The Foundations of Corporate Social Responsibility

The following post comes to us from Hao Liang and Luc Renneboog, both of the Department of Finance at Tilburg University.

A fundamental issue in business and economics is the sustainability—and not merely the growth—of economic development, which crucially hinges on the socially responsible operational and investment behavior of modern corporations (Porter, 1991). There is a widespread recognition, as well as growing empirical evidence, that corporate social responsibility (CSR) can substantially contribute to social progress and stakeholder wealth, including the wealth of shareholders (e.g., Dimson, Karakas, and Li, 2012; Deng, Kang, and Low, 2013). In our paper, The Foundations of Corporate Social Responsibility, which was recently made publicly available on SSRN, we examine the forces that fundamentally steer companies to behave as good citizens in society.

As our goal is to examine the foundations of CSR and how these foundations translate into economic sustainability, we start with defining CSR. Previous studies have usually taken only one perspective that mainly concentrates on firms’ voluntary initiatives, such as employee satisfaction (Edmans, 2011, 2012), environmental protection (e.g., Dowell, Hart, and Yeung, 2000; Konar and Cohen, 2001), corporate philanthropy (e.g., Seifert, Morris, and Bartkus, 2004), or consumer satisfaction (e.g., Luo and Bhattacharya, 2006; Servaes and Tamayo, 2013). However, CSR is by nature a multidimensional concept, as it captures various stakeholders’ interests, and is sometimes subject to laws and regulations. We define CSR as both a firm’s engagement (voluntarily initiated) in and its compliance (legally mandated) to environmental, social, and governance (ESG) issues. This concept addresses concerns for the environment (such as climate change, hazardous waste, nuclear energy, ecological balance, etc.), society (social diversity, human rights, consumer protection, consumer consciousness, etc.), and corporate governance (management/board structures and representation, employee relations, executive compensation, anti-corruption measures, etc.). The degree of CSR adoption should be determined both by the legal frameworks that define corporate boundaries, and by corporations’ own tradeoff between shareholders’ and stakeholders’ rights.

Some scholars, such as Friedman (1970), Jensen (2001), and recently Cheng, Hong and Shue (2013), are skeptical about CSR and consider it a value-diverting activity that does not contribute to aggregate social welfare and sustainability. In this paper, we quantify the relationship between the firm-level CSR and the country-level sustainability relationship by showing that CSR scores are significantly correlated with country-level sustainability ratings in many dimensions. Some correlations are almost 30%, which is substantial given that the CSR scores and country sustainability ratings are from very different data sources and use different rating metrics. These significant correlations imply that CSR is closely linked to economic sustainability, which represents the preservation of resources and wealth. Although the focus in this paper is on firm-level CSR performance, we also refer to the country-level sustainability interchangeably throughout the rest of the paper, and aim to connect the determinants of CSR to the broader theme of economic development and social welfare.

Most of the extant literature considers CSR as a firm’s voluntary initiative, and relates it to the firm’s financial and operational performance (“doing well by doing good“; e.g., Dowell et al., 2000; Orlitzky, Schmidt, and Rynes, 2003; Renneboog, ter Horst, and Zhang, 2008, 2011; Guenster, Bauer, Derwall, and Koedijk, 2011; Cheng, Ioannou, and Serafeim, 2012), or studies the inverse, whether it is only well-performing firms that can afford to adhere to ESG criteria (“doing good by doing well“; e.g., Hong, Kubik, and Scheinkman, 2012). Both the theoretical models and empirical evidence are rather ambiguous on the causal relationship between doing good and doing well (Margolis, Elfenbein and Walsh, 2007). If, apart from voluntary adoption, CSR is partly legally mandated, a single country study is not appropriate and one can only examine the fundamental determinants of CSR within a country-level institutional framework. Ioannou and Serafeim (2012) investigate the association between “national institutions” and the scores on a CSR index although most of what they call “institutions”, such as a leftist political ideology, are not true institutions with persistent and durable features in the spirit of North (1981), but rather the economic consequences of institutions (Glaeser, La Porta, Lopez-de-Silanes, Shleifer, 2004), which implies that those proxies for institutions may still be endogenously determined. This motivates to go one step further and think about the potential fundamental and latent (and thus other than financial and operational) determinants of CSR, especially at the country-level.

Currently, the consensus in the literature on the fundamental determinants of economic outcomes are the systematic difference among countries in their key institutional arrangements that define rules and rights, such as legal origins (e.g., La Porta, Lopez-de-Silanes, Shleifer, and Vishny [hereafter LLSV] 1997, 1998; La Porta, Lopez-de-Silanes, and Shleifer, 2008) and the political institutions (e.g., Rajan and Zingales, 2003; Pagano and Volpin, 2005; Perotti and von Thadden, 2006; Roe, 2003, 2006). A country’s institutional framework determines the key structural features of the firm (Matten and Moon, 2008: 408), “including the degree to which private hierarchies control economic processes, the degree of discretion owners allow managers in running the company, and organizational capabilities to respond to changing and differentiated demands.” Meanwhile, according to the theory of the firm (Williamson, 1981), the firm is to be seen as a nexus of legally and institutionally enforced contracts between interested parties—in addition to shareholders, these comprise customers, suppliers, owners, managers, employees and communities (“stakeholders”)—who realize economic gains through their participation in these contractual relationships. Therefore, we expect that these historically established laws and institutions, which define rules and rights for stakeholders are the more fundamental sources of CSR. We will contrast two competing views on legal origins—the principal-agent versus the stakeholder perspective, as well as two competing views on political institutions—the institutional versus the development view—to address their fundamental impact on CSR and sustainability. By empirically testing these views, we find that the variations in CSR and sustainability are most fundamentally driven by legal origins, and not by political institutions or the well-documented financial and cultural motives. However, among the different legal origins, the English common law fosters CSR the least, whereas the Scandinavian legal origin fosters it the most. Firms from German legal origin countries outperform their French counterparts in terms of ecological and environmental policy, but the French legal origin firms outperform German legal origin companies in social issues and labor relations. We also find that political institutions are not preconditions for CSR and sustainability, and sometimes even hinder CSR implementation. Moreover, CSR is more encouraged in richer and more globalized countries and in corporations with more dispersed ownership and with co-determination.

Our paper contributes in the following ways. First, while the majority of cross-country studies on the role of fundamental institutions focus on country-level differences and use macro-level data (e.g., Acemoglu, Johnson, and Robinson, 2001; Acemoglu and Johnson, 2005) that usually suffer from small sample inference and sensitivity to outliers, our unit of analysis is not only the country but also the firm for which we have extensive proprietary data on their performance on ESG issues. The fact that we combine a macro- and micro-level analysis enables us to better understand the mechanisms of how fundamental institutions determine corporate behavior. Second, our data enable us to differentiate between CSR engagement and compliance. Third, our study has policy and welfare implications: if institutional origins are found to be of first-order importance, then policymakers could imitate the tools associated with the winning origin. Hence, our empirical findings can offer a guide for institutional reform aiming at stimulating economic and societal sustainability. Many large corporations and countries worldwide today find it hard to achieve good citizenship and sustainable development, in part because of their institutional heritage.

The full paper is available for download here.

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