ESG-based remuneration in the wave of sustainability

ABSTRACT

By investigating ESG-based remuneration in the UK FTSE 350 companies, this article finds that in practice, ESG-based remuneration may depart from its expected role in promoting corporate sustainability, whereas being adopted as a tactic for impression management or managerial rent extraction. Due to the unmeasurable effects of most ESG factors on shareholder value and their subjective nature, ESG-based remuneration is vulnerable to exploitation for symbolic and self-serving purposes. For companies aiming to promote long-term shareholder value, extending the assessment period of financial performance is a less costly and risky option compared to ESG-based remuneration. Differently, for companies oriented by a stakeholder purpose, ESG-based remuneration may play a part in incentivising executives to achieve plural stakeholder interests. To mitigate the risk of exploitation, this article proposes rule tightening in the current disclosure and monitoring frameworks for executive remuneration.

KEYWORDS:

• ESG-based remuneration
• incentives
• corporate sustainability
• enlightened shareholder value
• stakeholder interests

I. Introduction

In recent years, an increasing number of UK companies have aligned executive remuneration with their performance in environmental, social and governance (ESG) dimensions.¹ This practice, known as ESG-based or ESG-linked remuneration, is gaining momentum as a strategy for improving corporate sustainability.

The proliferation of ESG-based remuneration is fuelled by a variety of public and private players. The UN Principles of Responsible Investment highlight that ESG-based remuneration can be value-enhancing for achieving long-term financial and sustainability objectives.² In the EU, the Shareholder Rights Directive II stipulates that where appropriate, ESG factors should be applied to assess directors’ performance.³ The UK Corporate Governance Code (CGC) 2018 emphasises that executive remuneration should be designed to promote long-term sustainable success.⁴ Along with the mainstreaming of sustainable finance,⁵ ESG engagement by institutional investors is dynamic and growing.⁶ One of their focuses is ESG-based remuneration. For example, the UK Investment Association (IA) advises remuneration committees to link performance-based remuneration with material ESG issues;⁷ the leading proxy advisor Glass Lewis has included the adoption of ESG-based remuneration in its UK-based proxy voting guidelines.⁸ Following these initiatives, institutional investors are increasingly pushing forward resolutions regarding ESG-based remuneration.⁹

In general, major UK companies have responded to these proposals and initiatives positively. According to the surveys by the London Business School and PwC, in 2021, around 45% of the FTSE 100 companies adopted ESG-based remuneration;¹⁰ in 2022, the percentage surged to more than 80%.¹¹

Not all ESG incentives are brand new. During the past three decades, many companies have been using both financial and non-financial performance indicators (NFPIs) as the criteria for executive remuneration.¹² The rationale for using NFPIs derives from the balanced scorecard model (BSM). To complement financial indicators, which only reflect short-term returns, the performance of executives¹³ should be assessed by their actions to achieve the company’s long-term strategic and operational objectives.¹⁴ Based on agency theory, contemporary executive remuneration is structured to align executive and shareholder interests. The use of NFPIs is believed to be useful for mitigating interest misalignment resulting from distortions in financial performance.¹⁵ Traditionally, NFPIs were the direct and significant indicators of business strategy and operation, among which customer and employee interests,¹⁶ from today’s perspective, belong to the social dimension of ESG. With the systemic challenges posed by various social and environmental concerns becoming more serious, it is widely acknowledged by institutional investors that ESG issues need to be integrated into risk assessment.¹⁷ Accordingly, they emphasise that remuneration incentives should be designed to reflect the material ESG risks for companies.¹⁸

Academics take a broader view to examine whether or not ESG-based remuneration can impel companies and their executives to improve social and environmental welfare at large. Among a limited number of empirical studies in this field, several of them find a positive correlation between ESG incentives and performance;¹⁹ however, there is also opposite evidence.²⁰ The controversy implies that a positive correlation is insufficient to prove that the improvements in social and environmental performance are a result of the use of ESG incentives.

While confirming the potential benefits of ESG-based remuneration, some market players and academics have expressed their concerns that it may be adopted as a window-dressing vehicle to ‘reap the benefits of being perceived as ESG conscious while avoiding costly ESG efforts’²¹ or a self-serving vehicle to boost remuneration packages.²²

Instead of seeking a correlation between ESG incentives and performance, this article conducts a qualitative analysis of the detailed ESG incentive arrangements in the UK FTSE 350 companies, including the focus of ESG incentives, the weights of ESG incentives in performance-based remuneration, and the features of performance metrics and assessments. On a holistic basis, there is ample evidence showing that companies’ motivations to adopt ESG-based remuneration are complex: in addition to long-term shareholder value maximisation, they also make use of it for symbolic and self-serving purposes. This finding fills a significant research gap regarding the specific arrangements and actual impact of ESG-based remuneration.

On the normative side, this finding also has implications for the (un)reasonableness of ESG-based remuneration. The expected role of ESG-based remuneration in promoting long-term shareholder value is not salient due to the difficulty of measurement. Considering its potential for being used for symbolic and self-serving purposes, ESG-based remuneration is a riskier and more costly option compared to the alternative proposal, which is to extend the assessment period of financial performance.

Nevertheless, following the calls for companies to embrace a plural stakeholder approach, some UK companies are making or planning to make such a shift. For these companies, the role of ESG-based remuneration in reorienting executives towards stakeholder interests is important, especially when the company law rules on decision-making power and directors’ fiduciary duties and traditional remuneration arrangements are pro-shareholder. To ensure that ESG-based remuneration is operated properly for a company to achieve its reoriented objectives, from a pragmatic perspective, this article proposes rule tightening in the existing disclosure and monitoring frameworks.

The remainder of this article proceeds as follows. The second section reviews the evolution of contemporary executive remuneration, with a particular focus on the theoretical rationale for ESG incentives through the lenses of agency theory and the BSM. The third section presents the empirical findings of ESG-based remuneration in the FTSE 350 companies and analyses their motivations. The fourth section discusses whether or not ESG-based remuneration is an ideal incentive mechanism for a shareholder-oriented and a stakeholder-oriented company, respectively. The fifth section is the conclusion.

II. Executive remuneration and shareholder value

1. Agency theory and the evolution of executive remuneration

The shareholder primacy norm places shareholders as the ultimate beneficiaries of a company²³ and identifies shareholder value maximisation as the duty and objective of executives.²⁴ For decades, corporate governance practices have been substantially illuminated by agency theory²⁵ and centred on how to prevent executives from exploiting their managerial power for self-interest.²⁶

Contemporary executive remuneration is an important corporate governance instrument for aligning shareholder and executive interests.²⁷ Specifically, two incentive mechanisms have been applied. The first is to pay executives share options or restricted shares; by making share price determinative of their incomes, equity-based remuneration orients executives to think like shareholders.²⁸ The second is to make rewards or bonuses conditional on the increase in shareholder value.

It is rationalised in theory that, when the interests of executives and shareholders are harmonised, the agency costs caused by managerial exploitation or the extra inputs to monitor executives are reduced.²⁹ However, throughout the evolution of contemporary executive remuneration, inconsistencies with this theoretical assumption have been frequently observed. Poorly structured incentives would lead to interest misalignment, making executive remuneration a source of rather than a solution to the agency problem.³⁰

In the operation of executive share options (ESOs), opportunistic tactics such as backdating and repricing have been widely used.³¹ Backdating means that executives choose the grant date of an option ex-post so that they can play with hindsight to ensure that the exercise price is low enough.³² Repricing is the resetting of the exercise price when the current market price falls below the original exercise price.³³ Both practices undermine the incentive mechanism, as executives are able to realise their incomes by manipulating the terms of options rather than improving their performance.³⁴ Share options also bring executives significant windfall gains if the share price increases due to exogenous factors rather than their efforts.³⁵

In the UK, the Greenbury Report published in 1995³⁶ introduced long-term incentive plans (LTIPs), which later became the most important component of executive remuneration.³⁷ LTIPs may take the form of either share options or restricted shares, but they are distinguished from traditional ESOs by being conditional on the performance targets of shareholder value, such as earnings per share (EPS) and total shareholder return (TSR).³⁸ To mitigate windfall gains, companies were encouraged to refer to relative rather than absolute value, such as the ranking of TSR or EPS in a group of comparators.³⁹

In addition to LTIPs, which are pegged to financial performance over a longer period,⁴⁰ annual bonuses⁴¹ are operated as a separate component based on similar financial indicators in the short term.⁴² Nowadays, they are the two primary components of performance-based remuneration adopted by UK companies.

By applying ‘more challenging performance criteria’, performance-based remuneration was expected to give executives ‘keen incentives to perform at the highest levels’.⁴³ However, practical evidence demonstrates that executives have continued to explore a variety of opportunistic tactics to operate performance-based remuneration in their own favour: they undertake earnings manipulation, ranging from misrepresentations in financial statements⁴⁴ to intentional control over the timing of reporting⁴⁵; they make speculative business decisions such as inefficient share repurchases⁴⁶ and acquisitions;⁴⁷ in a more straightforward way, they interfere with the selection of comparators, such as ex-post selections with hindsight.⁴⁸

Earnings manipulation and speculative projects may inflate the company’s short-term share price at the expense of its long-term development.⁴⁹ In this context, the incentive mechanism of performance-based remuneration would be distorted and therefore adversely affect shareholder value. Among different proposals re-examining the design of remuneration, the BSM has had a profound influence on remuneration practice.⁵⁰

2. The BSM and ESG incentives

The BSM was raised by Kaplan and Norton in the 1990s as a performance measurement system which integrates both financial and non-financial indicators.⁵¹ In its original structure, performance is measured from the financial perspective and three non-financial perspectives: customer, internal process, and learning and growth.⁵² The BSM confirms financial success as the ultimate purpose of a company.⁵³ Financial indicators are used to measure performance outcomes; however, they do not reflect the specific actions leading to these outcomes.⁵⁴

The BSM emphasises that the correct journey towards long-term shareholder value should be consistent with corporate vision and strategy, which, on a generic basis, encompass the three non-financial perspectives.⁵⁵ Objectives embedded in these perspectives, such as improvements in product quality, customer service, organisational efficiency and innovative abilities, are the key drivers of continuous business growth.⁵⁶ However, these improvements may not be converted into returns immediately.⁵⁷ If performance is measured only by current financial results, executives have incentives to divert their attention from the company’s long-term strategy,⁵⁸ whereas embracing manipulation and speculative projects.⁵⁹ Therefore, by integrating financial and non-financial indicators, the BSM is envisaged to evaluate performance by referring to not only the outputs – the achievements in shareholder value creation but also the inputs – the actions to create value.⁶⁰

The BSM was increasingly implemented by companies in the 1990s and 2000s. Incorporating NFPIs into executive remuneration was considered an effective way to enforce this model.⁶¹ Proponents of NFPIs believe that by aligning executive remuneration with the specific value-creating actions desired by shareholders, they provide a solution to the agency problem caused by distortions in financial incentives.⁶²

It is now widely acknowledged that many social and environmental factors are essential contributors to long-term corporate success.⁶³ The implication for management is that integrating these factors into decision-making and operation is in the best interest of shareholders.⁶⁴ In the UK, as a matter of law, shareholder value should be pursued with considerations of social and environmental issues, known as the enlightened shareholder value (ESV) approach. Section 172(1) of the UK Companies Act (CA) 2006 requires directors to ‘promote the success of the company for the benefits of its members’,⁶⁵ which reaffirms shareholder value maximisation as the corporate purpose.⁶⁶ It further articulates that ‘having regard to’ stakeholder interests is the correct approach to long-term corporate success.⁶⁷

Given that addressing the social and environmental issues concerning a company’s stakeholders is essential for its long-term development, through the lens of the BSM, the company should be equipped with an ESG-informed system of performance measurement. In recent years, in addition to the traditional employee and customer factors, companies have integrated a variety of other ESG factors into the scorecard of NFPIs.⁶⁸ The ESG-related segment in NFPIs is commonly known as ESG-based remuneration.

ESG-based remuneration has its roots in agency theory. Under the ESV approach, shareholder value maximisation is embedded in the company’s long-term success, rather than short-term profits. To this end, stakeholder interests should be integrated into management.⁶⁹ Therefore, ESG incentives are expected to better align executive interests with their non-economic activities for long-term corporate success.

Throughout the evolution of executive remuneration, all structural changes have been aimed at dealing with the inefficiency of the existing incentive mechanism. However, the reformed mechanism may also become dysfunctional due to imperfections in design and the consequential manipulation of performance outcomes. This problem has been observed in the operations of both ESOs and LTIPs. There is no reason to assume that ESG-based remuneration or the general system of NFPIs is an exception. In fact, the effects of the actions reflected by NFPIs on shareholder value may not be measurable. Many NFPIs are qualitative, and the performance assessments against them involve substantial subjective judgments. In these situations, there may be biased incentives or loopholes for manipulation. These potential problems will be further discussed in the next section with reference to the practice of ESG-based remuneration.

III. The practice of ESG-based remuneration

1. Hypotheses

This section examines the current practices of ESG-based remuneration in major UK companies and analyses the underlying motivations of these companies.

As stated above, the ESV approach instructs directors to have regard to stakeholder interests when promoting long-term shareholder value. Incorporating ESG factors into remuneration can better align executive interests with their sustainable value-creating actions. Therefore, the first hypothesis about companies’ motivations is:

Hypothesis I: the adoption of ESG-based remuneration is intended to promote long-term shareholder value by encouraging executives to improve ESG performance.

Stakeholder-oriented companies which treat stakeholder interests as independent corporate objectives may also adopt ESG-based remuneration to align executive and stakeholder interests. However, none of the UK companies investigated in this study follow a plural stakeholder approach at this moment.

According to Section 172(2) of the CA 2006, companies are allowed to have other corporate purposes.⁷⁰ Therefore, the ESV approach is actually the default rule for defining corporate purpose.⁷¹ The only feasible way for an existing shareholder-oriented company to redefine its purpose by virtue of Section 172(2) is to amend its articles of association through a special resolution of members.⁷² Despite that a shift away from the ESV approach is possible, none of the investigated companies have done so.⁷³ Therefore, the situation where a company employs ESG-based remuneration to create value for stakeholders is excluded.

Public communication of remuneration arrangements is one way for companies to address reputational concerns.⁷⁴ In terms of building a ‘sustainable’ image, the main measure companies have been using is social and environmental reporting whereby they communicate sustainability-related commitments and activities to influence shareholders’ and stakeholders’ perceptions.⁷⁵ However, it is shown that companies pervasively make use of social and environmental reporting for impression management.⁷⁶ In the literature on management and accounting, impression management refers particularly to using discretionary disclosures such as boasting positive aspects and camouflaging negative aspects to distort others’ perceptions.⁷⁷ In terms of social and environmental performance, a poorly performing company may choose to employ overoptimistic rhetoric and artificial or inauthentic representations to polish the surface of its performance whereas obfuscating the real situation.⁷⁸

Remuneration arrangements may also serve as impression management tactics. A previous study found that the boards of companies with poorer financial performance tended to announce the adoption of LTIPs as a signal of their commitments to shareholder interests; however, LTIPs were not necessarily helpful for shareholder value maximisation.⁷⁹ By analogy, a company whose social or environmental performance is poor may utilise ESG-based remuneration to make superficial commitments to sustainability. An essential consequence of impression management is the inconsistency between the appearance and substance of corporate performance. ESG-based remuneration adopted as an impression management tactic will have limited realistic effects on promoting corporate sustainability; instead, it is primarily symbolic. This article defines symbolic ESG-based remuneration as the practice by which a company creates the appearance that it is incentivising executives to improve ESG performance, whereas (at least part of) the rewards are not linked to substantive ESG improvements. Therefore, the second hypothesis is:

Hypothesis II: the adoption of ESG-based remuneration is a symbolic tactic for impression management.

One of the major reasons for a company’s board to undertake impression management is to maintain or improve the company’s reputation.⁸⁰ A good reputation can promote firm value. In this sense, the adoption of symbolic ESG-based remuneration may be driven by the board’s desire to benefit the company and shareholders. Nevertheless, it is distinguished from the motivation in Hypothesis I, which is to achieve long-term shareholder value by promoting corporate sustainability. In particular, the value-enhancing effect of impression management is usually temporary. It is empirically proven that after learning the actual performance and overstatements of a company, the market reacts negatively, suggesting that impression management harms shareholder value in the long term.⁸¹ In a company where ESG-based remuneration is more meaningful as a symbol than a real driver of performance, its shareholders will ultimately be worse off because a portion of ‘performance-based’ remuneration does not depend on actual performance.

In the UK, shareholders have the right to vote on executive remuneration, known as ‘say on pay’ (SOP). In principle, shareholders are able to prevent the adoption of symbolic ESG-based remuneration. However, as will be discussed below, in practice, the board, more specifically the remuneration committee, maintains a certain level of discretion to determine specific remuneration arrangements.

Symbolic ESG-based remuneration which does not entail substantive efforts is in the interest of those executives who regard slacking off as a benefit.⁸² The managerial power approach contends that executives can exert significant influence over the pay-setting process and have incentives to inflate their pay levels. Pay and performance are decoupled to the extent of inflation, and the decoupled portion of pay is the economic rent extracted by executives from their companies.⁸³

In reality, the influence of executives varies across different companies. In a company where executives are powerful enough to make de facto decisions on their own remuneration, they may push forward the adoption of ESG-based remuneration. ‘When changing circumstances create an opportunity to enjoy more rents or to better camouflage their rents, managers will try to take advantage of the opportunity’.⁸⁴ By design, ESG-based remuneration can create a new opportunity for rent extraction. This conjecture is consistent with the criticism of the use of NFPIs for enabling powerful executives to inflate their pay levels.⁸⁵ In particular, this self-serving intention can be well disguised by alleging that ESG-based remuneration is an essential step in sustainable corporate governance.

Given that executives are not allowed to participate in the pay-setting process,⁸⁶ not all executives in UK companies are powerful enough to determine remuneration arrangements. Nevertheless, if executives perceive that ESG-based remuneration is self-beneficial, they will try to influence the board to introduce it. Therefore, the third hypothesis is:

Hypothesis III: the adoption of ESG-based remuneration is favoured by executives for private interests.

Hypotheses II and III look at two different motivations that may drive the use of symbolic ESG-based remuneration. Hypothesis II emphasises that the motivation of the board as a whole is to enhance the company’s reputation. Differently, Hypothesis III emphasises that individual executives, who have significant stakes in remuneration arrangements, have incentives to make use of ESG-based remuneration for private interests. In practice, symbolic ESG-based remuneration can be driven by both motivations at the same time.

There are other situations where ESG-based remuneration is driven by a mix of different motivations. For instance, a company adopts some ESG indicators to promote corporate sustainability and others for impression management; even if an ESG indicator is adopted with the aim of encouraging ESG performance, executives may be able to manipulate the performance outcome. Therefore, rather than classifying companies by the three hypothesised motivations, this study aims to find evidence supporting each of them by holistically investigating companies’ remuneration practices.

2. Data collection

The data on ESG-based remuneration is collected from the remuneration reports of the FTSE 350 companies,⁸⁷ which are enclosed in their 2022 annual reports.⁸⁸ The rationale for this purposive sampling is two-fold. First, the FTSE 350 companies are the largest ones listed on the London Stock Exchange (LSE) by market capitalisation. It is these major companies that are more often reported to adopt ESG-based remuneration.⁸⁹ On the one hand, due to their significance in the market and higher levels of institutional ownership, major companies are under more pressure to make sustainability-oriented shifts, including the adoption of ESG-based remuneration. On the other hand, they usually have a sophisticated remuneration framework in place and appoint professional consultants, which enables them to make the shift promptly. Therefore, it is assumed that the FTSE 350 companies are taking the lead in the practice of ESG-based remuneration. Second, subject to stricter disclosure requirements, these companies can provide more publicly available information for empirical analysis.⁹⁰

In 2022, 212 of the FTSE 350 companies have incorporated ESG incentives into executive remuneration, which constitutes the sample of this empirical study.⁹¹ For data collection, the definition of ‘ESG incentives’ is based on the below criteria.

First, the term ‘incentives’ refers to the performance indicators for determining the rewards under annual bonuses and LTIPs. In this article, ‘indicator’ and ‘metric’ are distinguished. The former is the general objective regarding an ESG issue that executives are expected to address, such as ‘maintaining health and safety in the workplace’; the latter is the specific standard applied to measure or assess performance, such as the ‘fatal accident rate’. One performance indicator can be measured or assessed by several different metrics.

Second, two categories of NFPIs are defined as ESG-related:

1. An indicator of a specific type of stakeholder interest; in this empirical study, stakeholders are defined in a broader way to include not only human beings and entities but also the environment and the ecosystem;⁹² indicators in this category belong to the environmental and social dimensions;

2. An indicator of sustainability-related strategies, processes or arrangements; indicators in this category reflect a company’s prospect for sustainable development, but they do not directly represent the actual achievements in stakeholder interests; they usually belong to the governance dimension.

Information on ESG incentives⁹³ is categorised into three aspects: the focus of ESG incentives, the weights of ESG incentives in performance-based remuneration, and the main features of performance metrics and assessments. Findings about these three aspects are presented and analysed below.

3. Empirical findings

A. The focus of ESG incentives

Table 1 lists all ESG indicators adopted by the sample companies⁹⁴ and provides the number of companies that have adopted each indicator. This study identifies eight environmental indicators, six social indicators, and four sustainable governance indicators.⁹⁵ Despite the wide coverage in general, companies’ focuses converge on a few indicators: ‘employees’, ‘carbon emissions reduction’ and ‘sustainability strategy’ are adopted by around half of the sample companies; ‘diversity and inclusion’ and ‘customers’ are adopted by more than one-third of them.

Table 1. ESG Indicators in executive remuneration.

Environmental		Social		Governance
Carbon emissions reduction	102	Employees	115	Sustainability strategy	104
		Employee engagement: 93		Including reporting: 26
		Employee retention: 5		Others: 77
		Employee welfare: 6
		Employee engagement and retention: 9
		Employee welfare and retention:2
Renewable energy or energy intensity reduction	32	Diversity and inclusion	89	ESG ratings and certifications	30
Waste reduction, plastic reduction and recycling	19	Customers	76	Responsible investing	19
		Customer satisfaction score: 61
		Customer service: 15
Environmental innovation support	7	Health and safety	54	Stakeholder engagement	7
Water reduction	7	Social impact	31	ESG purpose and culture (unspecified)	1
		Via business: 15
		Via volunteering: 7
		Via volunteering and business: 1
		Engaging with communities: 8
Biodiversity protection	3	Suppliers engagement	6
Forestation	4
Zero discharge of hazardous chemicals	1
Environment (unspecified)	2

In a generic BSM, employee and customer interests are among the key NFPIs for all businesses.⁹⁶ As shown in previous studies, these two indicators have been prevalently adopted in remuneration incentives for more than two decades.⁹⁷ It is reasonable to infer that companies adopt them with the aim of increasing shareholder value.⁹⁸ Logically speaking, every indicator listed in Table 1 may have an impact on shareholder value, either directly or indirectly. For instance, some new ESG indicators show that companies are pushing forward their businesses towards ‘doing well by doing good’, such as responsible investing and services for disadvantaged groups⁹⁹ (social impact via business). It is possible that a company’s genuine motivation is to incentivise executives to promote corporate sustainability unless there is evidence revealing different motivations.

Different from employee and customer interests, studies examining previous remuneration practices do not find that ‘carbon emissions reduction’,¹⁰⁰ ‘diversity and inclusion’ or ‘sustainability strategy’ was widely incorporated into remuneration incentives.¹⁰¹ This demonstrates that the widespread adoption of these indicators has emerged recently.

The underlying issues of these indicators have entered the spectrum of public policy and law in the past few years. In 2019, the UK government made the commitment to achieving net zero emissions by 2050 a legally binding target,¹⁰² following which it introduced a wide range of regulatory measures on emissions.¹⁰³ Typical examples include the Streamlined Energy and Carbon Reporting¹⁰⁴ and the disclosure requirements based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD reporting),¹⁰⁵ both of which are mandatory for the sample companies. Similarly, since April 2022, listed companies have been required to report whether or not they have achieved the diversity targets set by the Financial Conduct Authority (FCA)¹⁰⁶ and make disclosures about their diversity policies.¹⁰⁷ Prior to the FCA’s mandatory rules, government-led voluntary diversity campaigns had been implemented in some industries, such as the ‘Women in Finance Charter’, which was launched by the HM Treasury and joined by financial firms.¹⁰⁸ Accordingly, among the 89 companies that have adopted diversity targets, more than one-third (34) are in the financial industry.

By bringing companies’ activities related to climate change and diversity into the spotlight, regulators aim to spur companies to make positive changes.¹⁰⁹ The enactment of mandatory regulations also conveys to investors and the wider public that companies are accountable for addressing these issues, which intensifies public pressure on companies. Therefore, incorporating the goals of carbon emissions reduction and improving diversity into remuneration incentives can be regarded as one of their adaptations to increasing policy and public pressures. For instance, in 2019, ITV did not incorporate any ESG indicator into executive remuneration;¹¹⁰ in 2020 and 2021, it adopted the delivery of a diversity plan as the only ESG indicator, whereas the specific diversity targets were not defined;¹¹¹ in 2022, it set clear-cut carbon emissions and diversity targets.¹¹²

Increasing policy and public pressures make corporate reputations more sensitive to these top-ranking sustainability issues. In this sense, maintaining or enhancing reputations is the main reason for companies to link these issues with executive remuneration. In contrast, it is less likely that companies which have recently adopted carbon emissions and diversity targets believe that there is an intrinsic need to promote long-term shareholder value by giving executives particular incentives to address ESG issues. This is because, first, the ESV approach has been implemented in the UK for many years; however, these companies did not attach these targets to remuneration previously. Second, other environmental or social issues are not widely incorporated into remuneration. It is unreasonable for companies to assume that only the carbon footprint has an impact on shareholder value, whereas other environmental issues do not. In fact, issues such as water or waste reduction are also pertinent to most businesses; however, they are not commonly adopted.

The fact that companies incorporate top-ranking sustainability issues into remuneration incentives as a strategy for reputation enhancement does not necessarily mean that their practices are symbolic. In general, companies may address reputational concerns in two ways – making substantive improvements or employing impression management tactics. Since the latter is usually quicker and less demanding, there is a possibility, but only a possibility, that some companies’ practices are symbolic responses to policy and public pressures. To prove this, it is necessary to find evidence that some pressure-driven indicators have limited incentive effects.

Nearly half of the sample companies adopt self-defined indicators such as designing or establishing sustainability strategies, publishing or communicating established strategies, and making sustainability-related disclosures. In this study, all these indicators are categorised into a generic one – ‘sustainability strategy’. The strategy is either an overall framework for corporate sustainability or a plan targeted at a certain dimension, such as setting diversity policies,¹¹³ updating the calculation methods of carbon emissions,¹¹⁴ or submitting emissions plans to the Science Based Targets initiative.¹¹⁵ Indicators defined as planning activities are different from those defined as clear-cut targets. The latter base performance assessments on substantive achievements, whereas the former allow executives to be paid for the completion of procedural tasks, also known as ‘business as usual’ activities.¹¹⁶ If executives are incentivised by clear-cut targets, they will certainly set up plans. In contrast, if they are only encouraged to make plans, they may not proactively make enough efforts to implement them. As a consequence, focusing only on procedural tasks may lead to check-the-box practices.

There are 14 companies which adopt ‘sustainability strategy’ as the only ESG indicator.¹¹⁷ Their ESG-based remuneration has weak effects on incentivising executives to make substantive efforts. By adopting this indicator, these companies want to impress investors and the wider public with the fact that sustainability goals are embedded in their strategies. However, without incentives for executives to make actual improvements, the indicator is mostly a symbol which gives the appearance of a company’s sustainability commitment.¹¹⁸

Furthermore, some procedural tasks are the legal responsibilities of companies. 26 companies pay their executives for making sustainability-related disclosures, especially the completion of TCFD reporting.¹¹⁹ This type of performance indicator is meaningless and superfluous for two reasons. First, making ESG-related disclosures is a relatively effortless action. Second, other incentive or deterrence mechanisms, such as the risk of being removed, are strong enough to drive executives to comply with mandatory requirements, in which circumstances the ESG indicator does not provide any incremental incentive. As will be discussed later, the use of undemanding targets is potentially a self-serving tactic.

B. Weights of ESG incentives

In practice, NFPIs are always minor contributors to performance assessment. Empirical findings show that greater weights allocated to NFPIs (including both business-related and ESG indicators) are positively correlated with shareholder value.¹²⁰ Accordingly, it is argued that ESG incentives which constitute a very small portion of performance-based remuneration are ineffective in driving sustainability-related performance; namely, they are more symbolic than substantive.¹²¹

Table 2 presents the distribution of companies by the range of the aggregate weight of ESG indicators. There is a huge disparity between the numbers of companies applying ESG incentives to annual bonuses and LTIPs, which are 191 (90%) and 68 (32%),¹²² respectively.

Table 2. The aggregate weight of ESG indicators^a.

Range of weight (%)	Number of companies
	Annual bonuses	LTIPs
0	12	126
1–5	30	1
6–10	44	21
11–15	42	17
16–20	34	18
21–25	20	8
26–30	10	0
31 and above	11	3
Underpins^b	2	3
n/a^c	7	15

^a Sometimes the company only provides the aggregate weights of all NFPIs, some of which are not ESG-related. It is then assumed that all NFPIs are equally weighted, and the aggregate weights are calculated on a pro rata basis.

^b The term ‘underpins’ refers to a situation where the rewards are based only on non-ESG performance indicators, however, if executives fail to meet the pre-specified ESG thresholds, their rewards would be forfeited or reduced at the discretion of the remuneration committee. For instance, see Marshalls annual report 2022, p. 101; Vanquis Banking Group annual report 2022, p. 132.

^c This refers to a situation where the company does not pay annual bonuses or LTIPs, or it does not disclose the weights of performance indicators.

Three factors may explain this disparity. First of all, a pragmatic reason is that conventionally, the scorecard of NFPIs is attached to annual bonuses, whereas LTIPs are determined purely by financial indicators.¹²³

In addition, the board usually has more discretion over annual bonuses than LTIPs. According to the SOP rules set in the CA 2006, shareholders in quoted¹²⁴ and unquoted traded companies¹²⁵ have a legally binding vote on the forward-looking remuneration policy, which is carried out at least every three years,¹²⁶ and a non-binding vote on the backward-looking implementation report, which is carried out every year.¹²⁷ In principle, the proposed changes to both annual bonuses and LTIPs must be included in a new remuneration policy for shareholder approval. In practice, since the remuneration policy is rarely submitted for approval annually, it is necessary for the board to have some discretion over annual bonuses so that they can make timely adjustments. Shareholders also tend to place more emphasis on their decision-making power over LTIPs. As noted by the IA, for annual bonuses, shareholders ‘expect to be informed of the main performance parameters’, whereas for LTIPs, ‘all new incentives or any substantive changes to existing schemes should be subject to prior approval by shareholders’.¹²⁸ For companies listed on the LSE, shareholders are also empowered by the Listing Rules to approve LTIPs.¹²⁹ Therefore, integrating ESG indicators into annual bonuses is more straightforward for the board, which also allows them to apply discretion to the performance assessments against ESG indicators.

Another possible reason is the lighter disclosure requirements applied to short-term bonuses. As will be further discussed in Section IV, annual bonuses, if not in the form of share options, are not subject to the disclosure requirements of performance indicators. Therefore, by design, companies can keep the details of ESG incentives confidential.

There are 126 companies which operate both annual bonuses and LTIPs, whereas attaching ESG indicators to the former only. This arrangement may possibly affect the incentive effects of ESG-based remuneration in two ways. On the one hand, the paid-out amount of annual bonuses is usually 25 to 37.5% of that of LTIPs;¹³⁰ therefore, the actual ESG-based portion is smaller than what the weight suggests. On the other hand, the board may make use of its discretion over annual bonuses to undertake impression management.

Table 2 also demonstrates that 116 of the 191 companies (60%) which attach ESG indicators to annual bonuses limit the aggregate weight to 15%. Even if the aggregate weight is relatively high, when a company adopts many indicators, the weight of every single indicator is low. Table 3 presents the distribution of companies by the range of average weight as well as the medians. As far as annual bonuses are concerned, the majority of the sample companies attach no more than 5% to a single ESG indicator.

Table 3. The average weight of a single ESG indicator^a

Range of weight (%)	Number of companies
	Short-term Bonuses	LTIPs
1–5	114	16
6–10	62	27
11–15	7	9
16–20	6	11
25–30	2	4
	Median of weight
	5%	10%

^a This table aims to reflect how much weight a company would like to allocate to a single ESG indicator and the difference among companies. The proxy for ‘the weight of a single ESG indicator’ is the average weight, which is calculated by dividing the aggregate weight by the number of indicators. Another reason is that many companies do not provide the precise weight of every single ESG indicator. In addition, companies classified as ‘underpins’ or ‘n/a’ are excluded.

The ESG indicators shown in Table 1 represent heterogeneous issues, and some of them may entail separate or conflicting actions.¹³¹ Differently, financial indicators are usually homogenous or positively correlated. Compared to the aggregate of financial indicators, every single ESG indicator is minor. For executives, the weights of performance indicators are the key determinants of the allocation of efforts and resources. If ESG incentives constitute a very small portion of executive remuneration, it is unlikely that executives will make substantial changes to their management. As a corollary, companies allocating very low weights to ESG incentives do not intend to shift to a more sustainable model for shareholder value maximisation; or at least, they do not expect to accomplish the shift through ESG-based remuneration. For them, ESG-based remuneration is more symbolic than substantive.

It is observed that companies attaching ESG incentives to LTIPs tend to allocate higher weights to ESG indicators. The median of the average weight in LTIPs is two times that in annual bonuses. Considering that LTIPs usually constitute a larger portion, these companies show a stronger willingness to enhance the incentive effects of ESG-based remuneration. There is also a positive implication for the role of shareholders. As discussed, both in regulation and in practice, shareholder approval over LTIPs is more emphasised. The contrast between the weights of ESG indicators in annual bonuses and LTIPs suggests that when the board perceives stronger monitoring by shareholders, it tends to make more substantive arrangements for ESG-based remuneration.

C. Performance metrics and assessments

In a company, the remuneration committee undertakes specific work related to the setting of performance targets and metrics as well as performance assessments. Given the remuneration committee’s substantial power over remuneration policy and enforcement, it is important to keep its operation independent of executive directors. For listed companies in the UK, the remuneration committee must be made up of independent non-executive directors.¹³²

However, the role of the remuneration committee in practice is a controversial issue, as the pay-setting and enforcement processes can be affected by a mix of factors.

The remuneration committee’s decisions are unavoidably influenced by the external environment, especially the market for executive talent. Competition in this market, which is often reified as existing or potential executives having many outside options,¹³³ drives companies to offer generous remuneration packages to attract or retain executives.¹³⁴ ‘Benchmarking and ‘pay-for-luck’ asymmetry are the two common ways adopted by remuneration committees. Benchmarking means that the remuneration committee determines the level of performance-based remuneration according to those offered by peers, which are usually among the highest.¹³⁵ ‘Pay-for-luck’ asymmetry means offering executives higher rewards for good luck without any diminution for bad luck,¹³⁶ for which the remuneration committee may intentionally manipulate incentive design, such as by using exogenous luck-related factors.¹³⁷ Both practices will result in performance-based remuneration decoupled from actual performance. Nevertheless, they are not necessarily illegitimate because appointing and retaining competent executives who can create business and management efficiency is also in the interest of shareholders.

An alternative view on the reason for the remuneration committee to provide large and performance-insensitive remuneration is managerial influence. As discussed earlier, the managerial power approach argues that executives may be powerful enough to control the pay-setting process for rent extraction. Given that remuneration should be determined independently by the remuneration committee, this assumption is only true if the remuneration committee colludes with self-serving executives. In the literature on corporate governance, the inadequacy of board independence has provoked significant concerns, as many ‘independent directors’ have personal relationships or social ties with executives.¹³⁸ Empirical evidence shows that socially or personally tied independent directors perform worse in monitoring executives.¹³⁹ In terms of remuneration, it is also found that less independent remuneration committees are inclined to pay performance-insensitive remuneration to executives.¹⁴⁰

In addition, many independent directors are outsiders, who rely largely on executives for information.¹⁴¹ When setting performance targets and making assessments, the remuneration committee may suffer an information disadvantage. Executives, who have the best knowledge about whether or not a specific performance target is easy to achieve, can make use of their advantage to influence the remuneration committee to adopt undemanding targets. When executives manipulate performance outcomes, the remuneration committee may be unable to detect them.

As far as ESG-based remuneration is concerned, for many ESG factors, there is no standardised approach for performance assessment.¹⁴² In this context, the remuneration committee needs to adopt self-designed metrics and assessment methods, on which it exercises substantial discretion.

Table 4 illustrates the percentage of companies applying discretion to assess the performance against a certain ESG indicator.¹⁴³ The majority of the sample companies prefer objective metrics. In this study, objective and discretionary metrics are distinguished by whether or not the remuneration committee applies subjective judgments. Therefore, they are relative. Some objective metrics may embed the subjective judgments of others. For instance, in terms of customer satisfaction, a company can refer to either a self-designed customer survey or a third-party index; apparently, the latter is more objective.¹⁴⁴

Table 4. The application of discretion to major ESG indicators.

Indicator	The proportion of companies applying discretion (%)^a
Carbon emissions reduction	6.86
Renewable energy or energy intensity reduction	31.25
Employees	36.52
Customers	19.74
Diversity and inclusion	35.96
Health and safety	16.67
Sustainability strategy	99.04
ESG ratings and certifications	13.33
Social impact	45.16

^a A company that uses both discretionary and objective metrics is included.

The sustainability strategy indicator is an exception, as almost all companies apply discretion to assess the performance against it. This is because the metrics related to sustainability strategy are firm-specific and many of the procedural tasks are not quantifiable. Subjective judgments, which are carried out internally, are more vulnerable to manipulation.¹⁴⁵ This study finds that the numbers of unspecified objective and discretionary metrics are 52 and 141, respectively. Unspecified objective metrics are those without specifications on the definitions of the metrics (excluding well-known industry-wide standards) or the quantitative details of targets or outcomes. Unspecified discretionary metrics are those without specifications on expected or actual achievements.¹⁴⁶ Where discretion is used, there is a higher probability that the remuneration committee tends to withhold performance-related information. In other words, it is easier for the remuneration committee to make use of subjective assessments than objective metrics to obfuscate performance outcomes. Nevertheless, objective metrics are not necessarily more effective or immune to manipulation. When companies create objective metrics internally or have the discretion to choose from various third-party metrics, those in use may also be dysfunctional.

By investigating the performance metrics and assessment methods adopted by the sample companies, several problems, which may undermine the incentive effects of ESG-based remuneration, are identified.

Incompleteness in metrics

For a multidimensional ESG issue, an ideal performance assessment captures as many dimensions as possible. However, as shown in Table 5, on average, most companies apply no more than two metrics to each ESG indicator, and the median of the average number of metrics is 1.6 only, implying that the performance assessments against some ESG indicators are partial. As noted in the literature, although employee interests are typically multidimensional, only a few aspects are factored into ESG-based remuneration.¹⁴⁷ Consistently, this study reveals that most companies base performance assessments on ‘employee engagement’, which is usually measured by the outcomes of employee surveys on their perceptions of engagement. In contrast, a very small number of companies assess performance based on the actions taken to improve employee satisfaction. The statistical results are presented in Table 1.

Table 5. The average number of ESG metrics.

Average number of metrics	Number of companies
1	72
1–2	90
2–3	38
3–4	9
5 and above	3

Performance regarding customer interests is assessed in a similar way. The majority of companies refer only to the net promoter score, which is a commonly used proxy for customer satisfaction. It is questionable to what extent a general score can reflect actual improvements in customer service. For example, in two large construction companies, the performance assessment against customer satisfaction is based on customers’ answers to a single question – ‘Would you recommend your builder to a friend?’, which is set in a survey by the National House Building Council.¹⁴⁸ A more complete survey operated by the same authority includes more detailed customer feedback on various aspects of services,¹⁴⁹ which is, however, not adopted. The consequence of limiting performance assessments to a narrower range of metrics or oversimplified metrics is that executives focus only on the outputs linked to their remuneration,¹⁵⁰ leading to suboptimal stakeholder treatment. However, executives and the remuneration committee can benefit from this suboptimal arrangement, as both of them can avoid more complex tasks.

Undemanding targets

Among the sample companies, undemanding targets are frequently adopted, such as the aforementioned procedural tasks. Another typical example is defining a performance target as maintaining the status quo rather than making incremental changes. In terms of the performance assessments against employee engagement, customer satisfaction and corporate ESG ratings, some companies only provide the absolute level in the present year, without indicating whether it is an upgrade or downgrade from previous years. By reviewing last year’s remuneration reports, it is found that in a few companies, the reported ‘achievements’ are the same as or even lower than previous records.¹⁵¹ Where there is still room for improvement, maintaining the existing level of performance requires less effort. In some situations, it does not require any additional contributions, such as maintaining the ratio of female managers at a certain level. Such performance targets provide executives with more comfort, whereas impeding the process of promoting corporate sustainability.

The consequence of rewarding executives for retrogression is more serious. In so doing, the remuneration committee manipulates performance assessments to fulfil executives’ private interests. This problem will be further discussed.

‘Easy to manipulate’ metrics

To enhance the sustainable image or meet certain requirements and standards, executives have incentives to hyperbolise their companies’ ESG performance with falsified outcomes.¹⁵² If executive remuneration is aligned with ESG performance, they may be further incentivised to do so.

Manipulation can be undertaken by executives through the use of illegitimate methods to ‘achieve’ performance targets or by the remuneration committee through distortions in performance assessments. The second situation, where the remuneration committee abuses its discretion, will be discussed as a separate problem.

In the first situation, even if the remuneration committee acts in good faith, the metrics designed by them may be vulnerable to manipulation. The measurement of carbon emissions is relatively objective due to its quantitative nature. It is also more standardised than other ESG indicators as a result of the increasingly uniform regulations. However, there have been reports of emissions manipulation. A widely known example is the ‘Dieselgate’ scandal – Volkswagen employed software techniques to falsify the emissions records of their cars.¹⁵³ Scholars also point out the potential for manipulation by way of misrepresentations of baseline calculations¹⁵⁴ or artificial transfers of carbon-intensive assets.¹⁵⁵

Some companies adopt ‘ESG ratings and certifications’ as an indicator. However, the current practices of ESG ratings and certifications have been criticised for lacking reliability, the main reason for which is unreliable sources of information.¹⁵⁶ For instance, when raters or certifiers use questionnaires to collect information, companies can selectively provide favourable or falsified information.¹⁵⁷ It is also found that companies are able to upgrade their ratings with check-the-box practices.¹⁵⁸ In the context that ESG ratings and certifications per se are vulnerable to manipulation, using them to measure executives’ contributions to corporate sustainability is dangerous, as they will impel executives to turn to those ready-to-use tactics of manipulation.

Abuse of discretion

Compared to carbon emissions and ESG ratings and certifications, the outcomes of which are determined or overseen by independent third parties, self-defined indicators can be manipulated at a much lower cost. In particular, manipulation can be undertaken at the stage of setting targets and metrics.

Driven by either managerial influence or the desire to retain executives, the remuneration committee may embrace executive-friendly arrangements.¹⁵⁹ More seriously, it may do so by abusing its discretion. Since the design of ESG metrics and performance assessments are very often carried out internally, the abuse of discretion is hardly detectable. Nevertheless, there is piecemeal evidence suggesting that in some companies, the remuneration committees have employed biased metrics or assessment criteria.

As stated, some companies provide an absolute level as the performance outcome, without specifying whether it is a negative or positive change. In a more obvious way, the board of Spectris admitted that executives have failed to meet the target of customer service; without declaring any other achievements, it still paid half of the scheduled bonuses to executives.¹⁶⁰ More commonly, many companies only illustrate successful outcomes as justifications for rewards, without elaborating on failures or unrealised targets. In the context that some companies do not provide ex-ante specifications on performance targets, they can ex-post report positive outcomes and camouflage negative ones to hyperbolise the whole picture of ESG performance. This action with hindsight is analogous to the aforementioned backdating of ESOs and the ex-post selection of comparators in LTIPs.

The abuse of discretion is also embodied by biased metrics, which refer to those inconsistent with the commonly accepted denotation of the measured indicator. To illustrate, employee engagement, which is about employees’ involvement in work, has been measured by the ratio of employees who participated in staff surveys;¹⁶¹ financial inclusion, which is defined by the World Bank as making financial products and services accessible and affordable to all individuals and businesses,¹⁶² has been measured by the frequency of card users’ logins.¹⁶³

In addition, some companies double the ESG-based remuneration for executives by duplicating performance metrics in two ways: the first is to repeatedly pay executives in different years for one-off achievements;¹⁶⁴ the second is to apply the same metrics to both group performance and executives’ individual performance.¹⁶⁵

To summarise, the four problems observed in the design of metrics and performance assessments commonly reflect that ESG-based remuneration is prone to be decoupled from actual ESG performance. The efforts executives are incentivised to make are subject to target levels and the scope of metrics. When performance is assessed against a narrow range of metrics or undemanding targets, fewer outcomes will be achieved. To the extent that outcomes are suboptimal, executives are relatively overpaid. When executives manipulate performance outcomes or the remuneration committee abuses its discretion to reward executives without performance, ESG-based remuneration fails to serve as an incentive mechanism for improving corporate sustainability. These rewards, which are not grounded on actual ESG achievements, are the rents extracted by executives from their companies.

4. Analysis

The empirical findings can support the three hypotheses on companies’ motivations to adopt ESG-based remuneration.

Traditional indicators of customer and employee interests are widely adopted by the sample companies. On a logical basis, other indicators, if properly designed, can also provide the impetus for sustainable development. These observations support the first hypothesis that some companies aim to promote long-term shareholder value by incentivising executives to improve their ESG performance.

Under intensive policy and public pressures, it is common for companies to adopt performance indicators regarding carbon emissions reduction, diversity and sustainability strategy. This tendency, which has been observed only in recent years, demonstrates that companies’ ESG-based remuneration practices are primarily driven by reputational concerns. Usually, sustainability strategy targets are defined as the completion of procedures, rather than substantive improvements. In the majority of the sample companies, ESG incentives make up a very small portion of the entire performance-based remuneration. The use of incomplete and undemanding performance metrics reveals that companies do not pay sufficient attention to the effects of ESG incentives. Furthermore, companies selectively report the positive side of ESG performance and camouflage the negative side. These practices demonstrate that ESG-based remuneration is very often employed as a symbolic tactic for impression management.

The use of incomplete and undemanding performance metrics also indicates that ESG-based remuneration creates new opportunities for rent extraction. Similarly, some indicators, especially ‘ESG ratings and certifications’, are vulnerable to managerial manipulation. When remuneration committees apply subjective judgments, they tend to make performance assessments less specific, showing a higher potential for abuse of discretion. There is evidence that some remuneration committees abuse their discretion to reward executives for negative results or double their ESG-based rewards. These problems reflect that, in practice, ESG-based remuneration can be used for self-serving purposes.

Among the three hypothesised motivations, only the first one is legitimate. ESG-based remuneration adopted with symbolic or self-serving purposes will ultimately undermine long-term shareholder value. Symbolic ESG-based remuneration is a myopic strategy. Through sustainability-related impression management, a company can affect others’ perceptions in a positive way, and thereby inflate its reputation. However, this effect is short-lived.¹⁶⁶ As suggested by empirical evidence, only actual engagement in sustainable development rather than rhetorical initiatives can contribute to firm value.¹⁶⁷ To the extent that the actual performance is overstated, the market will react negatively in the long run. Manipulation of performance outcomes and assessments exacerbates the agency problem between executives and shareholders. In addition, given that ESG issues are pertinent to stakeholders in general, manipulation may exacerbate the conflict between companies and the public interest.

Due to two essential characteristics of most ESG factors – the lack of measurability and the lack of standardisation, it is difficult to realise the expected role of ESG-based remuneration in promoting long-term shareholder value. In contrast, it is much easier for companies or executives to make use of ESG-based remuneration for impression management and rent extraction.

According to the BSM, NFPIs represent performance drivers, which measure executives’ actions to create long-term shareholder value. Since the full effects of these actions will not manifest immediately, NFPIs are inherently predictive.¹⁶⁸ Although the causal relationship between an NFPI and shareholder value is reasonable in logic and provable by empirical statistics, there is always uncertainty about how a specific action will affect shareholder value in a specific company,¹⁶⁹ such as whether or not a new product or a more diverse management team will push forward business growth. The uncertainty increases when the closeness between an NFPI and shareholder value decreases. For those traditional NFPIs which represent the actions that directly contribute to business operations, it is relatively easier to measure their effects in the foreseeable future. For instance, the effect of a new product can be measured by its sales. When using an ex-post measurable action as a performance indicator, the remuneration committee needs to provide precise and sufficient ex-ante justifications. However, for many ESG issues, the mechanisms through which they affect shareholder value are equivocal.¹⁷⁰ For instance, even if management improvements are observed following the establishment of a diverse management team, it is hard to ascertain to what extent diversity is helpful, as other factors within or beyond the team may also have an impact. When the effect of an envisaged performance driver is not measurable, on the one hand, the remuneration committee may incorrectly estimate its effect, which means that using it as an incentive will lead to inefficiency; on the other hand, the burden on the remuneration committee to provide justifications is lighter, as it is harder to attribute the losses in value to the committee’s decision, in which context there are fewer personal costs for committee members to make symbolic arrangements or favour the self-serving arrangements by executives. Even if the remuneration committee acts in good faith and adopts the indicators that it considers essential for shareholder value maximisation, when the effect of an action is unmeasurable, executives face limited deterrence of manipulation.

The lack of standardisation in ESG measurements has been frequently reported, and many commentators attribute it primarily to the subjective nature of ESG issues.¹⁷¹ Different companies interact with stakeholders in different patterns,¹⁷² leading to high variance in the definition, scope and focus of the same generic ESG issue. In terms of executive remuneration, self-defined indicators and assessment criteria are not comparable with each other. As a result, when external shareholders and stakeholders have difficulty verifying their reasonableness, manipulation in the setting of targets and metrics will be less detectable.

IV. Should ESG-based remuneration be adopted?

A classic guiding principle in theory for determining the indicators of the agent’s performance is: in a suboptimal incentive mechanism, the inclusion of an additional indicator should enhance the realisation of the principal’s objectives.¹⁷³ Based on this principle, this section discusses whether or not ESG incentives add value to executive remuneration. When the principal’s objectives change (including the change of the principal), performance indicators shall be adjusted accordingly. It implies that the role of executive remuneration depends on the corporate purpose it is expected to serve.

1. The ESV approach

Under the ESV approach, executives shall consider stakeholder interests to the extent that doing so will ultimately benefit shareholders.¹⁷⁴ Executive remuneration still plays the traditional role, which is to incentivise executives to maximise long-term shareholder value. The optimal remuneration setting, though unrealistic, is that all performance indicators can perfectly reflect executives’ performance in shareholder value creation. Considering the original situation where financial indicators convey imperfect information about performance, if adopting a new indicator can provide additional information, it will generate an incremental effect on incentive efficiency.¹⁷⁵ However, it will be counterproductive if the new indicator adds noise rather than additional information.

As discussed, ESG indicators may poorly reflect the performance in shareholder value creation due to the unmeasurable effects of the actions of stakeholder treatment on shareholder value and their vulnerability to manipulation. Adding ESG indicators poses the risk that a portion of remuneration is decoupled from rather than further aligned with shareholder value.

Returning to the idea of the BSM, in the context that financial indicators only capture short-term returns, as a remedy, NFPIs are used to reflect the performance in shareholder value creation on a predictive basis. However, the model has overlooked the probability that the remedy may not work out. If this probability is high, which is the case when NFPIs are ESG indicators, it will not add value to executive remuneration.

When executives genuinely pursue long-term shareholder value, they act by all means to achieve this purpose, including giving necessary consideration to stakeholder interests.¹⁷⁶ An alternative way to better incentivise executives is to extend the assessment period of performance against financial indicators, including share price. This idea is not new, instead, it reiterates the original purpose of LTIPs.

However, as pointed out by the House of Commons (HC) in one of its reports on corporate governance, LTIPs in UK companies have still been operated with the problem of encouraging price-boosting manipulation.¹⁷⁷ The HC has recommended aligning executive interests with ‘genuinely long-term’ share price.¹⁷⁸ This is grounded on two points. First, manipulation of financial results is less likely to affect long-term share price.¹⁷⁹ Second, achievements in stakeholder interests will be factored into share price over the long term.¹⁸⁰ The shareholding requirements suggested by the Financial Reporting Council (FRC),¹⁸¹ according to which executives should continue to hold the vested shares for an additional period, perform a similar function. To avoid manipulation around the time of vesting, The HC and the FRC have also recommended a phased-in vesting period, which means that a certain portion of granted shares become vested every year.¹⁸² In practice, both shareholding requirements and the phased-in vesting period have been adopted by a considerable number of companies.

These initiatives for enhancing the incentives for executives to create long-term shareholder value are based on the traditional remuneration system. Admittedly, they are not perfect. For example, there is a dilemma regarding how long the ‘genuine long-term’ should be. The five-year period recommended by the HC and the FRC¹⁸³ may not be long enough to capture sustainability-related achievements, whereas a very long period such as more than ten years will discourage executives. These initiatives will not completely eliminate manipulation, either. Nevertheless, they have two advantages over ESG-based remuneration. First, they do not create additional opportunities for symbolic or self-serving arrangements, that is, they will not worsen the existing incentive mechanism. Second, in terms of the design and enforcement of remuneration policies, they entail simpler adjustments compared to complex ESG incentives, offering more cost-efficiency. When the alternative way is safer and less costly, whereas ESG-based remuneration has a higher potential for interest misalignment, it is not an ideal option for companies to incentivise executives to create long-term shareholder value.

2. The stakeholder approach

A. Stakeholder orientation and the role of ESG-based remuneration

Discussions so far have focused on the role of ESG-based remuneration in promoting long-term shareholder value. In fact, the very central issue amidst the increasing debates on corporate sustainability is redefining corporate purpose by plural stakeholder interests.¹⁸⁴ For major UK companies, this means abandoning the ESV approach and treating stakeholder interests as independent corporate objectives. Section 172(2) indicates that redefining corporate purpose under the current company law framework is possible, and it is currently practised by an increasing number of UK companies. The ‘B Corp’ certification is a private ordering mechanism which certifies companies that are operated for stakeholder interests as ‘benefit corporations’.¹⁸⁵ 1,902 UK companies have been certified.¹⁸⁶ One of the sample companies in this empirical study – Pz Cussons has indicated that it will transfer to a benefit corporation,¹⁸⁷ and the adoption of ESG incentives is one step towards this goal.¹⁸⁸ In the future, more shifts among major UK companies might be observed.

The intensive calls for a fundamental shift in corporate purpose are impelled by concerns about sustainable development at large.¹⁸⁹ These concerns arise as companies have ubiquitously externalised the huge costs of their profit-driven activities to the environment and society.¹⁹⁰ In the past several decades, mechanisms that rely on mandatory obligations in laws and regulations as well as soft law corporate social responsibility (CSR) frameworks have been proven inadequate to push companies to internalise social and environmental costs.¹⁹¹ In the view that cost internalisation is detrimental to firm-level economic efficiency, companies have incentives to lobby for regulatory relaxation.¹⁹² In terms of CSR practices, companies may simply embrace impression management strategies or make use of them to frustrate regulatory intervention.¹⁹³ Even if companies fully comply with the hard and soft laws on social and environmental issues, they do so in a reactive way, without incentives to move further than the bottom lines.¹⁹⁴ All these widely debated problems reveal the limitation of pressing companies with external forces against what they are intrinsically motivated to do.

Redefining corporate purpose by stakeholder interests is believed to, at the cognitive and ideological level, provide the intrinsic impetus for paradigm and behavioural changes in managerial practice.¹⁹⁵ A company that truthfully conforms to stakeholder orientation will aim to advance multiple interests and values.¹⁹⁶ Since all stakeholder interests are equal objectives,¹⁹⁷ the company is expected to operate in an inclusive and balanced way, without giving priority to any particular stakeholder.¹⁹⁸ This particularly means that creating economic value for shareholders at the expense of social or environmental welfare runs counter to its corporate purpose. In this sense, the stakeholder approach is in and of itself a mechanism for companies to balance social and environmental costs and economic benefits internally.

The ESV approach is essentially different from the stakeholder approach, as it subordinates all other stakeholders to shareholders.¹⁹⁹ Executives feel comfortable excluding any type of social or environmental welfare if they believe it is irrelevant to long-term shareholder value.²⁰⁰ Therefore, a shareholder-oriented company would only partially address cost internalisation. The ESV approach views sustainability in a narrower, ‘outside-in’ way as the risks or opportunities related to the prosperity of the company itself.²⁰¹ A typical example is that the CEO of BlackRock conceptualises climate change as merely an ‘investment risk’.²⁰² Differently, the stakeholder approach views sustainability in an ‘inside-out’ way, following which companies proactively contribute their resources and experience to addressing the challenges to sustainable development at large.²⁰³

The increasing normative debates on the redefinition of corporate purpose reflect a general expectation that companies should act in accordance with the stakeholder approach. There is a trend that companies are making corresponding commitments.²⁰⁴ Despite that many commitments are rhetorical,²⁰⁵ some companies are willing to make substantive changes, such as benefit corporations. It is not the purpose of this article to propose a radical reform in UK company law to stimulate a system-wide shift in corporate purpose,²⁰⁶ which is by no means readily achievable. Instead, it considers, under the current framework where redefining corporate purpose is possible in principle, whether or not ESG-based remuneration can facilitate stakeholder-oriented governance.

Although Section 172(2) allows other corporate purposes, other key rules in the CA 2006 are predominantly in favour of shareholders. They have exclusive intervention rights and collective control over corporate voting and are the ultimate beneficiaries of directors’ fiduciary duties.²⁰⁷ These rules, in which shareholder primacy is well-settled, hold back further accommodation of stakeholder orientation in management practice, which implies that currently, stakeholder-oriented companies need to reorient management mainly through private arrangements.

In agency costs economics, identifying executives (and other directors) as the agents of shareholders is premised on shareholders being identified as corporate owners.²⁰⁸ This has been contested even in the context of shareholder primacy²⁰⁹ and is groundless under the stakeholder approach. A more general view is that directors are the agents of their company and should serve the objectives the company is devoted to.²¹⁰ However, it is the principal-agent relationship between shareholders and executives that theoretically underpins traditional executive remuneration, from ESOs, LTIPs to the BSM. If a company which is reoriented towards a stakeholder purpose still sticks to these traditional remuneration arrangements, there will be a discrepancy between the objectives executives are expected to achieve and the actual incentives for them to act.

Despite the oversimplified economic view offered by agency theory, it pinpoints the function of ESG-based remuneration in a stakeholder-oriented company. It is to give executives stronger incentives and clearer guidance to promote stakeholder interests. In particular, if shareholder orientation is well entrenched in its existing remuneration system, ESG-based remuneration helps direct executives’ attention to other corporate objectives.

A stakeholder-oriented company does not need to use ESG-based remuneration for impression management. Nevertheless, it is still exposed to manipulation by self-serving executives. Despite that in theory, ESG-based remuneration is useful for reorienting management, in practice it carries risks. Therefore, measures to reduce managerial manipulation and the abuse of discretion are needed.

B. Transparency and monitoring

While there is no controlling mechanism that can perfectly stop all rent extraction activities, it is still meaningful to impose controls as long as they increase the costs of these activities. In the regulatory domain, transparency and monitoring schemes are the primary controls over executive remuneration, with sophisticated rules having been implemented during the last several decades.²¹¹ However, the empirical findings presented in this article demonstrate that the current rules are inadequate.

In general, mandatory disclosures improve informational efficiency and reduce the costs of monitoring.²¹² Legal sanctions on the concealment of information or misleading information also help deter executives from manipulation.²¹³ A cross-jurisdiction analysis shows that ‘firms in an environment of limited disclosure requirements run a higher risk of skimming than firms subject to full disclosure requirements’.²¹⁴

For UK quoted and unquoted traded companies,²¹⁵ there is a well-established mandatory disclosure scheme for executive remuneration, which covers a wide range of information about remuneration levels, incentive components, and the decision-making process.²¹⁶ However, the disclosure requirements of performance indicators are vague. A company is obligated to provide a summary of the performance criteria applied to share options²¹⁷ and the details of the qualifying conditions for LTIPs.²¹⁸ In the remuneration policy statement, a company should include a detailed summary of any performance conditions to which the rewards under LTIPs or share options are subject,²¹⁹ with explanations of (1) the reasons for using these performance conditions and (2) performance assessment methods and the rationale for using these methods.²²⁰ This disclosure scheme is mainly for traditional remuneration practices, in which financial indicators are predominant. For instance, a particular disclosure requirement of assessment methods is about the elements in comparison-based indicators,²²¹ which is aimed at preventing ex-post selections of comparators.

It is not specified in these provisions how detailed the disclosures should be. This may not be a problem for financial indicators, as they are based on uniform accounting standards and more details are published in financial statements. Companies do not need to explain commonly acknowledged concepts and methods. In contrast, for self-defined ESG indicators and subjective judgments, when the remuneration committee uses vague and unspecific language, which is often observed in the reports of the sample companies, such as ‘developments in sustainability ambition’ or ‘the committee applying discretion to assess’, their disclosures do not add any value to information efficiency or manipulation control. Without details in ex-ante disclosures, selective reporting with hindsight and paying for retrogression can easily take place. Without details in ex-post disclosures, it is difficult to distinguish actual achievements from manipulated results. Furthermore, these disclosure requirements do not apply to annual bonuses that are not in the form of share options. As mentioned, this might be one of the reasons for companies to incorporate ESG incentives into annual bonuses rather than LTIPs.

Therefore, the current disclosure scheme needs to be refined to adapt to the increasing use of ESG-based remuneration. This article proposes as follows. First, the disclosure requirements should be more precise and explicit about what kinds of details companies need to provide, which at least should include ex-ante specifications on the definitions of performance indicators, the nature of underlying stakeholder interests, the correlation between indicators and stakeholder interests, the calibrations of targets and metrics, the criteria for assessments, and the justifications for the use of discretion, as well as ex-post specifications on performance outcomes and the actions taken to achieve these outcomes. Second, to thwart arbitrage, performance indicators applied to annual bonuses, which are to some degree overlooked by the current disclosure scheme, should be subject to equivalent transparency rules as those applied to other performance-based components.

To the extent that transparency rules make it more difficult for executives to implement self-serving arrangements, the effectiveness of ESG-based remuneration in promoting stakeholder interests improves. Transparency rules also facilitate stakeholders’ monitoring of the policymaking and enforcement of ESG-based remuneration. Specifications on performance indicators provide stakeholders with more information about how and to what extent their interests are integrated into corporate strategies and considered in daily management, based on which they can review the appropriateness of relevant performance metrics and assessment criteria. Active stakeholders, who are more often observed among employees and customers,²²² are better informed when engaging with companies for their interests.

However, more disclosures increase the cost of information analysis, and stakeholders may need to acquire professional knowledge to understand ESG incentives. Due to cost and expertise constraints, many stakeholders are not able to review ESG-based remuneration arrangements or engage with companies. Furthermore, under the current company law framework, non-shareholder constituencies do not have the right to act against unreasonable or distorted remuneration arrangements.

In the UK, following the amendment to SOP rules in 2013,²²³ shareholders’ power over executive remuneration has been strengthened from monitoring only to both monitoring and decision-making.²²⁴ However, the effectiveness of SOP has always been debatable: many shareholders vote consent on any remuneration arrangements or blindly follow the instructions of proxy advisors;²²⁵ they may pay attention to remuneration levels only, whereas ignoring the more complicated issues about incentives;²²⁶ instead of focusing on remuneration itself, shareholders may improperly make use of their votes to penalise executives for poor share price performance.²²⁷

Although in practice, shareholders may or may not exercise their votes effectively,²²⁸ the existence of SOP as a legal institution encourages the remuneration committee to work diligently and independently on remuneration issues.²²⁹ A high dissent, no matter binding or not, may impose reputation pressure on committee members.²³⁰ By urging the remuneration committee to communicate with shareholders both formally and informally and deterring them from colluding with self-serving executives, SOP helps contain managerial influence.²³¹ There is evidence showing that, following the 2013 legislation, the boards of major UK companies have made adjustments to both pay levels and incentive structures.²³² A similar effect of the US advisory vote introduced after the financial crisis has been noted.²³³ The finding in this empirical study that much fewer companies integrate ESG incentives into LTIPs, whereas those doing so choose to allocate higher weights to them also signifies the importance of shareholders’ decision-making and monitoring power.

Nevertheless, the main rationale for empowering shareholders to determine or monitor executive remuneration is based on shareholder primacy and the traditional agency theory, which is to ensure that executive remuneration is consistent with shareholder interests.²³⁴ It is therefore questioned how far shareholders are willing to exercise activism to voice for stakeholders.²³⁵

In a stakeholder-oriented company, when non-shareholder constituencies do not have monitoring power over remuneration – in fact, even if the law were to be amended to empower them, in many cases the broad and diverse range of stakeholders would fail to act collectively – SOP remains the only effective internal monitoring mechanism. In addition, stakeholder orientation means that the supermajority of shareholders in the company have agreed with the corporate purpose, and some of them may be self-motivated to advance the practice of ESG-based remuneration.²³⁶ In this context, SOP can play a value-enhancing role. Therefore, for stronger and more comprehensive monitoring, the ‘say’ can be expanded by explicitly requiring shareholder approval of any changes to performance criteria and conditions that are applied to all performance-based components. The remuneration committee is still primarily responsible for designing performance metrics and making assessments, nevertheless, they are impelled to do so with a higher level of care, diligence, and independence. This additional requirement can be added to the Listing Rules, or more broadly, specified in the SOP rules as a mandatory section in the remuneration policy.

More mandatory disclosures and communications with shareholders increase the economic costs of using ESG-based remuneration as it becomes more complicated for companies to compile and present data. To the extent that disclosures and communications increase costs, a company’s profits are relatively diminished. When a stakeholder-oriented company uses ESG incentives, these costs are integrated into the balance between economic profits and social and environmental welfare. However, the additional economic costs generated by disclosures and communications and the social and environmental welfare created by using ESG-based remuneration are not commensurable, which means that a precise cost–benefit analysis is unfeasible. For a stakeholder-oriented company, to pursue social and environmental improvements, a decline in profits is acceptable. Nevertheless, the threshold is that the economic costs shall not have a significant impact on the company’s ongoing operation or survival. For this reason, the tightened rules proposed in this article should be within the existing disclosure and monitoring frameworks, which apply to quoted and unquoted traded companies only.

V. Conclusion

This article makes two contributions to the scholarly debates on ESG-based remuneration: one is positive and the other is normative.

The positive one is drawn from the empirical findings of ESG-based remuneration in major UK companies. In practice, instead of effectively incentivising executives to promote corporate sustainability, ESG-based remuneration may be utilised by the board as a tactic for impression management or by executives for private interests. As a result, rewards in the name of ESG-based remuneration are decoupled from actual ESG achievements.

The normative one is about whether or not ESG-based remuneration should be adopted and, if so, how to operate it. This article gives different answers to companies oriented by the ESV and stakeholder approaches, respectively. For the former, extending the assessment period of performance in shareholder value maximisation, which has been proposed by the public authority, is a less costly and risky option compared to ESG-based remuneration. For the latter, ESG-based remuneration can play a part in guiding executives to deprioritise shareholder value and balance their attention among multiple stakeholder interests. This role is particularly necessary when company law rules on decision-making and directors’ fiduciary duties remain pro-shareholder. To mitigate exploitation by executives, this article proposes moderate rule tightening in the current disclosure and monitoring frameworks for executive remuneration, focusing mainly on the disclosures of performance indicators and the monitoring function of shareholders.

Acknowledgement

I am extremely grateful to the anonymous reviewers for their insightful comments. An earlier version of this paper was presented at the 2022 SLS/UCL Conference on Financial Law and Regulation in London. I thank the attendees at the conference, especially Prof. Iain MacNeil and Prof. Konstantinos Sergakis. I also thank Claudia Paduano and Aziz Ozturk for their excellent research assistance. All errors are my own.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Additional information

Notes on contributors

Longjie Lu

Longjie Lu is a Lecturer in Banking, Corporate and Financial Law, School of Law, University of Edinburgh and writes on both financial markets regulation and corporate governance. She has recently published the book Market or State: The Regulation and Practice of Bankers' Remuneration in the UK and China (Cambridge 2022).

Notes

1 Gaizka Ormazabal, ‘Why are Firms Adopting ESG Pay?’ ECGI (19 July 2022) <https://www.ecgi.global/blog/why-are-firms-adopting-esg-pay> accessed 30 July 2023; PwC and London Business School, ‘Paying Well by Paying for Good’ (2021) 5 <https://www.pwc.co.uk/human-resource-services/assets/pdfs/environmental-social-governance-exec-pay-report.pdf> accessed 30 July 2023; Gautam Naik, ‘Nearly Half of UK’s 100 Biggest Companies Link Executive Pay to ESG Measures’ S&P Global (30 March 2021) <https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/nearly-half-of-uk-s-100-biggest-companies-link-executive-pay-to-esg-measures-63248983> accessed 30 July 2023; ‘UK Executive Pay Increasingly Linked to ESG Targets’ ICAEW (17 January 2023) <https://www.icaew.com/insights/viewpoints-on-the-news/2023/jan-2023/uk-executive-pay-increasingly-linked-to-esg-targets> accessed 30 July 2023.

2 UN Principles of Responsible Investment, ‘ESG-linked Pay: Recommendations for Investors’ (17 June 2021) <https://www.unpri.org/executive-pay/esg-linked-pay-recommendations-for-investors/7864.article> accessed 30 July 2023.

3 Directive (EU) 2017/828 of the European Parliament and the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement, art.29.

4 CGC 2018, Principle P.

5 Iris H-Y Chiu, ‘The EU Sustainable Finance Agenda: Developing Governance for Double Materiality in Sustainability Metrics’ (2022) 23 European Business Organisation Law Review 87, 91; Dirk A Zetzsche and Linn Anker-Sørensen, ‘Regulating Sustainable Finance in the Dark’ (2022) 23 European Business Organisation Law Review 47, 53.

6 Gaia Balp and Giovanni Strampelli, ‘Institutional Investor ESG Engagement: The European Experience’ (2022) 23 European Business Organisation Law Review 869, 878–9.

7 The IA, ‘Principles of Remuneration’ (2022) 12 <https://www.ivis.co.uk/media/13907/principles-of-remuneration-2023-nov-2022.pdf> accessed 30 July 2023.

8 Glass Lewis, ‘2023 Policy Guidelines’ (2023) 45 <https://www.glasslewis.com/wp-content/uploads/2022/11/UK-Voting-Guidelines-2023-GL.pdf> accessed 30 July 2023.

9 Joe Marsh, ‘ESG-Linked Pay: Investors Push for More Robust Targets’ Capital Monitor (26 April 2022) <https://capitalmonitor.ai/institution/investment-managers/esg-linked-pay-investors-push-for-targets/> accessed 30 July 2023; ‘AllianzGI Insists EU Large Caps Link Exec Pay to ESG KPIs’ allianzgi.com (22 February 2022) <https://www.allianzgi.com/en/press-centre/media/press-releases/allianzgi-insists-eu-large-caps-link-exec-pay-to-esg-kpis> accessed 30 July 2023.

10 PwC and London Business School, ‘Paying Well by Paying for Good’ (n 1) 5.

11 PwC and London Business School, ‘Paying for Good for All’ (2022) 2 <https://www.pwc.com/gx/en/services/paying-for-good-for-all/Paying-for-good-for-all.pdf> accessed 30 July 2023.

12 Amal A Said and others, ‘An Empirical Investigation of the Performance Consequences of Nonfinancial Measures’ (2003) 15 Journal of Management Accounting Research 193, 194; Christopher D Ittner and David F Larcker, ‘Are Nonfinancial Measures Leading Indicators of Financial Performance? An Analysis of Customer Satisfaction’ (1998) 36 Journal of Accounting Research 1, 2–3; Rajiv D Banker and others, ‘An Empirical Investigation of an Incentive Plan that Includes Nonfinancial Measures’ (2000) 75(1) The Accounting Review 65, 67; Salma Ibrahim and Cynthia Lloyd, ‘The Association Between Non-financial Performance Measures in Executive Compensation Contracts and Earnings Management’ (2011) 30(3) Journal of Accounting and Public Policy 256, 258.

13 Throughout this article, the term ‘executives’ refers particularly to executive directors.

14 Robert S Kaplan and David P Norton, The Balanced Scorecard: Translating Strategy into Action (Harvard Business School Press 1996) 8.

15 Ibrahim and Lloyd (n 12) 258–60.

16 Christopher D Ittner and others, ‘The Choice of Performance Measures in Annual Bonus Contracts’ (1997) 72(2) The Accounting Review 231, 240.

17 Iain MacNeil and Irene-marié Esser, ‘From a Financial to an Entity Model of ESG’ (2022) 23 European Business Organisation Law Review 9, 15; Balp and Strampelli (n 6) 872.

18 The IA (n 7) 16; Institutional Shareholder Services, ‘United Kingdom and Ireland Proxy Voting Guidelines: Benchmark Policy Recommendations’ (2023) 18 <https://www.issgovernance.com/file/policy/active/emea/UK-and-Ireland-Voting-Guidelines.pdf> accessed 30 July 2023; Lewis (n 8) 45.

19 Bryan Hong and others, ‘Corporate Governance and Executive Compensation for Corporate Social Responsibility’ (2016) 136(1) Journal of Business Ethics 199; Caroline Flammer and others, ‘Corporate Governance and the Rise of Integrating Corporate Social Responsibility Criteria in Executive Compensation: Effectiveness and Implications for Firm Outcomes’ (2019) 40(7) Strategic Management Journal 1097; Sandra Cavaco and others, ‘Corporate Social Responsibility and Governance: The Role of Executive Compensation’ (2020) 59(2) Industrial Relations: A Journal of Economy and Society 240; Shira Cohen and others, ‘Executive Compensation Tied to ESG Performance: International Evidence’ (2023) 61(3) Journal of Accounting Research 805.

20 Karen Maas, ‘Do Corporate Social Performance Targets in Executive Compensation Contribute to Corporate Social Performance?’ (2018) 148 Journal of Business Ethics 573; Ans Kolk and Paolo Perego, ‘Sustainable Bonuses: Sign of Corporate Responsibility or Window Dressing?’ (2014) 119(1) Journal of Business Ethics 1.

21 Cohen and others (n 19) 812.

22 UN Principles of Responsible Investment (n 7) 12.

23 A Berle Jr., ‘Corporate Powers as Powers in Trust’ (1931) 44(7) Harvard Law Review 1049, 1049; D Gordon Smith, ‘The Shareholder Primacy Norm’ (1998) 23 Journal of Corporation Law 277, 278; Ross Grantham, ‘The Doctrinal Basis of The Rights of Company Shareholders’ (1998) 57(3) Cambridge Law Journal 554, 554.

24 Stephen Bainbridge, The New Corporate Governance in Theory and Practice (Oxford University Press 2008) 32; David Kershaw and Edmund Schuster, ‘The Purposive Transformation of Corporate Law’ (2021) 69(3) The American Journal of Comparative Law 478, 479; Michael C Jensen and William H Meckling, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure’ (1976) 3(4) Journal of Financial Economics 305, 308; Eugene F Fama and Michael C Jensen, ‘Separation of Ownership and Control’ (1983) 26(2) Journal of Law and Economics 301, 302–4.

25 Robert Dean Ellis, ‘Equity Derivatives, Executive Compensation, and Agency Costs’ (1998) 35(2) Houston Law Review 399, 401–2.

26 John Armour and others, ‘Shareholder Primacy and the Trajectory of UK Corporate Governance’ (2003) 41 British Journal of Industrial Relations 531, 533; Antoine Rebérioux, ‘Does Shareholder Primacy Lead to a Decline in Managerial Accountability?’ (2007) 31(4) Cambridge Journal of Economics 507, 510.

27 Geoffrey S. Rehnert, ‘The Executive Compensation Contract: Creating Incentives to Reduce Agency Costs’ (1985) 37(4) Stanford Law Review 1147, 1156–7; Michael C Jensen and Kevin J Murphy, ‘Performance Pay and Top-Management Incentives’ (1990) 98(2) Journal of Political Economy 225, 242.

28 Brian J Hall and Kevin J Murphy, ‘The Trouble with Stock Options’ (2003) 17 (3) Journal of Economic Perspectives 49, 49; Philipp Geiler and Luc Renneboog, ‘Managerial Compensation: Agency Solution or Problem?’ (2011) 11(1) Journal of Corporate Law Studies 99, 101–2 and 111.

29 Jensen and Meckling (n 24) 308.

30 Rehnert (n 27) 1155.

31 Geiler and Renneboog (n 28) 113–4.

32 Randall A Heron and Erik Lie, ‘Does Backdating Explain the Stock Price Pattern Around Executive Stock Option Grants?’ (2007) 83(2) Journal of Financial Economics 271, 274; Erik Lie, ‘On the Timing of CEO Stock Option Awards’ (2005) 51(5) Management Science 802, 804.

33 Alternatively, executives may reset the maturity of an option. See Menachem Brenner and others, ‘Altering the Terms of Executive Stock Options’ (2000) 57(1) Journal of Financial Economics 103, 104; See also Mary Ellen Carter and Luann J Lynch, ‘An Examination of Executive Stock Option Repricing’ (2001) 61(2) Journal of Financial Economics 207, 208.

34 MP Narayanan and others, ‘The Economic Impact of Backdating of Executive Stock Options’ (2007) 105 (8) Michigan Law Review 1597, 1624; Lucian A Bebchuk and others, ‘Managerial Power and Rent Extraction in the Design of Executive Compensation’ (2002) 69(3) University of Chicago Law Review 751, 821.

35 Ellis (n 25) 436; James Angel and Douglas M McCabe, ‘Market-Adjusted Options for Executive Compensation’ (2002) 4(1) Global Business and Economics Review 1, 1–2; Alistair Bruce and Trevor Buck, ‘Executive Pay and UK Corporate Governance’ in Kevin Keasey and others (eds), Corporate Governance: Accountability, Enterprise and International Comparisons (Wiley 2005) 117, 126; Lucian Bebchuk and Jesse Fried, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (Harvard University Press 2004) 122; Marianne Bertrand and Sendhil Mullainathan, ‘Are CEOs Rewarded for Luck? The Ones without Principals Are’ (2001) 116(3) The Quarterly Journal of Economics 901, 904.

36 ‘Directors’ Remuneration: Report of a Study Group Chaired by Sir Richard Greenbury’ (1995) <https://www.ecgi.global/code/greenbury-report-study-group-directors-remuneration> accessed 30 July 2023.

37 Steve Thompson, ‘Executive Pay and Corporate Governance Reform in the UK: What Has Been Achieved?’ in Randall S Thomas and Jennifer G Hill (eds), Research Handbook on Executive Pay (Elgar 2012) 59, 60; Alexander Pepper, The Economic Psychology of Incentives: New Design Principles for Executive Pay (Palgrave Macmillan 2015) 10; Trevor Buck and others, ‘Long Term Incentive Plans, Executive Pay and UK Company Performance’ (2003) 40 (7) Journal of Management Studies 1709, 1710.

38 TSR is measured by the change in share price from the start to the end of a specified financial period.

39 Geiler and Renneboog (n 28) 117; Bruce and Buck (n 35) 130. However, today, some UK companies still use the absolute change in accounting figures to measure shareholder value, for example, see OSB Group Annual Report 2022, 151; Jupiter Fund Management Annual Report 2022, 115; Safestore Holdings, Annual Report 2022, 101. All of them are using absolute EPS growth.

40 In practice, the vesting period of LTIPs in non-financial companies ranges from three to five years, and a three-year period is most commonly adopted. Financial institutions, due to stricter regulatory requirements, usually have a vesting period longer than five years.

41 Annual bonuses can take the form of cash, shares or a mix of both.

42 Geiler and Renneboog (n 28) 108.

43 ‘Directors’ Remuneration: Report of a Study Group Chaired by Sir Richard Greenbury’ (n 36) 17.

44 Keith J Crocker and Joel Slemrod, ‘The Economics of Earnings Manipulation and Managerial Compensation’ (2007) 38(3) The RAND Journal of Economics 698, 712; Patrick Bolton and others, ‘Pay for Short-Term Performance: Executive Compensation in Speculative Markets’ (2005) 30(4) Journal of Corporation Law 101, 109–10; Lin Peng and others, ‘Executive Pay and Shareholder Litigation’ (2008) 12(1) Review of Finance 141, 142.

45 David Yermack, ‘Good Timing: CEO Stock Option Awards and Company News Announcements’ (1997) 52(2) Journal of Finance 449, 450; Charles M Yablon and Jennifer Hill, ‘Timing Corporate Disclosures to Maximise Performance-based Remuneration: A Case of Misaligned Incentives?’ (2000) 35(1) Wake Forest Law Review 83, 88–9.

46 Managers may use retained profits to repurchase shares to boost EPS, instead of paying dividends, see Geiler and Renneboog (n 28) 115; Steven Young and Jing Yang, ‘Stock Repurchases and Executive Compensation Contract Design: The Role of Earnings per Share Performance Conditions’ (2011) 86(2) The Accounting Review 703, 703.

47 Patrick Bolton and others, ‘Executive Compensation and Short-Termist Behaviour in Speculative Markets’ (2006) 73(3) The Review of Economic Studies 577, 581.

48 Buck and others (n 37) 1711.

49 Patrick Bolton and others, ‘Pay for Short-Term Performance: Executive Compensation in Speculative Markets’ (n 44) 111.

50 Jörg Budde, ‘Performance Measure Congruity and the Balanced Scorecard’ (2007) 45(3) Journal of Accounting Research 515, 515.

51 Robert S Kaplan and David P Norton, ‘The Balanced Scorecard - Measures that Drive Performance’ (1992) January to February Harvard Business Review 71, 71.

52 Kaplan and Norton, The Balanced Scorecard (n 14) 8; Robert S Kaplan, ‘Conceptual Foundations of the Balanced Scorecard’ in Christopher S Chapman and others (eds), Handbook of Management Accounting Research Vol. 3 (Elsevier 2009) 1253, 1253.

53 Kaplan and Norton, The Balanced Scorecard (n 14) 25.

54 ibid 18.

55 ibid 21; Meena Chavan, ‘The Balanced Scorecard: A New Challenge’ (2009) 28(5) Journal of Management Development 393, 394.

56 Kaplan and Norton, The Balanced Scorecard (n 14) 28.

57 Ittner and others (n 16) 233; Caroline Flammer, ‘Does Corporate Social Responsibility Lead to Superior Financial Performance? A Regression Discontinuity Approach’ (2015) 61(11) Management Science 2549, 2563; Robert G. Eccles and others, ‘The Impact of Corporate Sustainability on Organisational Processes and Performance’ (2014) 60(11) Management Science 2835, 2836.

58 Kaplan and Norton, The Balanced Scorecard (n 14) Preface.

59 Hanne Norreklit, ‘The Balance on the Balanced Scorecard: A Critical Analysis of Some of its Assumptions’ (2000) 11(1) Management Accounting Research 65, 66; Caroline Flammer and others, ‘Corporate Governance and the Rise of Integrating Corporate Social Responsibility Criteria in Executive Compensation’ (n 19) 1101.

60 Kaplan and Norton, The Balanced Scorecard (n 14) 31; Norreklit (n 59) 67; Chavan (n 55) 396.

61 Budde (n 50) 516; Petr Snapka and Andrea Copikova, ‘Balanced Scorecard and Compensation’ (2011) 16 International Conference on Business and Economics Research <https://images.template.net/wp-content/uploads/2016/06/30090322/Cost-Based-Performance-Scorecard.pdf> accessed 30 July 2023.

62 Dirk Sliwka, ‘On the Use of Nonfinancial Performance Measures in Management Compensation’ (2002) 11(3) Journal of Economics & Management Strategy 487, 490; MyoJung Cho and Salma Ibrahim, ‘Non-financial Performance Measures and Pay-performance Sensitivity’ (2022) 20(2) Journal of Financial Reporting and Accounting 185, 188.

63 Amy J Hillman and Gerald D Keim, ‘Shareholder Value, Stakeholder Management, and Social Issues: What’s the Bottom Line?’ (2001) 22(2) Strategic Management Journal 125, 126–8; Lee Burke and Jeanne M Logsdon, ‘How Corporate Social Responsibility Pays Off’ (1996) 29(4) Long Range Planning 495, 499; David K Millon, ‘Two Models of Corporate Social Responsibility’ (2011) 46 Wake Forest Law Review 523, 524.

64 Marc J Epstein and Marie-Josée Roy, ‘Sustainability in Action: Identifying and Measuring the Key Performance Drivers’ (2001) 34(5) Long Range Planning 585, 587; Andrew Keay, ‘Tackling the Issue of the Corporate Objective: An Analysis of the United Kingdom’s Enlightened Shareholder Value Approach’ (2007) 29(4) Sydney Law Review 577, 590; Lucian A. Bebchuk and others, ‘Does Enlightened Shareholder Value Add Value? (2022) 77 The Business Lawyer 731, 733.

65 CA 2006, s.172(1).

66 Kershaw and Schuster (n 24) 488; Colins. C Ajibo, ‘A Critique of Enlightened Shareholder Value: Revisiting the Shareholder Primacy Theory’ (2014) 2(1) Birkbeck Law Review 37, 37.

67 CA 2006, s.172(1).

68 Kolk and Perego (n 20) 2; Cho and Ibrahim (n 62) 186.

69 David Millon, ‘Enlightened Shareholder Value, Social Responsibility and the Redefinition of Corporate Purpose without Law’ in PM Vasudev and Susan Watson (eds), Corporate Governance after the Financial Crisis (Elgar 2012) 69, 79; Virginia Harper Ho, ‘Enlightened Shareholder Value: Corporate Governance Beyond the Shareholder-Stakeholder Divide’ (2010) 36(1) Journal of Corporation Law 59, 79.

70 ‘Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes’, see CA 2006, s.172(2).

71 Kershaw and Schuster (n 24) 488; Department for Business, Energy, and Industrial Strategy, ‘Corporate Governance Reform: the Government Response to the Green Paper Consultation’ (2017) 30 <https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/640470/corporate-governance-reform-government-response.pdf> accessed 30 July 2023.

72 Kershaw and Schuster (n 24) 488; Adefolake Adeyeye, ‘Certified B Corps: An Examination of a Standard Based Approach to Stakeholder Governance’ (Presentation delivered at the SLS Conference on the Future of Company Law, Edinburgh, 27 April 2023).

73 It has not been learned that any of the FTSE 350 companies have opted out of the ESV approach by amending their articles of association.

74 Bruce and Buck (n 35) 119; Jean McGuire, ‘Legitimacy Through Obfuscation: The Presentation of Executive Compensation’ (1997) 5(2) The International Journal of Organisational Analysis 115, 118.

75 Reggy Hooghiemstra, ‘Corporate Communication and Impression Management – New Perspectives Why Companies Engage in Corporate Social Reporting’ (2000) 27 Journal of Business Ethics 55, 56; D Neu and others, ‘Managing Public Impressions: Environmental Disclosures in Annual Reports’ (1998) 23(3) Accounting, Organisations and Society 265, 268.

76 Dominique Diouf and Olivier Boiral, ‘The Quality of Sustainability Reports and Impression Management: A Stakeholder Perspective’ (2017) 30(3) Accounting, Auditing and Accountability Journal 643, 644; David Talbot and Olivier Boiral, ‘GHG Reporting and Impression Management: An Assessment of Sustainability Reports from the Energy Sector’ (2018) 147 Journal of Business Ethics 367, 376.

77 Jayne Godfrey and others, ‘Earnings and Impression Management in Financial Reports: The Case of CEO Changes’ (2003) 39(1) ABACUS 95, 96; Doris M Merkl-Davies and Niamh M Brennan, ‘Discretionary Disclosure Strategies in Corporate Narratives: Incremental Information or Impression Management?’ (2007) 27 Journal of Accounting Literature 116, 118.

78 Isabel-María García-Sánchez and Cristina-Andrea Araújo-Bernardo, ‘What Colour is the Corporate Social Responsibility Report? Structural Visual Rhetoric, Impression Management Strategies, and Stakeholder Engagement’ (2020) 27(2) Corporate Social Responsibility and Environment Management 1117, 1118.

79 See James D Westphal and Edward J Zajac, ‘Substance and Symbolism in CEOs’ Long-Term Incentive Plans’ (1994) 39(3) Administrative Science Quarterly 367, 372.

80 Ming-Chia Chen and Yuan-Cheng Tsai, ‘Earnings Management Types and Motivation: A Study in Taiwan’ (2010) 38(7) Social Behavior and Personality: An international Journal 955, 959.

81 Dalia Marciukaityte and Raj Varma, ‘Consequences of Overvalued Equity: Evidence from Earnings Manipulation’ (2008) 14(4) Journal of Corporate Finance 418, 418–9.

82 Bebchuk and Fried, Pay without Performance (n 35) 63.

83 ibid 67.

84 ibid 76.

85 Robert G Eccles Jr. and Sarah Clay Mavrinac, ‘Improving the Corporate Disclosure Process’ (1995) 36(4) MIT Sloan Management Review 11, 13; Ittner and others (n 16) 235–6.

86 Executive directors are not allowed to decide their own remuneration, see CGC 2018, Principle Q.

87 The data are based on the FTSE 350 list published in March 2023 <https://www.londonstockexchange.com/indices/ftse-350/constituents/table> accessed 30 July 2023.

88 When the author conducted data collection, a number of companies had not published their 2022 annual reports, in which circumstances the information in their last year’s (2021) annual reports was collected.

89 ‘UK Executive Pay Increasingly Linked to ESG Targets’ (n 1); Matt Mace, ‘More Than 75% of Major Companies Linking Carbon Targets to Executive Pay’ Edie (27 February 2023) <https://www.edie.net/more-than-75-of-major-companies-linking-carbon-targets-to-executive-pay/> accessed 30 July 2023.

90 Cho and Ibrahim (n 62) 189.

91 The original data is included in the appendix.

92 Samantha Miles, ‘Stakeholder Theory Classification, Definitions and Essential Contestability’ in David M Wasieleski and James Weber (eds), Stakeholder Management (Emerald Publishing 2017) 21, 24–27.

93 All information on ESG incentives is collected from the backward-looking implementation report. The forward-looking remuneration policy is excluded because it does not include information on ESG performance outcomes and assessments, and sometimes companies do not specify forward-looking performance metrics. Some companies integrate ESG incentives into individual performance indicators, in which case the information on the ESG incentives for the chief executive officer (CEO) is collected.

94 Companies may use different terms to refer to the same factor, such as decarbonisation and greenhouse gas emissions. The author has merged similar terms into the same category.

95 There are three exceptional cases where the companies did not specify the underlying issues. The three companies are: Natwest, which uses a ‘purpose score’ and a ‘culture score’, see Natwest annual report 2022, 153; Osb Group, which has a general ‘environment’ indicator, see Osb Group annual report 2022, 150; Barr (A.G.), which has a general ‘environmental sustainability’ indicator, see B Barr (A.G.) annual report 2022, 84.

96 Kaplan and Norton, The Balanced Scorecard (n 14) 34.

97 Ittner and others (n 16) 240; Said and others (n 12) 200; Ibrahim and Lloyd (n 12) 262; Heba Abdelmotaal and Magdy Abdel-Kade, ‘The Use of Sustainability Incentives in Executive Remuneration Contracts: Firm Characteristics and Impact on the Shareholders’ Returns’ (2016) 17(3) Journal of Applied Accounting Research 311, 317.

98 Said and others (n 12); Ittner and Larcker (n 12); Banker and others (n 12).

99 For instance, see Vistry annual report 2022, 109 (the company uses an indicator defined as ‘affordable housing’).

100 Another indicator ‘renewable energy growth or energy intensity reduction’, which in some industries is the primary method of carbon emissions reduction, was not widely adopted before, either. The division between these two indicators is based on the common practices of the sample companies. This is also based on the guidance of the Science Based Targets initiative (SBTi), in which the methods for carbon emissions reduction are divided into absolution reduction, sector-specific energy intensity convergence and renewable electricity. See SBTi, ‘Getting Started Guide for Science-based Target Setting’ (April 2023) <https://sciencebasedtargets.org/resources/files/Getting-Started-Guide.pdf> accessed 30 July 2023. The SBTi is a voluntary scheme jointly established by several international organisations to guide companies in setting science-based carbon emissions reduction targets.

101 Ittner and others (n 16) 240.

102 Climate Change Act 2008, s 1.

103 Alperen A Gözlügöl and Wolf-Georg Ringe, ‘Private Companies: the Missing Link on the Path to Net Zero’ (2023) Journal of Corporate Law Studies 2 <https://www.tandfonline.com/doi/epdf/10.1080/14735970.2023.2191779?needAccess=true&role=button> accessed 30 July 2023.

104 The regulation was introduced in 2019, which requires large UK companies to disclose their energy use and carbon footprint in their annual reports.

105 Companies Act 2006, ss. 414CA and 414CB.

106 FCA Listing Rules 9.8.6R(9).

107 FCA Disclosure Guidance and Transparency Rules 7.2.8A.

108 The ‘Women in Finance Charter’ is available at <https://www.gov.uk/government/publications/women-in-finance-charter> accessed 30 July 2023.

109 FCA, ‘PS21/24: Enhancing Climate-related Disclosures by Asset Managers, Life Insurers and FCA-regulated Pension Providers’ (December 2022) para.1.5 <https://www.fca.org.uk/publication/policy/ps21-24.pdf> accessed 30 July 2023; FCA, ‘PS22/3: Diversity and Inclusion on Company Boards and Executive Management’ (April 2022) para.1.2 <https://www.fca.org.uk/publication/policy/ps22-3.pdf> accessed 30 July 2023.

110 ITV annual report 2019, 133.

111 ITV annual report 2020, 141, and annual report 2021, 147.

112 ITV annual report 2022, 144.

113 See Capricorn Energy annual report 2021, 115; Molten Ventures annual report 2022, 113.

114 For instance, see Bridgepoint Group annual report 2022, 114; Abrdn annual report 2022, 108.

115 For an introduction to the SBTi, see (n 100).; Easyjet annual report 2022, 115; Legal & General Group annual report 2022, 113.

116 The IA (n 7) 16.

117 Barr (A.G.) plc annual report 2022, 82; Dechra Pharmaceuticals annual report 2022, 135.

118 Westphal and Zajac (n 79).

119 Melrose Industries annual report 2022, 106; Discoverie Group annual report 2022, 123; JD Sports annual report 2022, 122; Ncc Group annual report 2022, 112.

120 Ittner and others (n 16) 250; Cho and Ibrahim (n 62) 186.

121 Caroline Flammer and others, ‘Corporate Governance and the Rise of Integrating Corporate Social Responsibility Criteria in Executive Compensation’ (n 19) 1104.

122 These figures exclude those classified as ‘underpins’ or ‘n/a’.

123 Cho and Ibrahim (n 62) 187; High Pay Centre: ‘Are Bonus Payments and Long Term Incentive Plans Fair and Proportionate Rewards and Incentives for Business Leaders?’ (2021) 6 <https://highpaycentre.org/wp-content/uploads/2021/11/Bonuses-LTIPs-4-1.pdf> accessed 30 July 2023.

124 Quoted companies also include companies listed on other exchanges. For a detailed definition, see CA 2006, s.385(2).

125 Traded companies are admitted to trading on a UK or EU regulated market, see CA 2006, s.360C.

126 Companies Act 2006, s.439 (A).

127 Companies Act 2006, s.439.

128 IA (n 7) 12–3.

129 FCA Listing Rules 9.4.1.

130 High Pay Centre (n 124) 1 (‘bonuses have typically accounted for around a quarter of total executive pay awards, whereas LTIPs have accounted for somewhere between 40 and 60 per cent.’)

131 Lucian A Bebchuk and Roberto Tallarita, ‘The Illusory Promise of Stakeholder Governance’ (2021) 106 Cornell Law Review 91, 121.

132 CGC 2018, Principle Q & Provision 32.

133 KJ Martijn Cremers and Yaniv Grinstein, ‘Does the Market for CEO Talent Explain Controversial CEO Pay Practices?’ (2014) 18(3) Review of Finance 921, 923.

134 John M Bizjak and others, ‘Does the Use of Peer Groups Contribute to Higher Pay and Less Efficient Compensation’ (2008) 90(2) Journal of Financial Economics 152, 152.

135 Cremers and Grinstein (n 134) 921; Michael Faulkender and Jun Yang, ‘Inside the Black Box: The Role and Composition of Compensation Peer Groups’ (2010) 96(2) Journal of Financial Economics 257, 259.

136 T Colin Campbell and Mary Elizabeth Thompson, ‘Why Are CEOs Paid for Good Luck? An Empirical Comparison of Explanations for Pay-for-luck Asymmetry’ (2015) 35 Journal of Corporate Finance 247, 249.

137 Habib Jouber and Hamadi Fakhfakh, ‘Pay for Luck: New Evidences from the Institutional Determinants of CEOs’ Compensation’ (2012) 54(6) International Journal of Law and Management 485, 488.

138 Frederick Tung, ‘The Puzzle of Independent Directors: New Learning’ (2011) 91(3) Boston University Law Review 1175, 1179; Sanjai Bhagat and Bernard Black, ‘The Uncertain Relationship between Board Composition and Firm Performance’ (1999) 54(3) The Business Lawyer 921, 952; Yaron Nili, ‘Out of Sight, Out of Mind: The Case for Improving Director Independence Disclosure’ (2017) 43(1) Journal of Corporation Law 35, 41 and 54.

139 Byoung-Hyoun Hwang and Seoyoung Kim, ‘It Pays to Have Friends’ (2009) 93(1) Journal of Financial Economics 138, 139.

140 Hunghua Pan and others, ‘Friendly Compensation Committees and Pay-for-luck Asymmetry: Evidence from Taiwan’ (2020) 28(2) Corporate Governance: An International Review 141, 142; Pamela Kent and others, ‘Remuneration Committees, Shareholder Dissent on CEO Pay and the CEO Pay–performance Link’ (2018) 58(2) Accounting and Finance 445, 448.

141 Tung (n 139) 1177; Renée B Adams and Daniel Ferreira, ‘A Theory of Friendly Boards’ (2007) 62(1) The Journal of Finance 217, 217.

142 This is reflected by the high-level divergence among the ESG ratings provided by professional rating agencies. see Florian Berg and others, ‘Aggregate Confusion: The Divergence of ESG Ratings’ (2022) 26(6) Review of Finance 1315, 1320.

143 This table only includes those indicators that are adopted by more than 30 companies.

144 Since many companies do not disclose enough details, a more precise classification is not feasible at this stage.

145 Ittner and others (n 16) 235–6.

146 For instance, sometimes the remuneration committee uses vague expressions such as ‘having made process’ or ‘having made great improvements’, without elaborating on what the progress or improvement is. See Morgan Advanced Materials annual report 2021, 94; Trainline annual report 2022, 95; Tate & Lyle annual report 2022, 122.

147 Lucian A Bebchuk and Roberto Tallarita, ‘The Perils and Questionable Promise of ESG-Based Compensation’ (2022) 48(1) The Journal of Corporation Law 38, 62.

148 Taylor Wimpey annual report 2022, 140; Persimmon annual report 2022, 144.

149 See an overview of the survey provided by the NHBC <https://www.nhbc.co.uk/builders/products-and-services/customer-satisfaction> accessed 30 July 2023.

150 Bengt Holmstrom and Paul Milgrom, ‘Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design’ (1991) 7 Journal of Law, Economics, & Organisation 24, 25.

151 For instance: (1) Legal & General, whose customer net promoter score in 2022 and 2021 was 71 and 73 respectively; see Legal & General annual report 2022, 113 and annual report 2021, 105; (2) Londonmetric Property, whose staff turnover rate remained unchanged and the ‘landlord recommendation score’ (for measuring customer satisfaction) decreased from 9.0 in 2021 to 8.5 in 2022; see Londonmetric Property annual report 2022, 143 and annual report 2021, 127; (3) Safestore Holdings, whose ESG ratings in 2022 and 2021 were the same, see Safestore Holdings annual report 2022, 109 and annual report 2021, 98; (4) St. James’s Place, whose employee engagement score remained unchanged; see St. James’s Place annual report 2022, 151 and annual report 2021, 147.

152 Aline Grahn, ‘Precision and Manipulation of Non-financial Information: The Curious Case of Environmental Liability’ (2020) 56(4) ABACUS 495, 495.

153 Jack Ewing, ‘What Really Happened at VW’ The Economists (1 June 2017) <https://www.economist.com/books-and-arts/2017/06/01/what-really-happened-at-vw> accessed 30 July 2023; Gwyn Topham and others, ‘The Volkswagen Emissions Scandal Explained’ The Guardian (23 September 2015) <https://www.theguardian.com/business/ng-interactive/2015/sep/23/volkswagen-emissions-scandal-explained-diesel-cars> accessed 30 July 2023.

154 Xiaoyu Liu and Qingbin Cui, ‘Baseline Manipulation in Voluntary Carbon Offset Programs’ (2017) 111 Energy Policy 9, 10.

155 Bebchuk and Tallarita, ‘The Perils and Questionable Promise of ESG-Based Compensation’ (n 148) 63; Pascual Berrone and Luis R Gomez-Mejia, ‘The Pros and Cons of Rewarding Social Responsibility at the Top’ (2009) 48(6) Human Resource Management 959, 965.

156 Jason Halper and others, ‘ESG Ratings: A Call for Greater Transparency and Precision’ Harvard Law School Forum on Corporate Governance (10 November 2022) <https://corpgov.law.harvard.edu/2022/11/10/esg-ratings-a-call-for-greater-transparency-and-precision/> accessed 30 July 2023; The AMF and the AFM, ‘Position Paper: Call for a European Regulation for the Provision of ESG Data, Ratings, and Related Services’ (2020) 2–3 <https://www.amf-france.org/en/news-publications/amfs-eu-positions/french-and-dutch-financial-market-authorities-call-european-regulation-esg-data-ratings-and-related> accessed 30 July 2023; Alan Livsey, ‘Boom in ESG Ratings Leaves Trail of Confusion’ Financial Times (19 March 2022) <https://www.ft.com/content/c34fe314-838b-4b00-ae25-9a4f0d93f822> accessed 30 July 2023.

157 Javier El-Hage, ‘Fixing ESG: Are Mandatory ESG Disclosures the Solution to Misleading Ratings?’ (2021) 26(2) Fordham Journal of Corporate and Financial Law 359, 369.

158 David F. Larcker and others, ‘ESG Ratings: A Compass without Direction’ (2022) Rock Center for Corporate Governance at Stanford University Working Paper, 6 <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4179647> accessed 30 July 2023.

159 Stuart Ogden and Robert Watson, ‘Remuneration Committees, Pay Consultants and the Determination of Executive Directors’ Pay’ (2012) 23(4) British Journal of Management 502, 503.

160 Spectris annual report 2022, 90.

161 Lancashire Holdings annual report 2022, 111.

162 See the World Bank’s definition of financial inclusion at <https://www.worldbank.org/en/topic/financialinclusion/overview> accessed 30 July 2023.

163 Bank of Georgia annual report 2022, 209.

164 For instance, GSK has paid executives for the delivery of sustainability-related commitments in both 2021 and 2022. See GSK annual report 2022, 140 and annual report 2021, 129.

165 Prudential annual report 2022, 240–1 (gender diversity is included in both group and individual performance).

166 Niamh M Brennan and others, ‘Rhetoric, Argument and Impression Management in Hostile Takeover Defence Documents’ (2010) 42(4) The British Accounting Review 253, 254.

167 Joseph Taylor and others, ‘Are Corporate Social Responsibility (CSR) Initiatives such as Sustainable Development and Environmental Policies Value Enhancing or Window Dressing?’ (2018) 25(5) Corporate Social Responsibility and Environmental Management 971, 978.

168 It is ‘difficult to predict the long-run consequences of an agent’s actions based on the observed short-run contribution’. See Robert Gibbons, ‘Incentives in Organisations’ (1998) 12(4) Journal of Economic Perspectives 115, 118.

169 Norreklit (n 59) 70.

170 Florian Berg and others, ‘ESG Confusion and Stock Returns: Tackling the Problem of Noise’ (2023) NBER Working Paper 30562, 1 <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3941514> accessed 30 July 2023.

171 Bryant Rivera, ‘Green Bonds: Reforming ESG Regulation in the United States to Meet the Requisite Funding Demand for a Decarbonised Economy’ (2022) 28(2) Hastings Environmental Law Journal 191, 205; Dane M Christensen and others, ‘Why is Corporate Virtue in the Eye of The Beholder? The Case of ESG Ratings’ (2022) 97(1) The Accounting Review 147, 149; Berg and others, ‘Aggregate Confusion’ (n 143) 1317; Virginia Harper Ho, ‘Modernising ESG Disclosure’ (2022) 1 University of Illinois Law Review 277, 289.

172 Bebchuk and Tallarita, ‘The Perils and Questionable Promise of ESG-Based Compensation’ (n 148) 53.

173 Bengt Holmström, ‘Moral Hazard and Observability’ (1979) 10(1) The Bell Journal of Economics 74, 84; George P Baker, ‘Incentive Contracts and Performance Measurement’ (1992) 100(3) Journal of Political Economy 598, 598.

174 Bebchuk and others, ‘Does Enlightened Shareholder Value Add Value?’ (n 64) 733.

175 Holmström (n 174) 89.

176 Lucian A Bebchuk and Tallarita, ‘The Illusory Promise of Stakeholder Governance’ (n 132) 110.

177 HC and Business, Energy and Industrial Strategy Committee (BEISC), Corporate Governance: Fourth Report of Session 2016-17 (HC702) paras. 89-90.

178 ibid paras. 91 and 95.

179 Alex Edmans, Grow the Pie: How Great Companies Deliver Both Purpose and Profit (Cambridge University Press 2020) 170.

180 ibid; Yoko Shirasu and Hidetaka Kawakita, ‘Long-term Financial Performance of Corporate Social Responsibility’ (2021) 50 Global Finance Journal 22 <https://www.sciencedirect.com/science/article/pii/S1044028319302844> accessed 30 July 2023.

181 CGC 2018, para. 36.

182 HC and BEISC, Corporate governance: Fourth Report of Session 2016-17 (HC702) para. 93; ibid.

183 HC and BEISC, Corporate governance: Fourth Report of Session 2016-17 (HC702) para. 95. The FRC recommends that the aggregate of vesting and holding periods should be five years or more, which means that for a typical three-year LTIP scheme, the holding period is two years. See CGC 2018, para.36.

184 David Yosifon, ‘The Law of Corporate Purpose’ (2014) 10 Berkeley Business Law Journal 181, 183; Guido Ferrarini, ‘Redefining Corporate Purpose: Sustainability as a Game Changer’ in Danny Busch and others (eds), Sustainable Finance in Europe: Corporate Governance, Financial Stability and Financial Markets (Springer 2022) 85, 86; Jill E Fisch and Steven Davidoff Solomon, ‘Should Corporations Have a Purpose?’ (2021) 99 Texas Law Review 1309, 1310; Kershaw and Schuster (n 24) 480–1.

185 B Lab, ‘Meeting the Legal Requirement’ <https://bcorporation.uk/b-corp-certification/how-to-certify-as-a-b-corp/legal-requirement/> accessed 30 July 2023.

186 This figure was obtained in July 2023. See <https://www.bcorporation.net/en-us/find-a-b-corp> accessed 30 July 2023.

187 PZ Cussons annual report 2022, 2.

188 ibid 136.

189 Christopher M Bruner, ‘Corporate Governance Reform and the Sustainability Imperative’ (2022) 131(4) Yale Law Journal 1217, 1221; Fisch and Solomon (n 185) 1311.

190 Bruner (n 190) 1225; Fisch and Solomon (n 185) 1311; Edward B Rock, ‘For Whom is the Corporation Managed in 2020? The Debate over Corporate Purpose’ (2021) 76 The Business Lawyer 363, 366; William Savitt and Aneil Kovvali, ‘On the Promise of Stakeholder Governance: A Response to Bebchuk and Tallarita’ (2021) 106(7) Cornell Law Review 1881, 1884.

191 Bruner (n 190) 1225; John Armour and others, ‘Beyond the Anatomy’ in Reinier Kraakman and others (eds), The Anatomy of Corporate Law: A Comparative and Functional Approach (3rd edn, Oxford University Press 2017) 267, 271.

192 John Armour and Jeffrey N Gordon, ‘Systemic Harms and Shareholder Value’ (2014) 6(1) Journal of Legal Analysis 35, 38; Yosifon (n 185) 228; Felix Grey, ‘Corporate Lobbying for Environmental Protection’ (2018) 90 Journal of Environmental Economics and Management 23, 23; Jihyun Eun and others, ‘Green Product Portfolio and Environmental Lobbying’ (2023 forthcoming) Business and Politics 3 <https://www.cambridge.org/core/journals/business-and-politics/article/green-product-portfolio-and-environmental-lobbying/AA3786237522404CEE305CAC453C1913> accessed 30 July 2023.

193 Gary Fooks and others, ‘The Limits of Corporate Social Responsibility: Techniques of Neutralisation, Stakeholder Management and Political CSR’ (2013) 112 Journal of Business Ethics 283, 284.

194 Stavros Gadinis and Amelia Miazad, ‘Corporate Law and Social Risk’ (2020) 73(5) Vanderbilt Law Review 1401, 1409.

195 Edmans (n 180) 61.

196 Andrew Keay, ‘Stakeholder Theory in Corporate Law: Has it Got What it Takes’ (2010) 9(3) Richmond Journal of Global Law and Business 249, 256.

197 Alexei M Marcoux, ‘A Fiduciary Argument Against Stakeholder Theory’ (2003) 13(1) Business Ethics Quarterly 1, 2; R Edward Freeman and others, ‘Tensions in Stakeholder Theory’ (2020) 59(2) Business and Society 213, 217.

198 Scott J Reynolds and others, ‘Stakeholder Theory and Managerial Decision-Making: Constraints and Implications of Balancing Stakeholder Interests’ (2006) 64 Journal of Business Ethics 285, 286.

199 Bebchuk and Tallarita, ‘The Illusory Promise of Stakeholder Governance’ (n 132) 110; Millon, ‘Enlightened Shareholder Value, Social Responsibility’ (n 69) 68; Ajibo (n 66) 37.

200 Gadinis and Miazad (n 195) 1409.

201 Thomas Dyllick and Katrin Muff, ‘Clarifying the Meaning of Sustainable Business: Introducing a Typology from Business-as-Usual to True Business Sustainability’ (2016) 29(2) Organisation and Environment 156, 163.

202 Larry Fink, ‘Larry Fink’s 2020 Letter to CEOs: A Fundamental Reshaping of Finance’ BlackRock (2020) <https://www.blackrock.com/us/individual/larry-fink-ceo-letter> accessed 30 July 2023.

203 Dyllick and Muff (n 202) 166.

204 Lisa M Fairfax, ‘The Rhetoric of Corporate Law: The Impact of Stakeholder Rhetoric on Corporate Norms’ (2006) 31(3) Journal of Corporation Law 675, 677; Bebchuk and Tallarita, ‘The Illusory Promise of Stakeholder Governance’ (n 132) 94.

205 Bebchuk and Tallarita, ‘The Illusory Promise of Stakeholder Governance’ (n 132) 99.

206 There are proposals for embedding the stakeholder approach in UK company law. See Iris H-Y Chiu, ‘Operationalising a Stakeholder Conception in Company Law’ (2016) 10(4) Law and Financial Markets Review 173; John Gaffney, ‘The Nature of Stakeholder Capitalism and the Role of Corporate Law: Proposed Amendments to Chapter 2 of the Companies Act 2006’ Oxford Business Law Blog (19 September 2022) <https://blogs.law.ox.ac.uk/oblb/blog-post/2022/09/nature-stakeholder-capitalism-and-role-corporate-law-proposed-amendments> accessed 30 July 2023.

207 Marc T Moore, ‘Shareholder Primacy, Labour and the Historic Ambivalence of UK Company Law’ in Harwell Wells (eds), Research Handbooks in Corporate Law and Governance (Elgar 2018) 142, 145.

208 Stephen M Bainbridge, ‘The Board of Directors as Nexus of Contracts’ (2002) 88(1) Iowa Law Review 1, 6; Ronald M Green, ‘Shareholders as Stakeholders: Changing Metaphors of Corporate Governance’ (1993) 50(4) Washington and Lee Law Review 1409, 1410.

209 Bainbridge (n 209) 7; Lynn A Stout, ‘The Mythical Benefits of Shareholder Control’ (2007) 93(3) Virginia Law Review 789, 804.

210 Henry N Bulter and Fred S McChesney, ‘Why They Give at the Office: Shareholder Welfare and Corporate Philanthropy in the Contractual Theory of the Corporation’ (1999) 84(5) Cornell Law Review 1195, 1213; Alissa Mickels, ‘Beyond Corporate Social Responsibility: Reconciling the Ideals of a for-Benefit Corporation with Director Fiduciary Duties in the U.S. and Europe’ (2009) 32(1) Hastings International and Comparative Law Review 271, 296.

211 Bebchuk and Tallarita, ‘The Perils and Questionable Promise of ESG-Based Compensation’ (n 148) 62.

212 Paul G Mahoney, ‘Mandatory Disclosure as a Solution to Agency Problems’ (1995) 62(3) The University of Chicago Law Review 1047, 1048.

213 Allison Grey Anderson, ‘The Disclosure Process in Federal Securities Regulation: A Brief Review’ (1974) 25(2) Hastings Law Journal 311, 320.

214 Geiler and Renneboog (n 28) 125.

215 Traded companies, even if unquoted, have been required to comply with mandatory disclosures of executive remuneration according to the Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019, s.27.

216 These rules are set in: (1) CA 2006, s.420; (2) The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (hereafter Regulations 2008), Part 4 and Schedule 8.

217 Regulations 2008, Schedule 8, s.9(e).

218 Regulations 2008, Schedule 8, s.12(3)(e).

219 Regulations 2008, Schedule 8, s.3(2)(a).

220 Regulations 2008, Schedule 8, s.3(2)(b) and (c).

221 Regulations 2008, Schedule 8, s.3(2)(d).

222 Brett H McDonnell, ‘Stakeholder Engagement’ (2022) Minnesota Legal Studies Research Paper No. 22-16 p.3 <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4262976> accessed 30 July 2023.

223 Companies Act 2006, s.439(A).

224 Betty (H.T.) Wu and others, ‘Say on Pay’ Regulations and Director Remuneration: Evidence from the UK in the Past Two Decades’ (2020) 20 (2) Journal of Corporate Law Studies 541, 544.

225 Jeffrey N Gordon, ‘Say on Pay: Cautionary Notes on the U.K. Experience and the Case for Shareholder Opt-in’ (2009) 46(2) Harvard Journal on Legislation 323, 343; Jill E Fisch and others, ‘Is Say on Pay All About Pay? The Impact of Firm Performance’ (2018) 8 Harvard Business Law Review 101, 106; Martin Conyon and Graham Sadler, ‘Shareholder Voting and Directors’ Remuneration Report Legislation: Say on Pay in the UK’ (2010) 18(4) Corporate Governance: An International Review 296, 297.

226 Carsten Gerner-Beuerle and Tom Kirchmaier, ‘Say on Pay: Do Shareholders Care?’ (2018) ECGI Finance Working Paper No. 579/2018, p.27 <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2720481> accessed 30 July 2023.

227 Fisch and others (n 226) 104.

228 ibid 104; Gerner-Beuerle and Kirchmaier (n 227) 27.

229 Fabrizio Ferri and David A Maber, ‘Say on Pay Votes and CEO Compensation: Evidence from the UK’ (2013) 17(2) Review of Finance 527, 536–9; Wu and others (n 225) 561; Marinilka B Kimbro and Danielle Xu, ‘Shareholders Have a Say in Executive Compensation: Evidence from Say-on-pay in the United States’ (2016) 35(1) Journal of Accounting and Public Policy 19, 38; Steven Balsam and others, ‘The Impact of Say-on-pay on Executive Compensation’ (2016) 35(2) Journal of Accounting and Public Policy 162, 164; Gordon (n 226) 337.

230 Ferri and Maber (n 230) 528.

231 Conyon and Sadler (n 226) 296.

232 Wu and others (n 225) 561.

233 Balsam and others (n 230) 164.

234 Gordon (n 226) 335; Conyon and Sadler (n 226) 296; Jeremy Ryan Delman, ‘Structuring Say-On-Pay: A Comparative Look at Global Variations in Shareholder Voting on Executive Compensation’ (2010) 2 Columbia Business Law Review 583, 586.

235 Virginia Harper Ho, ‘From Public Policy to Materiality: Non-Financial Reporting, Shareholder Engagement, and Rule 14a-8’s Ordinary Business Exception’ (2019) 76(3) Washington and Lee Law Review 1231, 1233.

236 PwC and London Business School, ‘Paying Well by Paying for Good’ (n 1) 7.