The Use of ESG Ratings in Corporate Compensation Plans: Promises and Pitfalls

• Published in: Compensation and benefits review Vol. 57; no. 4; pp. 262 - 275
• Main Authors: Cregan, Charlie, Kelly, J. Andrew, Clinch, J. Peter
• Format: Journal Article
• Language: English
• Published: Los Angeles, CA SAGE Publications 01.09.2025; SAGE PUBLICATIONS, INC
• Subjects: Air travel; Banking; Business metrics; Companies; Compensation; Compensation plans; Environmental social & governance; Executive compensation; Incentives; Legislation; Manipulation; Political parties; Ratings & rankings; Stockholders; Third party; sustainability-linked compensation; ESG ratings; responsible rewards; sustainability performance metrics; ESG-linked compensation
• ISSN: 0886-3687; 1552-3837
• DOI: 10.1177/08863687251329843

This paper evaluates the use of third-party environmental, social, and governance (ESG) ratings as key performance metrics within executive and management compensation plans. Despite a widespread increase in ESG-linked compensation practices, there remains a paucity of research critically evaluating the use of third-party ESG ratings as meaningful performance metrics in this context. The paper utilises case-studies from the airline and banking industries to identify this emerging trend of ESG ratings-linked compensation. It goes on to synthesise extant research on ESG ratings to evaluate their suitability as performance metrics within the context of the broader executive compensation literature. We argue that the substantial evidence on the shortcomings of current ESG ratings, including divergence across rating agencies, opaque rating methodologies, and inadequate reflection of actual impact metrics, combine to present a material risk to the credibility and reviewability of such sustainability-linked compensation plans. Our critique highlights the ready potential and incentive for manipulation, where executives may influence the selection of ratings or utilise strategic disclosure tactics to achieve improved rating targets. We advise that companies and their boards prioritise objective measures of impact over existing third-party ratings when designing executive compensation criteria. We offer actionable recommendations for firms to adopt verifiable metrics aligned with their strategic objectives, drawing on frameworks provided by legislation such as the Corporate Sustainability Reporting Directive (CSRD) and voluntary standards including the Global Reporting Initiative (GRI). By doing so, companies can foster transparency and maintain shareholder trust and confidence while effectively incentivising management to deliver on key sustainability challenges.