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The moderating effect of corporate governance on the relationship between corporate sustainability performance and corporate financial performance

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Abstract

Corporate governance plays an important role in monitoring and counseling management’s decision making including strategic sustainability investing. Understanding the role of corporate governance may help top management of corporations allocate their limited resource in their strategic planning and decision making. This study examines the relationship between corporate governance and corporate sustainability performance (CSP) and whether corporate governance moderates the relationship between corporate sustainability performance and corporate financial performance (CSP–CFP). The study analyzes a sample of 456 top largest U.S. public companies to examine corporate sustainability performance and corporate governance jointly, particularly the moderating effect of corporate governance on CSP–CFP relationship. Lagged variables were used to address the endogeneity issue. Multiple regression methods were used. The results show that firms with stronger corporate governance are more likely to have higher CSP and that corporate governance contributes additional value to firm value. The impact of CSP on CFP is higher for firms with stronger corporate governance (moderating effect). Results are robust after using different regression methods and additional tests.

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Notes

  1. The term “sustainability” is often used interchangeably with “sustainable development,” "corporate social responsibility," “corporate responsibility,” “corporate citizenship,” and “social enterprise.” For the purpose of this study and for analysis of empirical results in the broadest way, I use an inclusive definition of sustainability, without drawing distinctions between this and related terms.

  2. Maintaining a certain percentage of female directors on the board is required by law in some countries. For example, Norway requires 40% female board presentation. Spain and Sweden require a future female board presentation of 40% and 25%, respectively. France requires a 50% of female board presentation by 2015 (Srinidhi 2011).New California law mandates that at least one female representation on Boards of Directors all publicly held domestic or foreign corporations whose principal executive offices are located in California by December 2019. (Thomas and Reese 2019).

  3. Relevant literature review on the four board attributes are presented in “Literature review and hypotheses development” section.

  4. AT is the variable name of total assets in the COMPUSTAT database. Other financial variables are described in the same way in COMPUSTAT.

  5. Similar results are obtained if using relative portion of female directors to total size of a board.

  6. The Model R squares are small although the interested variables (BSIZE, BIND, CEODUAL, FEMALE and CGOV) are all significant at conventional significance levels. The generalization is limited due to low model R squares.

  7. [The structure of members on board tends to be stale. We use CGOV at year t, rather t − 1 in the model to keep the same sample size. The main results still hold if one-year lag of CGOV is used.]

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Authors and Affiliations

  1. Foster College of Business, Bradley University, 1501 W Bradley Ave, Peoria, IL, 61625, USA

    Lucy W. Lu

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Appendix 1. Variable definition and measurement

Appendix 1. Variable definition and measurement

Corporate sustainability performance measures

CSP

= corporate sustainability score. CSP = ∑(STRENGTH-CONCERN) from six dimensions of KLD social ratings

HIGHCSP

= indicator variable set equal to 1 if CSP score is greater than 0, and 0 otherwise

Corporate financial performance measures

lnQ

= logarithm of Tobin’s Q. It is calculated as [Total assets (AT) + Market value of equity (CSHO*PRCC_F) -total common equity (CEQ) - Deferred taxed (Balance sheet) (TXDB)]/total assets (AT)a

Corporate governance measures

BSIZE

= total number of directors on the board

BIND

= total number of independent directors divided by total number of board members

CEODUAL

= indicator variable, set equal to 1 is the CEO is also the chairperson, and 0 otherwise

FEMALE

= indicator variable, set equal to 1 if at least one woman director is on the board, 0 otherwise

CGOV

= a composite corporate governance score, calculated from four boards attributes: board size (BSIZE), board independence (BIND), CEO duality (CEODUAL), and female directors (FEMALE). A score of 1 is assigned to a variable if strong board control, monitoring, or effectiveness is believed to be present. For example, BSIZE receives a score of 1 if the board size is above the sample median. BIND is equal to 1 if the board independence ratio is above the sample median. CEODUAL is assigned 1 if the CEO and chairperson are the same individual. FEMALE receives 1 if a board has at least 1 female director. CGOV is then calculated as the sum of the four scores from above four variables. It ranges from 0 to 4

SGOV

= indicator variable, set equal to 1 if CGOV is greater than 2 (the median of the sample) in a particular year

Control variables

SIZE

= logarithm of total assets (AT)

LEV

= total debt divided by total shareholders’ equity

CFO

= cash flow from operations divided by fiscal year-end total assets

SG

= sales growth, calculated as the percentage change in sales during the year

NEWNESS

= newness of equipment, calculated as net property, plant and equipment divided by annual depreciation expense, which assumes all firms use straight-line depreciation method

CAPIN

= capital intensity, calculated as capital expenditure divided by fiscal year-end total assets

INDUSTRY

= a set of 9 industry dummy variables. Energy (code 10) is the base industry

YEAR

= a set of 4 year dummy variables: 2007–2011 (2007 is the base year)

  1. aVariable names in the COMPUSTAT database

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Lu, L.W. The moderating effect of corporate governance on the relationship between corporate sustainability performance and corporate financial performance. Int J Discl Gov 18, 193–206 (2021). https://doi.org/10.1057/s41310-020-00099-6

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