CSR & the Capital Markets

Discussions about the relevance and influence of corporate social responsibility usually don't take into account the significance of corporate conduct on capital market decisions, perhaps because it is thought this is the arcane domain of financial analysts and academics.

However, if those of us who believe responsible conduct is an imperative and not just an afterthought to a business strategy, then we should get better at finding and defending the evidence that the capital markets will react to social and environmental behaviour if only to manage risk.

Fortunately, we've been given an advantage with two academic papers appearing over the past couple of months which look at the repercussions of CSR on cost of capital and investment strategies. (Thanks Tara, a colleague, for sending them my way!)

Having not read the full studies yet, I can't tell you whether the findings are  definitive. But the abstracts offered here suggest they may provide some materiel for engagement with the Freidmanites.

The first Does Corporate Social Responsibility Affect the Cost of Capital? jointly authored by four academics, three of whom are based at Canadian universities:

We examine the effect of corporate social responsibility (CSR) on the cost of equity capital for a large sample of U.S. firms. Using several approaches to estimate firms’ ex ante cost of equity, we find that firms with better CSR scores exhibit cheaper equity financing. In particular, our findings suggest that investment in improving responsible employee relations, environmental policies, and product strategies contributes substantially to reducing firms’ cost of equity. Our results also show that participation in two “sin” industries, namely, tobacco and nuclear power, increases firms’ cost of equity. These findings support arguments in the literature that firms with socially responsible practices have higher valuation and lower risk.

The second is a working paper called The Impact of Corporate Social Responsibility on Investment Recommendations by Ioannis Ioannou of London Business School and George Serafeim of Harvard Business School.

Using a large sample of publicly traded US firms over 16 years, we investigate the impact of corporate socially responsible (CSR) strategies on security analysts’ recommendations. Socially responsible firms receive more favorable recommendations in recent years relative to earlier ones, documenting a changing perception of the value of such strategies by the analysts. Moreover, we find that firms with higher visibility receive more favorable recommendations for their CSR strategies and that analysts with more experience, broader CSR awareness or those with more resources at their disposal, are more likely to perceive the value of CSR strategies more favorably. Our results document how CSR strategies can affect value creation in public equity markets through analyst recommendations.

A Model of Trust

Trust is one of those things companies want and stakeholders give sparingly. And trust is being granted even more sporadically today given ample evidence, for example, of a cavernous spin-reality gap in the social performance of some companies.

For companies wanting to assess how likely it is they will win trust, here is a simple graphic against which to chart their performance on the actions and values that are the simple building blocks of trust, credibility and belief.

Social Entrepreneurship

I had coffee yesterday morning with David Bornstein, author of How to Change the World and other books, who will soon be launching a news platform to get stories out about solutions to environmental, economic and social problems at dowser.org (still in beta although launching soon).

The emphasis here is on solutions . . . what is being done to fix things. David believes too much energy (and media attention) is spent on complaining about what's wrong and not enough on profiling successful social change programs. When live, 'dowser' will help right the balance by providing news stories about positive illustrations of social entrepreneurship and innovation. It will, as a note on the beta site says, "(T)ell stories about people who are creatively attacking social problems and show how achievable it is to make an impact."

Apparently indefatigable, sometime in the next couple of weeks David will also be releasing another book co-authored with Susan Davies called Social Entrepreneurship: What Everyone Needs to Know published by Oxford University Press. Part of the book focuses on a theme we talked about over espresso (me) and croissant (David), the need for "journalists who are both good storytellers and familiar with the challenge of social problem solving."

I haven't read David's books yet. But this call for more forward-looking storytelling is likely to be the toughest proposition on the social entrepreneurship agenda. The goal of dowser.org is a refreshed narrative archetype: I'll be cheering for David and dowser.org.

The Power of Apologies

Anyone who has followed my posts on apologies will know how important I feel they are as a way to manage reputation in a crisis. (Forgive the self-reference, but two of the most recent posts can be found here and here.)

A colleague in my firm's Seattle office, Drew Arnold, sent me an article from the Oregon Business Journal referencing a June 2009 discussion paper called 'The Power of Apology' from the University of Nottingham's Centre for Decision Research and Experimental Economics.

Here is the paper's abstract:

After an unsatisfactory purchase, many firms are quick to apologize to customers. It is, however, not clear why they should do that. As the apology is costless, it should be regarded as cheap talk and thus ignored by the customer. In this paper, we test in a controlled field experiment whether apologizing influences customers' subsequent behaviour. We find that apologizing yields much better outcomes for the firm than offering monetary compensation."

Based on a study of customers using eBay in Germany, the study found among other results:

1. "Customers who receive an apology instead of a monetary compensation are more than twice as likely to withdraw a (negative) evaluation."
2. "When money is offered, a higher purchase price makes it less likely that a customer withdraws his (negative) evaluation. An apology works independent of the level of the purchase price."

Why then can't we assume that the propensity to consider legal action when harm has been caused by an accidental event, even if negligence is involved, just might be mitigated by a genuine (and the key here is the word 'genuine') apology?

Philanthropy - No Stand-In for Better Behaviour

The Economist, not normally a booster of corporate social responsibility (CSR) or sustainability as it  tends to be known in Europe, this week has a piece on CSR that hits the mark. The author concludes that corporate philanthropy (contributions to charitable causes) is being cleaved but the attention being paid to behaviour -- ethics and governance in particular -- is holding steady, as it should.

There is one other important reason for thinking that companies will maintain their commitments to sustainability through the downturn and beyond: the  need to restore confidence in business. The financial crisis was triggered by a bout of corporate social irresponsibility on a massive scale that has tarnished the reputations of even the bluest of blue-chip companies. Now corporate leaders have a chance to show that they are not just motivated by short-termism after all."  

 As Intel (a client) says in the management analysis and strategy
portion of its 2008 corporate responsibility report (Note . . . I agree with ridding CSR of its restrictive 'S')

"By incorporating corporate responsibility directly into our strategy and objectives, we manage our business more effectively and understand our impact on the world more clearly."

Corporate or 'strategic' philanthropy is a programmatic means by which a company contributes to its community. Philanthropy evidences a corporate recognition that profits are derived from the community and that a return to the community in the form of wages paid for labor and consistent dividend payments to shareholders as well as steady share price growth is -- at least in terms of today's social expectations -- insufficient.

Communities expect companies to give back, and companies have obliged either through random acts of kindness or more structured investments in causes which match company values or business goals.

But let's be honest. Philanthropy is unlikely to define or affect company behaviour when it comes to choosing business strategy, rewarding employees, managing supply chain relationships, committing to respectful and sensitive business principles and overseeing board and C-suite conduct. 

A generous philanthropy program, and commitment to a cause, can comfortably sit side-by-side with dishonest accounting, excessive senior executive compensation, autocratic and harsh management, deferential governance, poor labour and sourcing practices, and denial of environmental impact. Philanthropy provides a reputational sheen, but it doesn't de facto require ethical conduct or a socially astute business strategy. Philanthropy buys goodwill but it doesn't drive responsible behaviour nor build social trust.

If The Economist is right, and I think it is, and the decline in spending on smoke-screen philanthropy is NOT being matched by a retreat from investment (time, focus, intensity) in better behaviour, then maybe out of the current crisis we will see a steady push-back within companies against insular corporate boards, inappropriate rock star-like CEO salaries, and short-sighted and opaque business strategies.