The Effect of corporate social responsibility incentives on financial results.

The Effect of Corporate Social Responsibility Incentives on

Financial Results

Master Thesis 30 May 2014

Student A. Bavelaar

1st Supervisor Prof. Dr. C.M. van Praag

2nd Supervisor Prof. Dr. R. Sloof

MSc Business Economics

The Faculty of Economics and Business University of Amsterdam

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Abstract

This report investigated the effects of CSR incentives on the management level on financial performance and market value for companies listed on the US stock market. Empirical data of 59 organizations was analyzed addressing the pivotal questions whether or not they give their board members CSR incentives, whether or not the board members have experience/ are specialized in CSR and whether or not the company has a committee (partly) devoted to CSR. The findings suggest that companies should only give their board members

CSR incentives, if they have experience in or are specialized in CSR. These two elements in combination are essential for differences in financial profit.

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Contents

1.2. Why companies act socially irresponsible ... 9

1.3. Motivations for CSR activity ... 10

1.3.1. CSR and improved financial performance ... 12

1.3.2. R&D ... 12

1.3.3. CSR and corporate strategy ... 13

1.3.4. Other CSR effects ... 13

1.4. CSR in remuneration package ... 14

1.5. General concerns coming along with CSR incentives ... 15

1.5.1. Opportunism ... 17

1.5.2. Middle level managers ... 17

1.6. Boards and implementation ... 18

1.6.1. Principles on CSR implementation ... 19 2. Methodology ... 21 2.1. Design of research... 21 2.1.1. Hypotheses ... 21 2.1.2. Dependent variable ... 22 2.1.3. Independent variables ... 23 2.2. Procedures ... 24 2.2.1. Data collection ... 24 2.2.2. Dataset ... 25 3. Results ... 27 3.1. Correlations ... 27 3.2. T-test ... 28 3.3. Regression analysis ... 29

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3.4. Crosstabs ... 30

3.5. Two way ANOVA ... 31

4. Conclusion ... 32

5. Discussion ... 33

5.1. Limitations ... 33

5.2. Recommendations for further research ... 34

References ... 35

Tables ... 38

Table 1 Descriptive Statistics of All Variables ... 38

Table 2 Frequency Table CSR ... 39

Table 3 Frequency Table EXP ... 39

Table 4 Frequency Table COMMITTEE ... 39

Table 5 Correlations ... 41

Table 6 T-test CSR on Net Income ... 42

Table 7 T-test CSR on Market Value ... 43

Table 8 Regession on NET INCOME ... 45

Table 9 Regession on MVE ... 47

Table 10 Crosstabs ... 49

Table 11 Two way ANOVA on NET INCOME ... 50

Table 12 Two way ANOVA on MVE ... 51

Appendices ... 53

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Introduction

People have constantly questioned about the responsibilities of companies, and to whom those responsibilities apply. Corporate Social Responsibility (CSR) has become a crucial issue for business leaders in every country. Public responses to issues that corporations had not previously thought were part of their business responsibilities took them by surprise and let to a continuous increase of the awareness for such issues.

An early definition of CSR was formulated in the 1980s by the former Norwegian Prime Minister which was later also picked up by the World Business Council for Sustainable Development: “Meeting the needs of the present without compromising the ability of future generations to meet their own needs” (WCED, 1987).

Today, many companies claim to be concerned about CSR. Already in 2005, of the 250 largest multinational corporations, 64% published CSR reports (Porter & Kramer, 2006). However, these publications rarely offer a logical framework for CSR activities, not to mention a strategic one. Furthermore, the effect of CSR activities on financial performance is still inconclusive in the existing literature. It is the aim of this research to point out if the specific incentives for board members have an effect on the financial performance of the corporation.

A dataset of 59 multinationals that are listed on the U.S. stock market has been established for this study. For all companies we found data on their board members monetary incentives on CSR, Experience in the field of CSR of the board members, whether or not the company has a committee related to CSR, the size of the company, R&D costs, sector and market value.

In this paper, section 1 provides an overview of the field of research and describes its most important findings relevant to this research. Section 2 presents the research design and the approach, followed by the presentation of the results in Section 3. Section 4 summarizes the results and gives a conclusion, which will in turn be discussed in Section 5.

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1. Literature Review

Corporate Social Responsibility (CSR) has changed from an irrelevant concept to a widely discussed topic nowadays. An idea that was once disapproved is now broadly accepted and even promoted by governments, corporations and consumers (Lydenberg, 2005). For shareholders, especially the financial returns of CSR are of interest.

Even though there has been research done on the relation between CSR and financial performance, results are still inconclusive. Margolis and Walsh (2003) for example found that less than fifty percent of the studies they looked at showed a positive correlation between CSR incentives and firm performance, while the majority showed a neutral or negative correlation. However, Orlitzky, Schmidt and Rynes (2003) on the other hand found evidence that CSR does have a measurable effect on financial performance.

The following paragraphs will provide an overview of the most influential findings relevant to this research.

1.1. Definition of CSR

It is hard to provide a definition of CSR, because “it means something, but not always the same thing to everybody” (Göbbels, 2002). CSR is often seen as a concept that will solve all world problems, but because of that it has become this large thing of which it is hard to get a definition that holds all segments but does not get too vague to be useful in an academic debate or for corporate implementation.

Jacques Schraven, the chairman of the Dutch Employers Association, once noted that “there is no standard recipe: corporate sustainability is a custom-made process”. According to Marrewijk (2003), each company should choose which concept and definition is the best option. The definition matching the organization’s goals and intentions will be best aligned with its strategy, such that it will result in the best response to the conditions it operates in. To provide an understanding of CSR I already provided a useful definition of CSR, formulated in the 1980s by the former Norwegian Prime Minister which was also used by the

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World Business Council for Sustainable Development: “Meeting the needs of the present without compromising the ability of future generations to meet their own needs” (WCED, 1987). This definition is quoted many times, as the definition Aquinis (2011) provides is too: “context-specific organizational actions and policies that take into account stakeholders’ expectations and the triple bottom line of economic, social, and environmental performance.” Many other authors on this topic adopt these definitions. Aguinis and Glavas (2012) try to make it more complete by noting that “although the definition of CSR refers to policies and actions by organizations, such policies and actions are influenced and implemented by actors at all levels of analysis (e.g. institutional, organizational, and individual)”.

However, many actions that are considered CSR often are not, and thus negatively affect the relation between CRS and organizational outcomes (Barnett, 2007). Figure 1 illustrates this.

Figure 1: Illustration of the types of corporate resource allocations.

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First let us consider the upper left corner “Agency loss”. This is where the type of social spending belongs that is not intended to increase corporate financial profit (CFP). Examples of these may be donations to charities founded by family members of the board members or just an anonymous donation to any charity. Managers’ welfare improves in these cases due to an increasing self-image, social standing or career prospects but is nowhere near improving the company’s reputation or its relations with important stakeholders. In this case the benefits go to society and not to the shareholders, and thus do not outweigh their costs for the organization. Barnett (2007) says that these donations should not be confused with the business case for CSR.

In the lower right corner we find “Direct influence tactics”, which are also different from CSR. This is the place actions belong of organizations that consist of political lobbying and campaign donations, the establishment of contractual donations and other ways of directly influencing regulators, legislators, nongovernmental organizations and other stakeholders that have the possibility to affect the discretion and performance of the firm. While these actions aim to improve important relationships, they are not necessarily aiming on improving social welfare. Actions like this thus cannot be put away as CSR.

In the lower left corner actions that contribute to process improvement, are more often linked to CSR, like energy conservation, waste reduction and pollution abatement. Often there are social welfare gains but the link here between cost savings due to improved efficiency of operations and CFP is so direct and is not from improved stakeholder relations that these are not considered to the business care of CSR.

Figure 1 provides a useful concept helping to make a distinction between all the different actions often mistakenly referred to as CSR. The business case of CSR is considered to have a high social welfare orientation and a high stakeholder relationship orientation and are both intended to be that way.

In the end, all definitions come down to the same thing; that CSR is a more humane, more ethical and a more transparent way of doing business. To put it in context: related concepts are sustainable development, corporate citizenship, sustainable entrepreneurship, business ethics and corporate sustainability (Marrewijk, 2003).

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1.2. Why companies act socially irresponsible

The welfare economics literature, and in special the literature on market failure gives us interesting insides about the reason companies in the first place do not act socially responsible. It is that, under perfect conditions, as under transparent information, strong competition and where costs are “internal” to the market transactions, incentives arise for profit-maximizing companies to engage in operations that serve the public’s demand (Cornes and Sandler, 1986).

However, as Mackenzie (2007) explains, when these conditions are not met, the incentives go into reverse so that companies engage in harmful operations even when they do not intend to do harm. He provides some examples. When markets are not competitive e.g. caused by barriers to entry, it is possible for companies to overprice their products. Incentives to produce and sell good value lacks because customers will keep buying them as they have no alternative. In the case of nontransparent markets, customers will also buy overpriced products because they simply do not know or understand the costs that were involved by producing the product. Conditions on insurance policies for example are made hard to understand and companies often write them in small print to be glanced over. Furthermore, when costs are external to the market transactions rather than internal, markets provide destructive incentives. Externalities are the core of problems related to toxic chemical emissions, deforestation, over-fishing, the droop of biodiversity and a number of health and safety problems. Because this is happening, external regulators and the public have started to ask companies to act correspondently to standards of corporate responsibility – i.e. treat customers and society fairly.

It is important to note that not all CSR violations are born out of market failure. CSR issues like gender and racial discrimination at work clearly do not originate from market failure. A reasonable number of CSR failures originate from managements ignorance and bounded rationality (Mackenzie, 2007).

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1.3. Motivations for CSR activity

In the proxy statement of Emerson (2010), one of the companies in our dataset, they write about their view towards social responsibility:

“The Board respects and supports the stockholders’ interest in good corporate citizenship and social responsibility, and recognizes the importance, as both an ethical and a business responsibility, of addressing the environmental and social impacts of Emerson’s business. We are genuinely concerned about and engaged in the issues that would be covered in the sustainability report requested by the proponents. We believe that the Company has demonstrated a long history of dedication to good corporate citizenship — environmentally, socially, charitably and otherwise… …www.Emerson.com provides investors with detailed information about the following subjects:

 Our business and personal standards of ethics;

 Commitment to people, open communication and leadership as a cornerstone of our business process;

 Efforts to create and sustain healthy and safe work environments reflecting our respect for our employees and others;

 Environmental stewardship activities, including 1) through our commitment to provide products and services that improve energy efficiencies and reduce potential harm to the environment, and 2) through efforts to operate our facilities in a manner that protects the environment, meets or exceeds government requirements, and continually reduces energy consumption and waste;

 Our engagement of the developing world in global growth, opportunity, and rising standards of living; and

 Our contributions to the community, such as charitable contributions and support to local educational programs throughout the world.”

A popular belief is that CSR pursuit is just a way to prettify and distract from real problems (Bakan, 2004). According to Vogel (2005), there is no evidence of the existence of some sort of a market premium that would compensate companies for taking on social responsibilities. Implementation of self-regulated CSR codes/ instruments would generate high costs, and in

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absence of a premium, we would not expect companies to incur these costs. The only way to justify these instruments would be if such a market-premium would exist or when socially irresponsible companies would be ‘punished’, which is only the case with external regulation. However, against these expectations, the number of (multinational) companies publishing CSR reports is increasing, as their actions towards taking their social responsibilities. Levis (2006) identified the motivations of multinational companies to adopt CSR codes, i.e. self-regulatory instruments that address their issue of social, environmental and human rights externalities. Managers sense CSR as a recipe to manage two kinds of risks.

1. The first risk to manage is the development of litigation and public regulation. Since the 1789 Alien Torts Claims Acts was rediscovered, instruments exist and used to prosecute international corporate behavior before US courts. When the companies adopt CSR policies themselves, there would also be no reason for the enforcement of external regulation, which would probably be more costly.

2. Indulging in social pressure is the second reason managers want to engage in implementing CSR codes. Incorporating CSR in the organizational strategy should prevent the company from alienating with society. Gunningham et al (2004) arguments that only the companies that are “not meeting the requirements of the social license will ultimately result in regulations or greater costs to the company” because social actors would only do business with responsible companies and punish the irresponsible ones. This could be through the use of media, boycotts and protests. Adopting and implementing CSR codes can also make the managers feel better about themselves, it shows society the values of the company, and thus makes up a significant part of their reputation. Pressure from peers can play a role in adopting those values, in the case when a company starts receiving signals from other companies that they should act the same.

Eliminating risk, however, is not the only reason managers engage in corporate responsibilities. Socially responsible organizations can attract and retain better partners, consumers, and employees than irresponsible ones (Buysee and Verbeke, 2003). CSR is seen as a source of opportunity to strengthen trust in their brands not only for customers (i.e.

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customer loyalty), but also for employees. Therefore, it is seen as a way to increase an employee’s motivation (Reichheld, 2001).

1.3.1. CSR and improved financial performance

Even though there has been research done on the relation between CSR and financial performance, results are still inconclusive. Margolis and Walsh (2003) for example found that less than fifty percent of the studies they looked at showed a positive relationship between CSR incentives and firm performance, while the majority showed a neutral or negative relation. However, Orlitzky, Schmidt and Rynes (2003) on the other hand found evidence that CSR does have a measurable effect on financial performance.

The missing empirical evidence that links CSR and improved performance comes from the difficulty in measuring the particular outcomes in relation to the particular investment. A worldwide-accepted measurement tool or metric that determines the effects of investments does not (yet) exist. Factors such as the “organizations financial health, regulatory environment, external culture, institutional conditions, and the given organizational unique history and strategy” all have their effect on the way an organization views CSR activities. Any appropriate level of CSR for any given organization depends on many factors like “the size of the firm, level of diversification, research and development, advertising, government sales, consumer income, labor market conditions, and stage in the industry life cycle” (McWilliams and Siegel, 2001).

In addition, it is important to note that socially responsible organizations are able to attract and retain better partners, customers and employees than socially irresponsible firms (Buysee and Verbeke, 2003). Logically, this results in a smaller employee turnover and less unproductive divisions.

1.3.2. R&D

Since academics have found positive, negative and neutral impacts of CSR on financial performance, McWilliams and Siegel (2000) study what the effect of research and development (R&D) is on this relationship.

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The positive and significant coefficient they find of CSR on organization performance reflects the impact of R&D on organization performance. R&D and CSR are highly correlated which suggests that they are both connected with product and process innovation: CSR creates a product innovation, a process innovation, or both. A lot of organizations that proactively act with CSR are also following another strategy, which asks for complementary strategic investments within R&D.

1.3.3. CSR and corporate strategy

The problem with CSR, as Porter and Kramer (2006) see it, is that social interests are being pit against business interests, which results in CSR activity that yield unproductive results. Looking for points of reciprocity instead would be a better way to look at CSR. If organizations were to analyze their chances for CSR by using the same model that directs their core business choices, they would find that CSR could be much more than a price, a burden, or a good deed. It could actually be a source of innovation and competitive advantage.

1.3.4. Other CSR effects

Kim, Park and Wier (2012) found a relation between CSR and earnings management. They find that companies that engage in socially responsible activities are less likely

1. to manage earnings through discretionary accruals, 2. to manipulate real operating activities, and

3. to be the subject of U.S. Securities and Exchange Commission investigations.

Referring to the definition provided by Carroll (1979) of CSR (“The social responsibility of business encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time.”) Kim et al. (2012) argued that managers that decide to engage in CSR activities have a moral drive to “do the right thing”. Managers who feel those values as to be very important are likely to be honest, trustworthy and ethical and are predicted to make responsible operating decisions, thereby keeping the financial reporting

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transparent. They suggest that CSR companies tend to be more conservative in both accounting and operating decisions.

There is also evidence found on the suggestion that CFOs with more experience are more likely to participate in CSR activities, as there is evidence for the relation between the age of assets and CSR performance (Sun and Rakhman, 2013). Education and professional certification in accounting of the CFOs however seem to have no effects on the level of CSR activity. Firms with younger assets are supposed to show better CSR performance than firms with older ones. This could be because firms with older assets may be less able to respond in a socially preferred way than firms with younger assets. Also firms that have older assets could buy or build their factories and machinery when the regulation was not as it is today. External regulators, like governmental agencies enforce stronger restrictions on organizations now and younger assets could be designed in a way that they already meet the criteria. Firms with older assets would need more resources to make their assets suit the new regulations. Based on their findings, Sun and Rahkman (2013) also suggest that firms with lower risk show stronger CSR performance, just like the firms that engage in CSR activities have lower returns too. Constituent with the literature, they also find evidence that organizations with better CSR performance get higher valuations by the market.

1.4. CSR in remuneration package

Deckop, Merriman and Gupta (2006) published evidence that the way CSR is rewarded, must also be taken into account. They show that the way a board members monetary reward is structured has an effect on corporate social performance. Organizations who have more short-term incentives in the board members pay, show lower social performance. This means that a short-term focus might give the board members a deterrence to engage in CSR activities. Based on their, theorization, this would be because CSR activity has a limited or even negative impact on short-term financial performance, and in addition represents an opportunity cost for scarce resources.

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The results of Deckop, Merriman and Gupta (2006) show that the more organizations use long-term incentives in board members pay, the more this will result in higher social performance. They substantiate this conclusion with the argument that a long-term focus removes the deterrence to engage in CSR activities that exist with short-term incentives. Furthermore, this is true because in the long-term, according to Deckop, Merriman and Gupta (2006), CSR and financial performance are positively related.

In 2005, Mahoney and Thorne also wrote a paper that examined the relation between long-term compensation and various measures of CSR by selecting the 90 largest Canadian organizations, based on the Toronto Stock Exchange based on market capitalization, from 1992 to 1996. They had data on long-term compensation, salary and other incentives, the organization’s financial results and data on CSR. Mahoney and Thorn (2005) find that certain aspects of CSR can be related to long-term compensation of board members. In their sample they use a three-year gap between board members long-term compensation and CSR. What they find that there is a difference between CSR product dimension and CSR people dimension, which means that the CSR product dimension is related to higher levels of long-term compensation, and total CSR people dimension is not. This is also what Johnson and Greening (1999) found in their study. They say that there is a positive relation between board members equity holdings and total CSR product dimension but not (significant) with total CSR people dimension. This means that qualitative products and services and a proactive environment are seen as long-term commitments to sustainability but a managerial emphasis on communities, women, minorities and employees are not (Mahoney and Thorne, 2005).

1.5. General concerns coming along with CSR incentives

Berrone and Gomez-Mejia (2009) present three concerns that spread light on the downside of implementing CSR policies.

First, even though there has been research done on the relation between CSR and financial performance, results are still inconclusive. The problem is like one of the HR executives that Berrone and Gomez-Mejia (2009) interviewed said; “one of the greatest challenges is that we have as managers is convincing our shareholders of the need for adopting social incentives.

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It is just too difficult for us to show that these will have economic returns.” Nonetheless, while literature is inconclusive about the beneficial side of CSR, it agrees on the downside. Socially irresponsible firms can be penalized by customers, employees, local communities, NGOs, etc. in their public image, reputation and legitimacy for not fulfilling their public responsibilities.

The second concern with implementing CSR are the benefits of compensating the management initiate and implement CSR policies on every single stakeholder. It is expected that all stakeholders are in favor of socially responsible policies and, as a result, are treated in the same way. However, one should not take as a fact that all CSR policies are not conflicting with the interests of some stakeholders. Instead, CRS policies are subject to trade-offs. Berrone and Gomez-Mejia (2009) explain this with the example that workers and their families rather are not that positive towards social responsible activities that are related to the part of the organization that involves putting their jobs at risk. A manager they interviewed stated that “we strongly believe that we should consider the needs of all our stakeholders … unfortunately, we have no rule of thumb when there are conflicting preferences among them … disparate stakeholders often pursue different paths to the promotion of sustainability, they don’t work together … and consequently have failed to realize the potential synergies of consensus for collective action … in those cases we rely exclusively on our judgment.” This “stakeholder-mismatch” (rewarding actions that are valuable for a specific group, but could be unfavorable for other stakeholders) is especially present when the stakeholders that benefit from these policies and the stakeholders that judge the firms’ and managers’ performance are not the same (group of) people (Wood and Jones, 1995).

The last concern discussed by Berrone and Gomez-Mejia (2009) is the more philosophical one, taking on social responsibilities should be driven by intrinsic motivation instead of monetary rewards. Altruism, self-image and fairness are at the core of people who feel motivated to act in a socially favorable way, which are all intrinsic motivators. Extrinsic motivators, as proven by theoretical and experimental research, can crowd out intrinsic motivation. There is enough reason to fear that if organizations start paying to do ‘good’ things, people might start doing right things for the wrong reasons. As a solution to this problem, firms have started to use nonmonetary rewards for ‘good’ actions, like extra vacation days, internal awards, flexible work hours, paying out hours spent working as a

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volunteer, donations to favorite charities, or offering free bicycles when employees cycle to the workplace a minimum of three times a week.

1.5.1. Opportunism

As discussed before, potential returns for social actions are ambivalent and as a result, managers who are not rewarded for the additional risk that comes along with these kind of actions, they probably will use the resources for other, less risky investments. However, linking monetary rewards and social performance may lead managers to consider social criteria opportunistically (Cennamo, Berrone and Gomez-Mejia, 2008). This is related to how social performance is measured. Financial measurements are developed extensively, but social results are still hard to present in a straightforward, measurable and comparable number. Some initiatives are better to measure than others are and organizations are still looking for a common place where social standards are developed. Financial performance is presented in financial statements, in the annual report, which are all conform the rules of IFRS so anybody understands them. On the contrary, within social performance there are no universal right measurements.

Sadly, this results in measures that are accessible for manipulation. Worries are existent that social measures are therefore more open for manipulation than financial measures. For instance, King and Lenox (2000) found that when there is no close monitoring from the government, the way organizations report their CSR numbers has great potential for manipulation. When managers’ pay depend on CSR reports, it is easy to write down the numbers more favorable to increase their pay. For this reason, monitoring policies and information systems are necessary (Berrone & Gomez-Meija, 2009) which will in fact increase the costs of paying for social performance.

1.5.2. Middle level managers

The internal structure seems to play a role in why companies don’t enforce their CSR structure. Divisional/ middle level managers performance are often evaluated in which way

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they managed to meet their objectives and financial targets, which are in many cases not in line with the companies CSR policy. Ackerman (1973) puts it this way: “the burden for implementing corporate policy on, social issues is ultimately placed on the middle level managers, the same managers who are primarily responsible for planning and directing the operations of the business”. The internal incentive strategy is contradictory and rewards rather than punishes the middle level managers for not enforcing the issued CSR policies.

1.6. Boards and implementation

Effectively, when boards desire to successfully implement their CSR policies, they need to make sure that the company’s remuneration structure and performance systems are well designed. Closely reviewing, and seeking new objectives and performance targets of the middle level managers in charge of divisions exposed to considerable market failures might be necessary. Replacing short-term targets by encouraging CSR practices could be needed. When formulating long-term targets, better CSR results may appear consequentially. Short-term financial targets often collide with long-Short-term values like reputation, customer satisfaction and good relations to the external regulator (Deckop et al., 2006).

Most companies delegate some of their work to board subcommittees. The number of companies creating subcommittees addressing issues within CSR is increasing. Mackenzie (2007) reviewed the terms of reference of board committees that focus on CSR to line out what in fact they are doing. He indicates the core elements of the board/ subcommittees:

- Discussing issues and risks - Setting standards

- Reviewing implementation and disclosure - Philanthropy

In the interviews he had with the companies, it was revealed that many of the problems and risks that boards discuss are seen as market failures in the literature. Nevertheless, board committees are not inclined to characterize them in that way, neither do they think of governmental regulation as a solution, like the literature proposes.

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Although not all CSR violations come from market failure, Mackenzie (2007) argues that it sure is a significant cause and therefore boards should commit to giving the matter significant attention. However, even if this is not on the boards agenda, in case of market failure it is likely that the boards discusses the matter anyhow because such conditions are potentially creating important strategic difficulties.

1.6.1. Principles on CSR implementation

To gain the positive results of implementing a CSR strategy, it seems clear that organizations should pay their managers for social performance. However, we should not forget all of the implications concerning this (e.g. opportunism, conflicting interests of stakeholders, financial risk, the lack of appropriate measures, absent monitoring etc.), and there are many aspects the board should think about to indeed yield a successful outcome. Therefore Berrone and Gomez-Mejia (2009) thought of seven principles to implement CSR policies successfully:

1. Recognize that the link between social and economic performances is not obvious but, rather, ambiguous. Thus, social goals should be carefully crafted to be balanced against economic considerations.

2. Comprehend the context in which the firm operates. By doing so, they will be in a better position to identify the aspects that are highly valued in the community. In turn, this will help establish the right social criteria for the firm and its members to pursue. 3. Identify stakeholders and groups to de- fine who and what really count. In this sense,

it is important to predefine the criteria that will help prioritize the needs of different (and sometimes conflicting) interest groups. This implies understanding how social initiatives affect the different stakeholders of the firm and account for potential trade-offs.

4. Once social goals are stated, define how social initiatives will be measured if these initiatives are to be included in compensation packages. Poor measures or unclear indicators may have negative consequences.

5. Realize that as any pay practice, such as including social issues in compensation schemes, is not immune to opportunism. Consequently, proper information systems and monitoring mechanisms should be considered.

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6. Communicate social commitments, actions, and achievements to the entire organization at all levels, just as you would with any strategic practice. Define them through participatory processes. If social goals are not shared and are supported by only a few individuals or isolated units, any practices surrounding them are likely to fail.

7. Be consistent between disclosure and actions. Companies relying exclusively on symbolic social actions may be seen as untruthful, unreliable, calculating, and manipulative. If symbolic actions are decoupled from substantive actions and this dissonance is exposed to the public, legitimacy will be compromised.

For the policy and these principles to be successful, HR programs, concerning all employees, should be consistent with the socially driven incentive plans designed by the top management. CSR policies should express the organizations’ mission, values, and identity.

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2. Methodology

The approach used in this study is empirical. We will first put forward three hypotheses that we try to confirm using the dataset that is established in this thesis. This dataset contains information on 59 U.S. stock market listed organizations. The academic computer program SPSS is used to evaluate the data.

2.1. Design of research

We now develop three hypotheses motivated by the literature research. To test whether CSR in the incentives/ remuneration package of board members has an effect on the financial performance of firms, the study uses a regression to control for variables. In this regression we use control variables, which we will discuss in this chapter.

2.1.1. Hypotheses

The literature research presented in the previous chapter indicates that CSR is expected to have a positive effect on financial performance. We therefore expect that when board members get incentives to act on CSR, this will have a positive effect on financial performance, too. Our first and most important hypothesis therefore is:

Hypothesis 1 CSR incentives for board members will have a positive effect on financial performance two years later.

This study tests the relation between CSR incentives for board members and financial performance over a span of two years, because we learned in our literature research, that results on an investment like CSR needs time before such activities affect the market. To test this hypothesis we use data on the net income of 2012 and a dummy variable on CSR incentives in 2010, collected especially for this study and further explained in the next paragraphs.

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We also learned that the market valuates corporations higher that act socially responsible. Our second hypothesis is a positive relation between CSR incentives and market value: Hypothesis 2 Firms that include CSR in the remuneration package of board members have

higher market valuations.

We can test this with data on market value of corporations in 2012 and again, CSR incentives for board members in 2010.

Our last hypothesis is about the relation between CSR and R&D, based on the published literature on this matter. Excluding R&D in the econometric model is ought to be problematic, because if R&D has a positive impact on firm performance, then the coefficient on any variable that is positively correlated with R&D will be overestimated when R&D is omitted from the equation. To secure for accurate conclusions, this includes R&D expenses in 2010, the same year we use for our data on CSR incentives.

Hypothesis 3 Research and Development is positively correlated with CSR.

2.1.2. Dependent variable

The "dependent variable" represents the output or effect, or is tested to see if it is the effect. Because the main focus of this study (hypothesis 1) is to find out the effect of CSR incentives on financial results, financial results therefore are the dependent variable. As a measure of financial results, we chose net income. The reason for this is that net income includes unrecognized net assets and the essence of this measure is to reflect the financial performance of a firm. As companies listed on the stock market need to report their financial results in accordance with the International Financial Reporting Standards (IFRS) rules, we can easily compare these numbers. According to Dhaliwal, Subramanyam and Trezevant (1999), net income is, more accurate than other measures such as comprehensive income, which is associated with the market value of equity and predicts future operating cash flows and income. Compared to other measures like return on assets (ROA) or return on equity (ROE), net income looks at profit made by the organization and is not dependent on the equity or

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assets of the organization. In that way we are able to make better comparisons between e.g. internet organizations and plants. Numbers are from the year 2012.

To be able to test hypothesis 2, the dependent variable is market value instead of net income. For this, a regression on market value will be used to control for control variables.

For both hypotheses, conclusions can be drawn from the coefficient of the independent variable CSR.

2.1.3. Independent variables

The "independent variables" represent the inputs or causes, or are tested to see if they are the cause. CSR, EXP and COMMITTEE are variables used to test if they have any effect on net income and market value. The other variables are included in the model because they have an effect on the dependent variables (net income and market value), and if not controlled for these variables, the test is less valid because other variables could inaccurately show their effects. Below we describe the independent variables of this study;

CSR The independent variables are as follows: Since we seek to find the effect of CSR incentives in board members remuneration packages, it is the first variable that reflects this. CSR is a measure of the presence of CSR incentives in the payment scheme, which is used as a dummy variable. This means that if an organization does not use CSR in their incentives, the CSR variable will be 0. If on the other hand CSR measures are used in the incentive scheme of board members, then the CSR variable will be 1. All net incomes are from calendar year 2010 to avoid different effects because of different economic environments. Numbers are in millions.

EXP The second independent variable is experience/ specialization in CSR of the board members. In their proxy statements, companies provide a brief discussion of the specific experience, qualifications, attributes and skills that the board of directors considered in nominating him or her for (re) election for a place in the board. This variable is a dummy variable, and when one of board members has experience, or is specialized in the field of CSR, and the company sees that as an area of relevant

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experience to write it in the statement, it will be 1. It will get value 0 when none of the board members has experience in this field.

COMMITTEE Multiple companies form committee’s related to CSR, and this is an independent variable in this research. This variable too, is a dummy. It will be 1 if the company has a committee with CSR responsibilities, and 0 otherwise.

RD As mentioned in section 1, we will control for the effect of research and development. This is represented by the independent variable R&D. We use the R&D costs including any marketing expenses, of the year 2010. This is important because these investments need their time to cause measurable benefits. Costs are in millions. Examining the coefficient of this variable, we will be able to valuate hypothesis 1. EMPL Furthermore, this study corrects for the size of the corporation, by including the

number of employees employed in the year 2012.

OILANDGAS Lastly, this study corrects for the industrial sector. This study distinguishes 5 large sectors that are incorporated as dummy variables. The five sectors are the oil and gas industry, consumer electronics, the medical industry, the financial sector and the transport industry. To avoid multi-collinearity, the first sector is neglected in the regression formula. ELECTRONICS MEDICAL FINANCE TRANSPORT

2.2. Procedures

Because public databases on this matter do not exist, we established a new database, and chose to use only U.S. listed companies for better comparison. Companies listed at the NASDAQ1 that had the highest market capital value in 2012 serve as the base for our analysis. Companies that did not fit in one of the five sectors were excluded so that we ended up with 60 companies for our sample. The five sectors are the oil and gas industry, consumer

1

http://www.nasdaq.com/screening/companies-by-industry.aspx?industry=ALL&exchange=NYSE&region=North+America&sortname=market cap&sorttype=1&page=3

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electronics, the medical industry, the financial sector and the transport industry. The companies were classified in these sectors by NASDAQ and further specifications about the sector are listed on the website of the NASDAQ.

For these identified companies we searched all annual reports for the net income of the year 2012, the R&D expenses of the year 2010 and the number of employees in the year 2012. On the NASDAQ website we found data on the market value of the companies in 2012, which is calculated as the product of a firm's stock price and the number of common shares outstanding.

Additionally, we searched all proxy statements of the sixty firms and analyzed them for information about their remuneration scheme in order to conclude whether they use CSR as a performance measure in the year 2010 or not. Appendix 1 shows the citations in the proxy statements for every firm that let us set the variable to 1 (= CSR incentives). Whenever it is a 0 (= no CSR incentives), there was no information regarding this available respectively the information was not sufficient. For those cases the quotes are stated and left blank if nothing is written about it in the proxy statements. We also collected data on the experience or specialization in CSR of board members and whether or not the board formed a committee related to CSR. The last two variables are also dummies and included for the year 2010.

2.2.2. Dataset

Of the 60 identified companies we excluded Enterprise Products Partners L.P. as we could not find their proxy statement of 2010. Not being able to say anything about their remuneration structure and CSR policies the resulting dataset has a sample size of 59 companies.

Of the 59 companies, 19 companies reward their board members on CSR, and 40 companies do not. This is 32% of the sample that used CSR as a performance measure in 2008. 56% (33) of the companies have board members that have experience in CSR or are specialized in the field. 59% (35) of the companies have formed a committee in which tasks related to CSR are described.

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Some organizations stated that they do not invest in research and development and for those companies these costs are thus equal to 0. For other companies we could not find any specification about the R&D expenses. Because the IFRS requests that R&D expenses are reported in the annual statements, we assume that those companies do not invest in R&D either. In total, 37 out of 59 companies reported their R&D expenses, and the remaining 22 companies did not.

The numbers of organizations per sector in the oil and gas industry, consumer electronics, the medical industry, the financial sector and the transport industry are 10, 12, 12, 15 and 11.

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3. Results

Table 1 gives a summary of the descriptive statistics of each variable in this study. Net income and market value are both in millions, and the mean market value is about 19 times the mean net income. Table 2, 3 and 4 give the frequencies of the dummy variables CSR, EXP and COMMITTEE. We find that 23.7% of the companies have incentives on CSR and thus reward their board members on CSR, 54.2% of the companies have board members that either have experience with CSR or are specialized in it, and 59.3% has formed a committee related to CSR. We speak of significant effects or results when it has a significance value of 10%. When significance is higher, we also report this in the chapter.

TABLE 1, TABLE 2, TABLE 3 and TABLE 4

3.1. Correlations

Table 5 shows the correlations between net income, market value, research & development, CSR in incentives of board members, experience of board members in CSR and CSR committee. As expected, net income and market value are highly correlated (0.845) at a 1% significance level.

The previous literature would expect for CSR to be correlated with Net Income, this found at a level of 0.340 on a 1% significance level. It is also found that CSR is a bit stronger correlated with the market value. The correlation between CSR and market value is 0.358 on a 1% significance level too.

Comparing between the dependent variables, experience on the other hand has the highest correlation with net income. However, we find that experience is also found to be correlated with both net income and market value, on a 10% level. Experience and net income have a correlation of 0.247 and experience and market value have a correlation of 0.229.

Research and development is correlated with net income on a 1% significance level. Therefore we can accept our third hypothesis. What is notable is that R&D also correlates with market value and CSR.

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Committee is not correlated with one of the dependent variables. TABLE 5

3.2.

T-test

After analyzing the data, the first test we did was an independent sample t-test to test the second and third hypothesis, which for the first hypothesis just the data on CSR and financial performance (=net income), and for the second hypothesis just the data on CSR and market value, without controlling for other variables. We do this, because when we want to control other variables, we must do a regression. However, a few assumptions must be met before we can do one. One of them is that all variables must be normally divided, and the other is that we need at least 49 observations, plus 10 observations for each independent variable. Because R&D is not normal distributed, and we do not have enough observations, we did a clear t-test first. The results of the first t-test are shown in table 6.

Table 6 shows the t-test of CSR on Net Income. What we notice is that the Levene's test for equality of variances shows that there is a difference between the variances. What we see next is that the mean difference between the net incomes of organizations with CSR is 5943.7587 million higher than organizations without CSR. This difference is significant on a 10% level and based on the t-test therefor we can accept our first hypothesis. However, in the next chapter we will test if we can still accept the hypothesis when we control for other variables.

TABLE 6

In table 7 we see that the Levene's test for equality of variances shows that there is a difference between the variances of the variables MVE and CSR. We can still compare them using the lower row, showing that the difference between the MVE of companies that use CSR and the companies that don’t use CSR is 61075.587. This difference is significant on a 10% level and we can therefor accept the second hypothesis that including CSR in the remuneration package gives companies higher market valuations. Again, we will also test this hypothesis controlling for either variables.

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3.3.

Regression analysis

It could be that more variables have effect on Net Income, and when we control for them, the effect of CSR on Net Income could change. Unfortunately, our data does not meet the assumption that all variables are normally distributed, but we still chose to do a regression so we can control for other variables and so that we are able to see the effect of every additional variable. Many economic researches use the same approach. We also have to few observations in our dataset to get clear results when we use all variables in one regression, and we therefor start with small regressions, and add variables one by one.

Table 8 displays regressions on Net Income. In the first regression we look at the effect of the variables EXP and CSR, which both have an effect on financial performance. COMMITTEE also does not have any effect on Net Income and is therefore included in the last regression of the series. When we add R&D, EXP does not have a significant effect on financial performance anymore. For this regression, the R square tells us that 23.8% of the model is explained by our variables. This increases for the further regressions.

When we also add the sector in the third regression, EXP again had no significant effect on net income. In our expectations this would not happen when using more observations. CSR and R&D have an effect on financial performance in all regressions.

The first hypothesis, that CSR incentives have a positive effect on financial performance, can be accepted be. This hypothesis is accepted when we only test the effect of CSR on financial performance, but also when we correct for R&D, sector and number of employees.

Experience of the board members also shows to have an effect of financial performance, which is only true when do not corrected for anything. However, when using more observations, we expect that its effect remains significant when we control for more variables.

TABLE 8

The regression on Market Value is shown in table 9. In the first regression we look at the variable CSR on MVE. What we find is that CSR has an effect on MVE. We included EXP

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and COMMITTEE only in the last regression of the model because they did not seem to have an effect on market value. This way we can get cleaner results in the first regressions.

If we add RD in the second regression, we see that the CSR beta decreases and remains significant. RD has a significant effect on market value, too. The R squared tells us that 15.9% of the model is explained by our used variables. It increases with the third (to 21.2%), fourth (22.5%) and the fifth (to 26.7%) regression, where we add sector, employees and experience and committee.

In the third, fourth and fifth regression remains the effect of CSR significant, but R&D loses its significance. We expect if EXP to have a significant result too, if the dataset were larger. The same expectations exist for R&D in the third, fourth and fifth regression. Still, these results confirms our previous statement about our second hypothesis, that firms that include CSR in the remuneration package have higher market valuations, also true when we correct for R&D, sector and number of employees.

TABLE 9

3.4.

Crosstabs

To make a good analysis, we should know if the 23.7% of the companies that have CSR in their incentives, are the same companies that have experienced board members (54.2% of the companies). If that would be the case, we would actually be measuring the same thing. This is displayed in table 10.

What we can conclude from table 10 is that the companies that use CSR in their incentives do not all have experienced board members. In our sample, 22 companies do not use CSR in their incentives and do not have experienced board members either. The remaining 23 companies that do not use CSR in their incentives have experienced board members. 9 Companies have both experienced board members and use CSR in their incentives and 5 Companies use CSR in their incentives but do not have experienced board members. We can thus conclude that CSR and EXP are two different variables.

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TABLE 10

3.5.

Two way ANOVA

We used the two way ANOVA test to check whether there are differences in financial performance and market value between the four groups above, so companies that have both CSR and EXP, companies that have only CSR, companies that have only EXP and companies that have none. The two way ANOVA on net income is presented in table 11.

Looking at table 11, we again find that there is a significant difference in net income between using CSR or not. Furthermore, we also find a significant difference in net income between companies that have experienced board members, and companies that do not. We also find that the interaction effect between CSR and EXP is significant. This means that there are differences between the four groups. When a company had both CSR and EXP, the effect is a lot higher, then when companies only have EXP or CSR or none. Looking at table 11, we are able to conclude that companies that only use CSR, find a relatively small effect on their net income. However, when also having board members that have experience in CSR, we find a large effect on net income. These results are very useful in practice, companies should only give incentives for CSR when the board members are experienced, and the effects yield from these incentives are proximately 10,000 million larger.

TABLE 11

We did the same test on market value, to be found in table 12. Here we also found significant differences between having experience in the boards of the company or not, and also significant differences between companies that have CSR incentives and companies that haven’t. We also find an interaction effect between the two variables, which leads us to the same conclusion as with net income. The combination of incentives and experience is crucial for a large effect on market value.

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4. Conclusion

This empirical study reports findings from a data analysis, investigating the effects of CSR incentives on management level on financial performance and market value for companies listed on the US stock market. A sample of 59 organizations was conducted with information about whether or not they give their board members CSR incentives, whether or not the board members have experience or specialized in CSR and whether or not the company has a committee (partly) devoted to CSR.

As expected in the literature we did find an effect of CSR incentives for board members on financial performance; hence the first hypothesis is accepted.

We also found evidence that experience of the board members in CSR has a positive effect on financial performance, and that both CSR incentives for board members and experience of the board members have positive effects on market value. We thus can accept the second hypothesis that CSR incentives increase market value of the company.

The first hypothesis, that research and development and CSR incentives are correlated is accepted too, on a 1% significance level.

A striking result is that companies should only give board members incentives on CSR, when they also have board members that have experience or have specialized in CSR. These two elements together make the difference for effects on financial performance and market value.

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5. Discussion

The results of this study can contribute to decisions companies have to take regarding their CSR strategy and remuneration package of their board members. We are satisfied with the evidence we can provide over the relations between CSR incentives, experience and net income and market value. This study is, however, subject to some limitations.

5.1. Limitations

As a result of the limited sample size, some criteria to perform the regression needed to be relaxed. Incorporating multiple independents in the regression as control variables asks for more observations. This is why we did not do one regression will all variables but added one by one to see the changing effects. This unmet criterion could have effect on the beta of the coefficients, and we expect more positive results for a bigger sample.

Another criterion for the regression is the use of normally distributed variables. Unfortunately, our variable of research and development expenses wasn’t normally distributed. We still chose to perform the regression as we found this is common to do in the economics field of research. Because we did, we could control for more independent variables like sector and number of employees.

Also, the time span used in this study was two years, which is relatively short for large investments.

Finally, it is important to note that the variable expectations could not reflect the real experience of the board members. It could be that companies reported in this research as not having board members with experience in the field of CSR, in reality to have board members with experience in CSR. Those board members could have the same qualifications, but in that case the company does not think of that as a quality important enough to report that in the proxy statement.

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5.2. Recommendations for further research

For future research a great emphasis should be placed on using a bigger sample, to strengthen the empirical results. To get even more secure results, we also propose to find data on multiple years to be able to see the yearly effects. When it is clear when organizations started to incorporate CSR as a performance measure and when the organization elected board members with experience in CSR, one could map the development of the effects on net income and market value right after incorporating CSR.

A further look into the experience of board members regarding CSR would be of value to explain if the companies that did not have experienced board members according to this study, is because of the company or the actual experience. One could build upon the knowledge gained in this research to study whether it is the company that thinks of CSR as an unimportant quality, or the board members that didn’t have experience in the field.

An interesting addition to the current research would be data on what kind of CSR the incentives are targeted would be interesting, as we everything that falls into the category ‘CSR’.

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Tables

Table 1

Descriptive Statistics of All Variables

Descriptive Statistics

N Minimum Maximum Mean

Std. Deviation NET INCOME 59 -11933,0 44880,0 5431,339 7501,1337 MVE 59 38380,0 416190,0 95214,068 73145,4806 CSR 59 0 1 ,24 ,429 EXP 59 0 1 ,54 ,502 COMMITTEE 59 0 1 ,59 ,495 RD 59 ,0 526000,0 10528,593 68311,5224 EMPL 59 2650,0 1349000,0 135082,305 191046,656 1 OilGasInd 59 ,0 1,0 ,169 ,3784 Electronics 59 ,0 1,0 ,203 ,4060 Medical 59 ,0 1,0 ,203 ,4060 Finance 59 ,0 1,0 ,254 ,4392 Transport 59 ,0 1,0 ,186 ,3928 Valid N (listwise) 59

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Table 2

Frequency Table CSR

CSR Frequency Percent Valid Percent Cumulative Percent Valid geen csr 45 76,3 76,3 76,3 wel csr 14 23,7 23,7 100,0 Total 59 100,0 100,0

Table 3

Frequency Table EXP

EXP Frequency Percent Valid Percent Cumulative Percent

Valid geen exp 27 45,8 45,8 45,8

wel exp 32 54,2 54,2 100,0

Total 59 100,0 100,0

Table 4

Frequency Table COMMITTEE

COMMITTEE Frequency Percent Valid Percent Cumulative Percent

Valid geen comm 24 40,7 40,7 40,7

wel comm 35 59,3 59,3 100,0