Moral management in competitive markets

• Published date: 01 June 2019
• Author: Steve Martin
• DOI: http://doi.org/10.1111/jems.12283
• Date: 01 June 2019

Received: 14 July 2017

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Revised: 9 February 2018

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Accepted: 22 July 2018

DOI: 10.1111/jems.12283

ORIGINAL ARTICLE

Moral management in competitive markets

Steve Martin

Department of Economics, University of

Ottawa, Ottawa, Ontario, Canada

Correspondence: Department of

Economics, University of Ottawa, Ottawa,

Ontario, Canada K1N 6N5.

Email:smart041@uottawa.ca

Funding information

Social Sciences and Humanities Research

Council of Canada, Grant/Award

Number: Canadian Graduate Scholarship

Abstract

The intrinsic motivation of a firm’s management for engaging in prosocial

behavior is an important determinant of a firm’s social conduct. I provide the

first model in which firms run by morally motivated managers engage in

corporate social responsibility (CSR) in a competitive setting. Moral manage-

ment crowds out a competitor’s strategic CSR, increasing profitability and

leading shareholders to strategically delegate moral managers, although

necessary for socially optimal CSR is that shareholders be morally motivated

as well. Shareholders appoint managers that engage in a socially excessive

amount of CSR, counter to existing literature, whenever product‐market

competition is sufficiently intense.

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INTRODUCTION

It is widely observed that firms engage in socially responsible behavior beyond the requirements of law, so much so that

this behavior has its own name—corporate social responsibility (CSR). Why then do firms voluntarily engage in socially

responsible behavior? While strategic CSR may be profitable for firms—differentiating their products to extract a price

premium from socially responsible consumers or forestalling regulation or activism—and hence aligned with the goal

of profit maximization (e.g., Besley & Ghatak, 2005; Maxwell, Lyon & Hackett, 2000), one motivation that is becoming

increasingly important is the intrinsic motivation of a firm’s management for addressing social issues.

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Morally

motivated managers—that is, managers interested in both the firm’s economic performance and social performance—

are often seen as necessary for firms to deliver needed social outcomes: “[corporate] [s]ocial responsibility can only

become reality if more managers become moral instead of amoral or immoral”(Carroll, 1991, p 39). This is especially

true in the context of environmental concerns.

The science is clear: We have overshot the carrying capacity of the planet, and serious repercussions are

now inevitable…We are in urgent need of companies that have a greater purpose than making money

(Ratan, Hart, Sharma, & Sarkar, 2013).

It is important to stress that moral management does not imply a lack of interest towards profit; rather, a moral

manager wants to be profitable while operating in a socially responsible way (Carroll, 1991).

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Movements such as

Capitalism 24902 further the idea that addressing social issues should be a core concern of business; creating

stakeholder value, not just shareholder value, should be a firm’s objective (Branson, 2011). This normative view is also

reflected in the economics literature, where profit‐maximizing firms often do not have enough incentive to engage in

CSR (e.g., Besley & Ghatak, 2005; Deltas, Harrington, & Khanna, 2013; Maxwell et al., 2000). At the same time,

managers not solely motivated by profit bring up issues of corporate governance—moral management is seen as

necessarily involving some cost to shareholders, undermining shareholder primacy (Bénabou, 2010).

In this paper, I develop the first model of CSR in which competing firms can be morally managed to understand how

strategic and nonstrategic motivations inform firms’social conduct—how do morally motivated managers affect firms’

J Econ Manage Strat. 2019;28:541–560. wileyonlinelibrary.com/journal/jems © 2018 Wiley Periodicals, Inc.

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and shareholders’strategies, and can these managers engage in a socially optimal amount of CSR? Given the various

motivations for firms to engage in CSR (Bansal & Roth, 2000), the interaction between morally motivated CSR and

strategic CSR is of interest not only from a business strategy point of view, but also from a normative perspective with

regard to firms’social conduct.

While there is a growing literature that looks at the incentives for firms to engage in CSR activities, there is little formal

modeling of moral management and the decision behind firms’CSR. Most models take CSR as private provision of a public

good and focus on CSR as a form of product differentiation (e.g., Bagnoli & Watts, 2003; Besley & Ghatak, 2007; Deltas et al.,

2013) or as a means to influence regulation or activism (e.g., Baron, 2001; Maxwell et al., 2000); in all cases, firms are profit

maximizers and CSR is of the strategic variety. Lyon and Maxwell (2008), Kitzmueller and Shimshack (2012), and Schmitz

and Schrader (2015) provide reviews. A general theme from this literature is that firms do not have enough incentive to

provide a public good, so that strategic CSR alone is unlikely to provide the socially optimal amount of public good.

Building on previous work, the model I develop in this study is a simple differentiated duopoly that treats CSR as a

form of product differentiation. Private provision of a public good beyond the requirements of the law appeals to

socially responsible consumers, increasing the quality of a firm’s output, and a firm can use this as a profitable

nonmarket strategy—a common reason why firms engage in strategic CSR (e.g., Bénabou & Tirole, 2010; Kitzmueller &

Shimshack, 2012). Rather than having firms engage in CSR solely to maximize profit, however, I allow for moral

managers that augment a firm’s objective from one of pure profit maximization to a hybrid that incorporates both

profitability and social conduct directly. Shareholders, which can themselves be morally motivated, then appoint a

manager to run their firm, in essence selecting how the manager weights profitability versus social conduct and

committing the firm to a particular type of strategy.

Analytically, the model I develop is similar to models of mixed oligopolies, especially those with partially privatized

firms that have a hybrid objective for profit and consumer surplus (e.g., Matsumura, 1998). However, by focusing on the

endogenous provision of a public good and the endogenous preferences a manager has for providing a public good, the

insights of the model are distinct and unique from those in the literature on mixed oligopolies.

With regard to previous work on moral management, Baron (2001, 2009) examines the incentives for a single

morally motivated firm to engage in CSR in the presence of an activist. In both cases the focus lies on activism and the

decisions of an activist, with minimal attention paid to the competitive implications of CSR, and no attention paid to the

decisions of shareholders or the normative outcomes of CSR. In a different vein, Baron (2008) considers a model of

managerial contracting for a monopolist under moral hazard when both shareholders and a manager can have

preferences over the provision of social goods, focusing on the reasons why managerial pay may depend on social

performance. My analysis builds on this study by not only explicitly taking the interaction between competition and

CSR into account, but also allowing for multiple firms to be run by moral managers, and examining how this in turn

affects shareholders’incentives to endogenously appoint managers. I also examine the normative implications of CSR in

terms of efficient provision of a public good when firms can be run by moral managers.

The model I develop is also related to the literature on CSR as a form of product differentiation (e.g., Bagnoli &

Watts, 2003; Besley & Ghatak, 2007; Deltas et al., 2013). Of these papers, the most closely related is that of Deltas et al.

(2013). These authors examine strategic CSR as a form of product differentiation, focusing on the welfare outcome of

strategic CSR and the policy implications of minimum environmental quality standards. Both my model and theirs treat

a differentiated Hotelling duopoly in which CSR acts as a form of vertical differentiation, and examine the resulting

impact that CSR has for the efficient provision of public goods. In contrast to their model, and the related literature,

however, I allow firms to be run by moral, rather than solely profit‐maximizing, managers, and I consider the incentives

that shareholders have to appoint such managers. Allowing for moral managers has important implications for firms’

CSR strategies and the welfare consequences of CSR.

Outside of the economics literature there is a considerable management literature on CSR, often defining CSR as

coming from a morally managed firm; socially responsible behavior by a firm is not CSR unless it is induced by moral

management. (This is in contrast to the economics literature, where CSR is private provision of a public good beyond

what is demanded by law—the motivation for the firm is not important.) Many of the classic criticisms against CSR—

particularly that firms should be profit maximizers and that CSR destroys the value of a firm—take this definition (e.g.,

Davis, 1973), and the model here can be used to speak to these criticisms. The strong presumption is that CSR induced

by managerial philanthropy necessarily forgoes profit. In this literature, McWilliams and Siegel (2001) is probably the

closest to the present article, discussing the implications of CSR induced by concerns beyond profit in a competitive

setting. Their discussion, however, lacks any formal modeling and fails to outline any strategic or normative

implications from this type of CSR.

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