Is Corporate Social Responsibility a Vanity Project?

It’s been more than 40 years since Milton Friedman famously declared that “the only social responsibility of corporations is to make money,” and business experts still debate the link between doing good and doing well.


At the Institute, most of us think the empirical evidence is strong that corporate social responsibility (CSR) correlates closely with maximizing shareholder returns.

And as Laura Tyson pointed out last year, there is a strong logic behind this. If corporations ignore the social and environmental context in which they operate, they run all kinds of bottom-line risks: reputational damage and loss of brand value; falling sales; lower worker productivity; regulatory backlash; higher costs tied to climate change.

But last week, the Center for Responsible Business awarded the 2014 Moskowitz Prize to a paper that examines a largely neglected underlying issue: are CSR programs likely to be vanity projects that serve the self-interest of individual executives at the expense of shareholders? Are executives squandering shareholder resources to promote their own glory or other private agendas?

In the language of management theory, some critics have argued that CSR is a sign of “agency problems” – that managers are putting their individual interests above those of shareholders. If that’s true, CSR is at best a waste of resources and at worst an indicator of more pervasive self-dealing.

Happily, the new paper concludes that critics are wrong.  Entitled “Socially Responsible Firms,” the paper comes from Allen Ferrell of Harvard Law School and Hao Liang and Luc Renneboog of Tilburg University in the Netherlands.

The researchers analyzed data from thousands of companies across 59 countries, and mapped levels of CSR activity against other indicators of good or bad corporate governance.

In a nutshell, the researchers find that the level of CSR activity correlate very closely with a host of other indicators of good governance aimed at maximizing shareholder returns.
These indicators include high capital expenditure rates, high cash holdings and high free cash flows, low dividend payout ratios, and low leverage.

Companies with very high levels of free cash flow, for example, have long been associated with diversions of corporate capital to private interests. The theory is that companies with an abundance of free cash flow come under less scrutiny from investors and create opportunities for managers to divert money for their own purposes. By contrast, managers are on a much tighter lease at companies that pay out a high share of profits as dividends to shareholders.

Management theory also holds that weak pay-for-performance incentives can lead to a misalignment between the interests of management and shareholders. Executives with smaller stake in the company’s growth are more likely to divert money to projects that benefit them personally than projects that benefit the company as a whole.

The researchers found that higher CSR performance was closely tied to companies with tighter cash and higher pay-for-performance – in other words, companies that seem more geared to maximizing shareholder returns. On top of that, firms operating in countries with strong shareholder-protection laws also tended to have high CSR ratings.

“Our empirical results…suggest that good governance causes high CSR, and that a firm’s CSR practice is consistent with shareholder wealth maximization,’’ the authors concluded. Far from being the result of self-dealing, entrenched management, corporate social responsibility “can actually preserve a core value of capitalism – generating more returns for investors.”

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