Corporate Donations and Shareholder Value

Hao Liang is Assistant Professor of Finance at Singapore Management University, and Luc Renneboog is Professor of Corporate Finance at Tilburg University. This post is based on their recent paper.

More and more companies strive for a reputation of “giving back to society” by the means of donation. A 2014 survey among 261 leading firms worldwide (CECP, 2014) concludes that the amount of corporate philanthropy totals $25 billion, with a median of $18 million per company which is equivalent to 1.01% of pre-tax profits, 0.13% of revenues, or $644 of per employee. At the industry level, industrial and energy companies are at the bottom with donations of only 0.76% of pre-tax income, which stands in marked contrast with the healthcare and consumer discretionary sectors as top contributors with 1.58% and 1.25% of pre-tax income, respectively. The main beneficiaries are educational organizations capturing 28% of the total donations, followed by health & social services with 27%. The amount of donations keeps growing; it has augmented by about 40% over the past decade.

Corporate philanthropy usually concerns voluntary donations of corporate resources to charitable causes. As corporate philanthropy consists of pro-social behavior, it is considered as part of corporate social responsibility (CSR) that involves explicit pro-social spending. We can partition donations on the basis of the type of beneficiary: charitable and political donations, but can also dissect total charitable donations on the basis of the type of payment: cash and in-kind donations. An important mechanism for distributing donations is through a corporate foundation/trust; a good third of corporate donations are made via a corporate foundation.

For society as a whole, corporate philanthropy may yield important benefits to non-shareholders that can increase social welfare. However, altruism comes at a cost because corporate giving lowers tax revenues and some donations, for instance those aimed at fulfilling politicians’ agenda, may not be pro-social. The scope of our study, however, is limited to the implications on shareholder wealth. At a first sight, corporate philanthropy may be inconsistent with maximizing shareholder wealth, because giving money or other assets away contradicts with the commercial, profit-making purpose of a company. According to such rationales, grouped under the agency theory, the primary reason why managers would still decide to donate is because it satisfies their personal altruistic needs or yields other private benefits. In other words, managers serve their own interests at the expense of the shareholders. In contrast, the value-enhancement view argues that corporate philanthropy increases the value of the firm. Donations could function as a kind of marketing tool, indirect cost saving mechanism, community-oriented investment, or mechanisms to bond employees to the company, and as such improve corporate financial performance. In addition, corporate donations can also solve a collective action problem in which it is difficult to aggregate individual investors’ donations to have a strong enough impact on society. If corporate philanthropy can serve the purpose of passing through individuals’ donations and make a bigger impact to society, investors may perceive it favorably, consistent with the value-enhancement view. Although there has been a noteworthy body of research in the area of corporate philanthropy, the causal effect on firm value is still ambiguous. Consequently, the two contradictory theories both find support in the literature. Of course, these views are not necessarily mutually exclusive, as corporate philanthropy can on one hand fulfill managers’ self-interest, while on the other hand enhance financial performance due to tax saving, reputation building, and solving the collective action problem. Which effects are more dominant is mostly an empirical question, which is investigated in this paper.

We first examine the agency hypothesis by linking corporate donations and the use of corporate foundations to measures of internal and external corporate governance that can capture the relative power of managers and shareholders, and of shareholders’ protection as regulated by law. Second, the value-enhancement view is examined by relating corporate donations to measures of current and future firm value and financial performance. Given that this relation between donations and firm value may be endogenous since doing well may enable a firm to do good, we employ an instrumental variable approach by using peer firms’ donations as an IV and also conduct a difference-in-differences analysis.

The results suggest that more charitable donations are associated with higher shareholder value for the largest listed corporations around the world. First, charitable donations are not strongly correlated with internal and external corporate governance. Charitable donations do not occur more in firms where management is entrenched, nor do we see less corporate philanthropy in firms with stronger shareholder power. This casts doubt on the view that considers charitable donations as an agency problem. Second, charitable giving is positively correlated with current and future measures of firm value and profitability (Tobin’s Q, ROA, and sales growth). This positive relation is stronger for charitable donations in cash than for in-kind donations. Third, distributing funds by means of a corporate foundation is correlated with poor internal governance and strong managerial power (as measured by the presence of golden parachutes, M&A limitations, larger board size, anti-takeover devices, CEO-chairman duality, and the corporate governance E-index), and poor external governance which is here equivalent to the absence of large shareholder monitoring. While one may interpret the use of a corporate foundation an agency problem, the fact that a foundation is positively related with current and future firm value casts doubt on this interpretation. Our findings are more in line with a foundation helping to ensure that donations are spent in the best interest of the firm and that they are actually a solution to the agency problems in the firm related to donations. Fourth, political donations do appear to be related to agency problems: they are associated with various indicators of poor internal corporate governance and managerial entrenchment and are unrelated to firm value and financial performance. A difference-in-differences analysis around the 2010 UK elections does not reveal any positive effect on the firm value of companies with political donations.

Our work contributes to the literature in several ways. First, it adds to the literature on corporate philanthropy. In contrast with previous studies suggesting that corporate philanthropy reflects an agency problem, we find that donations by a global sample of large public firms can positively affect corporate value and financial profitability, thereby offering a different perspective that is more in line with the value-enhancement view of corporate philanthropy. Nevertheless, we also add to the literature on political giving and agency costs by shedding light on the agency aspect of political donations. Second, to the best of our knowledge, this study is the first to dissect corporate donations by studying giving in cash or in-kind assets. Our findings suggest that this differentiation by the form of giving is important as the positive effect of donations on firm value is prevalent for cash giving but less so for in-kind donations. Third, by examining donations in their corporate governance context, we can show that impact of internal and external corporate governance mechanisms as well as the effect of the regulatory framework on the role of donations, an important aspect that is missed in the current literature which usually employs a single-country setting. Our focus on an international context helps to show how the relation between donations and shareholder value is related to legal investor protection at the country level.

The full paper is available for download here.

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