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doi: 10.1111/j.1467-999X.2010.04087.x
6995
69..95
Tommy Lundgren*
Centre for Environmental and Resource Economics (CERE),
Ume School of Business
(December 2008; revised January 2010)
ABSTRACT
This paper explores the economic mechanisms behind corporate social responsibility (CSR) in a
microeconomic model of the firm. The studys motivation is to shed light on the potential causes of the
observed phenomena of voluntary over-compliance among firms. We investigate how assumptions
about costs and benefits affect CSR behavior through a stock of goodwill capital. In optimum, the firm
must balance marginal costs and benefits of investing in CSR. We characterize the equilibrium and
examine comparative statics and dynamics from a parameterized model. Finally, we link some of the
models results to the empirical literature on CSR.
1. INTRODUCTION
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Tommy Lundgren
mechanisms behind corporate social responsibility based on a microeconomic perspective of the firm. The ultimate objective is to shed some light on
the rationale behind the observed voluntary over-compliance among firms.
Since the publication of the report Our Common Future (1987) by the
World Commission on Environment and Development, the terms sustainability and sustainable development have become prominent in the public debate.
The sustainability debate has, in part, focused on what companies can do to
facilitate sustainable development, so-called corporate social responsibility
(CSR). One of the first attempts to bring CSR into the public debate was from
Milton Friedman who in his article in the New York Times Magazine argued
that the corporate social responsibility of firms is to maximize its profits
(Friedman, 1970). While this statement may appeal specifically to neoclassical
economists, it may also seem provocative and without nuance to others. But
as we shall see, profit maximization does not have to be in conflict with
social responsibility (see, for example, Husted and Salazar, 2006). Following
Friedmans initial definition of CSR, a number of others have followed. For
example, Heal (2008) suggests that CSR is . . . the interactions between
corporate behavior and civil and legal society, and how these interactions
structure the companys incentives on social and environmental issues.1 We
simply consider CSR to be actions that, to some degree, imply corporate
beyond-compliance behavior in the social and/or the environmental arena.
Most of the empirical studies of the effects of CSR on either a firms
economic or financial performance have been performed during the last two
or three decades (and most focus on financial performance). The plethora of
individual studies has led to at least 1015 reviews, many of them assessed in
Margolis and Walsh (2001), which reviews nearly 100 separate studies. Also,
Reinhardt (2000), Orlitzky and Benjamin (2001), Orlitzky et al. (2003), Lyon
and Maxwell (2004) and Orlitzky and Swanson (2008) summarize to a large
extent the bulk of empirical CSR literature that is currently available. Hay
et al. (2005) offer a comprehensive review from the fields of economics, law
and business. The evidence from these review studies is not conclusive, but
empirical results seem to indicate that CSR leads to positive financial performance for a firm.2
When it comes to CSR and economic performance, the research is less
extensive. Indeed, economic and financial performances are linked,3 but there
are some interesting differences worth noting. The Journal of Productivity
1
See also McWilliams and Siegel (2001), Hay et al. (2005) or Portney (2008) for similar definitions of CSR.
2
Possibly because of publication bias, i.e. negative results tend not to be published.
3
If, for example, economic efficiency is improved by CSR this will most likely show in financial
performance such as stock price through higher profits.
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McWilliams and Siegel (2001) outline a model in which two firms sell identical goods, but one
company decides to add an additional social attribute to its product. This attribute is valued by
some consumers or, potentially, by other stakeholders. Firm managers conduct a costbenefit
analysis to determine the level of resources to devote to CSR activities. That is, firms simultaneously assess the demand for CSR and the cost of satisfying that demand, and then determine
the optimal level of CSR to provide.
5
See, for example, Greer and Bruno (1996). Greenwash refers to companies that disingenuously spin their products and/or policies as environmentally friendly, e.g. presenting cost cuts as
reductions in resource use.
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Tommy Lundgren
greater for experience and credence goods and services, which is empirically
confirmed by Siegel and Vitaliano (2007). Bagnoli and Watts (2003) extend
Baron (2001) and McWilliams and Siegel (2001) by analyzing how the structure of competition in the market for the private good affects CSR. Baron
(2007, 2008) provides further theoretical discussion of profit-maximizing
CSR, with a focus on managerial issues, reputation and stakeholder pressure/
incentives.
Closely related to the concept of reputation, Lundgren (2003) and Kristrm and Lundgren (2003) formally introduce goodwill capital in a microeconomic setting of the socially responsible firm. While Lundgren (2003)
concentrates on uncertainty in goodwill evolution and the timing of abatement investment, Kristrm and Lundgren (2003) develop a model where
voluntary abatement investments (one dimension of CSR) create a stock of
goodwill capital that enables the firm to differentiate their product. Other
product differentiation models connected to green consumerism include
Eriksson (2004) and Rodriguez-Ibeas (2007).
In our view, the most comprehensive and complete theoretical discussion
can be found in Heal (2005, 2008). Using a non-formal model he discusses
CSR from both economic and financial perspectives, and proposes how it is
reflected in financial markets. He discusses several cases in relation to CSR.
Heal defines CSR as actions to reduce externalized costs and/or to avoid
distributional conflicts. He suggests that there may be a resource allocation
role for CSR programs in cases of market failure through privatesocial cost
differentials. Furthermore, he argues that in sectors where social and private
costs are not in line, or where distributional conflicts are common, CSR can
play a valuable role in ensuring that the invisible hand acts, as intended, to
produce the social good. It can also act to improve corporate profits and
guard against reputational risks.
In light of the condensed review of theoretical studies on CSR presented
here, we conclude that this type of analyses are on the rise. However, to our
knowledge, a formal dynamic microeconomic model of the firm that
accounts for several dimensions of CSR, in terms of both different types of
CSR and the various drivers and mechanisms, is non-existing. Paul R.
Portney, in Hay et al. (2005), points out that despite a vast amount of
empirical studies of CSR, very few, if any, have derived testable hypotheses
from an adequate theoretical model of the firm. Moreover, few studies clearly
identify the basic mechanisms of how socially responsible behavior leads to
a economic/financial advantage. Portney provides a general outline of how
such a model might work: by engaging in CSR, output price (price differentiation), wages (higher worker productivity or lower wages through worker
satisfaction), and the cost of capital (risk reduction due to lower risk of
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This section outlines and discusses a firm-level model that sheds light on the
potential mechanism behind CSR. The model proposes that with stakeholders
(e.g. consumers, financial sector, government, employees, etc.) rewarding
CSR behavior, the cost of CSR may be balanced by benefits in terms of higher
profitability (see, for example, McWilliams and Siegel, 2001). Indirectly, we
are assuming that the firm is socially responsible for strategic reasons, i.e. it is
good business, or at least not bad business. The analysis relies on dynamics,
a pertinent feature of CSR since it potentially has effects on reputation or
goodwill, which has inherent intertemporal properties. Specifically, we assume
the notion of goodwill capital as a stock that acts upon a firms revenues and
costs in different ways. An intertemporal setting is reasonable when dealing
with CSR investments and goodwill capital. CSR projects build goodwill
capital over time, which can be seen as an intangible asset, a form of reputation. The reputational implications of CSR are highlighted and discussed in
detail in McWilliams and Siegel (2001, 2002), especially the potential effects
of asymmetric information about product attributes and firm activities. In
the model presented here, we abstract from the complications of asymmetric
information. That is, the activities of the firm and the product attributes are
perfectly transparent and known to the consumer.6
6
An asymmetric information case is investigated in Spremann (1985). He provides an interesting advertising model set-up that accounts for asymmetry of information. Advertising can be
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74
The notion of goodwill or reputation as an intangible asset is used extensively in dynamic models of advertising.7 Assuming CSR efforts are signaled
(advertised) appropriately to the market, CSR investment projects can potentially provide the firm with various benefits. We discuss these benefits below
using a model based on the green firm framework developed in Kristrm and
Lundgren (2003), which, in turn, are inspired by advertising models such as
Dorfman and Steiner (1954), Nerlove and Arrow (1962), Gould (1970) and
Jacquemin (1973).
2.1
75
here.8 Furthermore, societal benefits from CSR are not considered because
our model maintains a firm perspective. Based on a review of the CSR
literature, B1B3 are the main benefits that emerge as the usual suspects
when trying to rationalize socially responsible behavior at the firm level.
The costs of CSR are sorted into three categories:
C1. Actual investment costs in CSR projects. Whether it is an environmental
project or a project related to human rights, there is always an investment cost of engaging in such projects. This cost is assumed to be linear
in the amount of CSR.
C2. Costs of promoting (advertising) CSR investments to stakeholders
(see, for example, Wang, 2008). Without stakeholders knowledge of a
firms socially responsible behavior, the benefits cannot be fully realized.
Together with the project investment cost (as suggested in C1), these
constitute the unit cost, or price, of CSR investments.
C3. Costs that stem from crowding-out effects of CSR. Productive investments and/or production are held back to give room for CSR (for a
discussion of the environmental investments case, see Gray and Shadbegian, 1998). We assume that CSR may hamper conventional firm
activities, and that this cost is increasing at an increasing rate in CSR.9
2.2
The model
= ( g, G , H *) = R (G , H *) C (G , H *) A( g )
(1)
The right-hand-side terms represent revenues and costs. The first two terms
functions depend on the goodwill stock, G, and a set of parameters given by
H*, which are exogenous to the firm. We can think of H* as representing
inputs such as labor and capital that have been chosen optimally at a previous stage and are taken as given.10 This means we can abstract from H* in the
sequel, and thus focus solely on the intertemporal problem involving investment in CSR and the goodwill stock. The last term in the profit function,
8
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76
(2)
C = C (G ) = C [w (G ) , q (G )]
(3)
where
11
12
(4)
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A(g) is the total cost of investing in CSR, including promotional costs and
crowding-out costs. Crowding out means that CSR takes resources from
other productive activities at an increasing rate (since Agg > 0). This suggests
that small investments in CSR are relatively cheaper than large investments
as a result of convexity in A(g).
Our assumptions about functional forms govern how revenues and costs
are affected by CSR investments, g, and goodwill, G, and ultimately the
behavior of the firm. Let us now introduce dynamics into this setting.
Given the above functional forms, the value function for the management
problem is written as
V = max e rt[ R (G ) C (G ) A ( g )] dt
g
(5)
where V is the value function at time t, and e-rt is a discount factor where r is
the firm discount rate.13 Note that V is also the value of the firm since it is
defined as the perpetual discounted stream of profits. The management
problem is to chose g to build G as to maximize the future stream of discounted profits, given an equation describing how goodwill evolves over
time. In general, it is assumed that goodwill develops over time according to
the following relationship:
G = f ( g, G )
G (t = 0 ) = G0
(6)
f = f ( g, G )
fg > 0, fgg 0,
fG < 0,
13
fGG 0
(7)
More realistically, we could make the discount rate r also depend on goodwill; i.e. should the
perceived risk of the firm decrease through investment in CSR, then, as a consequence, the rate
of return, which is closely related to the firm discount rate, should also decrease. As a consequence, the value of the firm also changes. However, the inclusion of this mechanism creates a
substantial increase in model complexity. Therefore, we opt to leave this exercise for future
analysis.
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Investment in CSR has a positive effect on the change in goodwill. This effect
is either decreasing or linear with magnitude of g. Further, fG < 0 means that
the higher the level of goodwill, the smaller the relative change in goodwill,
ceteris paribus. No assumptions, at this point, are made concerning the
cross-effects between g and G. The following equation of motion for goodwill
is reasonable and easy to work with:
G = g G
(8)
H c = R (G ) C (G ) A ( g ) + ( g G )
(9)
where l is the adjoint variable or shadow price of goodwill. The shadow price
of goodwill represents the theoretically correct price of goodwill should it be
traded in a competitive market. That is, l is closely related to the marginal
cost of investing in goodwill (as we shall see below).
The optimal conditions given by the maximum principle are
H gc = 0
(10)
= r HGc
(11)
lim (t ) = 0
(12)
The first two conditions must hold along the optimal path. The third condition is a transversality condition associated with infinite horizon autonomous
problems and is needed to provide a boundary condition at the limit.14
Equation (10) can be written
14
The boundary condition is typically replaced by the assumption that the optimal solution
approaches a steady state and settles down (Kamien and Schwartz, 1991, section 9).
Ag + = 0
A
= g
79
(13)
which simply states that the shadow price of goodwill is equal to the marginal
cost of investing in CSR normalized with the efficiency parameter. Expanding the optimal condition (11) yields
= r ( RG CG )
= ( r + ) ( RG CG )
(14)
which is the differential equation for the shadow price of goodwill. Now we
can use (13) and (14) to extract the differential equation for CSR investments,
g. First, take the time derivative of (13), i.e. = Agg g , and substitute the
result for in (14), then substitute l for Ag/a in (14). After isolating changes
in CSRg on the left-hand sidewe have the following differential equation
for CSR investments:
(+)
(+)
Ag
(r + )
( RG CG )
g =
Agg
(15)
(+)
The development over time for g is a function of both g and G. From (15) we
see that the difference between marginal costs and marginal benefits governs
changes in CSR investments over time. We see that if
Ag RG CG
(r + )
g 0
(16)
This suggests that CSR investment/disinvestment will occur when the discounted marginal benefits are smaller/larger than the marginal cost of investing in one extra unit of CSR. This means that when marginal costs are
larger/smaller than marginal benefits, the firm invests/disinvests to the point
where benefits equal costs.
= 0 (and = 0). Assuming
The system is in steady state when g = 0 and G
that the efficiency parameter a = 1, then
Ag =
RG CG
(r + )
(17)
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80
g = G
(18)
The marginal cost of investing in one extra unit of CSR is equal to the
benefits associated with the goodwill it creates, instantly and in the future,
discounted by the rate of return plus the rate of depreciation of goodwill.
According to (18), the level of goodwill is kept unchanged if the firm invests
an amount of CSR equal to the decay of goodwill.
2.3
When certain concavity conditions are satisfied for the Hamiltonian, the
conditions in (10), (11) and (12) are sufficient for maximization (see, for
example, Mangasarian, 1966; Kamien and Schwartz, 1971; or Arrow, 1998).
In short, these conditions require that the current value Hamiltonian is
concave in g and G, jointly, implying that the Hessian of the current value
Hamiltonian is negative semi-definite. The Hessian can be written
c
H gg
H c
Gg
c
H gG
Agg
=
c
HGG 0
RGG CGG
(19)
Since both terms in the diagonal are non-positive by assumption, the Hessian
of the current value Hamiltonian is negative semi-definite in the arguments g
and G, and thus there exists an interior solution, which is a maximum.
Let us portray the steady state in a phase diagram. It is now convenient to
use (14) together with (18). Note that using the differential equation for g will
generate the same qualitative results and conclusions since g is proportional
to l. Setting = 0 in (14) and isolating l on the left-hand side gives the locus
for the co-state in steady state,15
RG CG
r +
(20)
The right-hand side depends only on G, and since R is increasing and concave
in G, and C is decreasing and convex in G, the term (RG - CG) is decreasing
and convex in G. Around G = 0 the term (RG - CG) tends to infinity, and the
locus = 0 is not well defined at this point. The locus for the state variable,
= 0, is given by g - dG = 0 (with a = 1), which implies a linear curve with no
G
15
The locus for g = 0 would look very similar, Ag = (RG - CG)/(r + d). Assuming a quadratic
function for A(g) implies that the locus for g = 0 is proportional to the locus for = 0, so the
qualitative results would be the same whether we use either locus in our phase diagram.
81
and G/G < 0, which gives the directional arrows depicted in figure 1.
The equilibrium is a maximum and is given by l* and G* with a stable
branch leading into it from both left and right. It is easy to formally show that
this equilibrium is a saddlepoint maximum. See the Appendix for details.
2.4
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Model parameterization
max = pY ( K , L ) wL qK
K ,L
(21)
where p , w and q are market prices for output, labor and capital, respectively. Y(K, L) is a production function with capital and labor as arguments.
This gives us L* and K*, the optimal levels of labor and capital.18 Next, the
firm maximizes profits with respect to investment in CSR and building to a
stock of goodwill capital. At this stage L* and K* are taken as given.19 The
CSR management problem is written
V ( ) = max e rt ( ) dt
0
G = g G
G ( 0 ) = G0
(22)
where w is a vector of parameters.20 Assume the following parametric specification for the functions p(G), w(G), q(G) and A(g):
(23)
These functions have the desired properties stated in the previous section (see
(2), (3) and (4)); i.e. there exists a steady-state saddlepoint equilibrium, which
is a maximum. The output price, wage and cost of capital functions are
17
See also, for example, Oniki (1973) for a similar methodology. Caputo (1990b) contains a
general discussion of comparative dynamics in optimal control problems.
18
Compare with the H* in (1).
19
The problem would be considerably more complex if we include K and L as controls, without
really adding relevant richness to the analysis.
20
All parameters are non-negative.
83
specified so that they depend on the exogenously given market rate and an
endogenous premium determined by a parameter and goodwill capital. The
CSR cost function consists of a linear part that depends on the price of CSR
and the price of promoting CSR, and a non-linear part that represents costs
that occur due to crowding-out effects.
2.4.2
First, let us look at the steady-state CSR investment behavior of the firm.
Recall that from the steady-state conditions in (17) and (18) we have
Ag ( g*) RG (G *) CG (G *)
=
r +
g* = G *
(24)
where g* and G* are steady-state levels of CSR investments and the goodwill
stock. Given the functional forms specified and parameterized in (23) we can
write
1
(Y * + L* + K *)
p csr + padv + g* G *
=
r +
(25)
a ( g*) + bg* + c = 0
2
(26)
where
a =1
b=
p csr + padv
c=
Y + L + K
r +
()
Solving for g* yields the following expression for the steady-state level of
CSR investments and the goodwill stock:
g* =
1
b 4ac + b2
2a
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84
G* =
b 4ac + b2
2a
Given a, b and c we can expand and cancel terms so that the steady-state
conditions become21
2
1 p csr + padv
1
Y * + L* + K * p csr + padv
4
2
2
r +
G * = g*
g* =
()
(27)
g*
g* ( p csr + padv )
= adv =
csr
p
p
2 2
G * G * ( pscr + padv )
=
=
2
p csr padv
(28)
( r + ) ( p csr + padv ) + 4 (Y * + L* + K *)
=
>0
2( r + )
2
Note that only the negative root makes sense in this case.
An increase in a would simply scale the stock of goodwill upward since CSR now adds more
goodwill per unit invested.
22
85
2 (Y * + L* + K *)
2 3( r + )
G * g*
=
(29)
which both have negative signs (for reasonable parameter values), as one
would expect.
2.4.3
H = e rt[( p + ln G )Y ( K *, L*)]
e rt[(w ln G )L* ( q ln G )K *]
1
e rt ( p csr + padv ) g + g 2 + ( g G )
(30)
23
Here we follow Caputo (1990b) and work with the present value Hamiltonian instead of the
current value Hamiltonian. This is convenient and enables us also to explicitly investigate the
effect of changing the discount rate, r.
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86
H = e rt ln GY *
H optimal path = e rt ln G * (t; )Y *
(31)
(32)
That is, if the output markets sensitivity with respect to the firms goodwill
increases, then the value of the firm also increases. Since goodwill creates a
price premium whose size is determined solely by the parameter e, it comes
as no surprise that Ve(w) > 0. The same procedure for the other parameters
gives us
Vw ( ) = e rt L*dt < 0
0
Vq ( ) = e rt K *dt < 0
0
(33)
(34)
(35)
(36)
(37)
(38)
(39)
24
The derivation of this convenient result in Caputo (1990b) is rather lengthy and involved. A
much neater and less rigorous derivation is found in Aronsson et al. (2004, ch. 9). The trick is to
introduce an artificial state variable in terms of the parameter of interest (in their case it
represents a project). Assume we want to examine the project a. Then the co-state dynamics
is represented by = 0, a(0) = a. The co-state variable or shadow price of a is la = V/a. It
is now easy to show from the co-state optimal condition (co-state equation) that
1 rt
2
e [ g* (t; )] dt < 0
0
2
V ( ) =
Vr ( ) = te rt ( ) dt < 0
0
87
(40)
(41)
(42)
(43)
Let us briefly comment on the partials portrayed in (33)(43). All partials are
unambiguously signed. None of the derived signs of the partials comes as a
surprise, since the Hamiltonian was carefully rigged to meet the conditions
necessary for a saddlepoint equilibrium. Note that these dynamic envelope
results recover cumulative discounted functions, and not instantaneous functions as with static envelope analysis. Vq(w), Vg (w) > 0 implies that should the
parameters governing the size of the premiums on wage and cost of capital
increasei.e. employees and capital markets become more sensitive to
CSRthen the value of the firm moves in the same direction. If price of CSR
and price of promoting CSR go up, Vpcsr ( ) , Vpadv ( ) < 0 , then, not surprisingly, the firm value decreases. Crowding-out effects are measured by the
parameter b. Since Vb(w) < 0, one can conclude that more severe crowdingout effects will lower the value function and thus firm value. Efficiency in
converting CSR efforts into actual goodwill is measured by the parameter a;
i.e. should a increase, the firm becomes more efficient in transforming CSR
policy into goodwill, and from Va(w) > 0 we see that the value of the firm also
increases.25 An increased depreciation rate of goodwill, d, or discount rate, r,
has a negative impact on firm value, Vd (w), Vr(w) < 0.
Another useful dynamic result that can be derived from optimal control
theory is that the change in the value of the firm is directly related to the
change in goodwill. This comes from a general result in optimal control (see,
for example, Brock, 1998), where the time derivative of the value function in
a dynamic optimal control problem is directly related to the net changes in all
stocks in the model in the following way:
V = i Si
i
25
(44)
Note that the comparative statics showed that in equilibrium, the CSR investment rate is not
affected by changes in the efficiency parameter. However, the dynamic long-run effect on firm
value associated with a change in the efficiency to convert CSR investments into goodwill is
unambiguously positive.
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88
where li is the shadow price of stock i, and Si is the ith stock. Since the present
control problem has only one stock, goodwill, we can write
V = G
(45)
This result suggests that all changes in goodwill, positive or negative, as a result
of investing or disinvesting in CSR, will have direct effect on the value of the
firm given that there is a non-negative shadow price of goodwill capital.26
The model presented in this paper can help grasp how empirical hypotheses
concerning CSR can be derived in a consistent way, without having to
resort to speculation or poorly undermined reasoning. Here we identify
some possible hypotheses drawn from the model framework and then look
into whether the empirical literature on CSR supports or refutes them. The
purpose of this exercise is to point out the usefulness of the model presented to facilitate the understanding of the drivers behind CSR and, consequently, how to build testable hypotheses consistently.27 It also reveals
that our model encompasses many of the known and tested features of
CSR.
H1: CSR behavior that increases goodwill may have a positive effect on output
price: P(G)/G > 0.
Is there a price premium for CSR firms? Just a cursory look around
suggests this, e.g. actual forest product price lists suggest that certification
of forest products leads to higher price. Kristrm and Lundgren (2003) find
evidence of a price premium for green pulp in Swedish pulp industry.
Furthermore, empirical results in Blend and Ravenswaay (1999) suggest
that American consumers are willing to pay a premium for eco-labeled
apples, but not too much. Similar examples from the literature abound.
H2: CSR efforts that increase goodwill may have a beneficial effect (i.e. negative) on the wage rate: w(G)/G < 0.
Empirical evidence of wage differentials for CSR firms are scarce. Bolvig
(2005) finds evidence of compensating wage differentials in CSR firms in a
26
This relationship is (implicitly) the most widely tested in the empirical literature on social
performance and financial performance. More on this below.
27
Bert Scholtens is thanked, without being implicated, for suggesting this section.
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Tommy Lundgren
4. CONCLUDING REMARKS
This paper provides theoretical underpinnings to help understand the mechanisms and incentives behind the behavior of a socially responsible firm.
Profit-maximizing firms consider both the costs and benefits of CSR. The
implications of these findings are that firms will engage in CSR activities if
stakeholders, such as the government, the financial sector, consumers, nongovernmental organizations, etc., reward or pressure firms to engage in such
behavior. The link between profitability and different dimensions of CSR is
therefore likely to differ across countries, sectors and even firms. The model
in this paper provides a useful theoretical background for the understanding
of CSR incentives and for constructing relevant hypotheses in empirical
applications.
Future research should include the impact of uncertainty, e.g. what are the
effects of environmental incidents or bad news that arrive over time in some
stochastic manner? A natural way to model this would be to include a
stochastic element to the evolution of goodwill capital, e.g. an Ito diffusion
process and/or a Poisson jump process.29 Another possible route of research
28
Although H5 can be considered a kind of overall test of whether social performance is
associated with higher firm value.
29
The models in, for example, Tapiero (1977, 1978) could be adapted and modified to tell the
story of CSR under uncertainty. See also Lundgren (2003) for an Ito/Poisson process applied to
the evolution of goodwill in a highly simplified investment optimal stopping problem.
91
would be to allow for potential Porter effects where some types of CSR
investments (e.g. investment in green technology) could have positive effects
on long-term efficiency of the capital stock and/or spur innovative processes
and investment in R&D. This could be modeled within the framework presented here, possibly combined with uncertainty components. It would also
be useful to explore the consequences of asymmetric information further;
that is, when reputation and sales can be boosted with advertising efforts
(see, for example, Spremann, 1985) without actually altering the product
attributes, so-called greenwash.
APPENDIX
In infinite horizon autonomous problems with one control and one state
variable, and when the discount rate is small enough, the equilibrium is
usually a stable saddlepoint (Kamien and Schwartz, 1991, section 9).
However, this is more of a rule of thumb than a mathematical certainty. In
general, the steady state may or may not exist, or there may be multiple
steady states. To characterize the equilibrium formally, we now proceed to
study the linear differential system that approximates (6) and (11).30 Again we
work with the differential equation for l instead of g. Since g is proportional
to l, compare (14) with (17), the qualitative results will be the same. Write the
Hamiltonian in general form as
H c = ( g , G ) + f ( g , G )
(A1)
H gc = g ( g, G ) + fg ( g, G ) = 0
(A2)
and
c
H gg
<0
(A3)
Recall that
= r HGc ( g, G , )
(A4)
g = u (, G )
(A5)
Now totally differentiate (A1) and (A5) to get the properties of u(l, G):
30
Tommy Lundgren
92
c
c
dH c = H gg
dg + H gG
dG + fg d
(A6)
dg = uG dG + u d
(A7)
fg
dg = c dG c d
H gg
H gg
(A8)
uG =
c
H gG
fg
, u = c
c
H gg
H gg
(A9)
G = f (u ( , G ) , G ) , G ( 0 ) = G0
= r HGc (u ( , G ) , G , )
(A10)
f (u ( *, G *) , G *) = 0
r H (u ( *, G *) , G *, *) = 0
g* u ( *, G *) = 0
c
G
(A11)
G = ( fG + fg uG ) (G G *) + fg u ( *)
c
c
c
= ( HGG
+ HGg
uG ) (G G *) + (r fG HGg
u ) ( *)
(A12)
G = a (G G *) + b ( *)
= c (G G *) + (r a ) ( *)
(A13)
c
c
c
c
c
H gg
, b = ( f 2 g H gg
where a = fG fg H gG
.
H gg
) and c = ( HGgc ) H ggc HGG
The characteristic equation and roots for the system (A13) are
2
m2 rm + a (r a ) bc = 0
1
r (r 2a ) + 4bc 2
m1, m2 =
2
2
2
(A14)
93
If the roots are real, then the larger root is positive. The sign of the smaller
root is either positive or negative. It is negative if
bc > a (r a )
or
(+)
2
f g c 2
c
c
HGG
c ( HGg ) H gg
H
gg
c
H gg
()
c
c
f
H
fg H gG
g
gG
> fG
r
f
G
c
c
H gg
H gg
If this holds, the roots are real and of opposite sign, and the steady state
satisfies the conditions to be a saddlepoint. It is easy to verify that for the
functional properties assumed in our model, this condition indeed holds.
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Tommy Lundgren
Centre for Environmental and Resource Economics
Ume School of Busniness
S-901 87 Ume
Sweden
E-mail: tommy.lundgren@usbe.umu.se
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