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Corporate social responsibility (CSR) has been on the business leadership agenda for more than 50 years, yet executives and corporate boards still demand to see the “business case” for CSR. Clearly, CSR’s familiarity as a concept has not translated into coherent ideas of where it fits into the cost-benefit calculations that motivate business strategy.
A forthcoming article in the Journal of Financial and Quantitative Analysis by Lei Gao, associate professor of finance at George Mason University School of Business, Jie (Jack) He (of University of Georgia) and Juan (Julie) Wu (of University of Nebraska – Lincoln) goes beyond the business case to form cause-and-effect connections involving companies’ CSR efforts. Gao and his co-authors found that companies under negative share-price pressure have used CSR to telegraph their strong fundamentals to investors, a tactic that paid off in the marketplace. The researchers homed in on real-life scenarios where companies randomly received tougher treatment in equities markets, so that price pressure could be cleanly separated from business fundamentals. They chose to look at the arbitrarily selected pilot group of companies affected by Regulation SHO, an SEC rule that abolished the “uptick rule” for short selling – thereby potentially making these companies more attractive targets. As an additional setting, they studied companies exposed to downward pricing pressure due to mutual fund fire sales.
The companies that suffered through these forms of arbitrary adversity exhibited higher-than-average levels of CSR activity, as reflected in the MSCI KLD Stats Database. KLD reports on individual companies’ strengths and weaknesses across seven areas, including employee relations, the natural environment, and human rights. To ensure accuracy, the KLD scores were double-checked against Thomson Reuters ASSET4, a leading CSR data provider for thousands of global companies.
Gao explains that when companies are randomly swept up in forces beyond their control (such as new regulations and asset fire sales) that throw their market value into doubt, executives try to send countersignals that reflect positively on company fundamentals. And if these countersignals can help the company connect with an entirely new category of well-informed investors, so much the better.
“If I want to show I’m a better company than peers, I can do a special dividend, or a share repurchase. This is a kind of signalling that is very direct and expensive, and only reaches existing shareholders,” Gao says. “CSR is basically kind of broadcasting to so many different kinds of stakeholders, including environmentally and socially aware investors.”
These messages seemed to reach their intended targets. The researchers found that in both the Regulation SHO and mutual fund fire sale settings, socially responsible institutional investors increased their holdings of price-pressured companies that stepped up their CSR signalling.
Enlarged positions from this investor class was a main contributor to an overall decline in cost of equity capital for CSR-signalling companies. In the case of the Regulation SHO pilot stocks, capital cost declined by around 50-60 basis points, compared to non-CSR-signallers and non-pilot stocks.
CSR initiatives, then, help firms with strong fundamentals distinguish themselves from others undergoing similar pricing pressures. But that doesn’t mean CSR can be used as a smokescreen for badly run businesses, or a cynical short-term evasion.
“Companies should keep in mind that it’s not a one-and-done,” Gao says. “You have to keep working to keep these investors happy once you’ve won them over…Signalling is not cheap talk or a rumor. This is something they have committed to. They have the resources to do so, and they believe it will benefit them in the long run.”
The companies in Gao’s sample were highly incentivized to undertake CSR signalling. But the tactic would presumably work for strong companies in general, regardless of pricing pressures. When it comes to CSR, therefore, “business case” thinking may be backward. Instead of pursuing a short-term upside, well-run companies may consider CSR engagement as a way toward claiming their proper status – and the rewards that go with it – in the eyes of investors. To put it another way: Rather than vegetables swallowed down dutifully, CSR could represent the icing on the cake of success.