A Duopoly Model of Corporate Social Responsibility and Location Choice

Transcription

1 A Duopoly Model of Corporate Socal Responsblty and Locaton Choce Alberto albon # and Fabo albon # Unversty of Pars Dauphne. E-mal contact: albertobalbon@yahoo.fr Unversty of ologna, LSE. E-mal contact: f.balbon@unbo.t JEL codes: C7, D43, L3, L5, L, M4 Keywords: Corporate Socal Responsblty, Duopoly, Mnmum Standards, Locaton, Vertcal Product Dfferentaton September 008 Abstract We adopt a framework of vertcal dfferentaton to study the ssue of Corporate Socal Responsblty (CSR). We develop a model of duopoly n a two-country settng, n whch frms choose the country of locaton, the level of CSR and fnally compete n the market à la ertrand. We show that: ) at equlbrum the two frms choose dfferent levels of CSR,.e. an "ethcal" and a "neutral" frm coexst n the market; ) regardless of ts locaton choce, the neutral frm undertakes a level of CSR equal to the mnmum nternatonal standard; ) the locaton choce of both the "ethcal" and the "neutral" frm depends on the relatve costs of CSR n the two countres; n addton the choce of the ethcal frm s nfluenced by the dstrbuton of consumers' tastes for CSR, whle the choce of the neutral frm s affected by the level of the mnmum nternatonal standard for CSR. We thank Ganpaolo Rossn for helpful comments. Of course all remanng errors and omssons are entrely our own.

2 . Introducton.. A short revew of the lterature Corporate Socal Responsblty (CSR) ncludes all the "stuatons where the frm goes beyond complance and engages n actons that appear to further some socal good, beyond the nterests of the frm and that whch s requred by law" (McWllams et al. [006]). ence, the fundamental dea behnd CSR s that companes ncur responsbltes to socety beyond maxmzaton of proft and should ntegrate socal and envronmental consderatons n ther decson makng processes. The ssue of CSR has ganed an ncreasng mportance over the past thrty years and t s now wdely dscussed n newspapers and busness school currcula. Furthermore, there s wdespread evdence that consumers care about CSR when choosng where to shop (see, among others, ecchett and Rosat [005]). owever, untl recently only few theoretcal works attempted to ntegrate the ssue of CSR n the economc lterature. The contrast between the ncreasng emprcal relevance of CSR and the lack of economc analyss of ths phenomenon led some authors to argue that the "challenge of the economc lterature s to ncorporate ths new feature nto ts theoretcal framework" (ecchett, Gallonardo and Tesstore [005]). One of the frst works whch studed CSR from an economc perspectve s the paper by McWllams and Segel (00), whch focused on the relatonshp between market structure and CSR and on the mplcatons of CSR as regards the strategc behavor of frms. In that paper CSR s seen as a dfferentaton strategy for the frms n response to the sophstcaton of consumers' demand towards more ethcal products. The frst concluson of the paper s that CSR should be "neutral" on profts,.e. at equlbrum socally responsble (SR) frms and non-sr frms make dentcal profts. The second s that certan frm/ndustry-specfc patterns n the provson of CSR should emerge, dependng manly on the characterstcs of the products, on the market structure, on the level and the type of competton. For example, a hgh level of CSR s lkely to be assocated wth the followng elements: a hgh level of product dfferentaton n the ndustry (whch normally comes from a more sophstcated consumers' demand), a hgh level of advertsng (snce CSR actvtes need to be advertsed n order to be promoted), experence-goods (.e. products that must be consumed before ther value s known, for whch advertsng s crucal), hgh There s not one sngle defnton of CSR on whch there s consensus n the lterature. Another possble defnton s the followng: CSR s a "concept whereby companes ntegrate socal and envronmental concerns n ther busness operatons and n ther nteracton wth ther stakeholders on a voluntary bass" (European Commsson, Green Paper on CSR [00]). Dfferently, the workng group of the ISO 6000 on Socal Responsblty defnes CSR as "the responsblty of an organzaton for the mpacts of ts decsons and actvtes on socety and the envronment through transparent and ethcal behavor that s consstent wth sustanable development and the welfare of socety; takes nto account the expectatons of stakeholders; s n complance wth applcable law and consstent wth nternatonal norms of behavor; and s ntegrated throughout the organzaton". When CSR s based only on proft motvatons and not on ethcal consderatons, ths result has to be verfed. In fact, f SR frms make hgher profts, more frms wll start provdng CSR, and ths process wll go on untl both types of frms have to attan dentcal profts (the same reasonng works f non-sr frms make hgher profts at the begnnng).

3 consumers' ncomes (because the sophstcaton of costumers' demand s lkely to be postvely related to ncome), hgh prces of substtutes goods (n fact, f these are sold at a much lower prce, the CSR features embedded n the product would not help gan sgnfcant market shares), large sze of frms (because of possble scale economes n the provson of CSR) and fnally mult-product frms (because of possble scope economes). Followng ths early contrbuton, there has been a surge of studes whch concentrated on the role of CSR as a dfferentaton strategy. These papers developed the dea that there s a demand for a more ethcal behavor by frms, n some of the markets where they compete (e.g. goods, captal, labor), and thus CSR can be used as a strategy to attan hgher profts. 3 In partcular, some authors (agnol and Watts [003], esley and Gathak [007]) vewed CSR as the prvate provson by frms of a local publc good (e.g. socal networks, communty development)/reducton of a publc bad (e.g. polluton); others (ecchett, Gallonardo and Tesstore [005], ecchett, Federco and Solferno [005], Manasaks, Mtrokostas and Petraks [007], Mtrokostas and Petraks [007]) as a dfferentaton strategy n the market of products, n response to consumers' demand for goods that embed certan "ethcal" characterstcs; some agan (rekke and Nyborg [004]) vewed CSR as a labor market screenng strategy to attract the most motvated and productve employees; others (aron [007]) as a strategy to attract "ethcal" nvestors and, fnally, some (Maxwell, Lyon and ackett [000], aron [00]) as a strategy used by frms to preempt government regulatory nterventon n response to the requests of lobby groups and the cvl socety. All these contrbutons try n dfferent ways to provde answers to a few key questons on CSR. The frst one s whether the frms competng on the same market at equlbrum provde dfferent levels of CSR (.e. there s dfferentaton at equlbrum) or they provde the same level of CSR (.e. there s no dfferentaton at equlbrum). The second one regards the effects of ncreased competton n the market on the level of CSR undertaken by frms. In fact aumol (99) argued that, the more compettve s the market, the less room there s for frms to undertake CSR because of the lack of extra-profts to spend on these actvtes. Fnally, there s the queston of whether CSR s welfare-enhancng or not, and what should governments do n order to maxmze the ncrease n socal welfare va CSR... Ths paper's approach to CSR modellng In the present paper we develop the dea of CSR as a dfferentaton strategy for the frms ntroducng a two-country settng, whch to our knowledge s a novelty n the CSR lterature. Our man reference s the model of duopoly dfferentated by qualty developed by Motta (993), whch we adapt to the ssue of CSR. Ths framework has already been 3 These works provde an ndrect answer to the famous clam by Mlton Fredman (97). Fredman affrmed that frms should not undertake CSR because t shfts resources from the frms most mportant objectve, whch s the maxmzaton of shareholders' value (.e. proft-maxmzaton). owever these theores have been able to show that n fact CSR, under certan crcumstances (e.g. t s algned wth the frms busness operatons or t caters certan consumers demands), can help the frms ncrease ther profts. For ths reason, the theores n whch CSR s seen as a proft-enhancng strategy are often referred to as the "neo-classcal" theores of CSR. 3

4 appled by Amacher, Koskela and Ollkanen (004) to a smlar problem (.e. envronmental qualty competton and eco-labelng). efore presentng our model, t s useful to quckly recall the man features and conclusons of the model developed by Motta (993). There, the consumers present dfferent tastes for qualty and are unformly dstrbuted wth unt densty. There s no a pror upper bound to the level of qualty, but there s lower bound to t, whch could be nterpreted as a mnmum legal requrement. A further assumpton s that the market s not covered,.e. some consumers do not buy the dfferentated good at all. 4 The model comprses a two-stage game n whch the frms frst decde the level of qualty of the dfferentated good, and then compete on the market, ether n prces (.e. ertand-nash equlbrum) or n quanttes (.e. Cournot-Nash equlbrum). Four dfferent cases are studed, assumng ether fxed or varable costs of qualty mprovement. The case whch s more nterestng for the purposes of our paper s the ertrand- Nash equlbrum (.e. frms choose prces at the last stage of the game) wth fxed costs of qualty mprovement (and no varable costs). In ths case, Motta (993) shows that, at equlbrum, the two frms choose dfferent qualty locatons (.e. there s dfferentaton at equlbrum). Ths confrms the results of a prevous paper by Shaked and Sutton (98), n whch frms choose to dfferentate ther products even when costs of qualty are zero, n order to relax prce competton on the market. owever, whle n Shaked and Sutton (98), wth nether varable nor fxed costs of qualty, one frm chooses the maxmum qualty possble and the other a level strctly hgher than the mnmum (.e. the maxmum dfferentaton equlbrum emerges), n Motta (993), wth fxed costs of qualty, both frms choose a level of qualty nternal to the nterval of possble qualtes. Motta (993) also shows that, should one remove the assumpton of uncovered market, t would become optmal, for the frm whch offers the lower qualty, to set ts qualty to a level equal to the mnmum requrement. Ths result corresponds to the one of Trole (988). The Cournot-Nash equlbrum (.e. frms choose quanttes at the second stage of the game) yelds less qualty dfferentaton than the ertrand-nash one, snce n the latter frms have a hgher ncentve to choose more dstant qualty specfcatons, due to the fercer competton at the marketng stage of the game. Dfferently from onanno (986) where frms choose not to dfferentate when fxed costs of qualty mprovement do not exst, n Motta (993) there s always qualty dfferentaton at equlbrum, even f not maxmum. owever, Motta (993) shows that an equlbrum wth no dfferentaton would occur f one ntroduced an upper bound to qualty choce and assumed that, when computed at ths hghest level, margnal costs of qualty are not as hgh as the margnal revenues. A framework of vertcal dfferentaton has already been adopted n the economc lterature of CSR, assumng that CSR s a feature embedded n the goods whch nduces the consumers to pay a hgher prce for t. From ths perspectve, CSR can be assmlated to qualty. owever t s worth notng that there s stll some debate n the lterature on whch framework of dfferentaton (.e. horzontal vs. vertcal) s more approprate to analyze the ssue of CSR. Some authors (ecchett, Gallonardo and Tesstore [005]) propend for the 4 Ths assumpton has been made because, wth full market coverage, the demand functon cannot be nverted and the Cournot-Nash equlbrum cannot be analyzed. 4

5 framework of horzontal dfferentaton, snce emprcal studes showed that consumers have ther own preferred locus on the ethcal segment, and do not necessarly prefer to have more CSR than less. Others (Mtrokostas and Petraks [007] among others) are favorable to a framework of vertcal dfferentaton (.e. more CSR s better for everyone). 5 Our opnon s that, even f t s true that consumers mght have dfferent preferred locatons on the ethcal segment wth respect to the dfferent aspects of CSR consdered separately (e.g. envronmental protecton, labor standards, gender ssues, etc.), when CSR s consdered n an holstc way t seems qute unrealstc to assume that there are consumers whch, at a gven prce, prefer to buy the varety of the good wth lower CSR content. For ths reason, n ths paper we adopt a framework of vertcal dfferentaton. 6 The remander of the paper s organzed as follows. Secton presents the basc model, analyses the market equlbrum n terms of the provson of CSR and ntroduces the problem of the locaton choce. Secton 3 presents some exercses of comparatve statcs. Fnally, secton 4 concludes.. The Model We consder a duopolstc market wth two frms ( and ) producng a dfferentated good. The goods produced by the two frms can dffer n ther CSR content.e. the CSR actvtes undertaken by the frms and perceved by ts customers. The CSR content of the good produced by frm, wth =,, s denoted by s, and we assume, wthout loss of generalty, that s s (cf. Trole [988] and Motta [993]). Followng Trole (988) and Motta (993), we suppose that consumers have the same (ndrect) utlty functon, U = υs p, f they buy one unt of the dfferentated good and zero utlty f they do not buy t. In ths expresson, s and p are respectvely the CSR content and the prce of the dfferentated good. We suppose that consumers dffer n ther tastes wth respect to the CSR content of the dfferentated good. The term υ s the consumer's taste parameter, whch can be nterpreted as each consumer's margnal wllngness to pay for CSR. Parameters υ are dstrbuted wth unt densty over the nterval 5 It should be noted that ecchett, n another paper (ecchett, Federco and Solferno [005]), mplctly accepts that there s at least one element of vertcal dfferentaton n CSR, snce n ther paper consumers bear a cost only n case of a downward devaton from ther preferred locaton n term of "ethcal" content of the product, and not otherwse. 6 One possble drawback n applyng Motta (993) s model to the ssue of CSR regards the result of dfferentaton at equlbrum. In fact, whle n Motta (993) at equlbrum the two frms choose dfferent levels of qualty, the emprcal evdence of CSR shows a convergence of frms towards an "ethcal" behavor, at least n the developed world (cf. the concept of "ethcal mtaton" n ecchett, Gallonardo and Tesstore [005]). owever t can be shown (cf. Motta [993]) that, f one ntroduces an upper bound to qualty mprovement and assumes that, when computed at ths level, margnal costs of qualty are not as hgh as margnal revenues, there wll be no dfferentaton at equlbrum, wth both frms choosng a level of qualty equal to the hghest possble level. The assumpton of margnal costs lower than margnal revenues seems qute realstc n the study of CSR. In fact, snce CSR has been exploted only recently as a dfferentaton strategy, t s plausble that each margnal nnovaton yelds very hgh returns, much hgher than the costs. Ths leads the majorty of frms to undertake a smlar level of CSR at equlbrum, correspondng to the current "fronter" of CSR. 5

6 [, ] υ υ, such that υ = υ. Smlarly to Motta (993), we assume that there s no upper bound to the possble level of CSR undertaken by frms, but there s a lower bound to t. 7 Ths can be nterpreted as a mnmum legal requrement for CSR (e.g. a CSR standard) vald all over the world, whch we denote as s 0. 8 Dfferently from Motta (993), we assume that the market s covered at equlbrum, whch means that all consumers buy one unt of the dfferentated good. Ths assumpton has been made for smplcty of the calculus, and could be removed n a follow-up paper. We can defne υ as the taste parameter of the ndvdual whch s ndfferent between buyng the good wth hgher CSR content and buyng the other one. For ths p ndvdual we have υ s p = υ s p, from whch we determne: υ = s p Then, we defne as υ 0 the taste parameter of the ndvdual whch s ndfferent between buyng the good wth lower CSR content and not buyng at all. ence υ0s p = 0. From ths we can fnd υ 0 = p s and derve the aggregate demand functons for goods and : If at equlbrum υ > p s the consumers wth υ [ υ υ ], p q = υ s q p s p p p = s s s s, then we can affrm that the market s covered because all buy good. In order to ensure that postve demands for the two goods exst, we must assume that the condton p s υ ( p p ) ( s s ) < < < υ holds at equlbrum. Wth covered market, the demand functons for goods and are: p p q = υ s s q p p = s s These functons are easer to use than those wth uncovered marked [] but, as prevously sad, they have the drawback that they can t be nverted n order to study the Cournot-Nash equlbrum. Therefore, only the ertrand-nash equlbrum wll be studed n ths paper. υ. [] [] 7 Several authors, followng McWllams and Segel (00) argue that there s an upper bound to the level of CSR whch can be undertaken by a frm. Ths level corresponds to the pont when one addtonal "unt" of CSR does not brng any addtonal beneft to the socety because of saturaton. owever for smplcty we prefer to follow the orgnal framework used by Motta (993). 8 An example of ths mnmum global standard for CSR could be UN Global Compact, the world's largest CSR framework. The UN Global Compact comprses ten prncples drawn from declaratons whch have been adopted by the majorty of countres n the world (the 948 Unversal Declaraton of uman Rghts, the 998 ILO Declaraton on Fundamental Prncples and Rghts at Work, or the 99 Ro Declaraton on The Envronment and Sustanablty). 6

7 The decson process of the two frms can be represented as a three-stage game. At the frst stage, frms choose ther locaton, n country A ("North") or n country ("South"). At the second stage, frms choose the level of CSR ( s ) smultaneously. Fnally, at the thrd stage, a compettve process occurs and frms choose prces smultaneously, determnng ndrectly the equlbrum quanttes of the two goods. The game s solved by backward nducton. The followng assumptons have been made: 9 Assumpton : υ υ. Ths ensures that there s a suffcent degree of heterogenety among consumers (cf. Trole [988]). Note that, snce υ = υ (cf. page 5), we must have 0< υ < and < υ <. Assumpton : ( )( ) equlbrum. Assumpton 3: υ υ s s 3< υ s. Ths ensures that the market s covered at s * * * s. Snce we have assumed that s s (cf. page 5), ths condton * * must also be verfed at equlbrum... Marketng stage Usng backward nducton, we frst study the last stage of the game, n whch frms choose prces subject to ther prevous choces of CSR and locaton. We assume that there are only fxed costs of CSR and no varable costs. In other words, varable costs of producton do not depend on the level of CSR ( s ), whereas fxed costs depend on t. The assumpton that the costs of CSR are fxed and do not depend on the level of producton can be justfed by the fact that n most cases these are up-front costs for a frm and only a smaller amount of them depends on the level of producton. ence, at the last stage of the game, the costs of CSR have already been sunk and there are only constant margnal costs of producton. Wthout loss of generalty, we assume that these costs are equal to zero. The study of the sub-game perfect Nash equlbrum at ths stage gves the followng results. Proposton. At the thrd stage of the game, frm sets a hgher prce and produces a larger output than frm. ence, at equlbrum there s one frm (.e. the "ethcal" frm) that sells to the most ethcal consumers, chargng a hgher prce than the other one (.e. the "neutral" frm), whch sells to the rest of consumers. 9 These assumptons regard the possble values of the exogenous parameters n the model. owever Assumpton and Assumpton 3 have been expressed usng the terms * s and * s, whch are the levels of CSR chosen by, respectvely, frm and frm at equlbrum (cf. sub-secton.). These are not exogenous varables per se, but are functons of the exogenous varables n the model (see Appendx). owever we preferred to express Assumpton and Assumpton 3 n ths way for smplcty of notaton. 7

8 Proof. The expressons for the two frms' profts, wth margnal costs of producton equal to zero, are: p π= p υ s π p p p s = p s s υ Each frms maxmze ts proft n the prce level. In order to determne the Frst Order Condtons (FOCs) for maxmzaton, we compute the dervatves of profts wth respect to prces and set them equal to zero: p p υ + = 0 s s [4] p p υ = 0 s s Solvng these expresson for the prces, we obtan the reacton functons of the two frms: p p ( ) p υ s s = p + υ s s = ( ) As expected, these reacton functons show that the prces of the two goods are strategc complements, snce each prce s an ncreasng functon of the other,.e. an ncrease of p makes t more proftable for frm to ncrease ts prce (cf. Varan [99]). After verfyng that also the Second Order Condtons are respected, we solve the system of the reacton functons of the two frms and we fnd the level of the two prces at the ertrand- Nash equlbrum: p * p * = = ( s s )( υ υ ) ( s s )( υ υ ) ence, at the last stage of the game, frms set prces at values gven above. Snce υ = υ and < υ < (cf. Assumpton ), t follows that υ υ > υ υ. ence, prces are postve at equlbrum. Snce quanttes are gven by the demand functons [] t s useful to calculate equlbrum: p 3 3 ( s s )( υ + υ ) p * * [3] [5] [6] > p and both p p at the * * * * p = [7] ence, at equlbrum prces, the outputs of goods and are, respectvely: * υ υ * υ υ q = ; q = [8]

9 Once agan, snce υ = υ and < <, we have υ υ > υ υ, and thus q υ Assumpton ( υ υ ) ensures that the output of frm s postve. > q. * * Fnally, t s nterestng to note that the outputs of the two frms at the ertrand-nash equlbrum depend only on the dstrbuton of consumers and not on the levels of CSR decded at the second stage of the game (see expressons [8])... The choce of CSR levels Now we can study the second stage of the game,.e. the choce of the level of CSR embedded n the good sold. Frms maxmze ther profts subject to ther prevous choce of locaton. Profts are gven by revenues, computed at the ertrand-nash equlbrum, less costs and can be wrtten as follows: * * F π = p q S s wth =, [9] We have prevously assumed that varable costs of producton are null. All costs are fxed, and come from two dfferent sources. The frst component s gven by S, whch corresponds to the costs of complance wth the labor standards and the envronmental regulatons, exstng n the country where the frm s located. ence, S depends only on the choce of the country of locaton by the frm and at ths stage of the game S s taken as gven snce the locaton s chosen n the frst stage of the game. The second component s gven by ( F ) s. These costs depend on the level of CSR undertaken by the frm and can be consdered as fxed costs wth respect to the quantty of the good sold by the frm. For these costs we assume a quadratc form, as often made n the lterature on vertcal dfferentaton (D Aspremont et al. [979]). Ths seems a realstc assumpton n the context of CSR. In fact, the frst "unts" of CSR are the least costly because a frm can drect ts efforts to the easly-achevable targets (the "low-hangng fruts"). Afterwards, the costs of addtonal nterventons ncrease, untl the frm comes to a pont when addtonal "unts" of CSR becomes extremely expensve. 0 These costs should be nterpreted as the costs of makng CSR "vsble" to the consumers and not only as the costs of "dong" CSR. In fact, CSR has to be somehow vsble n order for the parameter s to enter the consumers utlty functon and nduce the consumers to pay a hgher prce for the good. ence, we can refer to costs of makng t "vsble" to consumers. s as the "evdent" CSR, and by reflecton ( F ) s wll be the 0 For more detals see McWllams and Segel (00), usted and Salazar (006). It should be noted that s are unts of CSR, and not monetary costs for the frm, as t s for In practcal terms, we can dentfy these cost as the costs of mplementaton plus the costs of advertsng and promotng CSR towards the external envronment. In the exstng lterature on CSR ths second component of the costs (.e. advertsng and promotng CSR) has been set equal to zero snce, for large frms n partcular, they are not very sgnfcant (cf. Manasaks, Mtrokostas and Petraks [007]). owever n our paper we do not set them S. 9

10 From the study of the second stage of the game we can conclude the followng. Proposton. At the second stage the game, frm undertakes a level of CSR equal to ( υ υ ) * s =, whle the other frm sets ts level of CSR to the mnmum requred by 9F nternatonal standards (.e. s = s ). ence, at equlbrum there s dfferentaton n the levels * 0 of CSR, wth frm (.e. the ethcal frm) whch sets a level of CSR hgher than frm (.e. the neutral frm). 3 Proof. Usng the expressons of the prces and quanttes at the ertrand-nash equlbrum, we can wrte the profts of the two frms: π ( )( υ υ ) s s F = s S 9 ( )( υ υ ) s s F π = s S 9 These need to be maxmzed wth respect to the level of CSR. As regards frm, we can easly see that π decreases monotoncally n s. ence, frm wll always set CSR at the mnmum level allowed, s = s. 4 0 As regards frm, the FOC to maxmze π s the optmal level of CSR: ( υ υ ) * s =. 9F * [0] υ υ F s = 0 3, from whch we can derve Assumpton 3 ( s * s * ) ensures that at equlbrum frm sets a hgher level of CRS than frm, (.e. the equlbrum wth dfferentaton emerges). 5 There s only one case n whch the two frms at equlbrum set the same level of CSR, equal to the mnmum nternatonal standard (.e. the equlbrum wth no dfferentaton emerges). 6 equal to zero, because one of our objectves s precsely to see what happens when these costs dffer from one country to another. 3 Among the values authorzed by Assumpton 3, there s only one case n whch the equlbrum wth dfferentaton does not occur, whch s when the mnmum nternatonal standard s 0 (whch s fxed exogenously n our model) s equal to ( υ ) υ 9F. In ths case, snce the nternatonal standard s set at exactly the same level as the level chosen by frm, the two frms undertake the same level of CSR. ence, the equlbrum wth no dfferentaton emerges,.e. both frms set the level of CSR equal to the mnmum nternatonal standard s 0. owever, we do not take nto consderaton ths case n the remander of the paper, snce t occurs for one and only one partcular combnaton of the exogenous varables. 4 Of course ths result would be dfferent f we dd not make the assumpton that the market s covered. In fact when the market s covered consumers always buy the good and, snce there are costs attached to CSR, the optmal strategy for the second frm s always to set CSR equal to the mnmum level requred by law. 5 It s worth notng that the degree of dfferentaton emergng at equlbrum s not the maxmum possble, snce we have assumed quadratc fxed costs of CSR and no upper boundary for CSR. 6 See Appendx and note 3 (above) for more detals. 0

11 It s nterestng to note that the optmal level of CSR for the "ethcal" frm decreases n the costs of makng CSR "vsble to the consumers ( F). We wll see n the followng subsecton that these costs depend on the frm s locaton choce, whch s made n the frst stage of the game. On the other hand, the optmal level of CSR for the neutral frm does not depend on ts locaton choce, snce t s always set at the mnmum level allowed. ence, the lower the costs for the "ethcal" frm of makng CSR "vsble to the consumers, and the lower the mnmum nternatonal standard, the hgher wll be, at equlbrum, the degree of dfferentaton between the two frms n the provson of CSR..3. The Choce of Locaton Let's now turn to the frst stage of the game,.e. the choce of locaton of the two frms. There are two countres n whch frms can locate, denoted as A and. We assume that the costs of complance wth local norms and regulatons and the costs of makng CSR "vsble" to the consumers depend on the choce of locaton n one country or the other, such that: S = SA and F = FA f the frm s located n country A; S = S and F = F f the frm s located n country. y defnton, Sdepends on the country of locaton, because t represents the costs of complance wth country-specfc norms and regulatons. In addton, we assume that also F depends on the country of locaton, and n partcular that S and F are mutually dependent across countres. In fact, a frm that produces n a country wth very low labor and envronmental standards (low S ) wll probably ncur n hgh costs of makng a gven level of CSR "vsble" to ts customers (hgh F), as a result of the lack of transparency, relable ndcators, nfrastructure, accountable Cvl Socety Organzatons (CSOs) to partner wth, etc. In partcular, these costs should be hgher than those that the same frm would face n a country characterzed by hgh labor and envronmental standards, where t would be relatvely easy for a frm to credbly commt on certan CSR actvtes and also relatvely cheap to partner wth other enttes on CSR projects, explotng the exstng socal network. In concordance wth ths assumpton on the relatonshp between S and F across countres, n our model we assume that the costs of complance wth local norms and regulatons are hgher n country A than n ( S A > S ), whle the costs of makng CSR "vsble" to the consumers are lower n A than n ( F A < F ). Thus, we can refer to country A as "North" and to country as "South". One mportant remark s that n our model we assume that there s no cross-country heterogenety n the dstrbuton of consumers tastes for CSR, and no transport costs. Ths could represent a stuaton n whch frms and are constraned to produce n country A or, but sell ther products all over the world, and the demand for ther products comng from the rest of the world s overwhelmng wth respect to the demand comng from countres A and. 7 We made ths assumpton because the man objectve of our paper s to 7 An example of ths could be the ol market, n whch frms are constraned to produce n certan countres where the ol s present, but often sell only a small part of ther products n ths countres.

12 study how the "costs" of CSR n dfferent countres nfluence the choce of locaton of frms, n the smplest framework as possble. A further paper could nvestgate these ssues n a more sophstcated context, ntroducng transport costs and heterogenety n the dstrbuton of consumers tastes across countres. From the study of the thrd stage of the game we can conclude the followng. Proposton 3. The profts of frm (.e. the "neutral" frm) are always hgher when frm (.e. the "ethcal" frm) settles n the country where the costs of makng CSR "vsble"( F) are lower (.e. country "North"). The profts of the "ethcal" frm are unaffected from the choce of locaton of the "neutral" frm, snce t antcpates that the latter wll always undertake a level of CSR equal to the mnmum nternatonal requrement s 0. Proof. If we substtute the optmal levels of CSR (see Proposton ) n the expressons [0], we obtan the expressons of the profts at the second stage equlbrum: π ( υ υ ) ( υ υ ) ( υ υ ) 4 = s0 S 9 9F 6F ( υ υ ) ( υ υ ) F π = s0 s0 S [] 9 9F The expressons above prove that the profts of frm (the"ethcal" frm) are not affected by the choce of locaton of frm (snce they do not depend nether on F nor on S ), whle the profts of frm (the"neutral" frm) depend on the choce of locaton of frm. In partcular, from expresson [] we can deduce that, n every case, frm prefers that frms settles n country A, where F s smaller (snce the profts of frm depend negatvely on F). In fact, a lower F leads the "ethcal" frm to undertake a hgher level of CSR and charge a hgher prce for good. Ths, n turn, relaxes the competton at the marketng stage of the game, allowng the "neutral" frm to charge a hgher prce for good too. Fnally, t s worth notng that both frms profts depend negatvely on s 0. In fact, when the mnmum nternatonal CSR standard ncreases, there s less room for dfferentaton for the two frms, thus the competton at the marketng stage of the game s fercer and both frms have to reduce the prces at equlbrum (see equaton [3], consderng that, at equlbrum, * s = s ). 0 Proposton 4. The locaton choce of the "ethcal" frm depends on the costs of complance wth local norms and regulatons ( S), on the costs of makng CSR "vsble"( F) n the two countres, and on the dstrbuton of consumers tastes for CSR, but not on the of the mnmum nternatonal standard for CSR ( s 0 ). The locaton choce of the "neutral" frm nstead depends on the level of S and F n the two countres and on the level of the mnmum nternatonal standard for CSR ( s 0 ), but not on the dstrbuton of consumers tastes for CSR. [] Proof. We defne π j, wth =, and j= A,, as the profts attaned by frm when t settles n country j. These depend on the values of S and F n each country. Each frm

13 chooses to settle n the country where t acheves hgher profts. ence, frm chooses to settle n country A (country ) when: π > ( < ) π [4] A And frm chooses to settle n country A (country ) when: π > ( < ) π [5] A Let's study the choce of frm ( the "neutral" frm) frst. As prevously sad the profts of frm depend on the choce of locaton of frm (snce they depend on F, see condton []). owever, when frms nteract strategcally to choose ther locaton, the choce of frm s not affected by the choce of frm. In partcular, we can derve from condtons [] and [5] that, for any locaton of frm, frm wll settle n country A (country ) f: s0 SA S < ( > ) ( F FA) [6] As regards the "ethcal" frm, we can derve from condtons [] and [4] that frm wll settle n country A (country ) f: Proposton 4 follows. 4 ( υ υ) ( ) SA S < ( > ) F FA [7] 6F F The followng consderatons can be deduced from condtons [6] and [7]. Condton [6] mples that the "neutral" frm wll settle n the country wth strcter regulatons (.e. country A, or "North") only f the dfference n the costs of complance wth local regulatons ( S A S ) s more than compensated by the lower costs of undertakng a level of CSR equal to the mnmum nternatonal standard level ( s 0 ). On the contrary, f the dfference n the costs of complance wth local regulatons s large "enough", the "neutral" frm wll settle n country ("South"). From condton [6] t s evdent that, the lower the mnmum nternatonal CSR standard s 0, the more lkely frm wll settle n country "South", snce even a small dfference n the costs of complance wth local norms wll nduce the frm to settle there. Ths help us understand the general reluctance of developng countres to set and adopt strct nternatonal CSR standards. These countres often beneft from large amounts of FDIs from developed economes, and one of the reasons of the attractveness of developng countres for FDIs s that they are usually characterzed by looser norms and regulatons n the areas of labor and the envronment then developed ones. Wth respect to ths, condton [6] tells us that an ncrease n the nternatonal CSR standards would reduce the ncentves of all the "neutral" frms to locate ther producton n the countres characterzed by looser norms. As regards the locaton choce of the "ethcal" frm, condton [7] mples that frm wll settle n country ("South") f the dfference n the costs of mplementng local norms S S ) s large enough to counteract the hgher costs of makng CSR "vsble" to the ( A consumers than n country A. Ths condton s sgnfcantly dfferent from condton [6]: s does not enter nequalty [7], mplyng that the mnmum nternatonal CSR standard 0 A 3

14 does not affect the choce of locaton of the "ethcal" frm 8 and there s a term, ( υ υ )4, 6F F whch depends from consumers' preferences for CSR. Snce we assumed that consumers are dstrbuted unformly wth unty densty, υ s equal to can be wrtten as ( ) 4 υ. υ +, whch depends only on υ (see page 5) so ( υ υ ) 4 A ence, the hgher υ, the larger must be the dfference n local regulatons ( S A S ) n order to nduce the "ethcal" frm to settle n the country wth looser local regulatons (.e. country "South"). The parameter υ has dfferent nterpretatons. Frst of all, t can be nterpreted as the average consumers "preference" for CSR: the hgher υ, the more "ethcal" are the consumers on average. 9 Secondly, ths parameter also captures the heterogenety n the υ υ "ethcal preferences" of the consumers. Ths can be shown easly. The rato = υ υ measures the heterogenety n consumers' preferences for CSR. Snce 0< υ < and υ < < (cf. Assumpton ), the rato ( ) υ υ s a monotoncally decreasng functon of υ. 0 ence, the hgher υ, the more homogenous are consumers preferences for CSR. A fnal consderaton that can be made, s that condtons [6] and [7] suggest at least one possble way for developng countres to attract FDIs (.e. to attract both the "neutral" and the "ethcal" frms n our model). Ths would be to reduce F (.e. the costs of makng CSR "vsble" to consumers), n order to cut the dfference between F and F A. For ths purpose, developng countres should ntroduce the necessary reforms to facltate the practce of CSR and ncrease ts vsblty. Examples of these nterventons are the promoton of Publc and Prvate Partnershps (PPPs), of a socal network prone to CSR nterventons, and of systems allowng to ncrease the relablty of CSOs, such as the Cvl Socety Informaton System (CSIS) recently ntroduced n some developed countres (e.g. USA and Germany). 8 Ths result can be somehow compared to the case of an nnocuous mnmum standard (see Garella [007]). In the CSR lterature, the case of a standard whch s lower than the level of CSR already undertaken by frms, has been ncdentally analyzed by esley and Gathak (007) and rekke and Nyborg (004). 9 Snce υ and υ are lnked one to the other by a determnstc relatonshp, when υ ncreases, υ has to ncrease. 0 In fact, υ = = υ υ υ υ. Lookng at condtons [6] and [7], there s of course another strategy to attract FDIs, whch s to reduce further local norms and regulaton n the areas of labor and the envronment ( S ). Leavng asde all possble ethcal consderatons on the opportunty of dong so, t should be noted that, n any case, all the frms located n whatever country have to comply wth the mnmum nternatonal CSR standard. ence, ths consttutes a sort of lower bound for the countres n the process of reducng S, thus lmtng ther possbltes of relaxng labor and envronmental legslaton as a way to attract more FDIs. 4

15 3. Comparatve Statcs Let's turn now to some consderatons of comparatve statcs. We start from an ntal stuaton where both frms are located n country A ("North"), and then analyze the effects of possble varatons of the mnmum nternatonal CSR standard ( s 0 ) and of consumers' preferences for CSR ( υ ). The fact that both frms are located n country A mples that the exogenous varables respect the followng condtons: s0 SA S < ( F FA) [8] 4 ( υ + ) ( ) SA S < F FA [9] 6F F Condtons [8] and [9] ensures that, respectvely, frm (the "neutral" frm) and frm (the "ethcal" frm) settle n country A ("North"). In fact, when the exogenous varables S A, S, F A, F and s0respect condton [8], frm attans a hgher proft by settlng n country A than n country. On the other hand, when the exogenous varables S A, S, F A, F and υrespect condton [9], frm attans a hgher proft by settlng n country A than n country. We analyse frst the effects of an exogenous varaton of s 0. A varaton of s 0 does not affect the relatve attractveness of the two countres for frm (see condton [9]), hence t does not nfluence the locaton choce of the "ethcal" frm. Otherwse, t affects the relatve attractveness of the two countres for frm n the followng way (see condton [8]): an ncrease of s 0 makes country "North" even more attractve for the "neutral" frm, whle a decrease of t ncreases the relatve attractveness of country wth respect to A and, f ths decrease s large enough to nvert the sgn of nequalty [8], t wll nduce the "neutral" frm to relocate n country "South". ence, the overall effect of an ncrease of the nternatonal mnmum CSR standard s0 on the locaton of frms s the status quo (.e. both frms stay n country A). On the other hand, a sgnfcant reducton of s 0 could lead the "neutral" frm to relocate n country "South". In fact, as a result of the reducton of the mnmum nternatonal CSR requrement, frm undertakes less CSR at equlbrum, and thus the costs attached to CSR become less relevant relatvely to the costs of complance wth local labor and envronmental regulatons, n determnng the locaton choce. Then, we analyse the effects of an exogenous varaton of υ. We need to recall that an ncrease (decrease) of υ ndcates an ncrease (decrease) of the average consumers "preference" for CSR, and also a reducton (augmentaton) of the heterogenety of these preferences (see page 4). In more practcal terms, an ncrease of υ depcts the evoluton from an ntal stuaton n whch only a few consumers care about the "ethcal" behavor of frms and these consumers are concentrated n a few areas of the world, whle the majorty does not care or s smply unaware of the ssue, towards one n whch more people are aware of CSR and care about t when choosng where to shop. A reducton of υ nstead A 5

16 could result from the ncreased buyng power of consumers from developng countres, whch are usually less concerned about ethcal ssues when choosng where to shop. Ths reduces the average "preference" for CSR globally and ncreases the heterogenety of consumers preferences. In our model, a varaton of υ does not affect the relatve attractveness of the two countres for frm (see condton [8]), hence t does not nfluence the locaton choce of the "neutral" frm. Otherwse, a varaton of υ affects the relatve attractveness of the two countres for frm n the followng way (see condton [9]): an ncrease of υ makes country "North" even more attractve for the "ethcal" frm, whle a reducton of t ncreases the relatve attractveness of country wth respect to A and, f ths decrease s large enough to nvert the sgn of nequalty [9], t wll nduce the "ethcal" frm to relocate n country "South". ence, the overall effect of an ncrease of υ (.e. the average consumers preference for CSR ncreases and the dstrbuton of these preferences s less heterogeneous) s the status quo (.e. both frms stay n country "North"). On the other hand, a sgnfcant decrease of υ could lead the "ethcal" frm to relocate n the country wth the loosest labor and envronmental norms (.e. country "South). In fact, as a result of the lower consumers preference for CSR and the ncreased heterogenety of ther preferences, frm reduces ts level of CSR at equlbrum, and thus costs of complance wth local regulatons become more relevant relatvely to the costs attached to CSR, n determnng the locaton choce. Interestngly, the "neutral" frm stays n country "North", despte the strcter regulatons n that country wth respect to "South". We could repeat ths exercse startng wth dfferent ntal stuatons. For example one nterestng case s when the "ethcal" frm s ntally located n country "North" whle the "neutral" frm s n country "South". In our model, ths mples that the exogenous varables respect the followng condtons: s0 SA S > ( F FA) [0] 4 ( υ + ) ( ) SA S < F FA [] 6F F Condtons [0] and [] determne that, respectvely, frm (the "neutral" frm) settles n country ("South") and frm (the "ethcal" frm) settles n country A ("North"). A Ths s a stuaton whch we often observe n realty, and could be determned by some elements whch we dd not take nto consderaton n our model: the possble heterogenety of consumers preferences for CSR across countres and the exstence of transport costs (see page for a dscusson of ths ssue). In fact, f the average consumers preferences for CSR are dfferent across countres and there are transport costs, the two frms mght fnd t more proftable to serve prevalently the local market, undertakng a level of CSR whch reflects the average preferences of ther local customers. For example, companes n developng countres, where consumers are usually less concerned about CSR, could decde to undertake a lower level of CSR than ther counterparts located n developed countres, where the sophstcaton of consumer s demand s hgher. Ths s what typcally happens to the small and medum enterprses n developng countres, whch, unless they are part of the supplychan of large multnatonal companes, produce goods that are sold locally and thus are not affected by the preferences of global consumers and consumers n other areas of the world. 6

17 Startng from ths ntal stuaton, the overall effect of a reducton of the nternatonal mnmum CSR standard s0 on the locaton of frms s the status quo (.e. the "ethcal "frm stays n country "North" and the "neutral" n "South"). Otherwse, an ncrease of s 0, f t s large enough to nvert to nvert the sgn of nequalty [0], leads the "neutral" frm to relocate n country "North". In fact, as a result of the tghtenng of the nternatonal CSR standard, the costs of undertakng ths new level of CSR requred ncrease more n the country where CSR s more expensve (.e. country "South") than n the other one (.e. country "North"), hence the relatve attractveness of country "North" for the "neutral" frm ncreases. Fnally, the effects of a varaton of υ are smlar to the ones analyzed n the prevous stuaton. In fact we have seen that a varaton of υ affects only the relatve attractveness of the two countres for the "ethcal" frm, whch s located n the same country as n the prevous case (.e. country "North"). 4. Conclusons We developed a model of CSR as a dfferentaton strategy for the frms, adaptng Motta (993) s model of vertcal dfferentaton to the ssue of CSR. In the market there are two frms and a group of global consumers, exhbtng a preference for CSR whch s unformly dstrbuted wth unt densty. We ntroduced quadratc costs of CSR, whch can be nterpreted as the costs of undertakng CSR and makng t "vsble" to the consumers. Other costs for the frms are the costs of complance wth country-specfc labor and envronmental regulatons. All these costs are fxed wth respect to the level of the outputs. Fnally, there s an exogenous mnmum nternatonal CSR standard, whch s appled worldwde regardless of the country of locaton of the frms. In ths context, we showed that, when the market s covered and frms compete à la ertrand, the two frms choose dfferent levels of CSR at equlbrum. One frm (the "ethcal" one) undertakes a postve level of CSR, whch depends negatvely on the costs of CSR, targetng the more ethcal consumers; the other (the "neutral" frm) undertakes a level of CSR equal to the mnmum nternatonal requrement. The "ethcal" frm sells at a hgher prce than the "neutral" one, and produces a larger output. Then, we ntroduced the possblty for the frms of choosng between two countres of locaton. One country ("North") has strcter labor and envronmental regulatons than the other ("South"), whch translate n hgher fxed costs of producton for the frms. owever n country "North" the costs of undertakng CSR and makng t "vsble" to consumers are lower than n country "South". We showed that the profts of the "neutral" frm are always hgher when the "ethcal" frm settles n country "North". Nonetheless, the choce of locaton of the "neutral" frm does not depend on the locaton of the "ethcal" frm. Fnally, startng from dfferent ntal locatons of the two frms, we analyzed the effects of a change of the mnmum nternatonal CSR standard and of consumers' preferences for CSR. We showed that a change of the nternatonal CSR standard could affect the locaton choce of the "neutral" frm, whle a varaton of consumers' preferences for CSR (.e. a varaton of the average preference for CSR of the global consumers and of 7

18 the heterogenety of these preferences) mght have an mpact on the locaton choce of the "ethcal" frm. In partcular, a sgnfcant ncrease (decrease) of the nternatonal CSR standard can determne the relocaton of the "neutral" frm from country "South" to country "North" (from country "North" to country "South"), and an ncrease (decrease) of the average preference for CSR can determne the relocaton of the "ethcal" frm from country "South" to country "North" (from country "North" to country "South"). In concluson we would lke to pont out some of the lmts of our approach. In our paper we dd not address the ssue of the CSR "neutralty" on profts (cf. McWllams and Segel [00]), snce we could not solve the equaton of the frms profts for a unque range of the parameters. In addton, as prevously mentoned, n our model we assumed that there s a generc arena of global consumers, wthout takng nto consderaton transport costs and possble cross-country heterogenetes n the dstrbuton of consumer s tastes for CSR. It would be nterestng to analyze the effect of ntroducng dfferent hypotheses, such as for example dfferent average preferences for CSR n the two countres and postve transport costs, nducng frms to sell most of ther producton locally. We consder ths paper as the startng pont for future research n ths drecton, wth the addtonal objectve of studyng the trade patterns between the two countres. Appendx. Parameters values allowed n the model. The followng condtons can be derved, respectvely, from Assumptons and 3 (see * * page 7), when we substtute the equlbrum values of s and s determned at the second stage of the game (see Proposton ): s 0 > ( υ υ) ( υ υ ) 9F ( υ + υ ) s 0 ( υ υ ) [] [3] 9F From condtons [] and [3], one can deduce that the mnmum CSR standard ( s 0 ) must be wthn the followng range of values, expressed n terms of the other exogenous varables n the model: ( ) ( ) F ( υ + υ ) ( ) υ υ υ υ υ υ < s 0 9 9F It should be noted, however, that F s not exogenous per se, but at equlbrum t depends on the locaton choce of frm. In partcular, t s hgher (lower) when frm settles n country (A), snce we have assumed that FA < F(cf. page ). In the paper we have seen that, dependng on the values of the exogenous varables, at equlbrum frm could settle ether n country A or n country. ence, condton [4] must hold n both cases (.e. for F = FA and F = F). Fnally, one should note that a necessary condton for ths nequalty to hold s the followng: υ υ υ + υ. Snce υ = υ +, that s equvalent to: υ. [4] 8

19 blography Amacher, Gregory S., Koskela, Erkk and Markku Ollkanen (004), Envronmental Qualty Competton and Eco-Labelng, Journal of Envronmental Economcs and Management, Vol. 47, pp albon, Fabo, Charles-Soveral, Wayne and rgtte Levy (008), New Perspectves on Corporate Socal Responsblty, Carbbean Development Revew, Issue N., UNECLAC, pp agnol, Mark and Susan G. Watts (003), Sellng to Socally Responsble Consumers: Competton and the Prvate Provson of Publc Goods, Journal of Economcs and Management Strategy, Vol., pp aron, Davd P. (00), Prvate Poltcs, Corporate Socal Responsblty, and Integrated Strategy, Journal of Economcs and Management Strategy, Vol., pp aron, Davd P. (007), Corporate Socal Responsblty and Socal Entrepreneurshp, Journal of Economcs & Management Strategy, Vol. 6, pp aumol, Wllam J. (99), (Almost) Perfect Competton (Contestablty) and usness Ethcs, n aumol W.J. and lackman, S.A.. (99) (Eds) Perfect Markets and Easy Vrtue: usness Ethcs and the Invsble and, Cambrdge, MA, lackwell Publshers. ecchett, Leonardo and Furo Camllo Rosat (005), Globalzaton and the death of dstance n socal preferences ad nequty averson: emprcal evdence from a plot study on far trade consumers, Workng Paper N. 09, CEIS, Unversty of Tor Vergata, Rome. ecchett, Leonardo, Gallonardo, Lusa and Mara Elsabetta Tesstore (005) Corporate Socal Responsblty and Proft Maxmzng ehavour, Workng Paper N. 9, CEIS, Unversty of Tor Vergata, Rome. ecchett, Leonardo, Federco, Gorgo and Nazara Solferno (005), The Game of Socal Responsblty: A Product Dfferentaton Approach, Workng Paper N. 5, Cleonp, Unversty of Forlì. esley, Tmothy and Matreesh Ghatak (007), Retalng Publc Goods: The Economcs of Corporate Socal Responsblty, Journal of Publc Economcs, Vol. 9, pp oom, Annette (995), Asymmetrc Internatonal Mnmum Qualty Standards and Vertcal Dfferentaton, The Journal of Industral Economcs, Vol. 43, pp onanno, Gacomo (986), Vertcal dfferentaton wth Cournot Competton, Economc Notes, Vol. 5, pp rekke, Kjell A. and Karne Nyborg (004), Moral azard and moral motvaton: Corporate Socal Responsblty as labour market screenng, Memorandum n 5/004, Department of Economcs,Unversty of Oslo. Coller, Jane and Rafael Esteban (007), "Corporate Socal Responsblty and Employee Commtment", usness Ethcs: A European Revew, Vol. 6, N., pp