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The relationship between

board characteristics and

Corporate Social

Responsibility

Paul Klaassen

University of Groningen

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The relationship between

board characteristics and

Corporate Social

Responsibility

Master-Thesis Controlling University of Groningen

Faculty of Economics and Business

Author: Paul Klaassen Student number: 1384651

Supervisors: Dr. R.B.H. Hooghiemstra Prof. dr. H. van Ees August, 2008

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of the author.

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Preface

After two years of study, this Master-Thesis finishes my Master of Science in Accounting and Controlling at the University of Groningen. Last year I made the choice to extent my accounting study with a major in controlling. This decision was partly based on the slogan of a well-known producer of survival equipment: “Never stop exploring.” Studying controlling gave me the possibility to discover accounting, control and finance from an inside perspective. This will definitely help me with performing my future profession as an auditor.

Without the help of Ms. A.C. Kok I would not be able to perform my statistical data-research because she helped me with collecting the relevant data. In addition, Reggy Hooghiemstra from the University of Groningen, and Remco Vaanholt from Ernst & Young Accountants LLP supervised me with my research. Without their critical remarks and comments, this thesis would not have reached the same level of professionalism.

With studying the relationship between board characteristics and Corporate Social Responsibility, I tried to contribute to the research domain of social responsibility and corporate governance. These days, boards of directors, policy makers and scholars more and more discover the importance of social responsibility and corporate governance for company performance, investor- or stakeholder protection, and the functioning of financial markets in general. Therefore, research on these research domains must continue till all the questions are answered. I hope that this study will enlighten the importance of corporate governance and corporate social responsibility and the interrelationship between both. Furthermore, I hope that this thesis is readable and interesting for the reader.

Zwolle, 28 August 2008 Paul Klaassen

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Content

Abstract 4

1. Introduction 5

1.1 Introduction of the theme 5

1.2 Problem statement 6

1.2.1 Research goal 6

1.2.2 Main research question 7

1.2.3 Investigative questions 7

1.3 Research approach and delineation 7

1.4 Motivation and relevance 8

1.5 Overview of the Master-Thesis 10

2. Corporate Social Responsibility 11

2.1 Introduction 11

2.2 What is Corporate Social Responsibility? 11

2.3 Reasons for acting social responsible 14

2.3.1 Introduction 14

2.3.2 Resource-based theory 14

2.3.3 Stakeholder theory 16

2.3.4 Corporate Social Responsibility and financial performance 17

2.4 Conclusion 19

3. The relationship between board characteristics and Corporate Social Responsibility 20

3.1 Introduction 20

3.2 Board of Directors 20

3.3 Board independence and CSR 22

3.4 Board meeting frequency and CSR 24

3.5 The moderating effect of firm size 25

3.6 The moderating effect of financial performance 28

3.7 Conclusion 29

4. Research methodology 30

4.1 Introduction 30

4.2 Research approach 30

4.3 Data selection and sample size 30

4.4 Variables 31 4.4.1 Introduction 31 4.4.2 Dependent variable 31 4.4.3 Independent variables 33 4.4.4 Moderating variables 33 4.4.5 Control variables 34 5. Results 36 5.1 Introduction 36 5.2 Descriptive analysis 36

5.3 Regression analysis of hypotheses 1 and 2 38

5.4 Regression analysis of hypotheses 3 and 4 41

6. Conclusion 44

6.1 Introduction 44

6.2 Summary and conclusion 44

6.3 Limitations 47

6.4 Recommendations for future research 48

Bibliography 49

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Abstract

This Master-Thesis presents the results of a study which investigated the relationship between board characteristics and Corporate Social Responsibility (CSR). CSR reputation derived from the Fortune reputation index is used as a proxy for CSR. The following main research question was at the forefront of this study:

“What is the relationship between board characteristics and Corporate Social Responsibility,

and what is the effect of firm size and financial performance on this relationship?”

CSR has been defined in many different ways. A common element in all definitions is that companies act social responsible when they balance a multiplicity of interests instead of serving merely the interests of the shareholders; business and society are interwoven, rather than distinct entities.

Companies could act social responsible because they feel morally obliged to do so. However, companies could also engage in CSR because it could further economic success. From a resource-based perspective, acting social responsible could accrue some kind of competitive advantage. CSR reputation is a scarce and immobile resource which can inform external constituents about the trustworthiness, credibility and quality of the firm. Moreover, building relationships with stakeholders could also contribute to a firm’s wealth. Several studies confirm that a positive relationship between CSR and firm financial performance exists.

Corporate governance principles state that boards should guide corporate strategy. The structure of the board could therefore influence or even shape the strategy of the company. Based on theories and a review of the literature, it was expected that CSR reputation is positively influenced by the proportion of independent directors on the board and by the total number of board meetings. In addition, it was hypothesized that firm size and financial performance moderate these relationships.

Regression analyses did not find support for the hypotheses that CSR reputation is positively influenced by the proportion of independent directors on the board and the total number of board meetings. In contrast, it was found that the number of board meetings negatively influences CSR reputation. In addition, total directors influences CSR reputation positively. These results make clear that total directors on the board has a higher influence on CSR reputation than the independence of the board. Furthermore, a higher number of board meetings is probably perceived as a crisis in the respective firm. Consequently, board members could have less time and commitment to CSR.

Firm size as well as financial performance moderate the aforementioned relationships. The coefficient of determination is significantly higher when the moderating variables are added. Larger firms are more visible and attract more attention from external constituents. In addition, firms with slack resources available, have more opportunities to engage in CSR activities.

Although this study yielded some significant results, more research on the relationship between corporate governance and CSR is recommended. Ultimately this could lead to a refinement or further development of corporate governance principles.

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Chapter 1: Introduction

§ 1.1 Introduction of the theme

Henry Ford, founder of Ford Motor Company, once said: “A Business that makes nothing but money is a poor kind of business”. However, Friedman (1970) has another point of view. Friedman states that the social responsibility of business is to increase its profits. Executives should not waste corporate resources for social goals. The executive is an employee of the owners, i.e. the shareholders, of the business. Therefore, he has direct responsibility to the owners, i.e. his employers; he has to make profit and increase shareholder value instead of wasting corporate resources for social goals.

The credence of Friedman, which is well established in neo-classical economics (see Dam, 2008), does not conform to the concept of Corporate Social Responsibility (hereafter, CSR). According to neo-classical economics, production is achieved as efficiently as possible when competitive corporations maximize profits (Dam, 2008). Moreover, when firms also “stay within the rules of the game” (e.g. conforming to laws and regulations), maximum welfare for society will be yielded (Dam, 2008). In contrast to neo-classical economics, CSR is, in the words of McWilliams and Siegel (2001, p.117), “[a set of] actions that appear to further some social good, beyond the interests of the firm and that which is required by law.” Sacconi’s (2006) definition of CSR is aligned with the definition of McWilliams and Siegel (2001). Sacconi states that (p.262): “CSR is a model of extended corporate governance whereby those who run a firm (entrepreneurs, directors and managers) have responsibilities that range from fulfilment of their fiduciary duties towards the owners to fulfilment of analogous fiduciary duties towards all the firm’s stakeholders.” McWilliams and Siegel (2001) and Sacconi (2006) make clear that a company and “those who run a firm” should be attentive to the needs of constituents other than shareholders.

These days CSR is gaining more and more influence. KPMG (2005) found that corporate responsibility reporting has expanded steadily since 1993 and that it has increased substantially in the three years before 2005. Furthermore, during the past ten years, the number and sizes of investment funds that concentrate on the stocks of companies noted for being socially responsible in their policies and activities grew rapidly. In the 2007-report of the Social Investment Forum (SIF, 2007) it can be read that about one of every nine dollars under professional management in the United States today is involved in socially responsible investing. Next to the development of CSR, corporate governance also has come to prominence in the business world. During the last decade, each year has seen the introduction, or revision, of a corporate governance code in a number of countries (Mallin, 2004, p.19). These codes give a number of principles about e.g. the roles, structure and transparency of boards of directors.

Boards have a significant influence on the extent of CSR. According to the principles of Corporate Governance of the OECD (2004, p.59) the board of directors is not only accountable to the company and its shareholders. Boards are expected to take account, and deal fairly, with other stakeholder interests including those of employees, creditors, customers, suppliers and local communities. The principles of Corporate Governance (2002) of the Business Roundtable, the latter recognized as an authoritative voice on matters affecting US business corporations, have the same tenor. On page 1 of their 2002 report it is written that “the relationships of the board and management

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6 with stockholders should be characterized by candor; their relationships with employees should be characterized by fairness; their relationships with the communities in which they operate should be characterized by good citizenship; and their relationships with government should be characterized by a commitment to compliance.” Boards who effectively perform their tasks, should, according to these cited corporate governance principles, consider, and deal fairly with more than only the interests of shareholders.

Boards could also influence the extent of CSR through their task to challenge and help develop proposals on strategy. OECD principle VI-D states that the board as a whole should review and guide corporate strategy, major plans of action and business plans. The principles of Corporate Governance of the Business Roundtable (2002, p.4) state that the board is responsible for overseeing and understanding the corporation’s strategic plans. Hambrick and Mason (1984) contend that strategic decisions reflect the background of an organization’s most powerful managers and what the organization does could be explained in part by the profile of its upper-echelon. Because directors are in a position to shape the strategic direction of the firm, as prescribed by corporate governance principles, they are capable of determining which constituent groups’ values should be considered seriously in corporate operations (see also Zahra, 1989, p.240).

Luoma and Goodstein (1999, p.556) state that organizational size is an important determinant of corporate responsiveness to the legal and normative environment influencing stakeholder representation. Waddock and Graves (1997, p.307) write the following about the influence of organizational size on the extent of social responsibility of firms: “Size is a relevant variable because there is some evidence that smaller firms may not exhibit as many overt socially responsible behaviors as do larger firms. Perhaps this is the case because as they mature and grow, firms attract more attention from external constituents and need to respond more openly to stakeholder demands.”

The relationship between CSR and corporate financial performance (CFP) has been studied intensively. Dam (2008, p.7) states that economic theory suggests that CSR comes at a cost. Economic theory could explain why CSR could negatively affect a firm’s financial performance. Dam (2008, p.7-8) continues with stating that “an economic equilibrium suggests a trade-off between corporate social responsibility and financial performance.” Some empirical studies supported the economic theory (e.g. Vance, 1975). However, also many empirical studies found a positive relationship between CSR and CFP (e.g. Orlitzky et al., 2003). Section 2.3.4 will discuss the relationship between CSR and CFP in more detail, but at this place it could be stated that the relationship between board characteristics and CSR could probably be moderated by the financial performance of a company. A company with better financial performance has more resources, or money, to spend on social responsible activities.

§ 1.2 Problem statement

§ 1.2.1 Research goal

The goal of this research is to gain more insight into (1) the existence of a possible relationship between board characteristics and Corporate Social Responsibility and (2) the effect of firm size and financial performance on this relationship. Figure 1.1 shows a model that gives a graphical representation of the research that has been performed.

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Figure 1.1: Research model

§ 1.2.2 Main research question

The main question in this research is twofold: What is the relationship between board characteristics and Corporate Social Responsibility, and what is the effect of firm size and financial performance on this relationship?

§ 1.2.3 Investigative questions

To be able to answer the main research question, the following investigative questions must be answered:

1) What is Corporate Social Responsibility? 2) Why would companies act social responsible?

3a) To what extent is board independence related to Corporate Social Responsibility? 3b) To what extent is board meeting frequency related to Corporate Social Responsibility? 4) To what extent does firm size and financial performance have a moderating effect on the

relationship between board characteristics and Corporate Social Responsibility?

§ 1.3 Research approach and delineation

To be able to answer the main research question, a quantitative desk research has been performed with secondary data. In chapter 3 several hypotheses will be discussed which have been tested in a quantitative way with statistics. For this reason this study could be described as an explanatory study (Cooper and Schindler, 2003, p.11). This section will outline the research approach that is used and gives a delineation of the research.

In this study the relationship between board characteristics and CSR has been researched with single and multiple regression analyses. Board characteristics are the independent or X variables and CSR is the dependent or Y variable. CSR reputation is used as a proxy for the social responsibility of a company. Fombrun (1996, p.72, cited by Brammer and Pavelin, 2004) defined reputation as: “a perceptual representation of a company’s past actions and future prospects that describe the firm’s overall appeal to all its key constituents when compared to other leading rivals.” Using CSR reputation as a proxy of CSR is grounded on the work of, among others, Brammer and Pavelin (2004). They found a positive relationship between the (CSR-) reputation and social activities of companies. In the following sections of this thesis, CSR reputation will be equated with the actual social responsibility

Board characteristics: - Board independence - Board meeting frequency

Corporate Social Responsibility

Financial Performance Firm Size

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8 (performance) of companies. This means that a company with a high CSR reputation is thought to be a company who performs his business in a more social responsible way than companies with a low CSR reputation.

CSR reputation data is derived from the Fortune Ranking – America’s Most Admired Companies. Executives, directors, and analysts were asked to rate companies in their own industry giving each company a numerical score from zero (poor) to ten (excellent). In 2008, more than 3.700 responders ranked companies on eight attributes: (1) Quality of management, (2) Quality of products and services, (3) Innovation, (4) Long-term investment value, (5) Financial soundness, (6) People Management, (7) Social responsibility and (8) Use of corporate assets. This study used the score on the 7th attribute, social responsibility, as a proxy for CSR. Board characteristics data will be derived from the Spencer Stuart Board Index 2007. The use of these “databases” will be motivated in chapter 4. At this point it could mentioned that the total sample size consists of 230 US listed companies.

The above makes clear that this study researched the relationship between board characteristics and CSR in a quantitative way. Table 1.1 gives a summery of the different variables including the (operational) definition of the variables which are used to study the relationship between board characteristics and CSR. In chapter 4 the research methodology will be discussed in more detail.

Table 1.1: List of variable definitions

Variable Kind of

variable1

Operational definition Data source Year

Board independence Independent Percentage of independent directors on the board.

Spencer Stuart Board Index

2007

Board meeting frequency

Independent Number of board meetings per year. Spencer Stuart Board Index

2007

Corporate Social Responsibility

Dependent Relative CSR reputation ranking. Fortune Ranking – America’s Most Admired Companies

2006/ 2007/ 2008

Firm size Moderating Natural logarithm of total sales (in US dollars).

Thomson Datastream 2006/ 2007

Financial performance Moderating Quick Ratio (current assets minus inventory divided by current liabilities).

Thomson Datastream 2006/ 2007

§ 1.4 Motivation and relevance

This study makes a number of contributions. A lot of studies have used the concept CSR. However, a large multitude of measures have been used to gauge this complex variable. For example, Zahra (1989), Wang and Coffey (1992) and Coffey and Wang (1998) used the percentage of sales or pre-tax earnings devoted by the firm to charitable contributions to measure CSR. Other often used methods to measure the social responsibility of firms are assessing the degree of disclosure of “matters of social concern” (see e.g. Ullmann, 1985) or directing a survey to the directors of a firm (see e.g. Zahra et al., 1993; Ibrahim and Angelidis, 1995; Ibrahim et al., 2003). Only McGuire et al. (1988) and Herremans et al. (1993) used the Fortune annual survey of corporate reputations to proxy CSR. However, McGuire et al. (1988) researched the relationship between CSR and financial performance and Herremans et

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9 al. (1993) researched the relationship between CSR and economic performance. In addition, Orlitzky et al. (2003) performed a meta-analysis of 52 studies of the relationship between corporate social performance and financial performance. In their meta-analysis, several measures of CSR have been used, including the Fortune reputation index. However, these measures have been related with the financial performance of these companies without looking at several board characteristics. As far as the author knows, the relationship between board characteristics and CSR with use of the Fortune Reputation Ranking has not been researched yet. In other words, the main research question, the relationship between board characteristics and CSR, has been researched before. However, in these studies CSR has not been measured by the Fortune reputation index. These studies used used a survey questionnaire (Zahra et al., 1993; Ibrahim and Angelidis, 1995; Ibrahim et al., 2003) or measured CSR with the percentage of sales devoted by the firm to charitable contributions (Zahra, 1989; Wang and Coffey, 1992; Coffey and Wang, 1998). Therefore it could be claimed that, by using the Fortune reputation index to gauge CSR, this study fills a void in the existing research.

De Graaf (2005) states that the board (or governance) structure determines significantly how and when stakeholders (could) influence the policy and strategy (including the extent and kind of CSR) of a company. In other words, the board structure determines the extent of influence of stakeholders on a company. Stakeholders could have a direct or an indirect influence (see de Graaf, 2005; Frooman, 1999). A direct influence means that stakeholders discuss the policy directly with the directors or other policy makers. An indirect influence means that stakeholders (try to) convince a third party, for example the non-executive directors of a (unitary) board, to take account with the stakes of the different stakeholders. Therefore, how the board is organized, including the possibilities of a direct or indirect influence, could have an influence on the social responsibility of a company. How this process functions has been studied by de Graaf (2005) in a descriptive way with the use of case-studies. He concludes that the social responsibility of companies will be determined especially via direct influence processes. This study researched, in a quantitative way instead of a qualitative way, whether board independence (and board meeting frequency) influences CSR. As will be discussed in chapter 3, a more independent board means better possibilities for stakeholders to (indirectly) influence policy and strategy. It could be stated that this study complements the study of de Graaf (2005) because the aforementioned relationship is researched in a quantitative way and secondly, this study tries to find evidence of the possible indirect influence of stakeholders.

The studies of the relationship between board characteristics and CSR performed thus far yielded mixed results. For example, Zahra (1989) found that the proportion of outsiders (compared to the proportion of insiders) positively associated with the percentage of sales devoted by the firm to charitable contributions (as a proxy for CSR) whereas Coffey and Wang (1998) found that the percentage of pre-tax earnings devoted by the firm to charitable contributions (as a proxy for CSR) increases as the number of insiders (compared to the number of outsiders) increases. These contradictory findings give need for further investigation with another proxy for CSR.

This study also takes the possible effect of firm size and financial performance on the relationship between board characteristics and CSR into account. This has not been performed by the authors (see Zahra, 1989; Wang and Coffey, 1992; Zahra et al., 1993; Ibrahim and Angelidis, 1995; Coffey and Wang, 1998; Ibrahim et al., 2003) who researched the relationship between board

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10 characteristics and CSR. As mentioned before, the empirical evidence of the relationship between CSR and CFP has mixed results. These mixed results could probably be explained when financial performance is positioned as a moderating variable instead of an independent variable. This study will give more insight into the possible moderating effect of firm performance (and firm size) on the relationship between board characteristics and CSR.

Lastly, insights into the relationship between board characteristics and CSR could have important implications for directors (i.e. those responsible for nomination, selection and remuneration) and public policy makers. This study could provide evidence whether reforming board composition and/or increasing or decreasing the extent of board meetings are important conditions for improving CSR. Consequently, this could also be an input for the refinement or further development of corporate governance codes.

§ 1.5 Overview of the Master-Thesis

In this chapter a first introduction of the concept corporate social responsibility has been given. The next chapter will give more insight into this concept. Furthermore, the reasons for acting social responsible will be discussed in more breadth, including the relationship between CSR and financial performance. This discussion is based on two relevant theories: the resource-based theory and the stakeholder theory. In chapter three several hypotheses of the relationship between board characteristics and CSR, based on research performed thus far and several theories, will be developed. A further clarification and foundation of the research methodology, including the definition of the different (control) variables, will be the main subject of chapter 4. Chapter 5 firstly presents some descriptive analyses and secondly presents the results of the hypotheses-testing. Ultimately, the answering of the main research question, including the limitations of the study and recommendations for future research, will be presented in chapter 6.

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Chapter 2: Corporate Social Responsibility

§ 2.1 Introduction

Corporate Social Responsibility (CSR) is a concept which needs further clarification. According to Crowther and Rayman-Bacchus (2004, p.2) “the term corporate social responsibility is in vogue at the moment but as a concept it is vague and means different things to different people.” In this chapter this concept will be clarified. First of all, in section 2.2 some definitions of CSR will be discussed. Carroll (1979, p.498) writes that “social responsibility has been defined or conceptualized in a number of different ways, by writers of stature in business, and in its various definitions the term has encompassed a wide range of economic, legal, and voluntary activities.” The differences between these definitions could, partly, be explained when you look to the historical trend of CSR. In addition, more insight in CSR will be given when the reasons for acting social responsible will be discussed; this will be the main subject of section 2.3. Chapter 2 will be ended with a conclusion.

§ 2.2 What is Corporate Social Responsibility?

The definition and interpretation of the concept CSR varies between people and organizations who use the concept (De Waard, 2008, p.14) and has a long and varied history (Carroll, 1999, p.268). This results in several different definitions of CSR. In this chapter some definitions of CSR will be discussed. Differences between several definitions will be explained by the historical development of this concept (see Carroll, 1999). Furthermore, not only the differences between the different definitions will be discussed, but, more importantly, also the similarities between the various definitions of CSR.

Carroll (1999) gives an overview of the history of CSR. Carroll states that the 1950s mark the modern era of CSR. In the 1950s the term “social responsibility” was used more frequently than CSR. Carroll’s explanation for this phenomenon is that this was because the age of the modern corporation’s prominence and dominance in the business sector had not yet occurred or been noted. Bowen’s publication (1953) named “Social Responsibilities of the Businessmen”, could be seen as the beginning of the modern period of literature on this subject. Bowen (1953, p.6) describes the social responsibilities of businessmen as “the obligations (…) to pursue those politics, to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society.” Besides the work of Bowen, there was not written a lot about (corporate) social responsibility in the 1950s. However, the 1960s marked a significant growth in attempts to state what CSR means (Carroll, 1999, p.270). Davis (1960, p.70) as well as McGuire (1963, p.144) state that CSR goes beyond the direct economic interest of the businessman. A corporation not only has economic and legal obligations but also certain responsibilities to society which extend beyond the economic and legal obligations. The obligations of businessmen beyond economic interests also become clear in the definition of Davis and Blomstrom (1966, p.12): “Social responsibility, therefore, refers to a person’s obligation to consider the effects of his decisions and actions on the whole social system. Businessmen apply social responsibility when they consider the needs and interest of others who may be affected by business actions. In so doing, they look beyond their firm’s narrow economic and technical interests.”

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12 Economic Responsibilities Ethical Responsibilities Legal Responsibilities Discretionary Responsibilities

Figure 2.1: Social Responsibility Categories (Carroll, 1979, p.499)

In the definitions of social responsibility mentioned before the businessmen, with their consequent responsibilities, are a central element. The definitions from the 1970s more and more refer to business(es), corporations or firms instead of businessmen. Johnson (1971, p.50) states that “A socially responsible firm is one whose managerial staff balances a multiplicity of interests. Instead of striving only for larger profits for its stockholders, a responsible enterprise also takes into account employees, suppliers, dealers, local communities, and the nation.” Another important work from the 1970s is the work of Carroll (1979). Carroll states that a definition of social responsibility that fully addresses the entire range of obligations business has to society, must embody the economic, legal, ethical, and discretionary categories of business performance. Figure 2.1 shows a figure of Carroll (1979, p.499) which graphically represents his definition of social responsibility. Carroll (1979, p.499) remarks that the proportions suggest the relative magnitude of each responsibility and, although there are four kinds of responsibilities, they must be met simultaneously. They are not mutually exclusive but reinforce each other.

Carroll (1979, p.500) writes that, “though all of these kinds of responsibilities have always simultaneously existed for business organizations, the history of business suggests an early emphasis on the economic and then legal aspects and a later concern for the ethical and discretionary aspects.” According to Carroll the first and foremost social responsibility of business is economic in nature. Business has the responsibility to produce goods and services that society wants and to sell them at a profit. Making profit is an incentive and reward for business for its efficiency and effectiveness. The legal responsibility means that society expects business to fulfil its economic mission within the framework of legal requirements and, as a consequence, to obey the law. Not all behaviours and activities are codified into law. However, society does expect that business also take responsibilities beyond the economic

and legal responsibilities. These are the ethical responsibilities. Carroll (1979, p.500) remarks that the ethical responsibilities are among the most difficult for business to deal with because they are ill defined. Lastly, the discretionary responsibilities are those about which society has no direct opinion what is right. Carroll (1999, p.283-284) writes about the discretionary responsibilities that “these represent voluntary roles that business assumes but for which society does not provide as clear-cut an expectation as it does in the ethical responsibility. These are left to individual managers’ and corporations’ judgment and choice.” With regards to discretionary responsibilities it is worthy of mention that society does have an expectation that business perform these. An example of a discretionary responsibility is making philanthropic contributions or providing day-care centres for working mothers (Carroll, 1979, p.500). These kind of activities are guided by businesses’ desire to engage in social roles not mandated or required by law and not expected of businesses in an ethical sense, but which are increasingly strategic (Carroll, 1999, p.284).

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13 As a result, Carroll (1979, p.500) gives the following definition of social responsibility: “The social responsibility of business encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time.” This definition makes clear that the expectations that society has is leading, and consequently, there is no one static definition what social responsibility really is. The practical implication of social responsibility could change over time, depending on the expectations of society (see de Graaf, 2005, p.5). In addition, Carroll (1991) argues that the four categories (see figure 2.1) of CSR could be illustrated as a pyramid. At the bottom of the pyramid are the economic responsibilities. Without the economic responsibilities the other responsibilities cannot be achieved. This notion makes clear that “economic viability is something business does for society as well” (Carroll, 1999, p.284).

Whereas Johnson (1971, p.50) already summed up several “stakeholders” in his definition of social responsibility, the so-called stakeholder theory, which will be discussed in section 2.3.3, really emerged in the 1980s. Jones’ (1980, p.59) definition is very stakeholder oriented: “Corporate social responsibility is the notion that corporations have an obligation to constituent groups in society other than stockholders and beyond that prescribed by law and union contract.” Carroll (1999, p.290) writes that “[this] stakeholder nomenclature puts ‘names and faces’ on the societal members or groups who are most important to business and to whom it must be responsive.”

An important development from the 1990s is that the (sustainability of the) environment is explicitly mentioned as a responsibility for companies. Elkington (1997) introduced the concept “triple-P”, which means that corporations are responsible for “Profit”, “People” and “Planet”. In this context, “Profit” stands for profit maximisation, “Planet” for ecological quality and “People” for human well-being in and outside the organization (Cramer et al., 2006, p.380). Cramer et al. (2006, p.380) define CSR with an inclusion of the “triple-P” concept when they define CSR as “[the obligation of companies] to take ecological quality and the well-being of people in and outside the organisation into account while they make a profit.” Moreover, from the 1990s CSR is seen more and more as a business concept rather than a philanthropic concept. Carroll (1999, p.286) writes that “business ought to convert its social responsibilities into business opportunities.” Profitability and responsibility are not only compatible but business ought to “convert” its social responsibilities into business opportunities (Carroll, 1999, p.286).

It could be concluded that the concept of CSR has a long and diverse history in the literature. Whereas CSR started as a rather vague concept as taking care for “society” when doing business, CSR has becoming more and more tangible. Cramer et al. (2006, p.388) even call CSR “unmistakably a new buzzword.” The basic idea of CSR is that business and society are interwoven rather than distinct entities; therefore, society has certain expectations for appropriate business behaviour and outcomes (Wood, 1991, p.695). Firms have a broader responsibility than merely making profit. In later definitions of CSR the different constituent groups are mentioned by name and taking care for the environment has become an important part of CSR. However, this section makes clear that what is social responsible depends on the expectation of society. Furthermore, companies discover these days that acting social responsible does have a virtue, while in the early days acting social responsible

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14 was seen purely as a cost. In the next section the reasons why companies would act social responsible will be discussed.

§ 2.3 Reasons for acting social responsible

§ 2.3.1 Introduction

Companies could have a number of reasons why they would act social responsible. First of all, firms could behave in a socially responsible manner because it is morally correct to do so. Branco and Rodrigues (2006, p.112) call this the normative case. However, it is difficult to believe that companies act social responsible even when this has a negative influence on the financial performance of the firm. This section focuses on the reasons for acting social responsible from a business case perspective, i.e. acting social responsible as a motivation for furthering economic success. The following (overlapping) reasons mentioned by De Waard (2008, p.70) and Dam (2008, pp.5-6) are examples of reasons for acting social responsible from a business case perspective: reputation management, liability management, strengthening the position of the firm in the industry (by vertical product differentiation) and improving stakeholder relationships. All these reasons could be explained by two theories: the resource-based theory and the stakeholder theory. Both theories will be discussed in sub-section 2.3.2 respectively sub-section 2.3.3. The OECD (2004, p.46) writes that: “It is in the long-term interests of corporations to foster wealth-creating cooperation among stakeholders.” However, in the academic environment there is a lot of discussion about companies’ monetary benefits of acting social responsible. The relationship between CSR and financial performance will be discussed in sub-section 2.3.4. At this place it is important to note that the normative- and the business case are distinct perspectives, but the reasons why companies would act social responsible might reflect a mixture of the two (see Smith, 2003).

§ 2.3.2 Resource-based theory

An important reason why companies may engage in CSR could be that these companies consider that some kind of competitive advantage could accrue. Acting social responsible could have a strategic value (Branco and Rodrigues, 2006). This notion could be underpinned by the resource-based theory. Two central elements of resource-based theory are resources and capabilities. Besanko et al. (2004, p.426) state that, to achieve a competitive advantage, i.e. the ability of a firm to outperform its industry, a firm must create more value than its competitors. This creation of value depends on the companies’ resources and its distinctive capabilities that arise from using those resources. Resources are seen as the basic constitutive elements out of which firms transform inputs into outputs, or generate services (Branco and Rodrigues, 2006, p.116). Resources can be tangible, like firm-specific assets, or intangible, like patents, reputation and human assets. Branco and Rodrigues (2006, p.117) define capabilities as “(…) the outcome of organisational learning. They belong to the organisation as a whole and are built from the learning of individual members or individual business units.” The resource-based theory points out that if all firms in a market have the same stock of resources and capabilities, firms cannot have a sustainable competitive advantage because another firm, with the same stock of resources and capabilities, could immediately replicate the strategy of the firm with a competitive advantage. Sustainable competitive advantages can only be reached when a firm has

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15 resources and capabilities that are scarce and imperfectly mobile (Besanko et al., 2004, p.427). Branco and Rodrigues (2006, p.112) write the following about the importance of resources and capabilities in generating sustainable competitive advantage: “(…) firms generate sustainable competitive advantages by effectively controlling and manipulating their resources and capabilities that are valuable, rare, cannot be perfectly imitated, and for which no perfect substitute is available. Engaging in CSR can help firms to create some of these resources and capabilities.”

The above explanation of the resource-based theory makes clear that an excellent CSR reputation, an important intangible resource, could give a firm a sustainable competitive advantage. Branco and Rodrigues (2006, p.117) write that: “Reputation is built, not bought, thus being a nontradeable asset that may be much more difficult to duplicate than tangible assets.” In the words of Besanko et al. (2004, p.427) an excellent CSR reputation is scarce and imperfectly mobile. A good reputation could give an important signal which “can inform external constituents about the trustworthiness, credibility and quality of the firm. (…) reputational assets can be key drivers of external constituents positive reactions toward a firm vis-à-vis its competitors, thus positively impacting on firm success.” (Galbreath, 2005, pp.981-982, cited by Branco and Rodrigues, 2006, p.117). First of all, this could lead to higher profits because consumers are more willing to buy products or services from a firm who acts social responsible. For example, Bjørner et al. (2004) show that a good (bad) environmental reputation results in significant increases (decreases) in sales. In addition, Brown and Dacin (1997, p.80) state that “(…) our research indicates that CSR associations influence the overall evaluation of the company, which in turn can affect how consumers evaluate products from the company. All else being equal, more positive evaluations should produce greater revenues for a firm.” It could be concluded that CSR could be a form of vertical product differentiation (Dam, 2008, p.5). Secondly, an excellent CSR reputation could also be a valuable resource with regards to attracting highly motivated/skilled prospective employees (see e.g. Turban and Greening, 1997). Branco and Rodrigues (2006, p.121) state that firms perceived to have a strong social responsibility commitment often have an increased ability to attract better job applicants, retain them once hired, and maintain employee morale. These two examples are examples of the external benefits of CSR. Branco and Rodrigues (2006) also give examples of internal benefits of CSR. Acting social responsible could also lead to a more efficient use of resources. Branco and Rodrigues (2006, p.121) mention that “an improved social performance, namely through its environmental component, may lead to more efficient processes, improvements in productivity, lower costs of compliance and new market opportunities.” As a consequence, this could also lead to a competitive advantage.

Related to this theory is the resource dependence theory. Pffeffer and Salancik (1978, p.258-259), “founders” of the resource dependence theory, state that control over scarce and critical resources provides power. Besanko et al. (2004, p.615) define resource dependence theory as a “theory in which individuals and firms seek to gain power by reducing their dependence on other actors, while increasing the dependence of other actors on them.” As mentioned before, firms could have tangible and intangible resources. An example of the latter is a strong and positive reputation, e.g. with regards to CSR. This could, according to Besanko et al. (2004, p.589), reduce the costs of a firm for establishing its presence to customers, negotiating with rivals, or securing the cooperation of partners. Controlling scare, intangible, resources will lead to greater power of the firm and could therefore be a

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16 reason why companies would act social responsible and strive for an excellent CSR reputation. Greater power could lead to a competitive advantage, which links this theory with the resource-based theory.

This sub-section gave arguments why CSR reputation, as a scare and immobile resource, could positively influence the competitive advantage of a firm. However, it must be mentioned that it does have a cost to create a CSR reputation. A company could act social responsible, e.g. by using environmental friendly materials and machines in production, but the customers, or the ‘public’ in general, must be informed about the social and environmental responsibility of the company. Because the creation of a (high) CSR reputation is not free, it could also be burdensome for companies.

§ 2.3.3 Stakeholder theory

In addition of the resource-based theory, the stakeholder theory will be discussed. This theory gives more insight into the question why companies would act social responsible. Publicly held companies have one important stakeholder, which is the shareholder. Managers of publicly held companies have to take account with shareholders, because shareholders are the owners of the firm. According to the so-called “shareholder perspective” the maintenance or enhancement of shareholder value is paramount (Mallin, 2004, p.14) instead of serving the interests of all stakeholders. Managers, which are in fact the employees of the shareholders, use the corporate resources to increase the wealth of the shareholders by seeking profits. In contrast, the “stakeholder perspective” states that the shareholders are one of the many stakeholders a company has. Other groups than shareholders, like employees or the local community, are also affected by a company’s activities. As a consequence, the interests of these other groups have to be considered in managers’ decisions, possibly equally with shareholders (Branco and Rodrigues, 2007). Stakeholder theory takes account of a wider group of constituents rather than only focusing on shareholders (Mallin, 2004, p.14). Freeman (1998), “founder” of the stakeholder theory, defines stakeholders as (p.174) “groups and individuals who benefit from or are harmed by, and whose rights are violated or respected by, corporate actions.” According to the stakeholder theory, management should not only consider its shareholders in the decision making process, but anyone who is (positively as well as negatively) affected by business decisions; companies have a social responsibility that requires them to consider the interests of stakeholders affected by their actions (Branco and Rodrigues, 2007). The central idea of stakeholder theory is, according to Donaldson and Preston (1995, p.68), that “all persons or groups with legitimate interests participating in an enterprise do so to obtain benefits and that there is no prima facie priority of one set of interests and benefits over another.” Figure 2.2 gives a graphical representation of a firm and its stakeholder relationships.

The same size arrows (in boldness and length) in this figure make clear that no one stakeholder is more important than another. The two-way relationship between the firm and the different stakeholder groups means that companies cannot act social responsible when they do not know the expectations of these stakeholder groups. In section 2.2 the following definition of social responsibility was cited (Carroll, 1979, p.500): “The social responsibility of business encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time.”

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17 This definition conforms to figure 2.2. It makes clear that what is social responsible depends on the expectation of society; a two-way relationship between the company and the several stakeholders is therefore indispensable.

Figure 2.2: The firm and its stakeholder relationships (Donaldson and Preston, 1995, p.69)

An explanation of the term stakeholders, or stakeholder theory, alone does not give more insight into the question why companies would act social responsible. The following statement of Branco and Rodrigues (2006, p.119) makes clear why taking account of all stakeholders is so important: “it is relationships rather than transactions that are the ultimate sources of a firm’s wealth and it is the ability to establish and maintain such relationships within its entire network of stakeholders that determines its long-term survival and success.” For example, when a company has a good relationship with the local government, it will be easier to get a permit for an expansion of a factory. Waddock and Graves (1997, p.306-307) indicate that improved relationships with key stakeholder groups results in better overall performance. Dam (2008, p.5) discusses the theory of compensating wage differentials. This theory implies that improved labour conditions can reduce employee costs because employees (one of the several stakeholder groups of a firm – see figure 2.2) are willing to accept a lower wage in exchange for e.g. better safety conditions. In addition, Orlitzky et al. (2003) write that the efficiency of the organization’s adaptation to external demands can be increased by addressing and balancing the claims of multiple stakeholders. All these examples could have a possible consequence on the financial returns of the company or in the words of Donaldson and Preston (1995, p.71): “(…) adherence to stakeholder principles and practices achieves conventional corporate performance objectives as well or better than rival approaches.”

At the end of this section, a critical note must be made about the stakeholder theory. Sternberg (1997) disputes the stakeholder theory when she writes that (p.5): “An organisation that is accountable to everyone, is actually accountable to no one: accountability that is diffuse, is effectively non-existent.” Considering all stakeholders may not lead to a better CSR reputation and better financial performance. However, Sternberg (1997, p.9) does state that a business must treat all its stakeholders ethically.

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18 In section 1.1 neo-classical economics was discussed which suggests a trade-off between CSR and financial performance. This means that firms which engage in social responsibility activities are less profitable than firms which do not engage in social responsibility activities, because the latter have lower costs. However, recent studies have found that acting social responsible could also increase financial performance. In this sub-section the relationship between CSR and financial performance will be discussed in more detail.

Engaging in social responsibility activities involves costs, for example by purchasing environmentally friendly equipment. The question is whether these activities will pay-off. The relationship between CSR and financial performance has been debated at least since the 1960s (Branco and Rodrigues, 2006). Wood and Jones (1995) reviewed the relationship between corporate social performance and financial performance. They concluded that there is clear evidence that bad social performance is detrimental to a firm’s financial performance. In addition, Pava and Krausz (1996, p.322) concluded that: “Nearly all empirical studies to date have concluded that firms which are perceived as having met social responsibility criteria have either outperformed or performed as well as other firms that are not necessarily socially responsible.”

It is important to note that some other studies found a negative relationship between CSR and financial performance (see e.g. Vance, 1975). Moreover, Margolis and Walsh (2003) mention that, while most of the empirical studies found positive relationships, the conclusion of these studies are questionable by methodological problems. Wood and Jones (1995, p.261) also state that: “most studies are lacking in methodological rigor”. Orlitzky et al. (2003) performed a meta-analysis of 52 studies of the relationship between corporate social performance and financial performance. According to Orlitzky et al. (2003, p.404): “Meta-analysis has proven to be a useful technique in many substantive areas where multiple individual studies have yielded inconclusive or conflicting results.” Orlitzky et al. (2003) concluded that business social performance is positively correlated with business financial performance. Therefore, social and financial performance should not be presented as trade-offs. In addition, they found that high social performance is both a determinant and a consequence of high financial performance. Theoretical underpinnings of high social performance as a consequence of high financial performance can be found in the slack resources theory. Companies with slack resources, potentially available from strong financial performance, may have greater freedom to invest in social responsibility activities; as a consequence, those investments may result in improved corporate social performance (Branco and Rodrigues, 2006, p.115). Overall, the meta-analysis of Orlitzky et al. (2003) makes clear that the “too fractured and too variable” current evidence of the relationship between corporate social performance and corporate financial performance are a function of sampling and measurement error. In addition, Orlitzky et al. (2003, p.424) conclude that: “(…) many of the negative findings in individual studies are artefactual, so that the generalization of a positive CSP-CFP relationship applies more broadly than previously suggested.” This reconciles with the conclusion of Dam (2008). He reviewed the existing empirical literature of the past three decades on the relationship between CSR and financial performance. This review and his (general equilibrium stock market) model made clear that one cannot use financial performance measures interchangeably to develop an understanding of the relationship between CSR and financial performance. Overall,

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19 Dam’s (2008) review and model make clear that there are strong linkages between CSR and financial performance.

An important question is whether the benefits of corporate social performance apply to all types of social performance. Branco and Rodrigues (2006) write that social responsibility activities can pay off, as long as they are in the interest of the firm’s primary stakeholders. Moreover, Orlitzky (2005, p.40) writes that: “Social and environmental activities need to be visible to stakeholders (customers, suppliers, employees, etc.) before they can, in various ways, reward the organisation for them.”

It could be concluded that acting social responsible can lead to better financial performance than doing business without engaging in social responsibility activities. This makes clear that companies could act social responsible because it has a positive relationship with the financial performance of the company. However, the following quote of Branco and Rodrigues (2006, p.126) must be taken into account: “A firm can only obtain benefits from building a reputation for social responsibility if the community also considers social responsibilities important.”

§ 2.4 Conclusion

This chapter made clear what corporate social responsibility is and why companies would act social responsible. CSR has been defined in many different ways. Although there are many different definitions and interpretations of CSR, all definitions have in common that companies are to some extent social responsible when they care for more than only making profit. Carroll (1979) states that companies do not only have economic responsibilities (making profit), but also legal-, ethical- and discretionary responsibilities. Companies do not only have responsibilities towards their shareholders (i.e. profit), but also to society as a whole (i.e. people and planet). Wood (1991) states that the basic idea of CSR is that business and society are interwoven rather than distinct entities. However, the exact interpretation and practical implication of CSR depends on the expectations of society.

Section 2.3 made clear that companies could have a number of reasons for acting social responsible. Besides the normative case, which means that companies could act social responsible because they find it morally correct to do so, companies could have a number of economic reasons for acting social responsible. Companies could act social responsible because some kind of competitive advantage could accrue. A competitive advantage could exempli gratia arise when a company has a better CSR reputation than competitors. Moreover, having good relationships with the different stakeholder groups could also lead to a competitive advantage. Sub-section 2.3.4 made clear that acting social responsible has a positive relationship with financial performance. Overall, the following conclusion of Heal (2005, p.408) reconciles with the conclusion that could be distilled from all which has been written in this chapter: “it seems clear that a CSR programme can be a profitable element of corporate strategy, contributing to risk management and to the maintenance of relationships that are important to long-term profitability.” While this chapter gave a clarification of the concept CSR and discussed the reasons for acting social responsible, the next chapter will develop several hypotheses of the relationship between board characteristics and CSR based on a review of the literature and several theories.

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20

Chapter 3: The relationship between board characteristics and Corporate

Social Responsibility

§ 3.1 Introduction

In this chapter several hypotheses will be developed which are used to test the relationship between board characteristics and CSR and the moderating effect of firm size and financial performance. In chapter one it was mentioned that strategic decisions reflect the background of an organization’s most powerful managers and what the organization does could be explained in part by the profile of its upper-echelon. This chapter provides a basis why a relationship between board characteristics and CSR could exist.

In this chapter a lot of studies will be discussed which use a so-called black-box approach. These studies, which focus on external observable variables or characteristics instead of processes, must be interpreted with caution. After a review of several empirical studies which researched the effectiveness of boards, Pettigrew (1992, p.171) concludes that: “Great inferential leaps are made from input variables such as board composition to output variables such as board performance with no direct evidence on the processes and mechanisms which presumably link the inputs to the outputs.” This research, which studies the relationship between board characteristics and CSR, must also be interpreted with caution. The main criticism about the black-box approach, i.e. not considering processes but assuming a direct relationship between characteristics and performance, is that causality is not always clear (Postma and van Ees, 2004). However, not many studies have been performed which study the processes between boards and performances. The most important reason is that it is very difficult to get access to the processes of top executives’ decision making. Because of the limited amount of studies using a process-approach, this chapter only discusses studies with a black-box approach. It must be clear that these relationships must be assessed critically. These relationships are in the words of Forbes and Milliken (1999, p.490) not simple and direct, but complex and indirect.

Because Board of Directors are a central element of this chapter, it is important to give more insight into the roles, duties, and responsibilities of Board of Directors, their raison d'être and the difference between executive and non-executive directors. This insight will be given in section 3.2. Moreover, the interrelationship between corporate governance and CSR will be discussed as well. In section 3.3 till 3.6 several hypotheses will be developed. Section 3.7 concludes this chapter.

§ 3.2 Board of Directors

The Board of Directors (hereafter, boards) is the highest decision-making authority of an organization. The board is responsible for overseeing the actions of management, including the Chief Executive Officer (CEO). According to the corporate governance principles of the Business Roundtable (2002) the board performs this overseeing task “on behalf of the shareholders”. Mallin (2004, p.96) mentions that the board is responsible for determining the company’s aims and the strategies, plans, and policies to achieve those aims. In addition, boards should also monitor progress in the achievement of those aims. Although the board is the highest decision-making authority of an organization, senior management, led by the CEO, is responsible for running the day-to-day operations of the corporation.

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21 Forbes and Milliken characterize boards of directors as (1999, p.492): “large, elite, and episodic decision-making groups that face complex tasks pertaining to strategic issue processing”. With episodic it is meant that boards meet relatively infrequently. However, a board often appoints various sub-committees, like a nominating-, an audit- and sometimes even a CSR committee. In these committees, board members with specific experience and knowledge can discuss specific subjects in more detail. It must be mentioned that, although a board may delegate various activities to board sub-committees, the board as a whole remains responsible for the areas covered by the sub-committees.

The existence of boards is explained with agency theory. Due to the dispersed ownership of (publicly owned) companies, shareholders (have to) delegate their decision-making authority. This leads to a separation of ownership and control (see e.g. Berle and Means, 1932). In this situation, shareholders can be described as “principals” and the managers of the firm as “agents”. Agents and principals (could) have different goals and different attitudes towards risk. In addition, agents and principals will try to maximize their individual utility functions (Davis et al., 1997). This could lead to agency problems (Eisenhardt, 1989, p.58) or agency costs (Jensen and Meckling, 1976, p.308). There are several governance mechanisms which can reduce these agency problems/costs. One way is by linking the compensation of managers with the compensation of shareholders (Mallin, 2004), exampli gratia through stock options. Secondly, governance structures can be established which monitor the actions of the managers. The board is an example of such a governance structure. Mallin (2004, p.11) writes that: “agency theory views corporate governance mechanisms, especially the board of directors, as being an essential monitoring device to try to ensure that any problems that may be brought about by the principal-agent relationship, are minimized.”

The board structure of a company could be unitary or dual (Mallin, 2004, p.93). In a dual board system there are two separate boards: a supervisory and an executive board. Most US (and UK) firms have a unitary board. Because this study only has US companies in the sample which have a unitary board, the dual board will not be discussed further. In a unitary board system, there is one single board comprising of both executive (or inside, the US equivalent) and non-executive (or outside) directors (Mallin, 2004, p.94). As mentioned before, the board as a whole has a monitoring responsibility. However, non-executive or outside board members are in the words of Mallin (2004, p.101): “a control or counterweight to executive directors so that the presence of non-executive directors forms a balance with executive directors to help to ensure that an individual person or group cannot unduly influence the board’s decisions.” Non-executives are responsible for monitoring the executives which hold day-to-day responsibility. Non-executives also serve as a board member on a part-time basis while most executives are full-time involved in leading and directing the company. It is important to mention that non-executive directors are not always independent. However, corporate governance codes more and more emphasize that it is essential for a good functioning of the board that non-executive directors are independent. The NYSE Corporate Governance Rules (2003), which applies to all companies listed on the NYSE, and the principles of the Business Roundtable (2002) even prescribe that listed respectively publicly owned companies must have a majority of independent directors. According to NYSE Corporate Governance Rule 2 (2003) an “independent director” is a

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22 director who has no material relationship with the listed company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the company), at least not the last three years. The reason behind this independence-rule is according to rule 1 that “a majority of independent directors will increase the quality of board oversight and lessen the possibility of damaging conflicts of interest.” It could be stated that all independent directors are non-executive while the reverse is not always true. Executive or inside directors do have a material relationship with the firm and, consequently, cannot be determined as independent directors.

Boards, including their functioning, responsibilities and structure, are typical corporate governance topics. Corporate governance is concerned with “both the shareholders and the internal aspects of the company, such as internal control, and the external aspects, such as an organization’s relationship with its shareholders and other stakeholders” (Mallin, 2004, p.40). History shows that bad corporate governance is detrimental to the success of a company. Bad governance could lead to mismanagement, fraudulent actions, bad transparency, etc. As further explained in the following sections, this not only hurts the shareholders, but also the employees, suppliers and customers, i.e. other stakeholders. Van den Berghe and Louche (2005, p.427) write that: “corporate governance and CSR are two concepts that draw vigour from the same sources: transparency, accountability and honesty.” Therefore, a good corporate governance climate could be essential for a good CSR climate. Moreover, a company who wants to act social responsible cannot do so without taking care of governance. Furthermore, van den Berghe and Louche (2005, p.426) indicate that: “Both CSR and corporate governance have to do with the direction of companies and with the translation of that into corporate strategy.” The above makes clear that corporate governance and CSR are interrelated.

It could be concluded that the board leads and controls the company and is the link between managers and investors (Mallin, 2004, p.105). However, not every company has the same kind of board structure, with the same percentage of independent directors and the same amount of board meetings. Differences in these characteristics could lead to differences in CSR, which will be discussed in more detail in the following sections.

§ 3.3 Board independence and CSR

In this section a hypothesis of the relationship between board independence and CSR will be developed. As was outlined in table 1.1, board independence is defined as the percentage of independent directors on the board. Section 3.2 made clear that mostly all non-executive (or outside) directors are independent directors and that corporate governance codes more and more emphasize that it is essential for a good functioning of the board that non-executive (or outside) directors are independent. The corporate governance principles of the NYSE (2003) and the Business Roundtable (2002) even state that a majority of the board should consist of independent directors. The belief is that independent directors can strengthen corporate boards by monitoring the actions of management and ensuring that management decisions are made in the best interest of the stockholders (Petra, 2005, p.55). In other words, a more independent board increases the quality of board oversight.

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