Corporate social responsibility and firm financial risk reduction: On the moderating role of the legal environment

• Published date: 01 July 2017
• Date: 01 July 2017
• Author: Mohammed Benlemlih,Isabelle Girerd‐Potin
• DOI: http://doi.org/10.1111/jbfa.12251

DOI: 10.1111/jbfa.12251

Corporate social responsibility and firm financial

risk reduction: On the moderating role of the legal

environment

Mohammed Benlemlih1Isabelle Girerd-Potin2

1PricewaterhouseCoopers,PWC Luxembourg, 2

RueGerhard Mercator, 2182 Luxembourg

2Professorof Finance – Univ. Grenoble Alpes,

CNRS,CERAG - BP 47, 38040 Grenoble cedex 9,

France

Correspondence

MohammedBenlemlih, Pricewater-

houseCoopers,PWC Luxembourg, 2 Rue

GerhardMercator, 2182 Luxembourg.

Email:Mohammed.benlemlih@lu.pwc.com

JELClassification: G32, M14

Abstract

Approaching the institutional environment through its regula-

tive component, we distinguish between shareholder-oriented and

stakeholder-oriented countries. Identifying first this classification

with the distinction between common law versus civil law countries

and using a large sample of 5,716 firm-year observations that rep-

resents 1,169 individual firms in 25 countries between 2001 and

2011, we show that Corporate Social Responsibility (CSR) signifi-

cantly reduces firms’ idiosyncratic risk in civil law countries but not

in common law countries. Using then a more direct classification

based on shareholder and employee protection scores, our findings

suggest that CSR negatively affects firms’ idiosyncratic and system-

atic risks only in less shareholder-oriented and more stakeholder-

oriented countries, respectively. These findings are similar in the

different components of CSR with two notable exceptions: a high

score in corporate governancereduces firm risk only in common law

countries, and community involvementincreases idiosyncratic risk in

more shareholder-oriented and less stakeholder-oriented countries,

respectively. Taken together, our results strongly support the view

that the relationship between CSR and financial risk is moderated by

the institutional context of the firm.

KEYWORDS

corporate social responsibility, institutional context, shareholder-

oriented countries, stakeholder-oriented countries, financial risk

1INTRODUCTION

In recent decades, growing attention has been paid to CSR in both academic literature and the business world. CSR

is often seen as a strategic response to pressure from stakeholders who may be adversely affected bycompany prac-

tices (Jackson & Apostolakou, 2010). The Volkswagen scandal, which resulted in the company losing one third of its

J Bus Fin Acc. 2017;44:1137–1166. wileyonlinelibrary.com/journal/jbfa c

2017 John Wiley & Sons Ltd 1137

1138 BENLEMLIH ANDGIRERD-POTIN

market capitalization four trading days after the scandal broke on September 18, 2015,1reveals the increasing

attention from policymakers, investors, and social and environmentalactivists towards companies’ CSR strategies. In

September 2015, social rating agencies like Vigeo downgraded Volkswagen’s scores. But in its press release,2Vigeo

highlights the fact that, before the scandal, Volkswagen was positioned below the performance of its peers in the

automobile-manufacturing sector. The social scores already included Volkswagen’s middling CSR performance and

related risks. This example may help us understand why recent studies haveshown a negative link between CSR and

financial risk. Two theoretical arguments related to the stakeholder theory and information asymmetry suggest that

CSR is the cause of risk reduction. Attention to stakeholders and abundant disclosed information reduce firm risk. Our

empirical study first shows that CSR is negatively associated with firm financial risk and it is socially responsible (SR)

behavior that causes risk reduction. On these foundations we can go further and explorewhether and how differences

in institutional environments influence the perception of,and link between, CSR and financial risk.

Studieson CSR have revealed a significant variation in CSR involvement, not only across firms and industries but also

across countries. The institutional framework of a country seems to affect firms’ CSR scores (e.g., Ioannou & Serafeim,

2012) and moderate the relation between CSR and firm value (e.g., El Ghoul, Guedhami, & Yongtae,2015). However,

relatively few studies haveinvestigated whether and how different institutional environments could influence the per-

ception of CSR activities, and, consequently, their impact on firm actions and outcomes. Our study contributes to this

line of research by investigating whether a firm’s institutional context moderates the link between CSR and financial

risk.

Institutions may be defined as the rules and norms that guide how individuals, organizations and markets interact

with each other (North, 1990; Scott, 1995). Aguilera and Jackson (2003) emphasize that most researchers contrast

two dichotomous models of Anglo-American and Continental European corporate governance: ‘The Anglo-American

model is also labeled the outsider, common law, market-oriented, shareholder-centered, or liberal model, and the

Continental model labeled the insider, civil law, blockholder, bank-oriented, stakeholder-centered, coordinated, or

“Rhineland” model.’ We refer to this dichotomy to define two categories of countries: shareholder-oriented countries

and stakeholder-oriented countries.

Our intuition is that the relation between financial risk and CSR commitment is dependent on the way individuals

andthe country’s rules consider and protect shareholders on the one hand, and non-financial stakeholders on the other.

Individuals in shareholder-oriented countries are expected to havea low sensitivity to firms’ SR behaviors: employees

are not attracted by SR firms, and consumers do not use the SR criterion in their purchases. As a result, there is no

advantage to a firm increasing its SR involvement since it would not expect more fidelity,stability or reputation. The

effects of SR commitment could be a higher cost, a waste of a firm’s resources, and a deviationfrom the maximization of

shareholders’ wealth goal. With regard to the relation between CSR and financial risk, we thus expecta null or a slightly

positive relation, because the firm mayface more costs without any compensation. The profile of stakeholder-oriented

countries is the opposite – employees show a greater loyalty to SR firms, consumers use SR criteria in their purchase

choices and they are more patient in the case of unwanted events etc. SR involvementis well perceived and is likely to

increase a firm’s value through good reputation, high employee loyalty,and consumer confidence in product quality. In

these countries, a significant negative relation is expectedbetween SR commitment and financial risk.

One practical question to solve is the separation between the two kinds of countries. By referring to the three

dimensions in the institutional environment, namely regulative, normative, and cognitive dimensions (Scott, 1995),

we focus in this study on the regulative environment. Our choice is mainly motivated by the results of Liang and

Renneboog (2016), who empirically show that the legal foundation is the most fundamental source of CSR. We there-

forerely on legal aspects and we begin with the traditional distinction based on legal origins. As emphasized by La Porta,

1TheEconomist, September 26, 2015.

2Vigeo Press Release, September 23, 2015: ‘Up to now, Vigeo was considering Volkswagen’soverall performance as “limited”, with a score of 48/100, and

positioned it below the performance of its peers in the automobile-manufacturing sector.The highest score was obtained by PSA Peugeot Citroën (60/100),

sectorleader in Europe. Volkswagen was notably subject to several controversies, including allegations of corruption over the last decade, that had limited its

performancein terms of business ethics and governance.’