With the rising support for stakeholder capitalism and at the urging of its advocates, companies have been increasingly using environmental, social, and governance (ESG) performance metrics for CEO compensation. This Article provides a conceptual and empirical analysis of this trend and exposes its fundamental flaws and limitations. It shows that the use of ESG-based compensation has, at best, a questionable promise and poses significant perils.
We identify two structural problems with the use of ESG compensation metrics and provide empirical analysis highlighting their presence in current practices of S&P 100 companies. First, ESG metrics commonly attempt to tie CEO pay to limited dimensions of the welfare of a limited subset of stakeholders. Therefore, even if these pay arrangements were to provide a meaningful incentive to improve the given dimensions, the economics of multitasking indicates that the use of these metrics could well ultimately hurt, not serve, aggregate stakeholder welfare.
Second, and most importantly, the push for ESG metrics overlooks and exacerbates the agency problem of executive pay. To ensure that they are designed to provide effective incentives rather than serve the interests of executives, pay arrangements need to be subject to effective scrutiny by outsider observers. However, our empirical analysis shows that in almost all cases in which S&P 100 companies use ESG metrics, it is difficult, if not impossible, for outside observers to assess whether these metrics provide valuable incentives or merely line CEO’s pockets with performance-insensitive pay. Current practices for using ESG metrics, we conclude, likely serve the interests of executives, not of stakeholders. Expansion of such use should not be supported even by those who care deeply about stakeholder welfare.