The effect of ESG-linked compensation on firms' ESG performance

Abstract: This study examines the effect of having an ESG-linked compensation plan on ESG performance. In addition to that, board characteristics effect on linking ESG metrics to CEO compensation plans have been examined. Based on previous research, agency theory and corporate governance characteristics, two hypotheses were developed which posits that having an ESG-linked compensation plan would improve ESG performance and that board characteristics would increase the probability of setting an ESG-linked compensation. Applying a pooled OLS regression model and a logistic model to our sample of 411 firm-year observations of Swedish listed firms from 2019 to 2021 the two hypotheses were confirmed. The results suggest that ESG performance is improved by having an ESG-linked compensation contract. Furthermore, board characteristics influence the setting of ESGlinked compensation where board cultural diversity, board size and two-tier board structure has a positive relationship with the setting of ESG-linked compensation.