NOTE MAKING OR BUYING CORPORATE SOCIAL RESPONSIBILITY *

BRYAN W. HUSTED Instituto Tecnolgico y de Estudios Superiores de Monterrey and Instituto de Empresa Mailing address: ITESM/EGADE Campus Monterrey Av. Eugenio Garza Sada 2501 Sur Col. Tecnolgico C.P. 64849 Monterrey, N.L., MEXICO E-mail: bhusted@egade.sistema.itesm.mx Tel.: 528-358-2000, ext. 6163 Fax: 528-625-6198

July 2001

*An earlier version of this note was presented at the 1999 meetings of the Academy of Management. The author would like to thank Steve Wartick and David Allen for their helpful comments.

Making or Buying Corporate Social Responsibility Abstract

The decision to internalize corporate social responsibility (CSR) activities or to outsource them in the form of corporate philanthropy is of great significance to the ability of the firm to reap benefits from such activity. Using insights provided by the new institutional economics and the resource-based view of the firm, this paper describes how the variables of centrality and specificity affect CSR governance choice. Although the framework developed in this paper is helpful in elucidating the problem of CSR governance, the limits of this approach are also discussed.

Key words: corporate social responsibility, make-or-buy decision, social strategy

Managers face a wide spectrum of demands for corporate social responsibility (CSR) from different segments of society. Firms structure responses to these demands according to the capabilities and resources they bring to the problem at hand and their ability to obtain benefits from CSR activity. Generally, the firm may either buy CSR by outsourcing such activity through the funding of non-governmental and other not-for-profit organizations or make CSR internally through the development of in-house projects. The problem for the manager is to determine which kind of response is most effective. In this paper, I sketch a theory of the firms decision to undertake CSR activities internally or to outsource them to other organizations. Corporate social responsibility is employed in a loose sense to embrace similar concepts such as corporate citizenship, corporate social responsiveness, and elements of stakeholder management. Although these terms have very stylized definitions with fine distinctions among them (Wood, 1991; Tichy, McGill, & St. Clair, 1997; Frederick, 1994; Freeman, 1984), they are all concerned with actions that appear to further some social good, beyond the interests of the firm and that which is required by law (McWilliams & Siegel, 2001: 117). Thus, I look at corporate experience in undertaking CSR activity and begin to build a theory which draws from that experience in a way that is consistent with current thinking in the new institutional economics (Coase, 1937), which includes work both within agency theory (Jensen & Meckling, 1976) and transaction-cost economics (Williamson, 1975; 1985), as well as the resourced-based view of the firm (Barney, 1986; Peteraf, 1993). In the first section, I describe the forms of institutional governance for carrying out corporate social responsibility. Using the concepts of centrality and specificity, I then build a theory to explain the conditions under which each kind of CSR governance is most appropriate. Finally, I develop some of the implications for management and research.

THE VARIETIES OF CSR GOVERNANCE

Although there are a variety of forms of institutional governance for CSR activities, three patterns occur repeatedly: firms tend to outsource CSR through corporate philanthropy, internalize it through direct projects, or use some hybrid form. According to Williamson (1991), governance structures are typically characterized by at least four distinguishing attributes: autonomous adaptation, cooperative adaptation, incentive intensity, and administrative control. Autonomous adaptation deals with the capacity of the parties to a transaction to individually make changes to unforeseen contingencies or disturbances. Cooperative adaptation refers to the capacity of the parties to respond to disturbances in a coordinated way, either through bargaining or administrative fiat. Incentive intensity deals with the extent to which economic incentives vary according to performance. Finally, administrative control refers to the firms systems to monitor and either reward or penalize behavior that supports its objectives. Let us compare each of the three kinds of CSR governance in terms of these distinguishing attributes. Philanthropy refers to donations of money or goods to non-profit organizations that undertake charitable, social, educational, community, or scientific work. In the case of philanthropy, the participation of the donor in the development of CSR activity is minimal. It involves a high capacity for autonomous adaptation to unforeseen contingencies because administrative decisions are left to the recipient of the donation. On the other hand, cooperative adaptation is low. If the donor disagrees with the response of the recipient to unanticipated contingencies, the donors only recourse is to withhold future funding from the recipient. Incentive intensity is high given the ability of the donor to condition future donations on the recipients performance and the competition among potential recipients for such donations. But

administrative controls over the recipients managers are non-existent because of the donors inability to monitor and either reward or punish the recipients managers. CSR activities can go beyond philanthropy to the actual development and management of specific projects. Direct projects internalize CSR, as they require corporate involvement that goes beyond the donation of money or goods. Such involvement may include corporate participation in the planning, execution, and evaluation of social projects, either alone or in collaboration with other organizations. The firm may develop such projects either in its own name, through its employees, or through its foundation(s). Many social projects are internally focused on employees such as J.P. Morgans lactation facility for nursing mothers and domestic partner benefits. Other projects are focused on external stakeholders, such as American Expresss Travel and Tourism Academies, which train young people for careers in the travel industry. Direct projects are developed within the hierarchical structure of the firm and are thus subject to all of the advantages and disadvantages of hierarchies (Williamson, 1991). Cooperative adaptation within the firm is high because the recipient is a unit within the firm that submits to the same authority structure. However, autonomous adaptation is low. Incentive intensity is weak given the fact that employees responsible for CSR activity usually receive a fixed salary and the success or failure of a CSR project does not directly affect their economic incentives. Low incentive intensity is compensated with high administrative control as internal firm systems provide for surveillance. These systems also reward or punish employees in terms of their potential for career advancement. There are a number of hybrid forms of corporate social responsibility involving collaborations or alliances between the firm and other institutions (Mullen, 1997). Such collaboration may go beyond the mere contribution of financial resources to the actual design and even joint management of the projects in question. For example, Benetton frequently works with

international humanitarian associations to collect used clothing at its stores, which is then distributed by the partner to the needy in the Third World. Compaq has worked extensively with Goodwill Industries in Houston to prepare the disabled for employment. In this project, Goodwill assembles 300,000 kits for Compaq customers every year. In each case, a condition of bilateral dependence arises because of the location, people, and knowledge involved in the project. Hybrid forms of CSR governance are characterized by intermediate levels of the four governance attributes. Incentive intensity is greater for a hybrid structure than for a direct project, but weaker than in the case of philanthropic contributions given the fact that the alliance between the two organizations requires them to work out disagreements, rather than simply switch CSR partners. As a result of the bilateral dependence that is created between the two organizations, adaptation can neither be entirely autonomous nor based on administrative fiat. However, cooperative adaptation in the form of bargaining is possible. Administrative controls exist, but are effective only through negotiation between the two organizations. In summary, CSR activities can be carried out as corporate philanthropy through third parties (NGOs, etc.), directly as social projects of the firm, or through hybrid forms of collaboration and alliances. Each form displays different strengths and weaknesses with respect to its capacity for autonomous adaptation, cooperative adaptation, incentive intensity, and administrative control.

TOWARD A THEORY OF THE CSR MAKE-OR-BUY DECISION Strategy or altruism? The decision to internalize or outsource CSR depends first on the firms motivation for participating in CSR activities. Certainly CSR is animated in part by altruistic considerations. As such, businesses are viewed as having responsibilities as citizens, which they incur as costs

(Davis, 1983). Nevertheless, strategic concerns are also beginning to play an important role in the decision to undertake CSR. Several authors have argued that social responsibility and performance are positively related to business performance (Waddock & Graves, 1997; Hosmer, 1994; McGuire, Sundgren & Schneewies, 1988; Cochran & Wood, 1984). Burke and Logsdon (1996) go beyond this body of work to suggest that there are specific conditions under which corporate social responsibility may in fact be strategic and seen as a long-term investment by the firm to create competitive advantage. If the corporate purpose behind CSR is strategic in nature, then transaction-cost and agency-cost considerations appear to play an important role with respect to the problem of governance. The agency problem arises because of concern that the agent (e.g., the internal or external recipient of funds) will not seek the interests of the principal (e.g., the donor) who desires to pursue CSR activities. Transaction costs arise because philanthropy, social projects, and collaboration may involve search, bargaining, monitoring, or coordination costs. In philanthropy, for example, the firm has to search for worthy causes that will promote strategic objectives. Coordination costs are drastically reduced when the company or its foundation acts merely as a passive grant-making institution, seeking only to do good with no concern for gaining any direct benefit from philanthropic activity. It is natural to question the extent to which concerns about CSR activities can be reflected in transaction-cost and agency theory. Indeed, both transaction-cost economics and principalagent theory assume opportunism, which refers to the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse (Williamson, 1985: 47). Agency theory builds upon the narrower concept of moral hazard or shirking (Alchian & Demsetz, 1972), which is subsumed within the concept of

opportunism. Both theories seem to go against the spirit of corporate social responsibility, which is based on concerns for cooperation and solidarity. It should be noted that the assumption of opportunism only requires that some people act opportunistically some of the time; it is not necessary that people always behave opportunistically (Williamson, 1985). Thus, in terms of corporate social responsibility, governance choice depends only in part on the possibility of actors acting opportunistically. Opportunism may cause actual economic losses in the case of strategic CSR or goal displacement in the case of non-strategic uses of CSR. Goal displacement occurs when employees begin to seek objectives other than those expressed in the firms mission and objectives (March & Simon, 1958; Selznick, 1949). Corporate social responsibility thus occurs in a tension between two worlds: a strategic world in which cost considerations are predominant and an altruistic world in which cost considerations are less important, although not entirely irrelevant, and concerns about legitimacy may play a more important role. To the extent that strategic concerns are less important, one will find greater deviations from the economic logic and explanations of strategic choice will move to considerations of the institutional environment (DiMaggio & Powell, 1983; Meyer & Rowan, 1977; Zucker, 1986). For example, DiMaggio and Powell (1983) refer to mimetic isomorphism as the tendency of business firms to imitate structures that already exist within their organizational field. Thus where strategic concerns are weak, CSR activity may be a reflection of pressures to imitate other companies as a way to achieve legitimacy. The extent to which CSR will be used to pursue strategic opportunities is a basic decision made by management.

Make or buy CSR? If the firm gives corporate social responsibility a strategic role, then two variables appear

to be important in understanding when the firm internalizes or outsources CSR: centrality and specificity. Centrality refers to the closeness of fit between the firms CSR activity and its mission and objectives (Burke and Logsdon, 1996). Centrality is high when the firms CSR activity is closely related to the firms core business activity. Conversely, centrality is low when CSR is unrelated to the core business. This concept is relevant to the internalization decision for two reasons. First, centrality has a significant relationship to the agency problem. To the extent that CSR activities are closely related to the firms mission and objectives, the principal-agent problem is attenuated because the firm has a greater capacity to monitor social activities related to its core competencies. Second, the concept of centrality relates CSR activity to firm resources and core competences. Core competences integrate firm-specific assets or resources that allow it to engage in distinct activities that are related to its fundamental business (Teece, Pisano, & Shuen, 1997). A CSR activity is highly central when it is based on core competences of the firm. For CSR activities that display high levels of centrality, the firm already possesses the competences needed to undertake that activity. For those CSR activities marked by low levels of centrality, firm competences do not match the competences needed to undertake the activity. The firm may either acquire needed resources through collaboration with a non-governmental organization that does possess them or outsource the activity entirely through philanthropic donations (Barney, 1999). For example, J.P. Morgan has developed a core competence in the structuring and financing of commercial projects, which it often extends to social projects. It thus takes few new resources to engage in the same activities as a form of social action. This would not be the case of either Compaq Computer, when it donates money to the Houston Symphony, or Levi Strauss, when it donates money for AIDS research. Neither of these activities is central to the mission, objectives, and core competences of either Compaq or Levis. In these cases, the principal-agent

problem can be quite severe due to the condition of information asymmetryone of the parties (the recipient) has more knowledge regarding the social problem than does the other (the donor). Philanthropy tends to occur in areas of social concern that are less closely related to the core business mission of the firm. As observed in the case of Levis and Compaq, neither AIDS research nor classical music are central to their missions. These activities are characterized by information asymmetry given the fact that the donor organizations are not experts in AIDS research or classical music. Each faces a problem of monitoring the recipient of funds because of the lack of adequate administrative control. Consequently, these firms become involved in unrelated CSR activities through philanthropy. From the perspective of the donor, information asymmetry is reduced for social issues unrelated to the mission of the firm by outsourcing social action to external recipients (non-governmental organizations) that do have the necessary competence and face greater incentive intensity through competition for limited corporate funds. CSR activities in areas closely related to the core business of the firm are usually internalized because of the greater competence of the firm and thus the greater ability to monitor recipients through its administrative control system. For example, Benetton is involved in a number of publicity campaigns that feature social problems. Its Enemies campaign featured a clothing catalogue of Jewish and Palestinian citizens of Israel with statements by both about their daily life together. The catalogue sensitively portrayed the humanity of both sides of the conflict. The persons featured in the catalogue were not models, but regular people, all wearing Benetton clothing. In this case, the nature of the social campaign melded seamlessly into Benettons competence in marketing. Repsol, Johnson & Johnson, Compaq and Boeing are involved in programs to reduce the environmental impacts of their production activities. These projects are all closely related to each firms competence and existing administrative controls. Consequently, the firm may evaluate the effectiveness of internal social investments, thus reducing the problem

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of information asymmetry. Proposition 1: The higher the centrality of CSR activities to a firms mission, the less likely that the firm will outsource those activities as a form of corporate philanthropy. CSR activities may also be subject to pressures for transaction-cost economization through the variable of specificitynot to be confused with asset specificity. Specificity refers to the extent to which the firm is able to capture a share of the profit stream generated from its investments in CSR (Burke & Logsdon, 1996). Teece (1986) has talked about the same concept as appropriability, but in relation to the ability of the firm to capture rents from its investments in research and development. CSR activities that produce positive externalities or constitute public goods are not specific because there are no mechanisms to assure that the firm is paid for the benefits it provides (Layard & Walters, 1978). Generally, the firm accrues specific benefits when it endows its products with CSR attributes or uses CSR-related resources in its processes (McWilliams & Siegel, 2001). Specificity has several different sources. Firms are more likely to capture private benefits from CSR activities, which are difficult to imitate (Teece, Pisano, & Shuen, 1997) and which easily exclude competitors from the benefits of CSR investments (Burke & Logsdon, 1996; see also Teece, 1998). Intellectual property protection such as patents and trade secrets may apply to some kinds of CSR activities such as process or product innovations. But many forms of CSR activity cannot be protected. Specificity is high when it is a CSR activity that is both inherently difficult to imitate and easily excludes others from its benefits. Specificity is low when CSR activity is easy to replicate and fails to exclude others from its benefits because of its nature as a public good or positive externality. Projects involving process innovation tend to be highly specific. For example, projects to improve environmental performance are, by their nature, very specific to the firm. The firm can

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capture the benefits of reduced costs and greater efficiency that accrue through the improved design of its products (Hart & Ahuja, 1996; Russo & Fouts, 1997; Rugman & Verbeke, 1998; Porter & Van der Linde, 1995). Benefits of improvements to manufacturing processes can also be appropriated through green marketing given the preference of some consumers to purchase products made through environmentally friendly processes (Mendleson & Polonsky, 1995). Complementary products and services may help the firm capture benefits from a social loss leader. For example, low-interest rate loans to help the poor purchase a house are quite specific to the financial institution lending assistance. Such loans may result in the client opening other accounts with the same bank. American Expresss development of its travel and tourism academies strengthens the industry by training qualified travel professionals, some of whom may end up working for American Express. In each case, CSR activity helps to build loyalty to a specific company. Non-specific CSR activity occurs as philanthropy because administrative control mechanisms to capture benefits do not exist. A donation by an airline to found a university research chair to study the airline industry benefits the chair holder, students, and the industry as a whole. The donor airline benefits only indirectly. Since the benefits are non-specific, philanthropy reduces the costs of coordination as it avoids the costs associated with an internal governance structure. Specific CSR activities tend to be organized internally through the firm, rather than through outsourcing in the form of philanthropy because greater specificity creates greater coordination costs. The capture of benefits requires institutions and mechanisms that ensure that firms are paid for the benefits resulting from their actions (Layard & Walters, 1978: 189). These coordination costs are minimized in direct projects because of the superior capacity for cooperative adaptation of internal governance structures over outsourcing (Williamson, 1985).

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Proposition 2: The greater the specificity of the benefits of CSR activities, the less likely that a firm will outsource those activities as a form of corporate philanthropy. Until now, we have been dealing with the conditions that foster two polar forms of CSR activity: philanthropy (outsourcing) or direct projects. As previously mentioned, there are also important hybrid forms, including strategic alliances and other forms of collaboration. Collaborations allow the firm to participate in social projects outside its core business mission. The firm contributes its resources, such as managerial capacity or the structuring of financial transactions, together with other organizations that have greater expertise with a given social problem. For example, J.P. Morgan has collaborated with the Riverfront Development Corporation (RDC), which was formed in 1996 to implement a 25-year, $1 billion program to revitalize 500 acres along the Christina River in Wilmington, Delaware. Morgan supported the project by extending a $6.2 million letter of credit, which the RDC combined with a grant and tax-exempt loan of $5 million from the State of Delaware in order to purchase and renovate the site and structure a long-term lease with Amtrak. Morgan did not undertake revitalization alone, but was able to contribute in an area where it did have relevant resources. Collaborations allow the firm to leverage its resources to address social problems outside the realm of its core business mission. Obviously, these projects are less central to the firms mission than in the cases of internal social projects, but at the same time are related to the firms mission because of the particular resources that the firm invests. As a result of the contribution of these resources and competences, the condition of information asymmetry is attenuated without being eliminated entirely. In addition, the hybrid form displays a superior capacity for cooperative adaptation than does outsourcing, while preserving some capacity for autonomous adaptation not available to internal governance. Thus, I conjecture that hybrid forms most likely occur when the firm develops projects characterized by intermediate levels of centrality.

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Proposition 3: At moderate levels of centrality, hybrid forms of CSR activity are more likely to occur than either direct projects or outsourcing. Specificity can be moderate either when CSR activity is both easy to imitate and competitors may be easily excluded from its benefits or when CSR activity is nonimitable and others are excluded from its benefits only with great difficulty. Cause-related marketing provides a relevant example. Cause-related marketing is a collaborative form of philanthropy organized around the marketing objectives of increasing product sales or enhancing corporate identity (File & Prince, 1998: 1530). The firm justifies support of nonprofit organizations by linking such support to corporate benefits (Varadarajan & Menon, 1988). For example, a firm may tie a dollar donation to a charitable organization for each product unit sold. Although it is easy to imitate, it effectively excludes others from its benefits, which accrue only to the firm. Thus, cause-related marketing involves a moderate level of CSR specificity. Clearly, this kind of philanthropy is not a pure form of philanthropy because the level of donation varies with the level of product sales. Mechanisms, such as the marketing department, need to assure that the firm obtains benefits from its donation in the form of publicity and increased sales. These mechanisms to capture benefits involve significant coordination costs. However, these costs are not nearly as great as those that would be involved if the firm were to organize the entire project in-house. In the case of cause-related marketing, the CSR activity is outsourced, but the means for capturing the benefits remain in-house. Conflicts in the relationship are best managed through a hybrid form, which allows for some degree of cooperative adaptation through bargaining, rather than incurring the full costs of internal governance due to weakened incentive intensity and a non-existent capacity for autonomous adaptation. Proposition 4: At moderate levels of specificity, hybrid forms of CSR activity are more likely to occur than either direct projects or outsourcing.

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CONCLUDING REMARKS In this paper, I outline a theory of the internalization and outsourcing of CSR activity. The theory provides managers with guidelines for determining whether CSR activities should be outsourced, conducted in-house, or managed through some hybrid form. Clearly, CSR operates in a tension between two distinct worlds, depending upon the role assigned it by the upper-level management of the firm. If the firms intent in participating in CSR activity is strategic in nature, agency cost, transaction cost, and resource considerations will determine governance choice. Where the intent is altruistic in nature without concerns about effectiveness, other considerations such as legitimacy will play an important role and governance choice will respond to other forces, such as mimetic isomorphism. Further work needs to be done to build upon this framework and demonstrate its validity. At this point, a series of comparative case studies might be especially useful as we attempt to distinguish the conditions under which specific strategies are used. A large-scale survey may also be useful to determine the extent to which strategic and/or altruistic motives underlie the different forms of corporate social responsibility and the extent to which these motives affect the selection of different kinds of strategy. By demonstrating the possible mismatches between CSR governance and levels of centrality and specificity, a more robust theory should enable firms to obtain benefits from their CSR activities. As such benefits become more apparent to other firms, they should give CSR a more important role in their own strategic planning.

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