Peer Effects of Corporate Social Responsibility

Hao Liang is Assistant Professor of Finance at Singapore Management University. This post is based on an article authored by Professor Liang, and Jie Cao and Xintong Zhan, both of the Department of Finance at the Chinese University of Hong Kong.

Corporate social responsibility (CSR) has increasingly become a mainstream business activity—ranging from voluntarily engaging in environmental protection to increasing workforce diversity and employee welfare—although standard economic theories predict that it should be rather uncommon (Benabou and Tirole, 2010; Kitzmueller and Shimshack, 2012). The neoclassical economic paradigm usually considers CSR as unnecessary and inconsistent with profit maximization (e.g., Friedman, 1970). This discrepancy between theory and real-world observations has attracted much scholarly attention in recent years. One popular view on why CSR prevails is that it creates a competitive advantage for the firm and thus contributes to firm value. Following this line, numerous studies have investigated the causes and consequences of CSR by focusing on its strategic value implications.

These studies, which mostly examine cross-firm and cross-country variations in CSR, are largely silent on how CSR interacts with the firm’s surrounding environment—such as influencing industry structure and product market competitiveness. Notably, firms do not operate in isolation, and their business activities often compete with other firms in the product market. If CSR creates a competitive advantage, its effect should be mostly manifested through a firm’s competition with other firms. To the extent that CSR signifies a firm’s influence on the society in general and its product quality in particular, one can reasonably expect that it can affect other peer firms’ competitive position and CSR practice as well.

Properly addressing these questions has been challenging, as both CSR and a firm’s competitive position in the market are arguably endogenous choices of the firm. This presents an empirical challenge as to whether firms and investors react to their peers’ CSR actions by changing their firm’s CSR practices and market valuations, or whether the pre-existing differences in other unobservable firm characteristics lead different firms to adopt different levels of CSR. In our paper, Peer Effects of Corporate Social Responsibility, which was recently made publicly available on SSRN, we circumvent these empirical concerns and investigate the product-market peer effects of CSR by using a regression discontinuity design (RDD) approach. More specifically, we compare the effect of a firm’s shareholder-sponsored CSR proposals that pass or fail by a small margin of votes (around the 50% majority threshold) in annual meetings on its peer firms’ stock returns and subsequent CSR practices. The passage of such close-call proposals is akin to randomly “assigning” CSR to companies and hence not correlated with peer firms’ characteristics. Conceptually, there is no reason to expect that peer firms of a company for which a CSR proposal passes with 50.1% of votes are systematically different from peer firms of a company for which a similar proposal fails with 49.9% of the votes, keeping everything else constant. Therefore, close-call CSR proposals provide a source of random variation of a firm’s CSR that can be used to estimate the causal effect of CSR on its peer firms’ market valuation and CSR practice.

By empirically testing a large sample of 3,452 U.S. public non-voting “peer” firms over the period of 1997–2011 using the RDD approach, we find strong effects of the passage of close-call CSR proposals on peer firms’ shareholder value and subsequent CSR adoption. More specifically, on the days close to and right after the shareholder meeting, the passage of a firm’s CSR proposal by a narrow margin of votes yields a three-day cumulative abnormal return (CAR) of its non-voting peer firms that is 0.6% to 1% lower than the peers of the voting firm whose similar CSR proposal fails marginally. In addition, if the voting firm marginally passed a closed-call CSR proposal, the average CSR score for its non-voting peer firms in the following year is 0.16 points higher than that of the non-voting peer firms in which the vote marginally failed. The economic magnitude of this difference is significant given an average adjusted CSR score of -0.13 points. These results are robust when using global polynomial estimations, different measures of CSR and their sub-scores, as well as different peer samples (i.e., peer samples that are randomly drawn or based on SIC 3-digit industry classifications). Such effects are absent in non-peer groups.

We further explore a few channels through which such CSR-peer effects take place. We find that the aforementioned peer effects are stronger in firms with higher competitive pressure as measured by the similarity of the products between a voting firm and its non-voting peers. We also investigate the role of the relative CSR performance of the voting firm compared with its non-voting peers and find that such peer effects are stronger when the peer firm has a higher CSR score than its associated voting firm in the year prior to the voting. In addition, peers with more severe financial constraints experience more negative abnormal returns and less CSR adoption following the passage of the voting firm’s CSR proposal. Moreover, peer effects are stronger in peer firms with more transparent information environment, as proxied by analyst coverage and firm size. Such CSR-peer effects are also found in a sample of strategic alliances. Our empirical findings show that strategic alliance partners of the voting firm that marginally passed a CSR proposal demonstrate higher stock market returns and a higher KLD score in the following year than alliance partners of the voting firm in which a CSR proposal was marginally rejected. Taken together, these results suggest that a firm’s CSR adoption can affect its peer firms’ strategies and market valuation.

The full paper is available for download here.

 

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