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

Using hand-collected data on the precise structure of environmental and social targets in executive compensation (“ES Pay”) of U.S. firms from 2006 to 2021, we explore the optimal contracting structure for linking those targets to compensation. We find that companies with explicit contracting demonstrate better ES performance for targets that can be precisely measured, while implicit contracting is ineffective for those targets. For targets with less precise performance measures, we find that both explicit and implicit ES Pay schemes can be effective. These results show that the contracting structure of ES Pay determines whether it improves ES performance or not.