Monday, May 22, 2006

Is Corporate Social responsibility good for shareholders?

Corporate Social Responsibility as a Conflict between Shareholders

Main point of paper: Barnea and Rubin ask the tough and important question of whether Corporate Social Responsibilty (CSR) is value increasing or whether it is an agency cost problem whereby managers and others accrue benefits at the expense of shareholders.

They find that firms with "higher insiders ownership and leverage are negatively related to the firm’s social rating." This is largely consistent (although by no means the final word) with a view that "insiders...may seek to over-invest in CSR for their private benefit to the extent that doing so improves their reputations as good global citizens."

Longer Summary:

Barnea and Rubin begin by stating Corporate Social Responsiblity (CSR) is a very hot topic but we do not know to the extent that it benefits shareholders. This paper investigates this by examining the CSR ratings on approximately 3000 firms.

They key finding is that CSR ratings are negatively related to the percentage of insider ownership. This is tested in several ways. For instance from their probit analysis (OLS on if the firm passes the CSR screen or not), they report:
"The most striking result in our analysis is that the coefficients of insider ownership and leverage are negative and significant at the 1% level across all specifications. On the other hand, the coefficients of institutional ownership are insignificant with inconsistent signs."
The paper also points out that while some CSR spending may be good, too much may be bad. In their words:
"A key argument in our analysis is that the relation between CSR expenditure and firm value is non-monotonic. When CSR expenditure is low, we expect that it should contribute positively to firm value, for example, by increasing the productivity of employees or by avoiding reputational or pollution-related costs and fines. But at some point...the marginal effect of an additional dollar of CSR expenditure must decrease shareholder wealth as there is no limit to the amount that a firm can transfer
to its stakeholders."
This is tested with a piecewise regression. The results are as expected. Again in Barnea and Rubin's words:
"The analysis suggests that at low levels of insider ownership (up to 25%), there is no relation between insider ownership and CSR, while at levels above 25%, the relation is negative and highly significant. This suggests that only levels of ownership above 25% align insiders with other shareholders as only then do insiders bear a significant amount of the costs involved with CSR. On the other hand, lower levels of ownership do not help to mitigate a potential CSR conflict."
The paper also tests whether capital structure influences CSR. The logic behind the use of leverage is that debt payments may help control agency cost problems through both less available cash at managers' discretion and additional monitors. Like above, they find that firms with more debt are rated lower on CSR.

Overall a very interesting and important paper! I^3

Comments: First of all let me say again that I really liked the paper and the analysis and I agree with their findings. Moreover the paper adds much to our understanding of this very important question.

However, I would like to at least suggest some alternative interpretations (and be sure to read my admission of a slight bias below).

* To the extent that higher insider ownership means concentrated holdings by investors, it could be that CSR spending lower due to the increase in risk that the spending necessary to improve CSR ratings would entail.

* Higher leveraged firms tend to be less profitable. This has at least two implications:
  • The levered firm may not have the necessary resources to make this expenditures (especially to the degree that management ownership and size are tied together AND there are fixed costs of issuances.)
  • The deductions allowed on the CSR expenses (think of it as a donation) are not as valuable. This tax shield is thereby reduced.
An imperfect solution to this might be to use Q-values to proxy for agency costs rather than leverage.

Overall a definite must read!!! Highly recommended!

Cite: Barnea, Amir and Rubin, Amir, "Corporate Social Responsibility as a Conflict Between Shareholders" (March 10, 2006). Available at SSRN:

Disclaimer: Because of my ties to both a private University as well as the work I do with BonaServes I am at least partially dependent on donations, and hence not a totally disinterested party.

No comments: