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Journal of Business Ethics

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22.01.2022 | Original Paper

CEO Personal Hedging and Corporate Social Responsibility

verfasst von: Jongwon Park, Sunyoung Kim, Albert Tsang

Erschienen in: Journal of Business Ethics | Ausgabe 1/2023

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Abstract

This study examines whether and how the presence of managerial hedging opportunities, which allows executives to reduce the sensitivity of their equity-based compensation to the firm’s stock price performance, affects firms’ corporate social responsibility (CSR) activities. We find a significant and negative relationship between the presence of managerial hedging opportunities and firms’ CSR performance. The effect of managerial hedging opportunities on CSR performance is more pronounced for CEOs with greater personal hedging needs. Additionally, the effect is weakened if firms limit corporate insiders from trading exchange-listed options. Overall, this study suggests that allowing managers to delink their equity-based compensation from firm stock price performance through hedging their personal portfolios can lead to unexpected consequences for firms’ CSR performance.

Vorheriger Artikel Board Gender Diversity and Women in Senior Management

Nächster Artikel Corporate Social Responsibility and Stock Prices After the Financial Crisis: The Role of Strategic CSR Activities

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Agency theory suggests a positive relationship between managerial equity ownership and firm value (Jensen & Meckling, 1976; McConnell & Servaes, 1990) because of potential conflicts of interest between corporate managers and shareholders when managers have little equity ownership of a firm (Berle & Means, 1932). Because it is generally believed that stock price captures the various channels through which CEOs (and other key executives) affect long-term shareholder value (Edmans, 2016; Jensen, 2001), equity-based compensation is widely used as a vehicle to alleviate agency conflicts within a firm by aligning managers’ interests with those of shareholders.

Supporting this argument, Kang et al. (2006) find that greater equity-based compensation is positively related to long-term investment spending as measured by capital expenditures, R&D expenditures, and acquisitions. Similarly, Karim et al. (2015) find a positive relationship between CSR and equity-based compensation.

Prior research finds that firm’s CSR performance is correlated with various institutional- and firm-level factors such as organinzational culture (Galbreath, 2010), institutional environment (Di Giuli & Kostovetsky, 2014; Ioannou & Serafeim, 2012), investor sentiment (Naughton et al., 2019), analyst coverage (Qian et al., 2019), exogenous terrorist attacks (Do et al., 2020), institutional holdings (Dyck et al., 2020), and national-level board reforms (Liao et al., 2021). Recently, studies also provide evidence that CEO characteristics such as altruism (Borghesi et al., 2014), family composiition (Cronqvist & Yu, 2017), marital status (Hegde & Mishra, 2019), and materialism (Davidson et al., 2019) play an instrumental role in shaping the CSR activities. Relatedly, Davidson et al. (2019) find that CEO fixed effects explain 52% to 74% of the variance of firm’s CSR performance.

Hong et al. (2016) find that firms with more shareholder-friendly corporate governance are more likely to link their executives’ remuneration to CSR outcomes. They also show that the inclusion of CSR criteria in executive compensation leads to more CSR activities. Similarly, Flammer et al. (2019) show that the adoption of CSR contracting affects various firm-level outcomes including social and environmental initiatives.

For example, if personal hedging is carried to the extreme, it is possible that executives receive no performance-based incentive from equity ownership or equity-based compensation but receive entirely cash compensation (Larcker & Tayan, 2011, p. 312). Supporting this view, Gao (2010) and Hung et al. (2019) both show that shareholders/boards are likely to adjust CEOs’ compensation contracts when corporate executives can reduce the link between their equity compensation and stock price performance through hedging activities.

McGuire and Argheyd (2003) find salary and long-term incentives have a positive association with weak social performance. Mahoney and Thorne (2005) report a similar relationship between long-term compensation and CSR weakness. Deckop et al. (2006) find that a short-term (long-term) pay focus is negatively (positively) related to CSR. Fabrizi et al. (2014) find that monetary incentives designed to align the CEO’s and shareholders’ interests have a negative effect on CSR, while non-monetary incentives have a positive effect. McGuire et al. (2019) show that CEO pay-performance sensitivity increases the relevance of the consequences from poor CSR, while the duration of CEO compensation reduces poor CSR. Some recent studies investigate the determinants and consequences of CSR-linked CEO contracting (Flammer et al., 2019; Hong et al., 2016).

Firms often employ policies that put some restrictions on managerial hedging. However, Hung et al. (2019) claim that corporate policies that limit/ban executives from hedging may not function effectively because (1) completely eliminating managerial hedging is practically infeasible, and (2) such policies will incur additional monitoring compensation costs. Similarly, Garvey (1997) argue that corporate policy on executive hedging is costly because firms cannot perfectly control individual’s participation in hedging transactions.

See, for example, Kitzmueller and Shimshack (2012) and Radhakrishnan et al. (2018) for a review of the CSR literature.

Some prior research investigates the role of CEO characteristics on CSR (Cronqvist & Yu, 2017; Manner, 2010; Tang et al., 2018), but there have been no studies focussing on CEO’s hedging.

The literature suggests that a key driver of CSR at the firm level is a firm’s financial performance/constraints (Campbell, 2007; Orlitzky et al., 2003). Although CSR investment can be costly, studies report positive, negative, and even neutral effects of CSR on financial performance/firm value (McWilliams & Siegel, 2000).

Consistent with this view, Hubbard et al. (2017) show that increasing CSR activities sometimes even increase a CEO’s dismissal risk.

MSCI ESG provides CSR ratings from 1991 for member firms of the S&P 500 and Domini 400 indexes. The coverage was enlarged to include member firms of the Russell 1000 index from 2001 and member firms of the Russell 2000 index from 2003.

When identifying exchange-listed options, Gao (2010) only focuses on the six large U.S. options exchanges. However, due to a series of acquisitions made by the major U.S. exchanges in recent years, it is difficult to apply the same top-six exchanges condition to our study, as the sample period extends to 2016. Therefore, we consider all options exchanges covered by the OptionMetrics database.

One caveat of using Alt. Hedge is that we cannot completely rule out the possibility that the executives’ options trading volume might be correlated with various CEO characteristics. We thank the anonymous reviewer for pointing out this issue. We employ various empirical methodologies to handle this endogeneity concern and discuss them in later sections.

In addition to the six dimensions, MSCI ESG provides performance indicators for corporate governance. We exclude corporate governance in measuring CSR following the majority of studies in the CSR literature. In a later section, we test whether our results are sensitive to the inclusion of the corporate governance dimension and find that our main inference is unaltered.

MSCI ESG modified the scope of its database by dropping off some data items after 2013, which overlaps with our final sample period (2003–2016). To ensure that our results are not affected by the possible inconsistency in measuring CSR performance, we re-estimate the main analysis after removing the observations from 2014 through 2016. In untabulated tests, we find that our results remain qualitatively and quantitatively similar. We further address this concern in ‘Alternative Measures for CSR Performance’ by employing alternative measures for CSR performance.

Alternatively, we measure the CEO’s hedging opportunities variables in year t-1. Untabulated tests find similar results.

The percentage of sample firm-years listed on options exchange is 74% in Gao (2010) and 84.8% in Hung et al. (2019). The mean value of Alt. Hedge reported in Gao (2010) is 5.09.

In subsequent analyses, we bifurcate the test variables by incorporating firms’ policies that limit or ban executives’ hedging activities. This bifurcation increases the variation of our main test variable.

Since we measure a firm’s litigation risk based on its industry classification, firm fixed effects subsume the effect of Litigation. Therefore, across columns 2 to 4, we remove the variable Litigation from the regression model.

Unlike other matching techniques such as propensity score matching, entropy balancing relieves the covariate differences problem without any sample loss. Therefore, the technique is particularly suitable for our study where the size of treatment and control groups are largely unbalanced.

We further assess the robustness of the main inference using the Granger-style reverse causality minimization procedure (Godfrey et al., 2020). In untabulated tests, we find qualitatively similar results which reinforce the identification of managerial hedging effects on firms’ CSR performance. We thank an anonymous referee for this suggestion.

A one standard-deviation increase in Alt. Hedge (i.e., 2.987) leads to a change of − 0.125 (= 2.987 × − 0.042) in CSR performance (CSR score).

If the Execucomp item shrown_excl_opts is missing, we convert the missing value to zero. The results are robust to restricting the final sample to those having a non-missing value for shrown_excl_opts.

The firm-level political risk score, provided by Hassan et al. (2019) is computed based on a pattern-based sequence classification method used in computational linguistics. We obtain the data from the Firm-level risk webpage (https://www.firmlevelrisk.com/download).

Cook (2019), for example, shows that there is a growing tendency in prohibiting managerial hedging since 2006 when the SEC began requiring firms to discuss in the CD&A section any material hedging policies for their executives (i.e., Item 402(b) of Regulation S-K). The report documents that although the rule did not require firms to forbid executive hedging, some companies started forbidding hedging activities by executives as the safest response to the rule.

The SEC approved the rule requiring the disclosure of hedging policies in annual proxy statements on December 18, 2018. This rule became effective for proxy statements filed in fiscal years beginning on or after July 1, 2019.

In untabulated tests, following Chen et al. (2020), we standardize the CSR score within each year (i.e., each yearly observations will have a mean of zero and a standard deviation of one). We find qualitatively similar results.

We start the sample period in 2002 because the ASSET4 database provides the ESG data from the year, and end it in 2016 due to data availability. The ASSET4 database does not significantly alter its measurement basis throughout the period.

See Appendix for detailed descriptions for each variable. We thank Jee-Hae Lim for providing data on CEO financial expertise.

Due to data availability, the inclusion of future CSR performance measured in year t + 1 (t + 2) reduces the sample period to 2003 to 2015 (2014).

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Titel: CEO Personal Hedging and Corporate Social Responsibility
verfasst von: Jongwon Park
Sunyoung Kim
Albert Tsang
Publikationsdatum: 22.01.2022
Verlag: Springer Netherlands
Erschienen in: Journal of Business Ethics / Ausgabe 1/2023
Print ISSN: 0167-4544
Elektronische ISSN: 1573-0697
DOI: https://doi.org/10.1007/s10551-021-05021-w

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