CLS Blue Sky Blog

Corporate Social Responsibility by Joint Agreement

Voluntary industry-wide agreements have recently emerged as a way to promote corporate social responsibility (CSR). Competitors in industries as diverse as chocolate production, fashion design, and truck manufacturing aspire together to pay fair wages or transition to less polluting products. A growing management literature endorses the idea. Henderson (2020), for instance, calls for “industry-wide cooperation” to stop environmental degradation and economic inequality.

Joint decision-making allegedly would help reduce first-mover disadvantages that can dissuade companies from acting responsibly if it puts them at a competitive disadvantage. Firms coordinating their business decisions, however, raises antitrust concerns. To believers in the effectiveness of joint CSR agreements, this is no obstacle. They argue for exemptions from the cartel laws. At the same time, growing consumer awareness allows firms to build a comparative advantage in CSR. Permitting coordination of CSR efforts therefore risks eliminating competition on this dimension, which could result in a reduction of CSR efforts.

In a recent paper, we analyze which types of joint agreements are most effective at increasing CSR efforts, taking into account consumers’ growing awareness of CSR. In our paper, we study different types of joint CSR agreements in a general model of oligopolistic competition, with goods that are differentiated by the CSR efforts of their manufacturers.

Firms play a sequential two-stage game. In Stage 1, they invest in CSR efforts, after which their CSR standard becomes public knowledge. In Stage 2, firms select their output. We assume that fixed costs increase because of CSR efforts and by extension allow for marginal costs of production to also depend on CSR – positively or negatively. Consumers are assumed to be willing to pay at least something for CSR. This means that firms can steal business from their rivals by investing in a better CSR profile. In our baseline model, firms aim to maximize profit by attracting consumers willing to pay more for products produced by companies that invest in CSR. We also investigate how CSR incentives are affected by agreements if firms are intrinsically motivated to invest in CSR.

We compare three types of voluntary joint agreements with the benchmark case of firms that do not cooperate on CSR or output. In a CSR agreement, firms jointly determine their CSR efforts and remain in subsequent competition on the output market. In a production agreement, firms non-cooperatively select CSR investments and then jointly select output (or analogous prices). This raises immediate antitrust concerns. In a full agreement, both strategic variables are coordinated – which may be the result in practice of the previous two agreement types, once competitors are offered a platform to exchange commercially sensitive information and coordinate.

Proposals to allow anti-competitive agreements for the purpose of stimulating CSR have so far focused on CSR agreements. The Dutch competition authority, ACM, has an advanced set of guidelines for “sustainability agreements” that exclude price or production agreements. Different Member States have responded differently, and the European Commission is considering its position on the subject. To that end, it recently organized an international conference on Competition Policy and the Green Deal.

In stark contrast to green antitrust policy proposals, we find robust evidence that CSR agreements reduce CSR efforts compared with the non-cooperative benchmark – as do full agreements. The reason is that CSR coordination eliminates CSR as an aspect of competition, so that the firms jointly profit from reducing their CSR investment costs. A production agreement, by contrast, increases CSR efforts compared with  the non-cooperative benchmark. In that case, investing in CSR allows a firm to increase its market share, which is more attractive because the coordination of production increases the profit margin on each consumer. These findings are robust and not model-specific.

Moreover, we find that any agreement that is profitable for firms, so that they would voluntarily propose it, decreases consumer welfare. All agreements decrease total within-market welfare. This means that there is no way for firms to compensate consumers so that they are indifferent between an agreement and the non-cooperative benchmark. This is an important finding, since full compensation of consumers is one of the criteria that need to be fulfilled for an anti-competitive agreement to be exempted from European cartel legislation.

The conclusion, therefore, is that the only type of agreement that gives firms an incentive to embrace CSR, which is a production agreement,  cannot be exempted from existing cartel law, because it does not generate the means for full consumer compensation. The policy paradox is that society can only induce companies to invest more in CSR than they do in competition by allowing them to benefit from their additional CSR efforts at the expense of total within-market welfare.

Instead, to exempt production agreements from cartel law, other benefits to non-consumers and in different markets, such as reduced negative production externalities that are mitigated by CSR effort, would need to be taken into account. This is exactly what the Dutch ACM has done in its zeal to exempt sustainability agreements. Its guidelines commit to counting the benefits of an agreement to non-consumers against any harm to consumers. To that end, the agency has given its own interpretation to the European Treaty requirements for a cartel exemption. How the European Commission will respond to this relaxation remains to be seen.

It raises several concerns. Apart from forcing competition agencies to make normative calls on redistributions between different groups in society, it reduces their ability to demand substantial CSR efforts from the companies in return for being permitted to collude. We contend that CSR agreements and full agreements tend to increase negative externalities, as they decrease CSR efforts compared with the benchmark. Production agreements instead contribute to the reduction of production externalities by increasing CSR and by restricting output. So again, if collaboration to advance CSR is to be facilitated, it should be of the output or price type. Finally, we show that any regulated CSR level provides higher within-market welfare compared with that of an output-coordinating agreement that provides the same CSR level.

These results on CSR investments are robust with respect to: allowing firms to be intrinsically motivated to invest in CSR; varying consumers’ willingness to pay for CSR; allowing marginal costs to increase or decrease with CSR efforts; allowing firms to set prices instead of quantities; allowing for partial agreements that preserve some competition; and allowing alternative preference structures in which price and sustainability trade off directly. The key insight remains that high per-customer profit margins induce firms to invest in CSR in order to attract additional consumers. Any measure that either reduces profit margins or allows firms to eliminate competition on CSR therefore reduces CSR levels.

Our findings are in line with the broader empirical literature on the positive relationship between competition and CSR activities. The timing of our work coincides with a surge of interest, especially in Europe, in allowing anti-competitive agreements to promote CSR efforts. There is a growing realization that certain social objectives, such as slowing climate change, assuring fair trade, and promoting public health, require drastic measures that corporations should also take responsibility for. Our paper contributes to the debate by suggesting that relaxing cartel laws is not the appropriate way to increase CSR. We caution against the use of joint CSR agreements to increase CSR efforts in particular: They create incentives counter to desired results. Instead, with consumer awareness growing, competition is the stronger driver of CSR because it strengthens incentives to do well by doing good. We should be careful not to throttle it by allowing corporate collaboration.

This post comes to us from Professor Maarten Pieter Schinkel and Ph.D. candidate Leonard Treuren at the University of Amsterdam. It is based on their recent paper, “Corporate Social Responsibility by Joint Agreement,” available here.

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