“The compensation structure of CEOs as a pillar
for the promotion of Sustainability”
Name: Eleftherios Velivasakis Student number: 11088915
Thesis supervisor: dr. Georgios Georgakopoulos Date: 20 June 2016
Word count: 13554
MSc Accountancy & Control, specialization Control
Statement of Originality
This document is written by student Eleftherios Velivasakis who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
This paper presents an overview of my research topic which is based on two theoretical concepts. Building on theories of CEO compensation and corporate sustainability, I will try to establish a linkage between the design of CEOs compensation plans and the promotion of sustainability. Using current financial data from Compustat and ExecuComp coupled with up-to-date social responsibility indicators from KLD, the Thesis signals a positive linkage between the design of CEOs remuneration and the promotion of Sustainable Development. My sample incorporates 10625 firm-years observations and refer to organizations that report their social performance to the KLD Database from 2011-2013. Running regression analysis not only for the whole sample but also for each year separately, I found that, indeed, the structure of CEO compensation does matter in the promotion of the sustainable development within a firm. Long term incentives plans are positively and statistically significant related with the CSR score for 2012, supporting partly my hypothesis.
Contents
1 Introduction ... 5
1.1 Background ... 6
1.2 Research Question ... 9
1.3 Motivation of the study ... 9
2 Theory and Hypothesis development ... 12
2.1 Compensation Structure ... 12
2.2 Long term Compensation plans ... 13
2.3 Agency Theory ... 15
2.4 Stakeholder vs. Shareholder Theory ... 16
2.5 Sustainable Development ... 18
2.6 Hypothesis Development ... 20
3 Research Methodology ... 21
3.1 Empirical Approach-Sample ... 21
3.2 Data Collection and Measurement of Variables ... 22
3.3 Overview of variables ... 25
3.4 Empirical model ... 25
4 Results... 27
4.1 Basic descriptive statistics and baseline regression ... 27
4.2 Limitations... 30
4.3 Alternative measures of CSR ... 31
5 Conclusions ... 33
References ... 35
1 Introduction
The Earth provides enough to satisfy every man’s needs, but not every man’s greed.— Mahatma
Gandhi. This aphorism serves an on-going discussion about the crucial impact of Sustainable
Development on the societal welfare (Wagner and Blom, (2011), Callan and Thomas, (2011), WCED, (1987)). A term which is recently introduced in the economic framework and comes to add to our knowledge about the ultimate goal of each firm which is nothing more than reaching its targets, being profitable. What makes though a company being sustainable, is the willingness and the devotion of the top executives to include social responsibility and environmental protection in its operational management. Compensation can therefore be a potentially important mechanism for directing managerial attention to social objectives (McGuire et al, (2003). Consequently, the underlying premise is to examine whether remuneration can incentivize socially responsible decisions.
Undoubtedly, today’s business environment calls for both profitable and socially responsible management. Shell stated in its Report to Society, 1998: ‘The days when individual companies were judged solely in terms of economic performance and wealth creation have disappeared. Today, companies have far wider responsibilities to the community, to the environment, and to improving the quality of life for all’. Since the time Shell made the above statement (1998), I assume that the importance attributed to various corporate social responsibility issues, such as of climate change and sustainability, has significantly increased. In essence, this happens not just because we move forward, develop processes and demand a more long-term and sustainable economic horizon. Corporate scandals involving top executives have caused much attention to various evaluations and rankings of social performance such as the Kinder, Lydenberg, Domini, and Company (KLD) database while, at the same time, transparency is of ultimate importance (Eccles et al, 2014).
Sustainability is a term that incorporates not only financial but also, non-financial performance measures such as social ratings (Corporate Governance, Human Rights, and Environment). Whereat, the way that managers are evaluated is going to have an impact to their actions to incorporate the notion of Sustainability in the operations of the entity. Wallace (1997) comes to enhance the previous argument with his well-known adage “You get what you measure and reward”. Thus, I expect a greater emphasis on the promotion of sustainable actions if the compensation plans of CEOs are based merely on long term incentives plans (Kane, 2002). In parallel, the sample period chosen (2011-2013), namely in the aftermath of the global financial crisis, is going
to show whether there is a deviation from the findings of the established academic literature (Deckop et al, 2006, McGuire et. al, 2003).
The remainder of my Thesis is structured as follows: 1. Background information about my research topic and research question, 2. Literature topics that I am going to integrate into my thesis and formulation of Hypothesis and finally the research methodology that I will use and try to support my Hypothesis.
1.1 Background
My research proposal is substantially based on two research topics. On the one hand, I will draw on relevant aspects from objective performance measurement and specifically I will focus on the structure of CEOs compensation plans (Jensen and Meckling, 1976, Murphy, 1985, Mehran, 1995). On the other hand, I will use theories of Sustainability (Friedman, 1970, Freeman, 1984, Porter and Kramer, 2006). Both topics have been extensively researched before but the possible relationship between the level of long term remuneration plans and the promotion of Sustainable Development, to the best of my knowledge, is not yet examined.
Much attention has been paid to bibliography before about the relationship of CEO compensation and Corporate Social Responsibility1 (CSR) (McGuire et al., 2003, Mahoney and
Thorne, 2005, Deckop et al., 2006). Jian and Lee (2015) examine whether CEO compensation is associated with corporate social responsibility investment and found that CEO compensation level is negatively associated with CSR investment. However they make no reference to the design and the weight of the corresponding compensation plans while at the same time they take a more broad definition and calculation of CSR. On the other hand, McGuire et al. (2003) searched for the relationship between CEO incentives and Corporate Social Performance (CSP2)
and found that incentives have no significant relationship with strong social performance while long term incentives have a positive association with weak social performance. Quaintly enough, Mahoney and Thorne (2005) conducted a similar research but they focused on Canadian firms and they documented totally different results. Specifically, they found a positive relationship
1 CSR encompasses a firm’s consideration of its responsibility to investors and consumers, ethical responsibilities to
society, legal responsibility to the government or the law, and discretionary responsibility to the community. CSR is considered to encapsulate how well firms have met social and environmental expectations of the public and various stakeholders (Mahoney and Thorne, 2006)
2 I use ‘corporate social responsibility’ or CSR, to refer to the behavioral decision to engage in socially responsible
actions, and I use ‘corpoate social performance’ or CSP, to refer specifically to measures of CSR. This follows common practice in literature.( Callan and Thomas, 2011)
between long term compensation and CSR activities and thus they suggest that compensation structure can be the solution to the mitigation of risks that are attributable to the future orientation of the company and it can be highly related with environmental actions.
In addition and contrary to McGuire findings too, Deckop et al (2006) investigated the relationship between CEO pay structure and CSP finding among others that there is a positive relationship between long-term focus and CSP. However, both studies make no clear distinction among the characteristics of CSP and refer to the general social performance.
On the other hand, Sustainability is a term which includes the future impact that current actions of firms have. Correspondingly, Sustainable Development is a development which meets the needs of present generations without compromising the ability of future generations to meet their own needs (WCED, 1987, p.43). Or more generally, incorporating the notion of stakeholders in the business concept, corporate sustainability is defined by Dyllick and Hockerts (2002) “as meeting the needs of the firm’s direct and indirect stakeholders (such as shareholders, employees, clients, pressure groups, communities, etc.), without compromising its ability to meet future stakeholder needs as well.’’
KPMG’s report of 2013 denotes the recent increase in the portion of companies or organizations that report on the economic, environmental and social impacts caused by their daily activities3. Sustainability disclosure is a practice employed by a variety of companies across
the world. On the other hand, CEOs are charged with the responsibility of formulating corporate strategy and are often deeply involved in promoting the image of their firms through social responsibility. For instance, as reported by Waldman et al. (2006), Anita Roddick, CEO and founder of the Body Shop, developed a new category of cosmetics using ingredients that are based on non-animal testing procedures. Ben Cohen of Ben and Jerry’s Ice Cream used a combination of high quality ingredients that supported local businesses and reinvestment of after-tax profits to create and develop a high quality brand. These examples are not the unique evidence of firms trying to comply with the new standards and the pressure from the community that demands social equity and environmental protection.
Undoubtedly, Sustainable Finance4 is getting more and more popular and the society demands
not only transparency but also conscious deal of their money according to Peter Blom, CEO of Triodos Bank. In the direction of meeting the needs of customers and fulfilling the mission of
3 See Appendices for a detail overview of the trends in the sustainability disclosure. 4 Sustainable Finance is a term discussed by Peter Blom and Roel Beetsma at 12/4/2016
during the event organized by SEFA at UvA. The whole discussion can be found on the following link: https://www.youtube.com/watch?v=oW_S0R7654U
the organization about the integration of society in its operations, Triodos Bank introduced the Sustainable Mortgage5 two years ago. Consistent with the principles of the organization, Mr
Blom has moved sustainability one step further within Triodos Bank as investments of funds to orthodox churches are taking place. The CEO supports this venturing by explaining that Sustainability is not only about green policies and environmental protection as we thought in the previous century. It is much more about an integrated approach to society where diverse cultural life is incorporated too.
In alignment with Triodos, ING Bank has introduced the Green bonds in an effort to include people and planet in the decision making process. Ralph Hammers, the CEO of ING Bank, stated: “One of our key beliefs is that sustainable business is better business. We designed a really unique offering here based on our approach to integrate sustainability and grow free markets throughout all products and sectors. The Green bonds issued, showed that investors believe in our approach. This really takes sustainability within ING to the next level”. Judging from the actions of these two banks, I can conclude that they have absolutely accepted the words of Achim Steiner (UNEP)6; “If you really want to finance change as we need it in society, we first
need to change the financial system”. It is an obvious step that financial system is trying to integrate the sustainable finance as a new standard in economy.
Consequently, I can argue that organizations are continuously trying to adapt to the needs of the clients and to the demands of the society for a more long-term perspective. This willingness to change is going to be subject of investigation within this research. Are the organizations also taking measures within the structure of the compensation plans of top executives in an effort to integrate sustainability in their operations?
Thus, as the concept of sustainable development has become a central organizing theme within contemporary society (O’ Dwyer, 2007), and more and more companies incorporate the notion of Sustainability in their operations, it will undoubtedly affect the evaluation and consequently the compensation design of the managers. During the last 15 years many proposals were advanced so as to integrate and overcome the traditional methodologies, focusing on the financial dimension of corporate performance. Tools such as the balanced scorecard (Kaplan and Norton, 1992, 2004), the environmental and social reports (Bennett and James, 1999), the
5 In a few words, a sustainable mortgage is beneficial for home owners with a better energy level as they get a
discount on their interest rate while at the same time this type of investment qualifies for tax benefits. The surplus money that will not be spent thanks to future savings can therefore cover the surplus monthly loan repayment costs. (http://www.bipiz.org/en/advanced-search/triodos-launches-passive-mortgage-financing.html).
6 Achim Steiner is the Executive Director and Under-Secretary-General of the United Nations. UNEP is the initials
sustainability reports defined according to the triple bottom line (TBL) agenda (Elkington, 1994, 1997) and international standards such as the Sustainability Reporting Guidelines fostered by the Global Reporting Initiative and based on the TBL approach (GRI, 2002, 2006) are attempts to face the challenge represented by new information requirements for decision-making processes and communication policies (Wagner and Schaltegger, 2003; Schaltegger and Wagner, 2006).
1.2 Research Question
Given the background information and based on the notions of both Compensation plans and Sustainability, I would like to define whether there is a potential linkage between them.
Consequently, I consider it very interesting to fill the existing gaps of academic literature by examining the following research question:
“Does the structure of a CEO’s compensation plan influence the promotion of Sustainable Development within a firm?”
In more detail, I want to determine if the reward scheme of a CEO will have an impact on the Sustainable Development of a firm. Specifically, whether much weight on forward looking remuneration schemes of CEO, namely long term incentives plans, will lead to an increase in corporate sustainability. To determine if remuneration is in fact linked to the sustainability performance, regression analysis is used to identify the marginal effect of changes in sustainability measure.
Figure 1: Research Question
1.3 Motivation of the study
‘‘It could be argued that our descendants may become very sensitive to the relative scarcity of some environmental goods to which we pay little attention today because they are still relatively abundant, and that this requires that we immediately place a higher value on these items just because we think that our descendants may wish to do so” (Stiglitz et al., 2009, p. 75). From the
aphorism of Mahatma Gandhi to the words of Joseph Stiglitz on his report for the measurement of Social Progress, it is obvious that the meaning of Sustainable Development is vital not only from an entity’s perspective but also, and more importantly, from a worldview one especially if we think about the current pressing global problems such as climate change, human rights violation and poverty. Based on the wordings of these two important men and having realized the significance of Sustainability, I have formed this paper in such a way in order to establish a reasonable way of incorporating the notion of Sustainable Development into the operations of an organization.
Organizations may be deemed to be part of the problem but we should also investigate their potential to be part of the solution. In an effort to address sustainability at the corporate level, many strategies, policies, projects, programs, and other initiatives have been proposed. For example, there is a growing body of research on corporate sustainability reporting (see, for example, Brown et al. 2009a), sustainability auditing (Nitkin and Brooks 1998), corporate codes of conduct (Bondy et al. 2008), and standardized systems for environmental and socially responsible management (Castka and Balzarova 2008). Also, despite an increasing use of forward looking incentives plans in managerial compensation (Ittner, 1997), there is little empirical evidence of the performance impacts of such plans (Banker, 2000) let alone of the sustainability performance impacts.
Consequently, the answer in the abovementioned question is relevant for scientific purposes, as it is not only going to add to the existing literature about the role of the long term based compensation structure but also to propose an additional way of incorporating sustainability to the firm’s operations and increase top management’s sensitivity about this issue which seems to be of high importance in the recent years. Furthermore, a possible linkage between the structure of CEOs compensation plans and sustainable development is crucial from a societal point of view. Especially after the corporate scandals that have affected businesses worldwide, firms are under increasing pressure to be both profitable and socially responsible (Deckop et al. 2006).The promotion of sustainable actions does not only influence the viability and the prosperity of the regarding entity but also the various stakeholders who are affected by it. Establishing though a new way to enhance the Sustainable Development is regarded as vital for the welfare of the whole society. In addition, CEO compensation has long attracted a great deal of interest from press, and general public (Bebchuk et al., 2002; Choe et al., 2014). Moreover, recent controversies have induced many debates about these compensations (Choe et al., 2014; Murphy, 2012). These concerns about CEO compensation design indicate that this subject is not only important for shareholders, but also for society in general.
Thus, the purpose of this research is to point out the influence that the structure of CEO compensation plans can have to the promotion of Sustainable Development. While many studies have emphasized the importance of incentives plans to the financial performance of a firm (Banker, 2000), it has not yet examined if such measures can help the promotion of social stewardship and environmental protection along with a viable economic progression. Consequently, an answer to this research question can serve potential field for further examination about the role of long term remuneration schemes when designing a CEO bonus plan. Furthermore, a potential positive correlation between corporate sustainability and design of a CEO compensation plan can establish another way of diminishing the agency conflict between the shareholders and management while satisfying the demands of various stakeholders (NGOs, employees, organizations etc.).
The current research comes to add to our knowledge by extending previous researches and focusing mainly on the main characteristics of a Sustainable Development strategy, namely the economic prosperity, the environmental protection and the social stewardship. Thus, there is going to be a more analytical approach on the characteristics of CSR. Furthermore, and more importantly, with this research I will try to challenge the findings of McGuire as I am going to use the same pool of data, namely from North America. Mahoney and Thorne (2005) support their opposite results based on the geographical context of Canada by giving arguments about the U.S institutional environment while Fabrizi et al (2014) and Kochan (2002) come to add to this argumentation by pointing out the existed emphasis on shareholders’ wealth maximization (Fama, 1980). They suggest that CEOs remuneration plans are structured in such a way in order to promote short-term economic performance for the favor of the shareholders’ interests at the expense of other stakeholders. However, because of the recent trends in the economic framework and the ongoing demand for a sustainable future, let alone the previous global financial crisis in 2008, I assume that the U.S.A have also moved to the direction of supporting a more forward looking orientation and have made efforts to meet the demands of the society for a strategy focuses on the Sustainable Development and thus I expect the corresponding redesign of the CEOs’ compensation structure.
2 Theory and Hypothesis development
2.1 Compensation StructureBraam and Poutsma, (2015) investigate the relationship between broad-based financial participation plans and financial performance and they get support from the paper of Klein (1987), about the consequences that broad-based financial participation schemes have on the attitude and behavior of employees, and hence, outcomes for the organization. Klein, (1987) formulates three models;
(1) The impact of extrinsic motivation, in which employees make extra efforts because they expect to receive extra rewards in due course. Although this model relates to the agency theory, much of the literature also refers to the expectancy theory of Vroom (1964). This theory suggests a precondition, namely that, in order to produce extra efforts, employees are informed about achievable targets and told they will receive rewards for hitting these targets (whether a share in profits, share ownership or stock options).
(2) Commitment impact, also known as instrumental effect. Here, through financial participation both employees and employers share risks and act in the common interest. Interests are aligned by focusing employees’ attitudes and behavior on a willingness to participate in strategic decision making, a focus on value creation of the company and profits, as well as on cost-effective working practices.
(3) Ownership impact, also known as the intrinsic motivating effect; by receiving stocks in the company, employees develop a feeling of co-ownership and act accordingly. In this model the mechanism is psychological ownership (Pierce et al., 2003). The argument is that ownership changes mindsets in such a way that psychological ownership is developed, which leads to changes in attitudes and behavior such as organizational citizenship behavior and higher productivity. This is expressed in extra efforts to sustain the company and protect it from external threats. It generates ownership behaviors that improve financial performance.
An executive pay plan typically consists of salary, annual bonus, and long-term incentive pay (primarily stock options), with the allocation from each category varying greatly among CEOs. It is this allocation between short-term and long term incentives that most critically defines CEO performance interests (Jensen et al., 2004). What is more, a compensation structure can affect social performance along with financial performance. In other words, incentives, such as bonuses tied to specific targets, may encourage the adoption of strategies that can potentially affect the social performance. For instance, if great part of a CEO’s compensation is tied to
short term performance, the executives will have no motivation to adopt sustainable and forward looking strategies that are going not only to maximize the wealth of shareholders but also to create value for the society and sustain resources for the future generations. The Enron collapse can demonstrate how top managers are dedicated to market price increases at the expense of social performance (Despeignes and Hill, 2002; Parker, 2002). Jones (1999) states that the institutional context surrounding managerial decision making, here CEOs compensation, can influence expectations regarding social performance. Taking as granted that the investigated organizations are focused on achieving a sustainable development strategy, the next question we should examine is how CEOs translate this strategy into actions. CEOs are recognized as having extensive decision-making power and the ability to significantly influence their firm’s CSP (Kochan, 2002; Orlitzky & Swanson, 2002).
The abovementioned arguments exhibit a clear relationship between the design of a CEO compensation plan and the actions that he/she is willing to adopt in order to improve the performance of the organization. Although there is no clear reference about the sustainable performance of the organization, I have no reason to conclude that these arguments cannot be supported as far as the sustainability performance of an organization is concerned. Furthermore, these arguments referred to employees in general, but under separation of ownership and management of an organization, CEOs can be considered as employees too. Thus, I assume that the structure of a CEO compensation plan is going to highly influence the sustainability performance of an organization.
2.2 Long term Compensation plans
Value creation is the final objective of a company (Rappaport, 1986; Mills and Weinstein, 2000; Jensen, 2001; Grant, 2002). Thus, the evaluation of employees and managers is commonly and unavoidably based on their contribution to the firm value. The intuition is that CEOs are responsible for the decision making and the execution of strategies and consequently they are going to consider their own potential personal benefits when they decide whether or not to engage in specific strategies, in this case, sustainable development related activities. The outcome of their actions can be measured either by financial performance measures or non-financial performance measures. As Banker et al (2000) have pointed out in their research about the use of non-financial performance measures in the hotel industry, incentives plans that include such measures can affect financial performance either directly, or indirectly by improving nonfinancial performance which then impacts financial performance. On the other hand, long-term performance-contingent contracts also impose risk on executives (e.g. Baiman, 1982; Diamond
and Verrecchia, 1982; Harris and Raviv, 1979; Hirshleifer and Suh, 1992; Holmstrom, 1979). This may discourage top managers from accepting their remuneration to be based on long-term incentives plans but unavoidably such plans are the only way that an alignment between the interests of top executives and the concerns of society can be achieved. Across time, companies have increasingly made public commitments to sustainable development and to reducing their impacts on climate change. Management Remuneration Plans (MRPs) are a key mechanism to motivate managers to achieve corporate goals. Certainly it would seem that one way for organizations to demonstrate that they are embracing the sustainability agenda would be for organizations to incorporate not only financial measures of performance within their MRPs, but also measures tied to social and environmental performance (sustainability-related). That happens because longer term compensation based upon market valuation tends to motivate executives’ consideration for CSR (Kane, 2002) or to state it differently executive remuneration is an important mechanism for directing managerial attention to various social and environmental objectives (Deegan, 2012). One crucial assumption that should be made, though, is that such organizations that exhibit their willingness and devotion to care about environmental and social issues are capable of taking substantive actions on this direction and not just limit their efforts on a rhetoric discourse. In this case, I am going to focus on long term incentives plans that the organizations adopt in order to compensate their CEOs and if they can encapsulate the efforts of top executives to incorporate corporate sustainability into the operational environment. The underlying intuition is that a short-term compensation structure is solely based on accounting measures, namely they are indicators of past performance, and salary or short-term bonuses cannot subsequently affect CSR. Furthermore, typical accounting measures are prone to dysfunctional behavior such as manipulation of the numbers by top executives. On the opposite, long-term compensation plans are mainly determined by market values which undoubtedly incorporate a broader range of indicators of performance.
As it is explained below, the Sustainable Development is a future oriented strategy and entities that want to follow such orientation have to adapt their reward schemes. In addition, empirical research shows that managers tend to manipulate earnings to show larger short-term gains when bonuses are based on annual earnings (Healy, 1985), and this tendency decreases under pay plans tied to long-term performance (Richardson & Waegelein, 2002). This is a consideration in alignment with mitigating conflicts perspective between various stakeholders and top management that is going to be thoroughly analyzed below. Previous researches have proved that pay focused on long-term performance promotes management decisions that are more aligned with shareholders’ interests when it comes to capital investments and merger and
divestitures (Larcker, 1983; Tehranian, Travlos, & Waegelein, 1987). In addition, taking as granted that a Sustainable Development strategy increases the market value of a firm in the longer term, a compensation structure in alignment with market values will encourage executives to focus on factors that are consistent with the promotion of sustainability and are relevant to the firm performance. Another possible explanation of top executives’ willingness to engage in a CSR strategy and accept long-term incentives may be the decision of socially responsible firms to forgo short-term profits (by investing in the education of employees or in equipment that is going to bring benefits in the future) in their effort to be more socially responsible (Kane, 2002). This future potential for wealth accumulation provides the executive with a strong incentive to take action and to make decisions that are consistent with stakeholders and executive interests (Mehran, 1995).
The major elements of executive compensation are fixed compensation (salary), short-term incentives and long-term incentives (which include stock options, other forms of market based compensation, and non-market based long term incentive plans) (Murphy, 1999). I assume that, based on the abovementioned argumentation, the design of CEO incentives plans is going to be affected, with more weight on long term incentives plans and on forward looking remuneration schemes such as stock options. The final impact that this long term focus will have, however, should be assessed by the level of which managerial efforts are translated into increased firm performance.
2.3 Agency Theory
Sustainability strategy is going to, by its nature, address issues associated with the notion of “triple bottom line” (Elkington, 1997), namely of economic, environmental and social performance. The first dimension refers to the financial performance of firm, namely its ability to meet the needs of shareholders of wealth maximization. Although it is tempting to draw a clear distinction between agency theory formulations of corporate governance and stakeholder theory, both theoretical perspectives view the firm as a network of contracts with stakeholders (Fama, 1980). The agency theory includes the so-called agency problem that occurs when cooperating parties have different goals (Jensen and Meckling, 1976; Ross, 1973) and due to information asymmetry between owners and management, opportunistic behavior may arise. Thus, agency theory explains why the interests of owners and of managers are not always in alignment. On the one hand, shareholders want to maximize their wealth while, on the other hand, top executives could abuse their information advantage to pursue their own interest and benefit from increased bonuses at the expense of shareholders (Fama & Jensen, 1983; Jensen &
Meckling, 1976). Long term incentives plans are forward looking ones and I am firmly of the opinion that they are going to better address the strategy of the entity focused on Sustainable Development. Managers will not take actions for their own short-term benefit but they will have motivation to contribute for a long-term, sustainable firm growth. At this point, I would like to notice that there is always an option for trade-off actions and choices from the side of the managers. If they have a high averse on long term returns either because they are risk averse or because the non-financial performance measures do not highly influence their compensation and they, consequently, prefer short term benefits, there is going to be given less importance on non-financial performance measures which is going to barely affect the sustainable development project of an entity.
Furthermore, shareholder influence is of high importance. Apart from the benefits of decreased agency costs, long term compensation schemes could be the means to differentiate an organization from its competitors and consequently attract powerful shareholders. Norwegian Government Pension Fund, for example, invests only in sustainable companies and even uses its power as a shareholder to change the corporate governance and practices of these companies (Norwegian Ministry of Finance, 2008).
At this point, I believe that more weight on long term compensation plans can be a solution to the agency problem as both shareholders and managers are going to benefit from the increased firm value as the bonuses of top executives will be directly linked to the sustainable performance of the company.
2.4 Stakeholder vs. Shareholder Theory
Shareholder theory defines the primary duty of a firm’s managers as the maximization of shareholder wealth (Berle and Means, 1932; Friedman, 1962). However, the interests of any one given stakeholder (e.g. shareholders) should not dominate at the expense of others (Clarkson, 1995; Hillman and Keim, 2001; Jones et al., 1999). In the previous section, I explain why I believe that shareholders are going to benefit from the usage of long term compensation plans. In this section, I tend to explain why the adoption of such plans as a pillar for the evaluation of managers would be valuable for the various stakeholders, too, and consequently crucial for the social image of the firm. Stakeholder theory implies that corporations have obligations to individuals and groups both inside and outside of the corporation, including shareholders, employees, customers, and the wider community (Searcy, 2012). Gatewood and Carroll (1991), and Hill et al. (2007) propose four characteristics of CSR: economic, legal, ethical, and philanthropic which influence the quality of life of relevant stakeholders. Recently, Barnea and
Rubin (2010) and Jo and Harjoto (2011a, b) suggest that while the definition of CSR varies, it generally refers to serving people, communities, and the environment in ways that go above and beyond what is legally required of a firm. In addition, according to legitimacy theory7,
organizations are constrained to act in compliance with the terms of their “social contract”8 and
failing to do so is perceived to have negative implications for the ongoing operations and existence of the organizations (Deegan and Blomquist, 2005). However, legitimation strategies are not a panacea. Many researchers argue that a legitimizing behavior can be potentially quite harmful, especially if it legitimizes activities that are not in the interests of particular groups within society9. For example, Puxty (1991) states: ‘I do not accept that I see legitimation as
innocuous. It seems to me that the legitimation can be very harmful indeed, insofar as it acts as a barrier to enlightenment and hence progress’.
Obviously, not only regulations as Hubbard explains below but also public opinion and scrutiny can provide stimuli and incentives for businesses to become more sustainable and that happens due to possible loss of costumer goodwill and the resulting financial decline (Wagner, 2011). By adopting non-financial performance measures such as employees’ safety, reduction of energy consumption, etc., the entity enhances its environmental conscientiousness and social stewardship. In addition, a sustainable organization with good image can attract staff with above-average qualifications and motivations (Wagner, 2007) and consequently formulate its human capital into a well-developed strategic resource. Furthermore, Kochan (2002) argues that US firms have focused on maximizing shareholders’ value without considering the effects of their actions on other stakeholders and thus calls for a possible stakeholder-oriented decision-making and strategy formulation process. The structure of CEOs compensation plans can undoubtedly support a strategy focused not only on maximizing shareholders wealth but also providing socially responsibility.
In summary, I believe that more broad based compensation plans are going to positively affect the sustainable development of a company as they ensure not only the value creation and the
7 In defining legitimacy, Lindblom (1994) distinguishes between ‘legitimacy’, which is a condition or status that exists
when an organization’s value system is congruent with the value system of the larger social system of which the organization is a part, and ‘legitimation’, which is considered to represent the process that leads to an organization being adjudged ‘legitimate’.
8 Represent the multitude of explicit and implicit expectations that society has about how the organization should
conduct its operations (Donaldson, 1982). Also known with the term “license to operate”.
9 If such groups believe that the organization try to establish symbolic (which may not reflect actual change in
corporate activities) and not substantive legitimacy (which reflect actual change in corporate activities), the outcome may not be favorable for the entity.
benefits that arise from obtaining and maintaining legitimacy but also the interests of various stakeholders and consequently the social welfare.
Figure 2: The organization used as part of a wider social system
Deegan, C. (2014). Financial Accounting Theory, 4th Edition, McGraw-Hill Education, Australia, Sydney In chapter 8, figure 8.1.
2.5 Sustainable Development
Porter and Kramer (2006) pointed out that sustainability is one of the reasons why a company may wish to engage in CSR activities10. Thus, sustainability is just an element of the big part of a
CSR strategy11 and is defined as the capability of an organization to continue its activities
indefinitely, having taken due account of their impact on natural, social and human capitals. A sustainability-oriented company is one that develops over time by taking into consideration the economic, social and environmental dimensions of its processes and performance (AccountAbility 1999, p. 94). According to OECD proceedings in 2000, these three dimensions involve complex synergies and trade-offs and that organizations should place more emphasis on the interactions among these three dimensions in order to minimize possible conflicts in policy making. However, it is common that many organizations see sustainability, strategically, as a regulatory demand (something that has to be done because we should abide by law), a cost to be minimized (something to spend the minimum amount on) or an opportunity for competitive advantage (something that leads to opportunities) (Hubbard, 2009). Consequently, proper consideration of the social and environmental aspects of their operations is not only vital for the
10 According to the authors, there are four main justifications to explain why companies engage in CSR;
1) moral obligation, (2) sustainability, (3) license to operate, and (4) reputation.
environments and societies in which they operate, but also central to their operations and essential for corporate survival. Recent debates in the international agenda reflect that there is indeed an increasing awareness that economic growth can no longer be credibly pursued without a much stronger concern for its environmental and social implications. Thus, if social and environmental performance is an important focus of the organizations then the compensation plans of CEOs would be reasonably expected to incorporate social and environmental performance indicators together with the financial indicators that have traditionally been utilized (Deegan, 2012). In other words, CEOs are required to balance short- and long-term interests integrating economic, environmental and social considerations into business decision making. This paper aims to present sustainability as a way for an organization of gaining ground to the competitive environment in which it operates and compensation structure as a tool for the promotion of sustainable actions.
Furthermore, sustainability is proposed as a paradigm capable of ensuring the durable survival of firms (Perrini and Tencati, 2006). Additionally, Garay and Font (2012) suggest that reporting on corporate social responsibility can be a vital tool by stating that the most widely quoted argument for business engagement is the increased competitive advantage due to the development of some valuable capabilities, such as stakeholder integration, continuous innovation or higher-order learning, aligned with the classic objective of maximizing returns and obtaining competitive advantage through cost reduction, sales increase, new market opportunities and enhanced company image. In parallel, Sustainability strategy as a part of the whole Corporate Social Performance (CSP) may affect organizational reputation, thereby improving investor perceptions of the firm (e.g., Orlitzky et al., 2002), which in turn may affect stock price.
Thus, I can conclude that a sustainability strategy is crucial not only for the social image of the company but also for its economic prosperity as such a strategy can create a favourable operational environment for the firm, attract alliances and, thus, lead to a competitive advantage. A sustainability oriented company is fully aware of its responsibilities towards the different stakeholders and adopts methods and tools that allow it to improve its social and ecological performance (Perrini and Tencati, 2006) while the concept of sustainability and its increased presence in current society implies that companies are required to structure their activities in such a way that take into account the longer-term consequences12. Such a method or tool can be
the adoption of a policy that is focused on the optimal structure of CEO Pay and this is going to be examined by this research.
Figure 3: The three spheres of Sustainability
Adopted from the 2002 University of Michigan Sustainability Assessment
2.6 Hypothesis Development
Although there is no obvious and straightforward linkage between the design of compensation plans of CEOs and the Sustainability and nothing similar has been established before in the empirical literature, the above literature review indicates that the structure of CEO compensation could be a useful tool that firms may use in order to integrate the notion of Sustainability into their operations. Based on these evidences, I draw my hypotheses:
H1: Compensation contracts of CEOs that are merely based on long-term remuneration schemes will positively affect the Sustainable Development of the corresponding entity.
3 Research Methodology
3.1 Empirical Approach-SampleI structure the statistical part of my Thesis following the requirements of a well-based quantitative research (such as those of Rekker et al. (2014) or of Jian and Lee (2015)), namely determination of data sources, sample selection and operationalization of variables. In order to test my hypotheses and measure my theoretical constructs, I use an archival research as an empirical approach. My initial sample are all the companies that report their sustainability performance and the regarding contracts of CEOs along with overall financial information that I used in order to proxy my variables such as sales and debt from 2011-2013. Thus, I am testing my hypothesis using a three years period sample. I selected this period as I would like to examine if there is a change in the relationship between the sustainability performance of the firms and the compensation plans of the respective CEOs in the aftermath of the global financial crisis. Data on executive compensation are extracted from Execucomp and data on other company characteristics from the CRSP/Compustat merged database also through WRDS. Companies with missing or invalid data (i.e. values ≤0) on assets or sales are removed from the sample, as are any duplicates. I drop the following observations in the screening procedures to obtain my sample: (1) observations with CEO turnover during the year; (2) firms in the regulated industries (SIC code 4900–4999) or in the financial industry (SIC code 6000–6999)13; and (4) observations
with zero CEO compensation in the year. Moreover, I remove potentially outliers, because extreme observations could affect the results. There is a risk in drawing the wrong conclusion caused by only a few outliers. The final sample consists of 2857 firm-years for 972 firms for the period 2011–2013 Most importantly, my sample concerns only CEOs who work in companies that have incorporated the notion of sustainability and, thus, report their sustainable performance.
Table 1: Sample
Year Number of firm-years Percentage (%)
2011 970 33.95
2012 961 33.64
2013 926 32.41
Total 2857 100
This table presents the sample distribution over the sample period from 2011-2013
13 According to McGuire et al., (2003) risk and opportunities regarding social performance may vary with the
3.2 Data Collection and Measurement of Variables Sustainable Development
It is a fact that different understandings of sustainability, definitions of Sustainable Development Indicators (SDIs) and measurement procedures may give completely different assessments of whether an organization moves towards a sustainable development path or not. That is why, in this research, corporate social and environmental performance is measured by ratings by Kinder, Lindenberg, and Domini, and Company (hereafter KLD), a multidimensional Corporate Social Performance database. I measure corporate social performance using six dimensions from the KLD, namely employee relations, product quality and safety, community relations, natural environment, human rights, and diversity. KLD data have been used extensively in scholarly research to operationalize the CSR construct (e.g.,Szwajkowski and Figlewicz, 1999; Turban and Greening, 1997; Waddock and Graves, 1997). Waddock (2003) argues that the KLD data are “the de facto research standard” for measuring CSR in scholarly research. Chatterji et al. (2009) contend that KLD’s social ratings are among the most influential and the most widely accepted CSR measure used by academics. Mattingly and Berman (2006) assert that the KLD dataset has become the standard for quantitative measurement of corporate social actions. KLD evaluates CSR on seven main dimensions including corporate governance but I chose the above-mentioned dimensions because they are believed to reflect the stakeholder orientation toward CSP, were judged most important by ratings panels, and have demonstrated validity (Agle, Mitchell, & Sonnenfeld, 1999). Corporate governance is perceived as a distinct construct from CSR, hence, I construct the CSR measure based on the six remaining dimensions, excluding corporate governance14. Specifically, following prior studies (Chatterji et al., 2009; Johnson and
Greening, 1999; Waddock and Graves, 1997), I construct CSR, measured as total strengths minus total concerns in KLD’s six social rating categories: community, diversity, employee relations, environment, human rights and product. The higher the score for a firm, the more socially responsible the firm is deemed to be on that particular metric. The KLD database used in this study evaluates firm social performance along four dimensions: community, environmental, product and employee15. Reflecting the reality that firms may exhibit both
14 KLD also provide ratings on corporate governance. These are excluded from my analysis because CEO
compensation is intrinsic in governance. This exclusion is consistent with Cai et al. (2011).
15 The community dimension includes charitable giving, concern for the international community, and the economic
impact of firm operations. The environmental dimension includes pollution, hazardous waste, climate change, and environmental communication. The product dimension of the KLD ratings includes quality and safety, impact on the disadvantaged and marketing/contracting controversies. Employee dimensions include promotion of women and minorities, family benefits, safety issues, employee relations, and international labor issues. See Appendices for a detailed overview of the components
strengths and weaknesses on each dimension of social performance, social strength and social weakness are rated on separate scales ranging from 0 (neutral) to 2 (significant strengths/weakness) for each dimension. For example, Apple received 2 in environmental strengths for its communication efforts, but also received a 1 for environmental weakness for its treatment of hazardous waste. Regarding employee issues, it was given a “4” in strengths, and 0 for weakness. I do not sum the weaknesses and strengths into a single “social performance” measure as strengths tend to offset weaknesses, reducing variation in the dependent variable. For each firm, strengths and weaknesses are aggregated along the four dimensions for a measure of total strengths and total weaknesses. Deckop et al. (2006) notice that strengths and weaknesses should be considered together as a firm that faces concerns in a particular area may develop strategies to enhance its strengths in that or other areas and thus strengths and concerns should be considered as somewhat interdependent measures. I do not analyze differences among the four dimensions of social performance or differentiate between types of social performance (Hillman et al., 2001; Johnson et al., 1999). The four dimensions evaluated by KLD each focuses on primary stakeholders while the fact that there was a significant increase in the number of observations per year in and after 2003, mainly due to the fact that KLD more than doubled its coverage in 2003, covering not only MSCI KLD 400 Social Index but also the 3000 largest US companies, while in earlier years it covered only the 1000 largest US firms, makes my sample more representative of the U.S. situation than McGuire’s (2003).
CEO Compensation Structure-Long-Term Incentives plans
I measure my Independent variable of long-term compensation plans collecting public available data of the contracts of CEOs globally through Execucomp. As there were no available data for Long Term Incentives Plans (LTIP) Payouts and value of Options Granted, I deduct the short term compensation features, namely salary and bonus, from the Total Compensation16 in order
to define the LTIP. Furthermore, almost all the companies report their reward schemes more than one time per year. For some of them, I had even seven observations per year. As all the other variables are reported annually, I took the average of the Long Term Incentives plans and the Total Compensation correspondingly in order to create annual observations. There is a considerable amount of variation in CEO compensation in my sample. As can be easily seen on the Table 3 below, the average long term compensation of the CEOs in my sample is $2.53
16 Total Compensations is comprised of Salary, Bonus, Other Annual, Total Value of Restricted Stock Granted,
million, with a standard deviation of $2.71 million. Approximately one fifth of the total compensation is in the form of salary and bonus, with the remaining being stocks and option compensations. Both total and cash compensation have large positive skewness, suggesting that the pays of some CEOs in my sample are extraordinarily large. I therefore use the natural logarithm of the compensations in my regression analysis. Compensation measure is transformed by taking the natural log, consistent with Brick, Palmon, and Wald (2006) and Rekker et al. (2014).
Control Variables Firm Size-Profitability
A valid concern is that larger firms have greater resources for CSR investment (Wu, 2006). Thus, I use firm size as a control variable. Moreover, past studies (Rosen, 1982; Smith and Watts, 1992) find that large firms are more complex and they demand managers with more equilibrium wages while size and profitability have been proven to be linked to social performance (McKendall et al., 1999; McWilliams and Siegel, 2000). They also likely influence salary and CEO compensation as previous research has established a significantly positive relation between firm size and CEO compensation (Baker et al. 1988; Murphy 1999). To control for firm size I follow the research of Chhaochharia and Grinstein (2009) and Sanders (1999), and they used the natural log of the sales of the company (in $millions). I choose for the log of sales, because this is related to the size of CEO compensation, and probably also to the structure (Sanders, 1999). The database Compustat North America is used for firms’ size (log of sales17). To control for profitability, I follow
McGuire (2003) and Deckop (2006) who used the Return on Assets (ROA). I calculated ROA by dividing Net Income with Total Assets.
Ownership – Financial Slack
Craighead et al. (2004) found that firm’s compensation plans are related to firm ownership concentration; therefore, I controlled for the effect of corporate governance on CEO Compensation by including the percentage of common stock held by the CEOs in consistency with Cai et al. (2011) and Rekker et al. (2014).
Socially responsible activities may be affected by the availability of financial slack and free cash flows (McKendall et al., 1999; McWilliams et al., 2000). I used the debt-to-equity ratio as a
17 This item represents gross sales (the amount of actual billings to customers for regular sales completed during the
period) reduced by cash discounts, trade discounts, and returned sales and allowances for which credit is given to customers, for each operating segment.
measure of leverage/financial slack in alignment with Mahoney and Thorn (2006) while McGuire et al. (2003) used the times interest earned ratio as their measure of leverage.
3.3 Overview of variables
Table 2: Definition and source of variables
Variable Type Measurement Source
CEO compensation Independent (Natural Log) Long-term incentives of total compensation(LTI)
Compustat ExecuComp Sustainable Development(CSR) Dependent Total CSR strengths minus total CSR
concerns
KLD
Ownership (%) Control Percentage Ownership
of CEO shares
Compustat Execucomp
Profitability Control ROA (Net Income over book value of Assets)
Compustat NA
Firm Size Control The natural log of Total Sales Compustat
NA Financial Slack Control Book Value of Debt over book value of
Equity
Compustat NA
3.4 Empirical model
I use the following empirical model to test my hypothesis: CSR=β0 + β1*LTI+β2Own+β3*Prof + β4*Size + β5*Lev/FinSl
More analytically, CSR is defined as the total number of strengths minus the total number of weaknesses across a range of alternative metrics – environment, community, diversity, employee relations and product quality. Compensation (LTI) is measured as the natural log of the Long term Incentives plans and Value of Options Granted. Ownership (Own) is defined as the percentage ownership of CEO shares. Profitability (Prof) is defined by the Return on Assets (ROA) as the net income divided by the book value of assets and finally. Size is defined as the log of total sales and finally Financial Slack/Leverage is measured as the ratio of book value of debt to the book value of equity.
Table 3: Summary Statistics. This table presents various sample descriptive statistics for the variables employed in my analysis: dependent variable (Sustainable Development); independent variable (Long Term Incentives Plan) and control variables. The sample size is 2857 firm-year observations.
Mean SD Min p25 Median p75 Max
Dependent Variable Sust Development 0.90 3.12 -7 -1 0 2 18 Independent Variable LTI Plan18 2533.49 2713.63 0.20 932.14 1802.76 3259.23 38354.61 Control Variables Ownership (%) 0.77 1.63 0 0.11 0.30 0.69 23.13 Profitability 0.05 0.07 -0.53 0.19 0.05 0.09 0.53 Size 8770.89 27436.27 29.10 857 2223.09 6170.23 474259 Leverage 0.96 2.34 0 0.19 0.47 0.88 47.53 18 In Thousand USD
4 Results
4.1 Basic descriptive statistics and baseline regression
Summary statistics are presented in Table 3 and sample correlations in Table 4. With respect to the CSR variable, I observe a median, and often a 75% percentile, of zero, indicating that most firms are ‘neutral’, i.e. they have no strengths or concerns on a given metric. The negative minimum values of the CSR measure, indicates poor performers on this metric with more concerns than strengths. For example for employee relations, the total number of concerns possible is 6 and the number of strengths possible is 7. The worst performing firm on the environment with a score of −5, either had 0 (5), 1 (6) or 2 (7) strengths (concerns), respectively. Appendix 4 outlines the strengths and concerns relevant to each metric.
Mean (median) CEO long term compensation is $2.53 ($1.802) million. Mean CSR is 0.90. On average, the sample firms are profitable with a mean return on assets (ROA) of 0.05. Mean percentage of common stock owned by the CEO (Ownership) is 0.77%. Mean sales of reported company are up to 8.77 million while it is notable that the mean leverage ratio is 0.96, namely the book value of debt equals to the book value of equity.
Table 4 presents the sample correlations among the selected variables. Several results are note-worthy. First, long term CEO compensation level is positively associated with CSR investment. Second, I found that CSR is positively associated with firm size, operating profitability and debt-to-equity ratio. Third, CSR is negatively associated with CEO stock ownership. I caution that these simple correlations are univariate correlations that do not control for differences in other firm characteristics such as firm size.
Table 4
Sample correlations
CSR LLTIP Size Profitability Financial Slack Ownership
CSR 1 LLTIP 0,386848 1 Size 0,490954 0,587914 1 Profitability 0,118631 0,132226 0,103070 1 Financial Slack 0,014553 0,045661 0,053345 -0,12367 1 Ownership -0,16732 -0,21747 -0,212140 -0,028945 -0,015759 1
This table reports cross-sectional correlations between variables used in later analysis later. My sample consists of 2857 firm-year observations from 2011 through 2013. CSR is computed as the KLD strengths less KLD concerns for community, diversity, employee relations, environment, human rights and product. SZ is the natural logarithm of total sales. PROF is calculated as the net income divided by total assets. FINSL, the ratio of book value of debt to book value of equity; OWN is given by the percentage ownership of CEO shares and lastly LLTIP(log) is the natural logarithm of long term incentives plan, which comprising stock options granted and long term incentive payouts.
Results of the regression analysis testing my hypothesis are presented in Table 5. I run regression analysis separately for each year from 2011-2013 and one analysis for the whole model. The explanatory power is medium with an adjusted R2 of 0.26 which means that this model can
explain 26% of the variation of the dependent variable (CSR).
The first column of Table 5 presents the baseline regression results of 2011 in which total CSR Measure is the dependent variable. The regression results suggest that an increase in the LTIP score of a firm by 1 unit is expected to increase CSR Measure of the respective company by 1.054. As predicted, I establish that CSR has a significant positive relationship with the control variable Profitability (at the 5% level). There is a slightly negative relationship with OWN variable and FINSL but at a statistically insignificant level.
The second column shows the results of the regression of 2012. My hypothesis is supported only for 2012 as there is a statistically significant positive relationship of LTIP with CSR (p<0.05). Similarly, there is a positive and statistically significant relationship with the profitability of the company and CSR Measure and in alignment with McGuire et al (2003), I found a negative relationship between the percentage of shares owned by the CEO and the Sustainable Development index of the firm (p<0.05). This comes to support the argument that corporate
governance has a stronger relationship with weak social performance. In general, consistent with much of the literature, my control variables for size and leverage (debt-to-equity) are not found to be statistically significant. The lack of significance for size follows Deckop et al. (2006) while Mahoney and Thorne (2006), who also model leverage as debt-to-equity, and McGuire et al. (2003) find, as I do, that a firm’s risk posture does not statistically affect its social performance. The results of the third column for 2013 are similar with those stemming from the regression analysis for the whole sample. My hypothesis is not supported as there is not statistically significant relationship but there is positive relationship with Profitability and a negative one with ownership of shares by the CEO. It is particularly interesting that long term incentives do not seem to encourage strong social performance (at least statistically). This finding is congruent with the argument that strong social performance may be primarily driven by managerial beliefs (McGuire et al, 2003).
My findings challenge partly those of McGuire et al. (2003). They compare the estimation of two measures of CSR (total social weaknesses and total social strengths), using salary, bonus, and long term incentives as independent variables. In this research, long-term incentives are found to be statistically significant in the social weaknesses model. On the other hand, Mahoney and Thorne (2005) find that long-term compensation is positively related to CSP, controlling for size, industry and degree of ownership concentration, partly moving to the same direction as my research. Similarly with the outcomes of McGuire et al. (2003), Deckop et al. (2006) investigate the influence of short-term and long-term compensation in two distinct regressions of social performance and find that these two measures of remuneration have opposing effects on social performance. Lastly, the empirical analysis of Fabrizi et al. (2014) provides evidence of a negative and significant relationship between CSR and the CEO’s equity incentives, suggesting that when the CEO’s private interests are strictly related to those of shareholders (i.e., increasing stock price and accounting performance), the CEO is less likely to invest in CSR. In conclusion, it is obvious that long-term compensation rewards have mixed effects on the social performance of a firm.
Table 5 Exploring CSR Measure 2011 2012 2013 Total LTIP 1.054 (4.05) 0.614 (3.09)* 1.05 (4.54) 0.91 (6.78) SIZE 2.086 (11.11) 1.54 (10.39) 2.139 (12.72) 1.929 (19.65) PROF 3.82 (2.94)* 1.83 (1.80)* 2.436 (1.81)* 2.495 (3.54)* FINSL -0.019 (-0.55) 0.032 (0.91) -0.019 (-0.45) -0.009 (-0.51) OWN -0.048 (-0.90) -0.08 (-1.77)* -0.19 (-3.12)* -0.1 (-3.16)* Constant -10.14 (-14.54) -6.18 (-11.06) -9.48 (-14.28) -8.62 (-23.06) Adjusted R2 26.1% 22% 30.8% 26% F 5.29 2.64 7.47 1.007 Observations 970 961 926 2857
*Indicates Statistical significance at the 5% level
Exploring long term CEO compensation and CSR linkage – does the structure of CEO compensation matter? This table reports the results of estimating OLS regressions from 2011-2013 of long term CEO compensation (natural log transformed) on a measure of corporate social responsibility and a range of control variables. The sample is drawn from the companies available in the KLD database over the period 2011–2013. Long-term compensation is drawn after the deduction of short term compensation features, namely salary and bonus, from the Total Compensation. The key test variable is CSR is defined as the total number of strengths minus the total number of weaknesses on the following metrics; environment, community, diversity, employee relations and product. The control variables are defined as follows: SIZE, log of book value of sales; FINSL, the ratio of book value of debt to book value of equity; PROF, net income before depreciation divided by book value of assets; OWN, percentage ownership of CEO shares; Estimation is achieved with OLS. Coefficient estimates are reported with the associated t-statistic in parentheses.
4.2 Limitations
There are important econometric issues to deal with when investigating the relationship between CEO’s compensation structure and CSR. Firms might jointly determine both the compensation and the CSR level, and therefore the ordinary least squares (OLS) estimators may be biased in the presence of this endogenous relationship. This problem might drive the non-significant associations found in this study but also in previous studies (e.g., Mahoney and Thorne 2006; McGuire et al. 2003). Even though I used a list of control variables in order to reduce omitted variables bias in estimating the relation between a firm’s CSR and CEO long term compensation,
