Sustainability-Linked Debt and ESG-Linked Executive Compensation

Meg Adachi-Sato and Hiroshi Osano
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Meg Adachi-Sato: Research Institute for Economics and Business Administration, Kobe University, JAPAN and Faculty of Business Administration / Institute of Small Business Research and Business Administration, Osaka University of Economics, JAPAN
Hiroshi Osano: College of Business Administration, Ritsumeikan University, JAPAN

No DP2026-25, Discussion Paper Series from Research Institute for Economics & Business Administration, Kobe University

Abstract: We study the optimal design of sustainable debt when a for-profit borrower raises capital from socially responsible investors and incentivizes managerial sustainability effort through ESG-linked executive compensation. We characterize when fixed-rate debt suffices and when sustainability-linked debt is necessary. The optimal contract depends on investors' investment structure, the borrower's ability to commit to ESG-linked compensation, and the project payoff in the success state. When ESG-linked compensation can be adjusted appropriately, fixed-rate debt can replicate sustainability-linked debt's incentive effects under some conditions, whereas explicit ESG-contingent payments are optimalunder others. Sustainability-linked debt and ESG-linked executive compensation are potentially substitutable incentive instruments.

Keywords: ESG; Executive compensation; Managerial incentives; Sustainable debt; Sustainability-linked debt (search for similar items in EconPapers)
JEL-codes: D86 G12 G20 G32 M14 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2026-08, Revised 2026-09
New Economics Papers: this item is included in nep-env
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