CEO Pay-performance Sensitivities in the ESG Managed Firms

CEOs of highly rated ESG firms are paid significantly higher salaries. High ESG firms are larger, more profitable, and mature firms, facing less risks compared to low ESG rated firms. Although these systematic differences in firm characteristics account for a significant portion of the CEO pays, when we decompose the CEO pays between different ESG groups, there exists a non-trivial residual portion of the unexplained compensation gap that the traditional firm characteristics can not fully explain. About 79.8% of the mean difference is attributable to the firm characteristic part and the residual 20.2% can be ascribed to the ESG group effect. The high ESG firms are more active in using the incentive compensation scheme to discipline managers while the low ESG firms are more conservative in adopting the sensitive incentive pay systems because they are more susceptible to the negative factors such as risk and leverage. As a result, we observe significantly higher pay-performance sensitivities for the high ESG group and the low ESG firms are paid lower than what their firm characteristics prescribe. The ESG rating has an orthogonal part of the explanatory power that contributes to the pay-performance sensitivity over the traditional solvency measure such as credit ratings.