observations22,947
R-squared0.163
FirmYES
YearYES

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Robust t-statistics in parentheses.

ap<0.01, **p<0.05, *p<0.1.

4.4.3. Instrumental variable Analysis(IV)

In order to further mitigate the potential influence of endogenous explanatory variables on the research findings and enhance the robustness of the conclusions, this study utilizes the instrumental variable approach to conduct a two-stage least squares regression (2SLS) analysis. The instrumental variable employed in the regression model is the average executive compensation of other companies in the same province and year (referred to as Pay-IV). On the one hand, the average value of executive compensation of other companies in the same province in the same year reflects the average level of surplus management of companies in the same province in the same year, and companies in the same province face the same policy and external economic environment, thus the average value of executive compensation of other companies in the same province is highly correlated with the Company's executive compensation; on the other hand, there is no evidence yet to show that the average value of executive compensation of other companies in the same province in the same year is capable of influencing the Company's On the other hand, there is no evidence that the average executive compensation of other companies in the same province in the same year can influence the tone of the text of the Company's annual report. In addition, the instrumental variable passed the instrumental variable underidentification test as well as the instrumental variable weak identification test. Therefore, although the mean value of executive compensation in other firms in the same province may be affected by unobserved factors, by choosing it as an instrumental variable we can still reasonably argue that it meets the exogeneity and correlation requirements.

The results of the two-stage regression are presented in Table 10. In the first-stage regression, the executive compensation of other companies in the same province and year (Pay-IV) exhibits a significant and positive correlation with corporate ESG Ratings (ESG) at the 1% level of significance. In the second-stage regression, the coefficient of executive compensation (Pay) passes the significance test at the 1% level, which aligns with the theoretical expectation of Hypothesis 1. These findings indicate that the research conclusions remain substantively unchanged even after accounting for endogeneity issues.

Table 10

Two-stage regression results.

Phase IPhase II
VariablesPayESG
Pay-IV0.783***
(41.117)
Pay0.269***
(5.946)
FirmAge−0.0050.068***
(-0.394)(3.112)
Size0.293***0.325***
(81.297)(21.847)
Lev−0.433***−0.936***
(-22.668)(-21.446)
Dual0.064***−0.087***
(8.528)(-6.054)
Board0.132***0.235***
(7.477)(6.965)
Growth0.017**−0.054***
(2.033)(-3.924)
TobinQ0.052***0.030***
(18.837)(5.684)
Constant−3.651***−5.100***
(-13.041)(-14.225)
FirmYESYES
YearYESYES
Observations28,30628,306
R-squared0.236

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Note: t-values are in parentheses, and ***, **, and * indicate statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively.

4.5. Mechanism test

Table 11 presents the regression results for equation (3) and equation (4). Within this table, columns (1) and (2) exhibit the test results regarding the mediating effect of the transmission path "Executive Compensation - Green innovation efficiency - Corporate ESG Ratings." Columns (3) and (4) demonstrate the test results concerning the mediating effect of the transmission path "Executive Compensation - Environmental information disclosure - Corporate ESG Ratings." Lastly, columns (5) and (6) showcase the test results pertaining to the mediating effect of the transmission path "Executive Compensation - Financial Performance - Corporate ESG Ratings." The findings suggest that green innovation efficiency, environmental information disclosure, and financial performance partially mediate the relationship between executive compensation and corporate ESG Ratings. This implies that executive compensation enhances corporate ESG Ratings by elevating the levels of green innovation efficiency, environmental information disclosure, and financial performance, thereby confirming Hypothesis 2 in this study.

Table 11

Intermediary mechanism test results.

(1)(2)(3)(4)(5)(6)
VariablesGIESGEDIESGROEESG
Pay0.005***0.091***0.025***0.073***0.033***0.085***
(11.120)(7.601)(6.459)(6.558)(20.882)(7.070)
GIE1.532***
(10.207)
EID1.121***
(60.097)
ROE0.844***
(13.834)
FirmAge−0.010***0.105***0.019**0.073***−0.0010.126***
(-9.194)(4.514)(2.476)(3.359)(-0.501)(5.516)
Size0.008***0.372***0.130***0.240***0.027***0.340***
(22.238)(48.756)(54.611)(31.666)(24.163)(44.002)
Lev0.005***−1.078***−0.072***−0.989***−0.271***−0.790***
(3.128)(-25.276)(-5.544)(-24.682)(-29.205)(-17.898)
Dual0.001**−0.077***−0.032***−0.039***0.103***0.683***
(2.105)(-5.226)(-6.772)(-2.795)(17.425)(13.928)
Board0.005***0.237***0.103***0.130***0.002−0.075***
(3.251)(6.547)(8.910)(3.842)(0.976)(-5.193)
Growth−0.003***−0.043***−0.045***0.0020.015***0.257***
(-4.582)(-2.615)(-8.563)(0.098)(3.151)(7.178)
TobinQ−0.0000.044***0.008***0.035***0.086***−0.119***
(-0.437)(8.391)(4.583)(7.037)(27.845)(-7.066)
Constant−0.234***−3.493***−0.661***−3.144***0.010***0.036***
(-26.431)(-18.302)(-11.097)(-17.771)(10.969)(6.841)
FirmYESYESYESYESYESYES
YearYESYESYESYESYESYES
Observations24,05124,05124,13224,13224,15224,152
R-squared0.1560.2170.2950.3190.2450.232

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Note: t-values in parentheses, ***, **, * denote statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively. d

Moreover, to ensure the robustness of the mediating effect test results, the Bootstrap method was employed in this study to evaluate the regression results presented in Table 11. As depicted in Table 12, the estimation coefficients for both the direct and indirect effects of the mediating variables, namely green innovation efficiency (GIE), environmental information disclosure (EDI), and financial performance (ROE), exhibit statistical significance at the 1% level. Furthermore, the 95% confidence intervals' upper and lower limits do not encompass zero. The proportions of indirect effects for the mediating variables are 8.45%, 28.07%, and 24.55%, respectively. Notably, environmental information disclosure yields the highest proportion of indirect effect, followed by financial performance.

Table 12

Results of the Bootstrap method mediating effect test.

VariablesTest itemsObservation coefficientZP>|Z|[95% conf. interval]
GIEDirect effect0.0927.250.0000.0670.116
Indirect effects0.0087.810.0000.0060.011
EIDDirect effect0.0736.660.0000.0510.094
Indirect effects0.0286.490.0000.0200.037
ROEDirect effect0.0867.680.0000.0640.033
Indirect effects0.02811.710.0000.0230.109

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5. Further analysis

5.1. Heterogeneity analysis

5.1.1. Impact of management shareholding

Currently, two primary perspectives exist regarding the impact of management shareholding on companies. On one hand, in accordance with the incentive compatibility theory and the "alignment of interests" effect, providing management with a certain proportion of shares as incentives can enhance their sense of ownership, mitigate conflicts of interest with shareholders, and motivate them to make decisions that foster long-term company growth and increase company value. Moreover, implementing long-term equity incentives for management represents a favorable strategy for companies seeking to enhance their corporate social responsibility performance [51]. Higher levels of management shareholding have a detrimental effect on disclosure and may promote management entrenchment [52]. When management holds a large percentage of shares, they entrench their position in the firm through voting rights or influence, which may lead them to prioritize maximizing non-shareholder value [53]. The "entrenchment" hypothesis posits that an increase in management shareholding amplifies their power, ultimately resulting in higher external monitoring costs and difficulties, which in turn diminishes company value. Additionally, due to a desire for job security, management may exhibit a preference for short-term strategies that involve low risk and yield immediate returns, thereby negatively impacting company performance [54].

Therefore, this study examines the moderating effect of management equity incentives on the relationship between executive compensation (Pay) and corporate ESG Ratings. This is achieved by multiplying the management shareholding ratio (Mshare) with executive compensation and incorporating the resulting interaction term into Model (1). The regression results presented in Table 9, specifically in column (1), reveal a significantly negative coefficient for the interaction term Pay×Mshare at the 1% level. This implies that management shareholding weakens the positive relationship between executive compensation and corporate ESG Ratings. In this context, the "entrenchment effect" arising from equity incentives surpasses the "alignment of interests" effect.

5.1.2. Impact of independent directors

As representatives of the company's shareholders, independent outside directors on the board are expected to contribute to strategic orientations that enhance shareholder wealth, including investments in research and development [55]. According to the "resource support theory," the presence of independent directors brings positive value to the company by providing information and advice on operations, enhancing external networks, and accessing valuable resources [56]. Based on the "reputation hypothesis," independent directors, driven by their concern for reputation, are more inclined to fulfill their monitoring role to restrain opportunistic behavior by management, reduce insider control, and safeguard the company's interests. Through providing professional and objective information and knowledge for managerial decision-making, independent directors assist in making informed business and strategic choices and timely rectify management's risk-taking behaviors. However, when independent directors fail to effectively carry out their supervisory and advisory responsibilities, they may exacerbate agency problems and potentially lead to a decline in the company's value [57]. Additionally, some scholars express skepticism regarding the supervisory role of independent directors due to potential influences on their appointment by incumbent management and their limited access to company information.

To examine the moderating effect of the regulatory power of independent directors on the relationship between executive compensation and corporate ESG Ratings, this study employs the cross-multiplier of the percentage of independent directors on corporate boards (Dep) and executive compensation (Pay) and integrates this cross-multiplier term into model (1). The findings, presented in column (2) of Table 13, specifically focus on the coefficients of the cross product term and Pay×Indep. It becomes evident that the positive impact of executive compensation on corporate ESG Ratings is significantly strengthened with an increase in the percentage of independent directors. This outcome affirms the ability of independent directors to fulfill their monitoring role and leverage their professionalism to optimize corporate governance in collaboration with management.

Table 13

Heterogeneity test results.

(1)(2)
VariablesESGESG
Pay0.126***0.002
(10.786)(0.042)
Mshare1.590***
(3.856)
Pay×Mshare−0.100***
(-3.616)
Indep−3.659*
(-1.711)
Pay×Indep0.300**
(2.041)
FirmAge0.082***0.065***
(3.731)(2.998)
Size0.376***0.365***
(53.346)(52.082)
Lev−1.020***−1.014***
(-26.325)(-27.022)
Dual−0.079***−0.076***
(-5.678)(-5.551)
Board0.253***0.364***
(7.469)(8.968)
Growth−0.052***−0.049***
(-3.818)(-3.591)
TobinQ0.042***0.037***
(9.008)(8.143)
Constant−4.322***−2.731***
(-23.319)(-3.284)
FirmYESYES
YearYESYES
Observations953618,770
R-squared0.2610.171

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Note: t-values are in parentheses, and ***, **, and * indicate statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively.

5.2. Excess executive compensation and corporate ESG ratings

The previous article discussed the impact of executive compensation on corporate ESG Ratings and concluded that executive compensation contributes to corporate ESG Ratings. However, the concept of executive overcompensation highlights the notion that executives are paid more than what may be considered reasonable, often exceeding the fair value of their work and performance, and extending beyond the realm of corporate performance-based decisions. Academically, two main perspectives exist regarding executive overcompensation. One perspective argues that excessive executive compensation has a positive effect on firm value and can effectively address agency problems [58]. The other perspective views excessive executive compensation as a means for executives to prioritize their own interests at the expense of shareholders [59]. According to the "managerial power hypothesis," excessive managerial compensation reflects the power of executives and leads to increased agency costs. Executive compensation contracts contain performance noise, and executives may be motivated by self-interest to engage in unethical behavior in order to receive excessive compensation [60].Additionally, executives often justify their compensation by increasing the linkage between pay and performance, frequently resorting to earnings management [61]. Even with supervisory mechanisms in place, supervisors may still collude with agents to obtain excessive compensation by sharing the benefits of collusion [62]. Subsequently, the paper delves into investigating the impact of executive overcompensation on corporate ESG Ratings. The calculation process for executive overcompensation is outlined as follows:

Ln(CEOpayi,t)=α0+α1Sizei,t+α2ROAi,t+α3IAi,t+α4Zonei,t+Industry+Year+ε

(6)

Overpayi,t=Ln(CEOpayi,t)Ln(Expectedpayi,t)

(7)

where CEOpayi,t is the actual absolute compensation received by executives, the Overpayi,t is the excess compensation of executives, and Expectedpayi,t is the expected executive compensation. Sizei,t illustrates the company size, measured using the logarithm of total assets at the end of the year. ROAi,t signifies the performance of the listed company, measured by the return on assets. IAi,t represents the company's intangible assets ratio. Zonei,t denotes the dummy variable of region. The regression equation (6) is initially estimated using the sample data to obtain the regression coefficients. Then, these estimated coefficients are multiplied by the corresponding factors determining compensation to derive the expected executive compensation. Finally, in equation (7), the actual executive compensation is subtracted from the expected executive compensation to obtain the unexpected executive compensation. When Overpayi,t is greater than 0, it represents the excess compensation received by the company's executives.

Table 14 presents the regression results examining the relationship between executive overpay and corporate ESG Ratings. The coefficient of executive overpay (Overpay) is found to be significantly negative at the 5% level. This suggests that there is a negative association between executive overpay and corporate ESG Ratings. In other words, as the level of executive overpay increases, the corporate ESG Ratings tends to worsen. These findings indicate that, under certain circumstances, it is important to control executive compensation incentives within an appropriate range in order to enhance the firm's ESG Ratings. It further implies that excessive executive overpay can have detrimental effects on corporate ESG Ratings.

Table 14

Regression results of executive excess compensation and ESG ratings.

VariablesESG
Overpay−0.051**
(-2.017)
FirmAge0.024
(0.776)
Size0.431***
(48.772)
Lev−1.074***
(-19.670)
Dual−0.030
(-1.605)
Board0.251***
(5.366)
Growth−0.028
(-1.276)
TobinQ0.050***
(8.056)
Constant−3.643***
(-16.567)
FirmYES
YearYES
Observations13,894
R-squared0.248

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Note: t-values are in parentheses, and ***, **, and * indicate statistical significance levels of 1%, 5%, and 10% for two-tailed tests, respectively.

6. Conclusion

Using data from the annual reports of Chinese listed companies spanning the period from 2012 to 2021, this study aims to examine whether executive compensation incentives drive executives to improve corporate ESG Ratings. The key findings of this research are as follows:(1) Executive compensation incentives are found to have a significant and positive relationship with corporate ESG Ratings. These findings remain robust even after conducting various robustness tests and addressing endogeneity concerns. (2) Through path analysis, it is observed that executive compensation incentives primarily enhance corporate ESG Ratings by improving three key areas: green innovation efficiency, environmental information disclosure, and financial performance. (3) Heterogeneity analysis reveals that the positive correlation between executive compensation incentives and corporate ESG Ratings weakens when the management's shareholding ratio is high. This suggests that management's shareholding does not effectively align their interests with shareholders, resulting in diminished incentive compatibility. Conversely, the positive correlation strengthens when the percentage of independent directors is high, indicating that independent directors play a vital role in effectively monitoring corporate activities. (4) Further investigation demonstrates that executive overcompensation is significantly and negatively associated with corporate ESG Ratings. This suggests that excessive compensation beyond a reasonable range grants excessive power to management, leading to opportunistic behavior that hampers long-term corporate development. Overall, these findings highlight the importance of executive compensation incentives in driving corporate ESG Ratings. However, it is crucial to maintain compensation within an appropriate range to avoid excessive management power and its negative impact on corporate sustainability.

In recent years, the concept of Environmental, Social, and Governance (ESG) development has risen to the forefront of global attention, becoming a pivotal agenda item for countries worldwide and a crucial breakthrough point for international cooperation on carbon emissions and the green transition to low-carbon development. Sustainable development requires concerted efforts from macro, meso, and micro perspectives. The findings of this study contribute particularly to micro-level support for enterprises. Leveraging executive compensation incentives facilitates executives in making decisions aligned with stakeholder values, actively implementing more measures in line with ESG principles, and achieving high-quality corporate development.

Compared to previous research and findings, this study brings forth several new insights and revelations. Firstly, governmental bodies need to enact policies concerning executive compensation under the ESG framework, establishing norms for compensation of senior management personnel in companies to encourage executives to strengthen corporate ESG practices and accelerate the construction of top-tier enterprises. Tailored to the characteristics and needs of different types of enterprises, industries, and regions, relevant government departments should formulate ESG compensation incentive systems that emphasize effectiveness. Additionally, governments should emphasize the combined role of incentive and punitive policies, better leveraging their role in providing financial support, policy incentives, and signaling guidance in driving sustainable development in enterprises.

Secondly, corporate compensation committees should deepen their understanding of executive compensation incentives, integrating ESG performance more extensively into executive performance evaluations, establishing comprehensive performance management systems aligned with sustainable development principles, designing more rational compensation contracts, and incentivizing senior management to make greater contributions to the company's sustainable development. Through the implementation of effective compensation incentives, executives can fulfill their responsibilities more effectively, enhance the company's performance in financial, environmental, social responsibility, and corporate governance fields, and actively adhere to ESG principles to create corporate value.

Thirdly, as excessively high executive compensation can negatively impact corporate ESG ratings, companies should strengthen internal controls and supervision of executive behavior and adopt sound external oversight mechanisms to curb opportunistic behaviors among executives. As decision-makers, management will uphold ESG principles and prioritize ESG development amidst strengthened internal and external oversight and compensation incentives, striving to improve corporate governance, enhance green innovation efficiency, promote technological innovation optimization, and ultimately enhance corporate ESG performance.

Finally, at the societal level, there should be vigorous promotion of the ESG concept, actively fostering acceptance and recognition of this sustainable development concept among the general public. Guiding the public to consider corporate ESG ratings as key factors in evaluating company development and formulating investment strategies will encourage executives to be more proactive in disclosing corporate environmental information and enhancing company ESG performance.

Potential future research will delve more deeply into the repercussions of variations in longitudinal executive remuneration on the ESG Ratings of enterprises across various industries and geographical locales. Moreover, there will be an endeavor to construct an all-encompassing framework for evaluating the nexus between executive compensation structures and ESG Ratings through the lens of external stakeholders. This endeavour aims to enhance our comprehension of both executive and stakeholder perspectives along with their respective decision-making mechanisms. Such insights will, in turn, facilitate a more profound grasp of corporate sustainability principles and their implementation.

Data availability statement

The datasets used and analysed during the current study available from the corresponding author on reasonable request.

Funding

This paper is supported by the Scientific Research Fund of the Education Department of Liaoning Province (LN2020Q33) and the Scientific Research Project of Dongbei University of Finance and Economics (DUFE2020Q12).

CRediT authorship contribution statement

Chen Zhu: Writing – review & editing, Methodology, Funding acquisition, Formal analysis, Conceptualization. Xue Liu: Writing – original draft, Software. Dong Chen: Writing – review & editing, Funding acquisition. Yuanyuan Yue: Methodology, Funding acquisition, Conceptualization.

Declaration of generative AI and AI-assisted technologies in the writing process

During the preparation of this work the author(s) used [chatgpt] in order to [Polish the article and revise the grammar]. After using this tool/service, the author(s) reviewed and edited the content as needed and take(s) full responsibility for the content of the publication.

Declaration of competing interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

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Executive compensation and corporate sustainability: Evidence from ESG ratings (2024)

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