What firm characteristics stimulate receiving a shareholder proposal targeting the firm’s attention for its corporate responsibility? A focus on a firm’s financial performance and CSR performance.

What firm characteristics stimulate receiving a shareholder proposal

targeting the firm’s attention for its corporate responsibility? A focus on a

firm’s financial performance and CSR performance.

Master thesis, MSc Accountancy

Rijksuniversiteit Groningen, Faculty of Economics and Business

2018 WIANNEKE KASTELEIN S2359243 w.j.kastelein@student.rug.nl Supervisor/university Dr. R.B.H. Hooghiemstra

ABSTRACT

Nowadays, the majority of all shareholder proposals involve social concerns with an attenuated connection to shareholder value. By making use of the agency theory, the stakeholder theory, and shareholder activism, I study how CSR performance and financial performance have an effect on the receival of shareholder proposals concerning CSR. The sample of this study includes Fortune 250 organizations within the timeframe of 2005-2015. The conclusions of this research are that organizations with low CSR performance and/or high financial performance (in terms of a high market-to-book-ratio) are more likely to receive shareholder proposals concerning CSR. As such, I want to provide better knowledge of what explains the extent to which firms are confronted with CSR-related shareholder proposals.

INTRODUCTION

When Unilever rejected a $143 billion takeover bid of the US-based Kraft Heinz in February 2017, there were multiple speculations about what could be the reason of this immediate rejection. One of those speculations was about a possible culture clash between Kraft Heinz and Unilever. The latter company positions itself as a sustainable giant, whereas Kraft Heinz distinguishes itself with their cost-control strategy. Less than two months after this takeover attempt, Kraft Heinz’s directors faced three shareholder proposals at the company’s annual general meeting (AGM) concerning the company’s corporate social responsibility (CSR). The content of these proposals consisted of requests for a comprehensive sustainability report, recyclable packages and insights in Kraft Heinz’s role in deforestation.

This example illustrates the growing interest in shareholder proposals concerning the subject of CSR. The US-based organization ‘The Proxy Monitor’ signals that in 2016 “a majority of all shareholder proposals (at US-based firms) involved social or policy concerns with an attenuated connection to share value”. Despite this increasing ‘CSR-activism’ among shareholders, the literature lacks studies of shareholder proposals related to CSR. In one of the few studies focusing on CSR-related shareholder proposals, Eding & Scholtens (2017) conclude that the presence of responsible investors—investors who include social, environmental and governance considerations into their investment decisions— increases the probability that shareholders will file one or more proposals on environmental issues. This is in line with Gine et al. (2017) who argue that shareholder proposals are increasingly used as an instrument for shareholders to signal their discontent with the managements’ policies. Within this research, I will investigate the reason behind this dissatisfaction. Shareholders may have different motivations for submitting proposals. They might be dissatisfied with the financial performance, future compensation of executives or the policies concerning corporate social responsibility. The latter will be the point of attention in this study.

While at this stage we know that institutional ownership plays a role in explaining the extent to which firms are likely to face CSR related shareholder proposals, to date it remains unclear whether other firm-level predictors explain receiving shareholder proposals. It is interesting to discover more firm level predictors of receiving a proposal targeting the firm’s (lack of) attention for its corporate social responsibility. First, because the number of these proposals being filed are increasing. Second, because this type of shareholder engagement is used to pressure the management of a company.

In case of Kraft Heinz, shareholders faced the fact that a possibly value-creating extension of the company through a merger or acquisition was not likely because of the negligence of CSR performance and the strategy of the company. As a result of this event, shareholders were alarmed about the social performance of Kraft Heinz. H.J. Heinz and Kraft Foods merged in 2015 and, according to Bloomberg1_, Kraft Heinz characterized itself with cutting costs and expanding margins as much as possible ever since.

Elaborating on this example of Kraft Heinz, it is interesting to examine the relation between low CSR performance and the number of received CSR-proposals targeting the firm’s attention for its corporate responsibility. Do shareholders and stakeholders notice the negligence towards CSR engagement and are they willing to raise their voices concerning this omission? Besides that, it is interesting to examine whether high financial performance leads to more shareholder proposals concerning CSR. According to the agency theory, it is foremost important for shareholders to maximize profit (Jensen & Meckling, 1976). Trusting this theory, managers pay attention to CSR with the condition that the financial performance of the company is satisfying to shareholders. On the other hand, managers might pay attention to CSR if this is beneficial to shareholder value. Hence, this study sheds light on two firm-level indicators that might stimulate the receival of CSR-related shareholder proposals, by focusing on the following research question:

To what degree do high financial performance and low CSR performance stimulate receiving shareholder proposals targeting the firm’s attention for its corporate responsibility?

Empirical analysis reported in this study is based on shareholder proposals of the largest 250 US-based public companies. This data will be obtained from the Proxy Monitor, a database that registers shareholder proposals of US-based companies included in the Fortune 250.

The results of this research exhibit that low CSR performance leads to an increase in receiving shareholder proposals targeting the organizations’ attention for its corporate responsibility. This indicates that shareholders and stakeholders tend to show their discontent when organizations fail to engage in CSR. Moreover, the results indicate that organizations that are characterized by a high market-to-book-ratio, have an increased chance of receiving shareholders proposals concerning the

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organizations’ corporate responsibility. This might suggest that shareholders are only interested in CSR when their organizations’ financial performance is sufficient or that shareholder activists and organizations as ‘As You Sow’ consciously target firms that are successful in terms of financial performance.

This study contributes to the existing literature in several ways. First, through examining the research question, there will be better knowledge of firm characteristics that might relate to the chance of receiving a shareholder proposal targeting the firm’s attention for its CSR. Although the study of Eding and Scholtens (2017) illustrates that the presence of responsible (institutional) investors are positively related with the change of receiving a CSR-related shareholder proposal, to date we lack knowledge of what explains the extent to which firms are confronted with CSR-related shareholder proposals. By showing an association with both CSR and financial performance, I will fill some of this gap. This is of importance since the Proxy Monitor documents an increasing trend in shareholders proposals concerning CSR that are put to a vote on an organizations’ annual general meeting. Second, by using the number of received CSR proposals (a conscious action of shareholders towards the management) as dependent variable, we learn more about the demands of shareholders.

Besides these main contributions, it is interesting to explore the actuality of Friedman’s ideas on the role of CSR, which played a significant role in agency theory for decades. Basically, in the 1970’s Friedman (1970) argued that organizations do not have a responsibility towards society, since organizations are artificial persons. He stated that investments in CSR can be seen as wasting shareholders’ money (Friedman, 1970). Nowadays investors use their ownership rights to affect the practice and policies of a business’s attention for CSR (Uysal, 2014). This is not in line with the traditional agency theory that claims that the only interest of shareholders is profit maximization, what will result in a rising share price. The equation of CSR engagement at organizations with high financial performance and CSR engagement at organizations with low financial performance, can tell us something about the priority of shareholders. Do shareholders care about the practice and the policies of CSR regardless of the business’s financial position? Or do shareholders only care about the CSR of the company when their financial desire is fulfilled? This analysis provides a way to examine the relation between several firm characteristics and the possible subsequent shareholder proposals concerning CSR.

THEORY SECTION

This section is divided in three parts. First, I provide an informative section about shareholder proposals. Second, I will discuss two theories that contribute to this study. By addressing theory, there will be more background provided about the relevance and the understanding of this research. Last, the contributing theories and existing literature will emerge in two hypotheses.

Shareholder proposals

For U.S. companies, it counts that on an annual basis, shareholders have the opportunity to hand in proposals targeting the policies the company is using. If the proposals meet the requirements and guidelines of the US Securities and Exchange Commission (SEC) and is published in a company's annual proxy statement, the proposals are put to a vote of all shareholders at the company's annual general meeting (Monks et al., 2004).According to the SEC2_{, a shareholder is able to submit a proposal} in case the shareholder continuously held at least $2,000 of shares in market value. Besides this condition, it is sufficient to hold 1% of the securities as well. The relevant shareholder must have possessed these securities for at least one year at the time the proposal is submitted and must continue to hold on those shares until the meeting date. Each shareholder is allowed to submit one proposal for a company’s annual meeting. When the proposal is submitted and approved, the shareholder in question (or an adequate representative) must attend the meeting to present the proposal. Eventually there will be voted upon the proposal at the annual meeting and through the annual proxy vote. Even though successful proposals are of an advisory nature, it can express the ideas of shareholders towards the current policies and performances (Sun et al., 2013).

This proxy voting process is considered the cornerstone of shareholder control over company management in the U.S. corporate governance system (Monks et al., 2004). Shareholders and activists use the mechanism of a shareholder proposal to shine a light on numerous topics. The Proxy Monitor distinguishes three groups of shareholder proposals put to a vote at annual general meetings. First, they mention proposals relating to corporate governance. These proposals focus on the structure and composition (e.g., independence, diversity, etc.) of the board of directors and on election of individual board members. Second, the Proxy Monitor indicates that a large part of the proposals relates to executive compensation. Last, they mention proposals concerning social policies. This last topic contains subjects as the organizations’ reputational risks and the sustainability policies. The number of

proposals concerning social policies raised considerably over the last few years. Where in 2008 38% of all shareholder proposals were targeting an organizations’ social policies, the Proxy Monitor observed that this percentage rose to not less than 56% in 2017 for the same topic; implying an increase by almost 50%. Thereby the Proxy Monitor provides quantitative evidence of the increased attention for the CSR policies of companies. An example of a shareholder proposal targeting the organizations’ CSR policy is the following request concerning packaging recyclability:

The proposal asks the company to issue a report assessing the environmental impacts of continuing to use non-recyclable brand packaging. The supporting statement requests that the report include assessment of reputational, financial and operational risks associated with continuing to use

non-recyclable brand packaging and goals and a timeline to phase out non-non-recyclable packaging (Kraft-Heinz, 2017)

‘As You Sow’ was responsible for this proposal and in six pages this particular group explained why their point of view was important and what the benefits would be if the company adopt their request. ‘As You Sow’ is an organization that promotes environmental and social corporate responsibility through shareholder advocacy. This organization organizes multiple shareholder proposals targeting several organizations’ policies concerning CSR (e.g. Starbucks, Pepsi Co, McDonalds). Often, a network like ‘As You Sow’ is responsible for resolutions or proposals targeting CSR. These networks track shareholder proxy fights and encourages voting in favor for the proposal.

Agency theory vs. Stakeholder theory

Agency_theory

Even though there are multiple theories in the field of corporate governance, agency theory is still considered as the most dominant theory on which governance research is based (Dalton et al., 2007). The key notion of agency theory is that so-called principals and one or more agents enter an agency relationship. Jensen and Meckling (1976, p308) consider an agency relationship as “a contract under which one or more persons engage another person to perform some service on their behalf which involves delegating some decision-making authority to the agent”. The person who delegates the authority is the principal and the person who receives the decision-making rights is the agent. It is plausible that the agent will not always act in the best interest of the principal but rather tries to pursue his or her self-interest, resulting in so-called agency costs (Dalton et al., 2007). These agency costs

consist of three elements, namely the monitoring expenditures by the principal, the bonding expenditures by the agent and the residual loss (Jensen and Meckling, 1976). Respectively, these are costs made by the principal to observe the behaviour of the agent, costs made to guarantee that the agent will not take certain actions, which would harm the principal, and the costs that arise, by divergence between the agent’s decisions and those decisions which would maximize the welfare of the principal (Jensen and Meckling, 1976). We see this agency problem at every level in firms, but in this research, I focus on the agency problems that take place between shareholders (principal) and the management (agent).

To mitigate agency problems (and costs) as much as possible, there exist multiple corporate governance mechanisms. Internal mechanisms exist to stimulate the managers to focus on shareholders’ interest. Misangyi and Acharya (2014) provide an overview of the existing corporate governance mechanisms and of the potential of these mechanisms working together to mitigate the agency problem. The first set of intern mechanisms is meant to align CEO and shareholder interests by creating a compensation structure for CEO to stimulate firm performance (Misangyi and Acharya, 2014). This is often done through CEO stock ownership. Second, numerous mechanisms are created to improve the monitoring effectiveness of the board of directors. These include, for instance, the ensurance that the board consist of numerous independent directors. Another tool to improve monitoring effectiveness and subsequently reducing monitoring costs, is the prevention that one person is CEO as well as chairman (Fama & Jensen, 1983). Consequently, it will positively affect firm performance or at least it should help alleviating agency problems. (Misangyi and Acharya, 2014). The last set of internal mechanisms that are created to mitigate agency problems is a set to align the interests of the other directors and shareholders. The desired result of these mechanisms is to enhance mutual monitoring among the managers in order to align principal-agent interests in a better way. Besides intern mechanisms, companies make use of (in particular two) external mechanisms to mitigate the agency problem: the presence of shareholders who actively monitor the agent and the market of corporate control. The former is believed to be a primary control mechanism because these shareholders possess a block of the firm its shares, and therefore occur as active monitors of the management (Stepanov & Suvorov, 2017). It might be the case that all these mechanisms are still not able to restrain the agency problem and the self-serving interests of managers. At this point shareholders can try to bring about change within the company by themselves. Shareholder activism is seen as a solution when all these aforementioned mechanisms have failed to limit the conflict of interest (Goranova et al., 2017).

The classical agency view includes that managers have to maximize the welfare of shareholders or at least, must act in the interest of the shareholders. One might wonder why there exists something like shareholder proposals, because the management already acts for the sake of shareholders. In reality, this is not the case. The agent will not always act in the best interest of the principal. Barnea and Rubin (2010) argue that most agency conflicts are interpreted as managers demonstrating self-serving behaviour at the expense of shareholders. An example of this self-serving behaviour is the examination of Kang (2009) into the motivation of the decrease in CSR expenditures in case the CEO will retire soon. Because expenditures in CSR do not have an immediate impact on profit measures, CEO’s omit these investments to boost their last results as being a CEO. Due to future career prospects, they prioritise a short-term boost of the earnings instead of long-term CSR investments (Kang, 2009). Although CSR expenditures are not beneficial for earnings in the short term, CSR engagement appears to be beneficial in the long term (Waddock and Graves, 1997; Feng et al., 2017), and, hence are likely to create shareholder value in the long run.

Shareholder_activism

Agency theory is seen as the most used theory to explain corporate control, and shareholder activism is considered to be the response to the remaining agency problems when corporate governance structures have failed to limit self-serving managers (Goranova et al., 2017). “Shareholder activists are often viewed as investors who, dissatisfied with some aspects of a company’s management or operations, try to bring about change within the company without a change in control” (Gillian and Starks, 2007 p55). Lee and Lounsbury (2011) compare shareholder activism with social movement theory. This theory “relies on actors with ideological interests in change” (Lee & Lounsbury, 2011 p159) and indicates what brings them together in order to give a reason behind changes in behaviour. However, a clear distinction with shareholder activism is the approach being used by shareholder activists. As Weber et al. (2009) argues, social movements try to bring about change from the outside (in the streets), whereas shareholder activism try to bring about change from the insides (in the suits). Shareholder activists influence corporations by engaging in tactics such as shareholder proposals. The trend of shareholders acting like activists, partly conflicts with the idea of the aforementioned classical agency theory, since the shareholders live up to their principles instead of profit maximization.

Shareholder activism assumes that satisfied shareholders will remain silent until they disagree with the pursued policies of the management. An often-used model describing the options dissatisfied shareholders have, is the model of Hirschman (1970). According to this model, shareholders have three choices in case of dissatisfaction: exit, voice, and loyalty. As reported by Hirschman (1970), exit

involves selling the shares you possess. Voice on the other hand, refers to communicating your dissatisfaction with the management. Pertaining to shareholder activism this may involve for instance, the submission of proposals or the request for direct board meetings. The latter can be difficult to achieve, especially when it concerns small shareholders (Doidge et al., 2017). Loyalty implies holding onto your shares. Continuing on this theory, Gillan and Starks (1998) define shareholder activists as investors who perform activities with the intention to change the status quo through ‘voice’. Hirschman (1970) distinguishes voice in three different ways. First, he describes voice through individual or collective petition to the managers concerned. Doidge et al. (2017) provide a relevant example of this type of voice. Using a Canadian example of an investor collective action organization (ICAO), they found that collective action (cooperating institutional investors) has an impact in changing actual governance policies (Doidge et al., 2017). Second, Hirschman (1970) mentions to approach higher authorities to force the managers to alter their policies. Last, he describes voice through multiple variants of actions and protest, some with the idea to mobilize public opinion (Hirschman, 1970).

Even though the existence of numerous forms of voice, I will focus on the first type of voice, because shareholder proposals are an example of individual or collective petitions; a form of shareholder activism. Hillman et al. (2010) apply the model of Hirschman in their research concerning the motivation of shareholders to exercise voice with the intention to show their dissatisfaction through votes at the time of director elections. They consider showing your discontent through voting against the election, or withholding votes, as a type of voice. Hillman et al. (2010, p2) note that the use of voice “has the ability to improve corporate governance structures because it helps shareholders to realize the value that is destroyed by poor corporate governance structures.” They found evidence for shareholders using their voice to signal their dissatisfaction concerning both firm- and director-level indicators of monitoring. This suggests that voice can be addressed to the firm in general, but to specific matters, such as individual directors, as well.

Following agency theory, shareholders hold management responsible for the outcomes of their business. Since the information asymmetry between shareholders and management, shareholders will focus on firm characteristics and outcomes to pass judgement on the current policies of the management. Stakeholder theory

Besides shareholders, multiple other groups and organizations hold interest in the performance of a company. The United States are considered as one of the countries where stakeholders do not have a particular place to raise their voices. Contrary, in Germany, stakeholders do have considerable rights

as employees are involved in the structure of corporate governance (Monks et al., 2004). In the United States, stakeholders do not possess such a position. For them, shareholder proposals are an accessible instrument to raise their voices, provided that they possess the minimum amount of shares prescribed by the SEC. Freeman (1983, p46) is known as the first scholar writing about the stakeholder theory. According to Freeman, a stakeholder is “any group or individual who can affect or is affected by the achievement of the firm's objectives”. Freeman calls suppliers, environmentalists, employees, competitors, customers and governments as examples of stakeholders. Freeman (1994) has formulated two questions with respect to the stakeholder theory. Managers have to ask themselves what the purpose of the business is. By doing so, managers focus on the value they create and what brings its core stakeholders together (Freeman et al., 2004). Second, the stakeholder theory raises the question ‘what responsibility does management have to stakeholders?’ (Freeman et al., 2004). This question focuses on the relationship with the stakeholders. Therefore, stakeholder theory focuses on the understanding of the benefit for stakeholders and on the responsibilities, the business has towards their stakeholders. Where the agency theory takes the interest of shareholders into account, the stakeholder theory focuses on the interests of non-shareholders.

The reason why the management of a business is interested in the concerns of stakeholders is that they might lose their social contract. Brown and Deegan (1998) explain this contract as a contract between the company and those affected by the activities of the company. A key notion in the literature (Brown & Deegan, 1998) is that stakeholders, and ultimately society at large, determine the rules of this contract based on the expectations they have regarding behaviors they deem ‘appropriate’. Moreover, they also observe that the terms of this contract are subject to change and, therefore, a company has to adjust constantly in order to comply with the contract. The society has the ability to withdraw this contract in case the company is unable to justify its operations. The withdrawal of this contract can cause a decrease in consumers’ demand or trouble finding suppliers of labor and financial capital (Brown & Deegan, 1998). In case of breach of contract, the organizations’ legitimacy would be under fire.

Park and Choi (2015) explain their stakeholder approach towards CSR practices. They argue that any kind of behavior that is not in line with what is considered socially responsible, may have an impact on the image, reputation and financial performance of the entire company. They assume that this effect increases when an organization operates international. The implementation of good stakeholder relationships increases a firm's reputation, with high-qualified employees as a result. Good stakeholder relationships are contributory to customer loyalty and enhances the cooperation with suppliers (Arouri

and Pijourlet, 2017). Moreover, Russo and Perrini (2010) suggest that if an organization aspires a long-term success, they should embrace their stakeholders. The management of an organization has the aim to maintain relationships with their significant stakeholders in order to stay relevant in their industry. Stakeholder management has the potential to create instrumental value, if the organization manages to create value for the shareholders with their pursuits as well (Hasan et al., 2018). Because of that, an organization will pursue good stakeholder relationships in order to achieve rising CSR performance and incensements in value (Berman et al., 1999).

Mitchell et al. (1997) proposed a concept of stakeholder salience. They created a theory describing the identification of stakeholders based on three terms: power, legitimacy and urgency. Power refers to the power to affect the company. Legitimacy implies how legit the stakeholders’ relationship is with the company. Last, urgency describes how urgent the claim of the stakeholder is. Although their paper is meant to provide insight for managers in understanding and categorizing stakeholders, it may also be used to explain when stakeholder will decide to speak up. When one or more stakeholders will doubt the organizations’ legitimacy, he or they might decide to voice. For instance, Royal Dutch Shell faced a shareholder proposal earlier this year suggesting a climate resolution. After Shell’s negligence in investments in renewable energy, stakeholders doubted the legitimacy of Shell’s activities. Stakeholders can voice as a result of an organizations’ declining legitimacy, but stakeholders can also decide to voice if there is an urgent matter. The example of Kraft-Heinz, concerning packaging recyclability, can serve as an example of voice by means of urgency, because shortcomings in sustainability stood in the way of firm expansion. Following stakeholder theory, stakeholders have the ability to put pressure on management its decisions. According to the model of Mitchell et al. (1997), it is possible to estimate stakeholders’ behavior by determining their power, legitimacy and urgency. The business’ image, financial performance and long-term success might drop by ignoring the voices of stakeholders.

Hypothesis development

The reason why I include the stakeholder and the agency theory in this study is threefold. First, stakeholders and the concept of CSR (performance) are closely related to each other. Carroll (1991) argues that there is a natural fit between the idea of corporate social responsibility and an organization's stakeholders. Carroll (1991) suggests that managers have to delineate particular groups or individuals, which they have to consider when determining the CSR orientation. To put it briefly, stakeholder theory ensures that multiple subjects of CSR get the business' attention. Second, since agency theory advocates shareholder value maximization, Bento et al. (2017) believe that this maximization ideology can be seen as a major obstacle to CSR if the interests of shareholders are different from those of stakeholders.

Last, stakeholder theory and shareholder theory are intertwined with each other. Cordeiro and Tewari (2014) found that investors and potential shareholders do value good relationships with stakeholders such as employees and NGO’s. This reflects itself in rising stock prices, due to the expectation of increasing future cash flows (Cordeiro & Tewari, 2014). This would suggest that both stakeholders and shareholders have the same interests. In short, it is interesting to understand both theories as it is of great importance for understanding businesses and its shareholders.

With the agency theory in mind, shareholders demand high shareholder value of the firms’ managers. Managers are hired because of their expertise and because they can represent the interest of shareholders. Despite this, managers renounce to act in the best interest of the shareholders with agency costs as a result. Kang (2013) found that soon retiring CEO’s tend to decrease CSR expenditures to boost the short-term earnings. This example of self-serving behavior shows that managers prioritize short term performance over the long-term shareholder value, whereas CSR engagement appears to be beneficial for shareholder value on the long term (Waddock & Graves, 1997; Feng et al., 2017). Even though there are multiple mechanisms to restrain this agency problem and the self-serving interest of managers, there are some problems slipping through all these mechanisms (Misangyi & Archarya, 2014). In this case, shareholder activism appears to be a manner to limit the remaining conflict of interests (Goranova et al., 2017). An example of this shareholder activism is that shareholders using their voice to signal their dissatisfaction concerning firm-level indicators of monitoring. A submission of a shareholder proposal is a type of voice, in order to show the shareholders’ discontent.

Following stakeholder theory, managers have to take the interests of stakeholders into account. Brown & Deegan (1998) argue that managers have to respond to the interests of stakeholders because the social contract between society and the organization is at stake. By not complying with this contract, it may have serious consequences for its operations (Brown & Deegan, 1998). Stakeholders tend to come in action against organizations in case they doubt the organizations’ legitimacy or in case there exists an urgent matter (Mitchell et al., 1997). Stakeholders consider lack of CSR engagement as a reason to doubt the organizations’ legitimacy, as indicated by the examples of Shell and Heinz Kraft and the increased number of proposals concerning CSR registered by the Proxy Monitor. Since there does not exist a particular place in the United States for stakeholders to raise their voices, shareholder proposals appear to be an accessible way to show their doubts about meeting the social contract. Substantiated by the agency- and stakeholder theory, my first hypothesis is as follows:

The research of Waddock and Graves (1997) contributed to the existing literature by addressing the relation between social performance and financial performance. In line with slack resources theory, they find a positive association between previous financial performance and corporate social performance. The slack resources theory suggests that good financial performance will lead to the occurrence of slack resources. These resources provide organizations an opportunity to boost their social performance through investing in the relation with stakeholders (Waddock & Graves, 1997). Organizations with low financial performance may not have the ability and resources to invest in CSR activities, whereas organizations with better financial performance are able to invest in resources with long-term aspirations (Waddock & Graves, 1997). Orlitzky et al. (2003) partly confirm the findings of Waddock & Graves. They argue that corporate social performance and corporate financial performance mutually affect each other. They believe in a virtuous cycle of financial prosperity and corporate social performance. Organizations with good financial results possess more financial resources and investing in CSR provides the opportunity to grow financially in the long-term.

According to agency theory, the only interest of shareholders is profit maximization, resulting in a higher shareholder wealth (Friedman, 1970; Jensen & Meckling, 1976; Eisenhardt, 1989). In case the company is characterized by good financial performance, shareholders may be pleased with the satisfying financial numbers. In this condition, shareholders may notice CSR as a good destination of the profits because an organization with lots of financial resources might lose its legitimacy through CSR negligence. Moreover, CSR activists may choose high financially performing organizations, because they have the financial slack to engage more in CSR, hence, increases activists’ chances on success. Besides that, stakeholders might question the organizations’ legitimacy when the financial conditions of the organization are excellent, but the organization refuses to engage in CSR. Based on these arguments, the second hypothesis is formulated as follows:

METHOD Sampling and data sources

My research relies on a sample of the largest 250 US-based public companies according to Fortune. This sample is interesting for this research because Tkac (2006) and Rojas et al. (2009) found that activists, like ‘As You Sow’, tend to target large, well-known companies to maximize the impact of their campaign. I use the data within the timeframe of 2005 until 2015. As such, I focus on both the period of the financial recession as the period after the crisis. This combination is interesting, because nowadays companies have more access to financial resources to engage in CSR, compared to the years of the financial crisis. After matching the data retrieved from the Proxy Monitor (number of CSR proposals), Compustat (ROA, MTB-ratio, and firm size) KLD (CSR performance), GMI (board size, board independence, and institutional ownership) and, Fama and French (industries), I ended up with 2710 firm-year observations.

Dependent variable

The dependent variable of this research is the number of shareholder proposals a company has faced concerning CSR. This data is derived from the Proxy Monitor database. The Proxy Monitor is an organization that is sponsored by the Manhattan Institute’s Center for Legal Policy. It records the influence of shareholder proposals on the largest 250 US-based public organizations. Proxy Monitor tracks all the shareholder proposals received by these companies, and categorize them by year, company, industry, proponent (sponsors of the proposals), proponent type and the type of proposal (general and specific)3_{. The Proxy Monitor distinguishes proposals in multiple types, for instance, social} policy, executive compensation and corporate governance. The aforementioned shareholder proposal about recyclable packages of Kraft Heinz is of the type social policy, whereas the specific proposal type is environmental. In this study, I will focus on the shareholder proposals marked with the general proposal type social policy. This type includes ‘proposals that seek to reorient a company’s approach to align with a social or policy goal that may not be related -or, at least, has an attenuated relationship- to share value’4 _{and are labelled as CSR-proposals in this study. Examples of topics of these CSR proposals} are environmental concerns, gender equality, employment rights and deforestation. The database of the Proxy Monitor is considered as a comprehensive and reliable database (Subramanian, 2017) and is relevant for this study, since large firms receive more shareholder proposals (Karpoff et al., 1996).

3 _{www.proxymonitor.org}

Main explanatory variables

This research consists of two main independent variables. CSR performance

I will measure the organizations’ CSR performance using data of Kinder, Lydenberg and Domini. This dataset is the leading variant in estimating a firms’ CSR performance and is better known as KLD-data. This dataset is used both by scholars (e.g. Di Guili & Kostovetsky, 2014; Kim et al., 2012) as by investors (Di Giuli & Kostovetsky, 2014). Because of the wide range of what includes CSR, the KLD-data rates companies along six subjects of CSR. These subjects can be seen as separate group of stakeholders and are divided in environment, community, human rights, employee relations, product, diversity and corporate governance. For each subject, KLD assigns a grade (a net score) containing the sum of a companies’ strengths (beneficial issues) and concerns (harmful issues). To arrive at an overall net score, I deduct the concerns from the strengths. This is similar to, for instance, David et al. (2007) and Barcos et al. (2013), who also did research in the field of shareholder proposals concerning CSR. For example, under the subject of ‘environment’, the fact that a company make use of recycled paper is seen as a strength, whereas their use of plastic tableware will be considered as a concern by KLD. Weighing these strengths and concerns with each other, will result in a comprehensive score of CSR performance.

I exclude the corporate governance-topic from the KLD-scores because this topic is not integrated in what the Proxy Monitor considers as CSR proposals. The Proxy Monitor considers corporate governance as a separate topic, as it is one of the three topics they distinct in shareholder proposals. Financial performance

For the second independent variable I will make use of two variables. Using two measures of financial performance has the aim to create a diverse image of financial performance (Cavaco and Crifo, 2014). In the literature you can find two types of financial performance indicators: measures based on accounting numbers and measures of marked-based indicators (Cavaco and Crifo, 2014). Consequently, I include one measure (return on assets) to proxy for accounting performance and another measure (market-to-book-ratio) to proxy for market-based performance. The return on assets (ROA) is measured as net income divided by total assets. The market-to-book-ratio (MTB), which is able to captures value creating potential (Eding and Scholtens, 2017), is measured as the market value of the firm divided by the total assets.

Controls

In this research, I include six control variables. This is important in order to prevent noise in the explanation of the independent variables. Since prior research (Karpoff et al., 1996) show that large firms receive more shareholder proposals, I control for firm size. Another reason to incorporate firm size as a control in this research, is because Hillman et al. (2011) found that board size is positively related to showing discontent by withholding votes during annual general meetings. I measure firm size as the logarithm of the firm’s winsorized total assets. Second, board size is included as a control in this study. Prior studies, such as De Villiers et al. (2011), suggest that an organization’s environmental performance is positive related to large boards. De Villiers et al. (2011) also indicate that the level of board independency has a positive effect on environmental performance and, therefore, board independency is the third control of this study. Board independency is presented as a percentage of the board considered as independent. Before calculating this percentage, this variable has been subject to winsorizing. Fourth, I control for institutional ownership because Graves & Waddock (1994) found that institutional ownership leads to better environmental performance. Following Eding and Scholtens (2017), this variable is presented as a percentage of the shares held by shareholders who possess 5% or more of the outstanding shares. Fifth, it is interesting to control for different industries since corporate governance structures can vary a lot between industries. Therefore, the results can differ per industry. I make use of the Fama-French 17-industry classification, which can be found in appendix A. Due to the broad scope of this research and the wide timeframe I use, my last control is for year effects. Another reason why it would be interesting to control for year effects is that the timeframe partly includes the financial crisis of the beginning of this century. It is interesting if there will occur deviations in this period, comparing with the total sample.

Model

My study is classified as quantitative research, whereby the formulated hypothesis will be tested using SPSS through the method of least squares. This is an analytic analysis with a regression equation as a result.

Yi = β0 + β1* CSR performance + β2 * Firm Performance + ε

Whereby Yi is the dependent variable (number of received shareholder proposals targeting the firms’ CSR) and β0 is the constant variable. The controls are not incorporated in this model. Ε acts as the residual deviation.

RESULTS

In this section, I present the results of this study. First, I discuss the most important statistics of this study. Second, a correlation analysis is presented. This analysis gives an indication of possible mutual multicollinearity between variables. Moreover, this analysis provides a first indication concerning whether or not to accept the hypothesizes. The third part of this chapter consist of the results of the regression. On the basis of these results, I am able to accept or reject the two hypothesizes. In other words, after the regression, it becomes clear if high financial performance and low CSR performance leads to receiving more CSR proposals presented at an organizations’ annual general meeting.

Descriptive statistics

Table 1 provides an overview of important statistics concerning this study. These statistics show the characteristics of the variables incorporated in the research models. All the variables (with the exception of one variable) are winsorized in order to reduce the influence of outliers. The values above and under three times the standard deviation from the mean, have been replaced by the relevant limit number of this calculation. The dependent variable, the number of CSR proposals, has deliberately not been the subject of winsorizing. Considering the dependent variable’s mean and standard deviation, there would have been a loss of important information in case of winsorizing.

The mean of received number of CSR proposals is 0.55, while the maximum of received CSR proposals is ten. The minimum of zero refers to organization that not received any CSR proposals in a certain year. The mean of the return on assets (ROA) is 0.093, but the minimum of -0.149 shows that some Fortune 250 organizations are sometimes characterized with bad financial performance. The market-to-book-ratio has a mean close to 1, which indicates that the market value of an organization is close to its book value. However, the standard deviation, and minimum and maximum values show that this variable is highly dispersed. When comparing the statistics of the ROA and MTB, it is notable that these numbers share the same proportions between the four characteristics. Considering the KLD net score, indicating an organizations’ CSR engagement, I find a mean of 1,610. For the Fortune 250 organizations, this means that on average, KLD assigns more points for CSR strengths, than that they do for CSR concerns. Still, some organization deal with negative net scores in certain years, as shown by the minimum and the standard deviation.

N Mean Std. Dev. Min Max

Number of proposals 2288 0.550 1.073 0 10

Fin. perf. (ROA) 2566 0.093 0.069 -0.149 0.333

Fin. perf. (MTB) 2349 0.984 0.784 0.006 3.484 KLD Net Score 2199 1.610 3.895 -8 13 Firm Size 2349 81792.009 171245.568 202.587 916072.400 Board Size 2699 11.275 2.025 5 17 % Indep. board 2699 0.873 0.064 0.660 1 % Instit. own. 2710 0.172 0.134 0 0.605

Table 1: Descriptive analysis

Correlation analysis

The mutual relationship and connections between the main variables are presented in the correlation matrix (table 2). The correlation matrix shows the Pearson correlation between variables and is used to give first implications about the possibility of the occurrence of multicollinearity. Multicollinearity is the occurrence that takes place when two variables correlate to much with each other. If this occurs, the outcomes of this research are less reliable. There exists an indication of multicollinearity when the correlation exceeds the value of 0.5. As shown in table 2, there is a high correlation (0.759) between the two variables representing firms’ financial performance: the market-to-book-ratio and the return on assets. This is not surprising since they are both a measure of financial performance. However, table 3 also provides information of this study’s multicollinearity. The Variance Inflation Factor (VIF) is known as a better measure to determine multicollinearity. Table 3 shows that in each of the four models, the VIF is beneath the 4, which is below the common-used threshold of 10. This means that multicollinearity is unlikely to affect the outcomes of this study.

Besides the possible presence of multicollinearity, the correlation matrix also provides information concerning possible significant correlations. Using table 2 as source, there are expectations of significant correlations between variables. For the variables representing firm size and board size, I make use of the logarithm of respectively total assets and the number of board members. Concerning the hypothesizes of this study, it is interesting to discuss the correlation between the dependent variable and other variables. The return on assets, market-to-book-ratio, firm size, board size, and independency of the board seem to be significant positively correlated with the number of CSR proposals presented at an organizations’ annual general meeting. The positive correlation between firms’ financial performance and the number of received proposals is consistent with the direction of the first hypothesis

of this study, namely, that high financial performance leads to more shareholder proposals concerning CSR. The KLD net score and the percentage of institutional ownership seem to be significant negatively correlated to the number of received CSR proposals. The significant negative correlation between the KLD net score and the number of received CSR proposals, is consistent with my second hypothesis. All these correlations, both positive and negative, are significant at the level of 0.01.

Number of prop. Fin. perf. (ROA) Fin. perf. (MTB) KLD Net

Score Firm Size

Board Size % Indep. board % Instit. own. Number of prop. 1

Fin. perf. (ROA) 0.098* 1

Fin. perf. (MTB) 0.106* 0.759* 1 KLD Net Score -0.059* 0.110* 0.163* 1 Firm Size 0.343* -0.241* -0.154* 0.140* 1 Board Size 0.151* -0.034 -0.020 0.131* 0.443* 1 % Indep. board 0.102* -0.075* -0.087* 0.088* 0.222* 0.172* 1 % Instit. own. -0.214* -0.162* -0.226* -0.130* -0.315* -0.172* 0.014 1

* Correlation is significant at the 0.01 level (2-tailed).

Table 2: Correlation matrix

Linear regression

This section is devoted to the testing of the two hypotheses. The main results are presented in table 3. Table 3 provides the performed linear regression and shows all the variables, with the exception of the control variables year and industry. The regression table of these two control variables can be found in appendix B. Using linear regression, I performed four models with respect to the hypothesizes. The first model shows a controls-only model. The results in the first model show that firm size (β = 0.810 and α = <0.01), board independency (β = 0.767 and α = <0.05), and institutional ownership (β = 0.683 and α = <0.01) have a statistically significant and positive relationship with the number of CSR proposals presented at an organizations’ annual general meeting. Board size does not have a statistically significant relationship with the dependent variable.

The first hypothesis predicts that low CSR performance leads to more shareholder proposals concerning CSR. Together with the control variables, the KLD net score is subjected on linear regression. The results reported in Table 3, Column (2) indicate that the KLD net score has a negative significant effect (β = -0.025 and α = <0.01) on the number of received CSR proposals. Therefore, I conclude that this

hypothesis can be accepted. This acceptance indicates that organizations with low CSR performance, are more likely to receive more shareholder proposals concerning CSR. Corresponding with model 1 of the regression, firm size, board independency, and institutional ownership have a positive significant effect on the received number of CSR proposals.

The model in Column (3) presents the results of the second hypotheses. Besides the controls, the variables concerning a firms’ financial performance are tested as well. The second hypothesis states that high firm performance leads to more shareholder proposals concerning CSR. Column (3) shows a positive significant relationship (β = 0.140 and α = <0.01) between the market-to-book ratio and the number of received shareholder proposals concerning CSR. This indicates that an organization can expect more shareholder proposals in terms of CSR and that shareholder-activists are more likely to voice, when an organization is characterized by a high market-to-book-ratio. The other variable representing financial performance is the return on assets. Although the direction of the relation between the two variables is positive, there exist no statistically significant relationship. Because of the positive significant relationship between the market-to-book-ratio and the number of received shareholder proposals concerning CSR, but the lack of evidence for a significant relation between the return on assets and the number of received shareholder proposals concerning CSR, I partially accept the second hypothesis.

The fourth model shows a regression that incorporates all the previously used variables. The two independent variables are simultaneously trying to explain changes in the dependent variables. This fourth ‘all-in’ model shows that the KLD net score (β = -0.034 and α = <0.01), market-to-book-ratio (β = 0.170 and α = <0.01), firm size (β = 0.987 and α = <0.01), board dependency (β = 0.818 and α = <0.05), and institutional ownership (β = -0.352 and α = <0.10) have a significant relationship with the number of received CSR proposals.

With respect to the last two control variables, years and industry, the outcomes of this regression indicate that the year 2014 is significantly negative related to the number of received CSR proposals, within all four models. The variable with respect to the type of industry consistently shows significantly relationships with industry 3 (oil and petroleum products), 7 (drugs, soap, parfums and tobacco), 11 (machinery and business equipment), 12 (automobiles), 13 (transportation), 14 (utilities), 16 (banks, insurance companies and other financials) and 17 (other). All the directions, apart from the oil industry (industry 3), are negative, what indicates that these industries are less vulnerable for shareholder proposals concerning CSR. Contrary, organizations operating in the oil-industry are more likely to

receive shareholder proposals concerning CSR. The oil-industry variable is positive statistically significant with the number of received CSR proposals (β = 0,824 and α = <0,01).

The positive Adjusted R²’s and the low values of the VIF shown in table 3 contribute to the reliability of the research. The F-test tests whether there exists variance between the different variables. The table provides significant positive F-tests within all the models.

1 2 3 4 5 6

Constant -3.113*** -3.301*** -3.759*** -4.072*** -3.617*** -13.845***

Fin. perf. (ROA) 0.676 0.591 0.564 0.413

Fin. perf. (MTB) 0.140*** 0.170*** 0.157*** 0.479*** KLD net score -0.025*** -0.034*** -0.065*** Firm..size 0.810*** 0.832*** 0.951*** 0.987*** 0.814*** 2.347*** Board size -0.099 -0.014 -0.336 -0.227 -0.239 -0.406 % Indep. board 0.767** 0.821** 0.745** 0.818** 0.658* 4.148*** % Instit. own. 0.683*** -0.769*** -0.295 -0.352* -0.305* -1.275** KLD total strenghts -0.078 KLD total concerns 0.537*** Adjusted R² 0.250 0.255 0.274 0.284 0.282 0.232¹ F-test 26.169*** 26.051*** 26.044*** 26.440*** 25.606*** 558.115***²

Highest VIF 3.323 3.328 2.971 2.993 3.153 N.A³

Year Yes Yes Yes Yes Yes Yes

Industry Yes Yes Yes Yes Yes Yes

*, ** and *** coefficients are statistically significant with respectively α = 0.10, α = 0.05 and α = 0.01 (2-tailed). ¹ Because of logistic regression, this value entails the Cox & Snell R² instead of the Adjusted R²

² Because of logistic regression, this value entails the model’s Chi-square ³ Because of logistic regression, this value is not applicable.

Table 3: Linear regression and robustness checks

Robustness checks

This study provides two robustness checks. The reason to incorporate these checks into my study, is because it is important to consider your study from different assumptions in order to see if the results change. First, I include the strengths and the concerns of the KLD data separately, instead of the total

net score. Within the literature of CSR, some researchers (e.g. Gupta et al., 2014; Walls et al., 2012; Flammer, 2015) prioritize to treat these variables separately because they believe the strengths and the concerns capture distinct characteristics (Gupta et al., 2014). Walls et al. (2012) argue that using the combined score can lead to irrelevant and false results. Table 3 shows the results of this robustness check. In model 5, I exclude the total KLD score and include the separated KLD strengths and KLD concerns. These tests show that KLD concerns have a positively statistically significant effect (β = 0.537 and α = <0.01) on the number of received CSR proposals. Although the direction of the relation between KLD strengths and received CSR proposals is negative, it is not a statistically significant relation. The test of these two separated variables indicates that shareholder activists are mainly stimulated by high CSR concerns, rather than by low CSR strengths. This finding is in line with the aforementioned theory of Mitchell et al. (1997) concerning stakeholders. When stakeholder question the organizations’ legitimacy, they will voice through, for example, a shareholder proposal. Apparently, having many concerns is more threatening for an organizations’ legitimacy than having little strengths.

Second, I run a logit regression with the dependent variable as a dummy variable. Instead of the number of received shareholder proposals concerning CSR as dependent variable, this variable is redefined because of this robustness check in ‘the chance of getting at least one CSR-related shareholder proposal’. By making the dependent variable a dummy variable, I follow Eding and Scholtens (2017) who used ‘shareholder proposal probability’ as a variable, instead of the number of received CSR proposals. Organizations who received one or more CSR-related shareholder proposal in a certain year are labeled with a 1 and organizations who did not receive a CSR-related shareholder proposal are labeled with a 0. This variable has a mean of 0,32, which means that 32% of the firm-year observations are characterized by at least one receival of shareholder proposals concerning CSR. In addition to that, the variable has a standard deviation of 0,467. The results of this logistic regression are included in column 6 of table 3. Even though the coefficients differ from the ones in the other models, the directions of the results are the same. Moreover, significant relations exist between the same variables as in the other models. With this check I want to show that the results would have been more or less the same, in case I winsorized the number of received CSR proposals or when I used a dummy variable as dependent variable.

Conclusion

This study examines if low CSR performance and high financial performance have an effect on the number of receiving CSR proposals in a certain year. On the basis of linear regression, I find that low CSR performance increases the change of receiving shareholder proposals concerning CSR. This finding is mostly driven by the number of concerns the KLD data reports, which is indicated by Michelon and Rodrigue (2015) who argue that CSR proposals are viewed to signal shareholders’ concerns about the CSR strategy. This is in line with prior literature suggesting that shareholder activism plays a role in limiting the remaining conflict of interests between shareholders and management (Missangyi & Archarya, 2014), since managers sometimes prioritize short-term self-interest over CSR investments that only pay-off in the long run (Kang, 2013). Besides this explanation based on the agency theory, the first implication of this study is in line with literature concerning stakeholder theory as well. Stakeholders tend to voice in case they doubt the organizations’ legitimacy (Mitchell et al., 1997). Low CSR performance is an occasion in which stakeholders can doubt the organizations’ legitimacy. This argument is supported by the finding that the oil industry is more likely to face shareholder proposals concerning an organizations’ CSR, because this industry is known for its harmful activities. The second main finding of this study is that organizations that are characterized by a high market-to-book-ratio, are more likely to receive shareholder proposals targeting the (lack of) CSR performance. The other indicator of financial performance used in this study is the return on assets. The relation between this financial measure and the number of received CSR proposals proved positive, but this is not significant evidence. An explanation of this discrepancy can be found in the value creating potential of the market-to-book-ratio. An organizations’ book value does not capture unmeasurable elements like image and reputation, whereas the market value of a firm takes these elements into account.

This study has important implications for the literature that tries to explain the extent to which firms are confronted with CSR-related shareholder proposals. Apart from the study of Eding and Scholtens (2017), to date we lack knowledge in this field. This study responds to this gap in the literature, by showing that low CSR performance and a high market-to-book-ratio increases the number of received CSR-related shareholder proposals. This is interesting for managers when formulating their stakeholder management strategies and in the attempt to maintain the social contract.

Limitations and avenues for future research

This study is subject to limitations. First, when discussing literature concerning agency theory and shareholder theory, I argue that shareholders require shareholder value, even if it is only in the long-term. Even though this is true for most of the shareholders, there are some shareholders prioritizing short-term returns. Borochin and Yang (2017) describe these two types of investors. Dedicated investors care about the growth potential of the organization and tend to invest for the long-term. Transient investors are looking for short-term returns, because of their short investment horizon. This study particularly focusses on dedicated investors, since I assume shareholders require shareholder value on the long term. Some theory discussed in this research, like the slack resources theory, are not applicable for transient investors. Moreover, Cox and Wicks (2011) found that transient investors do not prioritize corporate responsibility. Therefore, transient investors will be less likely to submit shareholder proposals concerning CSR. Future research could examine the difference between these two types of investors with respect to their underlying reasons in submitting CSR-related shareholder proposals. The second limitation of this study is concerning the first hypothesis. As showed in table 1, the KLD net score has the least observations, in comparison with the other variables. This is mainly due to the first five year of the used timeframe, because KLD was not in possession of the required information to rate the organizations’ CSR performance. Assuming this lack of information during these years, is caused by the disinterest of organizations to disclose about their CSR engagement, it is likely that these organizations’ KLD rating would have been low. This may have affect the results concerning the first hypothesis.

A suggestion for future research is to examine the relations between the number of received proposals within different industries. For the aim of this study, I focused on the relation of financial performance and CSR performance towards the likeliness of receiving a CSR proposal. However, table 4 indicates that there are big differences between this likeliness within different industries. Besides the increased chance of receiving a shareholder proposal concerning CSR in the oil industry, the regression suggests several industries that are less likely to receive CSR proposals. It might be interesting to investigate why these industries are dealing with less proposals concerning CSR in comparison with other industries.

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