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Corporate Governance and Executive Compensation for Corporate Social Responsibility

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Abstract

We link the corporate governance literature in financial economics to the agency cost perspective of corporate social responsibility (CSR) to derive theoretical predictions about the relationship between corporate governance and the existence of executive compensation incentives for CSR. We test our predictions using novel executive compensation contract data, and find that firms with more shareholder-friendly corporate governance are more likely to provide compensation to executives linked to firm social performance outcomes. Also, providing executives with direct incentives for CSR is an effective tool to increase firm social performance. The findings provide evidence identifying corporate governance as a determinant of managerial incentives for social performance, and suggest that CSR activities are more likely to be beneficial to shareholders, as opposed to an agency cost.

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Notes

  1. For example, 63 % of CEOs surveyed in the UN Global Compact-Accenture CEO Study on Sustainability (2013) expected sustainability to transform their industry within 5 years.

  2. McWilliams et al. (2006) and Gao and Bansal (2013) provide overviews of the major theoretical perspectives regarding CSR and financial performance. In this study, however, we focus only on the agency cost argument.

  3. Walls et al. (2012) focus specifically on environmental measures of social performance as opposed to CSR more broadly, but we include their study here since environmental performance is an important component of CSR.

  4. Berrone and Gomez-Mejia (2009a) focus specifically on environmental measures of social performance.

  5. All associations mentioned here are from Tables 4 and 5, with the odds ratio computed using the exponential function of the coefficients.

  6. This does not assume that all managers always act in a way opposed to shareholders. However, some managers sometimes act in such a way, and even board members may collude with them (Li and Wu 2015). This then results in an average agency cost.

  7. As a robustness check, we also used the fraction of the board that is composed of independent directors (Rosenstein and Wyatt 1990) as a proxy for board independence, and find consistent results.

  8. CSR activities that benefit the manager at the expense of the firm represent an agency cost. For example, if a CEO uses firm resources to advance a charitable cause that represents a self-serving interest of the CEO but does not benefit the firm, it may be costly to the firm.

  9. We note that in contrast to many prior studies, our KLD-based measure of CSR is only a control variable (except in our final hypothesis test) and not a main variable of interest.

  10. Considering almost all the CEOs are board members, we test the hypotheses in the non-CEO sample and found similar results to support our hypotheses.

  11. Both CSRCONTRACTING and the dependent variable CSRLEVEL are for year 2013. However, compensation contracts are usually determined at the beginning of the year or the end of previous year, while CSR levels are evaluated over the entire year.

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Authors and Affiliations

  1. Ivey Business School, University of Western Ontario, London, Canada

    Bryan Hong & Zhichuan Li

  2. Kellogg School of Management, Northwestern University, Evanston, USA

    Dylan Minor

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  1. Bryan Hong
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Correspondence to Bryan Hong.

Appendices

Appendix 1

See Table 7.

Table 7 Variable definitions
Full size table

Appendix 2: CSR Compensation Terms

Based on an analysis of variable and performance-based pay, we identified those companies also incentivizing non-financial performance. We then analyzed the descriptions of non-financial performance to code the compensation as CSR-linked. The following were the most common such descriptions:

  • Community

  • Compliance with ethical standards

  • Corporate social responsibility

  • Diversity

  • Employee well-being

  • Energy efficiency

  • Environmental compliance

  • Environmental goals

  • Environmental performance

  • Environmental projects

  • Greenhouse gas emissions reductions

  • Health

  • Performance relative to a corporate responsibility index (e.g., Dow Jones Sustainability Index)

  • Product safety

  • Reduced injury rates

  • Safety

  • Sustainability

For example, as discussed in its Proxy Statement, the Kellogg Company divided its Annual Incentive Plan for its CEO John Bryant into financial and non-financial incentives: “90 % of the annual incentive opportunity was based on performance against corporate financial metrics…and 10 % was based on performance against non-financial targets (people safety, food safety and quality, and diversity and inclusion).” Thus, John Bryant of Kellogg is coded as being offered CSR-linked incentives.

The compensation plans typically contract on a dimension of social performance with symmetric consequences. For example, one common area of contracting is Employee Diversity and Inclusion. In principle, a CEO could be credited for doing well, poorly or both well and poorly on this dimension. For an example of the latter, the firm may experience an increase in promotions for women but a reduction in promotions for minorities. In this setting, the CEO’s compensation would be based on the net results of these “strengths” and “concerns.” Additionally, the CSR performance compensation payment is usually based on the net result of “strengths” and “concerns” across multiple categories. Hence, it could be that a given category of CSR compensation contains only “strengths” or “concerns.” Nonetheless, the final payment to the CEO is based on the net result of all of the categories, which mirrors our empirical analysis.

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Hong, B., Li, Z. & Minor, D. Corporate Governance and Executive Compensation for Corporate Social Responsibility. J Bus Ethics 136, 199–213 (2016). https://doi.org/10.1007/s10551-015-2962-0

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