The new measures, whose targets include the country's biggest supplier, financially troubled Thames Water, prohibit the companies from paying bonuses "to water bosses that oversee poor environmental and customer outcomes", the government announced in a statement.
Suffering from underinvestment in a sewer system that dates largely back to the Victorian era, UK water companies, privatised since 1989, have been under fire for several years due to the discharge of significant quantities of sewage into rivers and the sea.
Despite this, "water companies have awarded over GBP 112 million ($152 million) in bonuses and incentives over the last decade," the government noted.
These executives "should only get bonuses if they've performed well, certainly not if they've failed to tackle water pollution", said environment minister Steve Reed.
The Labour government, which came to power in July, has promised to reform a sector "in crisis" and has already legislated to toughen penalties for water company bosses who fail to comply with the law.
Water regulator Ofwat last week imposed a record fine of GBP 123 million on London supplier Thames Water, which serves 16 million customers, for repeated sewage spills.
Some GBP 18.2 million of the fines related to "unjustified" payouts of dividends.
The firm is seeking a private buyer to avoid a state bailout.
US investment fund KKR pulled out of a potential deal on Tuesday.
Yorkshire Water, Anglian Water, Wessex Water, United Utilities and Southern Water were also hit with the bonus ban.
Britain's public spending watchdog warned in April that the water sector as a whole will need to invest GBP 290 billion over the next 25 years to meet environmental and supply challenges.
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