The Information Value of Corporate Social Responsibility

Kose John is the Charles William Gerstenberg Professor of Banking and Finance at NYU Stern School of Business; Jongsub Lee is University Term Assistant Professor of Finance at University of Florida Warrington College of Business; and Ji Yeol Jimmy Oh is Assistant Professor of Finance at the Hanyang University Business School. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

A significant portion of the U.S. corporate expense budget is allocated to corporate social responsibility (CSR) spending. Given its importance, there has been a long-standing debate on its desirability from shareholders’ perspective. Several studies posit that CSR creates shareholder value through maximizing stakeholder value, a result known as “doing well by doing good” (Edmans, 2011; Ferrell, Liang, and Renneboog, 2016). In contrast to this performance view of CSR, the agency view of CSR claims it is merely a manifestation of managerial and shareholder interest misalignment (e.g., Cheng, Hong, and Shue, 2016). The empirical evidence on these two opposing views is mixed, leaving the important question—what is the fundamental motive of CSR activities?—largely unresolved.

Amid this debate, one important aspect of CSR that has been largely overlooked in the literature is its information value. Several anecdotes suggest that CSR activities could alter a firm’s information environment and consequently affect the board’s decision-making. For example,

Home Depot’s board members are expected to visit at least eight stores outside their home state between board meetings. […] GE’s board members dine with the company’s largest suppliers and distributors the night before the annual meeting” (Sonnenfeld, 2002).

The top 10 most socially reputable firms on Reputation Institute’s 2017 Global CSR RepTrak® 100 list also includes many high tech firms such as Microsoft and Google, where the intangible nature of human capital increases the opacity of information (Edmans, 2011), and firms producing consumer “experience goods” such as LEGO and The Walt Disney Company, where it is difficult to predict in advance how customers would react to a new product. This series of evidence hints at a close association between corporate information environment and subsequent willingness of a board to engage in CSR activities. Yet, these information benefits of CSR have not been singled out for analysis in the literature until now.

Our paper fills this void in the literature. We model a cheap-talk game between the CEO and the board similar to Adams and Ferreira (2007), while introducing a possibility that the board could endogenously acquire costly firm-specific information from stakeholders by engaging in CSR activities. In the absence of stakeholders’ information, the shareholders face a trade-off between firm-specific information and monitoring intensity. Although the board’s access to firm-specific information facilitates informed advising and benefits everyone, the CEO may be unwilling to share her information for fear of losing control because of the better-informed board’s increased monitoring, particularly if she derives strong private benefit from controlling the project. Thus, when there is a high degree of information asymmetry between the board and the CEO, the shareholders have no other option but to appease the CEO and sacrifice the board’s independence.

However, by endogenously engaging in CSR activities and inducing stakeholders to reveal their firm-specific information, if any, the board can achieve both informed advising and tight monitoring through this valuable second opinion from stakeholders, which renders the board’s functional efficiency without sacrificing its independence. The decision to engage in CSR in this context is therefore regarded as an optimal response by the board who endogenously intends to shake off its informational dependence on the firm’s CEO.

These intuitions lead to the following key testable predictions of our model. In an opaque information environment, the shareholders can increase the level of board independence because they correctly anticipate that the firm’s information environment would be enhanced by engaging in CSR activities, and consequently the board would be less informationally dependent on the CEO. In more transparent environment, the board may still opt for CSR to gain extra information and intensify its monitoring, but it has a less pronounced effect on the board independence because the board is less informationally dependent on the CEO to begin with. The model also predicts that the informational value of CSR is larger when the CEO derives a large private benefit from project control. In this regard, CSR ought to be perceived as a potential remedy for internal agency problems rather than simply being their symptom.

Using data on the U.S. firms from 1999 to 2013, we find results that are largely consistent with our model’s predictions. We indeed find a strong strategic complementarity between board independence and CSR activities, particularly when a firm’s information environment is opaque. Using segment- and analyst-forecast-based measures of a firm’s information environment, we find that the joint effect of board independence and information cost on the firm’s level of CSR activities is positive, with strong statistical significance across all information cost proxies. Our model also predicts that, while the strategic complementarity properties of board independence and CSR would be stronger in high information cost environment, CSR would directly lead to increased monitoring in low information cost environment. We indeed find strong empirical support for this prediction as well; the direct effect of CSR on attenuating excess pay of a CEO and increasing the likelihood of forced CEO turnovers is stronger among firms with transparent information environment, while the joint effect of board independence and CSR on the CEO monitoring is stronger when firms operate in high information cost environment. All our key findings are robust to controlling for firm fixed effect as well as the instrumental variable approach of Knyazeva, Knyazeva, and Masulis (2013), suggesting that they are unlikely to be driven by unobserved firm-level heterogeneity or simultaneity-induced endogeneity.

Overall, we propose a novel rationale for CSR—the information motive. To the best of our knowledge, we are the first to introduce the strategic complementarity between board independence and the information value of CSR. Although this positive association between board independence and CSR has been documented in some studies (e.g., Ferrell, Liang, and Renneboog, 2016), ours is the first to highlight this relationship that is strongly influenced by a firm’s information environment. We emphasize this information value of CSR through its link to the dual role of a board as an informed advisor and a monitor of management. In equilibrium, we show that the marginal information value of CSR is highest among firms that suffer most from self-entrenched CEOs who are unwilling to share valuable private information to highly independent board members for agency reasons. We demonstrate that the informationally-motivated CSR activities endogenously arise under such circumstances. Put together, both our theory and empirical evidence significantly complement and extend the two popular narratives of CSR in the literature—the good and bad governance views of CSR.

The complete paper is available here.

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