The Dark Side of Blockholder Philanthropy

Thomas Shohfi is an assistant professor of finance and accounting at the Lally School of Management and Technology at Rensselaer Polytechnic Institute; and Roger M. White is an assistant professor of accounting at the W.P. Carey School of Business at Arizona State University. This post is based on a recent paper by Professor Shohfi and Professor White.

Who would you rather own a business with, Mahatma Ghandi or Ebenezer Scrooge? Behavioral economics research points to considerable benefits of co-ownership with Ghandi, as counterparties (like suppliers, customers, and potential employees) work harder and offer better contracting terms when dealing with philanthropic principals. [1] Understandably, these contracting parties feel better about not driving the hardest possible bargain, as the proceeds to a firm co-owned by Ghandi go at least partially towards noble causes.

Corporate governance research based in agency theory, however, points to Scrooge being a major shareholder also having benefits. That is, small shareholders typically rely on the self-interest of large shareholders to monitor their shared investment. [2] For those small shareholders, having Scrooge as a blockholder may be comforting, as he would likely be a very close monitor of managers (for his own benefit). Research in this mold has found that self-interested blockholder monitoring is particularly effective at discouraging wasteful investments in R&D, M&A, and PP&E. [3] In this line of thinking, where the self-interest of large investors (and their associated monitoring of managers and the firm) comforts small investors, the market could view large investors’ philanthropy as troubling. If this philanthropy signals weakening self-interest on behalf of the newly charitable blockholder in question, smaller investors could worry that, as the monitor they rely on is less interested in wealth, this monitor will subsequently provide less monitoring of their shared investment. Sticking with our original analogy, this is akin to Scrooge taking a big step towards being Ghandi (i.e. Scrooge on Christmas morning). If you relied on Christmas Eve Scrooge’s preferences for wealth to keep an eye on an investment you two shared, this display of Scrooge’s new wealth preferences (giving wealth away à la Christmas morning Scrooge) could certainly have you worried!

On October 1, 2013, Microsoft made headlines for both of these effects. The morning saw Forbes release the results of a survey that named the firm the most inspirational in the world. [4] Press coverage surrounding this announcement gave much credence to the firm’s success relying on the encouraging, generous atmosphere propagated by Bill Gates, founder, chairman, and noted philanthropist (the Ghandi effect). [5] Hours later, Reuters broke a story detailing the efforts of three major Microsoft investors to dislodge Gates from his position on the board. [6] The investors were primarily concerned with Gates’ ability to affect corporate strategy and influence the CEO, all while dedicating so little time and attention to the company. In subsequent coverage, reporters were not hesitant to suggest that Microsoft’s shareholders would be better off with a chairman who was more focused on the interests of the firm and less concerned with philanthropic pursuits (i.e. these reporters speculated that a Scrooge would be preferable to a Ghandi). [7] Within a period of only a few hours, the business press was attributing both the successes and shortcomings of Microsoft to Gates’ focus on philanthropy.

In our paper, we test these two effects (Ghandi vs Scrooge) against one another in a sample of public corporations in the US. Specifically, we examine market reactions around the announcement that a major shareholder has unexpectedly made a large charitable pledge. As a sample, we use announcements of public company blockholders who join The Giving Pledge, which entails a pledge to donate or bequeath to charity at least half of one’s wealth. We find that the market views this announcement negatively, as the firms these new philanthropists own see share prices drop by about 2%. These declines in price are larger for firms with high monitoring needs and in cases where the shareholder in question is thought to provide particularly strong monitoring.

This is not to say that the Ghandi effect doesn’t exist in the real world. Some firms actually leverage it to their advantage. Bloomberg LP, for example, regularly touts the philanthropy of major owner Michael Bloomberg in recruiting. [8] Hiring managers, for example, have been known to ask, “What other company can you work for where the owner gives nearly all the profits to charity?”

This effect, however, does seem to be dominated in our setting by the concerns of other shareholders that a blockholder’s philanthropy signals some reduced dedication to the pursuit of wealth. Since that pursuit also enriches these other shareholders (who co-own public firms with the blockholders in question), its perceived weakening could understandably generate concern. In further tests, we find that these concerns are at least partially substantiated, in that the wages for CEOs tend to correlate less with firm performance after major blockholders make large charitable pledges. Weak pay-performance sensitivity (the alignment of CEO pay to the performance of the firm) is thought of as an agency problem for firms, as it leads to chief executives having less incentive to better the corporation (and shareholders). [9]

We believe that this analysis bears some practical importance for two reasons. First, it suggests that large philanthropists aren’t very good monitors, and that other investors realize it. While blockholders in general are at their pleasure to steward their investments as they see fit, many of our unexpected philanthropists serve as directors (like Bill Gates), and these individuals bear a legal and fiduciary duty to serve as ardent stewards on behalf of their electing shareholders. Our findings cast doubt on whether that charge is suitable for those who concurrently engage in high levels of philanthropy. Secondly, there has been some suggestion that firms should reduce charitable efforts to allow for more income to flow to shareholders, who can then direct firm proceeds to charity on an individual level. [10] While this idea certainly has some promise to unwind the agency problems involved in corporate giving, our results indicate that individual shareholder charity can introduce agency problems as well.

More broadly, we believe this result is a step forward in understanding how human behavior affects stock prices and financial markets. This is especially tricky in settings such as ours, where economic and behavioral pressures offer conflicting predictions (Scrooge effect vs. Ghandi effect). We hope our result encourages other researchers to pursue work in this vein to further our collective understanding of real world incentives, both economic and psychological.

The complete paper is available for download here.


1J. C. Cox, “How to identify trust and reciprocity,” Games and Economic Behavior, vol. 46, no. 2, pp. 260–281, Feb. 2004.(go back)

2A. Edmans, “Blockholder Trading, Market Efficiency, and Managerial Myopia,” The Journal of Finance, vol. 64, no. 6, pp. 2481–2513, 2009.(go back)

3S. Richardson, “Over-investment of free cash flow,” Review of Accounting Studies, vol. 11, no. 2–3, pp. 159–189, Jun. 2006.(go back)

4J. Smith, “America’s Most Inspiring Companies,” Forbes, 01-Oct-2013. [Online]. Available: back)

5D. Bean, “Forbes’ ‘Most Inspiring Companies’ list: Microsoft is number 1, Apple drops to 12th,” Yahoo News, 02-Oct-2013. [Online]. Available:—most-inspiring-companies–list–apple-drops-to-12th-152655663.html.(go back)

6N. Damouni and B. Rigby, “Exclusive: Microsoft investors push for chairman Gates to step down,” Reuters, New York/Seattle, 01-Oct-2013.(go back)

7W. Oremus, “Is Bill Gates Bad for Microsoft?,” Slate, 02-Oct-2013.(go back)

8N.-H. Tseng, “Why these billionaires are pledging away their wealth,” CNN Money, 05-Aug-2010. [Online]. Available: back)

9K. Kim, “Blockholder monitoring and the efficiency of pay-performance benchmarking,” Journal of Corporate Finance, vol. 16, no. 5, pp. 748–766, Dec. 2010.(go back)

10M. C. Jensen, “Value Maximization, Stakeholder Theory, and the Corporate Objective Function,” Journal of Applied Corporate Finance, vol. 14, no. 3, pp. 8–21, 2001.(go back)

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