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The Role of CEO’s Personal Incentives in Driving Corporate Social Responsibility

Abstract

In this study, we explore the role of Chief Executive Officers’ (CEOs’) incentives, split between monetary (based on both bonus compensation and changes in the value of the CEO’s portfolio of stocks and options) and non-monetary (career concerns, incoming/departing CEOs, and power and entrenchment), in relation to corporate social responsibility (CSR). We base our analysis on a sample of 597 US firms over the period 2005–2009. We find that both monetary and non-monetary incentives have an effect on CSR decisions. Specifically, monetary incentives designed to align the CEO’s and shareholders’ interests have a negative effect on CSR and non-monetary incentives have a positive effect on CSR. The study has important implications for the design of executive remuneration (compensation) plans, as we show that there are many levers that can affect the CEO’s decisions with regard to CSR. Our evidence also confirms the prominent role of the CEO in relation to CSR decisions, while also recognizing the complexity of factors affecting CSR. Finally, we propose a research design that takes into account endogeneity issues arising when examining compensation variables.

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Notes

  1. 1.

    Long-term incentives generally may include stock options, other forms of market-based compensation, and non-market-based long-term incentive plans (McGuire et al. 2003).

  2. 2.

    EIRIS monitors the CSR performance of companies listed in the FTSE World Index. It covers 2,970 firm-year observations in the US. Execucomp covers the S&P 1,500 companies and contains over 2,872 firms. Therefore, our final sample consists of all firm-year observations included in the EIRIS dataset which also have compensation data in the Execucomp dataset (2,770 firm-year observations). With reference to the period analyzed in the paper, the Execucomp dataset covers more than the 90 % of company-year observations included in the EIRIS database. Since our final sample is an intersection between companies listed in the FTSE World Index and firms listed in the S&P 1,500 Index, our inferences are mainly drawn from large and profitable firms, and thus results should be interpreted with this caveat in mind.

  3. 3.

    EIRIS measures five CSR attributes: employment, environment, community, human rights, and supply chain management. Nonetheless, full information is available only for the environment, employment, and community dimensions of social performance. Less data are available for human rights and supply chain management. Since including all five CSR attributes would unnecessarily restrict the sample size, the analysis is restricted to three dimensions of social performance: environment, employment, and community. This approach is commonly used in papers relying on EIRIS data (see Brammer and Pavelin 2004; Cox et al. 2004; Brammer et al. 2006; Brammer and Pavelin 2006; Cox et al. 2007).

  4. 4.

    EIRIS environmental performance would comprise a fourth additional item: environmental reporting. We do not consider it in our construct in order to avoid bias in our measure of environmental performance because of self-reported information (e.g., Cho and Patten 2007; Patten 2002).

  5. 5.

    Cronbach’s Alpha is used to measure how well a list of items measures a single latent construct. Values of Cronbach’s Alpha range between 0 and 1, with values above 0.7 commonly thought to provide a sufficient level of reliability (Hair et al. 1998).

  6. 6.

    Throughout the paper, we use the moral consensus approach described in Eabrasu (2012), since we measure CSR using the EIRIS dataset that analyzes firms’ good practices assuming the existence of a moral consensus. Even if giving a moral interpretation of results is well beyond the scope of our work, we acknowledge that our framework relies on the mainstream CSR definition of good CSR practices (OECD 2001), and therefore it remains somewhat arbitrary. The use of a moral pluralism approach, even if desirable from a theoretical standpoint, would be very difficult to operationalize in an archival study such as ours. Nonetheless, results should be interpreted with this caveat in mind.

  7. 7.

    Appendix A reports the formula used for computing the sensitivity of individual stock options to stock price.

  8. 8.

    Cash compensation is defined as the sum of base salary and annual bonuses.

  9. 9.

    The coefficient for age also has an important economic effect as we discuss in the “Adjusted Predictions and Marginal Effects” section.

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Acknowledgments

The authors are grateful to Claudia Arena, Pietro Bonetti, Antonio Parbonetti, and Den Patten for their insightful comments and suggestions. The authors also acknowledge the useful comments received at the 24th CSEAR International Congress on Social and Environmental Accounting Research (3–5 September 2012, St. Andrews, UK). Finally the authors are grateful to EIRIS for access to the EIRIS database.

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Correspondence to Giovanna Michelon.

Appendix A

Appendix A

Estimates of a stock option’s sensitivity to stock price are calculated based on the Black-Scholes (1973) formula for valuing European call options, as modified to account for dividend payout by Merton (1973).

$$ {\text{Option}\; {\text{value}}} = [{\text{S}}e^{ - dT} \,{\text{N}}\left( {\text{Z}} \right) - {\text{X}}e^{- rT}\;{\text{N}}({\text{Z }}-\sigma {\text{T}}^{( 1/ 2} )] $$

where

$$ Z = [\ln \left( {S/X} \right) + T \, (r-d + \sigma^{2} /2]/\sigma T^{(1/2)} $$

N is the cumulative probability function for the normal distribution, S is the price of the underlying stock, X is the exercise price of the option, σ is the expected stock return volatility over the life of the option, r is the risk-free interest rate, T is the time to maturity of the option in years and d is the expected dividend yield over the life of the option.

The sensitivity with respect to a 1 % change in stock price is defined as

\( [\delta ({\text{option value}})/\delta ({\text{price}})]*({\text{price}}/100) = e^{ - dT} *N(Z)*({\text{price}}/100) \)

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Fabrizi, M., Mallin, C. & Michelon, G. The Role of CEO’s Personal Incentives in Driving Corporate Social Responsibility. J Bus Ethics 124, 311–326 (2014). https://doi.org/10.1007/s10551-013-1864-2

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Keywords

  • Chief Executive Officer (CEO)
  • Corporate social responsibility (CSR)
  • Executive remuneration
  • Monetary incentives
  • Non-monetary incentives