Climate contracting and carbon performance: Does climate governance matter?

Abstract

Research Question/Issue: Despite the growing integration of environmental, social, and governance (ESG)-linked incentives in executive compensation contracts, empirical evidence on their effectiveness in driving substantive ESG outcomes remains inconclusive. This paper examines whether climate contracting leads to substantive improvements in corporate carbon performance and how climate governance moderates this relationship. Research Findings/Insights: Using actual firm-level carbon emissions, our findings reveal that climate contracting is associated with significant improvements in corporate carbon performance. This effect is more pronounced for direct (Scope 1) emissions, in carbon-intensive sectors, and among firms participating in emissions trading schemes (ETS). Moreover, the positive impact of climate contracting is amplified when supported by robust climate governance structures, underscoring the critical role of board oversight in ensuring the effectiveness of climate-linked incentives. These findings remain robust across alternative measurement and endogeneity tests. Theoretical/Academic Implications: This paper reconciles the efficient contracting and managerial opportunism perspectives by showing that climate contracting can drive real environmental outcomes, particularly when reinforced by effective board-level climate oversight. Practitioner/Policy Implications: Our findings offer practical insights for policymakers, boards, and investors, underscoring that both the design and governance of ESG-linked pay are critical for driving meaningful environmental outcomes. As global momentum builds around mandatory ESG-linked pay, this study highlights the value of outcome-specific climate metrics over broad, generic ESG targets in executive compensation arrangements.