Linking Executive Compensation and CSR

Companies are increasingly linking part of executive compensation to achieving Corporate Social Responsibility (CSR) targets, leading to a debate in management and academic literature about the technical problems involved. Linking pay to financial targets is relatively straightforward. But achieving a common definition of CSR targets is more challenging because of a lack of clear methodology, points out Andrea Dossi, Associate Professor at Bocconi Department of Accounting.

The paper "Corporate Social Responsibility Performance, Incentives, and Learning Effects" published in the Journal of Business Ethics by Dossi and co-authors looks at the effectiveness of linking executive compensation CSR goals across US firms through an empirical analysis of a cross-industry sample of 746 listed companies for the period 2002–2013.

Dossi and co-authors Laura Zoni (Università Cattolica del Sacro Cuore) and Giovanni-Battista Derchi (EHL) had two findings, both relevant for companies. Firstly, there is a correlation between CSR-based compensation for top management and CSR performance. It is an effective mechanism for stimulating CSR performance. Secondly, and more importantly, the study documented an improvement over 11 years. Linking compensation to CSR performance goals is likely to produce positive effects starting from the third year after adoption, as firms accumulate experience and learn how to use the system over time, the study said. "We found that the impact on CSR performance increased with the learning of how to use these mechanisms," Dossi said. "The higher the number of consecutive years you are using the measures, the higher the impact."

These results have implications. Companies seeking to generate CSR performance should start as soon as possible, said Dossi, because the learning curve is a long one and the targets need fine-tuning.

The trio also looked at CSR reports, a CSR advisory committee, and external audits. CSR incentives are strongly significant only when a CSR committee at the board level is established or a CSR report is produced and released. They found that CSR external audit did not seem to be positively associated with CSR performance. The audit would seem to be effective only if there were a clear methodology, and this is often not the case, said Dossi.

The complexity of linking executive compensation to CSR linked targets should not discourage companies from starting, he said, because the benefits are clear over time. The important thing is to start. "If you do not start this journey, you are losing CSR performance," he said. "And we can't afford to lose this."