Implicit versus Explicit Contracting in Executive Compensation for Environmental and Social Performance

We examine the effectiveness of both implicit and explicit contracting in linking executive compensation to environmental and social targets ("ES Pay"). Consistent with predictions from contract theory, firms with explicit ES Pay schemes demonstrate better ES performance for targets that can be precisely measured, such as emissions. By contrast, implicit ES Pay schemes are ineffective for targets that are easily measurable. However, they are effective and can even outperform explicit schemes for targets with less precise performance measures, such as community engagement. These findings highlight the crucial role that contractual structure plays in determining the effectiveness of ES Pay.