Peer Effects Of Corporate Social Responsibility
Chinese University of Hong Kong – Department of Finance
Singapore Management University, Lee Kong Chian School of Business; Tilburg University, CentER
Xintong Zhan
Chinese University of Hong Kong
July 21, 2015
Abstract:
We investigate how firms react to their peers’ adoption of corporate social responsibility (CSR) by using a regression discontinuity design that relies on “locally” exogenous variations of CSR generated by shareholder proposals that pass or fail by a small margin of votes. Specifically, we find that peers of a voting firm who passed a close-call CSR proposal experience lower announcement returns and higher following-year CSR scores compared to those of a voting firm that marginally failed a CSR proposal. Such effects are stronger in peer firms with higher competitive pressure, better CSR performance relative to the voting firm, and a more transparent information environment. We find a more pronounced negative cumulative abnormal returns and a smaller CSR improvement in peer firms with higher financial constraints. Taken together, our empirical results show that peer effects play an important role in shaping firms’ CSR performance and further confirm the argument that CSR has strategic value.
Peer Effects Of Corporate Social Responsibility – Introduction
Corporate social responsibility (CSR) has increasingly become a mainstream business activity-ranging from voluntarily engaging in environmental protection to increasing workforce diversity and employee welfare-although standard economic theories predict that it should be rather uncommon (Benabou and Tirole (2010), Kitzmueller and Shimshack (2012)). The neoclassical economic paradigm usually considers CSR as unnecessary and inconsistent with profit maximization (e.g., Friedman (1970)). This discrepancy between theory and real-world observations has attracted much scholarly attention in recent years. One popular view on why CSR prevails is that it creates a competitive advantage for the firm, such as enhanced social capital that may lead to higher profitability and sales growth (Lins, Servaes, and Tamayo (2015)), thus contributes to firm value. Following this line, numerous studies have investigated the strategic value implications of CSR by focusing on how the adoption of CSR leads to higher returns and lower risks (e.g., Deng, Kang, and Low (2013), Flammer (2015), Albuquerque, Durnev, and Koskinen (2014)). Others study the causes of CSR, and attribute the level of CSR to a firm’s own financial and operational performance (e.g., Hong, Kubik, and Scheinkman (2012)).
While shedding light on the relationship between CSR and firm performance, the extant studies are largely silent on how CSR interacts with the firm’s surrounding environment—such as influencing industry structure and product market competitiveness. Notably, firms do not operate in isolation, and their business activities often compete with other firms in the product market. If CSR creates a competitive advantage, its effect should be mostly manifested through a firm’s competition with other firms. To the extent that CSR signifies a firm’s influence on the society in general and its product quality in particular, one can reasonably expect that it can affect other peer firms’ competitive position and CSR practice as well. For instance, when a firm adopts a green technology in its production, it may be perceived as a threat to its peer firms, because such green technology may attract more environmentally conscious customers to switch from these peer firms to the adopting firm. Investors of these peer firms are aware of the potential loss of their companies’ market shares, leading to immediate negative market reactions of these companies. To catch up with their competitor and regain their competitive edge, these peer firms may then adopt similar technologies in the next period. In this study, we build on this competitive advantage perspective of CSR and formally examine whether and how a firm’s adoption of CSR can affect the practice and value of its peer firms.
Properly addressing these questions has been challenging, as both CSR and a firm’s competitive position in the market are arguably endogenous choices of the firm. This posits an empirical challenge as to whether firms and investors react to their peers’ CSR actions by changing their firm’s CSR practices and market valuations, or whether the pre-existing differences in other unobservable firm characteristics lead different firms to adopt different levels of CSR. It is also challenging to apply a typical quasi-natural experiment approach by exploring potentially exogenous legislative changes that affect the CSR of some firms but not of peer firms in the same industry or market. Moreover, the traditional definition of peer firms based on industry classification such as the Standard Industrial Classification (SIC) and the North American Industry Classification System (NAICS) may not properly capture a true peer group—which may span multiple industries with regard to CSR practices—as most CSR issues are not industry-specific and can affect a broad range of stakeholders (such as environmental protection and product quality). As a result, the existing literature generally falls short in providing causal estimates of the peer effects of CSR.
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