When the Harvard Business Review named Pablo Isla of Spanish retailer Inditex the Top CEO of 2017, it may have struck some as an odd choice. “Measured on financial returns alone, Isla comes in 18th in our ranking,” reads the article accompanying the list. But, it continues, “his company’s performance on environmental, social, and governance factors, which count for 20 percent of a leader’s score, propelled him to the top spot.”
Such is the new rubric in the age of corporate social responsibility, or CSR. Investors and customers increasingly demand that corporations not only make a profit, but also ameliorate their negative impact on the world, whether by reducing waste and greenhouse gas emissions, cutting sweatshops out of a supply chain, or improving labor standards for workers.
For company leaders, more than magazine rankings are at stake. Lately, a swelling number of firms have started to base part of their top executives’ compensation on how successfully they hit certain CSR benchmarks.
Such payment schemes, known as “CSR contracting,” struck Kellogg’s Dylan Minor as suspicious.
“For me, it wasn’t at all clear that if you’re a company contracting on CSR, you’re actually going to create greater levels of CSR,” says Minor, an assistant professor of managerial economics and decision sciences.
To him, many CSR efforts looked like little more than PR fluff. Minor suspected that when push came to shove, executives would prioritize the company’s bottom line over what was socially responsible. And because CSR is notoriously difficult to quantify, CEOs could likely use dubious metrics to pad their salaries with little accountability in terms of what they were actually accomplishing. “It would be a great way for executives to pull more money out of the company,” Minor thought.
Was this skepticism justified? To find out, Minor conducted a study with Caroline Flammer of Boston University and Bryan Hong of the University of Western Ontario, looking closely at corporations that base executive pay partly on CSR performance.
To Minor’s surprise, the research revealed that CSR contracting actually hit its mark, leading companies to reduce emissions, increase eco-friendly or “green” patents, and improve social responsibility ratings across the board. Those actions, in turn, increased companies’ value over the long run.
However, Minor notes that not every firm that does CSR contracting will reap easy rewards. “Half the folks out there are doing what we would call ‘greenwashing,’ where they just put these things up, and they’re not very substantive,” he says. “Our positive findings are based on those companies that are really being truthful and transparent about what they’re doing.”
Corporate Social Responsibility Catches Fire
When Minor was working in finance in the early 2000s, CSR contracting was hardly on his radar. “Some people were talking about it, but it definitely wasn’t mainstream,” he recalls.
As last year’s Top CEO criteria reveal, times have changed. Yet economists still know precious little about this phenomenon. “When I started working on this in the last year, there hadn’t been a single paper published on this,” Minor says.
That meant the researchers would have to gather their own data. They discovered that companies that engage in CSR contracting have to disclose the practice to the U.S. Securities and Exchange Commission. “So basically we orchestrated an army of research assistants to manually hand-gather data from all of these filings.”
The result was a first-of-its-kind database that includes CSR contracting data for all 500 companies in Standard & Poor’s 500 Index between 2004 and 2013.
Looking over the complete database, Minor was struck by the rapid pace of growth in CSR contracting. As of 2013, “almost 40 percent of public companies were currently contracting in some form,” he says. “Going back ten years, it was only 12 percent.”
Another surprise: companies in emissions-intensive industries like mining, energy, and transportation were roughly twice as likely as the average company to utilize CSR contracting.
“You can imagine, in those industries, it could be more tempting to take advantage of the environment,” Minor says. “But a good number of companies are saying to their executives, ‘Hey, also pay attention to emissions and these other kinds of things.’”
It was clear that CSR contracting was trendy, and getting trendier every year. But whether the practice yielded real results was another question altogether.
Does CSR Contracting Work?
To determine whether CSR contracting actually led to more responsible behavior, the researchers looked at three different measures for each company: its toxic chemical emissions (as measured by the Environmental Protection Agency), the number of green patents filed (according to a patent database), and its overall social responsibility rating (compiled regularly by an independent advisory firm). Because the dataset spanned a decade, researchers were able to contrast how companies performed before and after they adopted CSR contracting.
They found improvements in all three dimensions. On average, and controlling for other variables, CSR contracting led a company to cut emissions by nearly nine percent, increase green patents by three percent, and receive a five percent higher CSR rating.
Minor underscores how surprising this result is.
“These are the 500 largest U.S. companies, which are often criticized for only caring about the next quarter, and the bottom line, and how many more pennies did they increase for the quarter,” he points out.
Just as incredibly, these changes did not come at the expense of that bottom line. Minor’s team found that CSR contracting led a firm’s value to increase by three percent over the next year.
According to the researchers, this growth happens because CSR contracting forces executives to sacrifice short-term payoffs for long-term gains.
Cutting emissions, for example, may be costly in the moment, but significantly reduces the risk of hefty fines or a damaging boycott down the road. And by implementing better labor standards, a company improves worker satisfaction—which soon translates into higher productivity.
“It seems if you contract with your top executives on different social issues, that you can actually impact the ultimate performance of the company,” Minor says.
The Bright Future of CSR Contracting
Minor expects that within the next decade, 60 to 80 percent of major companies could be contracting on CSR. He thinks that small businesses may want to try out the practice as well.
“These findings should be even stronger for smaller kinds of companies, where there aren’t so many competing interests and so many layers between what one person does and the final performance of the company,” he says.
However, would-be CSR contractors should take heed: if they are not serious and explicit about their social responsibility goals, they will reap few benefits. In a follow-up study currently underway, Minor has found that companies that do CSR contracting fall neatly into two groups.
“Some companies are very loosey-goosey” in their requirements of executives, he explains. “They say, ‘Oh, we do some social responsibility stuff,’ but they don’t actually tell you how or why. As opposed to other firms who say, ‘Hey, we’re going to give our CEO an extra million dollars if they hit these three sustainability goals.’”
As expected, the bulk of the impressive results appear to be coming from the latter group.
Caveats aside, Minor says that this study has left him far less skeptical of firms that seek to improve social responsibility through executive compensation.
“I think it’s an innovation in terms of incentives and contracting that, fortunately, some companies tried out,” he says. “And now we’re getting enough data to show that it actually seems to work pretty well.”
Jake J. Smith is a writer and radio producer in Chicago.
Previously published in Kellogg Insight. Reprinted with permission of the Kellogg School of Management.