1. CASES STUDY IN CORPORATE FINANCE
Submitted to: Dr. Wasif
Present by: Mr. Adnan Khan
Program: MS Management Sciences
Session: 2022-24
Riphah International University, QIE, Lahore
2. TOPIC: Journal of Economics and
Business
• Corporate social responsibility and
CEO compensation revisited: Do
disaggregation, market stress, gender
matter?
3. A B S T R A C T
• In this paper we examine the relation between corporate social
responsibility (CSR) and CEO compensation. Both CSR and CEO
compensation are disaggregated into various sub-components. We
also consider impact of the market crisis and the relevance of
gender. Our results show that there is a negative relation between
total compensation and socially responsible firms. However,
disaggregation of CSR into its components matters. Dimensions of
CSR that are relevant are employee relations, environment and
diversity. Our results also show that the financial crisis and gender
matter: once they are accounted for interactively in the model, the
general relation between CSR and compensation weakens.
4. Definition of CSR and CEO Compensation
What Is Corporate Social Responsibility (CSR)?
• Corporate social responsibility (CSR) is a self-regulating business model that helps a company
be socially accountable to itself, its stakeholders, and the public. By practicing corporate social
responsibility, also called corporate citizenship, companies can be conscious of the kind of
impact they are having on all aspects of society, including economic, social, and
environmental.
• To engage in CSR means that, in the ordinary course of business, a company is operating in
ways that enhance society and the environment instead of contributing negatively to them.
What Is CEO Compensation?
• It's hard to read the business news without coming across reports about the salaries, bonuses,
and stock option packages awarded to chief executives of publicly traded companies. Making
sense of the numbers to assess how companies are paying their top brass is not easy. Investors
must ensure that executive compensation is working in their favor.
5. Introduction
• In this paper we examine the link between corporate social responsibility
(CSR) and CEO compensation. CSR is measured using the rating system
from Kinder, Lindenberg, and Domini (KLD) Research and Analytics
database. It looks at whether firms are rated based on their environmental
activities, community involvement, product qualities, employee relations
and diversity policies.
CEO compensation is divided into various components:
• Salary, Bonus Cash and long-term compensation. The relation between
CSR and CEO compensation has been examined in the prior literature (see
for example Cai, Jo, & Pan, 2011). The main contribution lies in the
consideration of the impact of the recent financial crisis. Such a
decomposition of the key variables allows a more in-depth analysis of the
identified relations.
6. Introduction (Cont.)
• CSR is associated with investments in negative net present value projects
that destroy shareholders' value. Under the second view, managers may
over-invest in CSR that transfer wealth from shareholders to other
stakeholders (such as community, regulators and employees) This is
because managers have incentives to use CSR investment to build their
personal reputations.
• But these investments may reduce shareholders’ value in at least three
ways. First, managers’ career concerns might make them focus excessively
on short-term profit and distort their investment decisions, such as myopic
CSR investment (Narayanan, 1985) and overinvestment (Holmstrom and
Costa, 1986). For example, managers often overinvest in CSR for private
rent-seeking benefits to secure their personal reputations in the community,
enhance their personal status with stakeholders,
7. Introduction (Cont.)
• It is important to distinguish normal CSR and
abnormal CSR for at least two reasons. First, Larcker
(2003) argues that although firms continuously strive
to optimize their corporate financial policies, it is
plausible that firm policies and managerial decisions
deviate from the optimal levels
8. 2. Data and research design
Sample formation:
• We obtain CSR data from the Kinder, Lydenberg and Domini
(KLD) Database. We drop the following observations in the
screening procedures to obtain our sample:(1) observations
with CEO turnover during the year; (2) observations in which
the current CEO has served the company for strictly less than
two consecutive years; (3) firms in the regulated industries
(SIC code 4900–4999) or in the financial industry (SIC code
6000–6999); and (4) observations with zero CEO
compensation in the year. Table 1 describes the sample
distribution over years.
9. 3. Results
• 3.1. Descriptive statistics
• presents the descriptive statistics. Mean(median) CEO total
compensations $5.552($3.329) million. Mean CSR is 0.280.
On average, the sample firms are profitable with a mean return
on assets (ROA) of 0. 106. Mean board independence
(BDINDEP) is 68%. Mean percentage of common stock
owned by the board of directors (BDOWN) is 4%.
• Mean percentage of common stock owned by the institutional
shareholders is 63%
10. 3.3. Determinants of CSR
Table 5 presents the regression results of the determinants of CSR based on Eq. We
conduct a number of robustness checks on the model. Results are qualitatively
consistent with prior studies. CSR is positively associated with operating cash flow,
firm size and research and development divided by sales. It is negatively associated
with corporate governance strength.
In column (1) we include all firm characteristics in addition to industry and year fixed
effects. In column (2), we include all firm characteristics, the corporate governance
measures as well as industry and year fixed effects. On the other hand, CSR is
negatively associated with corporate governance strength. In our next set of tests, we
use the fitted values of CSR based on estimated coefficients in Table 5 column (1) to
compute the normal CSR (optimal level of CSR based on firm characteristics).
11. 3.4. Regressions of CEO compensation on
normal CSR and abnormal CSR
• In Table 6, we examine whether there are systematic differences
between normal CSR and abnormal CSR in affecting CEO
compensation. In all specifications we find similar results. However,
CEO compensation is punished for excessive CSR investments
when CSR investment deviates from its optimal level. This result
suggests that CEO is rewarded for investing in optimal level of CSR.
• First, we find CEO compensation level is positively associated with
normal CSR at the 1% significance level. To the extent that normal
CSR reflects the optimal level of CSR investment, this result
suggests that CEO is rewarded for investing in optimal level of CSR.
Second, we find CEO compensation level is negatively associated
with abnormal CSR at the 1% significance level.
12. 3.5. Does corporate governance affect the
association between CEO compensation and
CSR?
• In Table 7, we examine the effect of corporate governance on the association
between CEO compensation and CSR investment. In firms with strong
corporate governance, we find that CEO compensation is negatively associated
with CSR. However, in firms with weak corporate governance (column (2) and
(3) we find no such association. The Chi-square to test the difference in
coefficient on CSR between strongly-governed firms and weakly
governmentally firms is 6.85, significant at 1% level. This result suggests that
CEOs' pay is lower when total CSR is higher.
• Higher scores of GOVSTRENGTH denote higher corporate governance
strength. In firms with strong corporate governance (column (1)), we find that
CEO compensation is negatively associated with CSR. However, in firms with
weak corporate governance (column (2)), we find that CEO compensation is not
associated with CSR.
13. 3.6. Robustness tests
• 3. 6. 1. Alternative measures of CSR:
• In a sensitivity test, as in McWilliams and Siegel (2000), we also use
an alternative measure of CSR, CSR DSI400, an indicator variable
that takes a value of 1 if the firm is included in the DSI400 in a
given year (for having passed the “social screen”), and 0 otherwise.
• In order to be eligible for the DSI 400, a firm must derive less than
2% of its gross revenue from the production of military weapons,
have no involvement in nuclear power, gambling, tobacco, and
alcohol, and have a positive record in each of the remaining six
categories. Our results are qualitatively similar
14. 3.6. Robustness tests (Cont.)
3.6.2. Financial constraints:
• Our main results on the association between CEO
compensation and CSR are robust across alternative
measures of “financial constraints. ” In addition, the
results are qualitatively similar based on a balanced
panel of firms for the sample period.
15. 3.6. Robustness tests (Cont.)
3.6.3. Endogeneity:
• To address the potential endogeneity problem, we perform two-
stage-least-squares (2SLS) regression analysis using religion rank
and a blue state dummy as instrumental variables for the CSR
investment (Deng et al. , 2013). This finding suggests that the
religion rank variable is likely to be positively correlated with a
firm`s CSR, thus satisfying the relevance requirement of
instrumental variables. However, to the extent that the construction
of the religion rank variable is based on the state in which a firm is
located, it is unlikely that this variable has a significant effect on the
CEO compensation, satisfying the exclusion condition of
instrumental variables.
16. 4. Conclusions
• We examine whether CEO compensation is associated
with corporate social responsibility (CSR) investment.
The value creation (value destruction) hypothesis predicts
a positive (negative) association between CEO
compensation and CSR. Consistent with the value
destruction hypothesis, we find that CEO total
compensation level is negatively associated with CSR
investment. Strong corporate governance is more
pronounced than weak corporate governance in this study.
17. 4. Conclusions (Cont.)
• Decomposing total CSR investment into a normal
component and abnormal component generates two
interesting insights. We find CEO compensation is
positively associated with normal corporate social
responsibility. Strong corporate governance structure
penalizes CEO more by reducing CEO compensation if
CEOs over-invest in CSR. This result suggests that CEOs
receive lower compensation for excessive CSR
investments.
