Why do corporations, in particular public corporations, adopt corporate social responsibility (CSR) policies? The CSR adage of “doing well by doing good” suggests that a firm can achieve higher financial returns by balancing the goals of different stakeholders. There are various ways to do that, including by increasing customer awareness, extending the planning horizon, creating a more resilient supply chain, or better addressing employee concerns.
This balancing act, however, depends on how other industry participants respond. For example, a firm may invest in making its supply chain more resilient, but that investment may prove of limited value if its suppliers don’t do the same. Or a car manufacturer may commit to switching to all-electric vehicle production, but the effort may fail, at least in the short run, if its competitors don’t make a similar commitment.
In a new paper, we propose a strategic theory of CSR. Consider the first application of our theoretical framework, the choice between adopting a clean-energy technology or remaining with a dirty, legacy technology. As in the other applications we develop, there is a positive) externality across firms: Adoption by one firm in isolation leads to high marginal production costs, whereas adoption by multiple firms leads to all-around lower costs. Examples include (a) non-excludable learning-by-doing cost savings in solar panel or battery manufacturing as well as the production of vehicles that operate on electricity, and (b) network benefits from a collective switch to electric vehicles due to a dense network of charging stations.
The presence of the externality means that the Nash (competitive) equilibrium may result in firms in the industry remaining with the legacy technology, because when making the decision individually each firm does not take into account the effect it has on the decisions of the other firms.
In our model, we add a mission-statement choice game before the game where firms choose which technology to adopt. In the mission statement stage, firms choose whether to adopt CSR policies. In this sense, strategizing over CSR policies is no different than engaging in price and quantity competition in the output market. There is, however, an important difference: CSR is more than a strategic decision variable. To the extent that a firm commits to a certain “mission,” CSR effectively changes the firm’s objective function. Specifically, in the clean-energy technology example, the CSR firm’s mission values having a clean-energy technology. The alternative is the “Friedman” firm whose mission is to be a profit maximizer.
We provide conditions such that the following is a Nash equilibrium: In the first stage, firms choose the CSR mission that places a heavy weight on the adoption of a clean technology; and in the second stage, firms adopt the clean technology. Moreover, we show that equilibrium profits are higher than in the one-stage game played by straight profit maximizers.
We also show that the one-shot game played by profit maximizers has the elements of a prisoner’s dilemma: Sticking to the legacy technology is a dominant strategy but leads to lower profits. Our interpretation of the “doing well by doing good” adage is that CSR helps solve a strategic dilemma, in this case a prisoner’s dilemma. In other words, by committing to departing from straight profit maximization, firms are able to effectively increase profits.
Our theory suggests an additional perspective on CSR policies. We provide conditions such that the first stage (the stage corresponding to the mission statement) is a pure coordination game: Firms are better off by committing to CSR, but no firm has the incentive to unilaterally choose CSR. This observation provides a natural interpretation of strategic leadership in the CSR context. Specifically, if a firm has the ability to move ahead of its rival in the first stage (the mission-statement stage), then that firm might commit to CSR in the hope of inducing the rival to follow suit and thus break the multiplicity problem of coordination-game equilibria.
We consider two additional applications of our two-stage CSR meta-game, where we change the nature of the second-stage subgame. In our second application, firms set wage rates. As in the first application, we prove the existence of multiple equilibria in the first stage, including one where firms commit to a mission statement that places positive weight on the wage rate and then set higher wages in the second stage. Also, as in the first application, we show that firms end up earning higher profits than they would have earned when playing the one-shot wage-setting game, where a low wage rate is a dominant strategy.
In our third application, firms make resiliency investments, which we model as an increase in the probability of remaining operational following an industry disruption. Unlike the first two applications, where firms belong to the same industry (horizontal firm interaction), our third application considers firms located at different stages of the value chain (vertical firm interaction). Unlike the first two applications, we show that opting for a CSR-like mission is a dominant strategy. Intuitively, the complementarities in resilience investments are so significant that, independently of what the other firm does, a firm optimally opts for a mission statement that places weight on resiliency beyond what a profit maximizer would do.
Our analysis is fundamentally dependent on the assumption that firms have the ability to commit to an objective function. One way to commit is via the firm’s mission statement. Many skeptics view such statements as cheap talk with no effective impact. However, considering the prominence and visibility of these statements, we believe that the skeptics are wrong. In a similar vein, Hart and Zingales (2017) suggest that founders can guide current and future managers and boards through the company’s mission statement, though they question the fiduciary strength of mission statements in light of the business judgment rule.
On the issue of fiduciary strength, we argue that mission statements should be approved by shareholders to help guide management in the pursuit of the desired goals. Other ways to generate commitment include the hiring of board members and CEOs with reputations for promoting CSR, as well as being friendly to outside investors with a preference for CSR. An interesting recent example of matching the firm culture with investor preferences is the filing of a “sustainable” initial public offering by Allbirds, a shoemaker that advertised to future investors the company’s commitment to maintaining a minimum ESG rating. As another example, in June 2021, an Exxon activist investor “successfully waged a battle to install three directors on the board of Exxon with the goal of pushing the energy giant to reduce its carbon footprint.” One may dispute whether this investor is genuinely concerned with ESG beyond financial value or is simply pushing for a strategic move as described in our framework – either way, this and other events suggest that we are in the presence of more than cheap talk.
Recent developments such as the Business Roundtable’s 2019 statement on the purpose of a corporation, the proliferation of support for “green” approaches to doing business, and the rise of ESG-monitoring organizations, as well as significant increases in socially responsible investing, all contribute to an environment where commitment is more easily enforced, notwithstanding companies engaged in “greenwashing.”
This post comes to us from professors Rui A. Albuquerque at Boston College’s Carroll School of Management and Luis M. B. Cabral at New York University’s Leonard N. Stern School of Business. It is based on their recent article, “Strategic Leadership in Corporate Social Responsibility,” available here.