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Prof. Clara Xiaoling Chen
Lillian and Morrie Moss Distinguished Professor in Accounting
Department of Accountancy | College of Business
University of Illinois at Urbana-Champaign

Despite increasing investor demand for corporations’ commitment to environmental, social and governance (ESG) issues, there is a lack of empirical evidence on how ESG targets are set in compensation contracts to incentivize CEOs’ social responsibility. Using hand-collected data on ESG targets disclosed in U.S. public firms’ proxy statements between 2006 and 2020, we examine the determinants and consequences of ESG target difficulty in CEO compensation contracts. We have the following findings: First, we provide large-sample descriptive analysis of the frequency, type, and difficulty of ESG targets used in CEO compensation. Second, we find that ESG target difficulty increases in prior-year ESG target difficulty, financial performance target difficulty, and board independence. Third, although socially responsible investors are more likely to invest in firms that meet or beat their ESG targets, a higher likelihood of meeting ESG targets (i.e. lower ESG target difficulty) is associated with worse ESG outcomes (captured by OSHA incidents and air emissions). Overall, our study contributes to a growing literature on ESG by shedding light on the antecedents and consequences of ESG target difficulty in executive compensation. Results of our study have important practical implications for firms’ design of executive compensation contracts as well as for investors and other stakeholders’ interpretation of ESG targets.