By Wenzhi Ding, Hong Kong University, Ross Levine, University of California, Berkeley, Chen Lin, Hong Kong University, and Wensi Xie, Chinese University of Hong Kong.
Does an intensification of market competition increase or decrease corporate social responsibility (CSR) activities by companies? According to our research, competition materially boosts CSR, with the largest effect among firms that (a) have more ready access to finance to undertake CSR investments, (b) have institutional investors with longer-term horizons, (c) have not already established very strong bonds with non-shareholder stakeholders, and (d) are based in countries where social norms prioritise CSR activities, as this is where the relationship-building effects of CSR are likely to be the greatest.
Many investors and companies stress the importance of CSR. For example, on 14 January 2020, Larry Fink, the CEO of BlackRock, the world’s largest asset manager, argued that “… a company cannot achieve long-term profits without embracing … the needs of a broad range of stakeholders,” such as customers, employees, suppliers, and the communities where the company operates.
More broadly, as of 31 March 2020, some 3038 companies with combined assets of over US$103 trillion were signatories to the United Nations-supported Principles for Responsible Investing.
Yet, the actual implementation of CSR actions varies markedly across firms and countries. Why is this? What factors shape the degree to which firms invest in CSR? In a recent paper, we examine the impact of competition on a corporation’s CSR activities and how firm and country characteristics shape a firm’s CSR response to competition.
The impact of competition
There are competing views about the impact of competition on CSR. The conventional view stresses that competition decreases CSR by compelling firms to focus on short-term survival and therefore forgo investments that pay off in the long-run, such as many CSR activities. For example, investing in workplace safety could build employee loyalty over the long run, but the combination of large fixed costs to improving workplace safety, the challenges associated with raising financing for such endeavours, and shrinking profit margins due to intensifying competition, could limit investments in workplace safety and other CSR activities.
Two alternative views, however, suggest that competition increases CSR. The stakeholder view begins by recognising that since there are limits to writing and enforcing formal contracts, the efficiency of corporate operations depends on the effectiveness of implicit agreements with non-shareholder stakeholders, such as employees, suppliers, customers, and the communities in which firms operate. The effectiveness of those implicit agreements depends on stakeholders’ trust that the firm will honour its commitments. Market competition compels firms to enhance efficiency, including by strengthening bonds with stakeholders. One strategy for doing this is by investing in CSR activities, such as ensuring worker well-being and providing safe products to customers, fulfilling informal obligations to suppliers, and protecting the local environment.
The product differentiation view suggests that firms can differentiate their products to cushion the adverse ramifications of competition on profits, and that CSR activities are one strategy for doing so. Indeed, existing research finds that markets view CSR as a positive signal about a firm and its products, which increases customer loyalty and pricing power. Thus, greater competition will induce firms to invest more in CSR as a strategy for enhancing product differentiation.
To evaluate these views, we look at how competition laws – such as those concerning mergers and acquisitions and anticompetitive agreements – from 47 countries impact on the CSR activities of 1,800 manufacturing firms between 2002 and 2015. We create an overall competition law index (CLI), where higher values indicate laws that more stringently foster competition.
We discover that intensifying the stringency of competition laws leads to an increase in CSR. This finding is consistent with the stakeholder and product differentiation views that competition spurs corporations, on average, to boost CSR to enhance stakeholder trust and boost differentiation.
Accounting for differences
We also examine how the competition-CSR link differs across firms and countries.
Since CSR is a costly investment, the ease with which firms can raise funding will likely shape how much they boost CSR in response to increasing competition. Consistent with this, we find that the impact of competition laws on CSR is smaller among more financially-constrained firms.
The CSR-enhancing effects of competition may depend on firm ownership. To the extent that the returns from building stronger stakeholder relationships through CSR emerge only over the longer run, shorter-horizon owners will be more reluctant to increase CSR activities in response to growing competition. We find that the CSR-enhancing effects of competition are stronger among firms whose blockholders have longer-term orientations (e.g., insurance companies) than those with shorter investment horizons (e.g., hedge funds).
CSR may be a less useful strategy for boosting stakeholder bonds and product differentiation if a firm has already established strong relationships and distinguished its brand. To test this view, we distinguish firms by whether they are family-controlled corporations or not. Research shows that family-controlled firms tend to build stronger bonds with workers, suppliers, and customers over many years than other types of firms, and as such, the CSR-boosting effects of competition are smaller among them.
We also examine how differences in societal norms across countries shape the CSR response of firms to competition. While the stakeholder and product differentiation views build on the idea that CSR activities provide positive signals about a firm’s reputation and products, the strength of this signal will naturally depend on how much society values those CSR activities. Put differently, if society does not value them, then CSR will not materially boost stakeholder trust or differentiate a firm’s products.
To test this, we develop a measure of social norms as a proxy of the likely impact of CSR on stakeholders. We use data from the World Value Survey, which measured the degree to which individuals in a country prioritise the types of activities associated with CSR, to construct a Social Norms index.
We find that the CSR-boosting effects of more stringent competition laws are greater – twice as large – on firms in societies with higher values on the social norms index – those with stronger CSR preferences.
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 By CSR, we refer to (1) corporate treatment of non-shareholder stakeholders, (2) corporate efforts to mitigate environmental degradation, including by reducing emissions, fostering sustainable resource use, and engaging in green innovation, and (3) governance over socially responsible actions.