The governance paradox: how management quality drives and constrains sustainability-linked executive compensation

Purpose This study investigates how management quality shapes the adoption of sustainability compensation incentives (SCI) in European Union firms. It explores the dual role of governance in promoting sustainability-oriented executive pay in the short term while potentially constraining innovation as governance systems mature. Design/methodology/approach Drawing on panel data from 952 EU-listed firms between 2010 and 2024, the study applies a dynamic random-effects Probit model with control-function and Mundlak corrections. This approach captures both immediate and persistent effects of management quality on SCI adoption while addressing endogeneity, temporal dependence and unobserved heterogeneity. Findings Results reveal a strong positive short-term relationship between management quality and SCI adoption. Firms with robust governance systems are more capable of translating sustainability priorities into measurable executive incentives, enhancing accountability and legitimacy. However, this influence weakens and may reverse over time, suggesting potential governance saturation or institutional rigidity over time. Sectoral analysis shows stronger responsiveness in environmentally intensive industries, while cross-country comparisons reveal higher SCI adoption in nations with more mature ESG regulatory frameworks. Originality/value The study advances corporate governance and sustainability compensation literature by theorizing a Governance Paradox, whereby the same governance capability that accelerates the initial adoption of sustainability-linked incentives subsequently attenuates their further development. Unlike prior work on organizational rigidity, institutional decoupling and diminishing returns, the Governance Paradox specifically captures how formalized management quality can translate into attenuated marginal expansion of SCI over time, even in high-ESG regulatory environments. Methodologically, it offers one of the few empirical applications of a dynamic Probit framework to executive sustainability incentives, providing new insights into how governance mechanisms evolve and shape long-term sustainability alignment.