‘Improvements in incentives and financial performance following ESG performance’... Proven through research results

Dongguk University (President Yoon Sung-Yee) announced on the 11^th November that the research by Professor Jeong Seon-moon of the Department of Accounting at Dongguk University Business School was published in the October 2022 issue (Volume 68, No. 10) of “Management Science,” the world’s most prestigious academic journal of business administration.

“Management Science” is one of the world's most prestigious academic journals in the field of business administration. It is an academic journal that has published many papers by world-renowned economists and management scholars including Nobel Prize winners Merton Miller, Franco Modigliani, Kenneth Arrow, Robert Lucas, James Heckman, Daniel Kahneman, Eugene Fama, Harry Markowitz, and William Sharp (SSCI, IF=6.172).

Professor Jeong participated as the first author of this thesis, and the corresponding author, Seoul National University Business School Professor Shin Jae-yong, co-authored the paper. (Thesis source: https://doi.org/10.1287/mnsc.2021.4232)

Providing financial rewards for ESG performance, an effective ESG improvement method... Proven by domestic researchers for the first time

The significance of ESG (environmental, social, and governance) management is becoming more prominent as the importance of non-financial performance management grows worldwide. Domestic and foreign companies are making various efforts, such as expanding ESG-related disclosures externally and establishing ESG-related board committees internally.

Through this study, Professor Jeong studied the effectiveness of financial reward methods to improve ESG performance more systematically. According to Professor Jeong's research, it has been scientifically proven that social performance increases significantly when the social performance of social enterprises is measured and financial reward is provided in proportion to the measured performance. For the first time, a domestic research team has proven that systematically measuring ESG performance and providing financial compensation is an effective ESG improvement method.

Professor Jeong's research was conducted based on the data of companies subject to the SPC (Social Performance Compensation) project, which was implemented by SK Group's Social Value Research Institute in 2015. The SPC project is a project that quantifies the performance of social enterprises based on the systematic social performance measurement system developed by SK, and grants financial incentives proportional to the performance measured in currency basis. For example, if the social performance related to the employment of a social enterprise that employs people with developmental disabilities is measured as KRW 1 billion according to a sophisticated measurement formula, KRW 250 million, equivalent to 25% of the KRW 1 billion, is paid as an incentive.

Professor Jeong emphasized that "the ultimate goal of measurement-based incentives is motivation." In other words, if ESG performance can be quantified with a standardized evaluation and measurement system, it is possible to provide financial rewards for ESG performance in the same way as providing bonuses for financial performance. “Just as managers work hard to increase financial profits when they receive bonuses in proportion to ROA (return on assets), they will naturally work hard to increase social performance if social performance is properly measured and rewarded,” he argued. The research also proved that the social performance of social enterprises improved statistically significantly after being linked to incentives, stating that "Financial compensation according to performance leads to motivation of organizational members."

Financial rewards for ESG are not always effective

However, financial rewards are not always effective. There are many cases among social enterprises, unlike for-profit enterprises, wherein people who are not accustomed to financial incentives and who pursue social missions gather to form an organization. According to Professor Jeong's research, financial rewards may have a less motivating effect in value-oriented organizations that value social missions. Professor Jeong said, "In a value-oriented organization, rather than receiving and distributing financial rewards to executives and employees, if they are used for reinvestment for ESG, the effect of improving employee performance can be maximized." It was also emphasized that whether to do it is an important issue in terms of motivation. In other words, financial incentives do not have a uniform motivating effect in all companies; the effect varies depending on the organizational culture and how financial rewards are used.

Providing financial incentives to ESG improves financial performance as well

Professor Jeong's research also found that financial rewards for ESG can improve financial performance. Companies with high task complementarity between social and financial performances have a business model in which financial profits increase as social performance improves. For example, local cooperatives purchase agricultural products from local small farmers at a reasonable price to create social outcomes that revive the local economy. On the other hand, it has a business model that improves financial performance while simultaneously reducing distribution margins because it can easily secure and sell local agricultural products directly to consumers. In the case of companies with high task complementarity like this, it has been statistically proven that financial incentive is significantly improved even if financial reward is provided only for social performance.

Korean ESG management analyzed and published in the world's most prestigious academic journal

Professor Jeong's research is significant as it presented a method for systematically managing ESG performance. Non-financial performance, such as ESG, was perceived as difficult to quantify and therefore difficult to motivate with financial incentives. Professor Jeong's research proved that ESG performance can be significantly improved if it is measured based on a systematic measurement system and financially compensated in proportion to the objectively measured performance. It was also scientifically revealed that financial incentives do not have uniform effects in all companies, but that the effects vary depending on the organizational culture and incentive usage. They also found that providing financial rewards to ESG performance can simultaneously improve financial performance under certain conditions.

Professor Jeong said, “I am delighted that a paper analyzing an incentive experiment uniquely conducted in Korea was published in ‘Management Science,’ the world’s most prestigious academic journal.”