ESG Overperformance? Assessing the Use of ESG Targets in Executive Compensation Plans

The practice of linking executive compensation to ESG performance has recently become more prevalent in US public companies. In this paper, we document the extent of this practice within S&P 500 firms during the 2023 proxy season and, using a combination of hand coding and GPT-auditing, we extract the unstructured information that details how often executives miss, meet, or exceed the financial and ESG-based targets in their compensation plans. We find that 315 of these firms (63.0%) include an ESG component in their executives' compensation and that the vast majority of these incentives are part of the annual incentive plan (AIA) rather than a part of the long-term incentive plan (LTIP). While executives miss all of their financial targets 22% of the time in our sample, we show that this outcome is exceptionally rare for ESG-based compensation. Only 6 of 247 (2%) firms that disclose an ESG performance incentive report missing all of the ESG targets. We ask whether the ESG overperformance that we observe is associated with exceptional ESG outcomes or, instead, is related to governance deficiencies. Our findings that meeting ESG-based targets is not associated with improvements in ESG scores and that the presence of ESG-linked compensation is associated with more opposition in say-on-pay votes provides support for the weak governance theory over the exceptional performance theory.