The Causal Effect of Corporate Governance on Corporate Social Responsibility

Baron (2010) distinguishes between corporate social performance (CSP) and CSR, where the latter involves a moral duty to undertake social activities. In contrast, CSP need not arise from moral duties. CSP pertains to social activities that satisfy two conditions. First, the activities are beyond the requirements of the law and regulation. Second, the activities involve the private provision of public goods or private redistribution. Consistent with Baron (2010), our CSR implies CSP, but CSP need not be morally motivated, because CSP could be strategically chosen to serve the firm’s interests.

Another related study is Baron et al. (2011) that describe three measurable markets in which firms operate: a product market, a capital market, and a market for social responsibility, as urged by shareholders, government, NGOs, and social activists. They suggest that consumer industries evidence a positive relationship between financial performance and social performance, while industrial firms have a negative relationship. That differs from overall corporations, which exhibit no strong empirical relationship between their social activities and their financial performance. They show that in the consumer sphere, at least, companies can get a financial edge by behaving socially responsibly.

According to the management literature summarized by Margolis and Walsh (2003), over 120 studies between 1971 and 2001 examine the empirical relation between CSR and CFP, and the results are largely inconclusive. They suggest that assessments of previous studies are complicated because of the studies’ various imperfections, such as measurement problems related to both CSR and CFP, omitted variable problems, a lack of necessary analyses of causality and/or endogeneity, a lack of methodological rigor, and a lack of theory. Nonetheless, these studies stress that bad social performance is detrimental to a firm’s financial performance. Although, it would be abstruse to draw a definite conclusion because of the imperfect nature of many studies, the review of the empirical CSR literature conducted by Margolis and Walsh (2003) indicates a positive relation between CSR and CFP, and Baron et al. (2011) suggest that consumer industries evidence a positive association between CFP and CSR, while industrial firms have an inverse association.

Prior et al. (2008) interpret Jensen’s (2002) and Fuller and Jensen’s (2002) view as an adoption of a compromised stakeholder-agency perspective, where a firm is conceived not only as a bilateral relation between managers and shareholders, but also as a multilateral set of relations among stakeholders.

CSR could increase firm value through other channels. For instance, having loyal shareholders who prefer to invest in socially responsible firms might lead a firm to have small volatility and stable share prices. Or if CSR engagement lowers the firm’s borrowing costs, CSR engagement enhances firm value.

In fact, the KLD database has few firms that actually have exclusionary items. We find only 756 firm-year observations that report exclusionary items. The rest have zero exclusionary items. For the KLD strength scores, we find 4,174 firm-year observations. For the combined strength and concern scores, we have 6,479 firm-year observations. In addition, while the KLD database reflects whether a company is engaged in CSR activities and includes a list of the types of activities, it does not report how much each firm invests in CSR activities. Although, we are not aware of the existence of CSR investment data, the availability of such data could provide additional benefits.

Tobin’s q is widely used as a measure of firm value in accounting, finance, and economics. See, for e.g., Chung and Jo (1996), among others. Following Chung and Jo (1996), Tobin’s q is calculated as: {[market value of common stock + book value of preferred stock + book value of long-term debt + book value of current liabilities − (book value of current assets − book value of Inventories)]/book value of total assets}. Thus, we use Tobin’s q to measure firm value. Accounting and finance literature typically uses ROA to measure firm’s operating performance. Thus, we examine this operating performance as well.

Sample-selection bias and endogeneity bias refer to two distinct problems, both entailing distinct solutions. In general, sample-selection bias refers to problems in which the dependent variable is observed only for a restricted, nonrandom sample. Endogeneity arises when an independent variable included in the model is potentially a choice variable, correlated with unobservables relegated to the error term. The dependent variable, however, is observed for all observations in the data (see Millimet 2001).

We also examine the association between the KLD exclusionary scores and ADJTOBINQ. Our untabulated results suggest that as anticipated, the KLD exclusionary scores from alcohol, tobacco, military, and nuclear-related revenues are inversely associated with CFP.

This result is available upon request.