Avoiding Harm by Doing Good. The Substantive Role of ESG Payments for Preventing ESG Misconduct

This paper examines whether an ESG-based compensation policy plays a substantive or symbolic role in the prevention of firm ESG-related misconduct. We anticipate that companies linking ESG to board compensation will experience fewer ESG-related misconducts, aiming to avoid adverse consequences, mitigate market reactions, and minimize harm to stakeholders. We also expect that institutional ownership strengthens this relationship. By analyzing a sample of European firms between 2015 and 2020, we found that boards with an ESG-linked compensation policy reduce irresponsible actions, confirming the substantive role of ESG-linked compensation in curbing ESG misconduct. Our findings also show a complementary effect of institutional investors in this association. Finally, we found that variations in negative ESG media coverage of misconducts that result from undertaking ESG-linked compensation policy can be explained by differences in legal systems and stakeholder orientation between countries. Specifically, our results suggest that ESG-linked compensation only plays a meaningful substantive role in constraining ESG wrongdoing in civil law countries and those characterized by greater public enforcement, increased control over corruption, and higher environmental awareness.