The dark side of individual blockholder philanthropy

• Date: 01 September 2020
• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/fima.12285
• Author: Roger M. White,Thomas D. Shohfi

DOI: 10.1111/fima.12285

ORIGINAL ARTICLE

The dark side of individual blockholder

philanthropy

Thomas D. Shohfi1Roger M. White2

1Department of Finance and Accounting, Lally

School of Management, Rensselaer Polytechnic

Institute, Troy,New York

2W.P. Carey School of Business, Arizona State

University, Tempe,Arizona

Correspondence

ThomasD. Shohfi, Department of Finance and

Accounting,Lally School of Management, Rens-

selaerPolytechnic Institute, Pittsburgh Building

Room1110, 110 8th Street, Troy,NY 12180.

Email:shohft@rpi.edu

Abstract

We examine the market reaction to charitable pledges by individ-

ual blockholders of public firms. As this philanthropy may signal a

weakening preference for wealth maximization and may be indica-

tive of distraction or relaxed monitoring, these agency costs may

overwhelm any reputation benefits. We find decreased firm value

and lower pay-for-performance sensitivity, the effects of which are

most severe where monitoring needs are high, the blockholder is a

director,or when the firm has ex ante high corporate social responsi-

bility ratings. Our results are robust to controlling for prior charita-

ble foundation involvement, busy director–blockholders, dual-class

share structures, blockholder exit, and pre-pledge firm sentiment.

1INTRODUCTION

Corporate social responsibility (CSR)is an increasingly popular topic in business research. Many of these studies focus

onmanagers taking charitable action with owners’ resources. However, of the approximately $300 billion given to char-

ity in the United States on an annual basis in recent years, corporations were responsible for only about 6%, while

individuals were responsible for 72% (Heavey,2013).1

The charitable actions of individuals have received, to the best of our knowledge, little serious examination from

either academic or practitioner researchers in business. This shortcoming is notable as both the philanthropic and

wealth maximizing preferences of individual shareholders (principals) have been shown to affect firm performance

and firm value (Balakrishnan, Sprinkle, & Williamson, 2011; Cox,2004; Edmans, 2009). We attempt to address this gap

in the literature and examinethe effect of individual shareholder philanthropy on firm value.

Examining individual philanthropy is complicated by data issues. Corporations must disclose financial statements

to the public for reasons of transparency, but individuals haveno such obligation. Given this matter of data availabil-

ity, we rely on a quasi-experimentin which individuals publicly announce their philanthropy. It is popular for wealthy

individuals to announce and celebrate their charitable gifts (and these events are often newsworthy), and we focus on

a specific philanthropic drive, The Giving Pledge, for the purposes of this paper.

c

2019 Financial Management Association International

1GivingU.S. Annual Report on Philanthropy only includes charitable donations. The remaining 22% of donations come from foundations and bequests.

Financial Management. 2020;49:741–767. wileyonlinelibrary.com/journal/fima 741

742 SHOHFI ANDWHITE

The Giving Pledge is a charitable drive instigated by Bill Gates and Warren Buffett that seeks to secure pledges

from highly wealthy individuals to donate or bequeath to charity at least half of their wealth. SEC (Securities Exchange

Commission) filings reveal that many of the signatories of The Giving Pledge are individual blockholders (own greater

than 5% of shares) of publicly traded corporations.

After identifying the subset of The Giving Pledge participants who own blocks of publicly traded U.S. corporations,

we use event studies to identify investors’ reaction to the news that a blockholder has pledged a substantial portion

of their wealth to charity.Behavioral theories based in psychology generally suggest that preferences of a firm’s stake-

holders for altruism and charity will result in positive abnormal returns to a firm’s socially responsible actions, such

as philanthropic pledges by blockholders (see Jones, 1995, for a review of stakeholder theory). Agency theory,how-

ever, suggests that small shareholders rely on the self-interest (preferences for wealth maximization) of blockhold-

ers to monitor managers. If a major charitable pledge by a blockholder signals weakening self-interest (and increas-

ing selflessness or distraction in pursuit of philanthropic goals), then smaller shareholders may: (a) fear that the indi-

vidual blockholder has incentives misaligned with their own and (b) subsequently question the blockholder’s ability

to act as an effective monitor. If individual blockholder charity creates this agency problem and enough small share-

holders lose trust in the ability of the philanthropic blockholder to monitor their shared investment, firm value could

suffer.

On October 1, 2013, Microsoft made headlines for both of these effects. The morning saw Forbes release the results

of a survey that named the firm the most inspirational in the world. Smith (2013)and subsequent coverage gavemuch

credence to the firm’s success relying on the encouraging, generous atmosphere propagated by Bill Gates, founder,

chairman, and noted philanthropist (Bean, 2013). Hours later,Reuters broke a story detailing the efforts of three major

Microsoft investors (who together own 4.5% of the firm) to dislodge Gates from his position on the board (Damouni

& Rigby,2013). The investors were primarily concerned with Gates’ ability to affect corporate strategy and influence

the chief executive officer (CEO) as he dedicated so little time and attention to the company. In subsequent cover-

age, reporters were not hesitant to suggest that Microsoft’s shareholders would be better off with a chairman who

was more focused on the interests of the firm and less concerned with philanthropic pursuits (Cyran, 2013; Oremus,

2013). Within a period of only a few hours, the business press was attributing both the successes and shortcomings of

Microsoft to Gates’ focus on philanthropy.

We weigh the effects of stakeholders’preferences for altruism versus the agency problem of selfless (or distracted)

individual blockholders. We find that mean run-up returns preceding the announcement of philanthropic pledges by

blockholders range from –35 basis points to –471 basis points (depending upon the model). This negative abnormal

return corresponds to the reduction of at least $3.2 million in shareholder value for the median firm in our sample

(market value =$900 million).

Further tests suggest that agency costs drive these negative abnormal returns. For example, these losses are far

moresevere when the blockholder serves as a director suggesting that the market views such philanthropy by directors

as a signal that they may relax their strong monitoring duties. Individual blockholder philanthropy is also particularly

detrimentalto firm value when the firm has high levels of free cash flow (a potential agency problem), where monitoring

has been found to be especially helpful in disciplining managers (Gul & Tsui, 1997).Likewise, the negative abnormal

returns we observe grow when the firm’s operations are headquartered in the blockholder’s state of residence. Local

monitors are thought to provide stronger monitoring (Alam, Chen, Ciccotello, & Ryan, 2014; Ayers,Ramalingegowda,

& Yeung, 2011; Kang & Kim, 2008). This result suggests that the marketreacts more negatively when this relatively

strongermonitoring is called into question. We also find more negative returns for firms with higher ex ante CSR ratings

suggesting that agency costs dominate when the marginal benefit from individual blockholder philanthropy is low (i.e.,

in these cases, counterparties are likely already granting concessions to the firm in reaction to the firm’s existing CSR

and further benefits emanating from additional associated CSR, like a blockholder’s philanthropic pledge, are likelyto

be small).

We subject our results to a series of robustness checks involving individual blockholder busyness, different

blockholder types (money managers, firm founders, and management), dual-class share structures, blockholder exit,