Corporate Social Responsibility and Governance: The Role of Executive Compensation

• Date: 01 April 2020
• Author: Patricia Crifo,Sandra Cavaco,Aymeric Guidoux
• Published date: 01 April 2020
• DOI: http://doi.org/10.1111/irel.12254

Corporate Social Responsibility and Governance:

The Role of Executive Compensation

SANDRA CAVACO, PATRICIA CRIFO and

AYMERIC GUIDOUX

This article examines the relationship between corporate governance and corporate

sustainability by focusing on an essential component of companies' governance

structure: executive compensation programs. We propose an original empirical

strategy based on a large set of the biggest capitalizations in Organization for

Economic Cooperation and Development (OECD) countries over the period

2004–2018, with explicit measures of how companies integrate into executive

managers' remuneration precise criteria of corporate social responsibility, an

incentive scheme called corporate social responsibility (CSR) contracting. Our

results show that proposing executive compensation programs including CSR cri-

teria has a negative impact on financial performance, and a large positive impact

on extra-financial performance based on the following dimensions: relationship

with customers and suppliers, and community involvement. Second, we explore

the moderating role of the corporate governance model by distinguishing the

impact between firms with a shareholder or stakeholder corporate governance

model and reveal significant differences in the impact of CSR contracting. For

firms with a stakeholder corporate governance model, CSR contracting is no

longer associated with a fall of financial performance and has a large positive

impact on human resources, environmental, and human rights performance. On

the other hand, CSR contracting has a negative impact on financial performance

but no impact on extra-financial performance for firms with a shareholder corpo-

rate governance model.

JEL codes: M14, M12, G30, C23.

*The authors’affiliations are LEMMA, University Panth

eon-Assas, Paris, France. E-mail: sandra.-

cavaco@u-paris2.fr; Ecole Polytechnique CREST and CIRANO, Palaiseau, France. E-mail: patri-

cia.crifo@polytechnique.edu; and Ecole Polytechnique, Palaiseau cedex, France. E-mail: aymeric.guidoux@

polytechnique.edu. The authors thank Vigeo-Eiris for granting access to their data. Support from the research

program Investissements d’Avenir (ANR-11-IDEX-0003/Labex Ecodec/ANR-11- LABX-0047) and from the

Chair of FDIR (Ecole Polytechnique & TSE IDEI) and the Chair of Energy and Prosperity, Finance and

Evaluation of Energy Transition is gratefully acknowledged. This research has also been conducted as part

of the project LABEX MME-DII (ANR11-LBX-0023-01). The usual disclaimer applies.

INDUSTRIAL RELATIONS, DOI: 10.1111/irel.12254. Vol. 59, No. 2 (April 2020). ©2020 Regents of the

Universit y of Calif ornia. Published by Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA,

and 9600 Garsington Road, Oxford, OX4 2DQ, UK.

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Introduction

In this article, we analyze the relationships between corporate governance

and corporate sustainability, and examine in particular the role of an essential

component of the companies’governance structure: executive compensation

programs. More precisely, we investigate whether corporate sustainability,

measured by environmental, social, and governance (ESG) performance, is

influenced by the adoption of “CSR contracting,”specific compensation pro-

grams based on extra-financial (ESG) factors.

While performance-based pay for chief executive officers (CEOs) has

received considerable attention in the literature, the role of extra-financial

(ESG) factors in executive compensation has been much less investigated. As

CEOs are charged with the responsibility of formulating corporate strategy and

in particular corporate sustainability (Waldman, Siegel, and Javidan 2006),

managerial incentives could influence a CEO’s decision on whether to allocate

funds for corporate social responsibility (CSR).

The inclusion of CSR criteria in executive compensation contracts (see

Hong, Li, and Minor 2016) is a recent phenomenon in corporate governance.

This practice is now called “CSR contracting”and is increasingly encouraged

at the international level, in particular under the initiative of the United

Nations (see PRI Principles for Responsible Investment 2012). Such programs

have become more prevalent in recent years in response to increased pressures

on firms to behave in socially responsible ways, and on their boards of direc-

tors to take action beneficial to stakeholder engagement through executive pay

(see Flammer, Hong, and Minor 2019).

Counterbalancing the classic theory of moral hazard, which recommends

sufficient rewards for “success”or “good performance,”a large literature rec-

ognizes that high-powered incentives can distort managerial effort or encour-

age various unproductive activities to improve indicators of performance and

lead to excessive short-termism (e.g., Baker 1992; Baker, Gibbons, and Mur-

phy 1994; Dixit 1997; Holmstrom and Milgrom 1991; Oyer 1998). A crucial

reason for the development of CSR contracting hence is to encourage execu-

tives to sacrifice short-term payoffs for long-term gains and stakeholder

engagement (Flammer, Hong, and Minor 2019).

Whereas there is a large literature on executive financial compensation pro-

grams (traditional “pay for financial performance plans”), little is known and

more research still needs to be conducted regarding the use and performance

effects of CSR contracting (“pay for extra-financial performance plans”), espe-

cially at the empirical level (Maas 2016). Empirical studies face at least two

challenges. First, many of these executive compensation incentives for CSR

are relatively new and data on CSR contracting are scarce. Second, empirical

Executive Compensation Programs and CSR / 241

identification can be challenging. Firm-level outcomes (financial and/or extra-

financial performance) may drive executive compensation program adoption,

or significant unobservable variables may influence both program adoption and

firm-level outcomes.

In this article, we examine how the adoption of CSR contracting affects

firm-level outcomes. Our study uses a comprehensive dataset on the adoption

timing of such programs. Descriptive statistics highlight the increasing preva-

lence of CSR contracting as a new phenomenon in corporate governance. We

exploit the timing of executive program adoption and employ a differences-in-

differences approach to identify its impacts on firm performance. Our results

indicate that the adoption of CSR contracting leads to (1) a decrease in firm

value (measured by return on assets [ROA], return on equity [ROE], and

price-to-book ratio) but (2) an increase in CSR performance, especially respon-

sible behaviors toward customers and suppliers and community involvement.

Moreover, we explore the moderating role of the corporate governance model

and find that once we take into account whether the company has a gover-

nance model oriented toward its shareholders or its stakeholders, the results

revert. In particular, for companies with a stakeholder governance model, the

impact of CSR contracting becomes nonsignificant on financial performance,

and positive on all environmental and social performance indicators. We con-

duct a number of additional analyses to check the robustness of our results.

This article makes two main contributions to the literature. First, it docu-

ments the development of CSR contracting over the past decade in a large set

of OECD countries and characterizes the type of companies that are adopting

such executive compensation programs. Second, it identifies the mediating fac-

tor between the adoption of CSR contracting and firm performance, and identi-

fies the impact of CSR contracting on financial and extra-financial

performance, moderated by the corporate governance model of the company

and its orientation toward shareholders or more distant stakeholders.

The remainder of the article is organized as follows: in the next section we

define the literature and hypotheses of our study. The subsequent two sections

present, respectively, the data and our identification strategy. We then provide

our empirical results and the robustness checks, and in the final section we dis-

cuss our results and then conclude.

Theoretical Framework and Hypotheses Development

Corporate governance and corporate social responsibility. Research on

corporate social responsibility and the corresponding environmental, social,

and governance factors has been very fruitful over the past decades. An

242 / SANDRA CAVACO,PATRICIA CRIFO AND AYMERIC GUIDOUX