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Ideas for Leaders #740

Doing Good' Does Not Always Improve the Bottom Line

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Key Concept

The inspiring phrase of “doing well by doing good” oversimplifies the connection between corporate social responsibility and corporate financial performance, according to new research that uncover the conditions that can weaken and even destroy the path from CSR to CFP.

Idea Summary

In their research, Afshin Mehrpouya of HEC Paris and Imran Chowdhury of Pace University explore the mechanisms, and importantly the assumptions behind the mechanisms, involved in transforming social responsibility (CSR) into financial performance (CFP). A closer look at those assumptions reveals why socially responsible behaviour is not always reflected in better financial results.

They first identify two broad sets of mechanisms: relational-reputational mechanisms and capabilities mechanisms.

Relational-reputational mechanisms are manifested when the firm’s social responsibility changes the relationship between the firm and its stakeholders. This changed relationships sparks certain behavioural changes on the part of stakeholders that can impact the financial performance of the firm. 

For example, a global firm outsources production to contractors in developing countries who treat their workers extremely poorly. When these working conditions become know, customers of the global firm are appalled, take their business elsewhere, leading to plunging sales for the firm. 

This familiar situation is an example of a market-based relational mechanism, which involves stakeholders that have market-based relationships with the firm, such as investors, suppliers, employees or customers. There is also the institutional relational mechanism, which involves institutional actors not necessarily engaged in market transactions with the firm. Regulatory agencies and non-profit watchdog groups are examples of these institutional actors.

As described above, the process involved in the market-based relational mechanism is straightforward: 1) stakeholders “capture” — discover or learn about — the firm’s social responsibility behaviour; 2) this discovery changes the image of the firm in the eyes of the stakeholders (either positively or negatively); 3) the firm’s new images changes the behaviour of stakeholders; 4) the firm feels the benefits or pain of the stakeholder behaviour on its bottom line.

This process, while familiar, also involves a number of assumptions that may or may not be valid. For example: What if stakeholders don’t have access to the firm’s behaviour? Negative corporate social responsibility actions can be hidden for years.  Or what if stakeholders don’t have the opportunity to change their behaviour toward the firm? If only one company makes the medicine you need to stay alive, there’s not much chance you’ll be able to react to the firm’s negative image. 

Examining these assumptions leads to a number of factors that can undermine or decisively break the link between corporate social responsibility and financial impact. A sample of these factors include:

The separation between supply and demand markets. Many social responsibility problems occur in production. Geographically, production facilities and customers are often located on different sides of the world. While some high-profile cases have travelled from far-away production locations to customers, it’s much easier to keep hidden social responsibility issues when plants are not located in the hometowns or regions of customers.

Vertical disintegration. The B2C brand company whose label adorns the product hides a myriad of B2B companies that consumers have never heard of. A B2B company made the box that holds the brand name detergent. Scores of anonymous B2B companies made the various components of the car sold under a single, hyper-advertised brand. Because these companies hidden in the supply chain are anonymous, they are also immune from the CSR to CFP process described above.

Market consolidation and other sources of market power. For social responsibility to have an impact on financial performance, customers and other stakeholders must be mobile: the must be able to move to another company. Consolidation can take away that mobility: if there are very few-to-no choices for stakeholders, they cannot change their behaviour as they would wish. Customers will have to continue to shop and employees will have to continue to work at the dominant retailer. Economic crises and high unemployment also increase the market power of firms, and their subsequent immunity to any image problems. 

Short-termism. While some highly publicized cases may highlight the short-term financial impact of firm misbehaviour in the CSR domain, the truth is that the financial benefits of socially responsible behaviour is more likely to be long-term. For many companies, however, short-term financial performance is the greater priority. Public companies with activist shareholders feel the pressure to produce short-term results. Companies in distress are also under pressure to generate short-term financial results; when your survival is at stake, the long-term carries little weight. 

These are a sample of factors that highlight the tenuousness of the link between corporate social responsibility and financial performance when considering the market-based relational mechanisms behind the link. 

These and other factors also emerge when Mehrpouya and Chowdhury dissect the institutional relational mechanisms and the capabilities mechanisms that connect CSR to CFP. For example, weak regulatory agencies in a developing country help ensure that poor corporate social responsibility behaviour remains hidden and is therefore never sanctioned — thus disarming the institutional relational mechanism that is supposed to make the firm pay for negative socially responsible behaviour. 

Likewise, the positive impact of corporate social responsibility on employee engagement and productivity is a familiar example of how CSR increases a firm’s capabilities, which in turn improves its financial performance. However, when a company’s workforce is low skilled and easily replaced, negative socially responsible behaviour has no corresponding negative impact on financial performance. 

Business Application

Mehrpouya and Chowdhury are not arguing that CSR does not lead to improved financial performance. They contend, however, that this improvement is conditional on a number of factors. As a result, simply relying on market forces to inspire corporate social responsibility is a mistake. There are too many conditions in which companies will have no market incentive to behave in a socially responsible behaviour. 

In short, translating CSR into a positive financial impact is not as easy as it is sometimes made out to be. However, while certain conditions may disarm the mechanisms involved, those mechanisms remain in place — and changing conditions can quickly make a socially irresponsible company pay a hefty price for its behaviour.

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Authors

Institutions

Source

Idea conceived

  • July 2018

Idea posted

  • May 2019

DOI number

10.13007/740

Subject

Real Time Analytics