CEO Power, Board Independence and ESG

Agency theory suggests that combining the role of CEO and board chairman would give the CEO more power over the board of directors, thus reducing the independence between the board and managers. This dual role amplifies the negative effects of principal-agent conflict of interest and reinforces the dominant position of the CEO over management [12]. Despite this, the theory recognizes that top management can contribute to corporate social responsibility and environmental performance, and a strong CEO can foster a positive perception of the company among stakeholders and society [13, 14]. Therefore, environmental and sustainable practices significantly contribute to corporate goodwill [15, 16]. Strong CEOs inspire flexible leadership, which enhances effective management amidst dynamic business environments [17]. Notably, a strong CEO promotes eco-friendly business behavior. When a person simultaneously serves as both the CEO and chairman of the board, it can suggest that they possess more comprehensive knowledge of the firm's environmental needs both internally and externally, thus enabling them to advocate for ecologically friendly business practices. Furthermore, the joint role of CEO and chairman may enhance the promotion and achievement of environmental goals compared to when the positions are separated [18]. However, a powerful CEO may also trigger the adoption of green governance practices within firms. Conversely, excessive executive power may result in suboptimal corporate green governance and heightened environmental risk. Some studies suggest that CEOs who hold the highest control of their companies may overlook environmental management and regulation of environmental risks, along with other operational issues. The dual role of CEO and chairman of the board (CEO duality) can weaken the autonomy and independence of the board [19], potentially leading to lower priority given to environmental governance and green mergers and acquisitions.

The proportion of 'outside' (i.e., external or independent) board members determines its level of independence, a vital characteristic of a board of directors. According to the stakeholder theory, outside directors are less susceptible to pressure from shareholders and managers and their behavior is not limited by organizational constraints, unlike inside directors [20]. Therefore, as a crucial characteristic of the board of directors, board independence is essential to enhance the effectiveness of the company's board of directors [21]. Furthermore, outside directors are granted greater social responsibility and face higher reputational costs, allowing them to provide more qualitative disclosures [16]. However, they still face limitations in disclosing their social responsibility efforts. Research indicates that a lack of experience with the contextual aspects of business activities may lead them to avoid disclosing uncertain information that could pose a reputational risk or that they may not be able to report on social responsibility performance in a way that can be properly evaluated [9]. Thus, we propose the following hypothesis:

H1: Board independence has the potential to mitigate the environmental, social, and governance effects of CEO influence.

Heterogeneity of Industrial Sectors

Many countries require heavily polluting enterprises to disclose environmental information. Furthermore, they are continuously raising the standards for environmental information disclosure. Studies show that China's carbon-intensive industries face high costs for pollution reduction measures, extensive technological adjustment expenses, and limited tolerance towards increased environmental regulation [22-24], making these industries more susceptible to rigorous environmental policies.

ESG performance is a crucial subject that centers on whether companies comply with environmental laws and regulations concerning environmental protection [25], energy conservation, and emission reduction in their daily operations. External factors, such as media attention and environmental regulations, also put the level of corporate sustainability governance under scrutiny. It is worth noting that the industrial sector is frequently identified as a significant contributor to environmental issues, particularly in developing economies [26, 27]. Consequently, we posit the following hypotheses regarding the correlation between CEO power and ESG:

H2: Independent directors and powerful CEOs in the industrial sector have an adverse impact on the environment, society, and corporate governance.

Heterogeneity of Political Connections

The CEO holds a position of great influence within an organization. As per social network theory, firms or individuals located at the core of a social network possess greater access to higher-quality social capital [2, 28, 29]. Valuable external social relationships exist through political connections, enabling informal channels for government intervention at the firm level [30]. Transitioning firms, grappling with the impact of external environmental regulatory pressures, have established informal ties with the government to alleviate the strain [31], and thus CEOs' political relationships are an important resource that can provide firms with "green facilitation", such as access to green loans and government policy subsidies and support, and enhance the effectiveness of firms' sustainable governance, which plays an important role in the context of external environmental pressures, especially in China and other emerging economies, such informal ties may be more pronounced and compensate for weak institutional environments [32] as a source of sustainable competitive advantage for firms. In addition, CEOs with political connections can inspire outside stakeholders' confidence in the sustainable governance of the firm, indicating organizational legitimacy and resilience to risk; but on the other hand, rent-seeking politicians and strong agentic identities may protect against CSR evasion [33]. Opportunism due to revenue pressure makes it possible for companies to forgo the long-term value of environmental protection in favor of short-term economic benefits that positively affect earnings [34], which can lead to imbalances in sustainable governance. Therefore, the existence of independent directors can monitor and control the behavior of corporate management, thus protecting the interests of the company and safeguarding shareholders' rights and market fairness. We believe that independent directors are independent and objective relative to company management, and are more likely to receive government and public supervision under the role of CEOs and independent directors with political connections. In summary, the existence of independent directors can strengthen the advantages of CEOs with political connections in sustainable governance, while reducing the environmental moral hazard of CEOs. We propose the following hypothesis:

H3: Board independence can have positive effects on the environment, society, and corporate governance in companies with political connections, despite CEO power.

Regional Heterogeneity

China is a large country with notable variations in economic development among different regions. Institutional policies, management models, and sustainable governance performance also differ significantly across regions. The impact of local environmental regulations, external environments, and industry characteristics can have a significant effect on a company's ESG performance [35]. Different regions are subject to varying degrees of environmental regulations. When faced with strict local regulations, firms may choose to relocate to areas with less stringent regulations or invest in technology research and development to decrease pollutant emissions. It is more challenging for these businesses to alter their fundamental direction than it is to relocate their operations and production to other regions. The Eastern region has amassed many skilled professionals and innovations since China began its reform and opening up policies, offering favorable conditions for the eco-friendly advancement of industries [36]. Moreover, the increased level of autonomous innovation encourages the restructuring of the eastern region's capabilities, as stated by Mao, Wang [37]. This, in turn, inspires businesses to pursue environmentally friendly transformations with the support of robust governmental regulations.

Compared to the central and western regions of China, the government in the eastern region enforces more rigorous environmental protection regulations for businesses. Companies in the East have higher environmental awareness due to the more severe environmental pollution in the region. In this region, decisive CEOs can make prompt environmentally conscious decisions while adopting green governance practices to comply with regulations and reduce their impact on the environment. Additionally, the eastern region experiences greater media attention, and independent directors adhere strictly to their monitoring responsibilities to protect their reputation under strict regulation [38], leading to an increase in both the quantity and quality of environmental disclosures [12]. We assert that the relationship between internal corporate governance mechanisms and external environmental pressures creates a mutually reinforcing connection. This symbiotic relationship is established based on effective corporate governance and reinforced internal corporate controls that result in a more comprehensive disclosure of environmental information. This helps to mitigate the issues arising from opportunistic conduct and the existence of asymmetric information. In addition, technological advancements in regions with high levels of economic development and innovation can incentivize companies to adopt environmentally-friendly production methods, thereby reducing damaging effects on the environment. Additionally, in regions experiencing high external pressures, such as intense environmental enforcement and heightened media scrutiny, companies are more likely to prioritize their green governance performance. As a result, we propose the following hypothesis:

H4: Board independence in the East compared to the Midwest can enable powerful CEOs to have a positive effect on the environment, greening and governance.

Sample and Data

Our research sample comprises firms listed on China's A-share market between 2011 and 2020. To limit the effect of outliers on parameter estimation, all continuous variables are trimmed at the 1% tail, and we omit samples of financial and delisted risky firms, as well as those with unusual financial data – for instance, missing data. We conducted observations on 2,495 firms. Please refer to Table 1 for variable sources and definitions. In defining industrial firms, industry code 06-46 is categorized as such based on the National Economic Industry Classification (GB/T4754-2017). We have chosen to select 39 broad industry categories from Chinese A-share listed companies, including but not limited to Coal mining and washing industry, oil and gas mining, ferrous metal mining and processing, nonferrous metal mining and processing, nonmetallic mining and processing industry, other mining industry, agricultural and food processing industry, food manufacturing industry, beverage manufacturing industry, tobacco products industry, textile industry, textile clothing, shoes, and hats manufacturing industry, leather, fur, feather (down), and its products industry, and more, are all included in this list. When choosing the criteria for the industrial companies we studied, we chose industry codes 06-46 based on their significance in China's economy and the potential influence on ESG performance. These industries constitute a fundamental sector of China's economy, comprising the mining, manufacturing, and energy sectors. Not only do these industries represent a significant portion of Gross Domestic Product (GDP), but they also face distinct challenges and opportunities concerning ESG performance. For instance, such sectors may be under unprecedented pressure to practice environmental stewardship, social responsibility, and corporate governance. We define the political affiliation PC as 1 if either the chairman or the general manager of a firm is or has been a government official; otherwise, it takes the value of 0. We also categorize listed firms into three regions: East, Central, and West. The East region comprises 12 provinces and autonomous regions, namely Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, Guangxi, and Hainan. The central region of China comprises nine provinces and autonomous regions: Shanxi, Inner Mongolia, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hubei, and Hunan. Similarly, Western China encompasses nine provinces and autonomous regions, namely Sichuan, Guizhou, Yunnan, Tibet, Shaanxi, Gansu, Ningxia, and Qinghai.

Control Variable

Early scholars have focused on the impact of disclosure regulations on senior managers’ power [42, 43]. The disclosure raises investor awareness of the company's situation, leading a company under scrutiny to pay more attention to green governance as a way to attract further investment. Therefore, disclosure affects CEOs' decisions concerning sustainable governance.

As the issue of global warming escalates, governments and authorities have implemented environmental regulations aimed at curbing its effects [44, 45]. To comply with various corporate social responsibility practices, including sustainable governance [46], enterprises have no choice but to implement these regulations. The implementation of environmental regulations prompts industrial firms to pursue innovations aimed at curtailing environmental pollution, which would otherwise lead to a hike in operating costs. CEOs, being the foremost decision makers of the firm, are proactively engaged in sustainable governance to trim the cost arising from avoidable pollution and stabilize the firm's expenditure on production and operation.

CEOs bear significant responsibility for corporate decision-making, and some have been dismissed for handling media crises related to ESG issues [47]. However, due to insufficient regulation of ESG information [36], available data on the matter is scarce and unreliable. Therefore, reporting on ESG issues may have a greater impact than reporting on other company-related outcomes. Reporting on ESG information motivates CEOs to emphasize sustainability in their companies.

To more thoroughly assess the effect of CEO duality on ESG performance under external monitoring pressure, this paper references existing literature and introduces the following control variables: (1) Tax administration effort (TE), (2) Environmental information disclosure (EID), (3) Media attention (NEWS), and (4) Environmental regulation (ER).

Empirical Models

This paper focuses on the impact of strong CEOs on firms’ ESG performance, moderated by dynamic environments as well as board independence. We construct a fixed-effects model in multiple dimensions as we consider the correlation between different sample clusters within the sample, in addition, our static panel model incorporates clustering robust standard error (clustering standard error). Based on the theoretical analysis and hypotheses, this study constructs the following empirical models:

ESG represents the ESG performance of the firm, CEO power represents the CEO power of the firm, CEO power*Independence represents the interaction term between CEO power and board independence, and Controls denotes the control variables. α and β are the regression coefficients, respectively, and ε is the random disturbance term.

Descriptive Statistics

Table 2 displays the findings of the descriptive statistics analysis. The analysis reveals that corporate ESG performance values range between a minimum of 11.77 and a maximum of 51.90, with a mean value of 27.68, indicating an insignificant overall difference. Conversely, the CEO power values range between a minimum of 0.125 and a maximum of 0.875, with a mean value of 0.479, significantly varying overall, suggesting an overabundance of CEO influence in some listed companies.

Static Panel Model Estimation Results

Table 3 indicates that CEO power has a negative and statistically significant impact on ESG performance. However, CEO power*INDEPENDENCE has a positive and statistically significant moderating effect, revealing that the relationship between composite leadership structure and firms' ESG performance varies compared to the independent structure [48]. This implies that an increase in the proportion of independent directors on the board of the company leads to a stronger positive correlation between CEO power and ESG performance.

Dynamic Panel Model: GMM Estimation Results

The system GMM estimation follows Roodman [49] standard procedure, with the exception of implementing a forward orthogonal transformation to address missing data samples in the difference transformation. Furthermore, we utilize Windmeijer's [50] method to correct for standard errors and minimize the issue of finite sample bias. Since instrumental diffusion may lead to overfitting of instrumental variables and weaken the Hansen overidentification and Difference-in-Hansen tests for instrumental validity and externality, we adopt a "Collapsing" method. In this approach, the instrumental vectors are combined into smaller sets by addition, and for each instrumental vector that is considered endogenous or non-strictly endogenous, we implement the "collapsing" method. For any variable deemed endogenous or not strictly exogenous, we restrict the number of instruments utilized to just the closest delay permissible.

Systematic GMM estimation tests comprise the Arellano-Bond test, assuming no second-order serial correlation in the first-differenced residuals, the Hansen over-identification test with the original assumption of robust instrumental variables, and the Hansen overidentification test with the original assumption of exogenous instruments. The Difference-in-Hansen test is also applied. The model must satisfy the requirement that all tests cannot reject their original hypothesis. Table 4 presents the estimated outcomes of the system GMM alongside relevant test results and p-values. According to Table 4, the instrumental variables' robustness and exogeneity can be demonstrated via Hansen and the Difference-in-Hansen test.

Additionally, Table 3 and Table 4 demonstrates that CEO power has a significant positive impact on ESG. Moreover, the interaction between CEO power and independent directors' proportion positively affects ESG. This finding supports H1, as well as previous research. Combs, Ketchen [51] reached a similar conclusion that greater board independence and effective CEO monitoring can enhance a firm's competitive advantage.

Heterogeneity Regression Analysis