By Rui Albuquerque, Carroll School of Management, Boston College, CEPR and ECGI, Yrjo Koskinen, Haskayne School of Business, University of Calgary, and Chendi Zhang, University of Exeter Business School


Why do firms invest millions of dollars in Corporate Social Responsibility (CSR) initiatives? According to our paper, it’s because they reduce systematic risk and increase company valuations.

Firms investing in CSR face less risk of demand for goods falling when they raise prices than firms which don’t, so they can charge higher prices for their products and retain loftier profit margins.

Customers become more loyal because they appreciate firms’ green credentials and socially responsible products, which are in line with their values and concerns about sustainability, so they are not so swayed by prices.

Customer loyalty pays off

Environmentally conscious consumers are willing to pay a premium for products such as organic food or electric vehicles, with CSR becoming a form of product differentiation for firms.

Those companies in tune with the changing demands of society and growing concerns around climate change can build a loyal customer base, making profits more stable and less correlated to economic cycles.

This in turn reduces their systematic risk and increases valuations. The impact on valuations is substantial, with an average increase of five per cent across the firms. Investing in CSR is akin to having a risk management policy; making companies less sensitive to booms and busts.

Using statistical analysis to measure the impact of investing in CRS on corporate valuations, we find firms relying heavily on advertising see an even bigger impact on valuations from adopting CSR, supporting our claim that consumers are the main drivers of valuation effects.

Higher CSR scores, lower risk

We analyse the performance of 4,670 US listed companies from 2003 to 2015. In the model we created, we assume investors are not interested in CSR initiatives. They are simply wealth-maximizing investors only interested in risk and return.

Instead, consumers are the driving force generating the results. The model predicts that the reduction in systematic risk is stronger for consumer-oriented companies, especially as these firms spend more on advertising, which amplifies the effect of CSR initiatives.

We use Morgan Stanley Capital Investments’ Environmental, Social and Governance (MSCI ESG) database to construct an overall CSR score for each of the firms in our study each year.

The score combines information on the firm’s performance across community, diversity, employee relations, the environment, product and human rights attributes.

We estimate firms’ systematic risk (beta) using the Capital Asset Pricing Model for each year, before studying the effect of CSR scores on beta. We find that firms with high CSR scores have lower betas compared to firms with lower scores. This finding is backed up by results showing that firms with higher CSR scores also have profits that are not as affected by the business cycle.

Consistent with the model, the reduction in systematic risk is 40 per cent stronger for firms that advertise a lot and the effect on their valuations is 20 per cent larger.

Sustainable investments and cost of capital

Our results have important practical implications for capital budgeting and portfolio selection. Investment projects that increase firms’ reputation for CSR should be reflected in the lower cost of equity. Calculating the value of sustainable investments with the firm’s overall discount rate would lead to underinvestment in these projects. However, CSR investments are not a panacea. They only work if they help to set a firm apart in a crowded marketplace.

Read the full paper here.


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