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Environmental audits and incentive compensation

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This paper studies the link between environmental audits and employee compensation. The context is a one-period principal-agent relationship where the risk-averse agent must alocate effort between financial and environmental tasks. The former are routinely monitored while the latter are audited (at some cost) only under specific circumstances. We find that the optimal wages have a lower mean and a greater variance when there is an environmental audit than when there is not. This puts more risk on the agent, so the expected wage ex ante must be higher than in a situation with no environmental audits. We also find that the agent might just split his effort between environmental and financial tasks, provided the information gathered using environmental audits is about as accurate as that coming from financial monitoring

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