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Do Contracts Make Them Care? The Impact of CEO Compensation Design on Corporate Social Performance

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Abstract

Using the behavioral agency model, we analyze how two compensation design characteristics, pay-performance sensitivity and duration of CEO compensation (taking into account multiple vesting periods), affect corporate social performance. We find that the performance sensitivity of CEO pay is negatively associated with poor social performance but also negatively affects strong social performance. These results suggest that pay-performance sensitivity increases the relevance of potential negative consequences of poor social performance. However, the ‘insurance’ benefits of strong social performance may also become less relevant. With respect to the duration of CEO compensation, we find that it reduces poor social performance. This finding confirms arguments that a long-term compensation time horizon increases the perceived threat that the negative effects of poor social performance will become visible. With our findings, we integrate behavioral agency theory with the traditional stakeholder views.

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Notes

  1. Firms often cite a desire to bring closure to an incident as a reason for settling litigation or regulatory action.

  2. We excluded financial firms as they are only partially comparable with industrial enterprises, for example, in terms of accounting measures or corporate governance (Adams and Mehran 2003). Although using the S&P 100 limited our sample size, it increased the liklihood that complete data would be available from all of our sources, most importantly KLD. Furthermore, calculating compensation duration and PPS was extremely time consuming.

  3. For some companies, data could not be collected for all six years of the time period as they became insolvent or were taken over by another company.

  4. We hand-collected data from annual reports to fill in missing entries, wherever possible.

  5. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_12_ind_port.html.

  6. In short, time horizon is calculated relative to the year end, so Salary has a vesting period of zero. Salary, Bonusi, Restricted stockj, and Optionk refer to the respective dollar values of the corresponding grants (in our analysis, Salary includes base salary and fringe payments, and we use the Option value as stated in the companies’ proxy statements). The variables nb, ns, and no refer to the total number of grants. Please refer to Gopalan et al. (2014) for more details.

  7. According to Hall and Liebman (1998) and Murphy (1999), PPS is primarily driven by changes in stock price affecting stock and option values, and not by other forms of compensation.

  8. As employees might choose to exercise options before reaching their maturity date, we tested our results by reducing the time-to-maturity by a constant percentage of 30%. All results were robust to this modification.

  9. The sample comprises 2006–2011 data for all non-financial firms that were part of the S&P 100 in 2006. Due to insolvency or takeovers, the number of firms included in the sample decreased over time from 84 in 2006 to 75 in 2011, leading to a total sample size of 467 firm years.

  10. Pay duration is calculated as the weighted average time horizon of the different CEO pay components (see above for more details). As the time horizon of salaries is always zero, and as salaries account for less than 10% of the total CEO compensation (on average across our sample), the effect of salary levels on pay time horizon is small.

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Acknowledgements

We thank Michael Holmes who provided valuable comments on an earlier draft of this manuscript. We thank the editor and reviewers for their excellent suggestions.

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  1. Rucks Department of Management, Louisiana State University, Baton Rouge, LA, USA

    Jean McGuire

  2. Chair of Management and Control, Georg-August University Göttingen, Gōttingen, Germany

    Jana Oehmichen, Michael Wolff & Roman Hilgers

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McGuire, J., Oehmichen, J., Wolff, M. et al. Do Contracts Make Them Care? The Impact of CEO Compensation Design on Corporate Social Performance. J Bus Ethics 157, 375–390 (2019). https://doi.org/10.1007/s10551-017-3601-8

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