ESG Metrics in CEO Pay: A Signal to Shareholders or a Shift in Strategy?

In recent years, environmental, social, and governance (ESG) concerns have become central to the corporate conversation. Social and environmental goals, in particular, often require long-term commitments—commitments that typically stretch well beyond the tenure of any individual CEO. It’s no surprise, then, that ESG-conscious investors increasingly worry that companies are quick to make bold, long-term promises but slower to implement the concrete short-term actions needed to deliver on these commitments.

One solution, often discussed in boardrooms and shareholder meetings, is to link CEO compensation to ESG outcomes. If ESG goals are truly strategic priorities, the logic goes, then tying them to executive pay ensures accountability. By embedding ESG metrics in compensation packages, companies appear to affirm that these goals matter—not just in press releases, but in the decisions that guide corporate behavior. But are these incentives real drivers of change, or are they simply well-crafted messages to placate concerned investors?

At first glance, using ESG metrics in executive pay seems like a tangible way to ensure companies walk the talk. It aligns managerial incentives with broader stakeholder goals and suggests a shift toward long-term value creation. However, this approach comes with caveats. ESG goals are notoriously difficult to define and measure in a way that is both objective and contractible. What exactly does “improving a company’s ESG performance” mean? Without clear answers, skeptics argue that ESG-linked compensation may reflect CEO influence more than shareholder accountability—a way for powerful executives to increase their pay and shape the narrative without meaningfully altering behavior.

Our research adds nuance to this debate. Analyzing a broad sample of global firms, we find that ESG metrics are rarely used in isolation. Instead, they are typically bundled with financial and non-financial performance indicators. Crucially, the presence of these metrics does not seem to be associated with high-powered incentives or excessive pay. In other words, companies adding ESG metrics to the compensation formula are not necessarily rewarding their CEOs more lavishly in the process.

Moreover, while ESG metrics do appear in pay packages, they often target dimensions where firms already perform relatively well. Even though boards are more likely to implement ESG compensation when the firm’s overall ESG performance has been poor—possibly to signal a change in direction—they still select specific metrics that reflect areas of relative strength. In other words, companies tend to emphasize their strengths, even when they’re underperforming overall.

This raises an important question: Are boards using ESG metrics to redirect managerial effort toward areas of weakness, or are they cherry-picking favorable metrics to present a rosier picture of performance? Our findings suggest the latter. This strategic selection of ESG targets—while technically transparent—undermines the intention behind ESG-linked pay. Rather than driving improvement, it appears to be more about shaping perceptions.

This behavior is hard for investors to detect, even diligent ones. Boards tend to select “material” metrics—those considered relevant to a firm’s industry—which makes the choice appear legitimate. However, assessing how a company actually performs along specific ESG dimensions requires highly granular data. In our research, we use data obtained through AI analysis of millions of news items to analyze the sentiment around a firm’s performance on specific ESG metrics—a level of scrutiny that goes far beyond the tools typically available to shareholders or even institutional investors.

So what role, then, do ESG compensation metrics really play? The evidence points to a signaling function—less about guiding internal strategy and more about managing external expectations. We find that companies’ choice of compensation metrics closely mirrors those of peer firms, particularly peers defined by proxy advisory firms like ISS. When companies face shareholder dissent on say-on-pay votes, they often respond by expanding the number of compensation metrics—ESG-related or otherwise.

And it works. Companies that adopt more pay metrics experience less opposition from shareholders, not only on compensation but also on broader corporate proposals. Shareholders appear more satisfied, or at least less combative, when they see detailed performance criteria embedded in executive pay. This is not limited to ESG issues: the addition of any type of performance metric is associated with a lower likelihood of ESG shareholder proposals being submitted.

Importantly, however, this increased shareholder approval does not translate into improved company behavior. Our data show little evidence that the adoption of ESG metrics leads to better ESG outcomes. Nor do we observe meaningful changes in how companies are run after introducing these metrics. The symbolic gesture may calm investor concerns, but it does not seem to move the needle operationally.

What are the implications of these findings? On one hand, the inclusion of ESG metrics in CEO pay packages does not appear to be a backdoor to excess compensation. We find little evidence of rent extraction or inflated payouts. On the other hand, investors should be cautious about interpreting ESG-linked pay as a credible signal of corporate transformation.

In practice, ESG metrics in pay seem to function more as reputation management tools than as mechanisms for change. They help companies maintain legitimacy in the eyes of shareholders and proxy advisors while reducing dissent. Yet they do not, based on our evidence, reshape strategy or outcomes in a meaningful way.

Our findings should prompt reflection among institutional investors who advocate for ESG integration in compensation. While well-intentioned, this approach may amount to little more than adding an ESG gloss to business as usual. If real progress is the goal, investors and boards alike may need to look beyond pay metrics and ask harder questions about how companies set priorities, allocate capital, and engage with stakeholders over time.

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Nickolay Gantchev is a Professor of Commerce and the Connaughton Professor of Alternative Investments at the University of Virginia’s McIntire School of Commerce, a Research Fellow at CEPR, and an ECGI Research Member.

Mariassunta Giannetti is the Katarina Martinson Professor of Finance at the Stockholm School of Economics, a Research Fellow at CEPR, and an ECGI Fellow and Research Member.

Marcus Hober is a Researcher at the Stockholm School of Economics.

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