Charity, Incentives, and Performance

Many companies spend substantial resources in order to be viewed as socially responsible. We argue that one reason firms do this is to create a warm glow about the firm and thereby affect employee behavior and improve performance. This proposition is tested with an incomplete contract principal-agent laboratory experiment where warm glow principals make donations to charity. The results show that both principals and agents are better off in treatments where principals are working on behalf of a charity. The principals demand higher effort, the agents take the principals' demand seriously and put in higher effort, and the principals reward sufficient effort more generously in the charity treatments. Our results imply that corporate donations to charity may affect the employee's incentives and lead to improved performance. We conclude that there is a bigger psychological cost of not living up to the other part's expectations when associated with charity