Private benefits of corporate philanthropy and distortions to corporate financing and investment decisions

Abstract

Abstract Research Question/Issue This study examines whether private benefits of control, as measured by corporate philanthropic activities, distort corporate financing and investment decisions. Research Findings/Insights We find that corporate giving represents a private benefit of control that distorts corporate investment and financing activity, consistent with free cash flow agency theory. Corporate giving discourages managers from pursuing external financing, especially debt issuance, to minimize outside monitoring. It creates preferences for internally financed cash acquisitions for the same reason. These distortions reduce shareholder wealth. Following both the 2003 dividend tax cut and hedge fund activism, corporate charitable contributions fall while investment rises, suggesting suboptimal investment caused by managerial private benefit extraction. Acquisition announcements of firms making large charitable contributions show negative stock market reactions that are more pronounced for acquirers with poor corporate governance. Theoretical/Academic Implications Our findings suggest that due to agency problems and managerial rent extraction, corporate philanthropic activities can distort corporate financing and investment decisions and yield corporate charitable contribution allocations that personally benefit a firm's CEO at shareholder expense. Practitioner/Policy Implications As corporate philanthropy imposes a significant cost to shareholders, managers may seek shareholder approval on corporate philanthropic activities. The Securities and Exchange Commission may also require timely disclosure of corporate donations.

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