In Search of a Philosophy on Executive Compensation and ESG

As researchers at ESSEC Business School’s European Centre for Law and Economics (CEDE), we have been closely studying the evolving landscape of executive compensation. What we observe is a fascinating intersection between corporate strategy, shareholder interests, and the broader societal demands encapsulated by the growing emphasis on environmental, social, and governance (ESG) factors. Our recent studies "ESG Criteria & Executive Directors’ compensation"  and  "Some Recommendations on ESG Criteria to Prioritize in the Executive Directors' Compensation Policy" of the CAC 40, France’s leading public companies, sheds light on how these dynamics are playing out in the realm of executive pay. The results are both encouraging and sobering.

The design of executive compensation has long been a balancing act—a high-stakes puzzle where companies seek to align the incentives of their leaders with the interests of shareholders, employees, and now, the public at large. Over the years, this puzzle has grown increasingly complex. Stock options, performance shares, and now ESG criteria are all pieces that must fit together to drive both financial and non-financial performance. However, as our study reveals, the integration of ESG into executive pay remains uneven and often lacks the rigor needed to drive meaningful corporate change.

To appreciate the significance of current trends, it is useful to take a step back and consider how executive pay has evolved. In the past, CEOs were typically compensated with straightforward salaries and bonuses, based primarily on the financial success of the company. However, as corporations grew in size and influence, and as shareholders demanded greater accountability, the design of executive compensation began to change. Performance-based pay became the norm, with stock options emerging as a key tool to align executives’ interests with shareholder value.

The logic was simple: if the stock price rises, everyone benefits. But this approach had unintended consequences, leading some executives to focus on short-term stock performance at the expense of long-term strategy. This realization prompted the introduction of long-term incentives such as restricted stock and performance shares, aimed at encouraging a more sustainable focus.

In recent years, ESG criteria have been added to the mix, reflecting the growing awareness that companies must consider their impact on the environment and, society, as well as their governance structures. The European Corporate Sustainability Reporting Directive (CSRD) has aimed to increase transparency and accountability by requiring companies to disclose their ESG impacts.In theory, linking executive pay to ESG performance should motivate leaders to take these issues seriously. But as our study shows, the reality is more complex.

Our analysis of the CAC 40 reveals that, as of 2022, all companies in this index have incorporated ESG criteria into their short-term variable compensation plans. This is a significant milestone, reflecting a widespread recognition of the importance of ESG factors. However, the actual influence of these criteria remains limited. On average, ESG components account for just 19.6% of short-term variable compensation and 19.8% of long-term incentives. In other words, while ESG is part of the conversation, it is not the dominant factor in executive pay in France - but not a trivial portion either. Often, ESG targets are included to embellish compensation packages rather than to drive substantial non-financial performance. This approach risks reducing the credibility of ESG initiatives, as executives might meet only the minimum requirements to secure bonuses rather than strive for genuine sustainable improvements. One way to make ESG factors more credible is as a negative incentive in the form of a malus clause— which could use salient ESG shortcomings to withhold incentive awards to company managers.

Moreover, there is a clear imbalance in the types of ESG criteria that companies prioritize. Environmental factors, particularly those related to carbon emissions, receive the most attention, while social and governance criteria are often secondary. This trend is consistent with what we have observed in other studies and markets: companies are more comfortable measuring and managing environmental performance, where the metrics are clearer and the regulatory pressures stronger. Social and governance factors, which are harder to quantify and sometimes seen as less urgent, receive less emphasis.

Even more telling is the lack of transparency and consistency in how these ESG criteria are applied. Only 23 of the 40 companies in the CAC 40 provide a detailed breakdown of ESG criteria in their short-term compensation plans, and just 16 do so for long-term incentives. This lack of clarity raises questions about the true impact of ESG-linked pay on corporate behaviour.

Where does this leave us? The future of executive pay will likely involve continued experimentation with compensation structures that seek to balance financial and non-financial goals. As ESG metrics become more standardized and reliable, we may see these criteria play a larger role in determining executive rewards. However, for now, financial performance remains the primary driver of executive pay.

For ESG-linked compensation to have a transformative impact, it must be given greater weight and treated with the same rigor as traditional financial metrics. This requires not only clearer and more consistent application of ESG criteria but also a cultural shift within companies to prioritize long-term sustainability over short-term gains.

We advocate for a set of principles to guide remuneration committees in selecting, assessing, and measuring bespoke ESG criteria. In French fashion, we propose moving beyond compliance to a philosophy where ESG performance is seen as integral to overall business success. The integration of ESG criteria into executive pay is a positive step, but much work remains to be done to ensure that these metrics drive meaningful change in corporate behaviour.

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By Viviane de Beaufort (ESSEC Business School and European Center for Law and Economics (CEDE)) & Hichâm Ben Chaïb (Alumnus ESSEC Business School)

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