Executive Compensation, Sustainable Compensation Policy, Carbon Performance and Market Value

We examine the interrelationships among executive compensation, environmental-social-governance-based (ESG) sustainable compensation policy, carbon performance and market value. Using one of the largest datasets to date, consisting of 4379 firm-year observations, covering a period of 15 years (2002–2016) from 13 industrialized European countries and insights from neo-institutional theory (NIT), our findings are fourfold. First, our results suggest that process-oriented carbon performance is positively associated with market value, whereas actual carbon performance has no effect on market value. Second, we show that the market value–process-oriented carbon performance nexus is moderated by executive compensation. Third, our results indicate that executive compensation has a positive effect on process-oriented carbon performance, but has no similar effect on actual carbon performance. Fourth, we show that the process-oriented carbon performance–executive compensation nexus is reinforced for companies that adopt ESG-based sustainable compensation policy. Our results are generally robust to controlling for governance mechanisms, alternative measures/estimations and endogeneities. Overall, our evidence supports the legitimization aspect of NIT and suggests that the market tends to reward firms with superior process-oriented carbon performance instead of undervaluing firms with excessive actual carbon emissions. This implies that firms appear to use incentive-based mechanisms to symbolically improve their process-oriented carbon performance without substantively improving their actual carbon performance.