Production and Externalities: The Role of Corporate Governance

We study how corporate governance impacts social costs. Our parsimonious principal-agent model with production externalities predicts that firms adopt higher-powered incentives in response to increased monitoring costs. This shift in governance mechanisms boosts production, but also results in higher social costs. We confirm this prediction using asset-level data on production and workplace safety in the coal industry. To establish causality, we exploit plausibly exogenous increases in monitoring costs driven by politically motivated coal divestment initiatives imposed on prominent activist institutional investors. Our findings highlight that firms' choice of governance mechanisms can have important implications for social and environmental performance.