New Evidence That Rewarding Executives For Corporate Social Responsibility Really Does Work

The Kellogg School of Management at Northwestern University took a close look at the growing practice of CSR contracting last week, and it seems that they like what they see. Corporate social responsibility contracting refers to the practice of linking executive compensation to achieving CSR goals. The question then becomes whether the goals are designed to mark substantial progress, or are they simply public relations "fluff." In other words, are executives being rewarded for genuine achievements or are they simply collecting a bonus for successful greenwashing campaigns.

Corporate social responsibility: from skeptical to not-so-skeptical

Kellogg describes the research of professors Dylan Minor, Bryan Hong and Caroline Flammer in its Kellogg Insight publication under the self-explanatory headline, "Rewarding CEOs for Corporate Social Responsibility Pays Off for Society—and for Firms: CSR contracting encourages executives to sacrifice short-term payoffs for long-term gains."

That pretty much sums it up, but do read the article for full details and some interesting background. Minor, who is a professor of managerial economics and decision sciences at Kellogg, was initially skeptical that the data would reveal any substantial bottom line benefit from CSR contracting:

To him, many CSR efforts looked like little more than PR fluff. Minor suspected that when push came to shove, executives would prioritize the company’s bottom line over what was socially responsible. And because CSR is notoriously difficult to quantify, CEOs could likely use dubious metrics to pad their salaries with little accountability in terms of what they were actually accomplishing.

The new corporate social responsibility research changed his mind. Minor, Hong (University of Western Ontario) and Flammer (Boston University) looked at the  data for companies that base executive pay partly on CSR performance:

To Minor’s surprise, the research revealed that CSR contracting actually hit its mark, leading companies to reduce emissions, increase eco-friendly or “green” patents, and improve social responsibility ratings across the board. Those actions, in turn, increased companies’ value over the long run.

Within the sample group, the study analyzed toxic emissions, number of green patent filings, and third-party overall corporate social responsibility ratings.

All three markers showed significant improvement over the 10-year span of the study, with emissions falling by almost 9 percent, patents increasing 3 percent, and corporate social responsibility ratings coming up 5 percent.

More good bottom line news for CSR

Minor cautions that corporate social responsibility contracting is a new field of study, so it will take time to shake out more hard evidence about the connection between CSR and stock performance.

Nevertheless, as a jumping-off point the study has broken new ground. With an "army of research assistants" at hand, the authors assembled the first database of its kind to include corporate social responsibility contracting for every company in the Standard & Poor's 500 Index between 2004 and 20013.

One surprise was the rapid growth in CSR contracting, from 12 percent in 2004 to 40 percent in 2013.

Another interesting takeaway is the involvement of high-carbon industries. The study found that mining, energy and transportation companies engaged in CSR contracting at double the average rate.

It seems that the research team was most surprised by the effect of CSR contracting on company value:

Just as incredibly, these changes did not come at the expense of that bottom line. Minor’s team found that CSR contracting led a firm’s value to increase by three percent over the next year.

Although it seems like simple common sense, the new study provides much-needed statistical support for the impact of CSR contracting on corporate culture.

Corporations have long been criticized for focusing on quarterly profits at the expense of long term growth and sustainability. CSR contracts can upend that equation:

According to the researchers, this growth happens because CSR contracting forces executives to sacrifice short-term payoffs for long-term gains.

CSR: moral capital is just not good enough any more.

Minor has already begun work on a followup study indicating that an undisciplined approach to goal-setting doesn't make the cut. He explains:

"Half the folks out there are doing what we would call ‘greenwashing,’ where they just put these things up, and they're not very substantive. Our positive findings are based on those companies that are really being truthful and transparent about what they’re doing.”

The followup study also builds on an earlier CSR study by Minor published in 2015, in which he confirmed and formalized a phenomenon that other CSR researchers have been tracking.

In the 2015 paper, Minor set out to understand why companies and investors were tuning into CSR, even without hard evidence of the bottom line evidence.

His research indicated that in the absence of a direct bottom line impact, companies do perceive value in using CSR to build moral capital. In that approach, CSR is a hedge against the consequences of an adverse event (Volkswagen's diesel emissions scandal is one example of an "adverse event).

The problem that Minor nailed down is that this kind of "CSR contribution" actually doesn't work, and may even expose a company to greater risks while worsening its overall CSR performance. That's because managers perceive moral capital as a cushion that blunts the consequences of bad decisions, which makes them more likely to take risks, which increases the chance of an adverse event.

In contrast, Minor and his research team found that managers who foresee potential trouble spots and strategically target CSR investments to address them are more likely to protect their firms from the effects of adverse events:

In particular, those firms that engage in CSR activities related to an adverse event are given more of the benefit of the doubt concerning their negligence related to the event. For example, if a firm engages in substantive (positive) environmental CSR, should it become involved in an environmental disaster...it is less likely the firm is guilty of negligence, reducing its expected event cost.

Last fall Caroline Flammer published a study that also sounds a cautionary note. She looked at the results of shareholder CSR and environmental votes from 1997 to 2012, and found that certain "close call" votes yielded a small but measurable positive effect on stock prices.

Interestingly, Flammer found that employee relations can be a key element:

Dr. Flammer found that increased shareholder value happens because of improved operating performance. The increase in operating performance can be attributed to improvements in labour productivity and sales growth, suggesting CSR improves employee satisfaction and appeals to customers.

However, she also found that results vary widely from one industry to another:

Stakeholders of companies operating in socially-conscious industries tend to have stronger interests in CSR. They therefore respond more favourably to new CSR activities, leading to higher returns.

And, she found that the law of diminishing returns can apply:

Initial financial benefits of CSR activities may be significant, but returns will eventually decrease. This is consistent with the findings of Wang and colleagues (2008) who found that firm-level CSR engagement plotted against financial performance initially rises but eventually tapers off, creating an inverse U-shaped curve.

That point about diminishing returns may seem somewhat discouraging, but as the body of CSR research grows, so does the knowledge base of best practices and effective strategies, leading to the prospect of more favorable outcomes even after the initial impact.

CSR focusing on environmental and energy issues may also help smooth out the "U-shaped" curves and lead to more strategic, effective CSR programs that yield strong results over the long run.

Photo (cropped): Andrei Niemimäki/flickr.