Introduction
Strategic initiatives like investing in CSR which affects short-term profits in favor of long-term value creation urges for establishing a balance between the interests of the management and other stakeholders, such as employees, customers, and society at large. The corporate board of a firm plays a vital role in developing and maintaining such a balance required between the interests of different stakeholders in respect to CSR initiatives. The board establishes stakeholder-friendly corporate policies, approves annual budgets for CSR, and creates committees taking care of CSR related issues. To effectively undertake these measures, the board needs to demonstrate proper oversight over management’s self-serving behavior.
In our research, Sami Vähämaa, Hanna Silvola, and I examine whether and how board co-option influences corporate social responsibility (CSR). Board co-option refers to the proportion of directors who joined the corporate board after the CEO’s appointment. The allegiance of co-opted directors to CEOs, generally, weakens the oversight role of corporate boards and gives more freedom to CEOs to decide on corporate investments. That is, CEOs use their influence during the nomination and selection process to appoint directors of their own choice and as such devise corporate outcomes benefiting managerial personal incentives. The newly appointed directors are, in general, sympathetic to CEOs and share similar views or social ties.
Why would a CEO skip investing in CSR?
In the recent years, the steeply declining CEO tenures coupled with increasing quarterly-earnings pressures have resulted in a higher focus on short-term decision making. CEOs, especially in the presence of weaker board monitoring, are more likely to skip investing in CSR to avoid unfavorable consequences like failing to meet security market’s earnings expectations and facing increased compensation risk. This is because stakeholder engagement through CSR generally drains short-term firm performance and requires long-term horizons for financial benefits to accrue. Another potential issue that could encourage the CEO to either avoid or postpone investing in CSR is the predominant use of traditional capital budgeting models by investors, analysts, etc. The net present value approaches (NPV) ignore the strategic value of CSR investments, as a result reflecting lower firm value that could spark a sell-off in in the security market. Some executives even deny the existence of potential environmental or social problems in the economy, making these executives more reluctant to remedy such problems.
Our Findings
We build our study on the conjecture that co-option adversely affects board monitoring, in the absence of which higher CSR initiatives are unlikely to take place. Specifically, the informal involvement of CEOs in the director nomination and selection process will make co-opted directors to serve loyalties and ties with CEOs and give the CEOs greater freedom to choose projects aligned with their personal incentives.
We consider publicly listed U.S. firms over the period from 2000—2018 as our sample. We show that co-option leads to lower CSR performance. Our additional analysis indicates that co-option leads to lower scores on toxic emissions and waste, carbon emissions, environmental management systems, energy efficiency, and product carbon footprint, all of which relate to the environment aspect of CSR. Co-option also leads to high scores on controversies related to a firm’s workforce diversity and concerns over no women on the corporate board. We further find that non-co-option is related to higher CSR.
Conclusion
Overall, our findings suggest that while co-opted directors undermine CSR performance, non-co-opted independent directors have an important role for promoting more socially responsible corporate behavior. Our research has important implications for all the investors in general and for responsible investors in particular. The latter group attempts to create social values through its investments and thus prefers firms that, besides maximizing profits, actively contribute to social aspects of the society. Our findings will enable such investors to meticulously analyze board composition in terms of co-option and accordingly take informed investment decisions.
Aaron Afzali
PhD candidate at Hanken School of Economics
