RIEB Discussion Paper Series No.2026-25

Title

Sustainability-Linked Debt and ESG Executive Compensation

Abstract

We study the optimal design of sustainable debt when a for-profit borrower raises capital from socially responsible investors and motivates a for-profit manager to exert sustainability effort through an executive compensation contract. We ask when fixed-rate bonds or loans are sufficient and when sustainability-linked debt is required, given that executive compensation can also be tied to ESG performance. The analysis shows that the optimal debt contract depends jointly on the investment structure faced by socially responsible investors and the borrower's ability to commit to ESG-linked managerial compensation. When the borrower can adjust ESG-based compensation appropriately, noncontingent debt can replicate the incentive effects of sustainability-linked debt in some environments, whereas explicit sustainability-linked payments remain valuable in others. The results clarify how sustainable debt and ESG-linked executive pay interact as alternative incentive instruments and provide implications for the design of sustainable bonds and loans.

Keywords

ESG; Managerial compensation; Managerial incentives; Sustainability-linked debt; Sustainable debt

JEL Classification

D86, G12, G20, G32, M14

Inquiries

Meg ADACHI-SATO
Junior Research Fellow, Research Institute for Economics & Business Administration, Kobe University
Faculty of Business Administration / Institute of Small Business Research and Business Administration, Osaka University of Economics
E-mail: m-sato@osaka-ue.ac.jp

Hiroshi OSANO
College of Business Administration, Ritsumeikan University