Does CSR-linked Executive Compensation Promote CSR Performance?

This paper examines the effectiveness of contracting associated with the use of CSR-linked executive compensation across firms. Empirical analysis of a cross-industry sample of 5,720 firmyear observations from 783 US listed companies for the period 2002-2013 revealed that the provision of CSR-linked incentives for senior executives promotes firms’ CSR performance. The result is in accordance with agency theory predictions arguing that the inclusion of environmental and social performance measures in compensation contracts increases the alignment between the agent and the principal by rendering contracting more effective. Specifically, corporate choice to tie senior managers’ pay to CSR objectives produces positive effects already in the year subsequent to the date of adoption, and increases CSR results monotonically as firms accumulate experience in using this mechanism over the years. Results are robust after controlling for potential endogeneity by means of a 2SLS estimation procedure with instrumental variables, as well as to additional controls for potential sample selection bias originating from variations in the coverage of the database across years. Furthermore, the use of CSR-focused advisory and monitoring systems is shown to increase the positive effects of a firm’s experience in tying top managers’ compensation to CSR targets. In accordance with agency theory and corporate governance research, a company’s experience in using CSR-linked executive compensation is likely to promote even higher CSR outcomes when a CSR committee is established within the board of directors or a CSR report is publicly disclosed. Taken together, this evidence emphasizes the importance for the principals of designing specific advising (CSR committee) and monitoring (CSR report) systems as powerful instruments for improving the effectiveness in contracting with agents in the field of CSR. In contrast, CSR external audits do not improve CSR performance, suggesting that they are likely to play a merely symbolic role.

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