The Association between Outside Directors’ Compensation and ESG Performance: Evidence from Korean Firms

ABSTRACT

Environmental, social, and corporate governance (ESG) has become essential for corporate sustainability. Among ESG activities, we focus on governance structure since firms can properly engage in activities related to environmental and social responsibility only when their corporate governance structures are well established. Outside directors play an important role in governance structure since they monitor the management and provide expertise to the board of directors. In this study, we pay particular attention to the compensation of outside directors, which reflects the effort, expertise, and independence of outside directors. Based on data from listed firms on the Korea Stock Exchange in South Korea between 2014 and 2020, we examine the association between outside directors’ compensation and ESG performance in certain firms with unique governance structures, namely, chaebols (or family firms). We find that the compensation of outside directors is positively associated with ESG performance, implying that outside directors’ compensation motivates effective monitoring and advisement of management and has an incremental effect on ESG performance. We suggest that the compensation of outside directors is one of the key factors that can significantly affect ESG performance. Therefore, investors and policymakers may evaluate whether a firm is doing well in terms of ESG activities by examining the compensation of outside directors.