The Effect of Corporate Governance on Corporate Social Responsibility

• Author: Pandej Chintrakarn,Young Sang Kim,Jang‐Chul Kim,Pornsit Jiraporn
• DOI: http://doi.org/10.1111/ajfs.12121
• Date: 01 February 2016
• Published date: 01 February 2016

The Effect of Corporate Governance

on Corporate Social Responsibility*

Pandej Chintrakarn

Business Administration Division, Mahidol University International College

Pornsit Jiraporn

School of Graduate Professional Studies, Pennsylvania State University and College of Management, Mahi-

dol University, The National Institute of Development Administration

Jang-Chul Kim

Haile/US Bank College of Business, Northern Kentucky University

Young Sang Kim**

Haile/US Bank College of Business, Northern Kentucky University

Received 27 July 2015; Accepted 28 December 2015

Abstract

Motivated by agency theory, we explore the effect of corporate governance quality on corpo-

rate social responsibility (CSR), using the governance standards provided by Institutional

Shareholder Services (ISS). Our evidence reveals that firms with more effective governance

make significantly less investment in CSR. It appears that managers tend to over-invest in

CSR and are forced to reduce CSR investments when corporate governance is more effective.

In particular, an improvement in governance quality by one standard deviation translates into

a decline in CSR investments by 7.16%. Our fixed-effects analysis also shows that, within

firms, when governance quality improves over time, CSR investments decline significantly.

Using the passage of the Sarbanes-Oxley Act of 2002 as an exogenous shock that improves

the quality of corporate governance, we demonstrate that high-quality governance is not

merely associated with, but rather brings about, lower CSR investments.

Keywords Corporate governance; Corporate Social Responsibility; Institutional Shareholder

Services; Agency theory

JEL Classification: G30, G34

*Acknowledgments: We wish to thank two anonymous referees and the Editor Hee-Joon Ahn

for their valuable comments. We also thank Alain Krapl, Ha-Chin Yi, and seminar partici-

pants at Penn State University, Northern Kentucky University, session participants at the

FMA annual meeting and the 2015 Annual International Conference on Asia-Pacific Financial

Markets, for their helpful comments. Any remaining errors are our own.

**

Corresponding author: Young Sang Kim, Associate Professor of Finance, Northern Ken-

tucky University, Highland Heights, KY 41099 USA. Tel: + 1-859-572-5160, Fax: 1-859-572-

6177, email: kimy1@nku.edu.

Asia-Pacific Journal of Financial Studies (2016) 45, 102–123 doi:10.1111/ajfs.12121

102 ©2016 Korean Securities Association

1. Introduction

Each year, corporations make enormous investments in activities related to corpo-

rate social responsibility (CSR). Mutual funds that pursue investment strategies

based on CSR command billions of dollars around the world. Academic debate on

the costs and benefits of CSR spans several disciplines, including management,

finance, economics, and marketing. The literature in the past 30 years has pro duced

a tremendous volume of research on the topic of CSR. Much of the literature has

been dedicated to the intensely debated question: does CSR improve firm value?

1

Surprisingly, despite the enormous volume of research in this area, the conclusion

on the costs and benefits of CSR remains largely elusive.

2

Another area of the literature takes an alternative approach. Instead of looking

directly at the impact of CSR on firm value, several recent studies examine factors

that influence CSR engagement. These studies seek to understand the motives

behind CSR decisions. For instance, prior studies find that CSR engagement is

influenced by ownership structure (Barnea and Rubin, 2010; Oh et al., 2011), by

takeover provisions (Jo and Harjoto, 2011), by CEO characteristics (Borghesi et al.,

2014), by managerial entrenchment (Surroca and Tribo, 2008; Jiraporn and Chin-

trakarn, 2013a,b; Johnson and Yi, 2014), and by analyst coverage (Borghesi et al.,

2014). Following the literature in this area, our study investigates how CSR engage-

ment is influenced by corporate governance. Due to the agency conflict, managers

may not always act in the best interest of shareholders. Corporate governance

mechanisms are put in place to alleviate the agency conflict. In firms with effective

governance, managers are less likely and able to take actions that maximize their

private benefits at the expense of shareholders. On the one hand, CSR can enhance

the reputation of the firm and thus increase shareholders’ wealth.

3

On the contrary,

managers may over-invest in CSR simply to gain private benefits, such as pers onal

reputation and media coverage, a wasteful deployment of resources that does not

maximize shareholders’ welfare.

4

By examining the link between corporate gover-

nance and CSR, we seek to understand whether managers engage in CSR activities

primarily to enhance shareholders’ wealth or to expropriate from them.

1

Solomon and Hansen, 1985; Pava and Krausz, 1996; Preston and O’Bannon, 1997; Stanwick

and Stanwick, 1998; Verschoor, 1998; Ruf et al., 2001; Bauer et al., 2002; Becchetti et al.,

2009;. Margolis and Walsh (2003) offer an exhaustive review of the literature on CSR.

2

A number of recent studies also examine the effects of CSR on various corporate outcomes.

For instance, CSR has been linked to the cost of capital (El Ghoul et al., 2011), to the cost of

bank loans (Goss and Roberts, 2011), to M&A returns (Deng et al., 2013), and to access to

finance (Cheng et al., 2014) etc.

3

Consistent with this notion, a number of prior studies find that CSR is beneficial to firm

value (Orlitzky et al., 2003; Saiia et al., 2003; Godfrey, 2005).

4

Supporting this view are a number of previous studies that report either negative or insignif-

icant effects of CSR on firm performance (Aupperle et al., 1985; McGuire et al., 1988; Wright

and Ferris, 1997; Teoh et al., 1999).

The Effect of Corporate Governance on CSR

©2016 Korean Securities Association 103