Toxic CEOs, ESG Funds as Watchdogs, and the Labor Market Outcomes

By | January 25, 2023

In a new paper, I examine changes in CEO labor market outcomes following corporate environmental misconduct, which creates negative externalities that firms are required by law to prevent. Corporate activities create significant negative environmental externalities. These economic costs can exceed $4.7 trillion a year, are multi-sectoral, and appear through the entire lifecycle of products. Externalities of this scale pose a major risk to business viability and the global economy, yet corporations have been hesitant to recognize and incorporate such risks into their policies. Despite the increased attention concerning corporate sustainability policies such as enhanced ESG disclosure, carbon pricing, and socially responsible institutions (SRIs), limited evidence exists about the role of CEO incentives in reducing environmental pollution. In my paper, I examine whether the labor market can prompt CEOs to internalize negative externalities from corporate environmental activities. This is an important question because CEOs are key decision-makers within firms, and the threat of holding them accountable for their actions can function as an important market-based deterrent to shape corporate environmental behavior. 

I focus on CEOs because they oversee corporate strategy on environmental matters, make up a significant fraction of corporate boards, and are rewarded with board seats in directorial labor markets due to their reputation, expertise, and performance. These directorships are valuable due to their monetary and non-monetary benefits, such as prestige, visibility, and influence. In order to assess the impact of environmental misconduct on CEO labor market outcomes, I obtained data on historical civil, judicial, and administrative EPA enforcement cases from the Enforcement and Compliance History Online database. I measure the severity of corporate environmental violation by its occurrence and its magnitude measured by the dollar value of federal, state, and local penalties and complying actions.  

The fact that CEOs often sit on the boards of other firms allows me to analyze both the likelihood of their dismissal as CEOs and the change in the number of their external board memberships as outside directors. The latter effect, ex-post settling up in the labor market, is especially important in situations where the internal governance dynamics waver on punishing CEOs for failure. I first evaluate if CEOs of firms that violate environmental laws are disciplined within their firms in the form of CEO dismissals. CEO turnover is shown to be an important disciplining mechanism following corporate failures. I observe in the data that such CEOs face a greater likelihood of dismissal from their firms. This effect is both statistically and economically significant. The offending CEOs face a 1.8 percentage point higher probability of dismissal, corresponding to an average 20.6% increase in CEO turnover. This higher CEO dismissal propensity reveals significant penalties for managers of firms engaged in environmental misconduct. 

Next, I test the disciplinary effects of environmental misconduct in directorial labor markets by the number of external board seats served. Consistent with the ex-post settling hypothesis that the labor market imposes penalties on directors for corporate wrongdoings, I observe a significant decline in the number of external boards served on by CEOs following environmental misconduct. CEOs lose, on average, 3.09% of board seats held, and this effect accumulates to 7.94% within three years of EPA enforcements. These results suggest that CEOs face further discipline from the directorial labor market regarding the number of external boards they sit on following the revelation of EPA enforcements. 

Examining the timing of these penalties on CEOs, I find that most changes in dismissal rates and external board memberships occur after 2010. This is a period marked by the BP oil spill disaster in 2010, the Volkswagen emission test scandal in 2015, the rapid rise of SRIs, and intensified media coverage of environmental issues. I also find that CEOs dismissed following an EPA enforcement action are less likely to get another CEO position in a listed firm within three years of dismissal than CEOs dismissed for other reasons. 

After documenting the labor market consequences of EPA enforcements on CEOs, I explore two channels through which these effects can occur; shareholder voice and SRIs. The ability of shareholders to replace ineffective directors ensures the proper functioning of the board of directors. Consistent with this argument, I observe significant shareholder dissent in elections of offending CEOs on other boards following EPA enforcements. Following the revelation of the EPA enforcement, shareholder dissent in elections of offending CEOs increased by 1.5 percentage points, corresponding to a 30.5% increase on average. Second, I examine SRIs as another channel through which CEOs of firms involved in EPA enforcements can be penalized. These institutional investors explicitly link their investment policies to ESG issues. I conjecture that if SRIs pay attention to environmental matters, their presence should amplify external and internal labor market penalties documented in earlier tests. This is indeed what I find: the number of external directorships of involved CEOs decreases by 7.95% in the year following EPA enforcements for a firm in the top quartile of SRI ownership compared to the one in the bottom quartile of SRI ownership. The likelihood of CEO dismissal and shareholder opposition in director elections are also significantly amplified when SRIs hold a greater share of the firm’s equity. These results suggest that SRIs put pressure on CEOs of violating firms following EPA enforcement actions internally and externally in the labor market for directorships. 


This study contributes to several strands of research. First, it adds to the rapidly growing literature on SRIs. These investors can improve firms’ ESG ratings and engage with their portfolio firms. I identify a specific engagement channel of SRIs with firms on environmental matters initiated by the EPA enforcement. I find that the monitoring exerted by SRIs imposes significant discipline on CEOs and directors. Thus, one way for SRIs to influence firm environmental behavior is through their disciplining of CEOs and directors involved in environmental misconduct. Second, it is related to the extensive literature studying the consequences of corporate misconduct. An interesting question that remains largely unanswered is whether such penalties extend to firms engaging in environmental misconduct. Unlike the aforementioned examples of corporate misconduct, there are no direct contractual relationships with the defendants in environmental misconduct cases. It is not clear that stakeholders are protected against corporate wrongdoings as well as shareholders by the legal system. 

This study has important policy implications. The finding that EPA enforcements affect CEOs’ careers mostly in firms with SRIs points to a bright side of SRIs, that market-based solutions can supplement regulatory actions to encourage more environment-friendly corporate behavior. Further, my results imply that the labor market for environmental reputation can be an important mechanism to internalize negative externalities from corporate environmental activities. Similar corporate actions are likely to be repeated without an adverse consequence of environmental failures to key corporate decision-makers. This paper also contributes to the public enforcement literature by showing that enforcing environmental law has repercussions for CEOs’ careers. 


EPA enforcements constitute a serious violation of environmental laws and represent negative corporate environmental externalities. Despite the recent interest in mechanisms mitigating environmental harm caused by corporate actions, little is known about the role of CEO incentives. If the goal is to better understand why firms (fail to) adopt certain environmental programs, we must understand the incentives of key decision makers such as CEOs leading the firms. Holding CEOs responsible for environmental failures in the labor market can effectively align CEOs’ interests with society’s environmental goals. As hypothesized by Fama (1980) and Fama and Jensen (1983), this ex-post settling up can provide incentives for CEOs to take more environmentally friendly policies ex-ante. Altogether, these results suggest that CEOs are penalized for environmental failures. This is important because similar corporate actions are likely to be repeated without an adverse consequence of environmental misbehavior to key corporate decision-makers. The results also provide evidence that SRIs are associated with greater disciplinary actions taken against offending CEOs, which points to a bright side for these investors. SRIs, as a market-based solution, can supplement EPA enforcements as regulatory actions to encourage firms to improve environmental performance. 


Ugur Lel is an Associate Professor of Finance at the University of Georgia Terry College of Business.  


This post was adapted from the paper “Toxic CEOs, ESG Funds as Watchdogs, and the Labor Market Outcomes,” available on SSRN. 

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