CSR Controversies and Director Reputation

JCF Special Issue Conference, Hong Kong, December 18-19th, 2017

Prof. Kent A. Hickman, Gonzaga University, Spokane, WA 99258, USA, hickman@gonzaga.edu

Prof. Timo P. Korkeamäki, Hanken School of Economics, 00101 Helsinki, Finland, timo.korkeamaki@hanken.fi

Ph.D. Student Niclas O. Meyer, Hanken School of Economics, 00101 Helsinki, Finland, niclas.meyer@hanken.fi

© Hanken Svenska handelshögskolan / Hanken School of Economics, www.hanken.fi

OP GROUP RESEARCH FOUNDATION

STIFTELSEN SVENSKA HANDELS-HÖGSKOLAN

JACOB PALMSTIERNA FOUNDATION

Research Question

» Reputation important for directors’ career prospects. Works as incentive

to monitor firms and managament.

» Director reputation is affected by earnings restatements (Srinivasan, JAR

2005), financial fraud (Fich & Shivdasani, JFE 2007), bankruptcy/debt

restructuring (Gilson, JFE 1990), and proxy contests (Fos & Tsoutsoura,

JFE 2014).

» Director reputation following other types of firm misconduct has received

less attention.

» Do other types of controversies, related to a firm’s social responsibility,

(also) affect director reputation?

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Motivation

» Firms suffer significant losses following financial misconduct (Karpoff &

Lott, 1993; Karpoff, Lee, & Martin, 2008; Haslem et al., 2017).

» But also following other types of misconduct, such as negative CSR events

(Krüger, 2015), and environmental misconduct (Karpoff, Lott, & Wehrly,

2005).

» The reputation hypothesis (Fama and Jensen, 1983) posits that directors

lose other seats following misconduct becuse of tarnished reputations.

» We study the proposition that directors on boards of firms involved in

CSR controversies incur reputational penalties in the director labor market.

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Hypotheses

» Hypothesis 1: Directors of CSR controversial firms will lose more seats at

other firms than will directors of clean (no CSR controversies) firms.

» Hypothesis 2: Directors of clean firms will be more likely to add

directorships than directors of CSR controversial firms.

» Research Question: What types of controversies (environmental, social,

governance, economic) have the greatest impact on directors’ desirability in

the labor market?

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Research Design

» Univariate results:

» Proportions tests, t-tests of equality of means, figures, etc.

» Director reputation (OLS regressions):

» Examine net change in other directorships.

» Logit regressions:

» Examine losses in other directorships.

» Dependent variable is indicator variable for whether director retains seat in four years.

» Main independent variable is our controversy measure.

» Director- and firm-control variables. Year-fixed effects.

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∆ 𝑂𝑡ℎ𝑒𝑟 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠ℎ𝑖𝑝𝑠𝑡+4 − 𝑜𝑡ℎ𝑒𝑟 𝑑𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠ℎ𝑖𝑝𝑠𝑡−1 𝑖 =

β0 + β1 𝐶𝑜𝑛𝑡𝑟𝑜𝑣𝑒𝑟𝑠𝑦 𝑚𝑒𝑎𝑠𝑢𝑟𝑒 𝑖 + β𝑛 𝐷𝑖𝑟𝑒𝑐𝑡𝑜𝑟 𝑐𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 𝑖 + β𝑘 𝐹𝑖𝑟𝑚 𝑐𝑜𝑛𝑡𝑟𝑜𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠 𝑖 + 𝑌𝑒𝑎𝑟 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + ε𝑖

Data

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» Asset4 ESG: screens newspapers, sustainability reports, NGOs, etc. for 1,014

US firms for controversies.

» We use the # of controversies as a measure of negative media attention.

» Controversial firms: Firms with # of controversies in the top 5 % of firms for

each year within each category between 2003 - 2008.

» Clean firms: No controversies between t – 3 and t + 4.

» BoardEx: We track directorships from t – 1 through t + 4.

» Control variables: age, tenure, # of directorships, gender, audit member, etc.

» 1,963 independent directors and 533 affiliated directors.

» Compustat: Firm-specific variables (size, performance, market values, etc.).

Asset4 ESG Controversy Types and Categories

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Samples

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Table 2 Controversies by type and firm-year observations from 2003 through 2008 and firm year observations for clean

firms from 2005 through 2008.

The controversial sample includes only the firms that belong among the top 5th percentile of firms based on the number of

controversies per category. The clean sample includes all identified 37 clean firms.

Controversy type Number of

controversies

Firm-year

obs. Mean Median Maximum Minimum

Environmental 85 37 2.30 2 6 1

Environmental Emission Reduction 53 15 3.53 3 6 3

Environmental Resource Reduction 0 0 0.00 0 0 0

Environmental Product Impact 32 23 1.39 1 5 1

Social 567 93 6.10 5 35 1

Social Community 314 49 6.41 6 25 3

Social Human Rights 37 18 2.06 1 5 1

Social Workforce 94 22 4.27 4 7 2

Social Product 122 21 5.81 4 13 3

Corporate Governance 48 41 1.17 1 3 1

CG Compensation Policy 48 41 1.17 1 3 1

CG Shareholder Rights 0 0 0.00 0 0 0

Economic 90 32 2.82 3 6 2

Economic Shareholder Loyalty 31 11 2.82 3 4 2

Economic Customer Loyalty 59 21 2.81 3 6 2

Clean firms 0 88 0 0 0 0

Controversial and clean firms

Panel B CLEAN DIRECTORS CONTROVERSIAL DIRECTORS VARIABLES N Mean Med. Stdev. Min. Max. N Mean Med. Stdev. Min. Max.

Net change in other directorships in two years 376 -0.160 0 0.794 -3 4 1,285 -0.286 0 0.892 -5 3

Net change in other directorships in three years 376 -0.215 0 0.940 -3 4 1,285 -0.388 0 1.083 -12 3

Net change in other directorships in four years 376 -0.274 0 1.029 -4 5 1,285 -0.460 0 1.207 -12 3

Total number of controversies 376 0 0 0 0 0 1,285 4.489 3 5.026 1 35

Controversy and loses board 376 0 0 0 0 0 1,285 0.188 0 0.391 0 1 Controversy and retains board 376 0 0 0 0 0 1,285 0.812 1 0.391 0 1

No controversy and loses board 376 0.141 0 0.348 0 1 1,285 0 0 0 0 0

No controversy and retains board 376 0.859 1 0.348 0 1 1,285 0 0 0 0 0 Estimated average costs (t through t + 2) 369 0.000 0 0.000 0 0.002 1,285 0.005 0.000 0.019 0 0.183

Controversies in years t - 1 and t - 2 376 0.077 0 0.267 0 1 1,273 5.046 3 7.596 0 66

Controversies in years t + 1 and t + 2 376 0.133 0 0.384 0 2 1,273 13.66 9 14.90 0 81

Age (Yrs) 376 60.91 61 6.930 42 83 1,285 61.04 62 7.308 36 82

Time on board + 1 375 7.709 5.8 7.376 0 43.9 1,285 7.536 6 6.444 0 36.9 # of boards at t 376 2.798 2 1.074 1 11 1,285 3.074 3 1.315 1 15

Female 376 0.197 0 0.398 0 1 1,285 0.153 0 0.360 0 1

Audit member 376 0.500 0.500 0.501 0 1 1,285 0.389 0 0.488 0 1

Portion of independent directors 376 0.771 0.800 0.104 0.417 0.923 1,285 0.810 0.833 0.105 0.385 0.933

Independent director 376 0.838 1 0.369 0 1 1,285 0.853 1 0.354 0 1 One year market-adjusted stock return 364 -4.509 -5.404 23.96 -76.50 69.07 1,278 5.695 2.801 30.78 -51.73 186.4

Sales 376 8165.8 4388 13546 258.93 70189 1,278 60030 31367 79794 472.68 42507

1 Market value 370 6440.8 5037.5 4870.0 66.05 23951 1,278 81187 48625 85941 989.20 50424

0

Clean and controversial directors with at least one other directorships at time t - 1

Results

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Univariate results

Independent directors Affiliated directors

1

1,2

1,4

1,6

1,8

2

2,2

-0,4

-0,3

-0,2

-0,1

0

0,1

0,2

t-1 t t+1 t+2 t+3 t+4

# of other directorships (controversial affiliated directors)

# of other directorships (clean affiliated directors)

Lost other directorships (controversial affiliated directors)

Lost other directorships (clean affiliated directors)

1

1,2

1,4

1,6

1,8

2

2,2

2,4

-0,6

-0,4

-0,2

0

0,2

0,4

t-1 t t+1 t+2 t+3 t+4

# of other directorships (controversial independent directors)

# of other directorships (clean independent directors)

Lost other directorships (controversial independent directors)

Lost other directorships (clean independent directors)

» Previous literature shows that Economic controversies lead to

reputational penalties, do they drive our results?

» Fos and Tsoutsoura (2014): 2.2 ~1.78 in three years following proxy contests.

» Fich and Shivdasani (2007): 1.96 1.62 in three years following financial fraud.

» Gilson (1990): Outside directors who leave board lose 34.6% of other seats in three years. In our CSR sample, they lose 34.55%.

1

1,25

1,5

1,75

2

2,25

2,5

t-1 t t+1 t+2 t+3 t+4

# of other directorships (including economic controversies)

# of other directorships (excluding economic controversies)

Effect of Economic controversies

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1.76

2.20 2.22

1.74

Independent controversial directors

Multivariate results

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Dependent variable: Net change in other directorships in t + 4

(1) (2) (3) (4) (5)

Explanatory variables Independ.

directors

Affiliated

directors

All

directors

Independ.

directors

Affiliated

directors

Constant 2.772*** 1.126 2.592*** 3.054*** 0.022

(5.270) (0.863) (4.760) (5.439) (0.017)

Controversy and loses board -0.252* -0.361 -0.260* (-1.719) (-1.102) (-1.795)

Controversy and retains board 0.130 -0.731** -0.015 (1.310) (-2.403) (-0.127)

No controversy and loses board -0.021 -0.395 -0.096 (-0.122) (-0.800) (-0.531)

Independent director -0.032 (-0.345) Total number of controversies -0.005 -0.037*

(-1.004) (-1.854)

Controversies in years t - 1 and t - 2 0.005 -0.037*

(1.371) (-1.830)

Controversies in years t + 1 and t + 2 0.001 -0.012**

(0.361) (-2.212)

Estimated average costs (t through t + 2) 0.960 -10.54***

(0.876) (-3.983)

Age (Yrs) -0.030*** -0.025* -0.030*** -0.033*** -0.027*

(-5.042) (-1.696) (-4.945) (-5.177) (-1.789)

Ln(Time on board + 1) -0.069 0.017 -0.051 -0.070 0.078

(-1.343) (0.154) (-0.973) (-1.317) (0.770)

Ln(# of boards at t) -1.364*** -1.113*** -1.310*** -1.365*** -1.052***

(-11.940) (-3.359) (-12.430) (-11.950) (-2.988)

Female 0.013 -0.496 -0.014 0.002 -0.677**

(0.133) (-1.510) (-0.135) (0.021) (-2.082)

Audit member 0.015 -0.018 0.014 0.018 -0.150

(0.235) (-0.040) (0.201) (0.268) (-0.360)

Independent director -0.0316

(-0.345)

Nationality = American 0.022 0.184 0.049 0.050 0.165

(0.299) (0.756) (0.688) (0.628) (0.687)

Board independence (%) -0.102 0.430 -0.083 -0.104 0.738

(-0.329) (0.646) (-0.234) (-0.322) (1.004)

One year market-adjusted stock return -0.001 -0.002 -0.001 -0.001 -0.003

(-0.864) (-0.882) (-0.760) (-0.606) (-1.060)

Ln(Sales) 0.010 0.089 0.022 0.004 0.139**

(0.327) (1.664) (0.845) (0.147) (2.284)

Observations 1,397 244 1,641 1,386 243

R-squared 0.263 0.213 0.238 0.250 0.237

Year fixed effects Yes Yes Yes Yes Yes

Multivariate results

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Dependent variable: Net change in other directorships in t + 4

(1) (2) (3)

Explanatory variables Independ. directors Affiliated directors All directors

Constant 2.749*** 0.870 2.553***

(5.782) (0.683) (4.663)

Environmental controversy and departs board -0.158 0.059 -0.121

(-0.635) (0.129) (-0.589)

Social controversy and departs board -0.192* -0.462 -0.231**

(-1.782) (-1.511) (-2.236)

Governance controversy and departs board 0.073 0.055 0.102

(0.487) (0.139) (0.841)

Economic controversy and departs board -0.421** -0.119 -0.333*

(-2.219) (-0.365) (-2.012)

Environmental controversy and keeps seat -0.001 -0.402 -0.050

(-0.012) (-1.643) (-0.526)

Social controversy and keeps seat 0.153* -0.656** 0.050

(1.816) (-2.425) (0.639)

Governance controversy and keeps seat -0.071 -0.435 -0.121

(-0.538) (-1.513) (-0.973)

Economic controversy and keeps seat -0.041 -0.887** -0.128

(-0.253) (-2.686) (-0.901)

No controversy and loses board -0.038 -0.323 -0.094

(-0.229) (-0.669) (-0.560)

Age (Yrs) -0.031*** -0.026* -0.030***

(-5.237) (-1.890) (-5.156)

Ln(Time on board + 1) -0.068 0.051 -0.051

(-1.326) (0.438) (-0.971)

Ln(# of boards at t) -1.365*** -1.190*** -1.311***

(-11.910) (-3.504) (-12.410)

Female 0.012 -0.461 -0.010

(0.128) (-1.409) (-0.096)

Audit member 0.026 0.048 0.023

(0.416) (0.108) (0.345)

Independent director -0.019

(-0.207)

Nationality = American 0.026 0.159 0.049

(0.355) (0.715) (0.698)

Board independence (%) -0.054 0.729 -0.042

(-0.176) (0.948) (-0.113)

One year market-adjusted stock return -0.001 -0.003 -0.001

(-0.605) (-1.036) (-0.663)

Ln(Sales) 0.016 0.096* 0.024

(0.486) (1.817) (0.818)

Observations 1,397 244 1,641

R-squared 0.262 0.231 0.240

Year fixed effects Yes Yes Yes

Results

» Seats at larger firms more valuable for directors (Masulis & Mobbs, 2014)

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Lowest and Middle ranked (market value of firm) directorships Retains board seat after four years

Panel D: Independent directors (at focal firm)

Controversial (n = 685) 63.07%

Clean (n = 420) 68.57%

Proportions test (z-distribution) between controversial and clean directors -5.51% *

(-1.86)

Panel E: Affiliated directors (at focal firm)

Controversial (n = 58) 65.52%

Clean (n = 81) 50.62%

Proportions test (z-distribution) between controversial and clean directors 14.90% *

(1.75)

Panel F: All directors

Controversial (n = 743) 63.26%

Clean (n = 501) 65.67%

Proportions test (z-distribution) between controversial and clean directors -2.41 % (-0.87)

Highest ranked (market value of firm) directorships Retains board seat after four years

Panel A: Independent directors (at focal firm)

Controversial (n = 457) 66.30%

Clean (n = 271) 78.60%

Proportions test (z-distribution) between controversial and clean directors -12.30% ***

(-3.53)

Panel B: Affiliated directors (at focal firm)

Controversial (n = 44) 63.63%

Clean (n = 50) 58.00%

Proportions test (z-distribution) between controversial and clean directors 5.64% (0.56)

Panel C: All directors

Controversial (n = 501) 66.07%

Clean (n = 321) 75.39%

Proportions test (z-distribution) between controversial and clean directors -9.32% ***

(-2.84)

Results

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Dependent variable: Director retains his/her seat in four years

Highest ranked other directorships Lowest and Middle ranked other

directorships

(1) (2) (3) (4) (5) (6)

Explanatory variables

Indep.

directors

Affiliated

directors

All

directors

Indep.

directors

Affiliated

directors

All

directors

Controversy dummy (focal firm) 0.568** 1.214 0.658* 0.865 1.707 0.914 (-2.031) (0.248) (-1.669) (-0.615) (0.958) (-0.419)

Age (Yrs) 0.931*** 0.976 0.939*** 0.986 1.038 0.992 (-3.366) (-0.451) (-3.750) (-1.244) (1.164) (-0.633)

Ln(Time on board + 1) 0.915 0.878 0.916 0.811* 0.302*** 0.753** (-0.682) (-0.350) (-0.813) (-1.909) (-3.307) (-2.433)

Ln(# of boards at t) 0.954 1.784 0.996 0.679* 1.917 0.785 (-0.191) (0.724) (-0.0154) (-1.683) (1.072) (-1.193)

Female 0.963 3.818** 1.041 1.610* 1.542 1.635** (-0.142) (2.030) (0.166) (1.866) (0.812) (1.988)

Audit member (other directorship) 1.058 2.772 1.157 1.545** 2.280 1.562*** (0.305) (1.387) (0.829) (2.304) (1.168) (2.624)

Nationality = American 1.287 1.341 1.287 1.282 2.370* 1.293

(0.703) (0.437) (0.857) (1.299) (1.840) (1.561)

Board independence (%) 0.036*** 0.027 0.043*** 0.183* 0.095 0.182**

(-3.678) (-1.164) (-3.331) (-1.910) (-1.234) (-2.156)

Market adjusted total stock return 1.000 1.008 1.000 1.000 1.000 1.000 (-0.187) (0.512) (-0.108) (-0.195) (0.0660) (-0.318)

Ln(Sales) 1.121 0.823 1.094 1.130*** 1.287 1.145*** (1.142) (-0.895) (0.880) (2.886) (1.108) (3.680)

Independent director (focal firm) 1.950* 1.488 (1.918) (1.604)

Constant 109.6*** 16.260 35.190*** 3.108 0.009 1.154 (3.132) (0.835) (2.666) (1.185) (-1.619) (0.157)

Observations 710 91 803 1,060 131 1,191

Year fixed effects Yes Yes Yes Yes Yes Yes

Table 9 Logistic regressions for “Highest” and “Lowest and Middle” ranked other directorships.

The table shows logistic regressions for two subsamples; the “Highest ranked other directorships” and the “Lowest and Middle

ranked other directorships” for all directors who hold at least two other directorships at time t. Columns (1) – (3) shows results

for independent, affiliated, and all directors for the subsample including only highest ranked (in terms of MV) other directorships.

Columns (4) – (5) shows results for independent, affiliated, and all directors for the subsample including only lowest and middle

ranked directorships. The dependent variable is an indicator variable for whether a director retains his or her directorship in four

years or not. The main independent variable is an indicator variable for controversial firms. The descriptions for the rest control

variables are found in Appendix A. Significance levels 1%, 5%, and 10% are indicated with ***, **, and *, respectively. Robust

(clustered by sector) standard errors are shown in parentheses below odds ratios. All models include year fixed effects.

Robustness checks

1. Different data source. We identify 17 controversial firms using RepRisk

(www.reprisk.com) and 24 clean firms using Asset4ESG between 2008 – 2009.

Controversial independent directors lose -0.39 other directorships in four years, clean

lose -0.29. Controversial affiliated directors lose -0.71, clean add 0.46. Multivariate

results largely unchanged.

2. Poisson regression for # of attained new other directorship. IRR is 0.61 following

ENV controversies, 0.60 following SOC controversies, 0.54 following ECON

controversies. Results indicate lower rates of appointments for controversial directors

in the director labor market.

3. Looking at CEO changes (n = 37 in our sample) yield very similar, albeit weaker,

results.

© Hanken

Conclusions

» Magnitude of losses for directors following CSR controversies comparable to

previously reported losses related to bankruptcies, financial fraud, and proxy

contests.

» Controversial independent directors lose more other seats when they depart

focal firm’s board.

» Controversial affiliated directors who retain board seat lose more other seats.

» Controversial independent directors lose their most valued (at largest firms)

seats.

» Social and Economic controversies have greatest impact on reputations.

© Hanken