Analysis: Why ESG-based pay often falls short — and how to fix it

When firms tie executive bonuses to environmental and social goals, they often assume that measurable targets will produce measurable impact. But poorly designed incentives can encourage ‘hitting the target while missing the point.’

A new analysis from ISF outlines the strategy for how boards can design ESG-based pay systems that actually work. Read and download the paper, “Why ESG-based pay often falls short — and how to fix it.”

As nearly three-quarters of S&P 500 companies now incorporate ESG metrics into executive pay — including firms such as Apple, Unilever, McDonald's, PepsiCo, Shell, and Chipotle — expectations are high that measurable targets will translate into measurable change. Yet results have been mixed. In some cases, companies meet ESG bonus targets while falling short of genuine environmental or social progress.

Co-authored by Pierre Chaigneau, ISF Research Fellow and Associate Professor & Commerce ’77 Fellow of Finance at the Smith School of Business, Queen's University; Maddy Davis, Com’27 at Smith; and Nicolas Sahuguet, Professor at HEC Montréal, the analysis draws on academic research and real-world examples to identify three core principles for effective ESG pay design: Avoid paying for what the stock market already rewards; use multiple, independent measures to prevent gaming; and ensure ESG incentives reflect genuine board priorities.

The paper also offers five practical steps — from clarifying purpose and diagnosing market alignment to selecting disciplined metrics and rewarding continuous improvement.

“ESG-based pay is not a silver bullet,” says Chaigneau. “When boards introduce ESG metrics without clarifying their purpose or understanding what markets already reward, they risk creating symbolism instead of substance. Well-designed incentives, however, can serve as a powerful governance tool to advance outcomes the market may otherwise underweight.”

The bottom line: ESG-linked compensation can either reinforce accountability or undermine credibility. When grounded in clear objectives, diverse and verifiable metrics, and authentic board commitment, it can help align corporate purpose with performance, and turn sustainability ambition into measurable impact.