Climate‐linked compensation, societal values, and climate change impact: International evidence

• Published date: 01 September 2023
• Author: Sudipta Bose,Natasha Burns,Kristina Minnick,Syed Shams
• Date: 01 September 2023
• DOI: http://doi.org/10.1111/corg.12504

ORIGINAL ARTICLE

Climate-linked compensation, societal values, and climate

change impact: International evidence

Sudipta Bose

1

| Natasha Burns

2

| Kristina Minnick

3

| Syed Shams

4

1

University of Newcastle, Queensland,

Australia

2

The University of Texas at San Antonio, USA

3

Bentley University, USA

4

University of Southern Queensland, Australia

Correspondence

Kristina Minnick, Bentley University.

Email: kminnick@bentley.edu

Abstract

Research question/issue: We examine whether linking executive compensation to

climate-related performance is associated with better firm-level climate change

impact. We also explore the interaction of culture and climate-linked incentive com-

pensation with climate change impact.

Research findings/insights: Using firm-level climate change strategy and carbon

emissions to measure climate change impacts, we find that climate-linked compensa-

tion is associated with improved climate change strategy. Climate-related incentives

for the CEO and other (operational) executives are found to be negatively associated

with firm-level carbon emissions, although the relationship is not as strong; however,

no such association is found for climate-linked compensation of the board and top-3

executives. Country-level attitudes to whether solutions for environmental issues are

considered a joint (society) responsibility versus an individual's personal responsibility

are found to have an effect on the association between climate-linked compensation

and climate change impacts. We also find that country-level cultural views enhance

the positive association between climate-linked compensation and climate change

strategy but not the association with actual firm-level carbon emissions. Further anal-

ysis shows that non-US firms drive our study's findings. Finally, improvement in cli-

mate strategy is found to have a positive effect on Tobin's Q but has no effect on

profitability.

Theoretical/academic implications: Academic research is growing on the role of cli-

mate change risk and carbon emissions in corporate decisions. The findings of our

study are important given that linking executives' compensation with climate perfor-

mance is gaining momentum. To the best of our knowledge, this is the first study to

examine any link between climate-linked compensation and climate change impact.

Practitioner/policy implications: While climate-linked compensation is associated

with positive changes in climate strategy, its association with firm-level carbon emis-

sions is promising. This is particularly the case when this compensation is offered to

executives who are likely to make operational decisions with a direct impact on a

firm's carbon footprint and carbon emissions.

KEYWORDS

corporate governance, climate-related incentives, climate change performance, carbon

emissions, international

Received: 6 December 2021 Revised: 26 October 2022 Accepted: 27 October 2022

DOI: 10.1111/corg.12504

Corp Govern Int Rev. 2023;31:759–785. wileyonlinelibrary.com/journal/corg © 2022 John Wiley & Sons Ltd. 759

1|INTRODUCTION

Climate change events related to extreme weather volatility are costly

to societies and can hurt firm growth and performance (Economic

Intelligence Unit [EIU], 2015). However, many reasons can explain

why managers have little incentive to reduce their firm's climate foot-

print to address the challenges of tackling climate change. Environ-

mentally friendly activities generally require thought and effort before

they can be implemented, and typically, they are not the firm's pri-

mary focus. With uncertain and difficult to measure costs involved in

responding to climate change, the firm's longer-term performance

may be affected (possibly after the current executives are gone). Fur-

thermore, executives can rationally conclude that polluting is value-

maximizing for shareholders, as Shapira and Zingales (2017) illustrate

with a basic present value analysis using information from court docu-

ments from a case involving a well-respected firm. This largely occurs

as the environment is an externality to a firm. Conversely, Chief Exec-

utive Officers (CEOs) may perceive climate-related investments as

long-term strategic investments that ultimately improve firm perfor-

mance. This is more likely to occur when more individuals in a society

have positive attitudes towards environmentally friendly policies and

actions—for example, they are willing to pay a premium for climate-

friendly products. In addition, management may be more likely to

make climate-related investments if society has positive attitudes

towards government regulation of shared resources, making costs

common to all competitors. In these cases, the attitudes of society

make it more likely that these investments will have a positive effect

on firm value, thereby providing an incentive for firms to make such

investments. Yet, a firm's environmental performance is not the pri-

mary goal of its business activity, so it is not clear if executives will

pursue these activities even when society values the environment.

One direct way to incentivize climate-friendly choices is to

reward executives for their efforts to address environmental issues, as

managers are more likely to pay attention to climate-related policies

that directly benefit them. In this research, we examine whether link-

ing executive pay to the firm's climate-related activities is associated

with improving the firm's activities related to climate change. Further-

more, we explore whether this is affected by a society's attitudes

towards the environment. The effects of climate-linked compensation

may be stronger in societies that place a higher value on the

environment.

Using a dataset that covers 40 countries from 2006 to 2018, we

examine whether a link exists between executives' compensation and

climate change impact, employing two unique measures for the latter.

The first climate change impact measure is the CCPS from the CDP

(previously, Carbon Disclosure Project), which measures a firm's com-

mitment to addressing its climate-related activities. Firms with strate-

gic goals and objectives to reduce carbon emissions receive higher

CDP ratings. However, it might be more costly to reduce pollution

than to plan (or signal) to reduce pollution as shown in the case study

on Dupont by Shapira and Zingales (2017). An actual reduction in car-

bon emissions shows a true commitment to reducing the level of cli-

mate risk. Our study's second measure of climate change impact is

carbon emissions, measured in carbon dioxide equivalent (CO

2

-e) met-

ric tons, which reflect substantive outcomes versus strategic objec-

tives. This emissions measure is at the firm level. Our empirical

strategy addresses sample selection bias using standard Heckman's

(1979) correction; this bias arises from self-selecting as responses to

the CDP questionnaire are voluntary. Our measure of climate-linked

compensation indicates if the firm provides monetary incentives to

management (defined as the following four groups) to focus on

climate-related issues: CEOs, top executives (including the CEO),

board of directors, and other executives (e.g., energy manager, busi-

ness unit manager, environment/sustainability manager, facilities man-

ager, process operation manager, procurement manager, public affairs

manager, and risk manager).

Our results show that climate-linked compensation is robustly

associated with higher CCPSs. When firms link CEO, executive, or

board compensation to climate issues, the firm's climate-related per-

formance score is significantly better. The score includes proposed

plans and strategies, so the positive relationship does not automati-

cally translate into lower carbon emissions. When we explore the

direct effect on climate outcomes, as measured by carbon emissions,

we find a weaker link between climate-linked compensation and

actual emissions. Specifically, when compensation for the CEO, direc-

tors, top executives, or other executives is directly linked to climate

change incentives, a significant improvement is observed in the cli-

mate change strategy score. To a lesser extent, climate-linked incen-

tives for CEOs and other executives (i.e., non-top executives) are

associated with a reduction in carbon emissions, while climate-linked

incentives for top executives and directors are not associated with a

reduction in carbon emissions. These results are primarily driven by

countries excluding the United States (US). As suggested by these

results, the link between compensation and climate performance

largely improves CCPS but is not significantly related to actual carbon

emissions. We further investigate the effect of climate-linked com-

pensation on carbon emissions by decomposing carbon emissions into

those that are directly (emitted directly by the company) and indirectly

(including supply chain-related) under the firm's control. Linking incen-

tives of executives to climate is shown to primarily affect direct emis-

sions. Only the CEO's climate-linked compensation is associated with

a reduction in indirect emissions.

Our cross-country sample allows the exploration of whether cul-

tural attitudes about the environment influence the effectiveness of

linking compensation to climate change impact. Henriques and

Sadorsky (1999) argue that management's “greenness”depends on

how sensitive it is to stakeholder pressures. We expect that the

extent of these pressures will depend on a society's attitude towards

the environment. The World Values Survey (WVS) is used to create

two indices that measure a society's attitude towards the environ-

ment: (1) the extent to which environmental issues are considered a

joint responsibility to be solved in a society, which we refer to as Car-

bon-Society; and (2) the extent to which taking personal responsibility

for the environment is valued, which we refer to as Carbon-Individual.

More support for government intervention may be present when

values for Carbon-Society are higher, with the threat of intervention

760 BOSE ET AL.