Does explicit contracting effectively link CEO compensation to environmental performance?

Empirical research in the area of corporate sustainability highlights potential conflicts between corporate financial performance and environmental performance. In such a situation, agency theory arguments applied to the corporate environmental context predict that top management compensation should be explicitly linked to environmental performance in order to bring about proper alignment of organizational environmental goals and management incentives. We test this proposition for a sample of 207 Standard & Poor 500 firms in the US in 1996 who explicitly report in Investor Responsibility Research Council (IRRC) surveys the presence or absence of a contractual link between environmental performance and executive compensation. We find that only in firms with an explicit linkage between environmental performance and executive contracts is there is any evidence of a significant impact of firm‐level environmental performance on CEO compensation levels. However, even this impact is not very impressive since (a) it holds only for IRRC compliance and spill indices and does not hold for IRRC toxic emission indices, and (b) even the effects for compliance and spill indices do not hold relative to industry levels of these indices. Copyright © 2008 John Wiley & Sons, Ltd and ERP Environment.