Giving directors pay incentives to meet sustainability goals makes them more likely to revise previous metrics in order to show year-on-year improvements, a study of top Australian companies has found.
The research, published this week in the Journal Of Management Accounting Research, analysed data published between 2004 and 2020 by 500 firms listed on the Australian Securities Exchange (ASX).
It found that “contracting on CSR increases the likelihood of restatements”: Specifically, where CEOs and other directors have financial incentives to meet this type of KPI, companies have a higher tendency to restate prior years’ performances “to be worse than originally reported,” leading to “improved comparative performance between the current and prior year”.
In total 33.5% of all the restatements found were on metrics specifically tied to CEO bonuses. Additionally, CEOs’ short-term incentive compensation was found to be “significantly greater” when those restatements resulted in improved comparative performance, “but only for firms that contract on CSR”.
This damning evidence comes at a time when more and more firms are tying executive pay incentives to sustainability performance: two-thirds of World Business Council for Sustainable Development members and 72% of S&P 500 companies now do so.
Yet it is not the first study to question the legitimacy of this type of mechanism: in 2022, Harvard researchers analysed ESG-based compensation in S&P 100 companies and concluded that its current use “likely serves the interests of executives, not of stakeholders”.
(This article looks at how other types of incentives may be much more effective at changing corporate behaviours.)
Examples and magnitude of sustainability data 'restatements'
The Australian study explains that sustainability report manipulation is more common when social impact KPIs are linked to executive pay, and gives anecdotal examples of this behaviour.
In 2012, the CEO of OZ Minerals had 30% of their short-term incentive weighted toward CSR-related KPIs, including “improvement in female gender diversity at all management and operational levels”. That same year, the company restated its 2011 gender representation statistics “in line with new methodology”.
Almost three-quarters of restatements were justified by measurement changes as opposed to errors, and the magnitude of the revision was considerable: 28.3% on average, but 36% for metrics linked to bonuses.
“It is the first study to provide empirical evidence that suggests that the inclusion of CSR-related performance measures within CEO compensation contracts provides incentives to manipulate CSR performance, at least in terms of restatements, which are associated with greater realised pay,” the authors write.
The study sample consisted of 674 CSR reports, as well as compensation and other data from 1,567 annual reports.