Green Incentives and Environmental Performance

Assigning monetary incentives to employees can be a powerful way for companies to promote greater performance in line with strategic goals. As environmental issues continue to become more prevalent, a growing number of companies have implemented green monetary incentives for managers and employees by introducing environmental measures in their compensation contracts.

There’s much debate on how organizations should implement green incentives. In the last decade, for example, we have observed a rush to tie executive compensation to various environmental, social, and governance (ESG) objectives, including environmental goals. While some companies started to use green incentives more than 10 years ago, the vast majority have introduced them more recently. Moreover, some companies distribute green incentives to all employees, while others restrict them only to specific managerial positions. Yet do all these companies need to introduce explicit monetary incentives for environmental goals within the organization? Are all companies capable of designing effective incentive systems that promote real performance improvement?

Conformity or Strategic Control?

Green incentives can be used for multiple reasons. From a strategic control standpoint, organizations following environmental objectives provide monetary incentives to align employees’ goals with the green strategic goals of the company. In this way, green incentives are part of the strategy implementation process to motivate and focus employees’ actions on achieving explicit environmental goals, like reducing carbon dioxide (CO₂) emissions and waste and water consumption. However, one of the most common challenges of introducing new incentive systems is the lack of accurate performance measurement. In fact, organizations are still learning how to measure environmental performance and have limited experience in identifying and designing measures to assess the environmental impact of their activities. Implementing a measurement and reporting process specific to environmental aspects might be a condition for the subsequent use of green incentives for strategic control.

Companies may also adopt green monetary incentives because they’re caught up in the rush to conform to outside stakeholders’ expectations. Some provide incentives just to symbolically conform to external pressures, perhaps leading to more pay rather than better environmental performance. Other organizations attempt to design incentive systems to produce substantial improvement; however, the difficulty and lack of experience in incorporating green aspects into management practices may prevent real performance enhancement.

Compared to other nonfinancial performance measures, such as customer satisfaction, quality, and safety, there are multiple conditions that make it difficult to implement environmental metrics in incentive systems. We identify three specific factors that affect the use of environmental performance measures in contracting:

1. Because green incentives are a recent phenomenon, organizations are still learning about the accuracy, congruency, controllability, level of precision in reflecting managers’ actions, and behavioral implications of environmental measures.

2. Most traditional nonfinancial performance measures focus on internal processes, while environmental measures focus mainly on aspects outside the boundaries of the organization, like CO₂ emissions based on the Greenhouse Gas (GHG) Protocol.

3. The use of nonfinancial performance measures is linked to the fact that they are leading indicators of future financial performance. Yet companies use environmental measures also because of regulation or because of a corporate social responsibility mandate.

Using Green Incentives

We examined the conditions for companies to use monetary incentives linked to a series of environmental goals, such as reductions of CO₂ emissions, improvement of energy efficiency, a circular economy, implementation of climate change risk mitigation plans, development of new processes or products, and changes in employees’ behavior for the benefit of the environment (see “Green Incentives for Environmental Goals,” Management Accounting Research, June 2023).

To study the use of green incentives for strategic control, we analyzed whether a company’s formal green strategy and use of ad hoc management control systems for implementing green objectives preceded the adoption of green incentives. We also examined whether these managerial reasons linked to improved strategic control explain the provision of green incentives to different managerial positions ranging from top managers, midlevel managers, and other employees, as well as how they affect the time to adopt these control systems.

We also looked at whether and when companies use green incentives as a response to specific conformity pressures: namely, the need to enhance their environmental performance in line with the industry and to mimic the behavior of industry peers.

In doing this, we discovered interesting aspects of companies’ use of green incentives. First, green incentives aren’t a direct consequence of a company’s formal green strategy implementation, which suggests that having a green strategy isn’t the only path to using green incentives. More importantly, we found that both strategic control and conformity pressures are important factors explaining a company’s decision to use green incentives as well as their time to adoption.

In fact, a high level of experience in measuring, reporting, and auditing environmental performance appears to be a precondition for adopting organizational green incentives to reinforce the implementation of environmental goals. In other words, it’s important for companies to accumulate experience in managing and monitoring environmental performance before being able to identify relevant green objectives, set appropriate goals, and select performance measures reflecting these objectives with enough accuracy. Interestingly, monitoring experience is a relevant precondition to using green incentives for top managers and other employees, but not for midlevel managers.

Conformity pressures are also powerful conditions that explain the use of green incentives. For example, when their environmental performance is significantly lower than the industry level, companies are more likely to adopt green incentives, perhaps to promote improvements or signal their commitment to the market. Moreover, as green incentives spread across an industry, a company’s adoption decision is increasingly driven by social conformity, but only after a critical mass is reached, estimated at around 40% in our setting. However, the pressure to conform and mimic peers’ behavior is relevant only to top managers and doesn’t apply to midlevel managers and other employees.

We also examined the combined role of these conditions and discovered that the effect of strategic control in part outweighs the effect of conformity pressure for higher environmental performance with regard to a company’s choice to use green incentives. Also, we observed that the pressure to conform and enhance environmental performance by using green incentives partly prevails over the pressure to mimic industry peers’ behavior.

Regarding the time to adoption of green incentives, companies with a green strategy and greater experience in monitoring environmental performance adopt them at an earlier stage. Conversely, companies taking more time before adopting green incentives face higher conformity pressures to environmental performance and industry peer practices. In other words, companies driven by strategic control reasons are in a better position and adopt green incentives earlier than those driven by social conformity.

Overall, our study shows that organizations can be more responsive to environmental demands by introducing green monetary incentives. Managers can be driven by strategic control and social conformity when deciding to use them. Green incentives play a role in the green strategy implementation process, but organizations need to first develop knowledge and learn how to manage and measure environmental performance.