Managerial contracting and corporate social responsibility

This paper presents a theory of corporate social responsibility in the form of the private provision of public goods and private redistribution by a firm. These social expenditures are determined by a manager operating under a compensation contract chosen by shareholders in a capital market that prices social expenditures. The theory incorporates three explanations for compensation systems that encompass social performance. First, consumers may reward the firm for its social expenditures; second, managers may have personal preferences for contributing to social causes; and third, the shareholder clientele a firm attracts may prefer social expenditures. Social incentives are higher powered the more consumers reward the firm and the stronger are shareholders' warm glow preferences for social expenditures. Profit incentives are higher powered the more consumers reward the firm but are independent of shareholder preferences. When consumers reward the firm for its social expenditures, firms with higher ability managers have both higher operating profits and higher social expenditures when times are good, so a positive correlation is predicted. In bad times, however, the correlation is negative, except for firms with very low ability managers in very bad times, where the correlation is zero. (C) 2007 Elsevier B.V. All rights reserved.