The Association between Outside Directors’ Compensation and ESG Performance: Evidence from Korean Firms

Abstract

Environmental, social, and corporate governance (ESG) has become essential for corporate sustainability. Among ESG activities, we focus on governance structure since firms can properly engage in activities related to environmental and social responsibility only when their corporate governance structures are well established. Outside directors play an important role in governance structure since they monitor the management and provide expertise to the board of directors. In this study, we pay particular attention to the compensation of outside directors, which reflects the effort, expertise, and independence of outside directors. Based on data from listed firms on the Korea Stock Exchange in South Korea between 2014 and 2020, we examine the association between outside directors’ compensation and ESG performance in certain firms with unique governance structures, namely, chaebols (or family firms). We find that the compensation of outside directors is positively associated with ESG performance, implying that outside directors’ compensation motivates effective monitoring and advisement of management and has an incremental effect on ESG performance. We suggest that the compensation of outside directors is one of the key factors that can significantly affect ESG performance. Therefore, investors and policymakers may evaluate whether a firm is doing well in terms of ESG activities by examining the compensation of outside directors.

1. Introduction

In 2006, the United Nations (UN) established the Principles for Responsible Investment, which reflect factors affecting environmental, social, and corporate governance (hereafter, ESG) in investment decisions. (The term “ESG” began to emerge after 2019 as threats to global sustainability intensified due to environmental pollution and other factors. Scholars who coined the term recognized that ESG can be directly connected to firm value.) Prompted by the outbreak of the COVID-19 pandemic, investors also began to respond actively and show interest in ESG management within firms (according to a 2018 report published by the Global Sustainable Investment Association, the percentage of investors considering the ESG factor in their decision making increased by 2.5% over the previous two years). Accordingly, research interest in ESG has greatly increased, also partly due to the outbreak of COVID-19.

On 20 April 2021, at the Boao Forum, the Asian version of the Davos Forum, SK Group Chairman Choi Tae-Won emphasized that ESG management is a matter of corporate survival. Since then, the Korea Chamber of Commerce and Industry has been promoting ESG management throughout the Korean economy. For long-term corporate survival and sustainable economic growth, firms must engage in ESG activities emphasizing eco-friendly management, social responsibility, and responsible governance alongside their financial activities [1,2].

Morgan Stanley Capital International, a representative ESG evaluation agency, views ESG as key to efficient resource distribution and corporate decision making. Firms managing their governance structures effectively and efficiently may be more sustainable in the long run [3,4]. The role of outside directors is considered especially important from the perspective of ESG in research based on agency theory and resource dependence theory [5,6,7]. This is because outside directors can not only monitor the management but also supply necessary expertise and diversity to the board of directors [8,9].

The effect of corporate governance characteristics on firm performance varies from country to country. Various institutional and environmental factors contribute to these differences [10,11,12]. In the United States, a representative free market economy, freedom of business activities and individual responsibility are emphasized rather than communal welfare and support provided by the state. On the other hand, Korea has a state-led market economy. Despite recognizing the influence of the institutional environment, most prior literature has been conducted in western countries such as the United States. Research on non-western cultures, especially Asian cultures, is relatively lacking [13,14,15]. Research using data from firms in western countries has revealed that greater independence, professionalism, and activity of the board of directors is associated with better performance in terms of corporate social responsibility (CSR) [9,16,17,18]. In studies targeting Asian countries, however, the relationship between the characteristics of the board of directors and CSR performance has not been consistently studied.

Since 1998, for all listed firms in Korea, outside directors must make up at least 25% of the total number of directors on the board. (Appointment of outside directors became mandatory for listed corporations under pressure to improve corporate governance after the 1998 financial crisis in Korea. As regulations on firms with assets of more than KRW 2 trillion have become stricter since 2003, firms have been forced to appoint at least three outside directors, and the number of outside directors must be a majority of the total number of directors.) Although this managerial control mechanism appears similar to that of western companies, most Korean companies only maintain the minimum appointment of outside directors as a formality to comply with legal regulations. Thus, the system for appointing outside directors in Korean firms has been criticized for lack of independence [19,20]. Outside directors hired only to meet legal requirements may have difficulty performing their roles independently from management [15]. In the case of a chaebol, which is a family firm with an owner-manager governance system, the board’s outside directors are subordinate to the owner, making it difficult for them to supervise, control, and check managerial behavior. Park and Kim [21] pointed out that the influence of outside directors is quite limited in Korea compared to that of internal directors because the average ownership stake of outside directors is very small compared to that of internal directors. Considering these characteristics of institutions in Korea, the impact of Korean outside directors on ESG performance as compared to western countries is difficult to predict.

No research on the compensation of outside directors in relation to ESG has been conducted in an Asian context, to our knowledge. Among the possible variables that proxy for the characteristics of outside directors, we examine the compensation of outside directors as a proxy for their expertise, effort, and independence [22,23,24]. The independence and expertise of outside directors may have no positive effect if they do not work hard. Compensation for outside directors is compounded by expertise, effort, and independence; therefore, this construct captures these characteristics all at once. The proxies used in previous studies for expertise and independence only capture certain features at a certain point, for example, input in the initial stage. In these studies, compensation, which is an intermediate stage variable, is determined by reflecting expertise, effort, and independence [25,26]. We predict an incremental effect of compensation of outside directors on ESG performance when controlling for other characteristics such as board size, the ratio of outside directors to all directors on the board, the professional ratio, and the gender ratio.

In research on the effect of compensation of outside directors on ESG performance, there are conflicting views [22,24,27]. Appropriate compensation for the time and effort of outside directors can strengthen the monitoring and advising function of the board of directors in terms of ESG activities. On the other hand, the compensation of outside directors may have a negative association with ESG performance. If their compensation is high, to maintain friendly relations with management and inside directors for career concerns, outside directors may not be able to independently criticize key issues regarding ESG activities. Thus, the compensation of outside directors may or may not have a positive effect on the governance structure and ESG performance.

This empirical study examines the association between the compensation of outside directors and ESG performance using data from Korean listed companies. Korea is relatively active in terms of ESG among Asian countries (Markets in Asian countries contributed nearly half of the transactions (APEC CEO Summit 2019) in the global market, and two-thirds of the human population of the world live in that region.). In Korea, many firms have a unique corporate governance structure based on owner management; these Korean companies are called chaebols or family firms. (The Fair Trade Commission of Korea determines a business group owned and operated by a founder-family to be a chaebol and specifies, among business groups, a large-scale business group (chaebol) as having total assets over KRW 10 trillion.)

We find that even after controlling for other firm characteristics such as board size, the ratio of outside directors to other directors on the board, the professional ratio, and the gender ratio, the compensation of outside directors is positively associated with ESG performance. In the analysis taking into account the endogeneity problem associated with compensation, the lag analysis controlling for confounding effects, and the excess compensation analysis, outside directors’ compensation showed a consistently positive relationship with ESG. On the other hand, no other characteristics of outside directors showed a consistent association with ESG across the various analyses. We suggest that compensation motivates outside directors to monitor and advise the management effectively. We find that the compensation of outside directors has an incremental effect on the ratio of outside directors and experts to all directors on the board, which we use as proxies for independence and expertise, respectively.

The contributions of our study are as follows: First, although studies on outside directors’ compensation have been conducted, examining firm value, investment efficiency, and earnings management, no study has been conducted regarding the association between outside directors’ compensation and ESG performance, to the best of our knowledge. Second, few studies have been conducted using data from non-western cultures, especially those in Asia, on the relationship between the characteristics of the board of directors and ESG. In this study, we analyze how various board characteristics affect ESG for Korean firms. The Korean setting sheds new light on governance structure in a somewhat different way from studies based on data from western cultures. Though Korean firms follow the Anglo-Saxon model, the chaebol (or family firms) governance structure persists in Korea. This unique structure may lead to different findings from those of prior studies based on western cultures. Third, we focus on how the compensation of outside directors can affect ESG performance differently from other attributes of the board, such as board size, the ratio of outside directors to internal directors and etc. Fourth, we provide incremental information to investors and regulators. Our results confirm that outside directors not only play a role in monitoring the management but also contribute to enhancing the firm’s reputation, which leads to the long-term growth of firms. Through their advice, networking, and communication with stakeholders, they apply their expertise and foster diversity in ways that internal management cannot do. Our findings suggest that our measure of outside directors’ compensation fully captures the expertise, effort, and independence of these board members, proving that the compensation of outside directors is one of the key factors that can significantly affect ESG performance. Therefore, investors and policymakers may evaluate whether a firm is doing well in terms of ESG activities by examining the compensation of outside directors. Furthermore, policymakers can utilize our empirical evidence to enhance their firms’ ESG activities and improve their boards by looking at the compensation of outside directors.

This paper is structured as follows. Section 2 deals with prior literature and develops the reasoning behind the hypothesis. Section 3 describes the sample selection process and the research design. Section 4 presents the empirical findings, and reports the results of the robustness tests. Finally, Section 5 concludes the study and mentions the contributions and limitations.

2. Theory and Hypothesis

2.1. Literature Review

2.1.1. ESG and the Board of Directors

Investors regard ESG as the core of sustainable corporate management. It is a major indicator of investment suitability. Disclosure of non-financial information about eco-friendly initiatives is therefore expanding. In addition, the COVID-19 pandemic, climate change, and deepening polarization of wealth have promoted a shift in the perception of what companies should be responsible for; they must now focus not only on financial performance but also on environmental and social externalities in their corporate activities. While ESG refers to how firms and investors integrate environmental, social, and governance concerns into their decision making, CSR emphasizes firms’ activities related to social responsibility [28]. Therefore, ESG may be seen as an extended version of CSR. There are three theoretical perspectives on CSR performance [29,30]. First, CSR performance can benefit both shareholders and stakeholders in the long term. Therefore, firms should focus more on CSR activities to increase the firm value [31,32]. Yoon et al. [33], using evidence from Korea, showed that the positive effect of ESG on valuation holds for emerging markets. The second perspective sees CSR activities as a response to social and institutional needs. In other words, various stakeholders expect or demand that firms be involved in fair trade regarding the purchase of raw materials and engage in volunteer activities that benefit the local community [34]. The third point of view is based on agency theory [35]. However, engagement in CSR activities can be used to further the private interests of management, thus affecting firm value negatively. With such a variety of perspectives, it is difficult to define each company’s CSR activities from a single perspective [29].

Since various motives are involved, the role of the board of directors requires attention. Previous studies mainly dealt with the association between characteristics of the board and CSR performance in terms of monitoring agency issues and coordinating interests, e.g., [8,36,37,38,39,40,41]. First, most studies measured board independence as the ratio of outside directors to other directors on the board. Existing studies on western cultures demonstrated a positive relationship between board independence and CSR performance [9,16,17,18]. On the other hand, not many studies have been conducted on non-western cultures, especially Asian cultures, and in those few studies that have been conducted, no consistent conclusion on the relationship between board independence and CSR performance has been reached. Chang et al. [20] found a non-linear correlation between board independence and CSR activities, which was interpreted as the board not playing a practical role in meeting stakeholders’ needs; outside directors were included simply for compliance with the Commercial Act. Some studies analyzing the expertise of outside directors based on resource dependence theory examined the diversity of the board of directors in terms of gender, disabilities, age, education level, and background, e.g., [42,43,44]. Other studies found a positive association between board diversity proxied by gender, but when expertise was measured by other measures, the findings were not significant [45,46]. The size of the board of directors and the number of meetings have been frequently examined, e.g., [19,36,47]. From the perspectives of agency theory and resource dependence theory, many papers showed that CSR performance increases as board activity increases. Prior studies stated that firms use outside directors to address stakeholder issues and interactively influence engagement in corporate social activity [41,48,49]. However, previous literature did not adequately determine the effects of characteristics related to the board of directors because proxies used in these studies do not fully capture outside directors’ expertise, effort, and independence. These properties are well reflected in the compensation of outside directors, an intermediate stage variable [25,26]. To our knowledge, no study on outside directors’ compensation in relation to ESG has been empirically conducted. To fill this gap, we examine the compensation of outside directors while controlling for measures used in previous studies that reflect independence, expertise, and activity.

2.1.2. Compensation of Board Members

Outside directors have the advantage of considering various stakeholders external to the firm and can effectively and independently supervise corporate CSR activities [50,51]. Research has demonstrated that compensation of directors on the board reflects their ability and effort [25,26,52,53]; many prior studies have analyzed compensation e.g., [22,24,27,52,54,55,56]. Not surprisingly, there are conflicting views regarding the compensation of outside directors. First, some studies argued that appropriate compensation can motivate outside directors to monitor management better. Perry [52] reported that the higher the incentive-based compensation paid to outside directors, the higher the probability of CEO replacement according to performance; high compensation was interpreted as a way of strengthening the monitoring effect. Cordeiro et al. [24] found that reasonable compensation can increase outside directors’ activities and the transparency of financial reports. Linn and Park [22] found a positive relationship between outside directors’ compensation and firm investment opportunities, implying that firms with more investment opportunities provide a higher level of compensation to outside directors than those with fewer investment opportunities. On the other hand, some studies suggested that the compensation of outside directors can have negative effects on firms. Crystal [54] stated that board members can collude with managers, and Jensen [55] found that compensation to outside directors above a certain level lowers management monitoring incentives; in fact, excessive compensation paid as a compromise actually hinders monitoring effects. Brick et al. [27] investigated whether excessive compensation for directors is related to the weak governance structure and low corporate performance; they found a positive association between these constructs and the compensation of CEOs and directors, suggesting that excessive compensation is associated with an inefficient monitoring environment. Hempel and Fay [56] analyzed the determinants of the level of compensation for outside directors in 225 major firms in the United States and found that only the number of board meetings and board size had a significant correlation with corporate performance. They argued that there was no relationship between outside directors’ compensation and corporate performance.

2.2. Hypothesis Development

Extensive research has demonstrated a positive relationship between CSR and valuation in advanced countries, while studies on the value relevance of CSR in emerging markets are few in number, and their results are inconsistent. However, recent papers provide some evidence of the positive effect of ESG on valuation in emerging markets [32,33]. The main function of the board in recent years has shifted to fulfilling their responsibility to various stakeholders’ interests for the firm’s sustainable development [41]. Nguyen et al. [41], using data from emerging Asian markets, provided evidence that the larger the board size, the more useful information the board could provide to managers, and the more independent the board of directors, the lower the cost between shareholders and managers in promoting ESG activities. Unlike prior studies, we examine outside directors’ compensation in response to their competence, which is comprised of expertise, effort, and independence; in this study, this construct captures these characteristics all at once.

For the board of directors to function effectively and efficiently, its members should be professional and able to make decisions independently. Independent outside directors can consider various stakeholders and effectively supervise corporate ESG activities [51], and they must be compensated accordingly. Previous studies also stated that appropriate compensation for the time and effort of outside directors can strengthen their monitoring and advising function [23,24,52]. Theoretically, the more compensation is paid to outside directors, the more effectively they will monitor ESG activity, and the higher the level of compensation, the more faithfully they will perform their duties.

According to agency theory, highly compensated outside directors can reduce potential agency problems between shareholders and managers to implement ESG strategies and performance [41]. Additionally, consistent with resource dependence theory, more highly compensated outside directors not only play a closer monitoring role but also facilitate access to resources such as expertise and provide diversity. (According to agency theory, the primary functions of boards are to monitor managers’ decisions on behalf of shareholders and align managers’ interests with those of shareholders [57]. However, the main function of the board in recent years has shifted to fulfilling their responsibility to various stakeholders’ interests for the firm’s sustainable development [41]. In order to deal with various stakeholders’ interests, firms must communicate effectively with stakeholders about every aspect of the organization. Members of the board of directors can communicate with external stakeholders effectively based on their various backgrounds and experience. The board’s resource provision role is important for organizations to manage stakeholders effectively, which supports the applicability of resource dependence theory in relation to ESG.) If the positive effects of monitoring and advising increase according to compensation, it is expected that ESG performance will be affected positively. On the other hand, if the pressure of controlling shareholders is strongly reflected in the appointment of outside directors [58,59,60], their compensation may not provide incentives for improved monitoring and control but may rather undermine their independence and promote opportunism [61]. In other words, to maintain friendly relations with management and inside directors for career concerns, outside directors may not be able to independently criticize key issues regarding ESG activities. In addition, there is considerable competition for places on the boards of firms that pay well, increasing the possibility that existing outside directors will not be re-elected and reducing board independence. In this way, the compensation of outside directors can have a negative association with ESG performance.

In some countries, the compensation of outside directors may have no significant relation with ESG because of corporate rotation policies. In Korea, the tenure of outside directors is limited to a maximum of six years (Article 34, Enforcement Decree of the Commercial Act). They can be re-elected, but if their tenure exceeds six years, including the current appointment period, they will lose their place on the board (for example, outside directors who have served for five years can be re-elected at regular shareholders’ meetings; however, after one year, they lose their positions on the board because the tenure cannot exceed six years). Outside directors whose tenure is coming to an end may not be interested in ESG activities, may not spend time to have firm-specific knowledge, and may not actively engage in ESG activities. This is consistent with the findings in prior literature that outside directors require a lot of time to accumulate sufficient knowledge about firms, and the more they serve, the better they can supervise the management using this accumulated knowledge [62,63]. Considering the characteristics of the Korean business environment, in which the influence of controlling shareholders is strongly reflected in the appointment of outside directors and in which the influence of outside directors on the board is limited, we see that the role of an outside director differs in Korea compared to western cultures. Due to the unique governance structure of chaebols (or family firms), the results of our study will differ from those based on data from western cultures. Specifically, the owners of family-owned firms have the freedom to be more actively involved in the firm’s ESG performance to improve their reputation while also exerting substantial influence on outside directors, which ultimately affects ESG activities negatively. In this study, we examine whether the high compensation of outside directors has a positive effect on corporate governance structure, which can lead to improved ESG performance. Using archival data, we verify the association between the compensation of outside directors and ESG performance. Therefore, we establish the following hypothesis 1, stated in a unidirectional form.

Hypothesis 1.

Outside directors’ compensation is significantly associated with ESG performance.

3. Research Design and Sample Selection

3.1. Sample Selection

We analyzed data for 3320 firm-years in a sample of firms listed on the Korea Stock Exchange from 2014 to 2020. The sample was limited to this seven-year period because data regarding gender on boards of directors, a control variable, were only available since 2014. We excluded firms in financial industries, firms with fiscal years that did not end on December 31, firms that did not receive an unqualified audit opinion, and firms with a loss in the beginning balance because data for these firms may cause bias in the results [64]. We also excluded firms without the necessary data for the ESG index, compensation of outside directors, and financial status. The sample selection process left us with a final sample of 3320 firm-year observations (see Appendix B of the sample selection process).

As a proxy for ESG performance, we used the KCGS’s CSR evaluation index. (The Korea Corporate Governance Service has published a social responsibility evaluation index for listed companies every year since 2011 in order to quantify the increase in CSR activities in the Korean capital market. The index is scored out of 300 points based on 43 detailed items (17 E items, 15 S items, and 11 G items) as of 2020 based on internal company data.) The index provides data for all listed companies, making it easy to derive reliable, comparable results. In particular, we expect that comprehensive and valuable results can be derived from an analysis using these data, as they come from various sources such as workers, partners, competitors, consumers, and local communities. The index is generally similar to Kinder, Lydenberg, and Domino’s Socrates database index, which is commonly used as a proxy for CSR activities in studies on U.S. companies [16]. Therefore, we expected few problems with instrumental validity. Financial and compensation data were obtained from Data Guide, provided by FnGuide, and other data regarding boards of directors, such as the gender ratio, numbers and positions of outside directors, and board size, were from the KIS-VALUE database. These Korean databases are similar to COMPUSTAT and CRSP, except that they provide data on Korean listed companies. All variables except the ESG index were winsorized in the upper and lower 1% of the sample.

3.2. Firm Clustered Regression Model

We utilized a firm-clustered regression model to examine our hypothesis using the equation specified below (1). We adopted a two-way fixed effect regression model with year and industry dummy variables.

ER (or SR or GR or ESG) = α₀ + β₁ PAYOUT (or PPAYOUT) + β₂ PAYIN
+ β₃ BOARD + β₄ OUTR + β₅ GENR + β₆ EXPR + β₇ SIZE+ β₈ LEV + β₉ ROA
+ β₁₀ ROCF + β₁₁ RDR+ β₁₂ GSALES + β₁₃ FOR+ β₁₄ LARGE + β₁₅ OWNER
+ β₁₆ FYERA+ β₁₇ BIG4 + year fixed effects + industry fixed effects + ε

(1)

where ER = environmental evaluation score obtained from the KCGS converted into one point; SR = social evaluation score obtained from KCGS converted into one point; GR = governance evaluation score obtained from KCGS converted into one point; ESG = ESG evaluation score obtained from KCGS converted into one point; PAYOUT = natural log of average compensation of outside directors; PPAYOUT = predicted value of natural log of average compensation of outside directors; PAYIN = natural log of average compensation of internal directors; BOARD = natural log of total number of directors on the board; OUTR = number of outside directors/total number of directors on the board; GENR = number of female outside directors/total number of outside directors; EXPR = number of outside directors with relevant expertise such as professors, certified public accountants, tax accountants, and lawyers/total number of outside directors; SIZE = natural logarithm of total sales; LEV = total liabilities/total equity; ROA = net income/total assets; ROCF = operating cash flow/total sales; RDR = R&D expenses/total sales; GSALES = growth ratio, which is equal to (sales − lagged sales)/lagged sales; FOR = share of foreign investors’ ownership; LARGE = share of controlling shareholders’ ownership; OWNER = share of management ownership; FYEAR = natural log of firm age; and BIG4 = an indicator of BIG 4 external auditor service (takes a value of 1 if the firm is audited by a BIG 4 auditor and 0 otherwise).

In Model (1), we examined the relationship between PAYOUT (or PPAYOUT), a variable of interest, and ESG performance (ER, SR, GR, and ESG). Consistent with the protocol in prior studies [65,66,67], ESG performance was formulated by standardizing the CSR index of KCGS on a one-point scale. The overall score of ER, SR, GR, and ESG was then expressed as a percentage ranging from 0 to 100 percent. To calculate PAYOUT, we used the log value of the average cash compensation of outside directors to alleviate heterogeneity within the model. (In Korean companies, granting stock options or stocks to outside directors is extremely rare; therefore, we only include total cash compensation in the analysis. We confirmed that stock options were given in 32 firms among 3320 firm-year observations. Excluding these firms, we see that the main results do not change.) In addition, we added the predicted value of PAYOUT to the interest variable to eliminate the endogeneity problem with outside directors’ compensation. Since the level of compensation for internal directors affects outside directors’ compensation, and internal directors can also affect ESG performance, we controlled PAYIN. To analyze the incremental effect of outside directors’ compensation, we controlled for other critical factors related to board structure and directors’ characteristics that may have also impacted ESG performance. Thus, we included BOARD and OUTR as proxies for board independence, and GENR and EXPR as proxies for board diversity and expertise, respectively.

Following the protocol in prior studies [16,35,68], we controlled for SIZE, LEV, ROA, ROCF, RDR, GSALES, FOR, LARGE, OWNER, FYEAR, and BIG4, which significantly impact ESG performance. Finally, we included year and industry-fixed effects to control for unobservable factors such as seasonal and business characteristics.

3.3. Measuring Predicted Value of Outside Directors’ Compensation (PPAYOUT)

Additionally, we utilized the two-stage least squares regression approach to address the potential endogeneity problem with outside directors’ compensation, which is influenced by executive compensation and other exogenous factors. In the first step, the predicted value (PPAYOUT) was estimated using the following model (2).

PAYOUT_t = α₀ + β₁ TPAY_t−1 + β₂ SIZE_t−1 + β₃ GSALES_t−1 + β₄ LEV_t−1
+ β₅ VOL_t−1 + β₆ TOBINQ_t−1 + year fixed effects + industry fixed effects + ε

(2)

where PAYOUT = natural log of the average compensation of outside directors; TPAY = natural log of total compensation of executives; SIZE = natural logarithm of total sales; GSALES = growth ratio, which is equal to (sales − lagged sales)/lagged sales; LEV = total liabilities/total equity; VOL = stock return volatility, defined as the standard deviation of daily stock returns; and TOBINQ = marker of value of equity/book value of equity.

Following the protocol in studies that analyze the determinants of directors’ compensation [27,69,70,71], we included as exogenous factors TPAY, SIZE, GSALES, LEV, and VOL for the fiscal year prior to the compensation observation. In addition, we included TOBINQ as an instrumental variable for compensation of outside directors by confirming that TOBINQ is related to PAYOUT and uncorrelated with the regression residuals in (1). The results of the first-stage analysis revealed a significantly negative relationship between VOL and LEV and PAYOUT, as in previous studies. In addition, TPAY, SIZE, GSALES, and TOBINQ showed significant positive correlations with PAYOUT.

In the first stage, we obtained the predicted value (PPAYOUT) using the coefficient estimates in Equation (2), and in the second stage, we replaced PAYOUT with PPAYOUT in Equation (1) to re-verify the impact of outside directors’ compensation on ESG performance.

4. Results

4.1. Descriptive Statistics

Table 1. Descriptive statistics (N = 3320).

	Mean	SD	Min	Median	Max
ER	0.285	0.226	0.000	0.206	1.000
SR	0.260	0.178	0.000	0.224	1.000
GR	0.263	0.154	0.000	0.250	1.000
ESG	0.255	0.194	0.000	0.221	1.000
PAYOUT	10.318	0.702	8.294	10.404	11.728
PPAYOUT	10.302	0.423	9.471	10.243	11.461
PAYIN	12.596	0.896	10.480	12.508	14.964
BOARD	1.671	0.362	1.099	1.609	2.485
OUTR	0.399	0.158	0.250	0.333	0.857
GENR	0.099	0.239	0.000	0.000	1.000
EXPR	0.342	0.381	0.000	0.250	1.000
SIZE	19.484	1.780	15.516	19.360	24.075
LEV	0.996	1.191	0.019	0.663	7.822
ROA	0.017	0.076	−0.311	0.023	0.213
ROCF	0.087	0.191	−0.547	0.062	0.903
RDR	0.018	0.038	0.000	0.004	0.243
GSALES	0.026	0.245	−0.699	0.010	1.294
FOR	10.244	12.675	0.000	4.946	58.712
LARGE	43.378	16.389	8.220	43.530	82.860
OWNER	0.069	0.208	0.000	0.000	1.620
FYEAR	3.691	0.549	1.386	3.871	4.828
BIG4	0.626	0.484	0.000	1.000	1.000

ER = environmental evaluation score obtained from the KCGS converted into one point; SR = social evaluation score obtained from KCGS converted into one point; GR = governance evaluation score obtained from KCGS converted into one point; ESG = ESG evaluation score obtained from KCGS converted into one point; PAYOUT = natural log of average compensation of outside directors; PPAYOUT = predicted value of natural log of average compensation of outside directors; PAYIN = natural log of average compensation of internal directors; BOARD = natural log of total number of directors on the board; OUTR = number of outside directors/total number of directors on the board; GENR = number of female outside directors/total number of outside directors; EXPR = number of outside directors with relevant expertise such as professors, certified public accountants, tax accountants, and lawyers/total number of outside directors; SIZE = natural logarithm of total sales; LEV = total liabilities/total equity; ROA = net income/total assets; ROCF = operating cash flow/total sales; RDR = R&D expenses/total sales; GSALES = growth ratio, which is equal to (sales − lagged sales)/lagged sales; FOR = share of foreign investors’ ownership; LARGE = share of controlling shareholders’ ownership OWNER = share of management ownership; FYEAR = natural log of firm age; BIG4 = an indicator of BIG 4 external auditor service (takes a value of 1 if the firm is audited by a BIG 4 auditor and 0 otherwise).

shows the descriptive statistics of all variables included in the study. There are four main dependent variables related to ESG performance: the environmental index (ER), social index (SR), governance index (GR), and ESG integrated index (ESG): The mean values of these variables are 0.285, 0.260, 0.263, and 0.255, respectively. This implies that there is no significant difference between variables. The average compensation for outside directors (PAYOUT) is 10.318, and the average predicted value of outside directors’ compensation (PPAYOUT) is 10.302. The lack of significant difference between these two variables means that the compensation of outside directors is mostly composed of explained portion. Additionally, the mean value of internal directors’ compensation (PAYIN) is 12.596, which is higher than that of outside directors (PAYOUT). The exponential conversion values of PAYIN and PAYOUT, which are natural logarithmic variables, are KRW 295 million and KRW 30 million, respectively. This means that the influence of internal directors in Korean companies is much greater than that of outside directors. Finally, the average percentage of female outside directors is 0.099, implying that only 9.9% of sample firms have female outside directors and that firms engaged in ESG are not yet diverse in terms of gender.

4.2. Correlations

Table 2. Correlation matrix (N = 3320).

	SR (2)	GR (3)	ESG (4)	PAYOUT (5)	PPAYOUT (6)	PAYIN (7)	BOARD (8)	OUTR (9)	GENR (10)	EXPR (11)	SIZE (12)	LEV (13)	ROA (14)	ROCF (15)	RDR (16)	GSALES (17)	FOR (18)	LARGE (19)	OWNER (20)	FYEAR (21)	BIG4 (22)
ER (1)	0.776	0.652	0.930	0.302	0.472	0.226	0.254	0.197	−0.001	0.005	0.467	0.139	0.092	−0.029	−0.004	−0.042	0.261	−0.079	−0.024	0.043	0.207
	<0.000	<0.000	<0.000	<0.000	<0.000	<0.000	<0.000	<0.000	0.962	0.766	<0.0001	<0.0001	<0.0001	0.098	0.815	0.016	<0.0001	<0.0001	0.173	0.013	<0.0001
(2)	1.000	0.726	0.927	0.375	0.583	0.326	0.310	0.288	−0.007	0.046	0.487	0.083	0.145	0.059	0.063	−0.007	0.341	−0.067	−0.000	0.008	0.311
		<0.000	<0.000	<0.000	<0.000	<0.000	<0.000	<0.000	0.683	0.008	<0.0001	<0.0001	<0.0001	0.001	0.000	0.707	<0.0001	0.000	0.978	0.655	<0.0001
(3)		1.000	0.833	0.244	0.393	0.170	0.204	0.168	−0.047	0.017	0.236	−0.004	0.133	0.067	0.043	0.020	0.221	−0.044	0.033	0.010	0.214
			1.000	<0.0001	<0.000	<0.000	<0.000	<0.000	0.007	0.314	<0.0001	0.822	<0.0001	0.000	0.012	0.257	<0.0001	0.011	0.061	0.564	<0.0001
(4)				0.346	0.542	0.273	0.289	0.244	−0.015	0.024	0.465	0.096	0.131	0.025	0.033	−0.017	0.308	−0.074	−0.003	0.026	0.269
				1.000	<0.000	<0.000	<0.000	<0.000	0.396	0.162	<0.0001	<0.0001	<0.0001	0.144	0.061	0.314	<0.0001	<0.0001	0.850	0.134	<0.0001
(5)					0.607	0.450	0.226	0.192	−0.014	0.090	0.464	0.027	0.131	0.162	0.046	−0.003	0.354	−0.009	−0.014	−0.047	0.369
					<0.000	<0.000	<0.000	<0.000	0.427	<0.0001	<0.0001	0.117	<0.0001	<0.0001	0.008	0.847	<0.0001	0.614	0.424	0.006	<0.0001
(6)					1.000	0.685	0.512	0.450	0.000	0.075	0.760	0.086	0.203	0.222	0.044	−0.040	0.546	−0.041	−0.015	−0.028	0.462
						<0.000	<0.000	<0.000	0.978	<0.0001	<0.0001	<0.0001	<0.0001	<0.0001	0.012	0.021	<0.0001	0.018	0.384	0.105	<0.0001
(7)						1.000	0.267	0.384	0.032	0.095	0.538	−0.025	0.227	0.228	0.140	0.017	0.436	−0.094	0.043	−0.058	0.322
							<0.000	<0.000	0.066	<0.0001	<0.0001	0.151	<0.0001	<0.0001	<0.0001	0.321	<0.0001	<0.0001	0.013	0.001	<0.0001
(8)							1.000	0.287	−0.018	0.048	0.469	0.061	0.052	0.046	0.076	0.014	0.362	−0.167	0.032	−0.062	0.258
								<0.000	0.303	0.006	<0.0001	0.000	0.003	0.009	<0.0001	0.433	<0.0001	<0.0001	0.062	0.000	<0.0001
(9)								1.000	0.130	0.015	0.414	0.088	0.052	0.074	0.054	−0.014	0.272	−0.076	0.003	−0.048	0.243
									<0.0001	0.378	<0.0001	<0.0001	0.003	<0.0001	0.002	0.412	<0.0001	<0.0001	0.853	0.006	<0.0001
(10)									1.000	−0.014	0.025	0.029	−0.014	−0.011	0.057	0.018	−0.002	−0.001	−0.007	−0.032	0.027
										0.426	0.143	0.098	0.432	0.510	0.001	0.295	0.903	0.962	0.684	0.068	0.124
(11)										1.000	0.039	−0.110	0.076	0.078	0.062	0.001	0.077	0.011	0.004	−0.101	0.073
											0.026	<0.0001	<0.0001	<0.0001	0.000	0.950	<0.0001	0.508	0.803	<0.0001	<0.0001
(12)											1.000	0.237	0.214	−0.053	−0.056	0.009	0.477	−0.061	0.027	−0.072	0.389
												<0.0001	<0.0001	0.002	0.001	0.599	<0.0001	0.000	0.123	<0.0001	<0.0001
(13)												1.000	−0.293	−0.189	−0.101	−0.033	−0.114	−0.083	0.059	0.017	0.052
													<0.0001	<0.0001	<0.0001	0.060	<0.0001	<0.0001	0.001	0.325	0.003
(14)													1.000	0.321	−0.001	0.200	0.258	0.185	−0.011	−0.056	0.131
														<0.0001	0.976	<0.0001	<0.0001	<0.0001	0.545	0.001	<0.0001
(15)														1.000	0.065	0.082	0.186	0.164	−0.073	−0.027	0.189
															0.000	<0.0001	<0.0001	<0.0001	<0.0001	0.121	<0.0001
(16)															1.000	−0.038	0.103	−0.175	0.046	−0.016	0.082
																0.030	<0.0001	<0.0001	0.008	0.348	<0.0001
(17)																1.000	0.011	0.006	0.012	−0.035	−0.010
																	0.519	0.716	0.486	0.041	0.554
(18)																	1.000	−0.199	−0.068	−0.058	0.269
																		<0.0001	<0.0001	0.001	<0.0001
(19)																		1.000	−0.140	−0.098	0.084
																			<0.0001	<0.0001	<0.0001
(20)																			1.000	0.010	−0.029
																				0.579	0.095
(21)																				1.000	−0.092
																					<0.0001

Pearson correlations are reported. p-values are presented in parentheses. See Appendix A for variable definitions.

shows the results of the Pearson correlation analysis. As shown in the table, the dependent variables (ER, SR, GR, and ESG) have a significant positive correlation with the variables of interest (PAYOUT and PPAYOUT). This indirectly suggests that outside directors’ compensation has a positive effect on ESG performance. Similar to the situation in prior studies [16,35,72], the correlations between ESG performance and PAYIN, BOARD, OUTR, SIZE, ROA, and BIG4 are 0.273, 0.289, 0.244, 0.465, 0.131, and 0.269, respectively; all these values are significant at the 1 percent level. In other words, for the firms in the sample, ESG performance increases according to the average pay for internal directors, total number of board members, ratio of outside directors to other directors on the board, firm size, profitability, and whether the firm is audited by BIG 4 auditors. The variables for ownership structure, FOR and LARGE, also showed significant positive and negative correlations with ESG. This means that foreign investors are interested in ESG activities, while the largest shareholder is uninterested in ESG activities.

4.3. Outside Directors’ Compensation and ESG Performance

Table 3. Impact of compensation of outside directors on ESG performance.

	Dependent Variables
VARIABLES	ER	SR	GR	ESG	ER	SR	GR	ESG
PAYOUT	0.018 ***	0.019 ***	0.006 **	0.017 ***
	(3.06)	(4.89)	(1.99)	(4.46)
PPAYOUT					0.127 ***	0.154 ***	0.043 ***	0.129 ***
					(5.24)	(8.72)	(3.27)	(7.73)
PAYIN	0.002	0.009 **	0.007 ***	0.007 *	−0.012 **	−0.009 **	0.003	−0.008 **
	(0.35)	(2.26)	(2.61)	(1.78)	(−2.04)	(−2.13)	(0.84)	(−1.97)
BOARD	0.024 *	0.021 **	0.025 ***	0.026 ***	0.004	−0.003	0.019 ***	0.006
	(1.86)	(2.41)	(4.09)	(3.08)	(0.30	(−0.31)	(2.92)	(0.72)
OUTR	0.071 ***	0.109 ***	0.092 ***	0.103 ***	0.051 **	0.085 ***	0.085 ***	0.082 ***
	(2.87)	(5.67)	(7.04)	(5.84)	(2.03)	(4.65)	(6.55)	(4.80)
GENR	0.017 *	−0.003	−0.008	0.003	0.018 *	−0.002	−0.008	0.004
	(1.81)	(−0.40)	(−1.58)	(0.49)	(1.83)	(−0.33)	(−1.56)	(0.56)
EXPR	0.007	0.011 *	0.007 *	0.010	0.008	0.011 *	0.007*	0.010 *
	(0.80)	(1.68)	(1.65)	(1.62)	(0.85)	(1.73)	(1.68)	(1.69)
SIZE	0.048 ***	0.034 ***	0.008 ***	0.036 ***	0.036 ***	0.018 ***	0.004 *	0.023 ***
	(13.48)	(13.64)	(4.03)	(15.20)	(8.14)	(5.96)	(1.75)	(8.08)
LEV	0.003	0.000	−0.004 **	0.000	0.004	0.002	−0.004 **	0.001
	(0.76)	(0.02)	(−2.47)	(−0.10)	(1.12)	(0.67)	(−2.15)	(0.48)
ROA	−0.098 **	−0.064 *	0.008	−0.064 **	−0.061	−0.016	0.021	−0.025
	(−2.13)	(−1.84)	(0.30)	(−2.01)	(−1.38)	(−0.49)	(0.82)	(−0.84)
ROCF	0.023	0.028 *	0.031 ***	0.031 **	−0.012	−0.016	0.019 **	−0.005
	(1.25)	(1.79)	(3.35)	(2.23)	(−0.61)	(−1.06)	(2.02)	(−0.40)
RDR	−0.066	0.239 *	0.162 **	0.122	−0.085	0.215	0.155 *	0.103
	(−0.37)	(1.79)	(2.00)	(0.85)	(−0.46)	(1.57)	(1.88)	(0.69)
GSAELS	−0.047 ***	−0.014 *	−0.007	−0.027 ***	−0.037 ***	−0.002	−0.003	−0.017 **
	(−4.33)	(−1.76)	(−1.08)	(−3.62)	(−3.46)	(−0.24)	(−0.51)	(−2.42)
FOR	0.053	0.099 ***	0.086 ***	0.090 **	0.019	0.056	0.074 **	0.055 *
	(1.23)	(2.59)	(2.95)	(2.83)	(0.42)	(1.48)	(2.56)	(1.68)
LARGE	−0.060 **	0.000	−0.003	−0.025	−0.070 **	−0.014	−0.007	−0.036 *
	(−2.11)	(−0.01)	(−0.19)	(−1.32)	(−2.46)	(−0.68)	(−0.41)	(−1.88)
OWNER	−3.802	−1.159	1.600 *	−1.526	−3.302	−0.534	1.771 **	−1.010
	(−1.52)	(−0.93)	(1.92)	(−1.06)	(−1.30)	(−0.44)	(2.09)	(−0.68)
FYEAR	0.007	0.002	−0.005	0.002	0.004	−0.002	−0.006*	−0.001
	(0.88)	(0.33)	(−1.40	(0.37)	(0.49)	(−0.32)	(−1.67)	(−0.23)
BIG4	−0.014	0.009*	0.008 **	0.001	−0.016 *	0.005	0.007 *	−0.002
	(−1.55)	(1.74)	(1.97)	(0.13)	(−1.88)	(0.98)	(1.74)	(−0.48)
Constant	−1.120 ***	−0.913 ***	−0.257 ***	−0.966 ***	−1.759 ***	−1.714 ***	−0.476 ***	−1.626 ***
	(−12.51)	(−14.78)	(−4.98)	(−15.54)	(−10.16)	(−14.21)	(−4.56)	(−13.65)
Observations	3320	3320	3320	3320	3320	3320	3320	3320
Year fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Industry fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Adj R-squared	0.658	0.673	0.790	0.780	0.843	0.844	0.857	0.865

***, **, and * represent significance at the 1, 5, and 10 percent levels of p-value, respectively, based on a two-tailed test. T-statistics based on robust standard errors clustered by firm are presented in parentheses. See Appendix A for variable definitions.

shows the results of testing the hypothesis regarding the association between outside directors’ compensation and ESG performance. The compensation of outside directors (PAYOUT) positively affects values for the ESG performance indexes (ER, SR, GR, and ESG), suggesting that firms paying higher compensation to outside directors have higher ESG performance. In other words, the coefficient of 0.017 for PAYOUT implies that an increase in outside directors’ compensation by 1 unit increases ESG values by 1.7 basis points (bps). This result still holds when using the predicted value of outside directors’ compensation (PPAYOUT). The coefficient of PPAYOUT is 0.129, which means that an increase in the explained portion of outside directors’ compensation by 1 unit increases ESG values by 12.9 bps, which is higher than PAYOUT. This implies that the high compensation of outside directors motivates them to fulfill their monitoring role, which, in turn, affects ESG performance positively. Unlike in other countries, the tenure of outside directors is legally limited to a maximum of six years in Korea which helps to ensure their independence. Additionally, during their six years as outside directors, they accumulate firm-specific knowledge, contributing their expertise to enhance firm performance. Furthermore, family-owned conglomerates in Korea are expected to be more involved in ESG activities to avoid criticism from the public and government related to owner risk problems, political scandals, and tunneling issues [33,73]. Therefore, unlike in western countries, outside directors’ compensation in Korea can have a considerable impact on ESG performance. Due to the unique governance structure of chaebols (or family firms), the results of our study will differ from those based on data from western cultures. The results for the compensation of outside directors are consistent in all columns, but the results for internal directors’ compensation (PAYIN) differ in each column. This finding may be interpreted as follows: the PAYIN variable can have various effects on ESG depending on the circumstances.

Examining other characteristics of the board of directors, first, we see that the BOARD variable has a generally positive relationship with ESG, as in previous studies [19,37,41]. This means that as the number of directors and their activity increase, ESG performance improves. Second, the proportion of outside directors (OUTR) has a positive correlation with the ESG performance indexes (ER, SR, GR, and ESG), as in prior studies [16,17,18,41], which indicates that the independence of outside directors is important for effective ESG management. Third, interestingly, the ratio of female outside directors to males (GENR) is not significantly related to the ESG performance indexes (SR, GR, and ESG) except for the environmental index (ER). This result indirectly suggests that the role of female directors may be more important for environmental management among sample firms. A positive relationship between GENR and CSR has been consistently demonstrated in several studies targeting U.S. companies [42,43,44]. No studies have been conducted on Korean companies; thus, we, for the first time, provide evidence relating to GENR, the gender ratio of outside directors, in the Korean context. Finally, EXPR appears to be positively related to SR, GR, and ESG, suggesting that having more experts on the board, such as accountants, lawyers, and professors, can improve ESG performance. Previous studies analyzed only some of the BOARD, OUTR, GENR, and EXPR; however, this study analyzes the characteristics of outside directors in various ways by adding PAYOUT and controlling many related variables.

Although values are slightly different for each column, in general, SIZE, ROCF, FOR, and BIG4 among the control variables show a significant positive correlation with ESG performance, as in prior studies [16,35,72]. As firm visibility increases due to increased size and auditing by BIG 4 auditors, and cash flow improves in accordance with slack resources theory, ESG activity increases.

4.4. Robustness Test: Lag Analysis

To offset the possibility of reverse causality in our model, we include lagged values of the control variables and variables of interest in the model to verify our results in Table 3.

Table 4. Additional test using lagged values.

	Dependent Variables
VARIABLES	ER	SR	GR	ESG	ER	SR	GR	ESG
PAYOUT	0.013 ***	0.015 ***	0.006 **	0.014 ***
	(2.03)	(4.08)	(2.00)	(3.51)
PPAYOUT					0.120 ***	0.127 ***	0.032 **	0.112 ***
					(4.87)	(7.66)	(2.22)	(6.86)
PAYIN	0.002	0.010 **	0.010 ***	0.008 **	−0.014 **	−0.006	0.006 *	−0.006
	(0.36)	(2.54)	(3.42)	(2.07)	(−2.05)	(−1.44)	(1.87)	(−1.41)
BOARD	0.020	0.022 **	0.024 ***	0.025 ***	0.001	0.001	0.018 **	0.006
	(1.43)	(2.41)	(3.30)	(2.60)	(0.04)	(0.12)	(2.49)	(0.65)
OUTR	0.081 ***	0.121 ***	0.094 ***	0.113 ***	0.059 **	0.098 ***	0.087 ***	0.092 ***
	(2.91)	(5.55)	(6.21)	(5.49)	(2.15)	(4.65)	(5.76)	(4.64)
GENR	0.013	0.000	−0.011**	0.002	0.016	0.002	−0.011 **	0.004
	(1.39)	(0.02)	(−2.16)	(0.32)	(1.62)	(0.36)	(−2.05)	(0.66)
EXPR	0.006	0.014 **	0.006	0.010*	0.006	0.013 **	0.006	0.010 *
	(0.68)	(2.32)	(1.38)	(1.80)	(0.61)	(2.19)	(1.36)	(1.69)
SIZE	0.047 ***	0.030 ***	0.004 *	0.033 ***	0.036 ***	0.019 ***	0.001	0.023 ***
	(11.82)	(11.59)	(1.72)	(12.20)	(7.94)	(6.11)	(0.44)	(7.48)
LEV	0.001	−0.001 **	−0.001 *	0.000	0.001	−0.001 **	−0.001 **	0.000
	(1.18)	(−2.39)	(−1.96)	(−0.55)	(1.20)	(−2.45)	(−1.97)	(−0.51)
ROA	−0.048	−0.034	0.045 **	−0.019	−0.048	−0.035	0.045 **	−0.020
	(−1.25)	(−1.31)	(2.34)	(−0.72)	(−1.40)	(−1.52)	(2.29)	(−0.83)
ROCF	0.000	0.000 ***	0.000 *	0.000 ***	0.000	0.000 ***	0.000	0.000 **
	(1.62)	(3.87)	(1.69)	(2.77)	(0.86)	(3.82)	(1.05)	(2.31)
RDR	0.013 ***	0.008 ***	−0.001	0.008 ***	0.010 ***	0.005 ***	−0.001	0.006 ***
	(5.81)	(3.94)	(−0.54)	(4.32)	(5.40)	(3.87)	(−1.00)	(4.30)
GSAELS	0.000	0.000 ***	0.000	0.000	0.000	0.000 ***	0.000	0.000
	(1.49)	(3.40)	(−1.23)	(1.48)	(1.21)	(2.86)	(−1.57)	(1.07)
FOR	0.043	0.079 **	0.086 ***	0.077 ***	0.001	0.035	0.076 **	0.039
	(1.06)	(2.25)	(2.81)	(2.74)	(0.02)	(0.94)	(2.46)	(1.27)
LARGE	−0.037	0.011	−0.003	−0.011	−0.052 *	−0.005	−0.007	−0.025
	(−1.30)	(0.62)	(−0.16)	(−0.62)	(−1.82)	(−0.24)	(−0.39)	(−1.39)
OWNER	−0.792	0.362	0.521	−0.010	−0.665	0.493	0.549	0.104
	(−0.46)	(0.61)	(1.52)	(−0.01)	(−0.40)	(0.81)	(1.57)	(0.13)
FYEAR	0.003	0.001	−0.007 *	−0.001	0.000	−0.003	−0.008 **	−0.004
	(0.43)	(0.18)	(−1.78)	(−0.11)	(0.00)	(−0.50)	(−1.99)	(−0.76)
BIG4	−0.004	0.015 ***	0.010 **	0.008	−0.010	0.009 *	0.009 **	0.003
	(−0.46)	(3.01)	(2.42)	(1.47)	(−1.07)	(1.92)	(2.09)	(0.52)
Constant	−1.050 ***	−0.835 ***	−0.189 ***	−0.884 ***	−1.678 ***	−1.495 ***	−0.343 ***	−1.461 ***
	(−11.84)	(−14.83)	(−3.68)	(−15.50)	(−9.65)	(−13.65)	(−3.14)	(−12.95)
Observations	2643	2643	2643	2643	2643	2643	2643	2643
Year fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Industry fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Adj R-squared	0.600	0.649	0.705	0.736	0.607	0.660	0.706	0.744

***, **, and * represent significance at the 1, 5, and 10 percent levels of p-value, respectively, based on a two-tailed test. T-statistics based on robust standard errors clustered by firm are presented in parentheses. See Appendix A for variable definitions.

shows the results of the lag analysis. The compensation of outside directors (PAYOUT and PPAYOUT) has a significant positive association with the ESG performance indexes (ER, SR, GR, and ESG), which is consistent with the results reported in Table 3. We thus confirm that the results of the analysis, including lagged values, are qualitatively similar to those of the main analysis.

4.5. Additional Test: Incremental Effect of Compensation of Outside Directors on OUTR and EXPR

We perform an additional test to verify that outside directors’ compensation (PPAYOUT) (in this analysis, we report only PPAYOUT results due to lack of space; in all analyses, PAYOUT results are qualitatively the same as those in the main analysis) has an incremental effect on the ratio of outside directors to all directors on the board (OUTR), a proxy for independence, and the ratio of experts (EXPR), a proxy for expertise. Accordingly, we classify the firms in the sample according to OUTR (or EXPR) to examine the effect of compensation for outside directors for different ratios of outside directors and experts on the board. In addition, we verify whether the interaction term of outside directors’ compensation and these ratios has a significant incremental effect.

Table 5. Additional test: incremental effect of compensation of outside directors on OUTR and EXPR.

	Dependent Variables: ESG (The Results of the Analysis and Subsamples Classified by ER, SR, and GR Were also Qualitatively Similar to the Main ESG Analysis Results.)
	Incremental Effect of PPAYOUT on OUTR			Incremental Effect of PPAYOUT on EXPR
VARIABLES	OUTR ≤ 0.25	OUTR > 0.25	Interaction Analysis	EXPR ≤ 0.25	EXPR > 0.25	Interaction Analysis
PPAYOUT	0.082 ***	0.138 ***	0.127 ***	0.148 ***	0.105 ***	0.127 ***
	(3.71)	(6.62)	(7.54)	(6.93)	(4.58)	(7.64)
PAYIN	−0.002	−0.009 *	−0.008 *	−0.011 **	−0.005	−0.008 **
	(−0.40)	(−1.80)	(−1.90)	(−2.23)	(−0.89)	(−1.99)
PPAYOUT* OUTD			0.001 **
			(2.10)
PPAYOUT* EXPD						0.003 **
						(2.50)
BOARD	−0.003	0.006	0.009	0.006	0.016	0.012
	(−0.22)	(0.53)	(1.02)	(0.53)	(1.16)	(1.23)
OUTR	−0.094	0.109 ***	0.107 ***	0.088 ***	0.082 ***	0.092 ***
	(−0.71)	(4.76)	(4.71)	(3.81)	(2.9)	(5.04)
GENR	0.001	0.001	0.003	−0.004	0.020	0.004
	(0.14)	(0.14)	(0.52)	(−0.54)	(1.95)	(0.61)
EXPR	0.016 **	0.007	0.010*	0.092	0.037 **	0.041 ***
	(2.26)	(0.83)	(1.73)	(1.52)	(2.15)	(3.23)
Control variables	included	included	included	included	included	included
Observations	1069	2251	3320	1740	1580	3320
Year fixed effects	Yes	Yes	Yes	Yes	Yes	Yes
Industry fixed effects	Yes	Yes	Yes	Yes	Yes	Yes
Adj R-squared	0.814	0.784	0.787	0.807	0.775	0.788

***, **, and * represent significance at the 1, 5, and 10 percent levels of p-value, respectively, based on a two-tailed test. T-statistics based on robust standard errors clustered by firm are presented in parentheses. OUTD: A dummy variable that takes a value of 1 if OUTR is greater than 0.25, and 0 otherwise; EXPD: A dummy variable that takes a value of 1 if EXPR is greater than 0.25, and 0 otherwise. See Appendix A for variable definitions.

presents the results for the incremental effect of outside directors’ compensation on the proportion of outside directors and experts on the board. Whether the ratio of outside directors (OUTR) is low or high, outside directors’ compensation (PPAYOUT) has a significant positive association with ESG. This is also true in the subgroup illustrating the expert ratio (EXPR), meaning that outside directors’ compensation has a positive effect on ESG performance regardless of OUTR and EXPR. In subsamples with low and high ratios of outside directors to all board members, the coefficient values of OUTR are not significant (t-value = −0.71) and significantly positive (t-value = 4.76), respectively. In Korea, listed firms are obliged to have at least 25% of the board made up of outside directors; therefore, we interpret this result as follows: outside directors appointed as a formality to comply with the law had no substantial impact on ESG activities in the firms in our sample. In the subsamples in which EXPR is low and high, the results for EXPR were not significant (t-value 1.52) and significantly positive (t-value = 2.15), respectively, suggesting that hiring only a few experts as a formality may not affect ESG performance.

Moreover, as shown in Table 5, the interaction term PPAYOUT * OUTD (or EXPD) is still positively related to ESG, supporting our main results. This confirms that outside directors’ compensation has an incremental effect on OUTR and EXPR.

4.6. Additional Test: Effect of Excess Compensation of Outside Directors

As mentioned earlier, there are conflicting views regarding the compensation of outside directors. Appropriate levels of compensation can motivate outside directors to monitor the management effectively, whereas excessive pay can hinder the independence of outside directors. Therefore, in this section, we perform an additional test to verify whether excess compensation of outside directors drives the differences between results by estimating the residual value of outside directors’ compensation. (RPAYOUT is measured as a residual value in the PPAYOUT estimation Model (2). Refer to the analysis of Brick et al. (2006) for more information about excess compensation.)

Table 6. Additional test: effect of excess compensation of outside directors.

Dependent Variables
VARIABLES	ER	SR	GR	ESG
RPAYOUT	0.014 **	0.015 ***	0.005 *	0.013 ***
	(2.42)	(4.30)	(1.89)	(3.74)
PAYIN	0.005	0.012 ***	0.008 ***	0.009 **
	(0.82)	(2.92)	(2.94)	(2.41)
BOARD	0.025 *	0.023 ***	0.026 ***	0.027 ***
	(1.94)	(2.59)	(4.16)	(3.22)
OUTR	0.070 ***	0.107 ***	0.092 ***	0.099 ***
	(2.79)	(5.59)	(7.01)	(5.74)
GENR	0.017 *	−0.003	−0.008	0.003
	(1.80)	(−0.40)	(−1.57)	(0.49)
EXPR	0.008	0.011 *	0.007 *	0.010 *
	(0.83)	(1.71)	(1.66)	(1.66)
Control variables	included	included	included	included
Observations	3320	3320	3320	3320
Year fixed effects	Yes	Yes	Yes	Yes
Industry fixed effects	Yes	Yes	Yes	Yes
Adj R-squared	0.657	0.672	0.790	0.780

***, **, and * represent significance at the 1, 5, and 10 percent levels of p-value, respectively, based on a two-tailed test. T-statistics based on robust standard errors clustered by firm are presented in parentheses. See Appendix A for variable definitions.

shows the results of this additional test. Excess compensation of outside directors (RPAYOUT) has a significant positive association with the ESG performance indexes (ER, SR, GR, and ESG), meaning that an increase in the residual value of outside directors’ compensation (RPAYOUT) by 1 unit increases ESG values by 1.3 bps, which is smaller than PPAYOUT in Table 3. This suggests that although excess compensation of outside directors may have a negative effect on firm performance by lowering independence (Brick et al., 2006), it may be positive for ESG performance.

4.7. Additional Test: Specific ESG Performance Indexes

In this additional test, we use the detailed ESG performance indexes to verify whether our main results still hold (see Appendix B for descriptive statistics). As shown in

Table 7. Additional test: specific ESG performance indexes.

Dependent Variables
VARIABLES	ER1	ER2	ER3	ER4	ER5	SR1	SR2	SR3	SR4	GR1	GR2	GR3	GR4	GR5
PPAYOUT	0.026	0.011	0.159 ***	0.079 ***	0.197 ***	0.188 ***	0.250 ***	0.103 ***	0.181 ***	0.076 ***	0.104 ***	0.138 ***	0.066 ***	0.095
	(0.71)	(0.36)	(4.17)	(4.11)	(6.84)	(8.56)	(9.78)	(3.93)	(8.24)	(3.96)	(6.23)	(7.00)	(3.89)	(1.55)
PAYIN	−0.001	0.008	−0.011	0.007	−0.006	−0.012 **	−0.003	0.000	0.006	0.019 ***	0.004 ***	−0.002	0.001	0.020
	(−0.10)	(0.98)	(−1.20)	(1.57)	(−0.81)	(−2.19)	(−0.50)	(0.04)	(1.12)	(3.79)	(1.11)	(−0.51)	(0.13)	(1.23)
BOARD	0.031	0.025	0.008	0.009	0.020	−0.002	0.002	0.001	0.014	0.010	0.037 ***	0.010	0.067 ***	0.013
	(1.60)	(1.47)	(0.39)	(1.00)	(1.23)	(−0.21)	(0.12)	(0.10)	(1.09)	(1.00)	(3.92)	(1.12)	(7.22)	(0.44)
OUTR	0.043	−0.026	0.053	0.048 **	0.056 *	0.096 ***	0.144 ***	0.043 *	0.121 ***	0.059 ***	0.165 ***	0.082 ***	0.168 ***	−0.087
	(1.13)	(−0.74)	(1.39)	(2.48)	(1.72)	(4.12)	(5.29)	(1.66)	(4.78)	(3.13)	(8.31)	(4.03)	(8.84)	(−1.26)
GENR	0.036 *	0.014	0.013	−0.010	−0.006	−0.019 **	−0.014	−0.014	−0.023 **	−0.008	−0.023 ***	−0.024 ***	−0.027 ***	−0.032
	(1.85)	(0.94)	(0.95)	(−1.29)	(−0.48)	(−2.23)	(−1.44)	(−1.14)	(−2.34)	(−0.99)	(−3.82)	(−3.16)	(−3.60)	(−0.81)
EXPR	0.016	0.025 **	0.022	0.002	0.024 **	0.012	0.024 **	0.013	0.011	0.005	−0.003	0.016 **	0.009	−0.002
	(1.08)	(2.07)	(1.58)	(0.34)	(2.25)	(1.44)	(2.38)	(1.21)	(1.36)	(0.71)	(−0.55)	(2.29)	(1.48)	(−0.08)
Control variables	Included	Included	Included	Included	Included	Included	Included	Included	Included	Included	Included	Included	Included	Included
Observations	2440 (Data for ER1 and GR5 were not disclosed separately since 2019 and 2015, respectively, and the number of observations decreased.)	3320	3320	3320	3320	3320	3320	3320	3320	3320	3320	3320	3320	536
Year fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Industry fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Adj R-squared	0.410	0.464	0.578	0.419	0.505	0.601	0.599	0.315	0.533	0.459	0.565	0.425	0.670	0.149

***, **, and * represent significance at the 1, 5, and 10 percent levels of p-value, respectively, based on a two-tailed test. T-statistics based on robust standard errors clustered by firm are presented in parentheses. See Appendix A and Appendix C for variable definitions.

, we find that outside directors’ compensation (PPAYOUT) is positively related to all of the specific ESG performance indexes except for ER1, ER2, and GR5. It is evident that the compensation of outside directors has a significant effect on ESG overall.

5. Discussion and Conclusions

Research on ESG has increased due to COVID-19 as firms recognize that ESG is essential to sustain growth in the future. Therefore, firms must now focus not only on financial performance but also on environmental and social externalities in their corporate activities. In evaluating ESG performance, corporate governance should be considered an effective measure of engagement in environmental and socially responsible activities. Regarding the effect of governance, most prior literature has focused on western countries, whereas research on ESG in non-western cultures, especially in Asia, is relatively insufficient [13,14,15]. In Korea, the chaebol (or family firms), the unique corporate governance structure of many Korean companies, is based on owner management. Therefore, the findings of studies based on western cultures may not apply to firms in Korea. Among the various proxies for corporate governance, we particularly focus on the compensation of outside directors as a reflection of the expertise, effort, and independence of outside directors.

This empirical study examines the association between outside directors’ compensation and ESG performance in a sample of Korean listed firms. We provide evidence that the compensation of outside directors is positively associated with ESG performance and that it motivates outside directors to monitor and advise the management effectively. The results support those of previous studies based on agency theory and resource dependence theory focusing on the board of directors. In additional tests, we find that the compensation of outside directors has an incremental effect on the outside director’s ratio and the expert’s ratio, proxies for independence and expertise, respectively. Excess compensation of outside directors is positively related to the ESG performance. This suggests that excess compensation of outside directors may have a negative effect on firm performance by lowering independence, but it may have a positive effect on ESG performance.

Our study has the limitation that we only focus on Korean firms in East Asian markets. For this reason, one should be cautious in interpreting our findings. However, it is important to find factors related to outside directors that have positive effects on ESG performance even in the context of unique governance structures, where outside directors may be subordinate to the owner. The results of our study also provide incremental information for investors and practical evidence for policymakers. Future studies may also identify how the association between outside directors’ compensation and ESG performance varies according to firm characteristics.