Corporate Social Responsibility (CSR) has become an incredibly vivant and important topic in the way of doing business. However, there are still significant differences in CSR between countries and especially national institutions are contributing to these gaps through the amount of business regulations. This blog will touch upon the influence of free-market institutions on CSR, to find out whether the focus should be on regulating firms or stimulating voluntary initiatives.
In the last few decades, the attention for acting socially responsible has significantly increased. Firms are expected to invest in socially desirable activities, whether it is within the firm or in an external way. There are many ways in which a firm can be socially responsible, of which improving the environment, dealing with societal issues and enhancing labor relations are among the most important ways. Recently, the notion that firms are unwilling to conduct CSR due to high costs has been challenged in the literature as well. For example, Cheng, Ioannou and Serafeim (2014) showed that firms can reduce their costs of acquiring capital by investing in socially responsible activities. Next to this, firms are eager to show their efforts in becoming more socially responsible to the public, since this enhances their brand reputation. In fact, there are many examples of firms that are going to great lengths to contribute to charities, supporting community activities, treating their workers and customers decently, abiding by the law, and generally maintaining standards of honesty and integrity (Campbell, 2006).
However, it is not in the nature of CSR to be profit-maximizing and this can therefore still collide with the economical side of doing business. Firms are often focused on creating shareholder value and are thereby neglecting their stakeholders. So from the shareholder theory perspective, firms should not spend resources to become more socially responsible at all, if these investments are not profitable. If this truly were the case, it would be remarkable that many firms are increasing their investments in responsible actions after all. The reason why it makes sense though is because it is called investing in CSR, not spending on. The firms can see their investments being paid back, because both investors and the public value the firm higher if it becomes socially more acceptable. Customers are more willing to buy products from firms that they feel have values closer to the wellbeing of the society. Investors are more willing to invest their funds in companies that have a positive image in the field of dealing with environmental and social issues. Furthermore, people who can identify with the social values of a firm, will more likely apply for a position at that firm, instead of applying for a job at a firm that has a deteriorated image.
What remains problematic though is that firms might want to find an option that is based on their preferences only, thus being an option that requires little investment and still enhances their image. They might want to conduct CSR just on a superficial level. By doing this, some firms might use CSR as a window-dressing opportunity, thereby enhancing their brand reputation, even though their initiatives are not helping society or the environment as much as they should (Aguilera, Ganapathi, Rupp & Williams, 2007). The question that arises is how much firms should be regulated in terms of acting socially responsible. Putting more or less regulation on firms might alter the origin from which the initiatives are founded and also the way they are conducted. Having more regulations will lead to a system in which firms are adopting CSR in an implicit way, which means that these actions are less visible to the public.
Less regulations will cause a lower amount of adopted CSR, but if firms in a less-regulated national business system do increase their CSR initiatives though, these activities are often adapted in an explicit way, making them easily visible to the public. This increases the benefits for these firms, since it enhances their brand reputation (Matten & Moon, 2008). The question remains whether these voluntary initiatives create better results for society and the environment than the regulated initiatives.
The one aspect that is often underrepresented in these kinds of analyses is the aspect of regulatory quality. A government can set up all the regulations regarding acting socially responsible it wants, but it likely requires a solid system of regulations in order to make sure firms are following the regulations. Otherwise, firms can just ignore the regulations and continue to focus on making profits for the purpose of boosting shareholder value, without considering their social impact. Next to this, a better legal framework can also help stakeholders to pressurize firms into acting responsible, which stimulates the amount of effort in creating explicit forms of CSR, i.e. initiatives that are not motivated by mere compliance with regulations. It is therefore interesting to see whether regulatory quality can weaken or strengthen the effect of the business regulations on CSR.
To research the true effects of regulations and voluntary initiatives on actual CSR outcomes, a CSR model is established, as shown in Figure 1. This model captures the effects of regulations on voluntary initiatives, which is expected to be negative, since firms have less resources to spend on voluntary initiatives if they have to comply with regulations. Furthermore, business regulations and voluntary initiatives are both expected to have a positive direct effect on CSR outcomes, simply because it means more effort is put into addressing the issue of CSR. Regulatory quality is expected to enforce the effects of business regulations, because firms will need to comply with the regulations even more, if the quality of the regulations is higher. Since, they will then face serious legal pressures if they do not comply with the regulations.
Within this research, the scope will be merely on the environmental aspect of CSR. The dataset for the firm-level CSR scores is provided by Thomas Reuters. Thomas Reuters created a database with ESG Asset4 data in which they indicate how firms score on the field of acting socially responsible. This therefore represents the CSR outcomes as given in the model. This data consist of the years 2003-2016 and includes about 5000 firms in 50 different countries.
Furthermore, the data concerning the economic freedom indicators is established by the Fraser Institute. The influence of economic freedom on CSR is not instantly visible though. Therefore, I will use a three-year gap between the data of the economic freedom indicators and the CSR data. This data will therefore include the years 2000-2013.
Finally, the dataset about regulatory quality is retrieved from the six Worldwide Governance Indicators, established by the Worldbank, and also consist of data from the years 2000-2013.
For the sake of this blog, the scientific details of the regression analysis will not be touched upon, only the conclusions of this research will be discussed.
Firstly, I find that there is a negative impact of regulations on voluntary initiatives. This confirms that indeed putting more regulations on firms will lead to a lower adoption of voluntary initiatives. Furthermore, this negative effect is strengthened by the presence of regulatory quality. These findings confirm both H1 and H4 indicated in the CSR model.
What matters most though is the impact on CSR outcomes and in the second part of the regression it shows that voluntary initiatives have no significant impact on CSR outcomes. This contradicts the theory that explicit forms of CSR contribute to better environmental outcomes. The presence of business regulations does however positively impact the environmental outcomes, suggesting that regulations are important in addressing the issue of CSR. However, this effect is not strengthened by the presence of a higher level of regulatory quality. Therefore, these findings confirm H3 and reject H2 and H5.
Although the results in this research only show that business regulations impact CSR outcomes, this does not mean that business regulations are the single best tool for establishing more policies that help improve the environment. In this research, ISO14000 standards were used as a proxy for voluntary CSR initiatives. However, the benefits of regulations on CSR outcomes might be expanded by the possible positive effects of other voluntary methods than ISO14000 in the form of new ideas and initiatives. These other methods might include the use of awards, linked with desirable financial rewards, or enhancing awareness about CSR on the student level already by increasing the amount of lectures about acting responsible. It is not one or the other that is going to be the key for improving the environment, both implicit forms of CSR and explicit forms of CSR are necessary. However, there is a current trend that firms are more and more focusing on explicit forms of CSR. In order to stay in sync with the firms, governments should therefore make sure they put enough attention to the promotion of voluntary initiatives, on top of imposing regulations.
Luckily, there is a growing interest in CSR and there have been already some steps made in the right direction. Nevertheless, there is still a long way to go and the one thing that could quite possibly be the key to improving the environment is the correct use of regulations, while still promoting the trend towards using more explicit forms of CSR.
Written by: Julien Govaarts – YAG Consultant Eindhoven-Tilburg
Note: This research was executed as part of a thesis for the MSc Economics at Tilburg University. Julien is currently working together with his thesis supervisor to slightly adjust this thesis, with the goal of getting it published in a scientific journal.
Aguilera, R. V., Ganapathi, J., Rupp, D. E., & Williams, C. A. (2007). Putting the S back in corporate social responsibility: A multilevel theory of social change in organizations. Academy of Management Review, 32(3): 836–863.
Campbell, J. L. (2006). Institutional Analysis and the Paradox of Corporate Social Responsibility. American Behavioral Scientist, 49(7), 925 – 938.
Cheng, B., Ioannou, I. and Serafeim, G. (2014). Corporate social responsibility and access to finance. Strategic Management Journal, 35: 1–23.
Matten, D., & Moon, J. (2008). “Implicit” and “explicit” CSR: A conceptual framework for a comparative understanding of corporate social responsibility. Academy of Management Review, 33(2): 404–424.