CEO Incentives
Jean McGuire
and Corporate
Social Performance
ABSTRACT. This paper examines the relationship
between CEO incentives and strong and weak cor-
porate social performance. Using the KLD database
we find that incentives have no significant relation-
ship with strong social performance. Salary and long-
term incentives have a positive association with weak
social performance.
KEY WORDS: corporate governance, executive
compensation, social performance, social responsibility
Although the relationship between corporate
governance and firm financial performance has
received considerable scrutiny, the impact of cor-
porate governance on social performance has
received less attention. This topic, however, is
of significant theoretical and practical impor-
tance. North American corporate governance
mechanisms emphasize shareholder wealth
maximization (Amihud and Lev, 1981; Fama,
1980). As a result, corporate governance may
focus managerial attention upon shareholder
objectives over the interests of other stakeholders.
Jean McGuire earned her Ph.D. from Cornell University.
She is professor of management at the John Molson
School of Business, Concordia University. Her research
focuses on corporate governance, including international
corporate governance.
Sandra Dow earned her Ph.D. from Concordia University.
She is associate professor of finance at the École des
Sciences de la Gestion, Université du Québec à
Montréal. Her research focuses on corporate governance
and international finance.
Kamal Argheyd has a DBA from the Harvard Business
School. He teaches strategy at the John Molson School
of Business, Concordia University. His research inter-
ests are cross-cultural management and business ethics.
Journal of Business Ethics 45: 341–359, 2003.
© 2003 Kluwer Academic Publishers. Printed in the Netherlands.
Sandra Dow
Kamal Argheyd
Stakeholder theory, in contrast, emphasizes the
firm’s relations with a wider range of implicit and
explicit stakeholders (Donaldson and Preston,
1995; Jones, 1995; Jones and Wicks, 1999).
These theoretical perspectives raise the issue of
whether corporate governance mechanisms
developed primarily to protect shareholder inter-
ests affect the firm’s performance toward a wider
variety of stakeholders and performance criteria.
This study builds upon prior research in two
ways. There have been few studies of the rela-
tionship between the various components of
executive compensation and firm performance.1
Executive incentives are a visible and potentially
important mechanism through which owners and
the board of directors can direct managerial
attention to specific objectives having both finan-
cial and social implications. Compensation can
therefore be a potentially important mechanism
for directing managerial attention to social
objectives. Indeed, the financial rewards given to
executives may signal the firm’s commitment to
social performance, and may provide “substance”
to corporate social policies. Second, we examine
both weak, or poor, social performance (socially
dubious or risky behavior) and strong social per-
formance (exemplary social performance or a
firm’s willingness to exceed expectations for
social performance). Most previous research has
implicitly conceptualized social performance
along a single continuum. We argue that the vari-
ables that encourage “exemplary” corporate per-
formance may differ from those that discourage
dubious social performance. Indeed, much
previous research has, implicitly or explicitly,
focused on “poor” social performance (Bansal
and Celland, 2000; Makendall, Sanchez, & P.,
1999; McKendall et al., 1999). In essence,
342 Jean McGuire et al.
existing research tells us little about the factors
that encourage exemplary social performance, or
its implications. There are, however, strong the-
oretical arguments to suggest that the factors
associated with strong social performance may
differ from those associated with poor social per-
formance. The following section will outline the
theoretical framework for the study.
Stakeholder theory, corporate governance,
and social performance
Although it is tempting to draw a clear distinc-
tion between agency theory formulations of cor-
porate governance and stakeholder theory,
particularly instrumental stakeholder theory, both
theoretical perspectives view the firm as a
network of contracts with stakeholders (Fama,
1980; Jones, 1995). Although corporate gover-
nance mechanisms in other contexts incorporate
a wider range of stakeholders (e.g. employees in
Germany), North American corporate gover-
nance mechanisms focus on shareholders as the
primary stakeholder (Eisenhardt, 1989; Fama and
Jensen, 1983).
Stakeholder theory examines the firm in the
context of a wider range of implicit and explicit
stakeholders having legitimate expectations,
urgent claims, and/or power regarding the firm
(Jones, 1995; Jones et al., 1999; Mitchell et al.,
1997). The broader approach inherent in stake-
holder theory requires that the interests of
multiple stakeholders be considered in manage-
rial decision-making. The interests of any one
given stakeholder (e.g. shareholders) should not
dominate at the expense of others (Clarkson,
1995; Hillman and Keim, 2001; Jones et al.,
1999).
The concept of corporate social performance
evaluates how well firms have met expectations
of stakeholders and environmental concerns. It
therefore focuses on the outcome of firm actions
(Griffin, 2000). Clearly, stakeholder management
and corporate social performance are distinct
constructs (Hillman et al., 2001). Building upon
Wood (1991) we view social performance as the
extent to which a firm meets the performance
expectations of important stakeholders. The focus
of this study is whether corporate governance
mechanisms focus managerial attention on finan-
cial performance objectives that impact a firm’s
social performance.
Existing empirical evidence suggests that cor-
porate governance mechanisms may promote
shareholder interests over those of other financial
stakeholders (Caves, 1976; Cruchley et al., 1999;
Gavish and Kalay, 1983; John and John, 1993),
and may direct managerial attention toward
financial objectives. This is not necessarily incon-
gruent with instrumental or descriptive stake-
holder theory: stakeholders as well as their
particular concerns, differ in their salience to
management (Jones, 1995).
Most relevant to our theoretical argument,
however is that the performance objectives
targeted by executive compensation may have
implications for social performance as well as
financial performance. It is therefore critical to
examine the particular performance objectives
implied by various components of executive
compensation. This approach is also congruent
with the argument that the institutional context
surrounding managerial decision making, specif-
ically here executive compensation, influences
expectations regarding social performance (Jones,
1999).
By defining managerial performance standards
and expectations, executive incentives may direct
managerial attention to specific outcomes or
objectives that have both financial and social
implications (Donaldson et al., 1995; Jones
et al., 1999). Simply stated, managerial incentives
may encourage strategies (or implementation
methods) having positive or negative implications
for social performance. For example, high levels
of compensation in the form of short-term bonus
payments may lead executives to focus on the
more immediate “bottom line”, rather than
building longer-term stakeholder relations.
Recent cases such as the Enron and WorldCom
bankruptcies suggest that stock-based incentives
may encourage executives to disregard social per-
formance in pursuit of market price increases
(Despeignes and Hill, 2002; Parker, 2002).
Further, Jones and Wicks (1999) argue that firm
social performance is often subject to manage-
rial discretion. The nature of executive com-
 CEO Incentives and Corporate Social Performance
pensation consequently influences the use of such
discretion in the area of social performance.
In addition to its theoretical interest, the
relationship between executive compensation
and social performance has important practical
implications. Perhaps more so than other aspects
of corporate governance such as ownership
structure and board of director structure or com-
position, executive compensation can be manip-
ulated by the board of directors to reward
managers for pursuing specific objectives. In
developing executive compensation plans, and
awarding executive incentives, the board of direc-
tors can encourage management to pursue social,
as well as financial objectives. Thus, compensa-
tion can be an important mechanism to promote
the implementation of the firm’s social objectives.
Further, institutional investors, particularly
“activist” investors, have identified corporate
governance, and specifically executive compen-
sation, as a major area of scrutiny (Prevost and
Rao, 2000; Wahal, 1996). Much of this attention
has focused on the high levels of compensation
awarded and the limited sensitivity of executive
pay to firm performance. The broader social per-
formance implications of executive compensation
have received less attention. Understanding of the
social performance implications of executive
compensation is relevant to those advocating cor-
porate governance reform.
Social strengths and social weaknesses: Distinct
dimensions or a continuum?
Most previous research has viewed high or low
social performance along a single continuum.
Although studies have disaggregated social per-
formance in terms of stakeholders or substantive
performance dimensions (such as employee/
community issues, environmental performance)
(e.g. Johnson et al., 1999; McKendall et al.,
1999), there has been no examination of the
validity of a continuum of strong to weak social
performance. Indeed, it may be quite possible
for firms to exhibit both strong and weak social
performance. A firm may exhibit strong social
performance along one dimension of social per-
formance, for example environmental concerns,
343
but may show weak social performance along
others, for example labor and employee relations.
A firm could exhibit both strong and weak social
performance along a single dimension. To illus-
trate, the Kinder, Lindenberg, Domini data used
in this study (described in more detail below)
noted that IBM exhibited strong environmental
performance in its communication efforts, but
performed poorly in its treatment of hazardous
wastes. Further, firm social performance may
be “strong” or “dubious” for several reasons,
including negative impact on important stake-
holders, raises/addresses more general social
concerns, and the like.
Particularly in the context of corporate gov-
ernance-social performance relations, however,
the factors contributing to strong social perfor-
mance (a more pro-active position in which the
firm exceeds usual expectations or performs
particularly well) and weak social performance
(socially risky strategies or those which do not
meet usual norms or expectations) may differ.
Corporate governance, specifically executive
incentives, may have a stronger relationship with
“avoidance” of poor social performance than
with the adoption of exemplary social perfor-
mance. Compensation typically does not reward
exemplary social performance (Murphy, 2000).
Rather, incentive payments and salary increases
tend to focus on the achievement of financial
and strategic objectives, as well as labor market
factors. There is little theoretical reason to believe
that such financial and strategic objectives provide
incentives for exemplary social performance.
Indeed, Donaldson et al. (1995) argue that
managerial discretion and decision making play
a critical role in determining the firm’s social per-
formance objectives. Congruent with steward-
ship theory (Davis et al., 1997) managers may
seek to work in the best interests of a wide range
of stakeholders. Even beyond this perspective,
managerial beliefs and discretion, rather than the
constraints and incentives provided by corporate
governance, are likely to be the principal drivers
of exemplary social performance. For example,
the strong social orientation of firms such as The
Body Shop or Ben and Jerry’s Ice Cream (under
founding ownership) were more likely a reflec-
tion of corporate philosophy and managerial
344 Jean McGuire et al.
beliefs than corporate governance (Hartman and
Beck-Dudley, 1999; Smith, 2000). Consequently,
our hypotheses will distinguish between weak or
poor social performance (socially dubious or
risky social performance) and strong social per-
formance (a pro-active social stance or exemplary
social performance).
This is not to imply that compensation has no
impact on the adoption of a pro-active position
regarding social performance. Rather, it may
form part of the institutional context which con-
strains management’s attention to social objec-
tives, or their ability to implement pro-active
social performance objectives (Jones, 1999). CEO
incentives may signal the board’s priorities
regarding social and financial objectives. A firm
whose compensation policies are characterized by
high levels of incentive payments based upon
achievement of financial performance objectives
may signal the dominance of achieving perfor-
mance objectives. Even socially concerned exec-
utives may accommodate such signals. Further
selection bias may also contribute to a negative
association between certain forms of managerial
compensation and exemplary social performance.
Simply stated, the “socially pro-active” CEOs
most likely to implement strong social programs
may avoid firms in which a “bottom line”
orientation dominates.
CEO compensation and social
performance: Research hypotheses
This section more fully discusses the links
between managerial incentives and firm social
performance. The major elements of executive
compensation are fixed compensation (salary),
short-term incentives, long-term incentives
(which include stock options, other forms of
market based compensation, and non-market
based long term incentive plans) (Murphy, 1999).
Equity ownership provides an additional mech-
anism of managerial incentives. The following
section will outline hypotheses linking each
element of managerial incentives to social per-
formance.
Bonus and social performance
We expect a positive association between short-
term incentives (bonus) and weak corporate
social performance. Bonus payments reward
executives for achievement of short-term per-
formance targets, rather than for building the
firm’s long term potential (Stata and Maidique,
1980). Further, the performance targets specified
in bonus plans are almost exclusively financial in
nature (Murphy, 2000). A major motivation for
less socially responsible actions may be to
improve the short term “bottom line” (Auperle
et al., 1985; McGuire et al., 1988; McKendall
et al., 1999; McWilliams and Siegel, 2000). This
motivation may be particularly relevant when the
executive received significant bonus compensa-
tion. Thus we propose:
H1a: There will be a positive association
between bonus and weak social perfor-
mance.
This logic also suggests a negative association
between bonus and strong social performance. As
noted earlier, short term incentives are typically
based upon achievement of financial and strategic
objectives, rather than social objectives (Murphy,
2000). They would therefore provide little
stimulus for strong social performance. Indeed
bonus compensation may tend to focus manage-
rial attention on financial objectives to the detri-
ment of other objectives. Further, a substantial
bonus component in executive compensation
may signal a “bottom line”, performance-driven
corporate orientation that may influence man-
agerial decision-making. Executive selection
processes (either by the board or through “self
selection”) may further lead management to
focus on financial objectives.
H1b: There will be a negative association
between bonus and strong social per-
formance.
CEO equity ownership and social performance
Two arguments concerning the relationship
between CEO ownership and corporate social
 CEO Incentives and Corporate Social Performance
performance can be made. On the one hand,
inside ownership may direct managerial attention
to performance and shareholder well-being,
rather than the interests of other stakeholders
(McKendall et al., 1999). If, indeed, a trade-off
exists between shareholder wealth maximization
and social performance, this would imply a
negative association between executive owner-
ship and strong social performance.
A further argument for a positive relationship
between CEO ownership and poor social per-
formance is based upon managerial entrenchment
and hubris. High levels of CEO ownership may
promote management entrenchment (Shleifer
and Vishny, 1989). Building upon Hayward and
Hambrick (1997), significant ownership may
encourage hubris which may lead managers to
underestimate the risks of poor social perfor-
mance.
Although the previous arguments held that
significant ownership implies performance pres-
sures that encourage weak social performance,
the ownership-social performance relationship
may be more complex. As noted earlier, the exis-
tence of a social performance-financial perfor-
mance trade-off is far from certain. Moreover,
significant ownership stakes may link executive
reputation to the firm. Particularly, given man-
agement’s numerous links to the firm, manage-
rial wealth may be more closely tied to the firm
than is the case for outside investors. In essence,
managers may therefore bear more of the
“downside” risk of socially irresponsible actions
in terms of both financial risk (Fama et al., 1983;
Jensen and Meckling, 1976; Zajac and Westphal,
1994), as well as damage to their reputation, than
outside owners. Building upon the behavioral
agency model (Wiseman and Gomez-Mejia,
1998; Sanders, 2001) it could be argued that
ownership stake may lead to more conservative
strategies as managers seek to preserve their
wealth. Such wealth preservation motives may
lead managers to avoid potentially costly socially
dubious behavior.
Again, empirical results have been mixed.
Although both studies used the Kinder,
Lindenberg, and Domini, ratings of social per-
formance, Johnson and Greening (1999) and
Simerly and Bass (1996) report contradictory
345
findings regarding inside ownership-social per-
formance relations. McKendall et al. (1999)
found a negative relationship between inside
ownership and illegal corporate activities. These
studies, however, focused on the broader
category of “inside” owners, which encompass
a broad range of holdings, including ESOPs and
holdings by a wide range of insiders and their
families. However, the limited decision making
power of this broader class of owners differs from
that of the CEO. Reputational effects may also
be more limited. In view of this ambiguity, we
will offer alternative hypotheses.
H2a: There will be a positive association
between inside ownership and weak
social performance.
H2b: There will be a negative association
between inside ownership and weak
social performance.
Entrenchment and hubris arguments also
suggest a positive relationship between CEO
ownership and strong social performance. As sug-
gested earlier, high levels of CEO ownership may
promote management entrenchment (Shleifer et
al., 1989). We noted earlier that pro-active social
agendas may reflect managerial or organizational
beliefs. The protection and power offered by
large ownership stakes may allow executives the
freedom to implement pro-active social agendas.
Just as hubris arguments suggest that managers
may discount the risks of socially risky behavior,
significant owner managers may discount the
risks of pro-active social agendas in terms of crit-
icism of the financial costs of exemplary social
performance or reduced attention to the “bottom
line”.
H2c: There will be a positive association
between CEO ownership and strong
social performance.
Long-term incentive compensation and social
performance
The relationship between social performance and
long-term incentives revolves around the issue of
whether socially responsible actions build the
346 Jean McGuire et al.
firm’s long-term potential. Since stock options
and other equity-based compensation are a major
component of long-term incentive compensation
(Murphy, 1999), the social performance impli-
cations of long-term compensation may parallel
those of inside ownership. Long term incentives
such as stock options, stock appreciation rights,
and long-term performance plans typically imply
no actual “loss” on the part of executives. Should
the firm’s market value fall, the executive incurs
an “opportunity cost” of lost income potential.
Using decision theory (Kahnman, 1979;
Kahnman, 1992), Sanders (2001) argues that
stock options (the major component of long
term incentives) encourage riskier strategies by
focusing attention on potential gains, rather than
loss. Such “riskier” strategies may include socially
dubious behavior. Further, stock options provide
no actual ownership stake until exercised and
provide a less visible link the CEO to the firm.
Thus, reputational arguments for a negative asso-
ciation between stock options and weak social
performance are less convincing. In essence,
stock options may provide greater incentives for
socially weak performance than ownership. We
therefore propose:
H3a: There will be a positive association
between poor social performance and
long-term incentives.
There is less reason to expect a positive asso-
ciation between long-term incentives and good
social performance. As noted earlier, long-term
incentive compensation is less likely to bring the
same reputational ties or feelings of “ownership”
as actual equity ownership. Therefore, reputa-
tional arguments for a positive association
between long-term incentives and strong social
performance would be less relevant. It can
be argued theoretically that exemplary social
performance may bring financial benefits.
Indeed, this belief may encourage firms toward
strong social performance. In the context of
executive compensation, which focuses manage-
rial attention on specific performance targets, the
perceived “instrumentality” of strong social per-
formance would likely be limited in comparison
to other strategic actions undertaken to improve
firm performance. In essence, it is less likely that
a CEO would take a pro-active stance regarding
social performance in hopes of greater incentive
compensation. Rather, a strong social position is
more likely an issue of executive beliefs than
wealth maximization.
The performance pressures implied by long
term incentives may encourage CEOs to focus
on achievement of financial objectives to the
detriment of the interests of other stakeholders.
In essence, the long term benefits of building
stakeholder relations may be less visible than the
strategies that may boost firm market perfor-
mance, at least in the short term. Indeed, stock
options (a major component of long term incen-
tives) have been increasingly criticized for
encouraging earnings manipulation and other
strategies aimed at improving market perfor-
mance without significantly building shareholder
value, as illustrated by the financial manipulations
preceding the Enron and WorldCom bankrupt-
cies (Despeignes and Hill, 2002; Parker, 2002).
This suggests the following hypothesis:
H3b: There will be a negative association
between strong social performance and
long term incentives.
Salary and social performance
Although salary has no direct incentive value,
agency theory holds that fixed compensation
(salary) may encourage risk aversion and more
conservative strategies (Gray and Canella, 1997;
Jensen and Murphy, 1990; Murphy, 1985; Zajac
et al., 1994). If, indeed, poor social performance
is considered “risky”, this argument suggests a
negative association between salary and poor
social performance. High levels of salary may also
build executives’ firm specific human capital,
thereby tying executives to the firm (Gray et al.,
1997). Therefore, executives may be less willing
to risk their firm’s reputation, and possibly their
continued employment, by less responsible
actions.
This line of reasoning is weakened by the
argument that the widespread attention given
executive compensation tends to suggest that
excessive salary may prove at least equally threat-
 CEO Incentives and Corporate Social Performance
ening to executive reputation as poor social per-
formance. Indeed, critics might claim that high
salary levels are, themselves, indicative of poor
social performance. Further, mere avoidance of
poor social performance does little to enhance
managerial reputation.
Empirically, Berman (1999) found a negative
association between salary and social responsive-
ness. Berman uses instrumental stakeholder
theory to argue that high levels of compensation
divert managerial attention away from a wider
range of stakeholders. This finding is also con-
gruent with Haward and Hambrick’s (1997)
argument that high salary may encourage
managerial hubris. Highly paid executives may
therefore minimize possible negative social reper-
cussions of their decisions.
H4a: There will be a positive association
between salary and weak corporate
social performance.
Similarly, the links between salary and strong
social performance may rest upon reputational
and hubris/insulation arguments. It is unlikely
that high salary provides direct incentives for
exemplary social performance. As noted earlier,
it might be symbolic of a lack of concern for
social issues.
Two counter arguments, however, can be
made. If, indeed, salary ties managerial social
capital to the firm, the perceived benefits of
exemplary social performance may lead highly
paid managers to act in socially responsible ways.
Simply stated, the potential benefits of good
social performance may be more relevant and
visible than simply avoiding any negative repu-
tational effects of poor social performance. To
illustrate, readers will probably find it easier to
identify firms (or executives) well known for
their strong social orientations, than to identify
those with negative social reputations. As noted
earlier, highly paid executives are often subject
to scrutiny and criticism. To some extent, exem-
plary social performance may serve to deflect
stakeholder concerns regarding compensation.
Hubris/insulation arguments may also come
into play. Just as high salary may lead managers
to discount the potential negative implications of
poor social behavior, they may also downplay
347
possible criticism of “excessive” concern for
social issues to the detriment of financial objec-
tives and may be more able to implement pro-
active social agendas. Although arguing that high
salary promotes both strong and weak social
behavior may appear contradictory, they are
based upon a single logic that high salary levels
encourage executives to discount the potential
negative implications of either strong or weak
social performance.
In view of these conflicting arguments, we will
propose alternative hypotheses:
H4b: There will be a negative association
between salary and strong social perfor-
mance.
H4c: There will be a positive association
between salary and strong social perfor-
mance.
The moderating effect of activist institutional
investment on the corporate governance-social
performance relationship
Although the role of activist investors in pro-
moting social performance is an important topic
of research (Prevost et al., 2000; Waddock and
Graves, 1995; Wahal, 1996), the focus of this
research suggests the need to control for the
direct effects of activist institutional investment.
Perhaps more critical to the focus of this
study, however, is that in addition to any direct
relationships between activist institutional invest-
ment and social performance discussed above,
activist investment may moderate the relationship
between corporate governance and social per-
formance. Large holdings by activist institutional
investors may encourage attention to the social
and environmental priorities of these institutions.
Such priorities may strengthen the compensa-
tion-corporate social performance relationship.
Further, investor activism has frequently
targeted corporate governance, for example in
promoting policies that facilitate shareholder
input and openness in corporate governance
and managerial accountability for firm actions
(Prevost et al., 2000; Wahal, 1996). Such pres-
sures toward accountability and openness in
348 Jean McGuire et al.
corporate governance may encourage firms to
look beyond financial performance to address a
broader range of shareholder concerns. They may
also imply greater management accountability for
both financial and social performance. Thus, we
hypothesize:
H5: Holdings by activist institutional
investors will moderate the corporate
governance-social responsibility rela-
tionship. Specifically,
H5a: Relationships between corporate gover-
nance and strong social performance
will be stronger for firms with higher
levels of shareholdings by activist insti-
tutional investors.
H5b: Relationships between executive incen-
tives and weak social performance will
be attenuated by high levels of activist
institutional investment.
Methodology
Data and sample
Data on salary and incentives are taken from
Standard and Poor’s Execucomp database.
Financial and ownership data are taken from the
Disclosure database. Data on corporate social
performance are drawn from the Kinder,
Lindenberg, and Domini Company database as
described below. The final sample consists of 374
firms for which data from the three sources were
available.2
Social performance measure
Corporate social and environmental performance
is measured by ratings by Kinder, Lindenberg,
and Domini, and Company (KLD), a multidi-
mensional Corporate Social Performance
database (http://www.socialfunds.com/csb/index.
cgi). Data were collected during Winter, 2000.
Examination of the qualitative descriptions of
firms showed the date of the ratings as 1999.
KLD data have been used in previous studies
(Graves and Waddock, 1994: Hillman, 2001
#460; Johnson et al., 1999). The KLD database
used in this study evaluates firm social perfor-
mance along four dimensions: employee, com-
munity, product and environmental.3 Reflecting
the reality that firms may exhibit both strengths
and weakness on each dimension of social per-
formance, social strength and social weakness are
rated on separate scales ranging from 0 (neutral)
to 2 (significant strengths/weakness) for each
dimension. For example, IBM received 1 in
environmental strengths for its communication
efforts, but also received a 1 for environmental
weakness for its treatment of hazardous waste.
Regarding employee issues, it was given a “2”
in strengths, and 0 for weakness. We do not sum
the weaknesses and strengths into a single “social
performance” measure for two reasons. Most
obviously, one focus of the study is to examine
the impact of corporate governance on each
dimension of social performance. Empirically,
strengths tend to offset weaknesses, reducing
variation in the dependent variable.
For each firm, strengths and weaknesses are
aggregated along the four dimensions for a
measure of total strengths and total weaknesses.
We do not analyze differences among the four
dimensions of social performance or differentiate
between types of social performance (Hillman et
al., 2001; Johnson et al., 1999). The four dimen-
sions evaluated by KLD each focus on primary
stakeholders. There is no a priori reason to
expect that corporate governance would favor
one dimension over others (Clarkson, 1995;
Hillman et al., 2001). Empirically, the number of
firms receiving “0” on a dimension would limit
the variance of dimensional measures.4
CEO incentives
Ownership. CEO ownership stake is measured by
the percentage of outstanding shares owned by
the CEO as reported by Disclosure.
Salary. Salary is measured by CEO salary as
reported in Execucomp.
 CEO Incentives and Corporate Social Performance
Bonus. To reflect the percentage of short-term
incentives in the executive’s compensation, we
calculate the percentage of bonus payments in the
CEO’s compensation.
Long-term incentives. We calculate the percentage
of long-term incentive payments (stock options
and other long-term incentives) in the CEO’s
compensation.
Activist institutional investment. In addition to the
need to control for the direct relationship
between activist holdings and CSP, we hypoth-
esize that activist holdings moderate the incen-
tive-CSP relationship. We calculated the
percentage of shares held by the “activist”
pension funds identified by Wahal (1996)
reported in our sample of firms. Prevost (2000)
identifies an essentially similar list.5
Control variables. We control for firm size,
industry, profitability, and financial slack. Since
risks and opportunities regarding social perfor-
mance may vary with the industry, we control
for the firm’s primary SIC code. Profitability and
size have been linked to social performance
(McGuire et al., 1988; McKendall et al., 1999;
McWilliams et al., 2000; Waddock and Graves,
1997). They also likely influence salary and
incentive compensation. We therefore use prior
ROA6 and the log transformation of the number
of employees as control variables. In addition
to the performance-CSP relationships, socially
responsible activities may be affected by the avail-
ability of financial slack and free cash flow
(McKendall et al., 1999; McWilliams et al.,
2000). This variable is measured by leverage and
the times interest earned ratio. Descriptive
statistics and correlations are presented in Table
I. It is significant to note that the correlation
between social weaknesses and social strengths is
very low (0.08) (Table I). This low correlation
supports the independence of the two dimensions
of social performance.
349
Results
Executive compensation and firm social performance
Results of the regression analysis testing
hypotheses 1 through 4 are presented in Table
II.7 The model for social strengths has little
explanatory power with an adjusted R2 of 0.07.
Neither the control variables tapping industry
and resources nor corporate governance variables
appear to influence strong social performance.
None of our hypotheses regarding the relation-
ship between CEO compensation and social per-
formance were supported. It is particularly
interesting that neither bonus nor long term
incentives discourage strong social performance.
This finding is congruent with our argument that
strong social performance may be primarily
driven by managerial beliefs.
The model for social weakness has an R2 of
0.25. The higher explanatory power of this
model supports our argument that corporate
governance has a stronger relationship with weak
social performance. Contrary to Hypothesis 1,
the coefficient for bonus is insignificant. Neither
Hypotheses 2a or 2b were confirmed: the
coefficient for CEO ownership is insignificant.
The significant positive coefficient for long-term
incentives confirms Hypothesis 3. Hypothesis 4a
is also confirmed. Salary shows a positive rela-
tionship with weak social performance.
On the whole, these results suggest that cor-
porate governance has relatively limited associa-
tion with strong social performance. Neither
control variables nor corporate governance pre-
dicted a pro-active social orientation (social
strength). This finding is congruent with the
argument that exemplary social performance may
be a function of more deeply held managerial
beliefs or corporate culture relatively insulated
from outside pressures. Both salary and long-term
incentives are positively related to poor social
performance. These findings are congruent with
arguments of hubris, as well as the performance
pressures imposed by long-term incentive com-
pensation. At the broader level, these findings are
congruent with arguments that high levels of
executive compensation are indicative of a less
 TABLE I
350
Descriptive statistics and correlations

Descriptive statistics

Mean Std. deviation

Size 009.91 001.31

Financial slack 035.72 406.80
Leverage 000.81 001.55
ROA 000.04 000.19
Activist institutional investment 002.28 001.36
Salary 874.91 355.32
Long term incentives 060.86 023.64
Bonus 018.40 015.12
CEO ownership 001.24 004.19
Total strengths 000.73 000.92
Total concerns 000.64 000.96

Correlations

Size Financial Leverage ROA Activist Salary Long Bonus CEO Total Total
Jean McGuire et al.

slack investment term ownership strengths concerns

incents

Size –1.00** –0.09** –0.07 –0.35** –0.13** –0.38** –0.16** –0.07** –0.07** –0.23** –0.20**
Financial slack –0.09** –1.00** –0.07 –0.16** –0.01** –0.04** –0.05** –0.01** –0.00** –0.04** –0.05**
Leverage –0.07** –0.07** –1.00 –0.00** –0.06** –0.02** –0.01** –0.01** –0.03** –0.04** –0.00**
ROA –0.35** –0.16** –0.00 –1.00** –0.11** –0.08** –0.05** –0.10** –0.01** –0.04** –0.10**
Activist institutional investment –0.13** –0.01** –0.06 –0.11** –1.00** –0.02** –0.05** –0.01** –0.11** –0.06** –0.13**
Salary –0.38** –0.04** –0.02 –0.08** –0.02** –1.00** –0.03** –0.01** –0.11** –0.20** –0.30**
Long term incentives –0.16** –0.05** –0.01 –0.05** –0.05** –0.03** –1.00** –0.66** –0.02** –0.13** –0.14**
Bonus –0.07** –0.01** –0.01 –0.10** –0.01** –0.01** –0.66** –1.00** –0.00** –0.03** –0.06**
CEO ownership –0.07** –0.00** –0.03 –0.01** –0.11** –0.11** –0.02** –0.00** –1.00** –0.13** –0.15**
Total strengths –0.23** –0.04** –0.04 –0.04** –0.06** –0.20** –0.13** –0.03** –0.13** –1.00** –0.08**
Total concerns –0.20** –0.05** –0.00 –0.10** –0.13** –0.30** –0.14** –0.06** –0.15** –0.08** –1.00**

** Correlation is significant at the 0.01 level (2-tailed).

* Correlation is significant at the 0.05 level (2-tailed).
 CEO Incentives and Corporate Social Performance 351

TABLE II
Full sample

Dependent variable: Poor social performance

Model Beta T statistic Significance

1 (Constant) –3.08 0.00

Size –0.30 –5.05 0.00
ROA –0.24 –3.79 0.00
Activist institutional investment –0.08 –1.33 0.18
Financial slack –0.00 –0.03 0.97
Leverage –0.04 –0.70 0.49
2 (Constant) –2.63 0.01
Size –0.13 –1.97 0.05
ROA –0.25 –4.07 0.00
Activist institutional investment –0.07 –1.22 0.22
Financial slack –0.00 –0.03 0.98
Leverage –0.04 –0.73 0.47
Salary –0.27 –4.43 0.00
Long term incentives –0.16 –2.09 0.04
Bonus –0.11 –1.46 0.14
CEO ownership –0.06 –1.14 0.26

Model 1 (controls) F Ratio: 7.1; Significance: 0.000 Adjusted R2 = 0.19.

Model 2 (full model) F Ratio: 7.19; Significance: 0.000 Adjusted R 2 = 0.25.

Dependent variable: Strong social performance

Model Beta T statistic Significance

1 (Constant) –2.29 0.02

Size –0.24 –3.66 0.00
ROA –0.07 –0.99 0.32
Activist institutional investment –0.04 –0.69 0.49
Financial slack –0.07 –1.07 0.29
Leverage –0.06 –0.89 0.38
2 (Constant) –1.91 0.06
Size –0.17 –2.26 0.02
ROA –0.08 –1.21 0.23
Activist institutional investment –0.03 –0.52 0.60
Financial slack –0.08 –1.19 0.23
Leverage –0.06 –1.00 0.32
Salary –0.06 –0.90 0.37
Long term incentives –0.11 –1.30 0.19
Bonus –0.01 –0.16 0.87
CEO ownership –0.08 –1.30 0.19

Model 1 (controls) F Ratio: 2.62; Significance: 0.00 Adjusted R2 = 0.06.

Model 2 (full Model) F Ratio: 2.32; Significance: 0.01 Adjusted R 2 = 0.07.
352 Jean McGuire et al.
socially responsible orientation. The significance
of long-term compensation, rather than owner-
ship, is congruent with Sander’s (2001) argument
that ownership stake is associated with greater
attention to the potential downside risks of
actions than stock options whose downside risk
is limited. Further, the performance pressures
implied by ownership may be balanced by
reputational effects. From perhaps a more prag-
matic perspective, levels of stock options and
long term incentives typically exceed ownership
levels (Conyon and Murphy, 2000). The lack of
significance for ownership may reflect the lower
levels of ownership stake as compared to the
value of long-term incentives.
The lack of significance for bonus did not
support our hypotheses. However, there has been
considerable debate as to the incentive power of
bonus payments. Simply stated, critics have
argued that given the potential for CEO’s to
manipulate accounting performance numbers,
and their control over the board of directors,
“bonus” payments provide very little incentive
value. This criticism argues that CEO’s often
receive their bonus regardless of firm perfor-
mance (Anderson, 1995; Boyd, 1994; Conyon
and Peck, 1998; Crystal, 1991; Healy, 1985). If
this were the case, executives would have little
reason to engage in poor social performance to
achieve bonus targets.8
The moderating effect of activist institutional
investment
Although we found no direct effects of activist
holdings on social responsibility, Hypothesis 5
postulates that higher levels of activist holdings
might moderate the relationship between cor-
porate governance and social performance. We
therefore split the sample at the median level of
activist holdings and repeated the preceding
analyses. These results are presented in Table III.
The top portion of Table III reports the results
for the equation for poor social performance.
Among firms with lower levels of activist insti-
tutional holdings, we found a small (0.03)
increase in the R2 with the addition of CEO
incentive variables. As with the full sample, the
coefficient for salary is significant and positive.
The coefficient for long term incentives, while
positive, is no longer significant. Activist holdings
remain insignificant. Among firms with high
levels of activist investment, the R2 of the
equation increases from 0.15 to 0.21 with the
inclusion of CEO incentive variables. Both
salary and long-term incentives are significant.
Interestingly, the coefficient for bonus becomes
significant and positive. These results suggest
a counter-intuitive finding that the positive
association between salary and long term incen-
tives and poor social performance is stronger
among firms with high levels of activist institu-
tional investment. Further, bonus compensation
becomes significantly related to poor social per-
formance among firms with high levels of activist
investment. In neither sub-sample is the coeffi-
cient for activist institutional investment signifi-
cant.
Turning to the equations for strong social per-
formance, in neither sub-sample is the coefficient
for activist institutional investment significant.
Among firms with low levels of activist holdings,
there is a slight increase (0.02) in the R2 with the
addition of CEO incentive variables. None of the
individual coefficients, however, are significant.
The equation for the high activist institutional
investment sub-sample has little predictive
validity. Neither category of institutional invest-
ment predicts social strengths.
Although it might have been expected that
high levels of activist institutional investment
might lead to stronger CEO incentive-social per-
formance relationships, this is not the case. The
findings of stronger relations between executive
compensation and poor social performance
among firms with high levels of activist invest-
ment are puzzling. However, Wahal (1996)
suggests that a major concern of activist funds is
the establishment of effective corporate gover-
nance to assure that management focuses on
shareholder value. In essence, the pension funds
examined in this study may have focused their
attention on shareholder accountability. Further,
a major area of concern for activist investors is
corporate governance, and most specifically exec-
utive compensation (Prevost et al., 2000). By
encouraging increased performance sensitivity in
 CEO Incentives and Corporate Social Performance
CEO compensation, activist investors may have
encouraged executives to focus on financial per-
formance to the detriment of social performance.
To shed some light on this counter-intuitive
finding, we went to the web sites for CALPERS
and TIAA/CREFF, the activist institutions with
the most significant holdings in our sample. Both
web sites give considerable attention to corpo-
rate governance issues, listing areas of particular
concern and specific corporate governance ini-
tiatives. The CALPERS web site notes that,
“The California Public Employees’ Retirement
System (known as “CalPERS”) has long been a
leader in the corporate governance movement.
As the largest public retirement system in the
U.S., CalPERS’ Board of Administration has
concluded that “good” corporate governance
leads to improved long-term performance”
(www.calpers.org). Proxy voting guidelines
provide extensive discussion of corporate gover-
nance policies, and specifically address CEO per-
formance evaluation and compensation. The
dimensions of social performance tapped by the
KLD measures, in contrast, are given consider-
ably less attention. The discussion of social
responsibility specifically highlights that social
objectives should not take precedence over the
organization’s primary objective of financial per-
formance for its members. The TIAA/CREF
annual report states: “In the area of executive
compensation, the oversight role of shareholders
is taking on increasing importance. TIAA-
CREF’s Policy Statement addresses several exec-
utive compensation issues, including the role of
stock and stock options” (www.tiaa-cref.org).
Little mention is given of social objectives. This
superficial exploration supports the argument that
activist investors may focus on issues of share-
holder return and shareholder responsibility
rather than other dimensions of social perfor-
mance.
Conclusions
The results of this study suggest that firm
strengths and weaknesses in the area of social per-
formance are subject to different dynamics. Firm
strength in social performance, in other words its
353
decision to adopt a pro-active stance along the
four dimensions of social performance examined,
is not related to the financial or corporate gov-
ernance variables used in this study. This suggests
that the firm’s decision to become an “exemplary
corporate citizen” is less subject to financial pres-
sures and corporate governance pressures than are
social weaknesses. This finding is also congruent
with the argument that corporate governance
effects regarding social performance may tend to
be more reactive in nature by deterring socially
risky behavior. In other words, they might serve
as a deterrent to potentially damaging actions,
rather than as an incentive to adopt more pro-
active stakeholder orientations.
However, we find that high levels of salary and
long-term incentives are related to poor social
performance. At the most general level, high
compensation levels may be indicative of a less
socially responsible orientation. Further, the per-
formance pressures implied by these incentives
may have encouraged managers to engage in
more socially “risky” behavior. Dividing the
sample by levels of activist investment supports
the conclusion that corporate governance has
limited effect on strong social behavior. However,
we find that the positive association between
salary and incentives and poor social performance
is stronger among firms with high levels of
activist holdings. Although initially surprising,
anecdotal evidence suggests that pay-performance
sensitivity is a major concern of activist investors.
Our findings may reflect a “trade-off ” between
corporate governance objectives and other
elements of social performance.
Several areas of future research can be sug-
gested. The relatively modest significance of both
control variables and corporate governance vari-
ables may suggest that management may have sig-
nificant discretion in establishing the firm’s social
orientation, particularly in the establishment of
a more “pro-active” social agenda. The charac-
teristics of management, as well as that of the
board of directors, may help shape the firm’s
social agenda. Thus, examination of the man-
agement characteristics, as well as the role of the
board of directors in shaping corporate social
policy and monitoring managerial actions, may
provide further insights.
354 Jean McGuire et al.

TABLE III
Split sample results (median level of activist institutional investment)

Dependent variable: Poor social performance

Low activist investment sub-sample

Model Beta T statistic Significance

1 (Constant) –2.28 0.02

Size –0.29 –3.57 0.00
ROA –0.23 –2.70 0.01
Activist institutional investment –0.12 –1.60 0.11
Financial slack –0.00 –0.04 0.97
Leverage –0.03 –0.36 0.72
2 (Constant) –1.65 0.10
Size –0.15 –1.60 0.11
ROA –0.24 –2.85 0.01
Activist institutional investment –0.10 –1.36 0.18
Financial slack –0.01 –0.15 0.88
Leverage –0.04 –0.51 0.61
Salary –0.19 –2.22 0.03
Long term incentives –0.14 –1.40 0.16
Bonus –0.01 –0.13 0.90
CEO ownership –0.10 –1.28 0.20

Model 1 (controls) F Ratio: 6.97; Significance: 0.000 Adjusted R2 = 0.32.

Model 2 (full model) F Ratio: 6.01; Significance: 0.000 Adjusted R 2 = 0.36.

High activist investment sub-sample

Dependent variable: Poor social performance

Model Beta T statistic Significance

1 (Constant) –2.83 0.01

Size –0.39 –4.32 0.00
ROA –0.28 –3.10 0.00
Activist institutional investment –0.05 –0.62 0.54
Financial slack –0.02 –0.22 0.82
Leverage –0.13 –1.51 0.13
2 (Constant) –2.99 0.00
Size –0.22 –2.15 0.03
ROA –0.31 –3.50 0.00
Activist institutional investment –0.07 –0.93 0.35
Financial slack –0.03 –0.40 0.69
Leverage –0.12 –1.41 0.16
Salary –0.28 –3.20 0.00
Long term incentives –0.19 –1.65 0.10
Bonus –0.24 –2.13 0.04
CEO ownership –0.02 –0.24 0.81

Model 1 (controls) F Ratio: 3.51; Significance: 0.00; Adjusted R2 = 0.16.

Model 2 (full model) F Ratio: 3.60; Significance: 0.00; Adjusted R 2 = 0.21.
 CEO Incentives and Corporate Social Performance 355

TABLE III
Continued

Social strengths
Low activist investment sub-sample

Model Beta T statistic Significance

1 (Constant) –2.23 0.03

Size –0.29 –3.19 0.00
ROA –0.15 –1.52 0.13
Activist institutional investment –0.02 –0.25 0.80
Financial slack –0.03 –0.32 0.75
Leverage –0.01 –0.12 0.91
2 (Constant) –1.86 0.07
Size –0.17 –1.53 0.13
ROA –0.15 –1.51 0.13
Activist institutional investment –0.05 –0.52 0.61
Financial slack –0.04 –0.45 0.66
Leverage –0.00 –0.04 0.97
Salary –0.13 –1.34 0.18
Long term incentives –0.21 –1.71 0.09
Bonus –0.07 –0.54 0.59
CEO ownership –0.10 –1.14 0.26

Model 1 (controls) F Ratio: 2.41; Significance: 0.01; Adjusted R2 = 0.10.

Model 2 (full model) F Ratio: 2.25; Significance: 0.01; Adjusted R 2 = 0.12.

High activist investment sub-sample

Dependent variable: Strong social performance

Model Beta T statistic Significance

1 (Constant) –0.98 0.33

Size –0.22 –2.26 0.03
ROA –0.02 –0.22 0.83
Activist institutional investment –0.01 –0.11 0.91
Financial slack –0.14 –1.50 0.13
Leverage –0.12 –1.28 0.20
2 (Constant) –0.87 0.38
SIZE –0.20 –1.69 0.09
ROA –0.04 –0.41 0.68
Activist institutional investment –0.02 –0.25 0.80
Financial slack –0.15 –1.53 0.13
Leverage –0.11 –1.21 0.23
Salary –0.01 –0.06 0.95
Long term incentives –0.05 –0.34 0.73
Bonus –0.04 –0.28 0.78
CEO ownership –0.06 –0.60 0.55

Model 1 (controls) F Ratio: 1.16; Significance: 0.32; Adjusted R2 = 0.01.

Model 2 (full model) F Ratio: 0.88; Significance: 0.58; Adjusted R 2 = 0.01.
356 Jean McGuire et al.
Although we made use of a well-accepted
measure of social performance, other measures
may provide additional insights. Specifically, firms
are increasingly adopting “triple bottom line”
reporting, which include non-financial measures
of social performance. Although Murphy (2000)
provides evidence for the dominance of finan-
cial performance criteria in executive compen-
sation plans, future research can examine the
extent to which consideration of broader per-
formance indexes influences firm social perfor-
mance. Further, research should examine the
extent to which “triple bottom line” criteria are
reflected in executive compensation.
The recent cases of Enron and WorldCom and
other instances of improper accounting practices
suggest that the relation between CEO com-
pensation and poor social performance may be
most relevant when poor social performance
(in these cases manipulation of accounting
results) directly impacts the executive’s personal
wealth. The incentives to manipulate accounting
numbers to meet performance targets or for
maximum gain from stock options are more
direct and obvious than the stakeholder manage-
ment issues examined in this article. Research
examining such issues as earnings restatements,
regulatory actions, or similar evidence of finan-
cial improprieties may reveal stronger compen-
sation-social performance links. Further, it is
interesting that the KLD social ratings do not
explicitly consider corporate governance in their
evaluation of social performance. Recent corpo-
rate governance failures may suggest the need to
incorporate corporate governance into evalua-
tions of social performance.
Finally, this research does not examine the link
between social strengths and weaknesses and firm
performance. Previous research considering social
performance as a continuum has ignored the pos-
sibility that the performance benefits of strong
and weak social performance may differ. From
the perspective of stakeholder theory, appropriate
corporate governance mechanisms that direct
managerial attention to stakeholder interests
should contribute to the firm’s long-term devel-
opment and performance. Stakeholder theory
suggests that building good relations with
primary stakeholders may build goodwill and a
strong network of ties that contribute to firm
success. Building upon this logic, the perfor-
mance benefits of exemplary social performance
may be stronger than those of simply avoiding
poor social performance. Simply stated, “doing
nothing wrong” may do little to build good rela-
tions with stakeholders, whereas exemplary
actions may bring greater long-term benefits.
The challenge to examining this link, however,
is to identify performance measures that tap the
long-term benefits of stakeholder relations.
Acknowledgements
The authors wish to thank Basma Ali, Zied
Guedri, and Elie Matta for their assistance in data
collection. We also thank Goeff Bell and Percy
Heugens for their useful comments. This research
was funded by the Social Science and Humanities
Research Council of Canada.
Notes
1
Studies examining ownership-social performance
relations are discussed in more detail later in this
paper. Studies examining the association between
Board of Director characteristics and social perfor-
mance include Coffey and Wang (1998); Harrison and
Freeman (1999); McKendallSanchez and Sicilian
(1999). Although we acknowledge the importance of
the board of directors as a corporate governance
mechanism, we do not examine board effects in this
study. Therefore, this literature will not be discussed
in detail.
2
There is no reason to suspect systematic bias from
incomplete data. The overlap between financial and
social performance data was good. Social performance
data were available on 374 of the 430 firms with
complete financial data.
3
The community dimension includes charitable
giving, concern for the international community, and
the economic impact of firm operations. The envi-
ronmental dimension includes pollution, hazardous
waste, climate change, and environmental communi-
cation. The product dimension of the KLD ratings
includes quality and safety, impact on the disadvan-
taged, and marketing/contracting controversies.
Employee dimensions include promotion of women
and minorities, family benefits, safety issues, employee
 CEO Incentives and Corporate Social Performance
relations, and international labor issues. Thus, this
version of the KLD database does not consider “diver-
sity” as a unique dimension of social performance, but
rather as a dimension of the firm’s performance vis-
à-vis employees.
4
Heteroscidastitity among the four dimensions
further complicates inter-dimensional comparisons
Hillman, A. and Keim, G. 2001. Shareholder value,
stakeholder management, and social issues: What’s the
bottom line? Strategic Management Journal 22(2):
125–139.
5
These funds were the California Public Employee
Retirement System (CalPers), The California State
Teacher’s Retirement System, The Pennsylvania
Public School Employee Retirement System, The
State of Wisconsin Investment Board, TIAA/CREF,
the Florida State Board of Administration, and The
New York State Common Retirement System, the
Colorado Employee Retirement System, and the
NYC pension fund system. The Colorado and NYC
funds are among the smallest of those identified, and
had negligible holdings in sample firms. Although
other “activist” institutional investors exist, those
included in our study are the most significant in terms
of both size of shareholdings and visibility. In addi-
tional analyses we subtracted “activist” institutional
holdings from total institutional investment to calcu-
late a “non activist” institutional investment variable.
Inclusion of non-activist holdings was insignificant
and was therefore eliminated from further analysis.
6
Since ROA can vary to a greater extent than size
or capital structure, we used a two-year average of
ROA. Results were similar when single year lagged
or concurrent ROA were used.
7
Coefficients for industry control variables are not
presented. Only two of the industry dummy variables
were significant. Examination of the qualitative
description of social performance on the KLD web
site suggests that social performance may have been
evaluated in the context of the social challenges facing
the firm and industry. For example, discussion of a
mining or forestry firm tended to focus on the firm’s
response the environmental challenges they faced,
rather than the environmental threats posed by the
industry itself.
8
We conducted additional analysis using the four
individual dimensions of social performance. These
results must be interpreted with caution given the
more limited variance in the dependent variable.
Nevertheless, results are suggestive. Congruent with
the aggregate analysis, models predicting strength
along each dimension were insignificant. Results on
the four social performance weakness dimensions
357
show a positive relationship between compensation
and environmental and product weaknesses. Although
in the predicted direction, long term incentives were
insignificant. Although these findings reflect the
greater variance along these dimensions of social per-
formance, they are also congruent with an argument
that poor performance along these dimensions may
be more subject to our hubris and cost-cutting argu-
ments.
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