Politics and Corporate Social Responsibility

The following post comes to us from Alberta Di Giuli of the Department of Finance at ESCP Europe and Leonard Kostovetsky of the Finance Area at the University of Rochester.

In our paper, Are Red or Blue Companies More Likely to Go Green? Politics and Corporate Social Responsibility, forthcoming in the Journal of Financial Economics, we test the hypothesis that Democratic-leaning firms (i.e., firms with a higher proportion of Democratic stakeholders) are associated with more socially responsible policies than Republican-leaning firms. Our results can be illustrated by a comparison of Starbucks and Wendy’s, two large and well-known food and drink retailers. Starbucks started as a coffee beans store in 1971 and began to grow as a popular coffeehouse chain in the late 1980s after entrepreneur Howard Schultz bought it. Schultz, who is the current CEO and Chairman of Starbucks, is a well-known Democrat who donated $130,500 to Democratic federal candidates and only $1,000 to Republicans over his lifetime. In addition, Starbucks was founded and is currently headquartered in Seattle, Washington, a bastion of progressivism and the Democratic Party.

Wendy’s founder is Dave Thomas, a Republican supporter who donated $47,000 to Republican candidates and $2,000 to Democrats. Furthermore, Wendy’s was founded and is currently headquartered in Dublin, Ohio (a Republican-leaning area). Based on these internal and external political differences, our hypothesis suggests that Starbucks should be more socially responsible than Wendy’s. Indeed, we find that Starbucks is one of the top CSR performers in our entire data set while Wendy’s is a significant CSR underperformed.

In our sample, we find a significant difference in CSR between typical Democratic and Republican firms. A one-standard deviation shock (to the political “left”) to the firm’s political environment is associated with a 0.1 standard deviation improvement in CSR. This result is robust to controls for firm-level heterogeneity, CEO-level heterogeneity, and a number of tests to rule out alternative explanations. There are several ways to understand the economic significance of our results. First, we find a positive and significant association between CSR and Selling, General, and Administrative (SG&A) expenses, allowing us to convert the estimated effect of political leanings on CSR into direct monetary costs (through higher SG&A) for the firm. Based on this conversion, we estimate that Democratic-leaning firms spend, on average, an extra $18 million per year on CSR relative to Republican-leaning firms (an extra $80 million per year for the subset of firms in the S&P 500), representing approximately 10% of a typical firm’s net income.

Second, because CSR performance is also associated with industry, we can use estimated industry effects as a benchmark for the economic significance of the estimated effect of politics. For example, the petroleum and natural gas industry (Fama-French 30) is near the bottom in environmental CSR performance while computer software (Fama-French 36) is one of the best in this category. Using those two industries as a measuring stick, we find that the average difference between Democratic-leaning and Republican-leaning firms in terms of environmental corporate social responsibility is about 20% of the difference between typical firms in petroleum and computer software.

Third, we take a broader view of economic significance by examining the implications of changes in CSR policies for the value of the firm, stock holdings by institutional investors, and future operating performance as measured by return on assets (ROA). We find that an expansion of CSR policies is associated with future stock underperformance and a long-run deterioration in ROA. We argue that the first of these effects is a direct market reaction to CSR with a lag resulting from delays in investors’ learning about CSR policy changes. The adverse financial effects of CSR on the firm help explain why firms whose stakeholders get “direct value” from CSR are more willing to implement it. After all, if CSR paid for itself or was financially profitable, one would expect all firms, regardless of stakeholder preferences toward social responsibility, to vigorously implement it.

Political affiliation is a natural measure of preferences for social responsibility. The Democratic Party platform places more emphasis on CSR-related issues such as environmental protection, anti-discrimination laws and affirmative action, employee protection, and helping the poor and disadvantaged. A 2007 National Consumers League survey found that 96% of Democrats believe Congress should ensure that companies address social issues, compared to 65% of Republicans. In addition, Hong and Kostovetsky (2012) show a significant difference between Democratic and Republican investment managers in their portfolio holdings of socially responsible companies. Recent papers have also found that political views affect corporate variables such as leverage and investment (Hutton, Jiang, and Kumar, 2011) as well as the decision of individual investors on whether to participate in the stock market (Kaustia and Torstila, 2011).

We measure corporate social responsibility using data from Kinder, Lydenberg, and Domini (KLD). KLD is a leading data provider of social research for institutional investors. In 2006, TIAA-CREF, one of the biggest U.S. retirement funds, sold a large stake in Coca-Cola stock after KLD removed Coca-Cola from its list of socially responsible companies. KLD rates U.S. corporations in nearly 60 categories along six social/environmental dimensions: community activities, diversity, employee relations, environmental record, human rights, and product quality. The richness of the KLD data set allows us to dig deeper into the type of CSR activities that are connected to politics. Our study complements recent work by Hong, Kubik, and Scheinkman (2011) who show how financial constraints affect firm KLD ratings, and Gillan, Hartzell, Koch, and Starks (2010) who investigate the relation between KLD ratings, corporate performance, and institutional ownership.

We collect political contributions of firm stakeholders from the Federal Election Commission (FEC) Web site, which provides data on contributions to federal candidates and parties starting from 1979. We measure a firm’s internal political environment using the partisan tilt of prior campaign contributions of the firm’s CEO, independent directors, and founders. Previous research highlights the importance for firm policies and performance of CEO characteristics (e.g., Bertrand and Schoar, 2003; Malmendier and Tate, 2005), outside director characteristics (e.g., Weisbach, 1988; Yermack, 2004; Goldman, Rocholl, and So, 2009; Krüger, 2010), and founder effects (e.g., Fahlenbrach, 2009; Adams, Almeida, and Ferreira, 2009). We find a strong association between a firm’s internal political environment and CSR policies. For example, a firm headed by a Democratic CEO (all past campaign contributions to Democrats) is associated with a 0.15 standard deviation improvement in CSR relative to a firm led by a Republican CEO, after controlling for firm characteristics, CEO characteristics, industry, and the state in which the firm is headquartered.

A firm’s external political environment, i.e., the political views of the firm’s employees, suppliers, shareholders, customers, and regulators, is more difficult to measure. However, there is likely to be significant geographic clustering in the political views of outside stakeholders (see Porter, 1998, 2000) which we exploit for identification. Since stakeholders are more likely to live in the state where the firm is headquartered, we use the home state’s voting patterns as a measure of the firm’s external political environment. We find that a Democratic external political environment is associated with more socially responsible corporate behavior. For instance, a ten percentage point increase in the state vote received by the Democratic candidate in the prior presidential election is associated with a 0.11 standard deviation improvement in CSR, after controlling for firm characteristics, industry, and the internal political environment.

Our work builds on Rubin (2008) who looks at the effect of home-state political voting patterns on whether a firm is a member of the Broad Market Social Index. It also complements the literature on the importance of geographic location in firm financing (Gao, Ng, and Wang, 2011), dividends (John, Knyazeva, and Knyazeva, 2011), and corporate governance (John and Kadyrzhanova, 2010).

The full paper is available for download here.

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