The Effect of a Ratings-Based Approach to Measuring Corporate Social Responsibility

The ratings-based methodology employed by Socially Responsible Investment (SRI) indices in their selection processes excludes many corporations by creating limited-membership lists. This received ratings-based structure is yet to offer an incentive for most of the excluded corporations to invest in improving their levels of Corporate Social Responsibility (CSR). We, therefore, investigate under what circumstances a ratings-based method for assessing CSR could provide an incentive to firms excluded from SRI indices to invest in CSR. In this article, we attempt to offer a theoretical reply to this question. We argue that when all firms are publicly ranked according to SRI index parameters, such indices can indeed create a market incentive for increased investment by firms in improving their performance in the area of social responsibility. We further show that this incentive tapers off as the amount of investment required exceeds a certain point or if the amount of payback on that investment fails to reach a certain threshold.