Since the 1950’s, it has been believed organizations have a responsibility to go above and beyond their financial and legal obligations to better society. Corporate philanthropy, pollution prevention, fair trade policies, employee benefit programs and other socially-accountable practices all fall under the self-regulating business model of Corporate Social Responsibility (CSR).
While early research established that CSR matters by identifying its impact on Corporate Financial Performance (CFP), more recent work has focused on documenting how and why CSR matters in positively influencing financial outcomes. Based on the accumulated empirical evidence so far, the question still remains, what are the key mechanisms through which CSR positively affects CFP?
In a new study published in the Journal of Management Studies (March 2020), researchers from University of Amsterdam, Erasmus University, Universidad Adolfo Ibáñez and University of South Carolina attempt to answer this question. They meta-analyzed research on the CSR-CFP relationship performed over the last five decades and concluded that CSR enhances performance through four key mechanisms: reputation, stakeholder reciprocation, innovation capacity, and risk mitigation.
Businesses with a strong CSR track record typically have better overall reputations. As a result, these businesses are more attractive to prospective stakeholders, and are more likely to develop financially productive relationships with them. Customers, for example, will derive more satisfaction from buying products from reputable organizations. This increases their purchasing intention and their willingness to pay a premium price. Similarly, investors perceive CSR as a legitimate, positive signal of future profitability, which often results in increased investment and a surging stock price.
Another mechanism through which businesses attain stronger performance outcomes from CSR is through stakeholder reciprocation. When organizations take care of their stakeholders, stakeholders reciprocate. For example, employees who benefit from CSR activities are generally more satisfied and engage in favorable citizenship behaviors. By the same token, equity providers will allocate financial resources with more favorable terms, local communities will engage in fewer protests, and governments will enforce more favorable regulations. By cultivating more cooperative, productive, and enduring stakeholder relationships, CFP is enhanced.
In addition to the relationship-based mechanisms of reputation and stakeholder reciprocation, the third empirical mechanism connecting CSR to CFP is innovation capacity. High CSR organizations typically engage in frequent stakeholder dialogue and adopt a broader societal perspective. This affords them access to larger bodies of knowledge, enabling them to identify new opportunities for innovation. CSR-based innovations, in turn, are likely to enhance CFP because businesses can use it to differentiate themselves from their competitors, reduce production costs, and develop new business models.
The final mechanism identified in the meta-analysis is risk mitigation. Many CSR activities such as pollution prevention and employee health and benefit programs directly reduce an organization’s overall risk exposure. But CSR reduces risk indirectly as well. When engaging with a broader range of stakeholders, organizations have access to more information and become more risk aware. As a result, they are able to better anticipate and mitigate risks. This has a positive effect on CFP because it reduces unproductive costs such as litigation and sanctions, refinancing costs or forgone sales.
Reflecting on existing research findings so far, the authors of this study conclude that it is possible for businesses to simultaneously create both social and financial value through CSR. The authors refer to these activities as Strategic CSR, which they define as those activities that appear to further some social good, while at the same time benefitting the organization financially by either enhancing its reputation, increasing stakeholder reciprocation, improving innovation, and/or mitigating risk.
Pushpika Vishwanathan PhD, Assistant Professor, University of Amsterdam