Pay for Performance: Environmental Risk-Taking and Disasters∗

We explore the relationship between equity compensation and the failure of risky projects, finding a non-monotonic relationship. However, for those settings where failures are high-stakes– e.g., environmental disasters and accounting scandals– the relationship is positive. We test these predictions for environmental and financial accounting failures of large US firms and find that changing CEO equity compensation from 100% stocks to 100% options can increases law breaking and incidence rates 50-80% and the magnitude of events by over 100%. The effectiveness of policies such as Sarbanes-Oxley and FAS123R are also analyzed. ∗I would like to thank Jennifer Brown, Georgy Egorov, Mitchell Hoffman, David Matsa and Max Schanzenbach for their helpful comments. Also thanked are the participants at the CRES workshop (Washington University, St. Louis), Institutions and Innovation conference (Harvard Business School), and Natural Experiments Workshop (Munich) and seminar participants at the Kellogg School of Management and Northwestern Law School. I thank Jared Petravicius for his excellent research assistance and the Ford Center for Global Citizenship for financial support of the project.