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E-MailHenri Servaes is the Richard Brealey Professor of Corporate Governance and Professor of Finance at London Business School; Research Associate of the European Corporate Governance Institute; and Research Fellow of the Centre for Economic Policy Research. Ane Tamayo is Professor of Accounting at the London School of Economics and Political Science. This post is based on a recent article by Professor Servaes and Professor Tamayo, forthcoming in the Oxford Review of Economic Policy.
While the importance of Physical Capital, Human Capital, and Intellectual Capital in corporations is well understood, there is another type of capital, perhaps equally important, which has received a lot less attention: Social Capital—broadly defined as the quality of the relationships that a firm, and its executives and employees, have built with other stakeholders. To date, most research on social capital has focused on the social capital of countries (or regions within countries), generally measured by the civic engagement of the population or the willingness of people in a society to trust each other, concluding that regions with more social capital enjoy higher economic growth. In a review article forthcoming in the Oxford Review of Economic Policy, we argue that the notion of social capital can also be applied to corporations.
Corporations that invest in social capital earn the trust of their stakeholders, thereby enhancing cooperation, potentially leading to better economic outcomes for the firm. In a forthcoming Journal of Finance paper “Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility in the Financial Crisis,” co-authored with Karl Lins, we illustrate that corporate social capital can be particularly beneficial during times of crisis. We show that firms that entered the financial crisis with higher social capital earned higher stock returns and experienced higher margins, sales growth, and sales-per-employee, relative to firms with lower social capital. The financial crisis was characterized by an erosion of trust in firms, markets, and institutions. In such a period, a firm’s social capital, and the trust that it engenders, paid off.
What, specifically, can firms do to build their social capital? We suggest that one way of building social capital is through efforts that generally fall within the umbrella of Corporate Social Responsibility (CSR). These include efforts to improve relationships with employees and the local communities where the firm operates, and efforts to protect the environment and the human rights of people who live in areas where the firm has facilities. Of course, when the interests of managers and shareholders are not fully aligned, firms may also engage in CSR to simply enhance the private benefits of their executives.
The literature on the relation between CSR and corporate performance has yielded mixed results. The majority of studies find a positive correlation between the two, but there is some evidence of a significant negative relation as well. More importantly, correlation does not imply causality: the positive relation between CSR and performance may well be due to the fact that firms that perform well have more resources available to be socially responsible. To overcome this, one could form portfolios of firms with good CSR performance and investigate whether these portfolios earn high subsequent returns. In our forthcoming Journal of Finance article, we find no evidence that high-CSR firms earn excess stock returns, except during the crisis.
Some observers have used the evidence of a positive relation between CSR and performance metrics to argue for increased commitments from corporations to CSR initiatives. We believe that such conclusions are premature, however, and that we need to get a better sense of the costs associated with such increased investments. Firms should be treating CSR/social capital investments as they treat other investments: invest until marginal costs are equal to marginal benefits. In our review article, we propose several reasons why firms may not be investing optimally in CSR, and discuss related evidence. In particular, firms may underinvest in CSR because they are capital constrained or because managers do not understand the merits of CSR investments. Of course, investors themselves may be the ones that do not fully understand the benefits of CSR investments (and/or suffer from short termism). If that is the case, and if managers do not have proper long-dated incentives, firms may also allocate insufficient resources to CSR. Currently, however, there is no compelling evidence to suggest that firms’ CSR investments are insufficient, while there is some evidence supporting the notion that, at least as far as philanthropic investments is concerned, firms invest too much.
CSR is but one possible metric of firm social capital and in our article we suggest a number of others. One could measure how central a firm’s operations are relative to its customers and suppliers. Firms with a larger network of customers and supplies have the potential to build more social capital. Of course, changing one’s position in a network is not straightforward. An alternative is to study the networks of individuals within the firms, and in particular those of the top managers; firms whose executives have larger networks, both professional and social, may have larger social capital that could benefit the firm. As research on Corporate Social Capital progresses, other metrics will undoubtedly be developed.
The complete article is available for download here.
One Comment
In my new book The Social Organization I review the case for investing in internal social connections and relationships. I’d suggest this type of social capital needs to considered separately from other CSR type benefits. External CSR provides substantial but indirect benefits, eg as the article suggests, through inclusion in best company lists. Internal social capital is a core and direct driver of business success.