CEO turnover risk and firm environmental performance
(May 2024, revised November 2024)
Summary
Focus
Technology will play a pivotal role in reducing carbon dioxide emissions to meet the high-priority goal established by the Paris Agreement to maintain the rise in the global average temperature below 2oC above pre-industrial averages. Developing technologies, and thus achieving these results, arguably requires a long-term commitment. However, management incentives may at times be oriented towards the short term, particularly when the chief executive officer (CEO) faces a higher probability of being unwillingly terminated. We study what happens to a firm's environmental performance when its CEO faces the risk of a forced turnover. Specifically, do they keep pursuing environmental performance or do their behaviours reveal short-terminism?
Contribution
We contribute to a fast-growing literature studying the interplay of firms' environmental, social and governance (ESG) performance and managerial behaviours by documenting the effect of the risk of a forced CEO turnover on firm's environmental performance and ESG controversies. We show that the effect is negative and that it is particularly detrimental for highly needed activities that are focused on more long-term environmental innovation. Furthermore, we complement the literature on executive compensation design by testing, in this context, the effectiveness of ESG-Pay clauses, which are increasingly being included in executive compensation packages. Finally, we document how the effect of an increase in the probability of a forced CEO turnover is consistent with "carbon leakage" practices aimed at reducing costs and boosting returns in the short term.
Findings
A higher probability of a forced turnover for the CEO corresponds to a worse environmental performance for the firm. First, we consistently find this effect across all dimensions of environmental performance, and it is particularly strong for more long-term environmental innovation. Second, the increasingly adopted ESG-Pay clauses don't seem effective at taming this effect. Third, a higher probability of a forced turnover for the CEO corresponds to higher scope 2 and 3 emissions. Contrarily, we don't find any effect on scope 1 emissions, which may be more difficult to alter in the short run. Finally, through an instrumental variable regression design we trace this effect to a strategic re-orientation towards short-terminism.
Abstract
We investigate the relationship between the probability of a CEO forced-turnover and firm performance on several environmental dimensions. Our findings suggest that a higher risk of being terminated for the CEO is correlated with a lower environmental ranking, particularly on environmental innovation activities, and more ESG controversies for the firm. The inclusion of ESG-pay clauses in executives' compensation packages only marginally offsets such deterioration. Looking at data on Greenhouse gas (GHG) emissions, we consistently find that a rise in the probability of being terminated corresponds to an increase in scope 2 and 3 emissions ("carbon leakeage"), whereas scope 1 emissions remain unchanged. Through an instrumental variable approach, we trace the deterioration of firms' ESG controversies- and environmental innovation scores to a strategic re-orientation towards short-terminism.
JEL classification: D22, G30, G34, O31, Q55
Keywords: corporate finance, ESG, emissions, environmental innovation, short-terminism
