by Thomas P. Lyon and John W. Maxwell
This commentary originally appeared in Resources for the Future Weekly Policy Commentary in January 2009 and is based on an article by the authors, “Corporate Social Responsibility and the Environment: A Theoretical Perspective,” Review of Environmental Economics and Policy, 2008, 2: 240-260.
Corporate social responsibility (CSR) is not a new concept, but over the past decade its focus has shifted from labor issues and local philanthropy toward environmental actions. More and more companies desire to go “green” and are building to LEED (Leadership in Energy and Environmental Design) certification standards, joining the Chicago Climate Exchange, and producing corporate social reports to make public their environmental performance in accordance with the Global Reporting Initiative. Numerous factors are driving this trend, including managerial altruism, cost-cutting efficiency improvements, the emergence of a new generation of green consumers, and savvier business leaders who take pro-active steps to avert political conflict rather than reacting to public pressure after the fact. Despite creeping concerns that some of the resulting corporate actions may be mere “greenwash,” for the most part they are welcomed by employees, consumers, investors, regulators, and the public. But is it really socially desirable for managers to take on costly environmental initiatives that are not required by law?
What Do We Mean by CSR?
One of the perplexing things about CSR is that it has long meant different things to different people. To some, an action only counts as true CSR if it is unprofitable and hence motivated by altruism. This was the position taken by Milton Friedman, in his highly influential 1970 New York Times Magazine article on the social responsibility of business. In this view, socially beneficial actions that increase profits are merely strategic CSR, or in Friedman’s words, “hypocritical windowdressing.” However, even advocates of altruistic CSR admit that most CSR actions can be viewed through a strategic lens. Thus we take a pragmatic perspective and define environmental CSR simply as environmentally friendly actions not required by law, encompassing both possible motives.
Is CSR Good for Society?
One familiar argument against CSR is that it imposes a manager’s preferences on shareholders, who might prefer to allocate their charitable contributions in different ways. This is a powerful argument in a world where shareholders are motivated solely by maximizing the monetary earnings from their investments, the market for charitable donations is efficient, and the political marketplace effectively internalizes all environmental externalities. If these assumptions do not hold in practice, however, the distinction between “altruistic” and “strategic” CSR blurs, and the argument against CSR weakens.
Socially responsible firms can be viewed as a vehicle for combining an investment with a charitable contribution, which can be attractive to investors since it avoids both taxation of corporate profits and the transaction costs of personal giving.
Even if investors prefer to make direct charitable donations, socially responsible firms can still survive in the marketplace, although they will trade at a discount to other firms. If investors are informed about the firm’s CSR activities at the time they invest, then it is the entrepreneurs who have created the firms that bear the cost of the CSR activities, not ordinary shareholders. The entrepreneur’s creation of a CSR firm is a gift to society—he benefits from starting the firm, investors benefit from the expanded range of investment opportunities, and the recipients of CSR benefit directly.
Even if CSR offers some benefits to investors, the question remains: is it more appropriate for altruistic managers and shareholders to work through the political system rather than through corporate voluntarism? If legislators and regulators actually pursue the public interest, there is little scope for CSR to improve on enlightened government regulation. However, many economists argue that regulatory agencies are too easily captured by the companies they regulate, implying that the political marketplace is far from efficient. If so, then the welfare effects of strategic CSR depend on the political context in which it occurs.
Even when politicians are well intentioned, government regulation can be a cumbersome and costly enterprise. As a result, CSR can be a less costly substitute for government mandates, and hence increase welfare. Industry self-regulation that preempts legislation is typically welfare-enhancing, since consumer groups can intervene in the political process if they find the firm’s CSR efforts unsatisfactory. Similarly, if CSR is executed through voluntary agreements with regulators, this improves welfare as long as the regulator has society’s best interests at heart. However, there is no guarantee that society gains if regulators are influenced by particular interest groups with narrow agendas.
CSR activities may influence regulatory decisions in several ways. CSR can benefit society by signaling to regulators that pollution abatement is not prohibitively costly, encouraging new regulations that may produce a competitive advantage for the signaler. However, if leading firms make modest environmental commitments, this may induce regulators to eschew tough environmental standards, potentially making society worse off. A company’s CSR investments may also induce regulators to shift enforcement resources toward other firms that are more likely to be out of compliance with regulations. This can be beneficial for society, but there is also a risk that firms will waste resources in a “CSR war” designed to deflect regulatory attention towards other firms.
Over the past decade, there has been a rise in direct engagement between firms and environmental non-governmental organizations (NGOs). While sometimes hostile, this engagement can also take the form of a partnership where an NGO advises a firm and then endorses its green products and services, often through a formal certification program such as the Forest Stewardship Council for forest products or the green-E scheme for renewable energy and carbon offsets. In an unregulated market, NGO approval can increase sales of environmentally friendly products and therefore enhance social welfare when consumers switch from “brown” to green products. When there is a possibility of government regulation, however, NGO involvement does not necessarily enhance social welfare. The existence of an NGO certification scheme can induce firms to lobby against government standards that might be of even greater value to society.
Firms have multiple motives for undertaking CSR, and its welfare effects are highly contingent on the institutional context in which it is undertaken. This makes it a fascinating field for researchers but a potentially tricky one for citizens and policymakers.
Friedman, Milton. 1970. “The Social Responsibility of Business is to Increase Profits,” The New York Times Magazine, September 13th, New York, The New York Times.
Hay, Bruce, Robert N. Stavins, and Richard H.K. Vietor, editors. 2005. Environmental Protection and the Social Responsibility of Firms, Washington, DC: RFF Press.
Tom Lyon is Dow Professor of Sustainable Science, Technology and Commerce; Professor of Business Economics; Professor of Natural Resources; and Director, of the Erb Institute. His primary research interest is the interplay between corporate strategy and public policy, including the areas of corporate environmentalism, electric utility investment practices, natural gas contracting, innovation in the health care sector, and the introduction of competition in regulated industries. His book Corporate Environmentalism and Public Policy was published by Cambridge University Press in November 2004.
John W. Maxwell is W. George Pinnell Professor of Business Economics & Public Policy at Kelley School of Business, Indiana University. He has published numerous articles and edited volumes on the political economy of regulation, voluntary environmental agreements, non-market strategy and conflict and cooperation over scarce resources. A collection of his work, entitled Corporate Environmentalism and Public Policy was published by Cambridge University Press in 2004.