Skin in the Game : Risk of Environmental Pollution and Executive Compensation Incentives

I investigate whether and how risk of environmental pollution affects executive compensation. Leveraging a novel database that tracks accidental chemical spills to the environment within the U.S., I study how salient environmental spills with large-scale evacuations affect executive compensation in the neighboring firms excluding the responsible parties. I find strong evidence that, following the occurrence of a major environmental spill, the neighboring firms experience significant increases in executive risk-taking incentives (vega) and pay-performance sensitivity (delta) while executive total pay barely moves. Meanwhile, managers increase corporate cash holdings to sub-optimal levels in response to the heightened pollution risk. Overall, the empirical patterns bolster the alignment hypothesis that risk of environmental pollution may exacerbate manager-shareholder conflicts and escalate the need for alignment compensation contracts