Co-author: Jessenia Davila, Post-Doctoral Researcher at IESE
Environmental, social and governance (ESG) criteria have become an established practice in the corporate landscape, leading more firms to tie executive compensation to ESG performance.
Known as ESG pay, this approach is transforming incentive structures and redefining the meaning of success at the top. But for the leaders of family-owned businesses, the path forward is not so straightforward.
Our international study on ESG pay offers a timely and data-rich analysis of how family firms approach this trend–and why many are choosing a different route.
ESG pay: a new standard for accountability
The global adoption of ESG pay rose by 19% between 2012 and 2020, fast becoming a standard practice, especially in Europe and North America.
ESG pay links executive bonuses and salaries to sustainability and social impact targets, ranging from carbon reduction and clean energy initiatives to workplace diversity and ethical governance.
Reflecting a broader shift from shareholder to stakeholder capitalism, ESG pay encourages leaders not only to deliver profits, but also to drive positive social and environmental outcomes.
Yet despite its upsurge among public companies, ESG pay remains markedly lower among family-owned firms, climbing from a mere 2% to 4% over the same time period.
Why the gap?
Family firms and ESG pay: a complex relationship
Family-owned businesses operate under unique dynamics. Frequently led by founders or family members, these firms are deeply influenced by socioemotional wealth (SEW), a set of non-financial goals related to legacy, control, reputation and other factors.
Among family businesses, SEW generally promotes a longer-term orientation and stronger sense of responsibility toward their employees and communities of operation compared to non-family-controlled companies.
At the same time, SEW elements may also explain their significantly lower adoption of ESG pay. Many family firms already internalize ESG values, leading them to see little need to formalize them through compensation contracts.
According to agency theory, family firms also face fewer conflicts between owners and managers (Type I agency costs), reducing the pressure to align incentives via pay. This structural overlap can make ESG pay seem redundant or even intrusive.
It should also be noted that verifying ESG performance is no small task. Metrics are often vague, difficult to audit and susceptible to greenwashing concerns.
For traditional family firms with lean governance and the desire to avoid reputational risk, the complexity and potential for misinterpretation may outweigh the potential benefits.
When ESG pay does work in family firms
When it comes to ESG pay adoption in family firms, our study also reveals notable exceptions, including the importance of robust governance structures:
> Board independence: The likelihood of adopting ESG pay rises with the inclusion of independent board members, who often bring specialized expertise and advocate for broader stakeholder accountability.
> CEO duality: Surprisingly, when a family firm’s CEO also chairs the board–a governance model often viewed as problematic–the probability of ESG pay adoption also increases. This role consolidation may offer CEOs the leverage they need to champion ESG initiatives without undermining the family’s control.
> Family CEOs: Contrary to expectations, CEOs with family ties are slightly more likely to implement ESG pay. This could reflect a desire to signal legitimacy to outside stakeholders or align the firm’s public image with its internal values.
These findings suggest that ESG pay is not inherently at odds with family firm values–but its implementation depends on context. When family leadership aligns with governance mechanisms grounded on transparency and strategic oversight, ESG pay can serve as a valuable tool.
Disaggregating ESG: the “S” matters the most
Another core research finding is that not all ESG components are treated equally. Family firms are especially reluctant to link executive pay to social metrics like employee well-being, diversity or community engagement.
This reluctance may stem from a belief that social responsibility dimensions are best addressed informally as part of the firm’s culture and identity, rather than codifying them in compensation models.
As noted by Prof. Álvaro San Martín, non-family firms–often more attuned to regulatory scrutiny and investor expectations–are more inclined to formalize social and environmental goals in pay structures.
Key takeaways for family business CEOs
For CEOs leading family enterprises, the decision to adopt ESG pay should be rooted in the firm’s unique values, governance structure and stakeholder landscape, with the following questions serving as a guide:
- Does our current compensation system align with our ESG values or is there a gap?
- How do we balance the benefits of ESG signaling with the risks of metric complexity and reputational exposure?
- Would independent directors or clearer ESG oversight help us meet external expectations while preserving internal control?
- How do we communicate our ESG commitments formally through pay incentives and informally through our culture and leadership?
A call for strategic reflection
ESG pay is more than a passing trend, shaped by the evolving expectations of customers, employees, investors, regulators and other key stakeholders and the rising demand for visible and verifiable ESG commitments.
ESG compensation offers family firms an ideal opportunity to reaffirm their core values, strengthen their governance and chart a sustainable path forward–on their own terms.
Homepage image: Youssef Bouhsini on Unsplash