Is there a link between risk-taking incentives in CEO pay packages and corporate social irresponsibility? I studied this question together with colleagues from the universities of St Andrews, Essex, and Montreal. Our work recently published in The British Accounting Review.

We investigated a large sample of US firms between 1992 and 2012. We found that the answer to the question is yes: firms having CEOs with more risk-taking incentives are more likely to be associated with socially irresponsible activities.

Our results show that CEO risk-taking incentives positively relate to socially irresponsible activities. Interestingly, the results are different before and after the global financial crisis. In the post-crisis period, we find no evidence of a significant relationship between CEO risk-taking incentives and socially irresponsible activities. Here, the increased scrutiny on compensation packages and the attention for reputational issues in the aftermath of the financial crisis might play a role.

For our study, we use the MSCI ESG Stats, which evaluates companies in terms of socially responsible and irresponsible activities, and the Standard & Poor's Execucomp database to measure CEO compensation. To measure risk-taking incentives, we use the Vega. This is the sensitivity of CEO wealth held in options to firm risk. It measures the change of CEO wealth for a 1% increase in stock price volatility.

What might explain the link between pay packages and risk-taking prior to the crisis? It seems compensation contracts that encourage chief executives to undertake risky strategies put more emphasis on financial performance. The pursuit of short-term profits is not fully consistent with socially responsible behaviour. It is also possible that faced with financial pressures, CEOs underestimate the potential negative impacts of socially irresponsible behaviour. It is therefore not surprising that when the scrutiny on CEO compensation contracts increased in the wake of the financial crisis, the association between risk-taking incentives and corporate social irresponsibility substantially weakened.

In our view, the study also is of policy interest because the design of executive compensation contracts can have profound implications for firm strategies, and overall societal welfare. While it is important for the board of directors to encourage CEOs to take risks and increase shareholder value, if such incentives lead to socially irresponsible behaviour then that can have a long term impact on risk and profitability. Looking forward, we think a study of non-US firms, as well as a closer examination into CEO’s motivations would also be interesting research questions for the future.

Further reading:

• Bouslah, K., Linares-Zegarra, J., M'Zali, B., & Scholtens, B. (2018). CEO risk-taking incentives and socially irresponsible activities. British Accounting Review, 50(1), 76-92. DOI: 10.1016/j.bar.2017.05.004