Nonfinancial Performance Metrics in Executive Pay and Corporate Risk-Taking—Evidence From S&P 500 Firms

Abstract

This study examines the implications of the use of nonfinancial performance metrics in executive compensation (hereafter, NFPM-linked pay) on corporate risk-taking and firm performance in subsequent periods. Using hand-collected data on the performance metric choices of S&P 500 firms and a comprehensive set of proxies for corporate risk-taking, the analysis reveals that linking executive compensation to nonfinancial metrics, particularly those related to environmental, social, and governance (ESG) factors, is associated with lower financial leverage, but higher volatility in operating and stock returns and increased strategic risk-taking proxied by capital expenditures. The effect is more pronounced in firms with greater analyst coverage and in industries where NFPM-linked pay is more prevalent. Notably, ESG metrics, especially those tied to environmental outcomes, demonstrate a distinct impact on corporate risk-taking compared to other nonfinancial measures. Additional analysis indicates that firms adopting NFPM-linked pay exhibit stronger performance in the 1- to 2-year period following the compensation grant. Overall, the findings suggest that NFPM-linked pay, particularly when tied to ESG metrics, can be an effective mechanism for encouraging strategic risk-taking that promotes sustainable value creation.