Corporate Environmental Responsibilities and Executive Compensation: A Risk Management Perspective

In this article, we examine how firms design executive compensation in light of their risk environment. Prior literature shows that corporate environmental responsibility (CER) of a firm inversely affects firm risk. We argue that firms with better CER performance benefit from the reduced firm risk, and therefore are more likely to provide greater managerial risk-taking incentives to encourage the risk-averse managers to undertake risk-increasing but positive net present value (NPV) investments. Consistent with our hypotheses, we find that a firm's CER rating is positively associated with its CEO risk-taking incentives (vega) in the following year. We also document cross-sectional variations in the CER-vega relationship, that is, a weaker association in the controversial industries. This study contributes to the literature by investigating the role of CER on executive compensation design from the perspective of risk management.