Abstract

We explore the relationship between managerial incentives and environmental harm. We find that high-powered executive compensation packages can increase the odds of environmental law-breaking by 40-60% and the magnitude of environmental harm by over 100%. We document similar results for the setting of executive compensation and financial accounting misconduct. Finally, we outline some managerial and policy implications to blunt these adverse incentive effects.

Highlights

  • We explore the relationship between managerial incentives and misconduct using the setting of environmental harm

  • We explored how executive compensation a¤ects misconduct

  • To do so we constructed an index of compensation called P; where increased P predicts a greater chance and magnitude of misconduct

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Summary

Theoretical Considerations

We begin by constructing our index P and generating several hypotheses. In the online appendix, we formally derive P: here we provide the intuition of the measure and its predictions. Hypothesis 2: The magnitude of accounting misconduct is increasing in the index P: The other dimension of misconduct is its likelihood of a harmful outcome This can be determined once we have ...xed the CEO’s standard of downside V : The CEO will face a variety of alternatives to the benchmark strategy, with downsides ranging from 0 to VSF : The lower the downside standard V ; the more often a CEO will choose a strategy with a greater downside than the benchmark one. CEOs with increased P will be choosing lower standard V : the odds of a harmful event are increasing in P: This generates our prediction: Hypothesis 3: The odds of a harmful environmental event are increasing in P: For the setting of ...nancial accounting, the logic is the same: those with greater incentive through a larger P to enhance pro...ts at the expense of greater downside, will more often choose the potentially harmful route, which means we more often see harmful events.

Executive Compensation and Environmental Harm
Results
Increased P Results in Increased Odds of an Event
Recall that the odds of an event is calculated as
Robustness Tests
Increased P Results in Increased magnitude of harm
Executive Compensation and Financial Accounting Misconduct
Conclusion
A Model of Executive Compensation and Misconduct
Full Text
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