Corporate social responsibility and cost of financing—The importance of the international corporate governance system

Published in: Corporate Governance: An International Review

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In his 2018 annual letter to CEOs, Larry Fink, the founder and the CEO of BlackRock (one of the most critical investment management corporations in the world), states that companies need to do more than make profits and contribute to society if they want to receive their support, emphasizing the importance of Corporate Social Responsibility (CSR) and stakeholders' needs to reap long-term rewards.

Since then, despite the growing body of research on CSR, the recent growth in socially responsible investments, and shareholders' proposals on social and environmental issues, there has been an important debate on the desirability of CSR from the investor's perspective.

On the one hand, some authors show that CSR creates shareholder value by maximizing stakeholder value, a result known as "doing well by doing good." In exchange for CSR initiatives, stakeholders reward firms with enhanced reputations, increased loyalty, and other forms of support that may develop into a strong "business case" for CSR.

On the other hand, some other authors, starting from the difficulty of indisputably establishing the business case for CSR, suggest that, instead of contributing to more shareholder value, CSR may be negative for corporate governance as managers may use their discretion over CSR to seek private benefits or to avoid being disciplined by investors.

We try to find a synthesis between these two perspectives by exploring how the firm's engagement in CSR shapes its cost of equity and debt, an important underlying mechanism linking the firm's commitment to stakeholders' needs and firm value, and by suggesting that international corporate governance system is an important issue to take into account.

In particular, we differentiate between shareholder-oriented and stakeholder-oriented systems. In the countries belonging to the first category, such as the UK, the US, and Canada, the primary target of a business is profit maximization which can guarantee the maximization of the wealth of shareholders, that is, the company owners. On the other hand, in the countries belonging to the second category, such as France, Germany, and Italy, any successful business has to create value for all groups of stakeholders where the stakeholder is a concept more comprehensive than the shareholder and embraces all the subjects having a stake, an interest in the firm: surely, shareholders, but also bondholders, employees, customers, suppliers, and the government.

We use a large international sample (more than 3,300 firms from 31 countries over the period 2002-2011) and highlight the importance of considering the shareholder/stakeholder orientation at the country level to explain the link between CSR performance and the cost of financing.

First, if the link between CSR performance and the cost of equity is negative in a shareholder-oriented system, this relationship is positive in a stakeholder-oriented system. These results suggest that, in a shareholder-oriented system, firms develop strong stakeholder relationships if, through these relationships, they expand their opportunities for value-creating exchanges and generate intangible resources that increase their future cash flows. In contrast, in a stakeholder-oriented system, institutional pressure induces managers to go beyond what is optimal from a shareholders' perspective, sacrificing shareholder value to attend to the demands of a broad set of stakeholders.

Second, we show that the link between CSR performance and the cost of debt is negative for firms close to default in both systems. More precisely, strong stakeholder ties seem essential for a firm to recover from a disadvantaged position, and maintaining strong stakeholder relations, even when financial resources are scarce, is beneficial for firm survival.

Our analysis of how the country's corporate governance system influences the effect of CSR performance on the cost of financing allows a deeper understanding of how investors respond to CSR initiatives worldwide and offers managers, directors, and policy-makers context-specific recommendations. It also highlights the limitations of transferring insights regarding CSR from one corporate governance system to another.

This article was the runner-up of the Corporate Governance: an Internation Review (CGIR) Best Paper Award 2020.

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Authors at the Department of Management

Barbara Petracci – Associate Professor

Academic disciplines: Corporate Finance

Teaching areas: Corporate Finance; Sustainable Finance

Research fields: Corporate Governance, Corporate Social Responsibility, Ethical Finance, Market Efficiency

Barbara is an Associate Professor of Corporate Finance at the University of Bologna. She is the Director of the Second Cycle Degree in Management for Social Economy. She was a visiting Ph.D. student at the University of Strathclyde (Glasgow). Her research focuses on corporate governance, CSR, and market efficiency. She belongs to the editorial board of Humanities & Social Sciences Communications.