CSR and the Insurance Industry

The international insurance industry has long had a strategic interest in the CSR (e.g., environmental protection) activities of its corporate clients (e.g., oil and gas companies) as part of its routine underwriting procedures (Hsu, Reference Hsu2012). However, over the last decade or so CSR in the insurance industry has acquired a much higher profile in the public media than hitherto had been the case (WestLB AG, 2004; McKinsey, 2015). The increased visibility of CSR activities highlights the important role that insurers play in economy and society as both bearers/traders of insurable risks and institutional investors (Bhambri & Sonnenfeld, Reference Bhambri and Sonnenfeld1988). The increased public salience of CSR also reflects the greater political scrutiny of financial services firms following the 2007/8 global financial crisis and the major government bailouts of failed financial firms, most notably the $182 billion US federal government support for the American International Group (AIG) (Walls, Berrone, & Phan, Reference Walls, Berrone and Phan2012). Recently, scholars such as Aguinis and Glavas (Reference Aguinis and Glavas2012), Marquis and Qian (Reference Marquis and Qian2014), and den Hond et al. (Reference den Hond, Rehbein, de Bakker and Lankveld2014) posit that firms operating in high profile and heavily regulated sectors, such as financial services, could voluntarily engage in philanthropy in order to secure economic and/or political benefits from government agencies (e.g., in terms of tax relief) and/or even avoid the costs of more substantive CSR engagement.

A prominent philanthropic public profile could be strategically important for insurers as their basic business model involves writing a contractual (promissory) commitment to indemnify policyholder-customers for future losses in exchange for the receipt of regular premiums (i.e., ‘solidity’) (Gaa & Krinsky, Reference Gaa and Krinsky1988). The contractual nature of insurance transactions not only highlights the ethical (moral) importance of maintaining the trust and confidence of existing as well as prospective policyholders and investors, but also satisfying other key stakeholders such as brokers, reinsurers, and industry regulators, particularly with regard to the maintenance of future solvency (Boubakri, Dionne, & Triki, Reference Boubakri, Dionne and Triki2008). The financial and risk management profile of insurers as well as the reputational interests of their managers and industry regulators can thus be protected through the purchase of reinsurance in a similar way as investing in CSR activities such as charitable giving. Koh et al. (Reference Koh, Qian and Wang2014) find that CSR engagement is particularly value-enhancing in an ex-ante and ex-post sense for firms (e.g., those in extractive industries) that are intrinsically exposed to potentially high levels of litigation risk and commercial uncertainty. However, in the insurance industry, other risk hedging tools, such as reinsurance (and likewise insurance in general industrial firms), could provide more cost-effective ‘insurance protection’ of a firm’s franchise value than contributing to charitable causes. Therefore, in the insurance industry, the CSR-risk management relation could be positively or inversely related, or even for some (e.g., small) insurance firms strategically disconnected. These aspects thus make the UK’s non-life insurance industry not only a prospectively interesting sector within which to examine the risk management attributes and trade-offs associated with CSR-type activities such as philanthropy but also to extrapolate to the risk management-CSR functions in other industrial sectors, particularly other risk-trading financial firms, such as banks, that relative to their net annual earnings also donate little to charitable causes (Zimmeck & Pharoah, Reference Zimmeck and Pharoah2015).

The UK’s Non-Life Insurance Industry

The UK’s non-life insurance industry is the third largest in the world (after the US and Japan) and comprises approximately 300 or so active domestically-owned and foreign-owned companies, subsidiaries, and branches of varying size, ownership structure, and output mix, which currently generates approximately £50 billion (US$72 billion) in gross annual premiums (International Underwriting Association, 2013). ^{Footnote 1} In addition, 94 active syndicates at the Lloyd’s of London insurance market currently underwrite direct non-life premiums of roughly £25.3 billion (US$37 billion) per annum, mainly in property and casualty lines of insurance (Lloyd’s of London, 2014). As made clear earlier, issues of CSP have become even more publicly prominent since the 2007/8 global financial crisis and the associated major corporate failures and government bailouts. Such strategic risk management considerations are also important for UK-based insurers going forward with the implementation of the European Union’s (EU) new risk capital (Solvency II) requirements in January 2016. Additionally, trade surveys of CSR in international insurance markets (e.g., McKinsey, 2015; WestLB AG, 2004) indicate that the CSR activities of insurers are potentially of interest to reinsurance companies as well as other stakeholders (e.g., industry regulators). For example, reinsurers could view corporate philanthropy as a signal that their insurance company clients are managed by boards of directors eager to promote a sustainable and socially aware and responsible business model to lawmakers, industry regulators, and others. In turn, such ‘public image-building’ could help reinsurers to generate future cash flows, increase firm value, and protect/promote their market brand-name.

Corporate Philanthropy, Ethics and (Re)insurance

The concept of insurance as a promissory contract that compensates policyholders for economic loss fits closely with Carroll’s (Reference Carroll1979) three-dimensional view of CSR activities as overlapping economic, legal, and ethical phenomena. Schwartz and Carroll (Reference Schwartz and Carroll2003) add that the incidence and scale of discretionary ethical (philanthropic) activities could be influenced by the economic interests of dominant constituents such as shareholders and board-level executives. This ‘micro’ pragmatic notion of corporate philanthropy, reflected for example in agency theory, contrasts with ‘macro’ perspectives that views corporate philanthropy, particularly in publicly visible organizations, as satisfying societal expectations of ‘desirable’ ethical behaviour and moral legitimacy (Suchman, Reference Suchman1995). Therefore, the decision of (insurance) firms to (re)insure and simultaneously donate to charitable organizations could help ‘harmonize’ the interests of key stakeholders (e.g., investors, managers, and policyholders) with society’s expectations of legitimate CSR behaviour. Therefore, the concepts of corporate philanthropy, risk management, and ethics are inextricably bound within the stakeholder constitution of organizations.

Stakeholder Theory and (Re)insurance

To frame our research, we draw on strategic stakeholder theory—an established analytical framework in organizational management and business ethics literature (Phillips, Freeman, & Wicks, Reference Phillips, Freeman and Wicks2003). Stakeholder theory emphasizes the pivotal role of the board of directors in interacting with stakeholders and balancing their (often conflicting) claims to ensure that the firm is financially successful and remains a ‘going concern’ (Freeman, Reference Freeman1984). In fact, Walls et al. (Reference Walls, Berrone and Phan2012: 904) state that a strategic stakeholder perspective can help researchers to “. . . investigate the very real and inseparable tensions between a firm’s financial and social demands.” El Akremi, Gond, Swaen, De Roeck, and Igalens (Reference El Akremi, Gond, Swaen, De Roeck and Igalens2016) further emphasize that CSR-type decisions are context-specific, and reflect stakeholders’ economic and social expectations. Additionally, Dewing and Russell (Reference Dewing and Russell2008) note that the UK Financial Services and Markets Act (2000), which regulates the governance and management of financial services firms, including insurers, is unique in the UK in that it is designed specifically to safeguard and balance the economic interests of plural stakeholders rather than just shareholders.

Such scholars as Moore (Reference Moore2001), Laplume et al. (Reference Laplume, Sonpar and Litz2008), and Chiu and Sharfman (Reference Chiu and Sharfman2011) advocate that strategic stakeholder theory can be also provide a useful basis for conducting CSP research as it highlights how firms legitimize their relations with multiple stakeholders through CSR activities such as charitable giving. This is particularly apt in the case of this study as the multiple stakeholders of insurance firms have competing but overlapping economic and political goals (Bhambri & Sonnenfeld, Reference Bhambri and Sonnenfeld1988). Cole, McCullough, Semykina, and Sommer (Reference Cole, He, McCullough, Semykina and Sommer2011) add that in the insurance industry, salient stakeholder groups have a strong mutual interest in monitoring and controlling the risk-taking activities of insurance managers in order to ensure future solvency and the protection of their contractual claims. Agle et al. (Reference Agle, Mitchell and Sonnenfield1999) conceptualize the salience of firms’ stakeholders in terms of their power (financial and political), legitimacy (legal and moral), and urgency (societal and economic). This is a useful analytical benchmark in the context of the present study as these three traits characterize insurance industry stakeholders and can be optimized using reinsurance. In a finance context, Navarro (Reference Navarro1988) argues that corporate giving helps increase revenue (e.g., by promoting the firm’s brand-name), lower costs (e.g., of government enforcement actions), and saves taxes (e.g., by timing donations when marginal tax rates are high). However, in the insurance industry, reinsurance can achieve such strategic objectives more cost-effectively than philanthropy. Moreover, as reinsurance reduces insolvency, underwriting, and other financial risks in insurance firms, it concomitantly enables managers to protect the interests of less immediately powerful stakeholder groups, such as future generations of policyholders and minority shareholders (Cole et al., Reference Cole, He, McCullough, Semykina and Sommer2011). Such attributes are clearly important in a ‘trust and relationship’ business like insurance.

Stakeholder analysis could also explain the nature of a potential substitutive relation between philanthropy and reinsurance. Indeed, some (e.g., larger and multiproduct) insurers may make modest investments in social projects as well as reinsure if the economic payoffs from such philanthropic endeavours exceed the costs (e.g., by generating new business). The positive net present value (NPV) of such an investment in ‘white-washing’ could have wider stakeholder benefits beyond merely increasing value for shareholders. In contrast, other (e.g., small and niche) insurers are likely to have a less diversified customer-base whose economic interests are better served solely by purchasing reinsurance. ^{Footnote 2} Therefore, stakeholder theory implies that differences in the reinsurance-philanthropy relation across insurance firms not only reflects the relative cost-effectiveness of reinsurance and CSR-type activities as strategic risk management options but also benefits a broader constituency of economic, social, and political interests.

Given the importance of reinsurance to the insurance industry, reinsurers are clearly important stakeholders for insurance firms (Cole et al., Reference Cole, He, McCullough, Semykina and Sommer2011). As a result, reinsurers could explicitly take societal legitimacy and other benefits of philanthropy into account in assessing the business (e.g., litigation) risks associated with their partnership with insurance firms. For example, by promoting public trust and market confidence—the essential ingredients of insurance—a prominent philanthropic stance could help an insurer to mitigate a decline of future free cash flows and/or increase in the costs of capital arising from financially damaging events such as a serious breakdown in corporate governance. To the extent that CSR-induced free cash flow generation and/or reputational capital protection reduces the risks of financial distress and/or bankruptcy for insurers then stakeholders other than reinsurers—for example, investors, policyholders, and industry regulators—could also value philanthropy. The legislative and regulatory structure of the UK insurance industry means that insurers are exposed to a high risk of litigation not only as a result of contractual dispute (e.g., policy mis-selling) but also statutory non-compliance (e.g., inadequate capital maintenance). According to Koh et al. (2009), firms operating in highly litigious industries are, in theory at least, more likely to benefit from ‘positive moral capital’ arising from CSR activities as it tempers the severity of ex-post sanctions from stakeholders in the event of a major shock event such as a high profile legal dispute. On the other hand, reinsurance can provide pragmatic (economic) and moral (reputational) legitimacy plus lowered exposure to socio-political risks for the salient stakeholders of insurance firms. Therefore, the stakeholders of insurance firms are likely to require the board of directors to strategically prioritize reinsurance over philanthropy.

Strategic stakeholder theory also fits comfortably with recent research that links the resource allocation function of corporate governance with CSR strategy (e.g., see Hambrick, Werder, & Zajac, Reference Hambrick, Werder and Zajac2008; Lan & Heracleous, Reference Lan and Heracleous2010; Harjoto & Jo, Reference Harjoto and Jo2011). Godfrey et al. (Reference Godfrey, Hatch and Hansen2010), Koh et al. (Reference Koh, Qian and Wang2014), and others further contend that reputational insurance protection through CSR engagement can be particularly important in competitive environments, such as the UK’s non-life insurance market, where customer switching costs and barriers of entry/exit tend to be low by international standards (Webb & Pettigrew, Reference Webb and Pettigrew1999). It is against this stakeholder theory backdrop that we now turn in developing our research hypotheses.

Reinsurance-Charitable Donations Relation

As corporate philanthropy and reinsurance can, as noted earlier, conceivably perform similar strategic functions in alleviating market imperfections (e.g., information asymmetries) between an insurer’s top management and its stakeholders, a substitutive (albeit non-equivalent) relation could exist between the decision to buy reinsurance and whether or not to engage in charitable giving. We argue that whilst CSR activities (e.g., philanthropy) and corporate (re)insurance serve the same strategic objective functions—namely, the maintained resilience and sustainability of the business—they are non-equivalent substitutes as the mechanism by which these two risk management options achieve these strategic goals will be different. For example, philanthropy could at one level, signal narrow (e.g., local community) stakeholder involvement, while reinsurance promotes financial stability that benefits a broader constituency of investors, policyholders, regulators, amongst others. Indeed, in the UK’s insurance industry the strategic role of reinsurance is underscored by industry regulation and statutory solvency maintenance requirements (Upreti & Adams, Reference Upreti and Adams2015). On a broader level, philanthropy (e.g., the sponsorship of medical research) can benefit multiple stakeholders at both a national and international level, and so have wider public appeal and more extensive brand development value (El Akremi et al., Reference El Akremi, Gond, Swaen, De Roeck and Igalens2016).

Koh et al. (Reference Koh, Qian and Wang2014) further suggest that risk management tools such as (re)insurance are not strictly equivalent to the intrinsic insurance qualities of CSR-type activities because the former are based on explicit contracts enforceable in law, whilst the latter are based on the intangible goodwill of stakeholders. However, we argue that CSR-type activities can be viewed as examples of multi-period implicit contracts between a firm and its constituents. These less formalized contracting arrangements could nevertheless be the subject of legal dispute—for example, take the case of a firm operating in the extractive sector reneging on a CSR commitment to invest in environmental protection—a decision that then results in severe economic losses and social disruption in the event of catastrophe (e.g., a major flood). If the firm’s stakeholders challenged such a ‘broken CSR promise’ in a court of law, judgement could affect the scope and/or scale of insurers’ liabilities under insurance contracts written with the firm, and in turn, possibly limit their ability to fully reclaim financial losses under reinsurance treaties.

There are two main functions of reinsurance in insurance markets (and indeed, for insurance in general industrial settings). First, reinsurance helps instil ex-ante confidence in an insurer’s financial viability amongst stakeholders thereby enabling it to grow/maintain product-market share. Second, reinsurance can enable an insurer to stabilize period earnings and reduce the risk of financial distress/bankruptcy ex-post a loss event (Abdul Kader et al., Reference Abdul Kader, Adams and Mouratidis2010). As a brand protection strategy, investment in CSR activities likewise performs ex-ante and ex-post risk mitigation (Koh et al., Reference Koh, Qian and Wang2014). Whilst reinsurance is extensively used in the non-life insurance industry (Froot & O’Connell, Reference Froot and O’Connell2008), it could nonetheless represent an opportunity loss to shareholders and other constituents unless it preserves and/or adds economic value to the insurance firm. Therefore, the board of directors is likely to prioritize the strategic decision to reinsure since it optimally protects the interdependent interests of the full constituency of stakeholders against the risk of financial distress/bankruptcy over an investment in corporate philanthropy that may only benefit a narrow constituency (e.g., see Lan & Heracleous, Reference Lan and Heracleous2010). This reasoning suggests a substitutive (negative) relation between reinsurance and the corporate decision to donate to charitable causes, and the amount of money contributed. Consequently:

On the other hand, the nature of the reinsurance-corporate donations relation could be complementary (positive). Insurers use reinsurance as a claims contingent capital alternative to holding (costly) equity and reserves (Abdul Kader et al., Reference Abdul Kader, Adams and Mouratidis2010). This has three main economic advantages for insurance firms. First, reinsurance tends to be more cost-effective and easier to secure than equity capital (e.g., due to lower frictional and supply costs). Second, reinsurance can help managers stabilize period earnings and reduce future taxes—particularly under the progressive corporate tax codes that exist in most developed economies, including the UK and US. Third, reinsurers provide ancillary risk management services (e.g., loss prevention advice), which can add ‘real value’ for primary insurers especially those operating in new and/or highly specialist segments of the market (Upreti & Adams, Reference Upreti and Adams2015). These strategic benefits of reinsurance could provide the free cash flows and contingent capital provisions necessary for insurers to not only engage in discretionary philanthropic activities such as charitable giving that advantage specific constituents (e.g., local communities), but also influence the level of investment in CSR projects that realize benefits for a much broader range of stakeholders at both the national and international scales.

Reinsurers, as key stakeholders could also be motivated to encourage philanthropy amongst their primary insurance clients as it could help them increase future rates of new business growth, improve the public visibility of the corporate brand, and/or minimize the risk (and cost) of regulatory intervention (Hsu, Reference Hsu2012). ^{Footnote 3} Indeed, recent adverse media publicity affecting the insurance industry in the UK and elsewhere—for example, with regard to product mis-selling, disputed insurance claims, and unclear and disputed contractual terms (Kvalnes, Reference Kvalnes2011)—could stimulate reinsurers to advise and encourage their primary insurance partners to donate to charitable causes in order to generate goodwill with other economically and/or politically influential stakeholders, such as investors and industry regulators. Such a strategy could be particularly beneficial for insurers entering new product-markets and/or operating in lines of business (e.g., pensions mis-selling) that have been subject to adverse media attention. Therefore:

Moderating-Effects of Board Composition

Recent management research (e.g., Jia, Reference Jia2013, Reference Jia2014) stresses the importance of testing for potential moderating-effects in predicted relations between variables. Harjoto and Jo (Reference Harjoto and Jo2011) note that board composition can particularly influence philanthropy as stakeholder and strategic risk management are integral to effective corporate governance. Accordingly, in our multivariate analysis we use, and briefly motivate, six variables identified as important in prior CSR studies to capture the moderating-effects of board composition on the relation between reinsurance and charitable giving.

Outside Directors: To promote their ‘human capital’ value, independent outside directors on the board could attempt to balance the conflicting resource claims of different constituents beyond the narrow goal of maximizing shareholders utility by reinsuring and engaging in philanthropy (Ibrahim, Howard, & Angelidis, Reference Ibrahim, Howard and Angelidis2003). Moreover, in promoting earnings stability, reinsurance could help insurers to accumulate the necessary resources needed to fund philanthropic projects and thus promote the public reputations of board outsiders as prudent and socially responsible managers. This is likely to be an important motivation in a public-trust orientated and regulated business like insurance. Therefore:

CEO-Chair Separation: Separating the CEO from the chair functions could reduce the degree of CEO power on the board and so better serve the socio-economic interests of a broader spectrum of stakeholders (Combs, Ketchen, Perryman, & Donahue, 2007). Reinsurance, in conjunction with separating the CEO and chair functions, could also help reduce the adverse effects of risk-taking and maintain financial stability. Again, such qualities are particularly important in a highly regulated and public trust-dependent industry such as insurance. This could increase the propensity of insurance firms to both reinsure and donate to charitable causes. As a result:

Inside Ownership: Owner-managers could engage in reinsurance and charitable giving in order to fulfill personal welfare objectives and/or assuage the claims of other stakeholders thereby complementing the link between reinsurance and philanthropy (Coffey & Wang, Reference Coffey and Wang1998). For example, reinsurance could allow owner-managers to concomitantly manage assumed risks and promote a philanthropic public profile—again a quality that is likely to be particularly important in a public trust and risk protection important business such as insurance. Accordingly:

CEO Bonus Plans: Mahoney and Thorn (Reference Mahoney and Thorn2006) report that CEO bonuses can facilitate CSR engagement as they can reduce the potentially deleterious reputational consequences arising from public media criticism of perceived excesses in executive compensation. By improving corporate solvency and signalling prudential management reinsurance could therefore limit the likelihood that CEO incentive compensation will attract adverse public criticism. Consequently:

Board-Level Female Directors: Prior studies (e.g., Brammer, Millington, & Pavelin, Reference Brammer, Millington and Pavelin2009) suggest that female directors tend to be behaviourally inclined to precautionary strategies, and more sensitive to balancing the needs and requirements of different stakeholders of the firm than their male counterparts. Therefore, the female board members of insurance firms could actively promote charitable giving and risk reduction strategies such as reinsurance as part of a prudent and precautionary approach to business management. Such reasoning implies:

Board-Level Financial Experts: The presence of professional finance experts (e.g., actuaries and/or accountants) on the board could positively influence charitable giving—for example, as a result of CSR guidelines issued by their respective professional bodies (e.g., the UK’s Association of Chartered Certified Accountants CSR Report, 2011). The purchase of reinsurance could also enable professionally qualified financial experts on the boards of insurance firms to realize both CSR-related goals and protect the interest of key stakeholders such as policyholders, investors, and industry regulators. As a result:

Data

A balanced panel sample of 77 UK-based non-life insurance insurers (924 data points) for which complete time-series data exist for the 12 years 1999 to 2010 are used to test our hypotheses. ^{Footnote 4} CSR decisions can be given different strategic emphasis from one year to another depending on factors such as changes in managerial priorities and firms’ financial condition (Godfrey et al., Reference Godfrey, Hatch and Hansen2010). Therefore, we consider that a longitudinal analysis is an appropriate approach to use in the current study. Moreover, the size of the panel data set was restricted in that statutory firm-level financial data had to be hand-matched with corporate donations and demographic governance details that were not always readily available for some insurers over the analysis period.

Our data derive as follows: (a) insurance data were obtained from Standard & Poor’s SynThesys insurance companies database, which is sourced from the regulatory returns submitted annually by UK insurance companies to the then-industry regulator—the Financial Services Authority (FSA); ^{Footnote 5} and (b) data on governance structures and corporate donations were obtained from annual reports and accounts, internet and charity sources, and UK insurance company directories. In the case of composite (life and non-life) insurers in our panel sample that only report group-level donations, the non-life insurance subsidiary’s annual share of charitable giving is estimated on a pro-rata of its contribution to annual group gross premiums written. The timeframe covered by our study includes the years from when CSR started to be of direct strategic interest to UK insurers following some high profile corporate failures to the time just after the 2007/8 global financial crisis. ^{Footnote 6} We conduct our analysis at the UK insurance firm-level as this is the relevant decision-making unit for financial reporting, statutory solvency monitoring, and most discretionary decisions (e.g., on CSR issues) that affect the local market. Our panel sample of 77 firms constitutes roughly 25% of non-life insurers actively operating in the UK over our period of analysis, and comprises a mix of firms of varying size, ownership, and financial structure. The majority of insurers in our data set (n = 67/87%) are stock companies of which roughly one-third are small mono-line insurers that specialize in niche segments of the market (e.g., personal lines). Furthermore, most stock insurers in the data set (n = 60/90%) are non-listed entities. However, the preponderance of stock over mutual forms of organization, and non-publicly quoted stock insurers in our data set, precludes us from controlling for organizational form and public/private listing status in our analysis.

Main Variables of Interest

Like some previous studies (e.g., Brown, Helland, & Smith, Reference Brown, Helland and Smith2006), we treat direct (cash) donations as our dependent measure of corporate philanthropy. This measure excludes philanthropic benefits-in-kind to charities such as tax advice, and indirect charitable contributions such as payments made under voluntary employee pay-as-you-earn schemes. ^{Footnote 7} Donations to charitable and altruistic (as opposed to promotional) community causes are a quantifiable aspect of corporate philanthropy, which in the UK can be obtained or estimated from companies’ annual reports and other public media (e.g., corporate brochures and charitable organizations) (Brammer & Millington, Reference Brammer and Millington2003, Reference Brammer and Millington2004, Reference Brammer and Millington2008). ^{Footnote 8} Charitable contributions are also an important form of discretionary corporate expenditure and are often viewed as a prime and integral aspect of CSR activity (Masulis & Reza, Reference Masulis and Reza2015). Brammer and Millington (Reference Brammer and Millington2004: 1412-1413) further argue that because of their lower susceptibility to measurement error (unlike multidimensional CSR indices) charitable donations are “. . . an excellent mechanism through which to observe and analyse the interface between stakeholders, corporate strategy, and CSR.” Peloza (Reference Peloza2006) also notes that corporate philanthropy has broad socio-economic and environmental impacts that can directly create business benefits as well as build ‘moral capital’ for the donator. For example, in the context of the insurance industry, support for community land improvements could have environmental benefits such as lowering the risk of insurance losses due to flooding, coastal erosion, and/or storm damage. In this way, charitable donations can correlate closely with broader CSR engagement. Moreover, unlike some other countries, such as the US, charitable donations in the UK tend to be made directly by companies rather than ‘hidden’ via intermediary charitable foundations (Brammer & Millington, Reference Brammer and Millington2008). This institutional advantage circumvents the potentially confounding effects of reduced shareholder/stakeholder accountability and agency problems that can arise when board-level executives use corporate resources to fund foundation charities with which they are personally affiliated (Masulis & Reza, Reference Masulis and Reza2015).

We acknowledge that whilst a precise indicator, corporate giving is a single dimension of the multifaceted CSP profile of a firm (Jo & Na, Reference Jo and Na2012). However, as noted by several scholars (e.g. Entine, Reference Entine2003; Krüger, 2014; Laplume, Sonpar, & Litz, Reference Laplume, Sonpar and Litz2008), composite CSR indices that derive from multiple data sources collected and compiled by CSR ratings firms such as Kinder, Lydenberg, Domini & Co. (KLD) have major limitations. For example, despite claims of construct validity (e.g., Godfrey et al., Reference Godfrey, Merrill and Hansen2009), many others (e.g., Krüger, 2014) argue that aggregate CSR indices are highly susceptible to: (a) measurement error (especially when component scores are based on subjective sources such as interview evidence); (b) sample selection bias (e.g., KLD data only relate to US publicly listed firms); and (c) limited comparability when used in longitudinal and transnational contexts, particularly when non-overlapping samples are used. For these reasons, and on the grounds of precision, we use charitable donations as our preferred measure of philanthropy.

Our main independent variable of interest in this study is reinsurance—a commonly used hedging (balance sheet and earnings protection) tool on which data, unlike for corporate insurance, are publicly available in the UK and indeed, other insurance markets such as the US and some European countries. It is further pertinent to note that as a pure indemnity mechanism, reinsurance cannot be used for speculation (unlike other hedging instruments such as derivatives) (Zou & Adams, Reference Zou and Adams2008). This means that in using reinsurance data, our study provides a potentially robust and reliable test of the corporate philanthropy-risk management relation.

Firm-Related Control Variables

Prior stakeholder theory-based studies (e.g., Adams & Hardwick, Reference Adams and Hardwick1998; Brammer & Millington, Reference Brammer and Millington2008; Barnett & Salomon, Reference Barnett and Salomon2012) indicate that in the context of exploring corporate donations, firm-specific factors can also be relevant. Therefore, we control for seven firm-related variables in our analysis: (a) firm size, (b) ownership structure, (c) managerial (insider) ownership, (d) leverage, (e) profitability, (f) product-line, and (g) firm age. We expect concentrated ownership structure and leverage to be inversely related to the decision to commit to charitable giving and the amount given. For example, dominant shareholders (such as pension funds) are likely to maximize their financial claims in order to meet obligations to their constituents (e.g., pensioners), whereas highly levered (cash constrained) insurers are less likely to donate to charitable causes). The other firm-specific variables are predicted to be positively related to the incidence and level of corporate charitable donations. For example, large, well-established, and profitable insurers are likely to have the ‘slack’ resources to contribute to charitable causes, while owner-managers, in conjunction with their reinsurance partners, may engage in philanthropy to raise the public visibility of the corporate profile and so increase future rates of new business. Multi-product line insurers tend to have a more diversified customer-base and broader stakeholder constituency than niche (e.g., personal lines) insurance providers, and as such, more likely to engage in philanthropy. Details of the measurement of our variables, and their predicted signs, are given in Table 1. ^{Footnote 9}

Modelling

As in previous CSR research (e.g., Harjoto & Jo, Reference Harjoto and Jo2011), we model the charitable donation-reinsurance relation using a two-step regression procedure. A separate analysis of the corporate decision to make charitable donations and the amount donated is necessary as it is not possible to formulate and test a single model that simultaneously captures both first-stage and second-stage strategic choices. The first ‘participation’ model (random-effects bivariate probit) tests the decision to donate or not, and the second ‘volume’ model (a left-censored tobit) estimates the amount donated. ^{Footnote 10} Another rationale for adopting our two-part modelling approach to the ‘participation’ and ‘volume’ decisions is that it could reveal insights into the focal firm factors (e.g., size and structure) that could influence the respective philanthropic and reinsurance decisions of managers. It is also possible that reinsurance could be linked indirectly with charitable giving through its mediation with other financial variables such as profitability. Therefore, we applied Heckman’s (Reference Heckman1979) two-step sample selection correction procedure, which includes the inverse ‘Mills ratio’ correction (λ) in the second-stage ‘volume’ model.

In the ‘participation’ model the dependent variable (DDUM) is binary, taking the value 1 if an insurer donates to charities, and 0 otherwise. Our choice of the probit model over other binary dependent variable models (e.g., logit) is based on the assumption that the indicator variable of interest (in our case charitable donations) is not random but a deliberate strategic decision conditioned by probabilistic rather than other (e.g., log-normal) distribution assumptions (Greene, Reference Greene2003). The random-effects estimator is preferred as some of our variables (notably reinsurance) show little within-firm variation over the panel period (1999 to 2010) (Greene, Reference Greene2003). To check the validity of the random-effects estimator we conducted a Hausman specification test (Hausman, Reference Hausman1978), under the null hypothesis that unobservable firm-effects are serially uncorrelated with the explanatory variables thus minimizing the risk of sample selection bias. The Hausman test did not reject the null hypothesis thereby supporting the random-effects specification. We also control for unobserved firm-related heterogeneity (e.g., differences in managerial ability) in the ‘participation’ model since failure to do so could lead to biased coefficient estimates and endogeneity concerns (Heckman, Reference Heckman, Manski and McFadden1981). ^{Footnote 11} Our random-effects probit model is thus:

In equation (1), P* denotes the unobservable factors influencing an insurer’s propensity to donate, or not donate to charitable causes. We assume that the incidence of charitable donations is observed only when the insurer’s propensity to donate exceeds zero. We thus have: ${P_{it}} = 1\,if\,P_{it}^* > 0$ and P _it = 0 otherwise; $X_{it}^'$ is a vector of time-varying explanatory variables (defined in Table 1); β is a vector of the parameters to be estimated; and i = 1, 2, . . . n indexes the sample observations for the period t investigated. To capture unobservable effects (e.g., managerial CSR experience) on the ‘participation’ decision we decompose the error term v _it in (1) as:

In equation (2), α _i denotes unobserved heterogeneous firm-effects that are time-invariant, while u _it represents unobserved firm characteristics that do vary across time; we also treat α _i as random. The random-effects probit model is estimated using the maximum likelihood procedure under the condition that: ${u_{it}}\~N(0,\sigma _u^2)$ , u _it are independent of vector X; and ${\alpha _i}\~N(0,\sigma _\alpha ^2)$ , the α _i are independent of the u _it and vector X. To gauge the sensitivity of the explanatory variables to changes in the predicted probability of the corporate donation decision, the coefficient estimates in the probit model are transformed to represent the marginal-effects evaluated at the means of the regressor variables computed from averaging individual observation responses (Hoetker, Reference Hoetker2007). Similarly, marginal-effects are also evaluated against median values given the skewed distribution of some variables (e.g., firm size) in the panel data set. The marginal-effects for the dummy variables are calculated as the discrete change in the dependent variable as it changes from 0 to 1 (Greene, Reference Greene2003).

The tobit (‘volume’ decision) model assumes that the dependent variable (Y* _it ) (DON) is a non-limited (positive) observation truncated at 0. That is:

In equation 3, β*X _it is a vector of the explanatory variables (as defined in Table 1); λ is the inverse Mills ratio; and u _it is a normally distributed error term that captures random influences on the variables to be estimated (Greene, Reference Greene2003).