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Vice or Virtue? The Impact of Corporate Social Responsibility on Executive Compensation

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Abstract

We empirically examine the impact of corporate social responsibility (CSR) on CEO compensation using a large sample of the US firms from 1996 to 2010. We develop and test two hypotheses, the overinvestment hypothesis based on agency theory and the conflict–resolution hypothesis based on stakeholder theory. We find that the lag of CSR adversely affects both total compensation and cash compensation, after controlling for various firm and board characteristics. Our estimates show that an interquartile increase in CSR is followed by a 4.35% (2.78%) decrease in total (cash) compensation. We also find an inverse association between lagged employee relations and CEO compensation. Our results are robust to the correction for endogeneity using instrumental variable approach. Taken together, our results support the conflict–resolution hypothesis, but not the CSR overinvestment argument.

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Notes

  1. See e.g., Jensen and Murphy (1990), Florin et al. (2010), and Frydman and Jenter (2010).

  2. While we tackle the reverse causality side of Mahoney and Thorn (2005, 2006), we adopt some of their relevant control variables including CEO ownership, profitability measure of ROA, and leverage variable measured by book value of debt over book value of assets because those variables are also relevant in the reverse causality investigation.

  3. Top management of socially responsible firms will also refrain or reduce controversial pay practices, such as generous severance pay, sign-on bonuses, unusual retirement packages, golden parachutes in case of a change of control, paying gross-ups for taxes executives owe on their compensation, option repricing, option backdating, and so on. O’Brien (2010) criticizes that extreme imbalance of the US CEO pay can undermine corporate culture, especially values like trust, loyalty, and fairness matter, and erode employee morale and engagement. According to Hennigan (2007), Towers Perrin, a consulting firm, reports that pay multiple, CEO compensation as a multiple of average employee compensation, is 300-531 for the U.S., 22 for Australia, 21 for Canada, 16 for France, 11 for Germany, and 10 for Japan as of April 2000. Hennigan (2007) further suggests that the pay disparity and global pay gap is getting more serious. For instance, Bob Nardelli, the former Home Depot CEO, broke the record in 2002. His compensation was 1,458 times the average hourly Home Depot employees’ compensation.

  4. Regarding social responsibility of executive pay, one of the earliest corporate pioneers in the area of stakeholder relations was Ben & Jerry’s, an American ice cream company. Ben & Jerry’s used to have a pay multiple policy that no employee could earn more than seven times the salary of the lowest paid worker in the company. In 1995, entry-level employees were paid $8 hourly, and the highest paid employee was President and Chief Operating Officer Chuck Lacey, who earned $150,000 annually. When Ben Cohen resigned as CEO and Ben & Jerry’s announced the search for a new CEO in 1995, the company ended the seven-to-one-ratio pay multiple policy (Carlin, 1995), because Ben & Jerry’s was unable to attract an acceptable top quality executive, and it had to loosen the compensation restriction.

  5. Tobin’s Q (1958) is widely used as a measure of growth opportunity in accounting, finance, and economics. See, for example, Chung and Pruitt (1994) and Chung and Jo (1996), among others. Following Chung and Pruitt (1994), Tobin’s Q is calculated from the formula: {[Market value of common stock + Book value of preferred stock + Book value of long-term debt + Book value of current liabilities − (Book value of current assets − Book value of inventories)]/Book value of total assets}.

  6. See, among others, Raheja (2005), Adams and Ferreira (2007), Boone et al. (2007), and Harris and Raviv (2008).

  7. In our sample, CEO ownership is not statistically different between firms with above-median CSR scores and those with below-median CSR scores (Panel B of Table 2). However, in our later multivariate regressions (Table 4), we find that CEO compensation decreases with CEO ownership.

  8. Moffitt (1999) suggests using the IV method, which focuses on finding a variable (or variables) that influences the first-stage, but does not influence the second-stage dependent variable (and thus, is not correlated with the random error term in the second-stage equation). Angrist (2000) asserts that the IV method works if the researcher focuses on the causal effects. Moffitt (1999) further suggests that each IV that is indeed uncorrelated with the random error term in the second-stage (i.e., executive compensation) equation will yield unbiased estimates. Certain IVs will yield more precise estimates, however. The more the highly correlated the IV is with the first-stage dependent variable, i.e., CSR engagement, the more precise the estimates will be. Thus, the challenge in an IV estimation is to find an appropriate IV that is highly correlated with the first-stage CSR variable, but uncorrelated with the second-stage executive compensation. Unfortunately, it is often hard to find variables that meet both of these requirements, and therefore, it is difficult to find good IVs among the many potential IVs.

  9. The CEO is responsible for leading the firm’s management, whereas the chairman of the board (COB) is responsible for leading the board. Sometimes, one individual often holds two positions, CEO and COB, commonly known as a CEO duality (Brickley et al. 1997).

  10. According to Wharton Research Data Services (WRDS), “Standard and Poors’ Execucomp database provides executive compensation data collected directly from each company’s annual proxy (DEF14A SEC form). Detailed information on salary, bonus, options and stock awards, non-equity incentive plans, pensions and other compensation items are available.”

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Acknowledgments

We are indebted to an anonymous referee for valuable comments.

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Authors and Affiliations

  1. Department of Finance, Leavey School of Business, Santa Clara University, 500 El Camino Real, Santa Clara, CA, 95053-0388, USA

    Ye Cai, Hoje Jo & Carrie Pan

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  1. Ye Cai
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Correspondence to Carrie Pan.

Appendices

Appendix 1 List of the strength and concern items in the KLD database

Table 7
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Appendix 2 Calculation of the CSR Composite Index

Table 8
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Cai, Y., Jo, H. & Pan, C. Vice or Virtue? The Impact of Corporate Social Responsibility on Executive Compensation. J Bus Ethics 104, 159–173 (2011). https://doi.org/10.1007/s10551-011-0909-7

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