Corporate & Securities Law

When markets let corporations be good

In my article, Accountability and Responsibility in Corporate Governance, I explored the complex relationship between social responsibility and markets. I noted among other things that social responsibility is a way to sell products, so it’s hard to untangle whether success let’s firms be “good,” or whether “goodness” causes firms to be successful. 

A new article by Kubik, Schenkman and Hong, Financial Constraints on Corporate Goodness suggests that the latter is at least part of the story.  Here’s the abstract:  

We model the firm’s optimal choice of capital and goodness subject to financial constraints. Managers and shareholders derive benefits over profits and social responsibility. Goodness is costly and its marginal benefit is finite; as a result, less-constrained firms spend more on goodness. We verify that less-constrained firms do indeed have higher social responsibility scores. Our empirical analysis addresses identification issues that have long plagued the corporate social responsibility literature, establishing the causality of this relationship using a natural experiment. During the technology bubble, previously constrained firms experienced a temporary relaxation of their constraints and their goodness scores also temporarily increased relative to their previously unconstrained peers. This temporary convergence applies to all components of the goodness scores such as community and employee relations and environmental responsibility but not governance.

The tech bubble provided a kind of natural experiment that helped untangle causation.  Firms could indulge their urge to be “good” because markets let them.  When the bubble popped, they had to get back to business. This supports my general story that, although the law lets managers be good, they are ultimately constrained by markets.

Full post as published by Truth on the Market on March 31, 2011 (boomark / email).