Optimal government ESG incentive and ESG performance under common ownership

Abstract

We construct a continuous-time multi-player game model involving $N$ firms and a government. Investors hire managers to operate projects that generate negative externalities, and the government incentivises entrepreneurs to fulfil their ESG responsibilities to mitigate these externalities. We establish a contractual incentive relationship within the company to derive the optimal competitive ESG incentive policy. We also consider the potential effects of common ownership among institutional investors to conduct a comparative analysis. Our findings indicate that the synergistic governance effect of common ownership improves total ESG performance when the total amount of government ESG incentives is fixed. Common ownership defers the payment threshold for managerial compensation. However, when the government implements the theoretically optimal incentive policy, collusive fraud and synergistic governance effects result in a decline in total ESG performance. Therefore, fixing the total subsidy amount might be a better solution for governments to incentivise companies’ ESG activities.