Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis

• Author: KARL V. LINS,HENRI SERVAES,ANE TAMAYO
• Published date: 01 August 2017
• Date: 01 August 2017
• DOI: http://doi.org/10.1111/jofi.12505

THE JOURNAL OF FINANCE •VOL. LXXII, NO. 4 •AUGUST 2017

Social Capital, Trust, and Firm Performance:

The Value of Corporate Social Responsibility

during the Financial Crisis

KARL V. LINS, HENRI SERVAES, and ANE TAMAYO∗

ABSTRACT

During the 2008–2009 financial crisis, firms with high social capital, as measured by

corporate social responsibility (CSR) intensity, had stock returns that were four to

seven percentage points higher than firms with low social capital. High-CSR firms

also experienced higher profitability, growth, and sales per employee relative to low-

CSR firms, and they raised more debt. This evidence suggests that the trust between

a firm and both its stakeholders and investors, built through investments in social

capital, pays off when the overall level of trust in corporations and markets suffers a

negative shock.

“The present financial crisis springs from a catastrophic collapse in confi-

dence . . . Financial markets hinge on trust, and that trust has eroded.”

—Joseph Stiglitz (2008)

“The fundamental problem isn’t lack of capital. It’s lack of trust. And

without trust, Wall Street might as well fold up its fancy tents.”

—Former U.S. Labor Secretary Robert Reich (2008)

∗Karl V. Lins is at the University of Utah. Henri Servaes is at London Business School, CEPR,

and ECGI. Ane Tamayo is at the London School of Economics and Political Science (LSE). The

authors have no conflicts of interest to disclose. We would like to thank TaylorBegley, Colin Clubb,

Joao Cocco, Mike Cooper, James Dow, Alex Edmans, Christopher Hennessy, Ioannis Ioannou,

Ralph Koijen, Jean-Marie Meier, Yuval Millo, Michael Roberts (the Editor), Kelly Shue, Rui Silva,

Hannes Wagner, Yao Zeng, an anonymous Associate Editor, an anonymous referee, and seminar

participants at City University,Erasmus University, ESSEC, HEC Paris, INSEAD, King’s College,

London Business School, London School of Economics, Tilburg University, University of Bristol,

University of Edinburgh, University of Leicester,University of Melbourne, University of New South

Wales,University of Southampton, University of Sydney, WHU Otto Beisheim, the French Finance

Association, London Business School Summer Finance Symposium, the International Accounting

Research Symposium at the Fundaci´

on Ram´

on Areces, the International Corporate Governance

Conference at Hong Kong Baptist University,and the University of Cambridge Financial Account-

ing Symposium for helpful comments and discussions. We would also like to thank the ECGI for

the 2016 Standard Life Investments Finance Working Paper Prize. Dimas Fazio provided excellent

research assistance.

DOI: 10.1111/jofi.12505

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1786 The Journal of Finance R

“The global financial and economic crisis has done a lot of harm to the

public trust in the institutions, the principles and the concept itself of the

market economy.”

—OECD Secretary General Angel Gurria (2009)

“Something important was destroyed in the last few months of 2008. It is

an asset crucial to production, even if it is not made of bricks and mortar . . .

This asset is trust.”

—Paolo Sapienza and Luigi Zingales (2012, p. 123)

The financial crisis highlighted the importance of trust for well-functioning

markets and financial stability, but discussions on the role of trust and, more

generally, social capital in economic life are not new. Already in 1972, Arrow

argued that “virtually every commercial transaction has within itself an ele-

ment of trust” (p. 357), and suggested that much of the economic backwardness

in the world might be due to the lack of mutual confidence. In line with this

view, Putnam (1993) shows that higher social capital societies, in which trust is

greater, display higher economic development (see also Fukuyama (1995), La

Porta et al. (1997), and Knack and Keefer (1997)). Focusing on capital markets,

Guiso, Sapienza, and Zingales (2004,2008) document that trust derived from

greater social capital allows for more stock market participation. These studies

and other related work demonstrate the importance of social capital and trust

from a macroeconomic perspective. However, the extent to which social capital

and trust impact firm performance is relatively unexplored in the literature.

The objective of this paper is to address this question.

Empirical identification of the effect of trust and, more generally, social capi-

tal on firm performance is challenging. First, social capital is a broadly defined

concept, often encompassing trust and cooperative norms (e.g., Scrivens and

Smith (2013)), and hence its measurement is not straightforward. Second, with-

out exogenous variation in firm-level social capital, it is difficult to attribute

changes in performance to changes in social capital.

To address the first challenge, we focus on a firm’s Corporate Social Respon-

sibility (CSR) activities as a measure of its social capital, following recent work

in economics (Sacconi and Degli Antoni (2011)) suggesting that a firm’s CSR

activities are a good proxy for its social capital, and also the widespread view

among practitioners and corporations that a firm’s CSR activities generate

social capital and trust.1

To address the second challenge, we employ the 2008–2009 financial cri-

sis, a period during which public trust in corporations, capital markets, and

institutions declined unexpectedly.2If a firm’s social capital helps build stake-

holder trust and cooperation (Putnam (1993)), it should pay off when being

1Following the financial crisis, many corporations have emphasized the importance of a firm’s

social capital, driven by its CSR investments, in rebuilding stakeholder trust. However, the prac-

titioner view that CSR helps build trust predates the financial crisis (Fitzgerald (2003)).

2The notion that the crisis led to a decline in public trust in corporations is corroborated by

surveys such as the 2009 Edelman Trust Barometer,which shows that 62% of respondents from a

Social Capital, Trust, and Firm Performance 1787

trustworthy is more valuable, such as in an unexpectedly low-trust period.

From a shareholder perspective, if high social capital firms are perceived as

more trustworthy, investors may place a valuation premium on these firms

when overall trust in companies is low (see Guiso, Sapienza, and Zingales

(2008)), as in the 2008–2009 financial crisis. From a stakeholder perspective,

the reciprocity concept often discussed in studies of social capital (i.e., the idea

that “I will be good to you because I believe you will be good to me at some

point in the future”) suggests that stakeholders (e.g., employees, customers,

suppliers, and the community at large) are more likely to help high social cap-

ital firms weather a negative shock, given that such firms displayed greater

attention to, and cooperation with, stakeholders in the past.

Totest whether firm-level social capital pays off during a crisis of trust, we ex-

amine the performance of 1,673 nonfinancial firms with CSR data available on

the MSCI ESG Stats database (formerly known as KLD) over the August 2008

to March 2009 financial crisis period. In regressions that control for a wide vari-

ety of factors and firm characteristics (including governance and transparency),

we find that firms that entered the crisis period with high CSR ratings have

significantly higher (between four and seven percentage points) crisis-period

stock returns than those that entered it with low CSR ratings. The economic

importance of social capital in explaining stock returns is at least half as large

as the effect of cash holdings and leverage, financial variables previously shown

to affect crisis-period returns (Duchin, Ozbas, and Sensoy (2010)andAlmeida

et al. (2012)). This result highlights the importance of expanding the focus

beyond financial capital when attempting to understand the determinants of

firm-level performance during a crisis of trust.

To alleviate concerns that the stock market outperformance we observe is

due to some factor other than a shock to trust, we conduct three further tests.

First, we investigate the association between CSR and stock returns during the

Enron/Worldcom crisis of the early 2000s, a period during which widespread

revelation of fraud undermined investor confidence in the U.S. stock market.

We find that high-CSR firms also earned excess returns relative to low-CSR

firms during this period. Second, we investigate whether our results are driven

by the decline in the supply of credit that firms faced during the financial crisis,

rather than by a decline in market-wide trust. Specifically,we test whether CSR

is related to stock returns in the period July 2007 through July 2008, when

there was a shock to the credit supply but no shock to the importance of trust.

We find no significant relation between CSR and stock returns during this

earlier period of the crisis. Third, we examine whether the relation between

CSR and crisis-period returns is stronger in high-trust regions, as identified in

the 2006 General Social Survey. We find that this is indeed the case.

It is possible, of course, that high-CSR firms also outperform low-CSR firms

during noncrisis periods (e.g., Edmans (2011)). To assess this possibility, we

examine whether the superior performance of high-CSR firms extends to

survey in 20 countries had lower trust in corporations in the aftermath of the financial crisis (for

respondents from the United States, this figure is 77%).