by Yuxia Zou, Winner of the Cambridge Finance Best Student Paper Award 2022, Research Associate, Cambridge Centre for Finance and Cambridge Endowment for Research in Finance
During the past few decades, corporate social responsibility (CSR) issues have attracted enormous attention from regulators and the investment community around the world. Until now, the most widely adopted measure is CSR-related reporting, which is believed to be a critical ingredient in achieving broader CSR goals. Another measure that has grown in popularity among publicly listed firms in recent years is the formation of a separate board committee dedicated to CSR-related issues, the CSR committee. The percentage of publicly listed firms worldwide with CSR committees increased from 5.5% in 2002 to 14.2% in 2018. Given the emerging trend in CSR committee adoption worldwide, the natural questions to ask are: What incentives are behind firms’ decision to establish CSR committees? Does having a separate board committee dedicated to CSR issues bring any real effects to a firm’s operations and CSR performance? In a recent study co-authored with Associate Professors Jenny Chu and Xi Li, we address these two questions using a comprehensive dataset on board committees for more than 19,000 publicly listed firms across 96 countries between 2002 and 2018.
We first explore what motivates firms to have distinct CSR committees on their boards. We argue that CSR committee adoption is associated with both country-level and firm-level incentives. At the country level, we predict that the prevalence of CSR committee adoption is positively associated with CSR-related legislations, norms towards environmental and social issues. Consistent with our expectations, we find CSR committees are more prevalent in countries with effective CSR reporting regulation, more stringent environmental policies, and stronger social norms.
At the firm level, we argue that the decision to form a CSR committee reflects the tradeoffs between both internal and external costs and benefits associated with having a distinct CSR committee. Internally, having a separate committee enhances both the advising and monitoring roles of the board. Externally, establishing a CSR committee signals a firm’s sustainability culture and its determination to tackle CSR issues. Such a signal could help attract CSR-conscious employees, customers, and investors, ultimately enhancing firm value. However, having a separate CSR committee is not costless and the costs mostly incur internally. Existing directors may not have the experience or expertise to advise or monitor CSR policies or activities. Even if they do, assigning them to an additional committee may increase their workload. The searching costs arise when firms need to hire suitable directors to sit on the CSR committee, as the pool of candidates might be limited. Information segregation might also occur with a separate committee when directors outside of the CSR committee are not aware of the committee’s activities. This might in turn reduce the usefulness and relevance of advice made by committee members who lack certain firm-specific information.
We find that firms’ decision to adopt CSR committees is shaped by the tradeoffs between the costs and benefits of having a separate committee dedicated to CSR issues. Externally, the adoption decision is more common among firms with higher shareholder and stakeholder demands for CSR activities, such as firms operating in high-polluting industries, experiencing more frequent negative environmental or social incidents, and having a larger proportion of foreign shareholders and customers. Internally, firms with larger, more connected, and less busy boards are more likely to adopt CSR committees as they benefit more from improved task division and enhanced director accountability and face lower searching costs.
Next, we assess the effectiveness of having a separate CSR committee. On the one hand, having a dedicated CSR committee could improve the firm’s CSR performance by enhancing the advising and monitoring role of the board on CSR-related issues. On the other hand, firms may use CSR committees as a window-dressing device in response to CSR-related concerns raised by various stakeholders and to meet investors’ demand. Furthermore, the presence of a separate CSR committee on the board could be a part of a firm’s overall culture that emphasises sustainability, and it is often correlated with other organisational structures and policies aiming to achieve CSR goals. Therefore, it is unclear whether the CSR committee itself has any impact on the firm’s CSR performance.
Many investors view CSR issues as a risk factor, hence our primary measure of CSR performance is CSR risk, computed as the frequency of negative environmental and social incidents during a year. To further address the endogenous nature of firms’ decision to establish CSR committees, we employ a two-stage least-squares (2SLS) approach by using the connectedness of non-CSR directors with CSR directors at other firms as an instrumental variable (IV). Our 2SLS regression results indicate that adopting CSR committees is not associated with any changes in firms’ CSR risk in the first year following the adoption. However, when we expand the time horizon of the CSR risk measure, we start to observe a negative association in the second year following the adoption, and this negative association becomes statistically significant in the third and fourth years. These findings suggest that the presence of CSR committees reduces firms’ CSR risk in the long run.
Given the effect of CSR committees in decreasing CSR risk, we lastly explore the influence of CSR committees on firms’ operations. We observe that CSR committees are negatively associated with firms’ subsequent profitability, measured by return on assets (ROA), capital expenditures, and sales growth. This negative impact on operations is long-lasting as firms’ profitability and investment are reduced up to four years after establishing a CSR committee.
Together with the results on CSR risk, these findings provide support for the abandonment argument first put forth in the context of CSR reporting. In our context, due to heightened scrutiny by the CSR committees, firms abandon or scale back CSR-controversial business activities and investments to reduce CSR risk. In summary, our consequences analysis suggests that on average, CSR committees bring about real changes at these firms. Establishing dedicated CSR committees helps reduce CSR risk by increasing board scrutiny of firms’ operations and investments.