1. The Impact of the Lack of Diversification in Managerial Portfolios on Corporate Social Responsibility Philip L. Cochran, Indiana University Melissa S. Baucus, University of Louisville Ann K. Buchholtz, University of Georgia October 15, 2006

2. Overview Many of the decisions top managers make that negatively impact stakeholders may stem from top managers’ equity position in the firm, i.e., their position as undiversified owners. Many of the decisions top managers make that negatively impact stakeholders may stem from top managers’ equity position in the firm, i.e., their position as undiversified owners. Increasing use of equity compensation was viewed as a way to more closely align top managers’ interests with those of owners. Increasing use of equity compensation was viewed as a way to more closely align top managers’ interests with those of owners. A consequence of top managers receiving significant equity compensation is that their personal portfolios have become highly undiversified. A consequence of top managers receiving significant equity compensation is that their personal portfolios have become highly undiversified.

3. Implications This, leads to resource allocation decisions that negatively impact the firm’s stakeholders. Executives with significant but undiversified personal portfolios will perceive decisions that benefit the firm’s primary stakeholders (excluding shareholders) as too risky financially. This has serious implications for corporate social responsibility.

4. Principal-Agent Problem The intersection of research and managerial practice is often a more efficient and effective set of organizational outcomes. The intersection of research and managerial practice is often a more efficient and effective set of organizational outcomes. The use of equity and stock options offered the potential to ameliorate the principal-agent problem. The use of equity and stock options offered the potential to ameliorate the principal-agent problem. The “solution” was a dramatic jump in managerial equity. The “solution” was a dramatic jump in managerial equity. And the dot-com bust? And the dot-com bust?

5. Unintended Consequences However, the unintended consequence of this approach has been the creation of wealth portfolios in the hands of managers that are unable to be sufficiently diversified. However, the unintended consequence of this approach has been the creation of wealth portfolios in the hands of managers that are unable to be sufficiently diversified. Managers undiversified wealth portfolios will tend to be more risk averse than a diversified owner. Managers holding undiversified wealth portfolios will tend to be more risk averse than a diversified owner. Decisions by non diversified managers may be counter to the interests of diversified owners, Decisions by non diversified managers may be counter to the interests of diversified owners, This is completely at odds with the precepts of agency theory. This is completely at odds with the precepts of agency theory.

6. Example - Pollution Diversified shareholders tend to hold “market portfolios.” Diversified shareholders tend to hold “market portfolios.” Pollution by one firm may help the focal firm Pollution by one firm may help the focal firm –but may many other firms in society –for a net negative social impact. A diversified stockholder will want the focal firm to reduce pollution A diversified stockholder will want the focal firm to reduce pollution An undiversified stockholder will want the opposite. An undiversified stockholder will want the opposite.

7. Stakeholder Salience Mitchell, Agle & Wood (1997) discussed the salience of stakeholders when designing an approach to stakeholder management. Mitchell, Agle & Wood (1997) discussed the salience of stakeholders when designing an approach to stakeholder management. Undiversified managers will likely be more prone to responding to stakeholders they view as highly instrumental. Undiversified managers will likely be more prone to responding to stakeholders they view as highly instrumental. Resource allocations may be directed in a manner that differs from the wishes of the more diversified owners. Resource allocations may be directed in a manner that differs from the wishes of the more diversified owners. This may invite the potential for unforeseen conflict between the firm and its stakeholders. This may invite the potential for unforeseen conflict between the firm and its stakeholders.

8. Questions Does stock ownership affect a top manager’s approach to stakeholder management? Does stock ownership affect a top manager’s approach to stakeholder management? Does stock ownership affect trade-offs made by managers among various stakeholders? Does stock ownership affect trade-offs made by managers among various stakeholders? Do executives with high equity holdings make decisions that result in poor performance with some primary stakeholder groups? Do executives with high equity holdings make decisions that result in poor performance with some primary stakeholder groups? What implications might this have for theories of CSR? What implications might this have for theories of CSR?