Corporate social responsibility (CSR) has become increasingly important in recent years owing to the dramatic growth in the number of institutes, mutual funds, and online resources and other publications that specialize in encouraging corporations to improve their practices according to various responsibility criteria (Bassen et al., 2006). To cope with the increased attention given to corporations’ impact on society, more than half of the Fortune 1,000 companies in the U.S. regularly issue CSR reports, and nearly 10% of U.S. investments are screened to ensure that they meet CSR-related criteria (Galema et al., 2008). Moreover, a growing number of firms worldwide have undertaken serious efforts to integrate CSR into various aspects of their businesses (Harjoto and Jo, 2007).
As summarized in Robinson et al. (2008), numerous theoretical arguments have been put forward to explain why CSR activities may enhance firm value. For instance, McGuire et al. (1988) argue that a perceived decline in CSR may lead investors to increase explicit claims on the firm, whereas an increase in perceived CSR may improve a firm’s reputation and thus permit it to swap costly explicit claims for less costly implicit charges. Fombrun and Shanely (1990) suggest further that building a positive reputation in the product and labor markets can generate subsequent benefits by allowing companies to charge customers premium prices and by attracting better job applicants.
Customers are likely to pay premium prices for products from high-reputation firms, thereby increasing revenues, because reputation serves as a signal of product quality. Similarly, because employees generally prefer to work for firms with a good reputation, they are likely to either work harder or accept lower compensation, thereby reducing the firm’s costs (Roberts and Dowling, 2002). Taken together, this thread of the literature suggests that CSR can increase firm value through positive reputation effects.
However, CSR activities may not always be value increasing. For instance, a firm that invests in pollution-control equipment while its rivals do not may be putting itself at a competitive disadvantage (Waddock and Graves, 1997). Agency issues may exacerbate this problem as corporate executives may seek to enhance their public image and pursue other private benefits at the expense of shareholders. For instance, Brown et al. (2006) find that agency costs play a major role in corporate philanthropic practices. They document that firms with larger boards of directors give more cash to charities and are more likely to establish corporate foundations.
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Does Corporate Social Responsibility Affect the Cost of Capital?
