Corporate Social Responsibility and Firm Performance Investor

7/23/2019 Corporate Social Responsibility and Firm Performance Investor

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Forthcoming in Academy of Management Review

CORPORATE SOCIAL RESPONSIBILITY AND FIRM PERFORMANCE: INVESTOR

PREFERENCES AND CORPORATE STRATEGIES

ALISON MACKEY

Ohio State University

TYSON B. MACKEYOhio State University

JAY B. BARNEY

Ohio State University

Debates continue to rage between those that argue that managers should maximize the present

value of their firms cash flows in making strategic choices and those that argue that,

sometimes, the wealth maximizing interests of a firms equity holders should be abandoned for

the good of a firms other stakeholders. This debate is addressed by proposing a theoretical

model in which the supply of and demand for socially responsible investment opportunities

determines whether these activities will improve, reduce, or have no impact on a firms market

value. The theory shows that managers in publicly traded firms might fund socially

responsible activities that do not maximize the present value of its future cash flows yet still

maximize the market value of their firm.

Debates continue to rage about whether or not firmsshould engage in socially responsible behavior. On the onehand, traditional economic arguments suggest that managersshould make decisions that maximize the wealth of a firmsequity holders (Friedman, 1962). Managers do this by makingdecisions that maximize the present value of a firms futurecash flows (Copeland, Murrin, & Koller, 1994). To the extentthat socially responsible activities are inconsistent with theseeconomic objectives, traditional financial logic suggests thatthey should be avoided. Indeed, firms that engage in suchactivitiesespecially when they are very costlymay besubject to various forms of market discipline, includinglimited access to low cost capital, the replacement of seniormanagers, and takeovers (Jensen & Meckling, 1976).1

On the other hand, some business and society scholarshave argued that firms have a duty to society that goes wellbeyond simply maximizing the wealth of equity holders(Swanson, 1999; Whetten, Rands, & Godfrey, 2001). Thesescholars argue that such a narrow focus can lead managementto ignore other important stakeholdersincluding employees,suppliers, customers, and society at largeand that sometimesthe interests of these other stakeholders should supersede the

1 Interestingly, managers are not required by law to maximizeshareholders wealth. Rather, they are only required to carry out thelawful directives of shareholders (Fairfax, 2002; Simon, 1993).Thus, managers can engage in activities that reduce shareholderwealth as long as directors do not engage in fraud or self-dealingand make rational, informed decisions (Fairfax, 2002: 440). Thus,this paper focuses less on the legal implications of engaging insocially responsible actions, and more on the market consequences ofthese actions. See cases such as Shlensky v Wrigley, 1968; Aronsonv Lewis, 1984; Sinclair v Levien, 1971 for examples of courtsallowing managers to put other interests above profit maximizinginterests. (The authors thank co-guest editor, Timothy Fort, forproviding these examples.)

interests of a firms equity holders in managerial decisionmaking, even if this reduces the present value of a firms cashflows (Clarkson, 1995; Donaldson & Preston, 1995; Freeman1984; Mitchell, Agle, & Wood, 1997; Paine, 2002; Wood &Jones, 1995).

One way to resolve this conflict is to observe that at leastsome forms of socially responsible behavior may actuallyimprove the present value of a firms future cash flows andthus may be consistent with the wealth maximizing interests ofa firms equity holders. For example, socially responsiblebehavior can enable a firm to differentiate its products in itsproduct market (McWilliams & Siegel, 2001; Waddock &Graves, 1997), can enable a firm to avoid costly government-imposed fines (Belkaoui, 1976; Bragdon & Marlin, 1972Freedman & Stagliano, 1991; Shane & Spicer, 1983; Spicer1978), and can act to reduce a firms exposure to risk(Godfrey, 2004). All these socially responsible actions canincrease the present value of a firms future cash flows andthus are consistent with maximizing the wealth of a firmsequity holders.

However, from a broader theoretical perspective, theentire effort to discover how socially responsible activities canincrease the present value of a firms future cash flows is

problematic. After all, the essential point of many businessand society scholars is that, sometimes, the interests of afirms equity holders need to be set aside in favor of theinterests of a firms other stakeholders (Banfield, 1985Carroll, 1995; Windsor, 2001). That isaccording to socialresponsibility theoristsfirms should sometimes engage inactivities that benefit employees, suppliers, customers, andsociety at large, even if those activities reduce the presenvalue of the cash flows generated by a firm (Mitchell et al,1997; Paine, 2002; Wood & Jones, 1995). Focusing the studyof corporate social responsibility on those actions that increasethe present value of a firms cash flows fails to address this


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central theme in the corporate social responsibility literature(Windsor, 2001)

In this context, what is required are not just examples ofsocially responsible actions that can have a positive impact ona firms cash flowsso called profit maximizing ethics(Windsor, 2001)but a theory that suggests the conditionsunder which firms will engage in socially responsibleactivities even if those activities reduce the present value of afirms cash flowsso-called costly philanthropy (Windsor,2001). This paper proposes such a theory. This theory buildson the simple observation that, sometimes, equity holders mayhave interests besides simply maximizing their wealth whenthey make their investment decisions. Sometimes, they maywant the firms they invest in to pursue socially responsibleactivities, even if these activities reduce the present value ofthe cash flows generated by these firms.

ASSUMPTIONS AND DEFINITIONS

Before developing the model, it is helpful to define of itskey terms and specify its central assumptions. Margolis &Walsh (2003) have noted that much of the current confusion inthe corporate social responsibility literature is due to a lack of

clarity about definitions and assumptions.

What Is Socially Responsible Behavior?

A wide variety of definitions of corporate socialresponsibility have been proposed in the literature (Margolis& Walsh, 2003). While these definitions vary in detail, manyfocus on voluntary firm actions designed to improve social orenvironmental conditions (Aguilera, Rupp, Williams, &Ganapathi, 2004; Davis, 1973; Wood, 1991a; 1991b; Wood &Jones, 1995; Waddock, 2004). This is the definition ofcorporate social responsibility adopted in this paper.

Of course, within this broader definition, differentstakeholders may have different preferences for specific

socially responsible activities they would like to see a firminvest in (Grass, 1999). Moreover, these preferences mayvary as the currency of social issues evolves over time(Clarkson, 1995; Davis, 1973; Moskowitz, 1975; Wartick &Cochran, 1985; Wood, 1991a). However, as long as a firmsactions are consistent with this general definition of socialresponsibilitythat is, as long as they are voluntary anddesigned to improve social or environmental conditionstheyare considered socially responsible for purposes of the modeldeveloped here.

The specific decision making context modeled herefocuses on determining the total demand for investmentopportunities in firms engaging in specific socially responsible

activities, the current supply of those opportunities in themarket, and whether current supply is less than, equal to, orgreater than demand. In this sense, the opportunity to invest ina firm that is engaging in specific socially responsibleactivities can be thought of as a product that is sold by firmsto potential equity investors as customers.2

2Of course, equity holders as customers for opportunities to investin socially responsible firms may vary in the kinds of corporate socialresponsible activities in which they would prefer to invest. Themodel developed here adopts the simplifying assumption that theseequity investors all have a preference for investing in firms pursuing

What Is Firm Performance?

A wide variety of definitions of firm performance havealso been proposed in the literature (Barney, 2002). Bothaccounting and market definitions have been used to study therelationship between corporate social responsibility and firmperformance (Orlitzky, Schmidt, & Rynes, 2003). Howeversince most social responsibility scholars seek to understandthe ways that socially responsible corporate activities cancreate or destroy shareholder wealth, market definitions offirm performance seem likely to be more appropriate thanaccounting definitions of firm performance in this contex(Margolis and Walsh, 2001).

In fact, the model developed here adopts such a markedefinition of firm performance by focusing on how sociallyresponsible corporate activities affect a firms market valueMarket value is defined as the price of a firms equitymultiplied by the number of its shares outstanding. Thus, themodel developed in this paper addresses the followingquestion: Suppose managers seek to maximize the markevalue of their firm in their decision making (Friedman, 1962Copeland, Murrin, & Koller, 1994), will they ever choose toinvest in socially responsible activities that reduce the present

value of their firms cash flows?Of course, there is some controversy about the

assumption that managers seek to maximize the market valueof their firms in their decision making. Some have suggestedthat under conditions of uncertainty and imperfecinformation, managers cannot know, ex ante, how tomaximize the market value of their firm (Alchian, 1950)Others have suggested that managerial interests are ofteninconsistent with maximizing the value of a firm (Jensen &Meckling, 1976). On the other hand, some of these sameauthors argue that managers that fail to maximize the markevalue of their firm, ex post, may be subject to a variety ofmarket sanctions (Jensen & Meckling, 1976), and thus the

assumption that managers seek to maximize the value of theirfirm is a useful approximation.

For the purposes of this paper, whether or not managerscan or do seek to maximize the value of their firm in theirdecision making is less important. Rather, this paper conductsa simple thought experimentsince corporate sociaresponsibility scholars have been interested in understandingthe economic consequences for a firm implementing sociallyresponsible activities, a model is developed where managersare assumed to focus on maximizing the market value of theirfirm and the impact of socially responsible activities on thismarket value is examined. In this sense, the assumption thamanagers seek to maximize the market value of their firm intheir decision making provides a standard against which toevaluate the economic consequences of engaging in sociallyresponsible activities that reduce the present value of a firmscash flows.

However, while this paper does examine the market valueconsequences of firms pursuing socially responsible activities

a particular socially responsible activity--although what this specificactivity is is not important in the model. Without loss of generalitythis preference can also be interpreted as a preference for a particularbundle of socially responsible activities. This simplifyingassumption is relaxed in the model extensions section of the paper.


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that reduce the present value of their cash flows, it does notassume that maximizing the present value of a firms cashflows and maximizing a firms market value are equivalent.Such an assumption is only justifiable if all of a firms currentand potential equity holders are solely interested inmaximizing their wealth in making their investment decisions.If, on the other hand, at least some of these investors haveinterests besides simply maximizing their wealth in makinginvestment decisions, then maximizing the present value of afirms cash flows and maximizing firm value are no longerequivalent concepts.

Market Efficiency Assumptions

The model presented here also assumes that capitalmarkets are semi-strong efficient (Fama, 1970). This meansthat publicly available information about the perceived valueof a firms assets will, on average, be reflected in the marketprice of those assets. Semi-strong efficiency, in particular,implies that if firms engage in specific socially responsibleactivities in a public way, that current and potential equityholders will be aware of both the nature of these activities andtheir impact on the present value of a firms future cash flows,and will, on average, adjust their valuation of a firms equities

accordingly.There is substantial evidence that U.S. capital markets

are, overall, semi-strong efficient (Copeland et al., 1994).This does not mean that the value of a firms equity alwaysequals the true underlying value of a firmcertainly there is agreat deal of private information about the value of thoseassets (Fama, 1970) and investor decisions are oftensystematically non-rational (Tversky & Kahneman, 1974) andaffected by emotions (Schiller, 1999; Shefrin, 2000; Thaler,1987a; 1987b). However, semi-strong efficiency does suggestthat whatever public information exists about the value of afirms assets is, on average, likely to be reflected in the priceof those assets (Fama, 1998)3. In this context, semi-strong

efficiency suggests that when a firm publicly pursues sociallyresponsible activities that reduce the present value of its cashflows, current and potential investors will factor these actionsand their consequences into decisions about whether or not tobuy or sell this firms stock.

Socially Responsible Activities and Firm Cash Flows

Finally, while acknowledging that some sociallyresponsible activities can sometimes have a positive impact onthe present value of a firms cash flows (McWilliams &Siegel, 2001; Waddock & Graves, 1997; Godfrey, 2004), themodel developed here examines the consequences of onlythose socially responsible activities that reduce the presentvalue of a firms cash flows.4 In this way, the model focuseson a central theoretical issue raised by those that study

3There continues to be significant debate about the impact of non-rational elements in equity holder decision making on the efficientcapital markets hypothesis (Fama, 1998). The approach adopted hereis to adopt the simple semi-strong efficient capital marketsassumption while acknowledging the importance of extending themodel to include these emotional and cognitive phenomena in thefuture.4The model is also generalized, later in the paper, to include sociallyresponsible activities that have no material impact, positive ornegative, on the present value of a firms cash flows.

corporate social responsibilitythat sometimes managersshould abandon efforts to maximize the present value of theirfirms future cash flows in favor of socially responsibleactivities that reduce the value of those cash flows.

Obviously, identifying socially responsible activities thaincrease the present value of a firms cash flows is interestingin its own right (McWilliams & Siegel, 2001; Waddock &Graves, 1997; Godfrey, 2004). However, no new theory isrequired to explain why firms will pursue such activities, onceidentified. Such actions are consistent with received economicand financial theories of firm behavior. On the other handnew theory is required to explain why firms might pursuesocially responsible actions that reduce the present value oftheir cash flows. Focusing the model only on these situationshelps develop this critical aspect of the theory of corporatesocial responsibility.

THE MODEL

In this section, a simple model of the supply of anddemand for opportunities to invest in socially responsiblefirms is presented. This model is used to describe the impacthat beginning or ending socially responsible activities tha

reduce the present value of a firms cash flows will have on afirms market value.

As is always the case, this model adopts a variety ofsimplifying assumptions. Many of these assumptions aretechnical in nature and do not have an impact on theconclusions drawn from the model. Some are moresubstantive in nature and might have an impact on theseconclusions. However, later in the paper, several of thesesubstantive assumptions are relaxed, and the conclusions ofthe model are re-examined. While relaxing these assumptiondoes generate important insights, it does not affect the modelscentral conclusion: That the impact of socially responsibleactivities that reduce the present value of a firms cash flows

on a firms market value depends on the supply of and demandfor opportunities to invest in these types of firms.

Firm Characteristics

Consider an economy with N firms which all sell thesame product in the same competitive product market. In thisetting, these firms will all generate the same earnings, Efrom their activities in this product market. By definition, afirms earnings equal the present value of its future cash flowsbefore any investments in socially responsible activities. Thegoal of all the firms in this model is to maximize their valueP, through revenues generated from the sale of shares of stockin their firm. Letsequal the number of those shares. Also, for

simplicity, the model assumes that each of these firms has thesame number of shares of stock to sell, they are the same sizeand they do not fund any of their activities through debt.

Indeed, in the model developed here, firms differ onlywith respect to their decision to invest or to not invest insocially responsible activities. Let equal the proportion offirms that choose to fund socially responsible activities. Thesefirms are called socially responsible firms in the rest of thepaper. It follows that (1 ) is the proportion of firms notfunding socially responsible activities. These firms are calledtraditional profit maximizing firms in the rest of the paper


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In this model, socially responsible firms are the only source ofsocially responsible initiatives in the economy.5

Social Initiative Characteristics

The firms in this simple model face a decision, F, ofwhether or not to fund a discrete bundle of sociallyresponsible initiatives. The decision to fund, F=1, is assumedto be costly and non-revenue enhancing, which implies thatthis decision reduces the present value of a firms cash flow.The firms that choose to use their earnings to fund sociallyresponsible initiatives incur a cost, C, for doing so whichreduces their net earnings by this amount. Thus, firms thatfund social initiatives have greater cash outlays than firms thatdo not fund social initiatives. The choice not to fund sociallyresponsible initiatives, F=0, is assumed to not impact thepresent value of the future cash flows of the firm.

Investor Characteristics

The number of potential equity investors in the economyisI. For simplicity, assume that each of these investors havebeen endowed with the same amount of money to invest inequities, equal to m, and that these funds are exhaustedthrough these investments. By assumption, some of these

investors are interested only in maximizing their wealth inmaking their investment decisions. These investors are calledwealth maximizing investors. Conversely, other investorsmay have interests besides simple wealth maximization inmaking their investment decisions. In particular, someinvestors may only invest in firms that fund sociallyresponsible activities. These investors are called sociallyconscious investors. Let equal the proportion of investorsin this market who are socially conscious; (1 ) is theproportion of these investors that are wealth maximizing.

Socially conscious investors derive benefit from theearnings of the firms they invest in, but they also derivebenefit from the socially responsible activities of these firms

as well. The total benefits (or utility) that a socially consciousinvestor obtains from investing in a firm pursuing sociallyresponsible activities (i.e.,F = 1) is:

I

CENUSC

)( =

(1)

The numerator of this equation is the total earnings of all thesocially responsible firms in the economy (i.e., Nis the totalnumber of socially responsible firms and E-C is their netearnings). The denominator of this equation is the number ofsocially conscious investors in the economy. The ratio of thenumerator (total earnings of all socially responsible firms) andthe denominator (number of socially responsible investors) iseach investors share of any earnings created by socially

responsible firms.6

5Of course, other institutions and individuals in the economy, besidesfirms, can fund socially responsible initiatives. However, thesealternative investment opportunities are ignored in this version of themodel.6This, and the other, utility functions in this paper are assumed to belinear. This eliminates considerations of the risk associated withinvestment decisions. That is, since these firms are identical, exceptwith respect to their social initiatives, the risk associated withinvesting in them is the same and thus can be ignored for purposes ofthis discussion.

On the other hand, the total utility that a sociallyconscious investor obtains from investing in a firm nopursuing socially responsible activities (F = 0) is zero. This ihow the difference between socially conscious and otherinvestors in this model is operationalized: Socially consciouinvestors obtain no utility from investing in firms that do notimplement socially responsible activities while other investorsdo.

The benefits derived from investing for wealthmaximizing investors is presented in equation two. Thesebenefits are the share of the total earnings created by firms notfunding socially responsible activities, (1 )NE, for each othe wealth maximizing investors, (1 - )I. In principle, theseinvestors are not restricted from purchasing equity in firmsthat are engaging in socially responsible activities. Howeversince, in this model, all these activities reduce the presenvalue of a firms cash flows (i.e., C > 0), wealth maximizinginvestors will prefer to not invest in such firms.7

I

ENUWM

)1(

)1(

= (2)

Determining the Stock Price

Determining the price of the stock for socially responsibleand traditional profit maximizing firms depends onestablishing the supply and demand for these different types ofstock in the economy. In the simple model developed herethe total supply of shares of stock in socially responsible firmsis simply:

SSR= s N (3)where SSR is the available supply of stock in firms that arefunding socially responsible activities. If there are N=100total firms in an economy each selling s= 10,000 shares ofstock and 25 percent, =.25, of these firms engage in sociallyresponsible behavior, then the total supply of stock in sociallyresponsible firms is 250,000 shares.

The total supply of stock for firms not engaging in

socially responsible behavior is:SPM= (1 ) s N (4)

where SPM is the available supply of stock in firms that arefunding only traditional profit maximizing behavior. If thereare N=100 total firms in an economy each selling s=10,000shares of stock and 75 percent, (1-) = .75, are funding onlytraditional profit maximizing behavior, then the total supply ofstock in profit maximizing firms is 750,000 shares.

Demand can be thought of as the total amount of moneycontrolled by different kinds of investors in this economyThus, in this simple model, demand for shares of stock insocially responsible firms is equal to:

7 This utility function has the non-binding constraint

I

CENUWM

)(

, that the wealth-maximizing investor will choose

to invest in socially responsible firms if these investments provide agreater return than investments in traditional profit maximizing firmsThe constraint is non-binding because if such a situation arose inwhich wealth maximizing investors had a financial incentive to invesin socially responsible firms, enough wealth maximizing investorswould pursue these opportunities, driving up the price of shares insocially responsible firms until returns from investing in sociallyresponsible firms equaled returns to investing in traditional profitmaximizing firms for the wealth maximizing investor.


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ImDSR = (5)

whereDSRis the total amount of money controlled by sociallyconscious investors in this market. If there are I=200 totalinvestors in an economy each endowed with m= $50,000and25 percent, = .25, are socially conscious investors, then thetotal amount of money controlled by socially consciousinvestors is $2,500,000.

The total demand for shares of stock in profit maximizingfirms is equal to:

ImDPM )1( = (6)whereDPMis the total amount of money controlled by wealthmaximizing investors in this market. If there are I=200 totalinvestors in an economy each endowed with m= $50,000and75 percent, (1-) = .75, are wealth maximizing investors asopposed to socially conscious, then the total amount of moneycontrolled by wealth maximizing investors is $7,500,000.

The price for a share of stock in these two types of firmsis found by dividing the amount of money controlled bysocially conscious and wealth maximizing investors by thesupply of stock of a particular typefor socially responsibleand traditional profit maximizing firms, respectively. This isdone in equations seven and eight.

Ns

ImPSR

=

(7)

( )( ) Ns

ImPPM

=

1

1 (8)

Using the numbers in the examples taken from above, theprice per share for socially responsible stock would be $10($2.5 million divided by 250,000 shares) and for profitmaximizing stock would be $10 as well($7.5 million dividedby 750,000 shares).

It is not surprising that the prices of these two types ofshares in this example are equal. In equilibrium, they shouldbe. Suppose that these share prices were not equal. Firms in

this setting would have an incentive to change their socialresponsibility policies until the maximum share price possibleis reached. If the stock price were higher for firms fundingsocial initiatives than for traditional profit maximizing firms,some of the firms not currently funding social initiativeswould have incentives to divert funds to social initiatives inorder to attract some of the excess demand in the equitymarket for shares in socially responsible firms. Firms wouldswitch types until the share prices were equal and there wereno further gains from beginning to fund social initiatives.

On the other hand, if the stock price were higher fortraditional profit maximizing firms, some of the firmscurrently funding social initiatives would have incentives toabandon these activities in order to attract some of the excessdemand in the equity market for shares in traditional profitmaximizing firms. Firms would switch until the share priceswere equal and there were no further gains from abandoningsocial activities. Thus, in equilibrium, the prices of thesedifferent types of shares will be equal.

Knowing that the share prices are equivalent inequilibrium allows us to solve for a crucial result of themodel8:

8Note that m, I, s, andNare on both sides of equation 9. Thismeans that equation 9 can be simplified to /=(1-)/(1- ).

( )

( ) PMSRP

Ns

Im

Ns

ImP =

==

1

1 (9)

=

Thus, in equilibrium, the proportion of socially consciousinvestors, , will equal the proportion of socially responsiblefirms, , and the proportion wealth maximizing investors, 1-, will equal the proportion of traditional profit maximizingfirms, 1 - .

This equilibrium result is important not because it existsin real economies. Indeed, in reality, such equilibrium staterarely exist. Rather, this result is important because it helpdefine the kind of incentives firms face when the economy inwhich they are operating is out of equilibrium. For when theeconomy is out of equilibrium, there will be unmet demand forcertain types of firmseither socially responsible ortraditional profit maximizingand firms looking to maximizetheir stock price will have incentives to change their type tomeet this excess demand. In particular, there will be settingswhen firms looking to maximize their stock price will haveincentives to pursue socially responsible initiatives, even whenthose initiatives reduce the present value of a firms cash

flows.Note that while, in equilibrium, the stock price of sociallyresponsible and traditional profit maximizing firms is thesame, the earnings per share of these firms are not the sameSince funding social initiatives is assumed to be costly andnon-revenue enhancing, the socially responsible firms in theeconomy that have spent C on social initiatives will havelower net earnings than those firms who have not funded suchinitiatives. Hence, earnings per share of the sociallyresponsible firm is lower than the earnings per share of thetraditional profit maximizing firm.

SOCIALLY RESPONSIBLE INVESTMENTS

AND FIRM VALUE

With the equilibrium result in equation nine in place, it ispossible to examine how the social responsibility activities offirms can affect their value. In general, firms can take threedifferent actions with respect to their socially responsibleactivities: (1) firms that currently do not engage in theseactivities can begin doing so, (2) firms that currently doengage in these activities can stop, and (3) firms can maintaintheir current policies, i.e., those that currently engage insocially responsible activities can continue to do so and thosethat currently do not engage in such activities can alsocontinue to do so. Each of these different activities can havean effect on the market value of a firm, depending on thecontext within which these activities take place.

Equation nine suggests that the most importandeterminant of the impact of these activities on a firmsmarket value is the relative supply of and demand foropportunities to invest in socially responsible firms in aneconomy. Again, three possibilities exist: (1) demand forsocially responsible investment opportunities may be greaterthan their supply, (2) supply for these investment opportunities

Simple algebraic manipulation makes it possible to derive theconclusion that, in equilibrium, = .


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may be greater than demand, and (3) demand for theseopportunities may equal supply.

The impact of a single firm beginning or abandoningsocial responsibility policies on the market value of that firmunder different supply and demand conditions is summarizedin Table One9. These predictions depend on the volume oftrade for the stocks of different types of firms in differentsupply and demand conditions (Karpoff, 1987; Wang, 1994).The impact of a single firm beginning, abandoning, or notchanging its socially responsible activities on the marketvalue of other firms in the economythose that maintain theirsocially responsible activities or maintain their traditionalprofit maximizing activitiesis described in Table Two.

When Demand for Social Responsibility Is Greater Than

Supply

The first column in Table One summarizes the impact ofdifferent firm strategies on a firms market value whendemand for socially responsible investment opportunities isgreater than supply. Suppose, for example, that the proportionof socially conscious investors in the economy, , is .4 ratherthan .25, while the proportion of socially responsible firms, ,is .25. In this setting, the demand for socially responsible

investment opportunities is greater than the supply of suchopportunities. The market value of firms that are currentlyengaging in socially responsible activities in this situation is$16 per share; the market value of traditional profitmaximizing firms is $8 per share.10

First, consider the market value of a traditional profitmaximizing firm that begins to fund socially responsibleactivities in this setting. If one firm does this, the total supplyof socially responsible investment opportunities, , increasesfrom .25 to .26. The new price per share of sociallyresponsible firms in this economy is $15.38. This means thatby beginning to fund socially responsible activities, this onefirm can shift its share price from $8 per share to $15.38 per

share. Thus, in this setting, beginning to engage in sociallyresponsible activities creates market value for a firm, even ifthose activities reduce the present value of a firms cash flows.This will be true as long as demand for these opportunities isgreater than their supply.

Next, consider the market value of a socially responsiblefirm that decides to become a traditional profit maximizingfirm in this setting. Here, the total supply of sociallyresponsible investment opportunities in the economy, , dropsfrom .25 to .24. This firms price per share will drop from $16per share to $7.89 per share. So, not surprisingly, whendemand for socially responsible investment opportunities isgreater than supply, abandoning such activities will reduce themarket value of a firm.

9Table One assumes that the firms changing their policies donot bring the economy into equilibrium. That is, this tableassumes that the conditions that demand > supply or supply >demand exist before and after a firm changes its policy byeither beginning or abandoning socially responsible activities.10The price per share of the socially responsible firm, usingequation 7, is (.4(50,000)(200))/.25(10,000)(100). Equation 8can be used to calculate the price per share of the traditionalprofit maximizing firm in the same way.

When Supply for Social Responsibility Is Greater Than

Demand

Suppose, now, that the proportion of socially consciousinvestors in the economy, , is .15 rather than .25, while theproportion of socially responsible firms, , is .25. In thissetting, the supply of socially responsible investmenopportunities is greater than the demand for suchopportunities. The market value of firms that are currentlyengaging in socially responsible activities in this situation is$6 per share; the market value of traditional profit maximizingfirms is $11.33 per share.

Consider the market value of a socially responsible firmthat drops its socially responsible activities in this setting. Ione firm does this, the total supply of socially responsibleinvestment opportunities, , decreases from .25 to .24. Thenew price per share of traditional profit maximizing firms inthis economy is $11.18. This means that by ending its sociallyresponsible activities, this one firm can shift its share pricefrom $6 per share to $11.18 per share. Thus, in this settingabandoning socially responsible activities can create markevalue for a firm. This will be true as long as the supply osocially responsible investment opportunities is greater than

their demand.Not surprisingly, a traditional profit maximizing firm that

begins to engage in socially responsible activities when thesupply of investment opportunities in these types of firms isgreater than demand will see its market value fall. If onetraditional profit maximizing firm begins to engage in sociallyresponsible activities, its price per share will fall from $11.33to $5.77. Traditional profit maximizing firms will experiencea drop in their market value from implementing sociallyresponsible activities as long as the supply of sociallyresponsible investment opportunities is greater than thedemand for such opportunities.

When Supply for Social Responsibility Is Equal toDemand

Finally, when the demand for socially responsibleinvestment opportunities equals the supply of theseopportunities, firms that change their policiesby eitherbecoming socially responsible or abandoning their sociallyresponsible activitieswill see their market value fall. This isbecause either of these actions will have the effect of creatingexcess supplyof socially responsible investment options inthe first case and of traditional profit maximizing investmenoptions in the second case.

So, if the proportion of socially conscious investors in theeconomy, , is .25, and the proportion of socially responsiblefirms in the economy, , is also .25, then the price per share ofsocially responsible and traditional profit maximizing firms inthis economy will be $10. If one firm in this economy decidesto change its strategy (say, from a traditional profimaximizing firm to a socially responsible firm), it will see itsshare price fall to $9.62. No profit maximizing firm wilengage in such activities. Thus, if there are no changes in thelevel of demand for socially responsible or traditional profitmaximizing investment opportunities in an economy, anychanges in a firms corporate social responsibility strategymust destroy some of a firms market value.


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______*The signs of these predictions are derived from Equation 9. Consider, for example, the first column of the table, wdemand > supply. Suppose a firm begins socially responsible activities (row 1). The number of socially responsible firmthe economy changes from Nto N + 1. The price of this firms equity will increase from PPMto PSRif and only if demis still greater than supply after this firm switches (Nis greater than or equal to N + 1). The relationship between PPMPSRis derived in the following way:

1

1

1

1

1

1)1(1

1

)1(1

1)1(

)1()1(

)1(

assumptionPP

NN

N

N

N

NN

N

N

PsN

Im

sN

ImP

PMSR

SRPM

>

+>+

+

+=

+

++

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Corporate Social Responsibility and Firm Performance Investor