Politically connected directors and ESG performance: Are
bureaucratic directors of importance?
Abstract:
Motivated by the lack of studies on the interplay between politically connected directors and ESG performance. This thesis examines the relationship between firms’ politically connected directors and the ESG performance in the U.S., thereby broadening the definition of politically connected directors by including former bureaucrats and politicians. The prediction is that the use of the politically connected directors relative to the ESG performance is based on the reputational interest of organisations. Where, U.S. organisations use politically connected directors to resist the ESG pressures, leading to a lower ESG performance. The reputational protective southern U.S. organisations align the politically connected directors and ESG performance, to enhance the ESG performance. Using data of 1.615 U.S. organisations between 2002 and 2015, I find that politically connected directors are negatively associated with ESG performance. Moreover, I find that politically connected directors in the southern U.S. are positively associated with ESG performance. Both associations are driven by board members who were former bureaucrats. This study reveals that the influence of politically connected directors on the ESG performance is affected by the reputational interest of organisations.
Keywords: ESG performance, politically connected directors, corporate culture, reputation
Date: 18-01-2021 Combined Master Thesis Accountancy & Controlling ’20-‘21 Max Droste – S2752271 m.j.droste@student.rug.nl Supervisor: dr. S. Mukherjee University of Groningen – Faculty of Economics and Business Course codes: EBM869B20 (Accountancy), EBM870B20 (Controlling) Word count: 6.737
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1. Introduction
Do political connections influence environmental, social, and corporate governance (ESG) performance? This is an interesting question in multiple ways. Most studies related to corporate political activity (CPA) strategies focused on the effect on financial market-based performances (Hillman, 2005; Boubakri, Mansi & Saffar, 2013). However, ESG1 strategies are taking an increasing value in the assessment of the firm valuation (Fatemi, Glaum & Kaiser, 2018; Bassen & Kovacs, 2008), and organisations look for alternative ways to meet the stakeholders’ expectation. Little research has been done, on the interplay between the non-market strategies CPA and ESG, exploring the reputational based decisions associated with the alignment or misalignment of the CPA and ESG strategies in the United States (U.S.) (den Hond, Rehbein, de Bakker & Kooijmans- van Lankveld, 2014). Here, the southern states’ culture of honor (Cohen & Nisbett, 1994), are more likely to take reputational advantages seriously. This thesis focuses on the interplay between politically connected directors and ESG strategies, contributing to a more integrated understanding of non-market activities. In specific, in what way could the co-option of politically connected directors enable organisations to use political resources to contribute to the ESG performance.
Firms accrue political advantages through various corporate strategies i.e., financial, informational, or relational (Rajwani & Liedong, 2015). Most studies analyse CPA by measuring political connections, through the co-option of politicians into the corporate board (Faccio, 2006; Rajwani & Liedong, 2015; Chaney, Faccio & Parsley, 2011). However, it is questionable that politicians have all overarching political power (Moe, 2006). Regulatory policies are not only the result of politicians, but there are also other political agents (Alesina & Tabellini, 2007). What these studies tend to overlook is the power of the bureaucrats in the political system (Moe, 2006). In this study, I introduce bureaucrats as a political agent for the co-option into the board.
In this thesis, I analyse the relationship between politically connected directors and ESG performance. I argue that the interplay between politically connected directors and ESG strategies are based on reputational value. The research question of this paper reads: “How do politically connected directors affect the organisational ESG performance in the U.S.?” Where the use of the politically connected directors relative to the ESG performance is based on the reputational interest of organisations. Focussing on the reputational value that is created through the ESG performance. Firstly, I substantiate that politically connected directors come with organisational political benefits. The political benefits
3 help organisations to withstand the increasing external ESG pressures. This means that fewer ESG resources are necessary to retain the created ESG reputation. The ESG resources that are diverted away, lead to “cannibalization” of the ESG performance in the long term. Leading to my first hypothesis that politically connected directors are negatively associated with the ESG performance in the U.S. Next, I substantiate that southern states are more protective about their reputation. Organisations in the southern states want to align their politically connected directors to the ESG strategy to improve the reputational value. Due to the alignment of politically connected directors and ESG strategies, my second hypothesis argues that politically connected directors in the southern states are positively associated with the ESG performance. Lastly, I substantiate that the visibility of the use of political preferential benefits negatively influences corporate reputation. I argue that the bureaucrats drive the negative association between politically connected directors and ESG performance, as well as the reversed association in the southern states.
In this study, I construct a database of U.S. organisations between the years 2003 and 2015. I analyse the effect of politically connected directors on the ESG score of 1.614 organisations. The ESG performance is based on the overall ESG score of Thomson Reuters, which I collect from the ASSET4 database. The independent variable consists of politicians and bureaucrats, who are appointed to the U.S. corporate board. Where politicians are gathered from the BoardEx database, we hand-collected the bureaucrats from reliable websites ourselves. Next, the states are divided into northern and southern states, in which the southern states exhibit behaviour classified as the culture of honor. The southern states’ culture of honor is measured as the three southern U.S. census divisions (Cohen, Nisbett, Bowdle & Schwarz, 1996).
This study contributes to the research of politically connected directors in two ways. Firstly, this study expands the literature on the effects of CPA and ESG performances in the U.S. The existing literature on the effects of CPA and ESG performance in the U.S. focuses mainly on the financial approach of CPA (Di Giuli & Kostovetsky, 2014; Hong & Kostovetsky, 2012). The majority of the studies that explore the relationship between politically connected directors and ESG performance focusses on non-democratic countries as China and Ghana (Liedong, Rajwani & Mellahi, 2017; Zhang, 2017; Cheng, Wang, Keung & Bai, 2017; Huang & Zhao, 2016; Huang, Li & Liao, 2021). Little research examined the effects of politically connected directors on the ESG performance in democratic countries, while evidence shows that politically connected directors in democratic countries influence the organisational value (Goldman, Rocholl & So, 2009; Bianchi, Monteiro, Azevedo, Oliveira, Viana & Branco, 2019). This study shows that politically connected directors also influence the ESG performance in the U.S.
4 Secondly, this study expands the definition of politically connected directors. In this study, I introduce a new political agent to the board, called bureaucrats. Different forms of political agents bring different forms of human and social capital to organisations (Alesina & Tabellini, 2007). Politicians are elected for their efforts and are held accountable by their voters (Bendor, Taylor & Van Gaalen, 1987; Alesina & Tabellini, 2007). While bureaucrats were appointed in the government based on their expertise and are held accountable by their professional peers (Alesina & Tabellini, 2007). Defining bureaucratic board members in organisations as politically connected directors could lead to different outcomes in the literature field of politically connected directors.
I organize the thesis as follows. Section 2 explains the theoretical background and discusses the relationship in previous research. Section 3 discusses the hand-collected data, the remaining data collection, and the method of the sample. Section 4 shows the results of the study, with the conclusion of these results described in section 5. Section 6 shows the discussion.
2. Theoretical framework and hypotheses
2.1 ESG performance
Mcwilliams and Siegel (2001, p. 117) define ESG strategies as “actions that appear to further some social good, beyond the interests of the firm and that which is required by law.” Stakeholders attach an increasing value to ESG (Bassen & Kovacs, 2008). An ESG strategy gives a competitive advantage, based on the reputation and development of lasting relationships with stakeholders (Aguinis & Glavas, 2012; Mcwilliams & Siegel, 2001). The interest of stakeholders in ESG has led to a strategic focus of organisations in measuring and rating their ESG performance (Kiessling et al., 2016). Where, organisations use ESG to differentiate themselves from competitors (Kiessling, Isaksson & Yasar, 2016). Bearing in mind that ESG performance is associated with the number of resources spend in ESG (Gjølberg, 2009). So, organisations make a trade-off between the number of resources they have to spend to improve the ESG performance and the possible reputational gain.
2.2 Political connections
Many researchers studied the effects of board composition on the performances of the organisation (Dalton, Daily, Ellstrand & Johnson, 1998; Hermalin & Weisbach, 1991). They found that board
5 characteristics influence the behaviour of the organisation. Rajwani and Liedong (2015) concluded that political connections in the board, separated over three CPA strategies, gain a competitive advantage. Firstly, the financial approach, which defines CPA as financial incentives to politicians, such as campaign contributions (Di Giuli & Kostovetsky, 2014; Goldman et al., 2009). Secondly, the informational strategy, which includes the influence in governmental policy decisions such as lobbying (Blau, Brough & Thomas, 2013). Thirdly, the relational strategy which defines CPA as the co-option of politicians in corporate boards. Here, political connections are a common construct form, divided into an informal and formal form (Chaney et al., 2011). The informal form defines political connections as the close relationships to politicians, while the formal form includes business executives and shareholders entering politics (Chaney et al., 2011). Most of the empirical studies use the formal form and define political connections as elected politicians (Faccio, 2006; Hillman, 2005). However, these studies exclude the influence of bureaucrats, while bureaucrats are key players in the execution of legislations in regulatory states like the U.S. (Alesina & Tabellini, 2007).
2.3 Non-market strategies and reputation
Both CPA and ESG strategies are non-market strategies. Non-market strategies are defined as “a firm’s concerted pattern of actions to improve performance by managing the institutional and societal context of economic competition” (Mellahi, Frynas, Sun & Siegel, 2016, p. 144). The integration of CPA and ESG strategies depend on different factors in the environment (den Hond et al., 2014). Often firms don’t see the use of CPA and ESG strategies in a way that they influence each other (Beloe & Harrison, 2007). However, evidence shows that there could be an interplay between CPA and ESG accompanied by reputational value (den Hond et al., 2014).
Reputation is defined by Ettensen and Knowles (2008 p. 20) as a “precondition for people’s willingness to do business with a company”. Both CPA and ESG strategies are part of the organisational character mechanism of reputation (Love & Kraatz, 2009). Various studies found a positive relationship between ESG performance and reputation (Fombrun, Gardberg & Sever, 2000; Raithel & Schwaiger, 2015; Agarwal, Osiyevskyy & Feldman, 2015). ESG engagement is an instrument to build and maintain corporate reputation, through the gain of trustworthiness and reliability (Agarwal et al., 2015; den Hond et al., 2014). However, studies found a negative relation between CPA strategies and reputation. Substantiated by the idea that organisations have power in the government and use this power for their interest (Milyo, Primo & Groseclose, 2000).
Both CPA and ESG strategies impact the organisational character and therefore the reputation of an organisation in a different way (Dowling & Moran, 2012). The strategy structure and interplay depends
6 on the demands and expectations of the environment (de Hond et al., 2014). When the strategies are incompatible, they send independent reputational signals to stakeholders (Frynas et al., 2017). Moreover, when the CPA and CSR strategies align, it strengthens the corporate reputation (den Hond et al., 2014).
2.4 Politically connected directors and ESG performance
Recent research analysed the association between CPA and ESG performance, which resulted in conflicting outcomes. Di Giuli and Kostovetsky (2014) found a positive association between politically connected directors and ESG performance, supported by several other studies (Huang & Zhao, 2016; Bianchi et al., 2019). Meanwhile, the study of Liedong et al. (2017) documented a negative association between CPA and ESG performance. This could be explained by the interplay between ESG and CPA strategies (Beloe & Harrison, 2007).
When, the external pressures for ESG strategy rise (Bassen & Kovacs, 2008), organisations have to comply with the pressures to avoid reputational loss (Fombrun et al., 2000) According to Ashforth and Gibbs (1990, p. 184), “a management’s reflex is often to defend the status quo through denial, accounts, or counterclaims rather than to engage in dispassionate problem-solving and substantive change.” Here, organisations choose not to enhance the ESG strategy but seek for alternatives to comply with the external ESG pressures (David, Bloom & Hillman, 2007). An interplay between CPA and ESG strategies emerges (den Hond et al., 2014), where organisations may use politically connected directors as a substitute for ESG strategies (Liedong et al., 2017). Organisations receive benefits from politically connected directors in three separate ways (Muttakin, Mihret & Khan, 2018). Firstly, politically connected directors give organisations access knowledge about the environmental policy (Zhang, 2017) and connections to the governmental network (Huang et al., 2021). Secondly, politically connected directors increase the economic viability through easily obtainable bank loans (Dinç, 2005), preferential tax benefits (Chen et al., 2011) and governmental subsidies (Shleifer & Vishny, 1993). Lastly, politically connected directors reinforce the credibility of the organisational ESG strategy (den Hond et al., 2014). These political benefits help an organisation to withstand the increasing external ESG pressures. The political benefits mean that an organisation needs to use fewer ESG resources to reach the status quo (David et al., 2007). This indicates that an organisation invests fewer resources in the ESG strategy to comply with the external pressures and maintain their created ESG reputation (David et al., 2007; den Hond, et al., 2014). However, the ESG resources are diverted to the politically connected directors. Suggesting a form of “cannibalization”, whereby politically connected directors erode the gains of ESG performance in the long term (Liedong et al., 2017).
7 As mentioned before, the influences of politically connected directors could lead to a reputational loss. The political benefits could be perceived as intentionally misleading the stakeholders (den Hond, et al., 2014). Therefore, it requires a political agent that doesn’t damage the corporate reputation when the organisation utilizes its political benefits. As mentioned before, the political agents are classified as politicians or bureaucrats. Politicians and bureaucrats have different motivations, skillsets, and social capital (Alesina & Tabellini, 2007). Politicians have a high hierarchical position and reach their goal through the ability to manipulate constitutional authority (Alesina & Tabellini, 2007; Bendor et al., 1987). Politicians’ goal is to be re-elected, which is associated with a high public profile and legitimacy (Leib, Ponet & Serota, 2012). This makes director-politicians prone to public criticism, especially when they extract political resources (Hillman, 2005; Faccio, 2006). Director-politicians could harm the corporate reputation and therefore not act as a substitution for ESG strategies.
Bendor et al. (1987, p. 797) stated that “bureaucrats rely on expertise-based agenda control, that is, on their ability to manipulate the design of policy alternatives.” In other words, bureaucrats are involved in law implementation and technical tasks, where ability is more important than effort (Alesina & Tabellini, 2007). Here, bureaucrats are appointed in the government based on their competence in their profession (Alesina & Tabellini, 2007). This process is through the administrative way and associated with a lower public profile (Aberbach, Putnam & Rockman, 1981). Due to the lower public profile and expertise, bureaucratic directors could use their preferential political benefits without damaging their corporate reputation. Here, bureaucrats could be used as a substitution for ESG strategies (Liedong et al., 2017). The expertise and social capital of bureaucrats may challenge the ESG demands from stakeholders and can be used as a buffer of the status quo (Bendor et al., 1987; Mellahi et al., 2016). Based on this argumentation, I propose the following hypotheses:
Hypothesis 1a: Politically connected directors on corporate boards are negatively associated with ESG performance.
Hypothesis 1b: Bureaucrats on corporate boards are negatively associated with ESG performance.
2.5 Southern U.S.
Cohen and Nisbett (1994) found a significant cultural difference in the south of the U.S. This phenomenon finds its roots in the history and economy of the region. The southern culture, also known as the culture of honor, is originally from the Scotch-Irish culture. In the 1800s, the culture of honor was adopted in the U.S through immigration. The southern formal institution was weak, this kept the
8 culture in place (Wyatt-Brown, 2001). The study of Cohen et al. (1996) stated that the southern U.S. show more aggressive and dominant behaviour in resemblance to the north. Moreover, Cohen et al (1996) found evidence that the southern culture has an insult-aggression cycle. Southerners are more protective about their reputation and are more likely to feel threatened about their reputation. The culture shows more aggressive behaviour to protect their reputation in comparison to northern culture. As of today, the culture of honor is a part of the institutional environment in the south (Grosjean, 2014; Nisbett, 1993). Organisations tend to act homogeneously in institutional environments, institutional forces shape the organisation (Dimaggio & Powell, 1983). The culture presents itself in the behaviour of the southern organisations.
As mentioned before, the integration of politically connected directors and ESG strategies are dependent on the external environment (den Hond et al., 2014). Organisations in the southern U.S. are more agile to make risky investments to protect their reputation (Barnes, Brown & Tamborski, 2012). It’s likely that southern U.S. organisations look for a strategic interplay that is reputational increasing. Den Hond et al. (2014) argues a model that potentially align politically connected directors and ESG strategies. The complementary use of both strategies requires an investment in both the politically connected directors and ESG strategies (Liedong et al., 2017). The organisational risk of spending resources in both strategies is accompanied by two benefits. Firstly, the politically connected directors improve the credibility and legitimacy of the ESG strategy (den Hond et al., 2014). This amplifies the positive reputational effects and mitigates the negative reputational effects of the ESG strategy (Love & Kraatz, 2009; den Hond et al., 2014). This is in line with the protective behaviour of the southern organisations (Cohen et al., 1996). Secondly, the gained political preferential benefits enhance the economic viability of ESG activities (Frynas, et al. 2017). On the long term, organisations could spend more resources on ESG performance and thereby improve their reputation (den Hond et al., 2014).
In order not to damage the reputation enhancement, it requires a political director who can use his political benefits without incurring reputation effects. Again, the difference between politicians and bureaucrats in human and social capital is notable (Alesina & Tabellini, 2007). As mentioned before, politicians have an elected position, which is associated with public visibility (Leib, Ponet & Serota, 2012). So, the extraction of political resources from politician-directors makes an organisation prone to reputational loss (Hillman, 2005; Faccio, 2006). The reputation gained by the improved ESG performance will be diminished, which is conflicting with the reputational protective culture in the southern U.S. (Cohen et al., 1996). It’s not likely that southern organisations use the political benefits of a politician-director to complement the ESG strategy. Here, bureaucrats with a low public profile have an advantage (Alesina & Tabellini, 2007). Bureaucrats could use their political resources to
9 complement the ESG strategy without reducing corporate reputation. The reputational gains of the enhancement in ESG strategies remain the same. It’s more likely, that the politically preferential benefits of bureaucrats improve the economic viability of ESG activities and increase the ESG performance (Frynas, et al. 2017). Based on this argumentation, I propose the following hypotheses:
Hypothesis 2a: Politically connected directors on corporate boards are positively associated with ESG performance in the southern U.S.
Hypothesis 2b: Bureaucrats on corporate boards are positively associated with ESG performance in the southern U.S.
3. Data and methodology
3.1 Data
For this research, I collect the data out of 4 sources. The data collection consists of ASSET4 data, BoardEx data, hand-collected data and Worldscope data. I gather the director and board profiles from the BoardEx database. The BoardEx database contains a ‘Director Profile employment file’, which gives information about directors who had a governmental background. The file gives information on whether the directors worked in the government. However, it lacks the further details about the governmental job history. So, we hand-collected the missing U.S. governmental work history data ourselves, which will be explained in section 3.2. Next to that, I collect the ESG performance from the ASSET4 database of Thomson Reuters. I merged the ASSET4 database with the firm ids of the BoardEx database, to connect the ESG performance to the firm profiles. Lastly, the accounting and market data are collected from the Worldscope database. This leads to a sample size of 1.614 U.S. companies, spread over the years 2003 till 2015. This comes down to a total of 9.305 firm years.
3.2 ESG performance
In this sample, the proxy for ESG performance is the ESG score of the ASSET4 database by Thomson Reuters. Since 2002, ASSET4 scored companies on their ESG principles. ASSET4 analyses firms on their economic, environmental, social, and corporate governance performance. The scores are based on 278 key performance indicators, divided over these four pillars (Ribando & Bonne, 2010). In this research, I use the overall company score on the environmental, social, and corporate governance
10 pillars (𝐸𝑆𝐺𝑠𝑐𝑜𝑟𝑒𝑖,𝑡). Next, I merge ESG company score data with the BoardEx database, this ensures
the link between the ESG scores and the firm ids. The merger provides a total of 10.019 useable firm years.
3.3 Hand-collected data
This study focusses on the effect of politically connected directors. Previous studies measured CPA through contributions to the party (Di Giuli & Kostovetsky, 2014; Goldman et al., 2009), governmental ownership (Abd Rahman & Ku Ismail, 2016) or political experience from outside directors (Agrawal & Knoeber, 2001). The study of Faccio (2006) found a more detailed way, and measured CPA through politically connected directors. Faccio (2006) measured politically connected directors as directors who were ministers or members of the political party, also including members who were closely related to top politicians. This study expands the view of Faccio (2006) and includes bureaucrats as politically connected. However, I exclude members that are closely related to former politicians. This study looks specifically into the human and social capital of former political agents, researching the direct forms of CPA. Thereby, I exclude members who are closely related to politicians.
The BoardEx database is the basis of our hand-collected data, containing U.S. directors with a governmental background. The director profile employment file lists the U.S. directors who were former politicians, political advisors, bureaucrats and/or military. However, this file doesn’t display the directors’ specific work background. We extended the file with our hand-collected data, linking the specific work background to the U.S. directors. We complemented the data with information about their political tenure, senior position and political affiliation. Also, we included their political power by distinguishing between federal and state government. We defined the job background of the politically connected directors through internet searches, using reliable public websites to find directors information, such as LinkedIn, Bloomberg, Marketscreener, Wikipedia or Prabook. We avoided social media sites like Facebook or Twitter as an information source.
We qualify the politically connected directors as follows. Politicians are directors with an elected governmental background i.e., secretaries. Bureaucrats are qualified as directors with a non-elected governmental background or an elected non-executive governmental background, they cannot be politicians. For example, a chairman of the federal reserve bank or a city mayor. Political advisors are qualified as advisors to the government, they cannot hold a position of politician or bureaucrat. Also, if a political advisor has a former position as politician or bureaucrat, it is qualified as politician or bureaucrat. An example of an advisor is an advisor for the US house of representatives. Lastly, all directors who have a military background, are qualified as a military.
11 We excluded some U.S. directors throughout our collection. Firstly, directors who are currently active in the government were excluded. This assures that the data only consists of directors with a historical governmental role. Secondly, we excluded directors without a clear governmental role description. Thirdly, we only included directors with a senior position, such as CEO, directors, and managers. Non-senior positions do not have the authority to make decisions that influence the ESG performance.
3.4 Politically connected directors
In this paper, directors with a political advisory and military background are excluded. Bureaucrats and politicians have a direct influence in the governmental process, where advisors and military don’t have this capability. Congruent with section 2.4, I divided politically connected directors into bureaucrats and politicians, to see the effects of the different political backgrounds on the director’s decision making.
In this sample, politically connected directors are measured by bureaucrats and politicians as a proportion of the board size (𝑃𝐶 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠𝑖,𝑡−1). Also, I make a distinguishment between bureaucrats
and politicians, to test the differences in political positions. Bureaucrats are measured as (𝐵𝑢𝑟𝑒𝑎𝑢𝑐𝑟𝑎𝑡𝑠𝑖,𝑡−1) and politicians are measured as (𝑃𝑜𝑙𝑖𝑡𝑖𝑐𝑖𝑎𝑛𝑠𝑖,𝑡−1). All the directors are controlled
using the lagged function.
Table 1 shows the proportion of politically connected directors on the board over the years 2003 till 2015. The table shows an increase of board members with a bureaucratic background over the years. However, it shows a decrease of directors with a background as a politician. This table displays the rising importance of bureaucrats, more companies have board members with a bureaucratic background. Meanwhile, fewer companies have board members who worked as a politician.
--- Insert table 1 here. ---
3.5 Southern United States
As mentioned in section 2.6, I use the U.S. southern states as a moderating variable between politically connected directors and ESG performance. For the classification of the southern states, I followed the research of Cohen et al. (1996). They classified the southern states as the census state divisions 5, 6 and 7, in which the following states are included: Alabama, Arkansas, Delaware, Florida, Georgia,
12 Kentucky, Louisiana, Maryland, Mississippi, North Carolina, South Carolina, Oklahoma, Tennessee, Texas, Virginia and West Virginia. The southern states are defined as a dummy variable, it represents 0 for the northern states and 1 for the southern states (𝐴𝑚𝑒𝑟𝑖𝑐𝑎𝑛 𝑆𝑜𝑢𝑡ℎ𝑖,𝑡).
3.6 Control variables
The control variables of this study are based on the research from Di Giuli and Kostovetsky (2014). Di Giuli and Kostovetsky (2014) divided the control variables in firm and board variables. The accounting and market control variables are collected from the Worldscope database. The board control variables are collected from the BoardEx database. The used firm control variables are as followed: 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠𝑡−1 (log of total assets), 𝑅𝑂𝐴𝑡−1 (operating income over total assets),
𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄𝑡−1 (market cap / (total liabilities + total assets), 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠𝑡−1(cash dividends over total
assets), 𝐶𝑎𝑠ℎ𝑡−1 (cash over total assets) and 𝐷𝑒𝑏𝑡𝑡−1(total liabilities over total assets). Besides firm
control variables, the following board control variables are used: 𝐵𝑜𝑎𝑟𝑑 𝑠𝑖𝑧𝑒𝑡−1,
𝐵𝑜𝑎𝑟𝑑 𝑖𝑛𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑐𝑒𝑡−1 (non-executive directors over board size), 𝐹𝑒𝑚𝑎𝑙𝑒 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑡−1 (female
directors over board size), 𝐹𝑜𝑟𝑒𝑖𝑔𝑛 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑡−1 (foreign directors over board size),
𝑁𝑜𝑛 𝑐𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑 𝑒𝑥𝑒𝑐𝑢𝑡𝑖𝑣𝑒 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑡−1 (non-certified executive directors over board size) and
𝐶𝐸𝑂 𝑑𝑢𝑎𝑙𝑖𝑡𝑦𝑡−1 (dummy variable). All the firm and board variables are winsorized, with exception of
the dummy variable CEO duality. Next to the firm and board control variables, two general control variables are implemented. I control for industry effects of the U.S. market, using the variable 𝐵𝑢𝑠𝑖𝑛𝑒𝑠𝑠 𝑠𝑒𝑔𝑚𝑒𝑛𝑡𝑠𝑡−1. The industry effects are a lagged log of the count of the total industry
segments a firm operates within, divided over 10 SIC codes. Secondly, the year effects are included. The control variable 𝑌𝑒𝑎𝑟 𝑒𝑓𝑓𝑒𝑐𝑡𝑠, controls that annual effects don’t occur.
3.7 Model
For the estimated effect of the politically connected directors on the ESG score, the ordinary linear regression with firm fixed effects is used. The X represents the sum of the lagged firm and board control variables. Whereas, the general control variables year and industry effects are mentioned separately. The 𝑖 implies the firm ids and the 𝑡 represents the years. The first equation is shown as follows:
𝐸𝑆𝐺𝑠𝑐𝑜𝑟𝑒𝑖,𝑡 = 𝛼 + 𝛽1 𝑃𝐶 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠𝑖,𝑡−1+ 𝛽2∑ 𝑋𝑖,𝑡−1 + 𝛽3 𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑒𝑓𝑓𝑒𝑐𝑡𝑠𝑖,𝑡−1+
13 The second hypothesis has included the southern states as a moderating variable. Here, equation 1 is used as a basis with addition of the moderating dummy variable U.S. south. The same control variables and firm/year effects are included. The equation is modified as follows:
𝐸𝑆𝐺𝑠𝑐𝑜𝑟𝑒𝑖,𝑡 = 𝛼 + 𝛽1 𝑃𝐶 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠𝑖,𝑡−1+ 𝛽2 𝐴𝑚𝑒𝑟𝑖𝑐𝑎𝑛 𝑆𝑜𝑢𝑡ℎ𝑖,𝑡 + 𝛽3 𝑃𝐶 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠𝑖,𝑡−1×
𝐴𝑚𝑒𝑟𝑖𝑐𝑎𝑛 𝑆𝑜𝑢𝑡ℎ𝑖,𝑡+ 𝛽4 ∑ 𝑋𝑖,𝑡−1 + 𝛽5 𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑒𝑓𝑓𝑒𝑐𝑡𝑠𝑖,𝑡−1+ 𝛽6 𝑌𝑒𝑎𝑟 𝑒𝑓𝑓𝑒𝑐𝑡𝑠𝑡+ 𝜀𝑖,𝑡
4. Results
4.1 Descriptive statistics
Table 2 gives an overview of the descriptive statistics, which consists of a sample of 9305 firm years and comprises 1614 U.S. organisations. In the sample, 30.2% of the organisations are established in the southern states. Tobin’s q is valued at 0.98, this means the worth of an average organisation is lower than the costs of assets. The average U.S. firm’s total assets are 30.7 million dollars. The total liabilities are 58% of the total assets and the operating income is 9% of the total assets. Additionally, the statistics show that a firm in the U.S. scores an average of 0.5 on the ESG score. The board variables display that a U.S. board contains 10 board members. In this sample, 1.8% of the board members are politically connected directors. Here, 1.56% of the board members consist of directors with a bureaucratic background and 0.21% of the board members consists of directors who were former politicians.
--- Insert table 2 here. ---
4.2 Regressions
This section describes the results of the tests, based on the hypotheses in section 2. The outcomes of the first hypothesis are presented in table 3. While the results of the second hypothesis, including the moderating variable, are presented in table 4. The results for each model are explained per subsection.
14 4.2.1 Politically connected directors
Table 3 gives an overview of the regression outcomes from model 1 discussed in section 3.7. It answers the question if politically connected directors influence the ESG performance. The main factor in this research is the explanatory variable politically connected directors. Where a distinction is made between directors who were bureaucrats and politicians. Column 1 includes all politically connected directors. Column 2 covers only directors with a bureaucratic background and column 3 includes only directors who were politicians. The regressions are controlled for firm fixed effects, besides the control variables mentioned in section 3.6. Column 1 indicates that the estimated coefficient β on politically connected directors is -0.126 (p < 0.05), which means that a board with politically connected directors leads to a decrease in ESG score of 0.126. Column 2 shows a coefficient β on directors with a bureaucratic background of -0.116 (p < 0.1). So, a firm with directors of a bureaucratic background generates an 0.116 lower ESG score. Column 3 indicates that the coefficient β on directors who were politicians is -0.134. However, the result in column 3 isn’t significant. This shows that the decrease in ESG score for politically connected directors is driven by the negative association of the directors with a bureaucratic background.
--- Insert table 3 here. ---
4.2.2 Moderating effect – the southern United States
Building further on the literature in section 2, table 4 includes the moderating variable ‘southern U.S.’ It answers the question if politically connected directors in the southern states influence the ESG performance. The regressions are based on model 2, which is explained in section 3.7. The control variables and fixed effects are preserved. Also, the column set-up of table 4 is the same as in table 3. Column 1 represents the politically connected directors, explained by column 2 and 3 which includes the directors with a bureaucratic background (2) and the directors who were politicians (3). The first column indicates that the coefficient β on politically connected directors is -0.213 (p < 0.01). However, the moderating effect southern U.S. shows a coefficient β of 0.256 (p < 0.1). This means that a U.S. firm with politically connected directors decreases the ESG score with 0.213. The southern U.S. politically connected directors reverse the ESG score with 0.256, which will lead to an increase in ESG score of 0.043. The second column gives a coefficient β on directors with a bureaucratic background of -0.201 (p < 0.05), with the inclusion of the moderating effect it indicates a coefficient β of 0.256 (p < 0.1). Board members with a bureaucratic background lower the ESG score with 0.201. However, if
15 the firm is established in the southern U.S. the effect will be reversed with a score of 0.256, which leads to an 0.055 increase of the ESG score. So, the moderating effect of the second column shows congruent with the first column a reverse effect. Column 3 presents a coefficient β on directors who were politicians of -0.161. The moderating effect shows a positive coefficient β of 0.098. However, the results in column 3 are not significant.
Overall, politically connected directors increase the basis negative effect on the ESG score. However, considering the moderating factor of the southern U.S., the southern politically connected directors reverse this effect to a positive ESG score. Under consideration that the directors who were politicians do not significantly affect the ESG score. Congruent with section 4.2.1, the effect is driven by the association of the directors with a bureaucratic background.
--- Insert table 4 here. ---
5. Conclusion
The purpose of this thesis is to explore the relationship between politically connected directors and the ESG performance of U.S. organisations. The underlying argument is that the interplay between politically connected directors and ESG strategies strategy is dependent on the value that organisations attach to its reputation. Where organisations in the southern U.S. attach more value to their reputation.
The results of the first model are consistent with the theorization of the first hypothesis. I theorize that politically connected directors have a negative association with ESG performance. ESG performance is associated with the reputation of an organisation. Due to the increasing ESG pressure, organisations have to invest their resources in ESG to maintain their reputation. The political benefits, gained from politically connected directors, ensures that fewer ESG resources are required to meet the status quo. Here, politically connected directors act as a substitute for the ESG strategy to maintain the organisational reputation. However, the substitution of the ESG strategy by the politically connected directors suggests a form of “cannibalization”. Where the organisations divert ESG resources away and
16 erode the gained ESG performance in the long term. Congruent with the theory, the results show a significant negative effect of politically connected directors on ESG performance.
The theorization of the second hypothesis is also consistent with the results of the second model. I theorize that reputational driven organisations, such as the southern states, are attached to the reputational value of ESG performance. Southern organisations see potential in the complementary use of politically connected directors and ESG strategy. Political benefits are used to gain economic viability in the ESG strategy. In the southern states, organisations use economic viability to improve their ESG performance, thereby improving the reputation of the company. In congruence with the theory, the results of the moderating effect show a reversion. The negative effect between politically connected directors and ESG performance turns to a significant positive effect.
Additionally, this thesis expands the view of politically connected directors. In this study, politically connected directors are divided into board members who were politicians or bureaucrats. Politicians and bureaucrats possess different motivation, skillsets and social network. Politicians are manipulative based and have a high public profile. Here, the use of political benefits is more prone to reputational loss. So, politician-directors couldn’t use their political resources as a strategic tool without damaging their corporate reputation. Congruent with the theory, politicians have no significant influence on ESG performance. Bureaucrats are competence-based and have a low public profile. Bureaucrat-directors could use their political resources without risking reputation damage. Congruent with the theory, bureaucrat-directors drive both associations between politically connected directors and ESG performance.
In conclusion, the main question of this thesis is: How do politically connected directors affect the organisational ESG performance in the U.S.? Based on the theory explained in section 2 and the results of the regressions in sections 4, can I answer this question. Politically connected directors in the U.S. affect the ESG performance negatively. While politically connected directors in the southern U.S. affect the ESG performance positively. Explainable by the interests of organisations in reputational value.
However, my results are is conflicting with comparable studies in other countries (Liedong et al., 2017; Huang & Zhao, 2016; Zhang, 2017). The difference in results is partly explainable by the drivers of the association. My results are driven by the bureaucrats, while the results of the relating studies are driven by the politicians. As mentioned before, the human and social capital of political agents are different (Alesina & Tabellini, 2007) Secondly, this study contains U.S. directors. However, comparative studies researched the effect of non-democratic countries. Here, the contextual value could explain the different results. Faccio (2010) documented evidence that the accounting effects of politically connected directors are different across different countries.
17
6. Discussion
6.1 Implications
This thesis contributes to the existing literature in the following way. Firstly, this study gives new insights into the relation between politically connected directors and ESG performance. Prior studies show that politically connected directors are positive associated with ESG performance (Liedong et al., 2017; Huang & Zhao, 2016; Zhang, 2017). However, these studies were examined the effect in the African and Asian continent. I document a negative association of politically connected directors on ESG performance in the U.S. I argue that the interplay between politically connected directors and ESG performance in democratic countries is based on the reputational interest of organisations by showing a reversed association in the reputational protective southern states.
Secondly, this thesis has contributed to the theoretical field of politically connected directors. Moe (2006) suggests that the political agents in organisations could be broader defined than the existing literature examines. The definition of political agents is not limited to politicians, bureaucrats also influence the governmental policy. Bureaucrats and politicians differ in their governmental position. Not only in the way they enter politics, but also the way they execute their position (Alesina & Tabellini, 2007). The publicity of the political agents influences the organisational outcome of political benefits. Consistent with the assertion, I find evidence that the public profile of politicians in regulatory countries as the U.S. could diminish the use of political resources. The results show that there isn’t a significant relationship between politicians and ESG performance. Here, the low-key profiled bureaucrats have an advantage when using their political resources. This is congruent, with my results that bureaucrats drive the influence of politically connected directors on ESG performance.
6.2 Limitations and recommendations
This study also presents some limitations. Firstly, my thesis is an in-depth study of one country, this precludes the possible contextual effects of the relation. However, this study proves that cultural aspects moderate the effect of politically connected directors on ESG performance. The existence of a moderating cultural effect means that research in other countries could lead to different results. Supported by the studies that suggest different results in China and Ghana (Liedong et al., 2017; Huang & Zhao, 2016). Future research could explore the effect of politically connected directors on the ESG performance in cross-country research. To extend the view of politically connected directors on ESG performance in developed countries.
18 Secondly, the hand-collected data of bureaucrats isn’t fully uniform. Bureaucrats have a wide field of differences in jobs and personal characteristics. Firstly, bureaucratic job positions are not fully generalizable over the U.S. Different job positions are characteristically different. For example, our dataset for bureaucrats includes both a chairman of the U.S. federal bank and an ambassador of the U.S. The difference in job characteristics is associated with different professional needs for human and social capital (Alesina & Tabellini, 2007). Secondly, the demographic characteristics of the bureaucratic director’s aren’t clear i.e., gender, age etc. Research should extend the theoretical lens on the job and demographic characteristics of bureaucrats. To give an insight into the characteristics of U.S. bureaucrats and give a comprehensive view of the effects of U.S. bureaucrats on the ESG performance.
19
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23
Table 1: Politically connected directors
Year N PC directors Bureaucrats Politicians
2003 2700 0,96% 0,79% 0,16% 2004 3340 0,94% 0,82% 0,11% 2005 3711 0,92% 0,81% 0,11% 2006 3961 1,04% 0,93% 0,11% 2007 4061 1,16% 1,05% 0,10% 2008 3967 1,22% 1,11% 0,10% 2009 3770 1,31% 1,21% 0,09% 2010 3719 1,37% 1,28% 0,09% 2011 3643 1,35% 1,25% 0,09% 2012 3600 1,46% 1,36% 0,09% 2013 3609 1,47% 1,39% 0,07% 2014 3666 1,53% 1,45% 0,07% 2015 3689 1,58% 1,50% 0,07%
24
Table 2: Summary statistics
Observations Mean S.D. Min Max
Independent/dependent variables ESG Score 9305 0,50 0,17 0 0,98 PC directors 9305 1,80% 4,33% 0% 37,50% Bureaucrats 9305 1,56% 4,11% 0% 3,75% Politicians 9305 0,21% 1,32% 0% 14,29% Southern U.S. 9305 30,20% 45,91% 0% 100%
Firm level variables
Total assets 9305 8,86 1,40 3,98 12,17 ROA 9305 0,09 0,09 0,86 0,35 Tobin’s q 9305 0,98 1,11 0,02 7,45 Dividends 9305 0,02 0,02 0 0,19 Cash 9305 0,13 0,16 0,00 0,94 Debt 9305 0,58 0,21 0,01 1,00 Business segments 9305 1,04 0,71 0 2,30
Board level variables
Board size 9305 10,23 2,39 4 17 Board independence 9305 0,79 0,12 0,14 1 Female director 9305 0,14 0,09 0 0,43 Foreign director 9305 0,05 0,08 0 0,73 Non-certified director 9305 0,04 0,08 0 0,43 CEO Duality 9305 54,50% 49,80% 0% 100%
25
Table 3: Regressions of politically connected directors on the ESG score
(1) (2) (3)
Variables ESG score ESG score ESG score
PC directors -0.126** (0.064) Bureaucrats -0.116* (0.068) Politicians -0.134 (0.148) Total assets 0.022*** 0.022*** 0.023*** (0.006) (0.006) (0.006) ROA 0.053* 0.053* 0.053* (0.029) (0.029) (0.029) Tobin’s Q 0.002 0.002 0.002 (0.003) (0.003) (0.003) Dividends 0.064 0.064 0.065 (0.095) (0.095) (0.095) Cash 0.044** 0.043** 0.044** (0.022) (0.022) (0.022) Debt -0.022 -0.022 -0.023 (0.020) (0.020) (0.020) Business segments -0.004 -0.004 -0.004 (0.004) (0.004) (0.004) Board size -0.002* -0.002* -0.002* (0.001) (0.001) (0.001) Board independence 0.112*** 0.112*** 0.110*** (0.029) (0.029) (0.029) Female director 0.139*** 0.139*** 0.139*** (0.032) (0.032) (0.032) Foreign director 0.079** 0.075* 0.078* (0.040) (0.040) (0.040) Non-certified director 0.056 0.056 0.054 (0.037) (0.037) (0.037) CEO duality -0.008* -0.008* -0.008* (0.004) (0.004) (0.004) Constant 0.162*** 0.164*** 0.160*** (0.055) (0.055) (0.055)
Firm FE YES YES YES
Year FE YES YES YES
Observations 9,305 9,305 9,305
Number of firms 1,614 1,614 1,614
R-squared 0.250 0.250 0.249
All explanatory variables are lagged by one year. Robust standard errors in parentheses. The notation ***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels, respectively. The definition and sources of the variables are presented in the Appendix.
26
Table 4: Regressions with southern U.S. as moderating effect
(1) (2) (3)
Variables ESG score ESG score ESG score
PC directors -0.213***
(0.078)
Southern U.S. x PC directors 0.256*
(0.138)
Bureaucrats -0.201**
(0.083)
Southern U.S. x Bureaucrats 0.256*
(0.146)
Politicians -0.161
(0.145)
Southern U.S. x Politicians 0.098
(0.397) Total assets 0.022*** 0.022*** 0.023*** (0.006) (0.006) (0.006) ROA 0.052* 0.052* 0.053* (0.029) (0.029) (0.029) Tobin’s Q 0.002 0.002 0.002 (0.003) (0.003) (0.003) Dividends 0.063 0.064 0.065 (0.094) (0.094) (0.095) Cash 0.044** 0.044** 0.044** (0.022) (0.022) (0.022) Debt -0.024 -0.024 -0.023 (0.020) (0.020) (0.020) Business segments -0.004 -0.004 -0.004 (0.004) (0.004) (0.004) Board size -0.002* -0.002* -0.002* (0.001) (0.001) (0.001) Board independence 0.115*** 0.114*** 0.110*** (0.029) (0.029) (0.029) Female director 0.140*** 0.140*** 0.139*** (0.032) (0.032) (0.032) Foreign director 0.079** 0.077* 0.077* (0.039) (0.040) (0.040) Non-certified director 0.056 0.055 0.055 (0.037) (0.037) (0.037) CEO duality -0.008* -0.008* -0.008* (0.004) (0.004) (0.004) Constant 0.161*** 0.164*** 0.160*** (0.055) (0.055) (0.055)
Firm FE YES YES YES
Year FE YES YES YES
Observations 9,305 9,305 9,305
Number of firms 1,614 1,614 1,614
R-squared 0.251 0.251 0.249
All explanatory variables are lagged by one year. Robust standard errors in parentheses. The notation ***, **, and * denotes statistical significance at the 1%, 5%, and 10% levels, respectively. The definition and sources of the variables are presented in the Appendix.
27
Appendix
Table A1: Variable definitions
Variables Definition Data source
Independent/dependent variables
ESG score The overall company score based on the ESG
pillars.
ASSET4 PC directors The proportion of bureaucratic and minister
directors on the board (per board size)
Hand-collected/BoardEx Bureaucrats The proportion of bureaucratic directors on the
board (per board size)
Hand-collected/BoardEx Politicians The proportion of minister directors on the
board (per board size)
Hand-collected/BoardEx
Moderating variable
Southern U.S. Dummy coded 1 for census divisions 5, 6 and 7; 0 otherwise
Cohen et al. (1996)
Firms level variables
Total assets Log of total assets Worldscope
ROA Operating income / total assets Worldscope
Tobin’s Q market cap/ (total liabilities + total assets) Worldscope
Dividends Cash dividends / total assets Worldscope
Cash Cash / total assets Worldscope
Debt Debt / total assets Worldscope
Business segments Count of business segments using 10 SIC codes Worldscope
Board level variables
Board size Total number of directors on the board BoardEx
Board independence Non-executive directors / board size BoardEx
Female director Female directors / board size BoardEx
Foreign director Foreign directors / board size BoardEx
Non-certified director Non-certified executive directors / board size BoardEx CEO duality Dummy coded 1 for chairperson or CEO; 0
otherwise
