2.1. Institutional Background
ESOPs in China have three main stages, as follows. First stage—China’s ESOPs actually began with internal employee share ownership as part of a state-owned enterprises (SOEs) reform. The Chinese government started the process of corporatization in 1992 that allowed SOEs to be privatized through share ownership and become an incorporated company. After SOEs become corporations, with the approval of regulatory authorities, SOEs can issue part of the equity to internal employees to improve their operating efficiency [
23]. However, owing to the lack of effective supervision, a large number of irregularities exist in ESOPs at this stage, resulting in a significant loss of state-owned assets, and the Chinese government eventually terminated the internal employee share ownership policy in 1994. Since then, the internal employee share of Chinese listed firms has gradually decreased. After 2007, all internal employee shares were converted into tradable shares.
Second stage—China implemented the split-share reform in 2005, which was a milestone in the development of the Chinese capital market by increasing the liquidity and information content of the shares held by controlling shareholders; this better realizes the alignment of interests between controlling shareholders and minority shareholders [
4]. To adapt to these changes and improve corporate governance and performance, Chinese listed firms were to provide better incentives to their employees. Therefore, the CSRC issued the ‘Regulation of Equity Incentive Plans (trial)’ that specified the general rules for firms to grant employee equity incentives, such as restricted stocks and stock options, in late 2005. The procedures for the implementation of equity incentive plans, information disclosure, regulatory procedures and penalties when violations occur are included in the rules. However, the main incentive objects of the equity incentive plans are the directors, supervisors and managers of listed firms, rather than the ordinary employees.
Third stage—In June 2014, the CSRC promulgated the ‘Guidance’, formally launching the ESOPs for listed firms. Although ESOPs and equity incentive plans are consistent in their goals of binding the interests of employees and shareholders, institutional designs have significant differences. For example, while equity incentive plans focus on motivating management, ESOPs are broadly distributed to employees. Equity incentive plans mainly include the granting of restricted stocks and stock options, and the management is accompanied by corresponding performance evaluation. Conversely, ESOPs are mainly administered through the listed company to repurchase the firm’s shares, as secondary market purchase and subscription of non-public shares, but without a related performance evaluation. In the former type of plans, provided that the management meets the performance standards, they can decide whether to drive the corresponding options. The shares held by employees in the ESOPs are generally managed centrally by an organization elected by employees, and the employees cannot sell their shares for a short period.
We were motivated to examine the relationship between ESOPs and CSR in China for the following reasons. First, Chinese listed firms have played a key role in the rapid growth of China’s economy. As of 2020, there were more than 4000 A-share listed firms in China, with a total market value of CNY 76 trillion and counting 133 Chinese firms in the Fortune Global 500. However, since the Chinese government started the process of corporatization in 1992, Chinese listed firms are relatively young at this stage, and many listed firms are facing weak corporate governance problems. To this end, China has learned from developed Western countries and introduced a series of reform policies including ESOPs aiming to improve the corporate governance level of Chinese listed firms. It is important to examine the effects of these policies, because these can provide important reference value for other emerging capital market countries such as China.
Second, in recent decades, excessive emphasis on economic growth has led many Chinese firms to ignore the fulfillment of CSR, and incidents such as Sanlu’s tainted milk powder and Changsheng’s fake vaccines have occurred. Although the Chinese government has introduced various regulations to encourage listed firms to fulfill their CSR, many listed firms still lack CSR. For example, only 1081 A-share listed firms issued independent CSR reports in 2019, and more than two-thirds of the listed firms did not disclose independent CSR reports. Among them, only 512 listed firms made voluntary disclosures, while other listed firms made mandatory disclosures in accordance with legal regulations. This reflects the inherent limitations of external institutional constraints such as government regulations, laws and enforcement mechanisms, which have driven us to consider whether the corporate internal governance such as employee incentives can affect the fulfillment of CSR.
2.2. Hypotheses Development
As a key group of a firm’s stakeholders, it is well known that employees play a key role in the development of a firm’s CSR strategies and activities [
24,
25,
26]. Collier and Esteban [
17] emphasized the dependence of organizations on employees’ responsiveness and participation in CSR. They argued that the effective implementation of CSR projects depends on the willingness of employees to collaborate. However, not all employees will be equally and actively engaged in organizational CSR goals. The financial transactions between employees and organizations are typically explicit contractual agreements from which employees can profit. In contrast, fulfilling CSR may exceed the scope of the normal economic contract between the employee and the organization and be considered a social contract, but the social contract does not have clearly defined responsibilities and obligations [
27]. Hence, some employees may not be sufficiently motivated to engage in CSR. Rodrigo and Arenas [
28] argue that organizations often have some ‘indifferent’ employees who are pragmatic, goal-oriented and personally indifferent to CSR engagement—even if they understand the role of CSR in the organization. Additionally, there are some ‘dissident’ employees who only regard work as an economic contract with no responsibility to a wider social role.
The principal–agent theory can also explain the absence of employees in CSR. CSR activities are a complex process with high investment, multiple levels and long cycles, and this require the engagement of employees from all departments. Agency theory argues that, in the corporate principal–agent relationship, the goals of agents (i.e., managers and employees) are often inconsistent with the interests of principals (i.e., shareholders) [
29]. For example, prior literature has argued that managers and workers are natural allies against takeover threats because takeovers and subsequent mergers are often associated with layoffs [
30,
31]. For shareholders, CSR can give a firm good reputation and increase shareholder value. Previous literature has shown that CSR can give a firm good reputation and increase shareholder value because better CSR can reduce corporate risk [
32], increase investment efficiency [
33], improve corporate reputation [
34] and ultimately increase the long-term firm value [
35]. However, employees only receive a fixed salary for their work, do not share in the ownership of firm assets and residual earnings and do not enjoy the reputational and financial benefits of high CSR, and some even profit from activities that undermine the firm’s CSR (e.g., Sanlu’s tainted milk powder incident was caused by typical employees neglecting CSR in pursuit of private interests).
Collier and Esteban [
17] believe that, to ensure that employees fulfil the requirements related to CSR goals, they should be given sufficient incentives. We posit that ESOPs motivate employees’ CSR engagement with at least the three following aspects. First, ESOPs can coordinate the interests of employees and shareholders and thus effectively mitigate the aforementioned agency conflicts [
36]. These create an ecosystem of incentive contracts throughout the organization, thus aligning the interests of employees and owners [
5]. By binding employee earnings to firm stock value, ESOPs can motivate employees to engage in CSR activities from external economic incentives. When employees hold firm shares, they will do their best to maintain and improve the firm reputation and image closely related to the firm stock value in the organizations’ daily activities. Previous literature has well documented that CSR is a key activity that affects firm reputation [
33]. At the same time, some studies have found that there is also a positive relationship between CSR and shareholder value [
37,
38]. For example, Lins et al. [
39] found that the stocks of higher CSR firms performed better than those of lower firms during the 2008–2009 financial crisis, and the firm-specific social capital established by engaging in CSR will be rewarded once society’s trust has been restored. This is also consistent with the results found in Nofsinger and Varma [
40].
Second, in addition to external economic incentives, the internal psychological incentives of ESOPs can also encourage employees to engage in CSR. Before the implementation of ESOPs, the limited labor of employees paid to work was the optimal choice. When employees hold shares in the firm, they technically become owners of the firm, allowing their employees to feel a sense of ownership [
41], which will greatly improve employees’ organizational identity and organizational commitment. For example, Chiu and Tsai [
42] found that stock-based profit sharing has a positive effect on employees’ organizational citizenship behavior. Organizational identity and organizational commitment is an important motivation for employees to engage in CSR activities, which ensures that they are motivated to implement CSR practices. There exists a stream of literature that views underlying psychological outcomes such as organizational identity and organizational commitment to be the key factors affecting employees’ individual levels to carry out CSR activities [
43]. For example, as suggested by Collier and Esteban [
17], if organizational attributes are perceived as attractive by employees, they will identify strongly with the organization, and strong organizational identification may translate into cooperative and citizenship-type behaviors.
Finally, the above two kinds of incentives will increase mutual supervision among employees [
44], reducing the behavior of employees seeking private interests from activities that damage organizational CSR. Hochberg and Lindsey [
45] argued that the value of ESOPs as a group incentive plan is demonstrated by employees working together; this enhances cooperation among employees which can also lead to mutual monitoring among colleagues. Furthermore, Sesil et al. [
46] argued that, owing to the complexity of the firm’s mission, shareholders may not have the adequate conditions to monitor the decisions of managers and employees. However, employees may be better qualified than shareholders to monitor the quality of each other’s contributions at work. Giving employees incentives for self-monitoring and peer monitoring through collective incentive schemes depending on performance may be a cost-effective alternative to formal monitoring (e.g., more supervisors). In particular, should employees collectively agree to exert this supplementary effort, the incentive to monitor and sanction their colleagues engaging in CSR will increase, because each employee’s actions affect organizational CSR goals [
45]. Thus, although an employee could profit from actions that undermine the firm’s CSR, other responsible employees would not allow it, as this would compromise the firm’s value and reputation and thus affect their compensation. Based on this analysis, we propose the first research hypothesis as follows:
Hypothesis 1 (H1). Compared to firms without ESOPs, firms with ESOPs have higher CSR.
ESOPs enable employees to become the owners of the firm and encourage them to participate in business decisions; however, the effectiveness of ESOPs depends on the corporate ownership structure [
4]. La Porta et al. [
47] found that, except for a few countries with developed capital markets, ownership concentration is a relatively common ownership structure worldwide, and firms often have the ultimate controller. In emerging capital markets such as China, the ultimate controller will control the firm through pyramidal shareholding and cross shareholding [
48], where pyramidal shareholding separates control and cash flow rights [
49]. Thus, as long as the controlling shareholder’s gain from using control to transfer the corporate resources is less than the loss suffered due to the existence of cash flow rights, the controlling shareholder has sufficient incentive to intervene in the interests of other shareholders.
When the degree of wedge structure is high in listed firms, the controlling shareholder intervenes in the interest of minority shareholders by diluting wages, delaying transactions and transferring assets, but other shareholders will not be able to perform effective supervision [
50]. In particular, in many emerging capital markets, wedge structures may be associated with weaker oversight [
48]. In such cases, the wedge structure can weaken the incentive effect of ESOPs because if the positive and governance effects of ESOPs limit the private interests of controlling shareholders, controlling shareholders may resist employee participation in corporate governance. Furthermore, as the wedge structure expands the controlling shareholders’ control, employees find it difficult to engage in corporate decision making in a real sense, and the equity interests of employees are also vulnerable to the infringement of the controlling shareholder. Based on this analysis, we propose the second hypothesis as follows:
Hypothesis 2 (H2). Wedge structure weakens the positive effect of ESOPs on CSR.
As ESOPs in Chinese listed firms target the majority of employees, some studies have argued that free-riding problems hinder the effectiveness of ESOPs [
51]. According to free-riding theory, collective action will benefit members who do not share the costs and risks. In profit-sharing or employee-owned firms, the marginal effort of any single employee will be shared by many other members. Thus, when firms have a large number of employees, individual employees may feel that their actions have little impact on the firm’s goals; therefore, they may be reluctant to perform tasks that require extra effort or sacrifice. This free-rider effect, often referred to as the 1/N effect, intensifies as the number of employees, N, increases [
51]. Conversely, firms with a small number of employees are less likely to experience free-riding as corporate performance is more sensitive to the behavior of individual employees, and individual employees have a higher ability to influence firm value [
52]. Related research has found that, in firms with a small number of employees, ESOPs provide stronger incentives for employees, so they are more motivated to increase firm performance [
3,
5,
44]. We speculated that the free-rider effect persists in the relationship between ESOPs and CSR. Based on this analysis, the following hypothesis can be proposed.
Figure 1 provides the theoretical framework of this paper.
Hypothesis 3 (H3). Firm size weakens the positive effect of ESOPs on CSR.