Sustainability-Linked Debt and ESG 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 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 (search for similar items in EconPapers)
JEL-codes: D86 G12 G20 G32 M14 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2026-08
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