Topic review

Corporate Social Responsibility and Corporate Governance

Submitted by: Frank Li


Corporate governance and CSR both play an important role in shaping the objective function and the constraints faced by companies. As both areas grow rapidly, the overlap between them becomes more extensive and prominent. The research that links corporate governance to CSR has been drawing increasingly more attention. As shown in this chapter, the dynamics between them are complicated and subtle, which requires careful research design, rich data and cautious interpretation. The policy implications of the study in this area is obvious. When some governance mechanism is not only shareholder friendly but also stakeholder friendly, the policy maker should be happy to implement such mechanisms to maximize value for both shareholders and stakeholders. As described in this chapter, some governance mechanisms and CSR are indeed complements. However, some other governance mechanisms and CSR are substitutes for each other, and therefore the benefits of shareholders and stakeholders need to be carefully balanced. The balance is different under different circumstances.

Corporate Social Responsibility and Corporate Governance


Firms use two mechanisms to regulate their operations: corporate governance and corporate social responsibility (CSR). Corporate governance, in financial economics, is specifically defined as a mechanism that protects and maximizes shareholder value. Many textbooks used in business schools identify maximizing shareholder value as the ‘ultimate goal’ of profit-making companies. The business practices across the world are converging on a shareholder-centric ideology (Engelen, 2002; Hansmann and Kraakman, 2001).

However, other stakeholders of a firm are not willing to passively accept the deci- sions made by the firm, especially when their interests conflict with the interests of the shareholders. CSR facilitates the integration of business operations and values whereby the interests of all stakeholders, including customers, suppliers, employees, communities, governments, civil society and the environment, are reflected in the company’s policies and actions. Over the last several decades, CSR activities have become an increasingly important investment for firms. This growing significance has raised a fundamental ques- tion in financial economics: does CSR enhance shareholder value or is it an agency cost enjoyed by a firm’s managers at the expense of its various stockholders?

With respect to agency costs, a fundamental premise of the corporate governance literature within the field of financial economics is the notion that improved corporate governance ultimately leads to improved  firm financial performance and the creation of value for shareholders through the adoption of shareholder-friendly policies and the reduction of agency costs (Gompers, Ishii and Metrick, 2003, 2010). Shareholders are the principals in corporate governance who delegate control to professional managers.  A variety of corporate governance mechanisms are put in place to ensure that managers will make decisions in the best interests of the shareholders. As claimed by Shleifer and Vishny (1997), ‘the fundamental question of corporate governance is how to assure financiers that they get a return on their financial investment.’ More shareholder-friendly (better) corporate governance is achieved through the implementation of rules, practices and incentives that align the interests of a firm’s managers with shareholders. As a consequence, shareholders benefit economically by advocating for improved corporate governance within a firm.

The relationship between CSR and governance seems simple and clear-cut: if  CSR   is a type of agency problem, then good governance should reduce CSR. On the other hand, if CSR is not a type of agency problem, and indeed improves firm value, then good governance should increase CSR. While substantial research has examined this question from different perspectives, the evidence continues to be conflicting (Borghesi, Houston and Naranjo, 2014; Griffin and Mahon, 1997; Krüger, 2015; Margolis, Elfenbein and Walsh, 2009; Masulis and Reza, 2015). In the debate among scholars about the effects of CSR on firm financial performance, one of the most prominent arguments against the financial benefits of CSR has been the agency cost prediction first made by Friedman (1970), who characterized CSR activities as self-interested behavior by individual manag- ers at the expense of the firm’s shareholders. Subsequent studies have found supporting evidence of CSR as a potential agency cost, finding that CSR may be used to advance personal interests over the interests of shareholders (Borghesi et al., 2014; Brown, Helland and Smith, 2006; Cheng, Hong and Shue, 2014; Jiraporn and Chintrakarn, 2013; Krüger, 2015; Li, 2016b; Masulis and Reza, 2015), provide added job security to inefficient managers by pleasing stakeholders (Cespa and Cestone, 2007), compensate for the nega- tive consequences of engaging in earnings management (Prior, Surroca and Tribó, 2008) and enhance individual reputations of  managers (Barnea and Rubin,  2010). However,    a number of studies have also found a positive relationship between CSR activities and firm financial performance (Orlitzky, Schmidt and Rynes, 2003). Despite the considerable amount of academic attention on the topic, few definitive conclusions can be drawn from the collection of findings produced thus far. One important reason is that both corporate governance and CSR are multidimensional constructs, and hence the interac- tions between them are subtle and deserve tightly focused research. For example, different corporate governance mechanisms mitigate different agency problems and involve different monitoring costs. Some corporate governance mechanisms, while working to benefit the shareholders, also work in favor of stakeholders. For example, the media may blow the whistle on wrongdoings of the executives that hurt not only the shareholders but also some stakeholders; financial analysts help to increase the transparency of corporate affairs to outside stakeholders. Similarly, the different social activities of a firm may have different implications on shareholder value. Good governance encourages shareholder value–improving CSR projects while avoiding value-destroying CSR.

This chapter presents when and how CSR and governance could possibly affect each other, positively or negatively. These results can be grouped into four categories:

  • If a corporate governance mechanism is shareholder friendly and a CSR activity improves shareholder value, then the relation between the strength of governance mechanism and the CSR investment is
  • If a corporate governance mechanism is shareholder friendly and a CSR activity destroys shareholder value, then the relation is
  • If a corporate governance mechanism is stakeholder friendly and a CSR activity improves shareholder value, then the relation is
  • If a corporate governance mechanism is stakeholder friendly and a CSR activity destroys shareholder value, then the relation is ambiguous because the firm needs to balance between shareholders and

 It was not until recently that researchers began to examine the corporate governance– CSR dynamic. This is the first work that comprehensively surveys the relations between CSR and each of the corporate governance mechanisms.

Our contribution is threefold. First, this chapter summarizes the status quo in the interdisciplinary study of CSR and corporate governance. Second, it examines the specific channels, through which CSR and different governance mechanisms could be related.

Third, it provides suggestions for future research in each specific subfield. The rest of the chapter is organized as follows. Section 2 studies the relationship between CSR and board of directors, while Section 3 discusses the dynamics between CSR and executive com- pensation and incentives. Section 4 examines the CSR in firms with different ownership structure. Section 5 is on accounting and auditing regulation and practice. CSR-related firm culture is summarized in Section 6. Section 7 introduces law and regulations that are related to CSR. Section 8 concludes.


The board of directors, representing the shareholders, is usually the center of a firm’s corporate governance system. It is the board’s duty to set the strategy related to sustain- ability (Mackenzie, 2007), tie executive compensation to long-term sustainability (Ikram, Li and Minor, 2016), form sustainability-oriented committees and name executives, such as the Chief Sustainability Officer (CSO), to oversee social projects (Peters and Romi, 2015), and monitor sustainability reporting (Amran, Lee and Devi, 2014), and so on.

Johnson and Greening (1999) find that outside director representation improves corporate social performance, particularly in the people dimension and the product dimension of CSR, leading to their claim that ‘outside directors are hired to represent their constituents and have a stakeholder orientation.’ In addition, independent boards, which are composed of more outside board members, also encourage socially responsible behavior of firms (Webb, 2004) and discretionary dimensions of CSR (Ibrahim, Howard and Angelidis, 2003). According to Kesner and Johnson (1990), insider-dominated boards are more likely to be the subject of law suits. This effect is even stronger if the CEO also holds the position of board chairperson (CEO duality). Webb (2004) finds that CEO duality is negatively linked to CSR, while Berrone and Gomez-Mejia (2009) discern no association between it and environmental performance.

Meanwhile, board size generates contradictory results for CSR: it is positively related to environmental litigation (Kassinis and Vafeas, 2002) but also positively related to corporate philanthropy (Brown et al., 2006). Board diversity is a particular issue that falls into the overlap between corporate governance and CSR. The board of directors must be diverse to understand and accommodate different perspectives of a heterogeneous group of stakeholders. Boulouta (2013) finds that board gender diversity significantly improves CSR ratings by reducing ‘negative’ business practices. The author argues that female directors have higher ‘empathic caring’ than male directors. Meanwhile, Fourie (2013) asserts that diversity of board members’ ethnicity and age also matters to corporate social performance.

In addition, the affiliation between boards may affect the CSR of the companies involved through the channels of director interlocks1 (Ortiz-de-Mandojana and Aragon- Correa, 2015) and sustainability-themed alliances with more independent directors involved (Post, Rahman and McQuillen, 2015).



Excessive executive compensation and misaligned executive incentives, reflecting weak corporate governance, may destroy shareholder and stakeholder value. The literature (e.g., McClendon, 2009) identifies excessive executive compensation in the financial industry as a factor that led to the recent financial crisis. Agrawal and Chadha (2005), Johnson, Ryan and Tian (2003) and Peng and Röell (2003) have all discovered that some executive incen- tives, such as option-based compensation, are highly correlated with the propensity of firms to restate earnings, commit fraud, or be subject to class action lawsuits. Meanwhile, Minor (2016) finds that higher executive pay-for-performance sensitivity leads to higher odds of environmental law-breaking and magnitude of environmental harm. The consen- sus seems to be that equity-based compensation is a strong incentive for the executives to work harder and better for the shareholders, sometimes at the cost of the stakeholders.

More recently, firms have started tying executive compensation directly and explicitly to sustainability metrics as a way to signal their commitment towards CSR and motivate their executives to make socially responsible decisions. Hong, Li and Minor (2016) hand-collected compensation contract data for the top five highest-paid executives of firms in the Standard & Poor’s 500 Index in 2013 and found that 38 percent of the S&P 500 corporations explicitly linked their executive compensation to social performance. For instance, Intel links 3 percent of all its employees’ annual bonuses to environmental sustainability metrics and goals. Similarly, 20 percent of the executive bonus plan in Alcoa is linked to carbon dioxide reduction and other environmental and safety-related goals. The media and practitioners have also advocated for more widespread use of such CSR-contingent compensation,2 claiming that they can be more effective at creating firm value when compared to standard pay-for-performance initiatives that induce myopic managerial decision-making and unduly prioritize short-term stock returns over long-term value for all stakeholders (Jensen, 2002; Kaplan and Norton, 1992; Lenssen, Bevan and Fontrodona, 2010). Related academic research on the use of non-financial performance metrics to award executive compensation also suggests that under certain situations granting CSR-contingent compensation to executives can constitute optimal contracting (e.g., Feltham and Xie, 1994; Hölmstrom, 1979; Ittner, Larcker and Rajan, 1997).3 Additionally, institutional theory posits that firms stand to gain legitimacy by conforming to the expectations of institutions and stakeholders (Aldrich and Fiol, 1994; Bansal, 2005). Given that corporations are increasingly expected to fulfill their duties towards all stakeholders, institutional theory suggests that granting CSR-contingent contracts can establish or reinforce a firm’s legitimacy, thereby reducing the probability of organizational failure (Scott, 1995) and possibly improving financial performance (King and Lenox, 2002).

At the same time, however, critics of pay-for-CSR argue that these contracts create the same perverse incentives that their pay-for-performance counterparts do. According to this view, managers have significant say in determining their own pay, especially when boards are co-opted and board monitoring is weak (Bebchuk and Fried, 2004; Linden and Lenzner, 1995). As such, it is no coincidence that more firms have started using CSR-contingent compensation contracts recently as regular bonuses have come under increased scrutiny by market participants and regulators in the wake of the financial crisis (Kolk and Perego, 2014).4 Relatedly, Ittner et al. (1997) report that one way  managers  are able to increase their compensation is by tying it to the achievement of non-financial performance measures, including sustainability metrics, that are potentially easy to manipulate and hard to assess. Setting CSR benchmarks can also be fairly subjective, and managers who have ‘captured’ the board can set easy-to-achieve CSR targets in order to boost total compensation.

Hong, Li and Minor (2016) tested the above two opposing theories and found robust evidence that stronger corporate governance is more likely to provide compensation to executives linked to firm social performance outcomes. Furthermore, they found that providing such direct incentives for CSR is an effective tool to increase the corporate social performance of a firm.

In terms of other compensation incentives, such as pay–performance sensitivity (delta) and pay–risk sensitivity (vega), there is simply a void in the literature. A manager with high delta is more likely to choose CSR projects that create more value for the sharehold- ers. Similarly, a manager with high vega is inclined to invest in riskier CSR projects. Based on these hypotheses, researchers can test what type of CSR projects increase firm value or risk under which circumstances. For example, a CEO currently running many low-risk projects while investing in a new CSR project may add uncertainty because it may be riskier than all the currently ongoing projects. On the contrary, if the CEO is running many high-risk projects, adding CSR projects may diversify the risk or the CSR projects themselves may have lower risk than the current projects. In other words, investing in CSR may very well be riskier than investing in the firm’s ongoing projects in which it has obtained a certain expertise and comfort in assessing the risks. In the end, this is an empirical question.


Higher institutional ownership leads to stronger corporate monitoring (Del Guercio and Hawkins, 1999; Grossman and Hart, 1980; Hartzell and Starks, 2003; McConnell and Servaes, 1990; Nesbitt, 1994) as dispersed share ownership creates a ‘free rider’ problem (Grossman and Hart, 1980). In the context of CSR, it appears that large owners, through their intensive monitoring efforts, improve both financial and social performance (e.g., Graves and Waddock, 1994). However, the literature also finds that large shareholders are typically not generous on corporate philanthropy (Bartkus, Morris  and  Seifert, 2002; Brammer and Millington, 2005). Meanwhile, Barnea and Rubin (2010) and Jo and Harjoto (2011, 2012) find no significant relation between institutional ownership and CSR.

On balance, different  institutional  owners  have  different  interests,  and  therefore we do not expect a uniform relationship to exist for all types of institutional owners. Shareholders vary in their risk preference (Ryan and Buchholtz, 2001), their goals (Ryan and Schneider, 2003) and their investment horizons (Gaspar, Massa and Matos, 2005). Ultimately, institutions face a choice between exerting monitoring effort for shared gain versus simply trading for private benefit (Kahn and Winton, 1998; Shleifer and Vishny, 1986). Consistently, prior empirical research shows that institutions whose private benefits are likely to exceed the net benefit from monitoring exhibit weak corporate gov- ernance. For instance, Brickley, Lease and Smith (1988) argue that institutional investors such as insurance companies have either existing or potential business relationships with firms, and are therefore less likely to challenge management decisions in order to protect those relationships. In contrast to such pressure-sensitive institutions, institutions such as investment companies, independent investment advisors and public pension funds are pressure insensitive (in that they do not seek business relationships with the firms they have a stake) and are therefore more likely to be effective independent monitors. Using Brickley et al.’s classification of pressure-sensitive and pressure-insensitive institutional owners, Almazan, Hartzell and Starks (2005) document that greater share ownership by pressure-insensitive investors is associated with greater discipline on executive compensa- tion. Using the same classification, Chen, Harford and Li (2005) show that pressure- insensitive ownership is associated with better acquisition decisions. In the context of CSR, Oh, Chang and Martynov (2011) find that ownership by banks, pension funds   and foreign investors is positively related to firms’ social performance. They attribute this finding to the long-term investment horizon of these institutional investors, which is consistent with other studies reporting similar results (e.g., Neubaum and Zahra, 2006). In closely held companies (by directors and managers), the level of public interest can be low (e.g., Ghazali and Nazli, 2007).

Most previous literature on CSR and mutual funds focuses exclusively on socially responsible investments (SRIs) and their financial performance (Geczy, Minton and Schrand, 2006; Renneboog, Horst and Zhang, 2008). Li, Patel and Srikanth (2016) measure CSR of mutual funds by averaging the CSR ratings of all the companies they are holding. They find that socially responsible mutual funds not only select socially responsible firms, but also that they improve their social performance through the channel of corporate governance.

Another line of research looks at the investment horizons of different investors and suggests that institutions’ investment horizons are positively related to corporate social performance (Neubaum and Zahra, 2006). Banks are more likely tobe stakeholder friendly. Thompson and Cowton (2004) and Oh et al. (2011) argue that banks, as facilitators of industrial activity, are obliged to demand more sustainable behavior from the firms they control. Johnson and Greening (1999) document a positive relationship between pension fund ownership and different aspects of firms’ social performance, especially the product quality, but find no relation between mutual and investment bank funds and CSR.


In the literature, ‘sustainability accounting’ and ‘sustainability auditing’ are usually juxtaposed as they are very closely intertwined. According to the basic definitions of accounting and auditing, we believe sustainability accounting is an activity of prepara- tion and presentation of sustainability-related information, while sustainability auditing involves verification and evaluation of this information.

Good accounting practices mitigate information asymmetry between the insiders and the outsiders, and therefore reduce misleading information and wrongdoing. Internally, ‘sustainability accounting’ is acquiring increasing importance in the integrated account- ing systems of companies to provide help for managers dealing with CSR-related deci- sions. Externally, to provide regulators and society with precise information of CSR, the Global Reporting Initiative publishes corporate sustainability reports (Lamberton, 2005) to improve sustainability reporting quality.

Henri and Journeault (2010) show that environmental performance plays a mediating role between the management control system and economic performance. The implica- tion for management is to integrate environmental issues into the accounting system. For example, accountants should develop specific social performance indicators and use these indicators to monitor compliance, assess performance and motivate improvement. The goal is to efficiently engage stakeholders to improve social, environmental and economic performance (Gao and Zhang, 2006).


Firm culture is the breeding ground for corporate governance. Li (2014, 2016a) finds that a culture of mutual monitoring among the top executives can mitigate the agency problem and improve firm financial performance. Dyck, Morse and Zingales (2010) discover that employee whistle-blowing is an important source of discovering corporate fraud. This culture is usually bottom up, but can be encouraged from the top down, for example by providing financial incentives to whistle-blowers from firms (Call, Kedia and Rajgopal, 2016) or from the government (Section 922 of the Dodd-Frank Act).

Other aspects of firm culture are also salient. It is intuitive that a socially responsible firm culture goes hand in hand with better governance. McGuire, Omer and Sharp (2012) show that firms located in religious areas are less likely to engage in financial irregularities. Additionally, Li et al. (2016) find that socially responsible mutual funds not only select socially responsible firms to invest in, but also further enhance their social performance. Moreover, employees at philanthropic firms are more likely to blow the whistle when they observe wrongdoing and the board is more likely to force out a CEO after miscon- duct is revealed (Bereskin, Campbell and Kedia, 2016). The reason, they argue, is that corporate philanthropy attracts socially conscious employees that have a low tolerance to misbehavior. In addition to the above, other recent papers that link CSR to governance through a possible culture channel show that CSR ratings are associated with less insider trading (Gao, Lisic and Zhang, 2014), smaller discretionary accruals (Kim, Park and Wier, 2012) and fewer tax-avoidance strategies (Hoi, Wu and Zhang, 2013).


As a result of corporate scandals, we have seen major regulatory changes in the past two decades to engage in good governance practices, so as to avoid economic pitfalls and to encourage disclosure and transparency as part of good business ethics. These reforms are categorized as audit, board and disclosure relate. Many equity markets and countries have adopted CSR-related regulations and guide- lines while developing global standards for CSR remains a mission impossible. The Global Reporting Initiative and its Sustainability Reporting Guidelines, which attempt to elevate sustainability reporting practices to a level equivalent to that of rigorous financial report- ing, have considerably improved the quality of information reported, voluntarily, by companies about their social performance. Some countries, such as Germany, Denmark, Finland, Sweden and the Netherlands, have made sustainability reporting compulsory for certain categories of firms, depending on size or sector of activity.


Corporate governance and CSR both play an important role in shaping the objective function and the constraints faced by companies. As both areas grow rapidly, the overlap between them becomes more extensive and prominent. The research that links corporate governance to CSR has been drawing increasingly more attention. As shown in this chapter, the dynamics between them are complicated and subtle, which requires careful research design, rich data and cautious interpretation. The policy implications of the study in this area is obvious. When some governance mechanism is not only shareholder friendly but also stakeholder friendly, the policy maker should be happy to implement such mechanisms to maximize value for both shareholders and stakeholders. As described in this chapter, some governance mechanisms and CSR are indeed complements. However, some other governance mechanisms and CSR are substitutes for each other, and therefore the benefits of shareholders and stakeholders need to be carefully balanced. The balance is different under different circumstances.

While this chapter summarizes the most important and popular research areas, there are areas on which little research has been conducted. For example, the effects of media, financial analysts and corporate takeover, as corporate governance mechanisms, on CSR are equally important but unexplored. Substantial progress in these areas affords potential research opportunities and plausible ways forward for both theorists and empiricists.


  1. That is, directors who simultaneously sit in the boards of multiple companies.
  2. According to Veena Ramani, Senior Director of Corporate Programs (CERES), ‘at the end of the day people are motivated by their pocketbooks. So I think investors have come to recognize that if you want companies to take [sustainability] seriously, you are going to have to link it to people’s ’
  3. For example, Davila and Venkatachalam (2004) find that load factors, an important non-financial perform- ance measure in the airline industry, provide incremental information about the CEOs’ actions. Coles, Li and Wang (2017) consider industry tournament as effective executive
  4. A study by GMI Ratings indicates that at some firms as much as 30–40 percent of an executive’s annual bonus could be tied to sustainability targets. Xcel Energy, for instance, tied one-third of its CEO’s annual bonus to renewable energy, emission reduction, energy efficiency and clean technological goals in 2013 (Kapur, 2013).


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