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Dynamic incentive contracts for ESG investing

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  • Zhang, Yuqian
  • Yang, Zhaojun

Abstract

We develop a continuous-time model in which an ESG investor hires a manager to run a project and incentivizes the manager to fulfill ESG responsibilities. The manager’s private efforts and ESG investing determine the project’s cash flow and ESG performance subject to random shocks. We derive the optimal contract and its implementation after introducing carbon credits following the cap-and-trade program in practice. We provide comparative static analysis and empirical implications. The results demonstrate that ESG investing enhances contract efficiency. The more significant the carbon emission reduction, or the less the cost of ESG investing, the higher the contract efficiency, the average q, the marginal q, and the optimal investment–capital ratios, implying that ESG investing mitigates inefficiencies arising from information asymmetry and enhances investment values. Our model predictions are partially verified by empirical facts.

Suggested Citation

  • Zhang, Yuqian & Yang, Zhaojun, 2024. "Dynamic incentive contracts for ESG investing," Journal of Corporate Finance, Elsevier, vol. 87(C).
    • Handle: RePEc:eee:corfin:v:87:y:2024:i:c:s0929119924000762
    DOI: 10.1016/j.jcorpfin.2024.102614
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    More about this item

    Keywords

    ESG investing; Moral hazard; Dynamic contracts; Carbon credits; Contract implementation;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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