Corporate Social Responsibility and Asset Pricing in Industry Equilibrium Rui Albuquerque Boston University, CEPR and ECGI Art Durnev University of Iowa Yrjö Koskinen Boston University and CEPR
What is CSR? Definition of CSR (FT Lexicon): Corporate social responsibility is a business approach that contributes to sustainable development by delivering economic, social and environmental benefits for all stakeholders We are interested in CSR to the extent that consumers find it valuable
This Paper CSR as a part of firm s profit maximization CSR as investment in customer loyalty We build a theoretical model Demand less sensitive to economic conditions Cheaper for some firms to produce CSR goods Imperfect competition firms have pricing power
This Paper Empirical implications Systematic risk and expected returns Behavior of profits over the business cycle Impact of CSR on non-csr firms Testing of implications U.S. and international firm-level data
Our Contribution The extant literature on CSR and asset pricing has concentrated on expected returns The research has been largely empirical and lacking rigorous foundations We focus on how CSR affects risk and we build a theoretical model making the link between CSR and risk explicit
Model Intuition Consumers allocate money between CSR and non-csr goods CSR-goods have lower price elasticity of demand - Demand less sensitive to price changes Firms decide to produce either CSR or non-csr goods Fixed costs for producing CSR goods differ Free entry Firms enter CSR market until the marginal firm is indifferent Monopolistic competition Firms have pricing power Less competition in CSR markets - producing CSR goods yields higher operating margins
Model Intuition Early entrance to CSR market: firms with low fixed costs Low operating leverage leads to lower systematic risk, hence lower expected returns Countervailing effect Entry to CSR market lowers profits Later entrants have higher fixed costs Higher operating leverage, lower margins lead to higher systematic risk, higher expected returns Overall effect on systematic risk depends on how much consumers spend on CSR goods
Comparative Statics Fraction of CSR firms, Stock price, Q P 0.118 0.116 0.114 0.112 0.11 0.108 0.4 0.45 0.5 0.55 0.03 0.025 0.02 0.015 0.01 0.4 0.45 0.5 0.55 Mean excess returns (%) Wage rate, w 2.5 E(r G - r) E(r P - r) 0.51 0.5 Recessions Expansions 2 0.49 1.5 0.48 0.47 1 0.46 0.5 0.4 0.45 0.5 0.55 Elasticity of substitution, G 0.45 0.4 0.45 0.5 0.55 Elasticity of substitution, G
Comparative Statics Fraction of CSR firms, Stock price, Q P 0.24 0.22 0.2 0.18 0.16 0.14 0.12 0.05 0.1 0.15 0.2 0.15 0.1 0.05 0.05 0.1 0.15 Mean excess returns (%) Wage rate, w 1.4 1.2 E(r - r) G E(r - r) P 0.45 Recessions Expansions 1 0.8 0.4 0.6 0.35 0.4 0.2 0.3 0.05 0.1 0.15 Expenditure share, 0.05 0.1 0.15 Expenditure share,
Empirical Implications Increased firm-level CSR is associated with lower firm-level systematic risk The effect should be stronger for differentiated and consumer goods The ratio of CSR firm profits relative to non-csr firm profits decreases in business cycle expansions Increased industry CSR is associated with lower risk for non-csr firms
Data MSCI's Environmental, Social and Governance (ESG) database: coverage for main international companies that constitute the following major international stock indices: MSCI World, MSCI Emerging Markets, ASX 200, and FTSE 350 U.S. stock return and accounting/ownership: CRSP, Compustat, and Spectrum International: Datastream, Worldscope Other: World Bank's World Development Indicators, ICRG
Countries
Industries
Empirical Strategy For every firm, we estimate yearly β:s Time-series regression on excess returns using weekly data Estimated β as the dependent variable Cross-sectional regression with yearly data
Results The level of systematic risk is significantly lower for firms with higher CSR score (-0.213) Economically, this effect is significant. One standard deviation increase in the CSR score (0.860) decreases beta by 0.183 Larger effect for firms that produce differentiated or consumer goods
Results The ratio net income of 1st to 4th quartile CSR firms negatively associated with GDP growth Profits for high CSR firms grow less in expansions Median β for 4th quartile CSR firms negatively associated with industry CSR score Not statistically significant
Beta and Profits: U.S. Sample
Differentiated and Consumer Goods
Beta and Profits: International Sample
Results Expected returns lower for CSR firms Control for β, since CSR may not subsume all systematic risk Increase in latter period and with economic expansions
Expected Returns: U.S. Sample
Expected Returns: International Sample
Reverse Causality Potential problem: low risk firms may adopt CSR policies (reverse causality) Take first differences, use lagged level variables as instruments Indentify shocks that that affect customer loyalty, but not systematic risk Environmental and engineering disasters Product recalls Results are robust
First Differences
IV-results
Conclusions This paper presents an equilibrium asset pricing model to analyze firms' CSR choices and their impact on systematic risk We model CSR as investment in demand loyalty CSR lowers systematic risk Industry equilibrium effects Profits of CSR adopters less correlated with the business cycle Industry adoption of CSR reduces non-adopters' systematic risk Evidence consistent with model predictions
Implications Consumer behavior is important in influencing firm policies and risk CSR as part of product differentiation strategy Capital budgeting β remains major parameter in estimating cost of equity We should expect CSR firms to have lower cost of equity Projects that increase firms' reputation for CSR (e.g., green energy) should be discounted with lower cost of equity