Badawi & Bartlett on the Use of ESG Targets in Executive Compensation Plans

I just read a really interesting paper by Adam Badawi and Robert Bartlett,\ESG Overperformance? Assessing the Use of ESG Targets in Executive Compensation Plans, available at SSRN: https://ssrn.com/abstract=4941016.

They examine the integration of environmental, social, and governance (ESG) targets into executive compensation plans among U.S. public companies, with a specific focus on S&P 500 firms during the 2023 proxy season. 

Their main findings are:

1. Prevalence of ESG-Linked Compensation:
• 63% of S&P 500 companies incorporated ESG performance targets into their executive compensation plans.
• These targets were primarily integrated into short-term annual incentive plans (AIAs) rather than long-term incentive plans (LTI).
• Only 2% of companies reported missing all ESG targets, in contrast to 22% missing all financial targets.
2. Structure and Weighting:
• ESG targets in AIAs were given a mean weight of 15% within target award sizes.
• In LTI plans, only 10% of companies incorporated ESG metrics, and their influence on total CEO compensation was relatively minor (6%-7%).
3. Governance and Oversight Issues:
• ESG targets were often less transparent than financial targets, making them easier to achieve.
• High rates of achievement for ESG targets were linked to governance deficiencies rather than actual exceptional ESG outcomes.
• Firms meeting all ESG targets faced more shareholder opposition in say-on-pay votes, suggesting skepticism regarding governance.
4. Performance Analysis:
• High achievement rates for ESG targets did not correlate with improved past or future ESG scores from rating agencies.
• Firms missing ESG targets often used more transparent and quantifiable metrics, such as OSHA-regulated worker safety measures.
5. Theoretical Implications:
• The study challenges the notion that ESG-based compensation drives genuine improvement in ESG outcomes.
• Findings align with the theory that these targets may serve as tools for rent extraction by executives in poorly governed firms.
6. Use of AI in Research:
• The study incorporated GPT-auditing to validate data collection from proxy statements, highlighting both the potential and limitations of AI tools in handling unstructured data.

They conclude that ESG-linked compensation plans often fail to deliver substantial improvements in ESG performance and are associated with governance challenges.

Much of their critique supports the arguments about the role of ESG in executive compensation that I made in my book The Profit Motive.