The classical view in finance on modern corporations takes a shareholder value maximization perspective, which holds that corporations are accountable only to profit-maximizing shareholders, and apart from their contractually determined obligations, have no responsibility to enhance society’s welfare. In reality, however, corporations often focus on objectives beyond profit maximization and participate in activities that improve other stakeholders’ welfare. Indeed, corporate social responsibility (‘CSR’) has increasingly become a mainstream business activity. This raises the question of why some firms want to be socially responsible rather than pure profit maximizers, and, more importantly, why firms in some countries engage in CSR to a greater extent than firms in other countries.
The common explanation for why companies invest in CSR is that doing so enhances profitability and firm value, a relationship often referred to in the literature as ‘doing well by doing good’ or ‘doing good by doing well’. However, neither of these ‘doing good—doing well’ arguments can explain the cross-firm or cross-country variation in CSR. In addition, the multi-dimensional and externality-driven nature of CSR suggests that it should be fundamentally related to not only a firm’s own choice but also regulations, institutional arrangements, and societal preferences.
In this paper, we examine whether differences in CSR practices across countries can be explained by relating CSR to a country’s legal origin, which has been shown to systematically shape various country-level institutions and the firm-level contracting environment. In the context of CSR, a country’s legal regime determines how ‘public goods’ should be provided by the private sector (corporations): through regulations and rules, firm discretion, or government involvement in business. A country’s legal regime also shapes the explicit and (more often) implicit contracts between shareholders and other stakeholders through its effect on governance structures and the decision-making process. A common law origin is a more discretion-oriented system that supports private market outcomes, places fewer ex ante restrictions on managerial behavior (but discourages inappropriate or unacceptable behavior by relying on ex post sanctions such as litigation or other judicial mechanisms), and favors shareholder protection. A civil law origin, in contrast, is associated with state intervention in economic life through rules and regulations (eg, an ex ante delineation of acceptable behavior) and a ‘stakeholder view’. The level of CSR in a country is therefore a result of both a governance tradeoff concerning the rights and preferences of shareholders and other stakeholders, and the form in which this tradeoff is made (ie, by rules or discretion).
To empirically test the legal origin view of CSR, we employ several newly assembled international databases on firm-level CSR that together cover more than 25,000 large public companies around the globe. Our CSR data measure corporations’ engagement in and compliance with environmental, social, and traditional corporate governance (‘ESG’) issues, where engagement refers to a firm’s voluntary investment in CSR projects while compliance refers to behavior that a firm is required or encouraged to follow.
Using these comprehensive global CSR data, we find that legal origin appears to be the strongest predictor of CSR adoption and performance at the firm level, stronger than alternative factors such as political institutions, regulations, social preferences, and a firm’s financial and operational performance. Firms with a common law origin score significantly lower on various CSR ratings than civil law firms, while firms from the Scandinavian legal regime obtain the highest scores on most of the CSR ratings. The results are supported by several quasi-natural experiments of global disasters and scandals that shift societal demand for CSR. In these experiments, we find that firms in civil law countries are more responsive to large natural disasters and industry scandals, such as food safety and oil spill pollution. Such responsiveness does not appear to be explained by changes in firms’ market shares. Moreover, we find that firms in civil law countries face less shareholder litigation risk but more regulations concerning stakeholder welfare, rely more on supermajority rules among shareholders, and have stronger state involvement in their businesses, all of which are strongly related to higher CSR scores. Overall, the results suggest that there is a strong link between firm-level CSR and country-level legal origin, which may help explain cross-country variation in CSR.
Hao Liang is an Assistant Professor of Finance at Singapore Management University (SMU).
Luc Renneboog is a Professor of Corporate Finance at Tilburg University.