Paying for pollution: Air quality and executive compensation

Exposure to air pollution is linked to an increased severity of physical and mental illnesses. This study examines whether and to what extent air pollution affects executive compensation in Chinese listed firms. We document a significant and positive association between air pollution and executive compensation, indicating that firms located in more polluted areas have to pay a higher wage premium to their executives in order to compensate for unpleasant air quality. Cross-sectional analyses further reveal that the pay premium for air pollution depends on managerial labor market competition, substitution of other livability factors, as well as public attention on air pollution. The evidence thus highlights the importance of information completeness in optimal contracting and provides firms another market-oriented incentive to closely follow the current environmental protection regulation of China.