Executive Compensation with Environmental and Social Performance

How to incentivize a manager to create value and be socially responsible? A manager can predict how his decisions will affect measures of social performance, which are (randomly) biased. He will therefore game an incentive system that relies on these measures. Still, we show that the compensation contract is based on measures of social performance when the level of social investments preferred by the board exceeds the one that maximizes the stock price. When these measures are used, social investments are distorted because of gaming, and the sensitivity of pay to social performance is reduced to mitigate this effect. When there are several social performance measures with i.i.d. biases, relying on multiple measures based on different methodologies will generally mitigate inefficiencies due to gaming. This implies that harmonization of social performance measurement can backfire.