Does Executive Compensation with ESG Target Improve Firm's ESG Performance? —Evidence from Japan

Environmental, social, and governance (ESG) in-vestment has gained significant attention across both practical finance applications and academic research. This study explores the impact of executive compensation systems that integrate non-financial indicators, with a particular focus on ESG criteria, on a company's ESG performance. As the executive compensation system has developed alongside the separation of ownership and management of companies, various compensation mechanisms have appeared. However, empirical findings on the impact of integrating ESG indicators into executive compensation systems have been mixed, with some studies highlighting positive effects on corporate ESG performance, while others suggest negative or negligible effects. Therefore, this study specifically explores whether incorporating ESG targets as Key Performance Indicators (KPIs) in executive compensation systems can effectively enhance ESG performance. To achieve this, we initially introduce a classification task aimed at identifying the inclusion of ESG targets as KPIs in the executive compensation systems of companies listed on the Tokyo Stock Exchange Prime Market. Then, we propose a methodology that utilizes the BERT model to automatically address this task. Finally, our empirical analysis provides strong evidence of the significant impact that executive compensation systems, which emphasize ESG criteria, have on a company's ESG performance.