CEO Current and Prospective Wealth Option Compensation and Corporate Social Responsibility: The Behavioral Agency Model

Round 1

Reviewer 1 Report

Thank you for the opportunity to review the manuscript submitted to Sustainability.

Overall, the research addresses the relevant topic and takes as a starting point some questions that require further investigation. These research questions are developed in a theoretical and conceptual framework. Empirical analysis has been carried out to provide evidence for the research questions.

The paper must be improved in line with the comments below:

1. In the conclusions part, comparisons of the results of the article with the results of other studies should be found.

2. It would be good for the literature section to have more articles from 2022 and even 2023.

3. The author needs to mention limitations of the study.

I hope you find the above comments useful, and I wish you the best of luck with developing the paper further.

Author Response

Thank you for the opportunity to review the manuscript submitted to Sustainability. Overall, the research addresses the relevant topic and takes as a starting point some questions that require further investigation. These research questions are developed in a theoretical and conceptual framework. Empirical analysis has been carried out to provide evidence for the research questions.

The paper must be improved in line with the comments below:

1. In the conclusions part, comparisons of the results of the article with the results of other studies should be found.

Author Response:

Thank you for this comment. To the best of our knowledge, very few studies examine similar research questions to ours, making it difficult to compare our findings from those of others. Jain et al. (2023) is the only study that is closest to ours. Therefore, following your suggestion, we have stated that our findings complement Jain et al. (2023) in “Conclusion” section in the revised manuscript (please see the paragraph highlighted yellow on page 26). For your convenience, we have reproduced this paragraph below:

We utilize more precise constructs from BAM by arguing that CEOs’ loss aversion and risk-taking behavior from their current and prospective wealth option compensation influence their decisions to engage in positive CSR activities (CSR strengths), socially irresponsible activities (CSR concerns), CSR that brings benefits broader stakeholders in the society at large (institutional CSR), and CSR that provides benefits to stakeholders who are directly related to the firms’ operations (technical CSR). Our findings complement Jain et al. (2023) which shows that CEO perceptions of unfairness in compensation amplify the positive effects of CEO prospective option on excessive risk-taking, thereby increasing the likelihood of corporate social irresponsibility. Using KLD ESG concerns as one of proxies for socially irresponsible activities of firms, Jain et al. (2023) finds that CEO current option wealth is negatively associated with CSR concerns.

References

Jain, T., Zaman, R. and Harjoto, M. (2023), “Behavioral Agency Model and Corporate Social Irresponsibility: Uncovering the Implication of Fairness in CEO Compensation”, Journal of Management, Forthcoming. https://doi.org/10.1177/01492063231174873

2. It would be good for the literature section to have more articles from 2022 and even 2023.

Author Response:

Thank you for pointing this out. In the revised manuscript, we have added Al-Shaer et al. (2023) published in Review of Quantitative Finance and Accounting in “Related Literature” section and discussed their findings as follows (please see the paragraph highlighted yellow on page 7):

Using a sample of FTSE-All-Share companies for the period 2011–2019, Al-Shaer et al. (2023) find that CSR-linked compensation (CEOs who receive compensation from engagement in environmental activities) is positively related to socially responsible activities captured by enhancement in firms’ environmental performance.

We also have added one most recent study (Jain et al., 2023) forthcoming in Journal of Management into “Related Literature” section (please see the paragraph highlighted yellow on page 8). For your convenience, we have reproduced this paragraph below:

In the context of corporate irresponsible behaviors, Jain et al. (2023) attempts to advance the BAM by theorizing how the presence of conditions that result in distributive and procedural injustice in CEO compensation can further amplify the positive effects of CEO prospective option wealth on risk taking, thereby destroying stakeholder value. Using a longitudinal cross-sectional sample of 8,669 firm-year observations for the period 2001 to 2018, Jain et al. (2023) find that CEO perceptions of unfairness in compensation amplify excessive risk-taking, thereby increasing the likelihood of corporate social irresponsibility. This study has important implications, not only for advancing the BAM, but also for designing executive compensation.

References

Al-Shaer, H., Albitar, K., and Liu, J. (2023), “CEO power and CSR-linked compensation for corporate environmental responsibility: UK evidence”. Review of Quantitative Finance and Accounting, Vol. 60 No. 3, pp. 1025-1063.

Jain, T., Zaman, R. and Harjoto, M. (2023), “Behavioral agency model and corporate social irresponsibility: Uncovering the implication of fairness in CEO compensation”, Journal of Management, Forthcoming. https://doi.org/10.1177/01492063231174873

3. The author needs to mention limitations of the study. I hope you find the above comments useful, and I wish you the best of luck with developing the paper further.

Author Response:

We greatly appreciate this comment. We have discussed limitations of our study in “Conclusion” section in the revised manuscript (please see the paragraph highlighted yellow on page 26). For your convenience, we have reproduced this paragraph below:

We recognize that our study has potential limitations. One such limitation may result from endogeneity issues. Although we try to fully address these issues using firm fixed-effects and year fixed-effects in our model specifications, we cannot completely rule out endogeneity concerns that arise from omitted variable, simultaneity, and measurement error. We also acknowledge some weaknesses of the KLD database such as its unbalanced panel structure, certain construct–validity issues, and KLD’s own assessment of a firm’s CSR based on surveys and KLD’s in-house analysis (Cay et al., 2011; Chatterji et al., 2009). Therefore, we are careful not to overreach in our conclusions. Despite these limitations, the KLD database is one of the most used data sources for quantitatively measuring CSR engagement of firms.

References

Cai, Y., Jo, H. and Pan, C. (2011). “Vice or virtue? The impact of corporate social responsibility on executive compensation”, Journal of Business Ethics, Vol. 104, pp. 159-173.

Chatterji, A. K., Levine, D. I., and Toffel, M. W. (2009), “How well do social ratings actually measure corporate social responsibility?”, Journal of Economics & Management Strategy, Vol. 18 No. 1, pp. 125-169.

Author Response File: Author Response.docx

Reviewer 2 Report

Thank you for the opportunity to read this interesting article. The paper is written well but need some changes to further enhance its quality and readability. Below are some comments to address:

The introduction needs to be improved. It should be started from a broader area/ global context then narrow down it to your area/ local/ specific context. Highlight the problems/ research gaps and your proposed solution for that. Afterward, highlight the contributions of your study in a precise and focused way. Also provide paper structure therein. 

Also be consistent with the CSR or ESG. As you are looking for CSR therefore the ESG should be covered within the concept of CSR. 

Also strengthen the debate why you analyzed the time effect, industry effect, and firm effect in your regression analysis. 

The discussion of the findings should be strengthened and must be supported by latest literature (covered in 2023 and 2022).

The conclusion should be precise and focused to summarize the study.

Add some latest references.

I hope the comments and paper provided will help in this regard.   

Need to proofread the paper.

Author Response

Thank you for the opportunity to read this interesting article. The paper is written well but need some changes to further enhance its quality and readability. Below are some comments to address:

1. The introduction needs to be improved. It should be started from a broader area/ global context then narrow down it to your area/ local/ specific context. Highlight the problems/ research gaps and your proposed solution for that. Afterward, highlight the contributions of your study in a precise and focused way. Also provide paper structure therein. 

Author Response:

Thank you for your comments. Following your suggestions, we have streamlined the introduction section in a precise and focused way in our revised manuscript (please see “Introduction” section on pages 2 - 6).

Following your comments, we start our first paragraph in “Introduction” section with a broader context by citing a survey from top managers in the U.S. and European countries regarding their commitment in maintaining or increasing CSR spending.

We then highlight the research gaps by stating that seminal research studies that examine the relationship between CEO incentive and CSR performance based on the traditional agency model, which assumes top executives are rational agents who act based on their risk aversion, produce mixed empirical results.

We then introduce recent studies that propose to examine the relationship between CEO compensation and CSR from the behavioral agency model (BAM) perspective instead of the traditional agency model. Following this paragraph, we narrow down our focus into our research questions in which we implement BAM framework to examine the effects of CEO option compensations on firms’ CSR strengths, CSR concerns, institutional CSR and technical CSR. In doing so, we fill the gap in the literature since relatively little attention is paid to disentangle the relationship between top managers’ risk-taking and loss aversion incentives and firms’ CSR performance from the BAM perspective.

We then show our findings from this research and state our three contributions to the existing literature. Finally, we provide our paper structure in the last paragraph as you suggested in this comment.

2. Also be consistent with the CSR or ESG. As you are looking for CSR therefore the ESG should be covered within the concept of CSR. 

Author Response:

Thank you for pointing this out. We have discussed the link between CSR and ESG in footnote 1 in “Introduction” section in the revised manuscript (please see footnote 1 highlighted yellow on page 2). For your convenience, we have reproduced this footnote 1 below:

The terms ‘‘sustainability’’, ‘‘corporate social responsibility’’ (CSR), and ‘‘environmental, social, and governance” (ESG), have been used interchangeably in the literature to indicate a firm’s voluntary activities associated with its environmental, social, and governance impact and increase its positive contribution to society (Gillan et al., 2021; Khan et al. 2016). Consistent with recent literature, we use CSR and ESG interchangeably (Harjoto et al., 2022; Tsang et al., 2023; Yahia et al., 2023).

References

Gillan, S., Koch, A., and Starks, L. T. (2021), “Firms and social responsibility: a review of ESG and CSR research in corporate finance”, Journal of Corporate Finance, Vol. 66, 101889. https://doi.org/10.1016/j.jcorpfin.2021.101889.

Harjoto, M., Hoepner, A. G. F., and Nilsson, M. A. (2022), “Bondholders’ returns and stakeholders’ interests”, Review of Quantitative Finance & Accounting, Vol. 59 No. 4, pp. 1271-1301.

Khan, M., Serafeim, G. and Yoon, A. (2016). “Corporate sustainability: First evidence on materiality”, The Accounting Review, Vol. 91, pp. 1697-1724. 

Tsang, A., Frost, T., and Cao, H. (2023), “Environmental, Social, and Governance (ESG) disclosure: A literature review”, British Accounting Review, Vol. 55 No. 1., 101149. https://doi.org/10.1016/j.bar.2022.101149

Yahia, N. B., Chalwati, A., Hmaied, D., Khizer, A. M., and Trabelsi, S. (2023), “Do foreign institutions avoid investing in poorly CSR-performing firms?”, Journal of Banking and Finance, Vol. 157, 107029. https://doi.org/10.1016/j.jbankfin.2023.107029.

3. Also strengthen the debate why you analyzed the time effect, industry effect, and firm effect in your regression analysis. 

Author Response:

We thank the reviewer for pointing this out. We have discussed why we include firm and year fixed effects in “Empirical models” section in the revised manuscript (please see added sentences highlighted yellow on page 18). For your convenience, we have reproduced these sentences below:

To control for unobserved, time-invariant heterogeneity, we include firm fixed effects () in our model specification. We also use year fixed effects to control for factors changing each year that are common to all firms for a given year. Industry fixed effects are subsumed by firm fixed effects, thereby industry fixed effects are not included in both equations (1) and (2). 

4. The discussion of the findings should be strengthened and must be supported by latest literature (covered in 2023 and 2022).

Author Response:

We agree with the reviewer that we need to strengthen the discussion part of our findings using the latest literature. Accordingly, we have added one most recent study (Jain et al., 2023) forthcoming in Journal of Management into “Related Literature” section as well as “Conclusion” section in the revised manuscript (please see the paragraphs highlighted yellow on page 8 and page 26). To the best of our knowledge, very few studies examine similar research questions to ours, making it difficult to compare our findings from those of others. So far, Jain et al. (2023) is the only study that is closest to ours. In this regard, we ask for your understanding that we are not able to compare our findings, as much as we would like to, with those of the most recent studies. For your convenience, we have reproduced our new editions below:

“Related Literature” section:

In the context of corporate irresponsible behaviors, Jain et al. (2023) attempts to advance the BAM by theorizing how the presence of conditions that result in distributive and procedural injustice in CEO compensation can further amplify the positive effects of CEO prospective option wealth on risk taking, thereby destroying stakeholder value. Using a longitudinal cross-sectional sample of 8,669 firm-year observations for the period 2001 to 2018, Jain et al. (2023) find that CEO perceptions of unfairness in compensation amplify excessive risk-taking, thereby increasing the likelihood of corporate social irresponsibility. This study has important implications, not only for advancing the BAM, but also for designing executive compensation.

“Conclusion” section:

Our findings complement Jain et al. (2023) which shows that CEO perceptions of unfairness in compensation amplify the positive effects of CEO prospective option on excessive risk-taking, thereby increasing the likelihood of corporate social irresponsibility. Using KLD ESG concerns as one of proxies for socially irresponsible activities of firms, Jain et al. (2023) finds that CEO current option wealth is negatively associated with CSR concerns.

5. The conclusion should be precise and focused to summarize the study.

Author Response:

This is certainly a helpful comment. We have concisely summarized the conclusion in a focused and precise way (please see “Conclusion” section in the revised manuscript on pages 24 - 26).

We have removed the previous first paragraph in “Conclusion” section indicated below and directly summarized our study right from the first paragraph.

As corporate social responsibility (CSR) has taken the front and center of corporate managers’ priorities and top managers have indicated their commitments for investing in CSR, we pose a question regarding how CEO option incentive influences CSR investment. While the literature on CEO compensation and CSR has been well-populated, we argue that it is important to examine CEOs behavior as agents with bounded rationality from the behavioral agency perspective because CEOs are not always acting rationally and are not always behaving as risk-averse agents as the traditional agency theory assumed. Instead, CEOs may exhibit loss aversion and therefore, their actions are based on their fear of losing what they already earned and at the same time their actions can also represent their willingness to take on risks because they have nothing or very little to lose.

While we have streamlined our conclusion to deliver our findings more clearly to JRFM readers, we have also added and discussed limitations of our study in “Conclusion” section in the revised manuscript (please see the paragraph highlighted yellow on page 26). For your convenience, we have reproduced this paragraph below:

We recognize that our study has potential limitations. One such limitation may result from endogeneity issues. Although we try to fully address these issues using firm fixed-effects and year fixed-effects in our model specifications, we cannot completely rule out endogeneity concerns that arise from omitted variable, simultaneity, and measurement error. We also acknowledge some weaknesses of the KLD database such as its unbalanced panel structure, certain construct–validity issues, and KLD’s own assessment of a firm’s CSR based on surveys and KLD’s in-house analysis (Cay et al., 2011; Chatterji et al., 2009). Therefore, we are careful not to overreach in our conclusions. Despite these limitations, the KLD database is one of the most used data sources for quantitatively measuring CSR engagement of firms.

References

Cai, Y., Jo, H. and Pan, C. (2011). “Vice or virtue? The impact of corporate social responsibility on executive compensation”, Journal of Business Ethics, Vol. 104, pp. 159-173.

Chatterji, A. K., Levine, D. I., and Toffel, M. W. (2009), “How well do social ratings actually measure corporate social responsibility?”, Journal of Economics & Management Strategy, Vol. 18 No. 1, pp. 125-169.

6. Add some latest references. I hope the comments and paper provided will help in this regard.   

Author Response:

Thank you for this suggestion. Following your suggestion, we have added two recent references in the revised manuscript. First, we have added Al-Shaer et al. (2023) published in Review of Quantitative Finance and Accounting in “Related Literature” section and discussed their findings as follows (please see the paragraph highlighted yellow on page 7):

Using a sample of FTSE-All-Share companies for the period 2011–2019, Al-Shaer et al. (2023) find that CSR-linked compensation (CEOs who receive compensation from engagement in environmental activities) is positively related to socially responsible activities captured by enhancement in firms’ environmental performance.

Second, we have added Jain et al. (2023) forthcoming in Journal of Management into “Related Literature” section (please see the paragraph highlighted yellow on page 8). For your convenience, we have reproduced this paragraph below:

In the context of corporate irresponsible behaviors, Jain et al. (2023) attempts to advance the BAM by theorizing how the presence of conditions that result in distributive and procedural injustice in CEO compensation can further amplify the positive effects of CEO prospective option wealth on risk taking, thereby destroying stakeholder value. Using a longitudinal cross-sectional sample of 8,669 firm-year observations for the period 2001 to 2018, Jain et al. (2023) find that CEO perceptions of unfairness in compensation amplify excessive risk-taking, thereby increasing the likelihood of corporate social irresponsibility. This study has important implications, not only for advancing the BAM, but also for designing executive compensation.

References

Al-Shaer, H., Albitar, K., and Liu, J. (2023), “CEO power and CSR-linked compensation for corporate environmental responsibility: UK evidence”. Review of Quantitative Finance and Accounting, Vol. 60 No. 3, pp. 1025-1063.

Jain, T., Zaman, R. and Harjoto, M. (2023), “Behavioral agency model and corporate social irresponsibility: Uncovering the implication of fairness in CEO compensation”, Journal of Management, Forthcoming. https://doi.org/10.1177/01492063231174873

7. Need to proofread the paper.

Author Response:

Thank you for this comment. We have checked our manuscript thoroughly and made our revisions carefully. We also have our manuscript proofread by our colleagues.

Author Response File: Author Response.docx

Reviewer 3 Report

Congratulations to authors on original and well-developed idea. Interdisciplinarity of the paper makes it very attractive as it successfully combines concepts from behavioral economics, CSR, pay structures and risk-taking. I would just recommend to take into consideration panel data methodology in future work. To sum up, the paper is well-rounded and interesting, and I am looking forward to its publishing.

Author Response

Congratulations to authors on original and well-developed idea. Interdisciplinarity of the paper makes it very attractive as it successfully combines concepts from behavioral economics, CSR, pay structures and risk-taking. I would just recommend to take into consideration panel data methodology in future work. To sum up, the paper is well-rounded and interesting, and I am looking forward to its publishing.

Author Response:

Thank you for your kind review. We will consider panel data methodology in our future work.

Author Response File: Author Response.docx