An examination of how sustainable business practices and firm performance are influenced by board diversity and executive compensation: the case of UK FTSE 350 non-financial firms

The role of businesses in addressing climate change and sustainable business initiatives has taken center stage with the UK net zero agenda for 2050. With increasing attention on the impact of board diversity and pay incentives on carbon emission reductions, the question arises whether board diversity and executive compensation have any influence on the decarbonization of firms. This study empirically examines the complex interrelationships among Chair-CEO diversity, CEO Pay, executive compensation, sustainable business practices, financial performance and market value. Furthermore, this thesis explores the moderating role of sustainability-based compensation policies on these associations. The investigations in this thesis are underpinned by a solid and well-defined multi-theoretical framework which fits with existing literature on board diversity, pay incentives and sustainable business practices. Specifically, this study employs a homophily, upper echelons and neo-institutional multi?theoretical framework, arguing that a more diverse board of directors (i.e., homophily and upper echelons theories) and incentive-based executive pay mechanisms (i.e., neo-institutional theory) can lead firms responding to climate-related risks by making substantive investments in corporate sustainable initiatives. The initiatives include environmental innovations, carbon emission reductions and efficient use of resources. These initiatives can promote the firm’s effort to reduce greenhouse gases emissions and to improve carbon performance. To provide unique insights, this study includes a broader range of variables to capture the corporate carbon footprint, more variables to measure board diversity and pay incentives and employing a myriad of empirical approaches including testing for direct and indirect relationships. Precisely, to provide an in-depth investigation and address endogeneity issues, this thesis employs a variety of statistical techniques including ordinarily least squares, two stage least squares, generalised method of moments estimation, and lagged structure estimations. The findings of the thesis are derived from an analysis of data collected by hand and machine-readable data from 262 listed non-financial firms in the United Kingdom for the period 2009 to 2018. First, the empirical evidence shows that the greater the diversity between the Chair and the CEO, the greater the actual greenhouse gases emissions reduction. Second, the study finds that the pay-for-sustainability sensitivity is much stronger for firms that implement sustainability-based compensation. Additionally, the study detects that both the pay-for-sustainability sensitivity and the moderating effect of sustainability-based compensation on the pay-for-sustainability sensitivity are higher for the self-reported carbon performance measures than the actual carbon performance measures. Third, the results suggest that pay incentives have a positive moderating effect on both ‘carbon performance-for-firm performance’ sensitivity and ‘’carbon performance-for-market value’ sensitivity. The results of the thesis are robust to alternative measures, estimation methods, potential endogeneity issues and sample selection issues. The findings of the study suggest that firms can rely on board diversity, especially Chair-CEO diversity and pay incentives, as these crucial governance mechanisms that can drive firms to engage in sustainable business practices and achieve carbon emissions’ reductions. Next, the results of the study suggest that the ‘pay-for-sustainability’ sensitivity metric is contingent on the sustainability-based compensation policy. These findings suggest that firms can achieve greater carbon performance by linking executive compensation with actual carbon emission reduction targets. The results also show that investors tend to reward firms with superior self-reported carbon reduction initiatives and undervalue firms with an actual reduction in carbon emissions. This implies that firms can employ incentive-based mechanisms to symbolically enhance their self-reported carbon performance, which may not lead to actual greenhouse gases emissions’ reductions. Overall, the central contribution of this thesis is that board diversity and pay incentives play a crucial role in promoting sustainable board decisions and carbon emission reduction investments of firms. The findings have key implications for researchers, corporate executives and policymakers. First, future carbon footprint studies have to engage in both substantive (actual) and legitimisation (self-reported) investigations to enhance the robustness of the findings. Second, corporate executives are encouraged to adopt a more diverse board based on demographic attributes as crucial governance mechanisms, whilst shareholders should be encouraged to vote for board members from diverse demographic backgrounds and with diverse profiles. Third, policymakers are encouraged to push for sustainable business practices-related targets in compensation contracts which will motivate CEOs and executives to achieve such goals. Fourth, policymakers need to set mandatory targets on actual carbon emissions for firms. Fifth, the findings of the thesis call for rating agencies and analysts to focus on actual, validated reduction in carbon emissions of firms and no limit their analyses to self-reported reduction. In this context, the findings here offer strong evidence in support of the establishment of global sustainability standards. The final regulatory implication of the findings of this study relates to external assurance of sustainable business practices (i.e., distinct from credit rating agencies and financial analysts) as part of the audit report of a firm.