MHC International Limited – News Item


March 2001

Economics of Corporate Social Responsibility (CSR)

Does it make sense to talk about the Economics of CSR? Is not CSR just a good thing in itself? There are at least two issues. First, here will added emphasis on CSR bring about an adequate return to company bottom lines? Second, viagra sale will increased expenditure on CSR lead to lower competitiveness? Basic economics tells us that an emphasis on CSR will lead to price increases that may not allow the specific markets for a companiesí goods and services to clear.

This can be illustrated by considering two companies producing similar products such as Coca-Cola and Pepsi-Cola or Shell and Exxon. One company has a vigorous CSR policy – a manager appointed to deal with CSR, capsule production of a social report, staff trained on CSR issues, a clear code of ethics, stakeholder needs addressed regularly. The other company does the minimum – only takes on board good corporate governance guidelines when legislation insists, considers pro-active HR policies to train people the minimum to do the job well, observes environmental regimes passed into law, consults as few stakeholders as possible.

Clearly under this simple economic model the CSR company will have additional costs compared with the non-CSR company. If these costs are then transferred to the companiesí products then, all other things being equal, neo-classical economics will predict that the non-CSR company will find it easier to clear its product market than the CSR company. The consequences are that the non-CSR company will eventually drive its CSR competitor out of business or force it to reduce CSR costs.

But, economics does allow price increases and markets to clear if product quality increases. Thus there is a CSR premium (i.e. an additional benefit because of CSR earned by firms or appreciated by consumers and other stakeholders) that can be earned by firms on such items as product quality, employee productivity, consumer satisfaction. Therefore, the additional CSR costs could well be cancelled out by consumers accepting to pay for this additional premium or through prices being positively affected by the additional efficiency that CSR is likely to bring about.

Evidence for this positive CSR premium is growing. For instance the London Evening Standard announced at the end of April that The Co-operative Bank today sought to distinguish itself from rival banks by stressing its socially responsible credentials as it announced record profits for the seventh year running. How big this premium is likely to be is a matter for further research although, as we showed in another Monthly Feature (see J-curve), visionary CSR companies can have a premium of at least 5% over non-visionary companies.

Thus, with a well-managed CSR premium, consumers would be willing to pay extra in the knowledge that the products they bought had not been produced by slave labour, had respected the environment, that the technology to produce them had been acquired without corruption payments, and that the human rights of its employees and the local community had been protected etc. They would also know that the products or services delivered were at the cutting edge of technology and design. CSR does not mean sacrificing high levels of product or service quality

A CSR premium is also earned from increased productivity through sound human resource (HR) policies of employees and managers. Product quality is also likely to be much improved when employees are treated as part of the company rather than as add-ons ñ this much is already known in business circles but it is also part of a CSR approach. As the Evening Standard also noted the Co-operative Bank’s Chief Executive Mervyn Pedelty made great play of attributing the Bank’s success to its employees at a time when other financial institutions were culling staff and closing branches. ‘It is not normal for a bank to put such strong emphasis on its staff but we are absolutely committed to them and they are committed to us. I passionately believe it is our staff who make the difference,’ said Pedelty.

CSR is also investment as much as a cost per se. Consequently, to costs come benefits that are not always immediately apparent when the ësocialí investment is made. Training is an obvious social investment that is accepted as essential for future growth and profits. Other investments that serve to increase ësocial capitalí are less obvious but are beginning to be accepted as previously under-played but essential for the future. For example reputation, a key ingredient of social capital, is known to be an important force in the market place. But can reputation be more easily destroyed for a CSR than a non-CSR company? There is certainly evidence that Nikeís attempts to adopt CSR policies throughout have led them to attract criticism more than its competitors such as Reebok or Adidas. But is this a result of adopting CSR policies or simply a result of cynicism on the part of corporate watchers who have heard so much promise but been disappointed so many times? Certainly, the more companies and institutions that adopt CSR policies the less particular companies will be picked upon, and the more resilient they will be to attacks on their reputation.

As the world teeters toward slower growth another ‘R’ word enters play –  that of recession. Under a worsening business climate, what will become of CSR? Clearly, non-essential investments and costs are quickly cut back but why would a company have non-essential investments or costs anyway? The real issue is what defensive measures can be taken when a downturn in the global economy is apparent. These could include cutting product lines, reducing investment in products likely to suffer from a fall in consumer spending and reducing inventories. CSR being an increasing part of a companies’ strategy and having a longer term payoff than other investments might, at first sight, seem to be an obvious area to cut. But a little more thought shows that CSR is actually part of a progressive corporate strategy. The same issues of consumer alienation exist in a downturn as much as in an upturn ñ for instance using child labour in appalling conditions is unacceptable in growth or recession. In fact, a CSR strategy would give a company an edge either in a downturn or upturn compared with its competitors and thus CSR is likely to be recession proof.

This article has looked, briefly, at the economics of companies but not the public sector, NGOs nor other non-profit making activities. As in the private sector, survival means satisfying consumer needs. CSR is more willingly accepted in non-private institutions than private companies themselves but similar economic arguments prevail. There is, increasingly, more and more competition for the provision of most public goods and if the public perceives that this provision is accomplished in a non-CSR manner then that institutional provider will suffer. To date, as we will show in next month’s article on CRITICS we have found that the private sector has performed significantly better than the public sector on CSR.

Contributed by: Michael Hopkins, Director, MHC International Ltd with thanks to Ivor Hopkins and Jawahir Adam for comments.

Comment on the Economics of Corporate Social Responsibilityby Dr Leonardo Lanzona, Chairman, Dept. of Economics, Ateneo University, Philippines and member E-Metrics MHCi’s collaborating company in Asia.

The State in Corporate Social Responsibility

The article assumes that the firm can undertake Corporate Social Responsibility (CSR) activities without any intervention from the state even on a non-financial and structural sense. The idea is that the firms will voluntarily invest in such activities since the returns will be fully obtained by them. This assumption however may seem rather overstated because part of the returns from such activities will flow to society, instead of the firm. Social externalities are found in these activities, and hence markets by themselves cannot be relied to achieve social optimality. These social externalities will only be optimally supplied if the government intervenes. There are a number of ways that the government can play a major role in the formation of these activities.

First, the government can justifiably intervene in situations where an oligopoly is involved. The article seems to be based on a particular market structure, where firms produced differentiated products, and exit and entry into the industry is allowed. Over the long run, these markets, featuring differentiated competition, are expected to result in a socially optimal situation. However, in most cases, we are dealing with oligopolies, including the examples stated in the article, i.e., Coca-Cola vs. Pepsi and Shell vs. Exxon. The point here is that the optimal supply of CSR activities depends on the market structure.

In the markets where only two companies produce homogeneous products in the market, the decisions of one firm will have perceptible effects on the profitably of the other. There is then a game of mutual deterrence between firms in which each tries to convince the other that it is committed to produce. If a CSR firm succeeds in getting a larger a market share and making the commitment credible, it can deter its rival from getting a large share of the market and reaping profits. Firms however may lack any credible way to make a commitment to produce. In this situation, the government can make a difference. If the government makes a promise to pay the socially responsible firm a subsidy that is large enough to capture a greater market share, the non-CSR firm loses its profits and perhaps even leave the industry. Keeping consumer losses low, this can be justified as long as social externalities are generated. How large the subsidy should be is subject to further research.

Second, the premium from CSR depends ultimately on the productivity the socially responsible firm can generate. However, the existence of CSR itself can increase worker welfare and at the same time can cause moral hazard problem, possibly resulting in disincentives against effort. The CSRís function is frustrated unless the workers almost always complete their work successfully. But carrying out a simple routine is typically more engaging than failing to accomplish a complicated one. Managers will want to layoff workers who then shirk repeatedly.

A manager must make sure that the costs of the CSR do not exceed the benefits it produces. Given the difficulty of observing worker effort, managers must balance a series of subtle tradeoffs between original costs, monitoring expense, safety, visibility, and market share. In the light of these various concerns, CSR activities may have a limited supply, and can cause workers not to participate.

In general, there is no reason to suppose that governments should direct managers either to tax or to subsidize institutional risk-taking and effort. Nevertheless, widespread and clear-cut government rules on hiring and job security will be preferred in order to increase worker morale and clarify to firms the CSR concerns. Although these may be more costly to employers, by being more visible, these rules can lessen the sense of risk sharing that lies at the heart of worker and firm performance. Enforceable legal structures can be formulated in order to protect both firms and workers. Nevertheless, such laws may make CSR more costly to build and maintain. Moreover, whenever the CSR activity that manager erects somehow proves unable to stop an unfolding disaster, emergency medical treatment must be accessed optimally and the manager must expect a storm of condemnation to rain down on his head from all sides. In this case, financial state assistance may be necessary.

Whether or not the elements of the CSR are defined by explicit statutes, authorities in every country must establish a de facto financial assistance and must support the CSR by incurring monitoring costs and penalizing to some degree fraudulent and corrupt behavior in financial and governmental transactions. Further studies will be needed to explain how to design and operate the CSR at minimum cost to taxpayers and well-managed banks in countries whose informational and contracting environments differ in stylized ways.

Finally, there is also some concern if the country is engaged in trade. In cases where recession is felt in many developed countries, countries may well compete on basis of lowering prices, using varied standards of production and employment. This puts a strain on CSR firms that have to compete with countries that deliberately decrease their prices in order to remain competitive. The government in this case can demand the incorporation of social clauses in the industrial structure and employment, and seek to enforce these clauses internationally. However, for many other countries, especially in developing countries, such social clauses can undermine their comparative advantage over certain commodities. The correct evaluation of costs and benefits of these CSR activities can thus clear the way towards formulating and implementing these social clauses in different countries.

In conclusion, the weaker is a country’s informational, ethical, and corporate-governance environment, the more a wholly governmental system of explicit deposit guarantees may be needed to enforce CSR activities. At the same time, inappropriate state interference can also serve to undermine firm performance and stability. Put positively, the design features and operating protocols of a country’s CSR activities ought to evolve over time with changes in private and government regulators’ capacity for valuing banking institutions, for disciplining risk-taking and resolving insolvencies promptly, and (above all) for being held accountable for how well they perform these tasks.