Is corporate social responsibility a value-increasing investment? Evidence from antitakeover provisions

Abstract

This study empirically tests whether corporate social responsibility (CSR) is a value-increasing investment by estimating the effect of antitakeover provisions on CSR. Results indicate that managerial entrenchment measured by the G-index of antitakeover provisions is negatively associated with CSR. However, this negative effect is driven by CSR strengths; G-index has no significant effect on CSR concerns. Overall, this study supports the stakeholder theory of CSR by showing that CSR is a value-increasing strategic investment, as entrenched managers tend to reduce CSR instead of overinvesting in it.

Introduction

Is corporate social responsibility (CSR) a value-increasing strategic investment or a value-decreasing agency problem? Stakeholder theory (Freeman, 1984) posits that CSR is a strategic investment that increases firm value by balancing the interests of investing and non-investing stakeholders. The resource based view (RBV) also argues that CSR increases the firm's value by enhancing its competitive advantage. In contrast, agency theory (Jensen & Meckling, 1976) contends that CSR is a value-decreasing agency problem in that managers tend to overinvest in CSR to gain private benefits at the expense of shareholders (Barnea and Rubin, 2010, Friedman, 1970). Moreover, managers' ability to expropriate benefits increases when they become entrenched through antitakeover provisions (Jensen & Ruback, 1983). In this study, I argue that antitakeover provisions provide a natural setting to test whether CSR is a value-increasing strategic investment or a value-destroying agency problem, as they increase managerial ability to expropriate benefits. Specifically, if CSR is an agency problem and a form of entrenchment, as Cespa and Cestone (2007) suggest, then antitakeover provisions should be positively related to CSR. However, if CSR is a long-run strategic investment that enhances firm reputation (McWilliams & Siegel, 2011) and market value, then antitakeover provisions should be negatively associated with CSR, as entrenched managers tend to avoid long-term value-increasing investments.

In order to test the relation between managerial entrenchment and CSR, I use CSR data from MSCI ESG (formerly KLD) and antitakeover provisions data from Institutional Shareholder Services (ISS). I use the G-index of antitakeover provisions (Gompers, Ishii, & Metrick, 2003) to measure managerial entrenchment, and the difference between CSR strengths and concerns on five dimensions of social performance (community, diversity, employees, product, and environment) to measure CSR. I use ordinary least squares (OLS) and industry fixed effects regressions to estimate the effect of managerial entrenchment on CSR. I also recognize the endogeneity of managerial entrenchment and run instrumental variable (IV-GMM) regressions. Moreover, I run separate regressions to estimate the effect of entrenchment on CSR strengths and CSR concerns.

This study contributes to the literature on corporate social responsibility, managerial entrenchment, and firm value in two distinct ways. First, it contributes to the literature on the choice of CSR as a strategic investment, by providing indirect empirical support to the stakeholder theory of CSR. Second, previous studies document that antitakeover provisions impair firm value (Chang and Zhang, 2015, Cremers and Ferrell, 2009, Gompers et al., 2003); this study shows how they do so.

The remainder of this study is organized as follows. Section 2 provides motivation and develops hypotheses. Section 3 describes the data, measurement, and construction of variables used in benchmark regressions. Section 4 explains the empirical method used to estimate the effect of managerial entrenchment on CSR. Section 5 discusses empirical results and robustness tests. Section 6 describes additional tests, and Section 7 concludes.