On the Foundations of Corporate Social Responsibility

• Published date: 01 April 2017
• Author: HAO LIANG,LUC RENNEBOOG
• Date: 01 April 2017
• DOI: http://doi.org/10.1111/jofi.12487

THE JOURNAL OF FINANCE •VOL. LXXII, NO. 2 •APRIL 2017

On the Foundations of Corporate Social

Responsibility

HAO LIANG and LUC RENNEBOOG∗

ABSTRACT

Using corporate social responsibility (CSR) ratings for 23,000 companies from 114

countries, we find that a firm’s CSR rating and its country’s legal origin are strongly

correlated. Legal origin is a stronger explanation than “doing good by doing well”

factors or firm and country characteristics (ownership concentration, political insti-

tutions, and globalization): firms from common law countries have lower CSR than

companies from civil law countries, with Scandinavian civil law firms having the

highest CSR ratings. Evidence from quasi-natural experiments such as scandals and

natural disasters suggests that civil law firms are more responsive to CSR shocks

than common law firms.

THE CLASSICAL VIEW IN FINANCE on modern corporations takes a shareholder

value maximization perspective, which holds that corporations are account-

able only to profit-maximizing shareholders, and apart from their contractu-

ally determined obligations, have no responsibility to serve other stakehold-

ers’ interests or to enhance society’s welfare (Friedman (1970), B´

enabou and

Tirole (2010)). In reality, however, corporations often focus on objectives be-

yond profit maximization and participate in activities that improve other

∗Hao Liang is from Singapore Management University. Luc Renneboog is from TilburgUniver-

sity. We acknowledge that we are aware of the Journal of Finance’s submission guidelines and

policies and conflict of interest disclosure policy and that there are no conflicts of interest that

exist for this paper. We are very grateful to Andrei Shleifer and Holger Spamann for comments

and suggestions on early versions of the paper. Wealso wish to thank Ian Appel, Lucian Bebchuk,

Gennaro Bernile, Daniel Beunza, Archie Carroll, Martijn Cremers, Hans Degryse, Frank De Jong,

Elroy Dimson, Joost Driessen, Tore Ellingsen, Fabrizio Ferraro, Allen Ferrell, Caroline Flammer,

Edward Freeman, Richard Friberg, Jesse Fried, Marc Goergen, Jarrad Harford, Oguzhan Karakas,

Philipp Krueger, Amir Licht, Paul Malatesta, Alberto Manconi, Chris Marquis, Mark Roe, Amir

Rubin, Paola Sapienza, Enrique Schroth, Roy Shapira, Oliver Spalt, Matt Spiegel, Gaspar van

Weerbeke, J¨

orgen Weibull, Bernard Yeung; seminar participants at Harvard Law School, Harvard

Business School, Tilburg University, London Business School, University of Cambridge (Judge),

Stockholm School of Economics, University of Zurich, University of Antwerp, Institut Bachelier

and Ecole Polytechnique Paris, Humboldt-Berlin University, Ghent University, University Paris

Dauphine, Norwegian School of Economics, Cardiff Business School, and Singapore Management

University; as well as conference participants at the 10th and 11th Corporate Finance Day (Ghent

and Li`

ege), EFMA 2014 Conference, 2014 China International Conference in Finance, Harvard

Business School Conference on Sustainability and the Corporation: the Big Ideas, Vigeo’s Cor-

porate Social Responsibility Conference ‘Assessing Corporate and Sovereign Intangible Capital’

(Paris), and the 2nd Geneva Summit of Sustainable Finance for helpful comments and suggestions.

All errors are our own.

DOI: 10.1111/jofi.12487

853

854 The Journal of Finance R

stakeholders’ welfare, such as providing employee benefits, investing in

environment-friendly production processes, selecting suppliers that avoid the

use of child labor, and organizing projects to help the poor in less-developed

countries. Indeed, corporate social responsibility (CSR), a term frequently used

to describe such stakeholder-oriented behaviors, has increasingly become a

mainstream business activity (Kitzmueller and Shimshack (2012)). This raises

the question of why do some firms want to be socially responsible rather than

pure profit maximizers, and more importantly, why firms in some countries

engage in CSR to a greater extent than firms in other countries.

The common explanation for why companies invest in CSR is that doing so

enhances profitability and firm value,1a relationship often referred to as “doing

well by doing good” (e.g., Dowell, Hart, and Yeung (2000), Orlitzky, Schmidt,

and Rynes (2003), Renneboog, Ter Horst, and Zhang (2008,2011), Guenster

et al. (2011), Deng, Kang, and Low (2013), Flammer (2015), Krueger (2015),

Dimson, Karakas¸, and Li (2015)). Other studies consider the inverse, that is,

“doing good by doing well,” by examining whether it is only well-performing

firms that can afford to invest in CSR (e.g., Hong, Kubik, and Scheinkman

(2012)). However, neither of these “doing good—doing well” arguments can

explain the cross-firm or cross-country variation in CSR. For instance, if on

average CSR enhances firm value, why do some companies adopt a CSR-

oriented strategy whereas others do so to a lesser extent, and why do com-

panies in some countries systematically invest more in CSR than companies in

other countries? In addition, these “doing good—doing well” arguments mostly

take CSR to be a voluntary initiative. Extant studies also usually take only

one perspective on CSR, such as employee satisfaction (Edmans (2011,2012),

Edmans, Li, and Zhang (2014)), environmental protection (e.g., Dowell, Hart,

and Yeung (2000), Konar and Cohen (2001)), corporate philanthropy (e.g.,

Seifert, Morris, and Bartkus (2004), Masulis and Reza (2015), Liang and Ren-

neboog (2016)), or consumer satisfaction (e.g., Luo and Bhattacharya (2006),

Servaes and Tamayo (2013)), and test CSR relations for only one country (typ-

ically the United States). However, CSR spans multiple dimensions of firm

behavior and captures a firm’s effort to address various externalities that it

generates in the process of pursuing profit maximization (Tirole (2001)) that

are not internalized by shareholders (Magill, Quinzii, and Rochet (2015)). This

multidimensional and externality-driven nature of CSR suggests that it should

be fundamentally related to not only a firm’s own choice but also regulations,

institutional arrangements, and societal preferences. Moreover,beyond looking

at CSR as a mechanism to address externalities, we consider CSR as a more

fundamental tradeoff between a shareholder focus and an other-stakeholder

focus (at the firm level) (Ferrell, Liang, and Renneboog (2016)), as well as be-

tween rules and discretion by institutions governing economic life. Such trade-

offs, as we argue, hinge crucially on a firm’s explicit and implicit contractual

1B´

enabou and Tirole (2010, p. 2) define CSR as “sacrificing profits in the social interest.” Follow-

ing many other studies, here we adopt a broader definition of CSR that focuses on firm activities

that improve social welfare but not necessarily at the expense of profits (or shareholder value).

On the Foundations of Corporate Social Responsibility 855

environment, which is likely to be shaped by legal rules and enforcement mech-

anisms that differ across countries.

In this paper, we examine whether differences in CSR practices across coun-

tries can be explained by relating CSR to a country’s legal origin, which has

been shown to systematically shape various country-level institutions and

the firm-level contracting environment (Doidge, Karolyi, and Stulz (2007), La

Porta, L´

opez-de-Silanes, and Shleifer (2008)). In the context of CSR, a coun-

try’s legal regime determines how “public goods” should be provided by the

private sector (corporations): through regulations and rules, firm discretion,

or government involvement in business (Kitzmueller and Shimshack (2012)).

A country’s legal regime also shapes the explicit and (more often) implicit

contracts between shareholders and other stakeholders through its effect on

governance structures and the decision-making process.2A common law origin

is a more discretion-oriented system that supports private market outcomes,

places fewer ex ante restrictions on managerial behavior (but discourages in-

appropriate or unacceptable behavior by relying on ex post sanctions such as

litigation or other judicial mechanisms), and favors shareholder protection. A

civil law origin, in contrast, is associated with state intervention in economic

life through rules and regulations (e.g., an ex ante delineation of acceptable

behavior) and a “stakeholder view” (La Porta, L´

opez-de-Silanes, and Shleifer

(2008), Allen, Carletti, and Marquez (2015), Magill, Quinzii, and Rochet (2015)).

The level of CSR in a country is therefore a result of both a governance tradeoff

concerning the rights and preferences of shareholders and other stakeholders,

and the form in which this tradeoff is made (i.e., by rules or discretion).

To empirically test the legal origin view of CSR, we employ several newly

assembled international databases on firm-level CSR that together cover more

than 25,000 large public companies around the globe. Our CSR data measure

corporations’ engagement in and compliance with environmental, social, and

traditional corporate governance (“ESG”) issues, where engagement refers to a

firm’s voluntary investment in CSR projects while compliance refers to behav-

ior that a firm is required or encouraged to follow.3Engagement and compli-

ance activities across the different ESG dimensions capture various aspects of

2For example, in Germany,corporations are legally required to take into account the interests of

employees through the system of codetermination, which requires that employees and shareholders

have an equal number of seats on the supervisory board (Allen, Carletti, and Marquez (2015)).

Moreover, the harmonization laws of the European Community include provisions permitting

corporations to take into account the interests of creditors, customers, potential investors, and

employees and the corporate laws in Japan presume that Japanese corporations exist within a

tightly connected and interrelated set of stakeholders, including suppliers, customers, lending

institutions, and friendly corporations (Donaldson and Preston (1995)).

3For example, engagement in ESG may include a company’s voluntary R&D investment in an

environmentally friendly project (the “E” dimension), an employee training program designed to

increase employee welfare or productivity (the “S” dimension), or a voluntary increase in gender

and racial diversity of the board of directors (the “G” dimension). Compliance with ESG may

include following environmental regulations on CO2emissions (the “E” dimension), guaranteeing

working conditions above the minimum requirements in factories located in developing countries

(the “S” dimension), or consulting investors on management compensation (say on pay) (the “G”

dimension).