Does physical climate risk affect executive pay? Empirical evidence from the extreme heat weather

Abstract

Purpose This study aims to examine the impact of extreme heat on executive compensation and further investigate how executives’ risk aversion moderates this relationship. Design/methodology/approach This study draws on a sample of Chinese A-share listed firms on the Shanghai and Shenzhen Stock Exchanges over the period from 2007 to 2022. Findings The results indicate a significant and positive relationship between extreme heat and executive compensation, and this effect becomes stronger at higher levels of executive risk aversion. The risk-compensating effect is also reflected in greater failure tolerance; that is, extreme heat is associated with greater executive pay stickiness. The impact of extreme heat on executive pay is especially significant in labor-intensive industries, less-concentrated industries and firms with higher media attention. In addition, higher executive pay associated with extreme heat is linked to a lower cost of equity capital. Practical implications This study suggests that firms should give careful consideration to climate risk when designing executive compensation policies. In the context of extreme heat, offering appropriate risk-related compensation to executives can help attract and retain talent and reduce the cost of equity capital. These findings provide empirical evidence for firms to optimize governance structures and refine executive compensation contracts. Originality/value This study extends the existing literature on climate risk and executive compensation, providing emerging market empirical evidence on the risk–compensation effect. Furthermore, it finds that extreme heat enhances the stickiness of executive compensation. The evidence is consistent with the view that pay stickiness may reflect a risk–compensation mechanism under extreme heat.