Corporate governance and the rise of integrating corporate social responsibility criteria in executive compensation: Effectiveness and implications for firm outcomes

Abstract

Research SummaryThis study examines the integration of corporate social responsibility (CSR) criteria in executive compensation, a relatively recent practice in corporate governance. We construct a novel database of CSR contracting and document that CSR contracting has become more prevalent over time. We further find that the adoption of CSR contracting leads to (a) an increase in long‐term orientation; (b) an increase in firm value; (c) an increase in social and environmental initiatives; (d) a reduction in emissions; and (e) an increase in green innovations. These findings are consistent with our theoretical arguments predicting that CSR contracting helps direct management's attention to stakeholders that are less salient but financially material to the firm in the long run, thereby enhancing corporate governance.Managerial SummaryThis paper examines the effectiveness and implications of integrating environmental and social performance criteria in executive compensation (CSR contracting)—a recent practice in corporate governance that is becoming more and more prevalent. We show that CSR contracting mitigates corporate short‐termism and improves business performance. Firms that adopt CSR contracting experience a significant increase in firm value, which foreshadows an increase in long‐term operating profits. Furthermore, firms that adopt CSR contracting improve their environmental and social performance, especially with respect to the environment and local communities. Overall, our findings suggest that CSR contracting directs management's attention to stakeholders that are less salient but financially material to the firm in the long run, thereby improving a firm's governance and its impact on society and the natural environment.