Corporate Governance and Environmental Performance: Is there really a link?

Judith L. WallsJohn Molson School of Business, Concordia University

Pascual BerroneIESE Business School, University of Navarra

Phillip H. PhanCarey School of Business, Johns Hopkins University

CIRANO &l'École Polytechnique de Paris

MontréalNovember 12, 2010

Motivation• Corporate governance is cause celebre

– Explosion of research– Emphasis on financial performance

• Corporate scandals– Debate: should social issues be included in strategic

agenda?

• Corporate governance and CSR– Only handful of academic research– CSR is a very broad topic– No dominant theoretical paradigm– Often in “vacuum” (shareholders or boards or management)– Contradictory results

Our approach• Phenomenon-driven research (Hambrick, 2007)

– Surprising and previously undocumented– Associational pattern– Temporal order is clear– Outcome variable is important– Sample is large and carefully constructed– Obvious covariates have been controlled for– Effect size is big

• All three levels of corporate governance

• Tightly focused– Environmental performance

Broad research questions

Institutional Ownership

Board of Directors

Managerial Incentives

Environmental Performance

Broad research questions

Institutional Ownership

Board of Directors

Managerial Incentives

Environmental PerformanceInteractions

Methodology• Reviewed literature on governance and CSR

– Selected independent variables based on past research– Shareholders

• Institutional owners (TF/Reuters)• Investor turnover (TF/Reuters)• Investor activism (RiskMetrics)• Investor concentration (TF/Reuters)

– Board• Independence (RiskMetrics)• Environmental committee (DEF 14-A)• Diversity (RiskMetrics)• Size (RiskMetrics)

– Managerial• CEO duality (ExecuComp)• Managerial control (ExecuComp)• CEO salary, bonus and options compensation (ExecuComp)

Methodology• Dependent variable: environmental performance

– KLD environmental strengths (beyond compliance)– KLD environmental concerns (failure to comply)

• Control variables (Compustat)– Financial performance (ROA)– Firm size– Leverage– Sales growth– R&D intensity– Capital intensity– Advertising intensity– Year effects (dummies)– Industry effects (dummies)

Methodology• Sample & estimation technique

– 313 firms over 9 years (1997-2005)– S&P500, polluting industries (primary & manufacturing)– Unbalanced panel of 2002 firm-years– OLS panel regression, transformed DV

Results – Main effects (owners)ENVT STR ENVT STR ENVT CON ENVT CON

Constant -0.456* -0.411* -0.520* -0.436†(s.e.) (0.183) (0.196) (0.213) (0.225)Firm Performance -0.015 -0.018 -0.064 -0.069

(0.064) (0.064) (0.071) (0.071)Firm Size 0.101** 0.098** 0.177** 0.170**

(0.017) (0.017) (0.020) (0.020)Sales Growth -0.004 -0.008 -0.039† -0.039†

(0.021) (0.021) (0.023) (0.023)Leverage 0.167* 0.185* 0.202* 0.226**

(0.077) (0.078) (0.086) (0.087)Cap Intensity 0.281* 0.269† -0.436** -0.448**

(0.140) (0.140) (0.157) (0.158)R&D Intensity -0.097 -0.103 -0.064 -0.065

(0.097) (0.098) (0.109) (0.109)Advg Intensity 0.784 0.782 -0.655 -0.699

(0.564) (0.565) (0.646) (0.644)Year Dummies incl incl incl inclIndustry Dummies incl incl incl inclInstitutional Owners 0.104 0.012

(0.119) (0.133)Investor Turnover -0.083 0.027

(0.164) (0.182)Environmental Proxies -0.031† 0.037†

(0.018) (0.021)Investor Concentration -0.291† -0.184

(0.161) (0.180)Overall R-Square 21.86% 21.80% 49.46% 49.56%

Two-tailed t-tests: ** p<0.01, * p<0.05, † p<0.10

Results – Main effects (board)

Two-tailed t-tests: ** p<0.01, * p<0.05, † p<0.10

ENVT STR ENVT STR ENVT CON ENVT CONConstant -0.456* -0.517** -0.520* -0.635**

(0.183) (0.186) (0.213) (0.210)Firm Performance -0.015 -0.011 -0.064 -0.058

(0.064) (0.064) (0.071) (0.071)Firm Size 0.101** 0.094** 0.177** 0.159**

(0.017) (0.018) (0.020) (0.020)Sales Growth -0.004 -0.001 -0.039+ -0.035

(0.021) (0.021) (0.023) (0.023)Leverage 0.167* 0.165* 0.202* 0.212*

(0.077) (0.077) (0.086) (0.086)Cap Intensity 0.281* 0.308* -0.436** -0.403**

(0.140) (0.140) (0.157) (0.156)R&D Intensity -0.097 -0.091 -0.064 -0.052

(0.097) (0.097) (0.109) (0.108)Advg Intensity 0.784 0.854 -0.655 -0.653

(0.564) (0.560) (0.646) (0.628)Year Dummies incl incl incl inclIndustry Dummies incl incl incl inclBoard Independence 0.001 0.002*

(0.001) (0.001)Environmental Committee 0.067** 0.143**

(0.025) (0.028)Board Diversity -0.000 -0.003+

(0.001) (0.002)Board Size 0.003 0.013*

(0.005) (0.005)Overall R-Square 21.86% 23.42% 49.46% 53.08%

Results – Main effects (managers)ENVT STR ENVT STR ENVT CON ENVT CON

Constant -0.456* -0.476* -0.520* -0.459*(0.183) (0.185) (0.213) (0.216)

Firm Performance -0.015 -0.012 -0.064 -0.071(0.064) (0.064) (0.071) (0.071)

Firm Size 0.101** 0.102** 0.177** 0.162**(0.017) (0.018) (0.020) (0.021)

Sales Growth -0.004 -0.001 -0.039+ -0.036(0.021) (0.021) (0.023) (0.023)

Leverage 0.167* 0.156* 0.202* 0.194*(0.077) (0.077) (0.086) (0.086)

Cap Intensity 0.281* 0.289* -0.436** -0.418**(0.140) (0.140) (0.157) (0.158)

R&D Intensity -0.097 -0.096 -0.064 -0.055(0.097) (0.097) (0.109) (0.109)

Advg Intensity 0.784 0.794 -0.655 -0.637(0.564) (0.566) (0.646) (0.649)

Year Dummies incl incl incl inclIndustry Dummies incl incl incl inclCEO Duality 0.022 -0.022

(0.024) (0.027)Managerial Control 0.000 -0.002

(0.003) (0.003)CEO Bonus -0.007 -0.001

(0.005) (0.005)CEO Salary 0.012 0.096*

(0.034) (0.038)CEO Options B/S -0.001 -0.000

(0.000) (0.000)Overall R-Square 21.86% 21.61% 49.46% 49.69%Two-tailed t-tests: ** p<0.01, * p<0.05, † p<0.10

Main Effects - SummarySTRONG ENVT PERF POOR ENVT PERF

InstitutionalOwnership

Less investor activismLess concentrated investors

More investor activism

Board of Directors Dedicated committee Dedicated committeeMore independent boardLess diversityLarger boards

Managerial Incentives

Higher CEO salary

Interaction effects – summary (within)STRONG ENVT PERF POOR ENVT PERF

InstitutionalOwnership

-- --

Board of Directors -- Diversity*Committee (-)Diversity*Size (+)

Managerial Incentives

Bonus*Options (-) Bonus*Duality (+)

Interaction effects – summary (between)STRONG ENVT PERF POOR ENVT PERF

Ownership & Board

Turnover*Independence (-)Activism*Board size (+)

Inst ownership*Diversity (-)Turnover*Independence (-)Activism*Independence (-)Concentration*Diversity (-)

Ownership &Management

Inst ownership*Salary (+)Activism*CEO duality (+)Activism*Bonus (-)Concentration*Mgr control (-)

Inst ownership*CEO duality (+)Inst ownership*Mgr control (-)Concentration*Mgr control (-)

Board & Management

Independence*CEO duality (-)Independence*Bonus (+)Independence*Salary (+)Diversity*Bonus (+)Board size*Bonus (+)Board size*Salary (+)

Independence*CEO duality (-)Board size*CEO duality (-)Board size*Salary (+)

Discussion• Agency theory: predicts no attention to long-term strategic

issues (EP)– Managerial discretion should be only determinant due to agency

gap– Board protects interest of shareholders and should side with them

• Phenomenon-driven approach shows:– Institutional investors are involved:

• investors engage in activism if “bad” EP• higher investor activism helps “good” EP, especially when CEO is powerful• when institutional investors control the firm, EP is worse

– Board structure can contribute to:• “bad” EP, especially if independent, large and lacking in diversity

– Managerial incentives:• largely irrelevant, except higher salary when “bad” EP• higher managerial control allows for better EP, especially if investor oversight is

minimal• when CEO has too much discretion (bonus, duality), then EP tends to be worse

Discussion• Resource-dependence theory: predicts that board provides

access to external resources– Boards play important role for long-term strategic goals– Support managers’ by giving access to critical expertise, skills, and

external resources• Phenomenon-driven approach shows:

– Board environmental committees• appear to be important both to mitigate “bad”, and promote “good” EP

– Board diversity• moderates some ownership structures so that EP is less “bad”

– Board interacts with managerial incentives• more independent board seems to support “good” EP, unless CEO already has

power through dual role as Chairman• managerial discretion is an important driver of “good” EP or less “bad” EP in

combination with multiple board structures• when board is (too) large, “bad” EP surfaces, especially if CEO has little discretion

Implications for theory• Traditional governance perspectives

– Emphasize shareholder primacy– May not be sufficient to explain this very complex phenomenon

• Consider other views relevant to EP:– Legal theories of governance (Lan & Heracleous, 2010)

• Stakeholder/Communitarian models• Managerialism• Director primacy models

– Behavioral governance approaches (Hambrick et al, 2008)• Power dynamics• Social networks• Social psychology• Symbolic management

Contributions• Coherent approach to assess governance and

non-financial outcome– All three levels of corporate governance– Interactions among and between them

• Phenomenon-driven– One of the earliest examples of this– First step towards developing theory– Drive future research in this important field

• Practical implications– How firms can set up governance structures for

environmental outcomes

Environmental Performance – Post Hoc Tests

• When environmental performance is “normal”(i.e. not failure to comply, not beyond compliance)

– Less likely to have environmental committee– Smaller board– Positive association with CEO Bonus

Appendix A – KLD

KLD environmental strengths KLD environmental concerns

Environmental products and services Hazardous waste liabilities > $50mil

Pollution prevention programs Substantial fines, penalties for air, water and other environmental regulation

Uses recycled materials Manufactures HCFCs or other ozone depleting chemicals

Uses alternative fuels (natural gas, wind, solar)

High level of toxic emissions (per EPA)

Environmental reporting such as CERES, GRI or other systems

Substantial producer of agricultural chemicals

Other Substantial climate change concerns (fuel, coal, oil)

Other

Appendix B - Correlations1 2 3 4 5 6 7 8 9 10

1 KLD strengths

2 KLD concerns 0.27

3 ROA 0.02 -0.03

4 Firm Size 0.33 0.49 0.00

5 Sales Growth 0.00 0.03 0.15 0.08

6 Leverage 0.11 0.20 -0.06 0.19 -0.06

7 Capital intensity 0.09 0.11 -0.07 0.18 0.11 -0.06

8 R&D intensity -0.08 -0.21 -0.34 -0.17 -0.01 -0.32 0.00

9 Advg intensity -0.06 -0.17 0.15 -0.04 -0.07 0.09 -0.13 -0.07

10 Institutional holdings -0.01 -0.09 0.11 -0.19 0.05 -0.03 -0.02 0.02 -0.08

11 Turnover (horizon) -0.05 -0.10 0.14 -0.21 0.11 0.03 -0.03 -0.03 -0.02 0.53

12 Activism 0.04 0.09 0.05 0.24 -0.02 0.00 -0.03 -0.05 0.09 -0.06

13 Invt concentration -0.08 -0.05 -0.04 -0.24 -0.06 0.09 -0.06 -0.02 -0.04 0.69

14 Board indep. 0.13 0.25 0.00 0.17 -0.04 0.17 -0.07 -0.03 -0.06 0.09

15 Board committee 0.25 0.42 -0.02 0.25 -0.04 0.10 0.01 -0.13 -0.08 0.02

16 Diverse board 0.08 0.03 0.13 0.14 -0.07 0.24 -0.17 -0.11 0.19 0.01

17 Board size 0.17 0.31 0.04 0.46 -0.03 0.27 0.02 -0.23 0.11 -0.22

18 CEO duality -0.08 -0.03 0.06 -0.06 0.01 -0.01 0.03 -0.05 0.07 0.00

19 Mgr Control -0.07 -0.14 0.01 -0.17 0.00 -0.10 -0.03 -0.06 0.18 -0.12

20 CEO bonus 0.08 0.09 0.13 0.26 0.08 0.02 0.12 -0.07 0.07 0.03

21 CEO salary 0.13 0.32 0.10 0.50 -0.02 0.17 -0.04 -0.16 0.12 -0.01

22 CEO options -0.03 -0.06 0.00 0.06 0.05 -0.10 0.01 0.11 0.03 -0.05

Appendix B - Correlations11 12 13 14 15 16 17 18 19 20 21

11 Turnover (horizon)

12 Activism -0.13

13 Invt concentration 0.33 -0.12

14 Board indep. -0.05 0.04 0.04

15 Board committee -0.01 0.07 0.06 0.18

16 Diverse board -0.05 0.08 -0.02 0.26 0.12

17 Board size -0.10 0.10 -0.17 0.08 0.17 0.14

18 CEO duality 0.08 -0.05 0.06 0.00 0.00 -0.05 -0.02

19 Mgr Control -0.04 -0.01 -0.06 -0.31 -0.04 -0.11 -0.09 0.02

20 CEO bonus -0.03 0.13 -0.09 0.02 0.02 0.07 0.06 -0.01 -0.08

21 CEO salary -0.11 0.22 -0.09 0.16 0.17 0.24 0.29 0.01 -0.12 0.26

22 CEO options 0.00 0.04 -0.09 -0.04 -0.04 -0.02 -0.06 -0.02 -0.04 0.03 -0.05