Corporate social responsibility (CSR) is defined as “actions that appear to further some social good, beyond the interests of the firm and that which is required by law” (McWilliams and Siegel, 2001). According to this definition, CSR activities not only affect investing stakeholders such as stockholders and debtholders, but also non-investing stakeholders such as customers, community, and social organizations. With such a broad scope of stakeholders involved, is a firm’s socially responsible behavior consistent with value-maximizing interests of investors? Put another way, does CSR enhance firm value? Whether and how does influential institutional ownership affect the relation between CSR and firm value?
Existing theoretical research remains inconclusive regarding the effect of CSR on firm value or financial performance. The conflict resolution theory contends that high CSR activities can lead to high firm value by mitigating conflicts of interest between managers and non-investing stakeholders, improving firm reputation and enhancing firm profitability. Contrasting with this is the overinvestment theory that argues such practices are costly, which in turn generates overinvestment concerns, especially when a firm faces financial constraints.
Furthermore, influential institutional ownership (IO) can affect the relation between CSR and firm value in two contrasting ways. On the one hand, influential investors, such as block holders and long-term dedicated institutions, help to mitigate CSR overinvestment concerns through effective monitoring. On the other hand, influential IO can exacerbate the conflict between shareholders and non-investing stakeholders, which overshadows the CSR conflict-resolution effect. Ex ante, the predictions in the literature are inconclusive as to the overall impact of influential IO on the CSR-firm value relation.
Identifying the impact of CSR on firm value presents a number of challenges. First, CSR can be endogenous to factors such as firm financial performance and liquidity, i.e., firms tend to do good when they do well. This issue can lead to biased estimation on the CSR-firm value relation. Second, the CSR-firm relation depends on which CSR effect dominates: the conflict resolution or the overinvestment effect.
To overcome these challenges, we examine the CSR effect surrounding the 2008 financial crisis. We treat the recent financial crisis as an exogenous shock to firms and use it to disentangle the iterative relation between CSR and firm value. Faced with limited financial resources over an uncertain period, firms tend to significantly reduce investment and are unlikely to relate their CSR engagement to prior firm performance. In addition, our empirical design allows us to identify the time-varying CSR-firm value effect. After all, the financial crisis exacerbates agency problems and amplifies the costs of CSR.
Furthermore, the financial crisis provides an interesting opportunity to focus on the monitoring effect of influential IO. Research shows that institutional investors affect firm management and firm values via two complementary channels: 1) to engage with management actively, known as “voice”; and 2) to influence manager decisions through an “exit threat” by selling their shares if managers underperform. During a financial crisis, when stock liquidity becomes low, the block holders’ exit threat becomes weaker and institutional engagement intensity increases. In other words, around a financial crisis, institutional investors monitor firms mainly through their involvement in corporate governance.
In this paper, we apply difference-in-difference (DID) methodology using non-CSR firms as a control group to help “difference out” possible confounding factors and isolate the effect of CSR practices on firm value. A propensity score matching approach is applied to construct a comparable control group. We investigate changes in firm value, measured by Tobin’s Q, for CSR firms surrounding the financial crisis, controlling for changes in firm value of matched non-CSR firms over the same period. Tobin’s Q is different from stock returns in that it not only incorporates forward-looking market valuation, but also reflects management performance. So a high Tobin’s Q suggests that managers can generate large market value from per unit of underlying assets.
We find that CSR firms have higher firm value than non-CSR firms before the financial crisis. However, when the crisis occurs, CSR firms experience more loss in firm value. Our evidence suggests that the importance of the CSR conflict-resolution effect and overinvestment effect varies with economic conditions: The relative importance of the overinvestment effect increases following the onset of the financial crisis.
We next explore how influential institutional ownership (IO) affects CSR effects. We apply triple difference analysis (DDD) to identify the effect of influential institutional ownership on the CSR-firm value relation. We find that before the crisis the relation between CSR and firm value is positive for low institutional-ownership firms, which indicates that the CSR conflict-resolution effect dominates. However, the results show that this effect is significantly lower for firms with high influential IO than for firms with low IO. The evidence suggests that the benefits of implementing CSR are higher for firms with low monitoring IO than for high-IO firms.
Moreover, the results show that during the crisis, high levels of institutional holdings have a positive impact on the CSR value effect when the crisis occurs. We find that relative to their comparable non-CSR peers within the same IO group, the decrease in firm value of high-IO CSR firms is less substantial than that of low-IO CSR firms. Our results support the view that institutional ownership can be an effective value-increasing mechanism, especially during the crisis when agency problems get worse.
To study how financial constraints influence the interaction among CSR, institutional ownership, and firm value, we focus on firms with debt maturing at the start of the financial crisis. Interestingly, we document an insignificant impact of influential institutional ownership on CSR-firm value relation when the crisis happens. Our results suggest that the negative impact of refinancing risks and the monitoring role of short-term debtholders subdue the positive impact of a high level of institutional ownership on CSR-firm value relation during the crisis.
Our results are robust to a variety of model specifications, various measures of influential institutional ownership, different propensity matching methods, and different industry definitions. In addition, our results remain qualitatively the same when applying a regression discontinuity design to a restricted sample firms ranked around the Russell 1000/2000 cut-off.
Contributing to the ongoing debate regarding the value implications of CSR, we find that CSR value effect varies with economic situations. Our test design not only allows us to study the effect of CSR on firm value at a particular time, but also helps us examine the evolution of such an effect over economic cycles. Instead of focusing on a cross-sectional CSR effect on the level of firm value, we investigate the CSR effect on the change in firm value surrounding the financial crisis. We show that the change in CSR firms’ value, net of the change in non-CSR firms’ value, is significantly negative following the onset of the crisis.
Our paper also adds evidence to the literature by examining the joint effect of influential institutional ownership and CSR on firm value. We show that the CSR value effect varies with the influential institutional ownership level. Our evidence highlights the value-enhancing role of institutional ownership.
Finally, our study provides implications to socially responsible investments (SRI). Our results suggest two important factors that SRI investors should consider: influential institutional ownership and market conditions.
This post comes to us from Bonnie G. Buchanan, the Fulbright-Hanken Distinguished Chair in Business and Economics at Hanken School of Economics in Helsinki, Finland, and a professor of finance at Seattle University; Cathy Xuying Cao, an associate professor at Seattle University; and Chongyang Chen, an assistant professor at Pacific Lutheran University. It is based on their recent paper, “Corporate Social Responsibility, Firm Value, and Influential Institutional Ownership,” available here.