Mackey 2007

Corporate Social Responsibility and Firm Performance: Investor Preferences and Corporate
Strategies
Author(s): Alison Mackey, Tyson B. Mackey and Jay B. Barney
Source: The Academy of Management Review, Vol. 32, No. 3 (Jul., 2007), pp. 817-835
Published by: Academy of Management
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?
Academy ofManagement Review
2007,Vol. 32,No. 3, 817-835.
AND
CORPORATESOCIALRESPONSIBILITY
FIRM PERFORMANCE: INVESTOR
PREFERENCESANDCORPORATESTRATEGIES
ALISON MACKEY
TYSON B.MACKEY
California Polytechnic State University
JAYB. BARNEY
The Ohio State University
We address the debate about whether firms should engage in socially responsible
behavior by proposing a theoretical model in which the supply of and demand for
socially responsible investment opportunities determine whether these activities will
improve, reduce, or have no impact on a firm's market value. The theory shows that
managers in publicly traded firms might fund socially responsible activities that do
not maximize the present value of their firm's future cash flows yet still maximize the
market value of the firm.
Debates continue to rage about whether or not On the other hand, some business and society
firms should engage in socially responsible be scholars have argued that firms have a duty to
havior. On the one hand, traditional economic society that goes well beyond simply maximiz
arguments suggest that managers should make ing the wealth of equity holders (Swanson, 1999;
decisions that maximize the wealth of their Whetten, Rands, & Godfrey, 2001). These schol
firm's equity holders (Friedman, 1962). Managers ars argue that such a narrow focus can lead
do this by making decisions that maximize the management to ignore other important stake
present value of the firm's future cash flows holders?including employees, suppliers, cus
(Copeland, Murrin, & Koller, 1994). To the extent tomers, and society at large?and that some
that socially responsible activities are inconsis times the interests of these other stakeholders
tent with these economic
objectives, traditional should supersede the interests of a firm's equity
financial logic suggests that they should be holders in managerial decision making, even if
avoided. Indeed, firms that engage in such ac this reduces the present value of the firm's cash
tivities?especially when they are very costly? flows (Clarkson, 1995; Donaldson
& Preston,
may subject to various
be forms of market dis 1995; Freeman, 1984; Mitchell, Agle, & Wood,
cipline, including limited access to low-cost 1997; Paine, 2002; Wood & Jones, 1995).
capital, the replacement of senior managers, One way to resolve this conflict is to observe
and takeovers (Jensen & Meckling, 1976).1 that at least some forms of socially responsible
behavior may actually improve the present
value of a firm's future cash flows and, thus,
Comments from Ruth Aguilera, Jyoti Ganapathi, Deborah may be consistent with the wealth-maximizing
Rupp, Sandra Waddock, JimWalsh, David Whetten, Mauri interests of the firm's equity holders. For exam
zio Zoilo, and in the Fisher College of Business
participants
ple, socially responsible behavior can enable a
Strategic Management Seminar, the BYU/University of Utah
Winter Strategy Conference, and seminars given at the
Copenhagen Business School, Arizona State University, and in fraud or self-dealing and make informed
engage rational,
the University of Oklahoma were helpful in the development decisions" (Fairfax, 2002: 440). This paper therefore focuses
of this paper. We presented an earlier version of this paper less on the legal of engaging in socially re
implications
at the 2004 annual meeting of the Academy of Management. actions and more on the market of
sponsible consequences
1
Interestingly, managers are not required by law to max these actions. See cases such as v. Wrigley (1968),
Shlensky
imize shareholder wealth. Rather, they are required only to Sinclair Oil Corp. v. Levien (1971), and Aronson v. Lewis
carry out the "lawful directives of shareholders" (Fairfax, (1984) for examples where courts allowed managers to put
2002; Simon, 1993). Thus, managers can engage in activities other interests above interests. (We thank
profit-maximizing
that reduce shareholder wealth as long as they "do not Timothy Fort for providing these examples.)
817
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818 Academy of Management Review July
firm to differentiate its products in its product ASSUMPTIONS AND DEFINITIONS

market (McWilliams & Siegel, 2001; Waddock &
Before
developing the model, it is helpful to
Graves, 1997), can enable a firm to avoid costly define its key terms and specify its central as
government-imposed fines (Belkaoui, 1976; Brag
sumptions. Margolis and Walsh (2003) have
don & Marlin, 1972; Freedman & Stagliano, 1991; in the
noted that much of the current confusion
Shane & Spicer, 1983; Spicer, 1978), and can act
corporate social responsibility literature is due
to reduce a
firm's exposure to risk (Godfrey, to a lack of clarity about definitions and as
2004). All of these socially responsible actions
sumptions.
can increase the present value of a firm's future
cash flows and are therefore consistent with
What Is Socially Responsible Behavior?
maximizing the wealth of the firm's equity hold
ers. A wide variety of definitions of corporate so
However, from a broader theoretical perspec cial responsibility have been proposed in the
tive, the entire effort to discover how socially literature (Margolis & Walsh, 2003). While these
activities can increase the present definitions vary in detail, many focus on volun
responsible
value of a firm's future cash is problem
flows tary firm actions designed to improve social or
atic. After all, the essential point of many busi
environmental conditions (Aguilera, Rupp, Wil
ness and society scholars is that the interests of liams, & Ganapathi, 2007; Davis, 1973;Waddock,
a firm's equity holders sometimes need to be set 2004; Wood, 1991a,b; Wood & Jones, 1995). This is
aside in favor of the interests of the firm's other the definition of corporate social responsibility
we adopt here.
stakeholders (Banfield, 1985; Carroll, 1995;Wind
Of course, within this broader definition, dif
sor, 2001). That is, according to social responsi
ferent stakeholders may have different prefer
bility theorists, firms should sometimes engage
ences for specific socially responsible activities
in activities that benefit employees, suppliers,
they would like to see their firm invest in (Grass,
customers, and society at large, even if those
1999). Moreover, these preferences may vary as
activities reduce the present value of the cash
the currency of social issues evolves over time
flows generated by the firm (Mitchell et al., 1997; (Clarkson, 1995; Davis, 1973; Moskowitz, 1975;
Paine, 2002; Wood & Jones, 1995). Focusing the
Wartick & Cochran, 1985; Wood, 1991a). How
study of corporate social responsibility on those
ever, as long as a firm's actions are consistent
actions that increase the present value of a
with this general definition of social responsi
firm's cash flows fails to address this central
bility?that is, as long as they are voluntary and
theme in the corporate social responsibility lit to improve social or environmental
designed
erature (Windsor, 2001). are considered re
conditions?they socially
In this context, not just examples of socially for the purposes of the model devel
sponsible
responsible actions that can have a positive im
oped here.
pact on a firm's cash
flows?so-called profit The specific decision-making context mod
maximizing "ethics"
(Windsor, 2001)?are re eled here focuses on determining the total de
quired but, rather, a theory that suggests the mand for investment opportunities in firms
conditions under which firms will engage in so engaging in specific socially responsible activ
activities, even if those activ ities; the current supply of those opportunities in
cially responsible
ities reduce the present value of a firm's cash the market; and whether current supply is less
flows?so-called philanthropy (Windsor, than, equal to, or greater than demand. In this
costly
a theory. sense, the opportunity to invest in a firm that is
2001). In this paper we propose such
on the simple observation engaging in specific socially responsible activ
This theory builds
inter ities can be thought of as a "product" that is sold
that equity holders may sometimes have
by firms to potential equity investors as "cus
ests besides simply maximizing their wealth
tomers."2
when they make their investment decisions.
Sometimes, they may want the firms they invest
in to pursue socially responsible activities, even 2
Of as "customers" for opportuni
course, equity holders
if these activities reduce the present value of the ties to invest in socially responsible firms may vary in the
cash flows generated by these firms. kinds of corporate social responsible activities they would

2007 Mackey, Mackey, and Barney 819
What Is Firm Performance? managers seek to maximize the value of their

firm is a useful approximation.
A wide variety of definitions of firm perfor
For our purposes here, whether or not manag
mance have also been proposed in the literature
ers can or do seek tomaximize the value of their
(Barney, 2002). Both accounting and market def
firm in their decision making is less important.
initions have been used to study the relation
Rather, we conduct a simple "thought experi
ship between corporate social responsibility ment": since corporate social responsibility
and firm performance (Orlitzky, Schmidt, &
scholars have been interested in understanding
Rynes, 2003). However, since most social respon
the economic consequences for a firm imple
sibility scholars seek to understand the ways
menting socially responsible activities, we de
that socially responsible corporate activities
velop a model where managers are assumed to
can create or destroy shareholder wealth, mar
focus on maximizing the market value of their
ket definitions of firm performance seem likely
firm, and we examine the impact of socially
to be more appropriate than accounting defini
responsible activities on this market value. In
tions of firmperformance in this context (Margo
this sense, the assumption that managers seek
lis & Walsh, 2001).
to maximize the market value of their firm in
In fact, in the model developed here, we adopt
their decision making provides a standard
such a market definition of firm performance by
against which to evaluate the economic conse
focusing on how
socially responsible corporate
quences of engaging in socially responsible ac
activities affect a firm's market value. Market
tivities that reduce the present value of a firm's
value is defined as the price of a firm's equity
cash flows.
multiplied by the number of its shares outstand Yet while we examine the market value con
ing. Thus, our model addresses the following
of firms' pursuit of socially
sequences responsi
question: Supposing managers seek to maxi
ble activities that reduce the present value of
mize the market value of their firm in their de
their cash flows, we do not assume that maxi
cision making (Copeland et al., 1994; Friedman,
mizing the present value of a firm's cash flows
1962), will they ever choose to invest in socially
and maximizing a firm's market value are
responsible activities that reduce the present
equivalent. Such an assumption is only justifi
value of their firm's cash flows?
able ifall of a firm's current and potential equity
Of course, there is some controversy about the
holders are solely interested in maximizing
assumption that managers seek tomaximize the
their wealth in making their investment deci
market value of their firms in their decision
sions. If, however, at least some of these inves
making. Some have suggested that under con
tors have interests besides simply maximizing
ditions of uncertainty and imperfect informa
their wealth in making investment decisions,
tion, managers cannot know, ex ante, how to
then "maximizing the present value of a firm's
maximize the market of their firm (Al
value
cash flows" and "maximizing firm value" are no
chian, 1950). Others have suggested that mana
longer equivalent concepts.
gerial interests are often inconsistent with max
imizing the value of a firm (Jensen & Meckling,
1976). However, some of these same authors ar
gue that managers who fail to maximize the Market Efficiency Assumptions
market value of their firm, ex post, may be sub
The model presented here also assumes that
ject to a variety of market sanctions (Jensen &
the that capital markets are semi-strong efficient (Fama,
Meckling, 1976), and, thus, assumption
1970). This means that publicly available infor
mation about the perceived value of a firm's
to invest in. The model here adopts the
assets will, on average, be reflected in the mar
prefer developed
simplifying assumption that these equity investors all have ket price of those assets. Semi-strong efficiency,
a preference for investing in firms pursuing a particular in particular, implies that if firms engage in
socially responsible activity?although this specific activity
specific socially responsible activities in a pub
is not important in the model. Without loss of generality, this
lic way, current and potential equity holders
preference can also be
interpreted as a preference for a
bundle
of socially activities. This sim
will be aware of both the nature of these activ
particular responsible
plifying assumption is relaxed in the model extensions sec ities and their impact on the present value of a
tion of the paper. firm's future cash flows and will, on average,

adjust their valuation of a firm's equities accord cially responsible activities that reduce the
ingly. value of those cash flows.
There is substantial
evidence that U.S. capital Obviously, identifying socially responsible
markets are, overall, semi-strong efficient activities that increase the present value of a
(Copeland et al., 1994). This does not mean that firm's cash flows is interesting in its own right
the value of a firm's equity always equals the (Godfrey,2004;McWilliams & Siegel, 2001;Wad
true underlying value of the firm; certainly, dock & Graves, 1997). However, no new theory is
there is a great deal of private information required to explain why firms will pursue such
about the value of those assets (Fama, 1970), and activities, once identified. Such actions are con
investor decisions are often systematically non sistent with
received economic and financial
rational (Tversky & Kahneman, 1974) and af theories of firm behavior. But new theory is re
fected by emotions (Schiller, 1999; Shefrin, 2000; quired to explain why firms might pursue so
Thaler, 1987a,b). However, semi-strong effi cially responsible actions that reduce the
ciency does suggest that whatever public infor present value of their cash flows. Focusing the
mation exists about the value of a firm's assets model only on these situations helps develop
is, on average, likely to be reflected in the price this critical aspect of the theory of corporate
of those assets (Fama, 1998).3 In this context social responsibility.
semi-strong efficiency suggests that when a
firm publicly pursues socially responsible activ
THE MODEL
itiesthat reduce the present value of its cash
flows, current and potential investors will factor In this section we present a simple model of
these actions and their consequences into deci the supply of and demand for opportunities to
sions about whether or not to buy or sell this invest in socially responsible firms.We use this
firm's stock. model to describe the impact that beginning or
ending socially responsible activities that re
duce the present value of a firm's cash flows will
Socially Responsible Activities and Firm Cash
have on the firm's market value.
Flows
As is always the case, we adopt a variety of
Finally, while
acknowledging that some so simplifying assumptions. Many of these as
cially responsible activities can sometimes sumptions are technical in nature and do not
have a positive impact on the present value of a have an impact on the conclusions drawn from
firm's cash flows (Godfrey, 2004; McWilliams & the model. Some are more substantive in nature
Siegel, 2001; Waddock & Graves, 1997), our and might have an impact on these conclusions.
model examines the consequences of only those However, later in the paper, several of these
socially responsible activities that reduce the substantive assumptions are relaxed, and the
present value of a firm's cash flows.4 In this way conclusions of the model are reexamined. While
the model focuses on a central theoretical issue relaxing these assumptions does generate im
raised by those who study corporate social re portant insights, it does not affect the model's
sponsibility?that managers should sometimes central conclusion: the impact of socially re
abandon efforts to maximize the present value sponsible activities that reduce the present
of their firm's future cash flows in favor of so value of a firm's cash flows on a firm's market
value depends on the supply of and demand for
opportunities to invest in these types of firms.
3
There continues to be significant debate about the im
pact of nonrational elements in equity holder decision mak Firm Characteristics

ing on the efficient capital markets hypothesis (Fama, 1998).
We adopt the simple semi-strong efficient capital markets Consider an economy with N firms that all sell
assumption while acknowledging the importance of extend the same product in the same competitive prod
ing the model to include these emotional and cognitive uct market. In this setting these firms will all
phenomena in the future.
4 generate the same earnings, E, from their activ
The model is also generalized, later in the paper, to
ities in this product market. By definition, a
include socially responsible activities that have no material
or negative, on the present value of a firm's firm's earnings equal the present value of its
impact, positive
cash flows. future cash flows, before any investments in so

cially responsible activities.The goal of all the through these investments. By assumption,
firms in this model is tomaximize their value, P, some of these investors are interested only in
through revenues generated from the sale of maximizing their wealth inmaking their invest
shares of stock in their firm. Let s equal the ment decisions. We call these investors "wealth
number of those shares. Also, for simplicity, the maximizing investors." Conversely, other inves
model assumes that each of these firms has the tors may have interests besides simple wealth
same number of shares of stock to sell, they are maximization in making their investment deci
the same size, and they do not fund any of their sions. In particular, some investors may only
activities through debt. invest in firms that fund socially responsible
Indeed, in the model developed here, firms activities. We call these investors "socially con
differ only with respect to their decision to in scious investors." Let equal the proportion of
vest or to not invest in socially responsible ac investors in this market who are socially con
- co
tivities. Let 0 equal the proportion of firms that scious; 1 is the proportion of these investors
choose to fund socially responsible activities. that are wealth maximizing.
We call these
firms "socially responsible firms" Socially conscious investors derive benefit
throughout the rest of the paper. It follows that from the earnings of the firms they invest in, but
?
(1 6) is the proportion of firms not funding they derive benefit from the socially responsible
socially responsible activities. We call these activities of these firms as well. The total bene
firms "traditional profit-maximizing firms" fits (or utility) that a socially conscious investor
throughout the rest of the paper. In this model obtains from investing in a firm pursuing so
firms are the only source of =
socially responsible cially responsible activities (i.e., F 1) is
initiatives in the economy.5
socially responsible -
6N(E C)
Usc =--,- (D
~cof
Social Initiative Characteristics
The numerator of this equation is the total earn
The firms in this simple model face a decision,
F, of whether or not to fund a discrete bundle of ings of all the socially responsible firms in the
initiatives. The decision to economy (i.e., ON is the total number of socially

socially responsible -
= responsible firms and E C is their net earn
fund, F 1, is assumed to be costly and nonrev
enue enhancing, which ings). The denominator of this equation is the
implies that this deci
number of socially conscious investors in the
sion reduces the present value of a firm's cash
flow. The firms that choose to use their earnings economy. The ratio of the numerator (total earn
ings of all socially responsible firms) and the
to fund socially responsible initiatives incur a
denominator (number of socially responsible in
cost, C, for doing so, which reduces their net
amount. vestors) is each investor's share of any earnings
earnings by this Thus, firms that fund
created by socially responsible firms.6
social initiatives have greater cash outlays than
However, the total utility that a socially con
firms that do not fund social initiatives. The
scious investor obtains from investing in a firm
choice not to fund socially responsible initia
not pursuing activities =
= socially responsible (F
tives, F 0, is assumed to not impact the present
value of the future cash flows of the firm. 0) is zero. This is how the difference between
socially conscious and other investors in this
model is operationalized: socially conscious in
Investor Characteristics vestors obtain no utility from investing in firms
that do not implement socially responsible ac
The number of potential equity investors in
tivities, whereas other investors do.
the economy is J. For simplicity, assume that
each of these investors has been endowed with
the same amount of money to invest in equities,
6
equal tom, and that these funds are exhausted This and the other utility functions in this paper are
assumed to be linear. This eliminates considerations of the
risk associated with investment decisions. That is, since
5
Of course, other institutions and individuals in the econ these firms are identical,except with respect to their social
omy, besides firms, can fund socially responsible initiatives. initiatives, the risk associated with investing in them is the
However, we ignore these alternative investment same and thus can be for purposes of this discus
opportuni ignored
ties in this version of the model. sion.

The benefits
derived from investing for =
SpM ?-0)sN (4)
wealth-maximizing investors is presented in
Equation 2. These benefits are the share of the where SPM is the available supply of stock in
total earnings created by firms not funding so firms that are funding only traditional profit
- behavior. If there are N = 100 total
cially responsible activities, (1 6)NE, for each maximizing
? firms in an economy each s = 10,000
of the wealth-maximizing investors, (1 a>)/. In selling
- =
principle, these investors are not restricted from shares of stock, and 75 percent, (1 6) .75, are
purchasing equity in firms that are engaging in funding only traditional profit-maximizing be
socially responsible activities. However, since havior, then the total supply of stock in profit
in this model all these activities reduce the maximizing firms is 750,000 shares.
value of a firm's cash flows (i.e., C > 0), Demand can be thought of as the total amount
present
investors will to not of money controlled by different kinds of inves
wealth-maximizing prefer
invest in such firms.7 tors in this economy. Thus, in this simple model,
demand for shares of stock in socially responsi
-
-_ (1 d)NE ble firms is equal to
UwM - (2)
(1 a>)J = (oml (5)
DSR
where DSR is the total amount of money con

Determining the Stock Price
trolled by socially conscious investors in this
Determining the price of the stock for socially market. If there are J= 200 total investors in an
=
responsible and traditional profit-maximizing economy each endowed with m $50,000, and 25
firms depends on establishing the supply of and co = .25, are conscious inves
percent, socially
demand for these different types of stocks in the tors, then the total amount of money controlled
economy. In the simple model developed here, by socially conscious investors is $2,500,000.
the total supply of shares of stock in socially The total demand for shares of stock in profit
responsible firms is simply maximizing firms is equal to
= 6sN(3) = ~
SSR DPM (1 o))mI (6)
where SSR is the available supply of stock in where DPM is the total amount of money con
firms that are funding socially responsible ac trolled by wealth-maximizing investors in this
=
tivities. If there are N 100 total firms in an market. If there are J= 200 total investors in an
s = =
economy each selling 10,000 shares of stock, economy each endowed with m $50,000, and 75
and 25 percent, 6 = .25, of these firms engage in percent, (1
?
co)
=
.75, are wealth-maximizing
socially responsible behavior, then the total investors as opposed to socially conscious, then
supply of stock in socially responsible firms is the total amount of money controlled by wealth
250,000 shares. maximizing investors is $7,500,000.
The total supply of stock for firms not engag The price for a share of stock in these two
ing in socially responsible behavior is types of firms is found by dividing the amount of
money controlled by socially conscious and
wealth-maximizing investors by the supply of
7
stock of a particular type?for
socially responsible
This utility function has the nonbinding constraint,
- and traditional profit-maximizing firms, respec
0N(E C)
UWM ^-j-, that the wealth-maximizing investor will tively. This is done in Equations 7 and 8.
choose to invest in socially responsible firms if these invest
(oml
PsR= te? (7)
ments provide a greater return than investments in tradi
tional profit-maximizing firms. The constraint is nonbinding
because if such a situation arose in which wealth
investors had a financial incentive to invest in -
maximizing
-
_ (1 (o)mI
socially responsible firms, enough wealth-maximizing in PpM - {8)
vestors would pursue these opportunities, driving up the
(l e)sN
price of shares in socially responsible firms until returns
returns Using the numbers in the examples taken from
from investing in socially responsible firms equaled
to investing in traditional profit-maximizing firms for the above, the price per share for socially responsi
wealth-maximizing investor. ble stockwould be $10 ($2.5million divided by

250,000 shares), and the price per share forprofit ality, such equilibrium states rarely exist.
maximizing stock would be $10 as well ($7.5 Rather, this result is important because it helps
million divided by 750,000 shares). define the kind of incentives firms face when the
It is not surprising that the prices of these two economy in which they are operating is out of
types of shares in this example are equal. In equilibrium, for when the economy is out of
equilibrium, they should be. Suppose that these equilibrium, there will be unmet demand for
share prices were not equal. Firms in this set certain types of firms?either socially responsi
ting would have an incentive to change their ble or traditional profit-maximizing?and firms
social responsibility policies until the maximum looking to maximize their stock price will have
share price possible was reached. If the stock the incentive to change their type to meet this
price were higher for firms funding social initi excess demand. In particular, there will be set
atives than for traditional profit-maximizing tings where firms looking to maximize their
firms, some of the firms not currently funding stock price will have the incentive to pursue
social initiatives would have the incentive to socially responsible initiatives, even when
divert funds to social initiatives in order to at those initiatives reduce the present value of the
tract some of the excess demand in the equity firms' cash flows.
market for shares in socially responsible firms. Note that while, in equilibrium, the stock price
Firms would switch types until the share prices of socially responsible and traditional profit
were equal and there were no further gains from maximizing firms is the same, the earnings per
beginning to fund social initiatives. share of these firms are not the same. Since fund
If the stock prices were higher for traditional ing social initiatives is assumed to be costly and
profit-maximizing firms, however, some of the nonrevenue enhancing, the socially responsible
firms currently funding social initiatives would firms in the economy that have spent C on social
have the incentive to abandon these activities in initiatives will have lower net earnings than those
order to attract some of the excess demand in firms not funding such initiatives. Hence, earnings
the equity market for shares in traditional profit per share of the socially responsible firm are
maximizing firms. Firms would switch until the lower than the earnings per share of the tradi
share prices were equal and there were no fur tional profit-maximizing firm.
ther gains from abandoning social activities.
Thus, in equilibrium, the prices of these differ
ent types of shares would be equal.
SOCIALLY RESPONSIBLE INVESTMENTSAND
FIRM VALUE
Knowing that the share prices are equivalent
in equilibrium allows us to solve for a crucial With the equilibrium result in Equation 9 in
result of the model8: place, it is possible to examine how the social
- responsibility activities of firms can affect their
= (oml (1 o))mI = value. In general, firms can take three different
PsR ~0sN= (1 - 6)sN PpM (9)
actions with respect to their socially responsible
activities: (1) firms that currently do not engage
.-. w = e
in these activities can begin doing so; (2) firms
Thus, in equilibrium, the proportion of socially that currently do engage in these activities can
conscious investors, co,will equal the proportion stop; and (3) firms can maintain their current
of socially responsible firms, 0, and the propor policies?that is, those that currently engage in
- activities can continue to
tion of wealth-maximizing investors, 1 co,will socially responsible
the of traditional do so, and those that currently do not engage in
equal proportion profit
firms, 1-0. such activities can also continue to do so. Each
maximizing
This equilibrium result is important not be of these different activities can have an effect on
cause it exists in real economies. Indeed, in re the market value of a firm, depending on the
context within which these activities take place.
Equation 9 suggests that the most important
8 determinant of the impact of these activities on a
Note that m, I, s, and N are on both sides of Equation 9.
This means that Equation 9 can be simplified to cd/0= (1
- firm's market value is the relative supply of and
-
w)/(l 0). Simple algebraic manipulation makes it possible demand for opportunities to invest in socially re
to derive the conclusion that, in equilibrium, a> = 6. firms in an three pos
sponsible economy. Again,

sibilities exist: (1) demand for socially responsible trade for the stocks of different types of firms in
investment opportunities may be greater than different supply and demand conditions (Kar
their supply, (2) supply for these investment oppor poff, 1987; Wang, 1994). The impact of a single
tunities may be greater than demand, and (3) de firm beginning, abandoning, or not changing its
mand for these opportunities may equal supply. socially responsible activities on the market
The impact of a single firm beginning or value of other firms in the economy?those that
abandoning social responsibility policies on the maintain their socially responsible activities or
market value of that firm under different supply maintain their traditional profit-maximizing ac
and demand conditions is summarized in Table tivities?is described in Table 2.
l.9 These predictions depend on the volume of
When Demand for Social Responsibility Is

Greater Than Supply
9
Table 1 assumes that the firms changing their policies
do not bring the economy into equilibrium. That is, we as in Table
This column 1 summarizes the impact
sume that the conditions or supply >
that demand > supply of differentfirm strategies on a firm's market
demand exist before and after a firm changes its policy by
value when demand for socially responsible in
either beginning or abandoning socially responsible activi
vestment opportunities is greater than supply.
ties.
TABLE 1
The Effect of Beginning or Abandoning Socially Responsible Activities on a Firm's Market Valuea
Firm Demand
Action > Supply > Demand = Demand
Supply Supply
??
A firm begins socially responsible +
activities
? -
A firm abandons socially responsible +
activities
aThe signs of these

predictions are derived from Equation 9. Consider, for example, the column of the table where
demand > supply. a firm begins socially responsible activities (row 1). The number of socially responsible firms in
Suppose
the economy changes from 6N to 6N + 1. The price of this firm's equity will increase from PPM to P'SR if and only if demand is
still greater than supply after this firm switches (coN is greater than or equal to 6N + 1). The relationship between PPM and P'SR
is derived in the following way:
?
(1 o))mI (oml
? ?
PpM 7? - ^TT7~~ <K /??t ,
iT~ P'sF
(1 6)Ns (ON+ l)s
(\-a>) ! (l-O)N
l<
? =?~ 0N+1
? 1< (1-0)N+0N+1 N+l

ON+ 1 6N + 1
(oN + cd> ON + 1
' ''
P'sr > Ppm assumption 1
Now, suppose instead that a firm abandons socially responsible activities (i.e., the number of traditional profit
maximizing firms increases from {l-6)N to [(1-0W+1]). After switching, the new price for traditional profit-maximizing
firms, P'pm> is less than the original price for traditional profit-maximizing firms, PPM:
- -
(1 ?))ml (1 (o)mI
= =
iPm
P'pm< T,-^T7- Pp.Pm
((l-0)N+l)s (l-O)Ns
denominator has increased and numerator has not changed
'
P'pm < Psr
Similar calculations can be conducted for the remaining columns and rows of this table.

TABLE 2
The Effect of a Firm Changing Its Socially Responsibility Strategy on the Market Value of Other
Firms in the Economy
One Firm Switches from One Firm Switches from

Profit Maximizing to Social Responsibility to
Social
Action Responsibility Profit Maximizing No Firm Switches
-
Firm maintains activities + 0
-
Firm maintains profit maximizing 0 +
Suppose, for example, that the proportion of so than supply, abandoning such activities will re
cially conscious investors in the economy, co, is duce the market value of a firm.
.4 rather than .25,while the proportion of socially
responsible firms, 0, is .25. In this setting the
demand for socially responsible investment op When for Social Is
Supply Responsibility
portunities is greater than the supply of such Greater Than Demand
opportunities. The market value of firms that are
ac Suppose now that the proportion of socially
currently engaging in socially responsible
conscious investors in the economy, , is .15
tivities in this situation is $16 per share; the
value of rather than .25,while the proportion of socially
market traditional profit-maximizing
firms is $8 per share.10 responsible firms, 0, is .25. In this setting the
supply of socially responsible investment op
First, consider the market value of a tradi
to fund portunities is greater than the demand for such
tional profit-maximizing firm that begins
activities in this setting. If opportunities. The market value of firms that are
currently engaging in socially responsible ac
one firm does this, the total supply of socially
tivities in this situation is $6 per share; the mar
responsible investment opportunities, 0, in
ket value of traditional profit-maximizing firms
creases from .25 to .26. The new price per share
is is $11.33 per share.
of socially responsible firms in this economy
Consider the market value of a socially re
$15.38. This means that by beginning to fund
this one firm can sponsible firm that drops its socially responsi
socially responsible activities,
ble activities in this setting. Ifone firm does this,
shift its share price from $8 per share to $15.38
in this setting, beginning to the total supply of socially responsible invest
per share. Thus,
in creates ment opportunities, 0, decreases from .25 to .24.
engage socially responsible activities
for a firm, even if those activities The new price per share of traditional profit
market value
reduce the present value of the firm's cash flows. maximizing firms in this economy is $11.18. This
means that by ending its socially responsible
This will be true as long as demand for these
is than their activities, this one firm can shift its share price
opportunities greater supply.
the market value of a socially from $6 per share to $11.18 per share. Thus, in
Next, consider
firm that decides to become a tradi this setting, abandoning socially responsible
responsible
tional profit-maximizing firm in this setting. activities can create market value for a firm.
the total supply of socially This will be true as long as the supply of so
Here, responsible
investment in the economy, cially responsible investment opportunities is
opportunities 0,
from .25 to .24. This firm's share greater than their demand.
drops price per
will drop from $16 per share to $7.89 per share. Not surprisingly, a traditional profit-maximiz
ing firm that begins to engage in socially re
So, not surprisingly, when demand for socially
investment opportunities is greater sponsible activities when the supply of invest
responsible
ment opportunities in these types of firms is
greater than demand will see its market value
10 fall. If one traditional profit-maximizing firm be
The price per share of the socially responsible firm,
using Equation 7, is (.4(50,000)(200))/.25(10,000)(100).
Equation 8 gins to engage in socially responsible activities,
can be used to calculate the price per share of the traditional its price per share will fall from $11.33 to $5.77.
profit-maximizing firm in the same way. Traditional profit-maximizing firms will experi

ence a drop in their market value from imple using the parameter values stated earlier, ifde
menting socially responsible activities as long mand for socially responsible investment oppor
as the supply of socially responsible investment tunities is greater than supply, the first tradi
opportunities is greater than the demand for tional profit-maximizing firm to begin engaging
such opportunities. in socially responsible activities will see its
market value jump from $8 per share to $15.83, a
98 percent increase. The last of these firms to
When Supply forSocial Responsibility Is Equal
change its policy before the economy reaches
to Demand
equilibrium will see its price per share rise from
Finally, when the demand for socially respon $9.84 to $10, an increase of 2 percent.11
sible investment opportunities equals the sup While there appear to be significant first
ply of these opportunities, firms that change mover advantages in this setting, there could
their policies?by either becoming socially re also be important first mover disadvantages.
sponsible or abandoning their socially respon For example,changes in demand for socially
sible activities?will see their market value fall. responsible activities may be difficult to gauge.
This is because either of these actions will have A firm that changes its policies assuming such
the effect of creating excess supply?of socially changes have occurred when they have not will
responsible investment options in the first case see its market value fall accordingly.
and of traditional profit-maximizing investment
options in the second case.
Implications for the Market Value of Other
So, if the proportion of socially conscious in
Firms
vestors in the economy, co, is .25 and the propor
tion of socially responsible firms in the econ Table 1 examines the impact of adding or
omy, 0, is also .25, then the price per share of abandoning socially responsible activities on
socially responsible and traditional profit the market value of a firm that engages in these
maximizing firms in this economy will be $10. If strategies in different supply and demand con
one firm in this economy decides to change its ditions. However, these actions not only affect
strategy (say, from a traditional profit-maximiz the market value of this firm but also affect the
ing firm to a socially responsible firm), it will market value of other firms in the economy. As
see its share price fall to $9.62. No profit suming these other firms do not change their
maximizing firm will engage in such activities. current strategies?that is, they either maintain
Thus, if there are no changes in the level of their current socially responsible activities or
demand for socially responsible or traditional maintain their current traditional profit-maxi
profit-maximizing investment opportunities in mizing status?Table 2 shows this impact. The
an economy, any changes in a firm's corporate logic behind Table 2 is straightforward. When
social responsibility strategy must destroy some one firm changes from a traditional profit
of the firm's market value. maximizing firm to a socially responsible firm,
the total supply of socially responsible invest
ment opportunities in the economy increases
Predicting the Size of Firm Market Value
and the market value of firms maintaining their
Changes activities will
socially responsible decrease,
Table 1 examines the impact of beginning or while the market value of firms maintaining
abandoning corporate social responsibility pol their traditional profit-maximizing status will
icies on the market value of the firm engaging in increase. The opposite effects occur when a so
these activities. However, the size of these ef cially responsible firm abandons its socially re
fects on the market value of this firm is not sponsible activities
and becomes a traditional
discussed in the table. The size of these effects profit-maximizing firm. Of course, if no firm
depends on the timing of any changes a firm changes its strategies, then firms that maintain
might implement. The first few firms that make
a value-enhancing policy change in an economy
in disequilibrium will experience much larger 11
Of course, this last firm has seen its stock rise
price
increases in market value than the last few from $8 per share to $9.84 per share before it decides to
firms that make such a change. For example, change its strategy.

their strategies will see no change in their mar ket value of a firm depends on the supply of and
ket value. demand for opportunities to invest in socially
Interestingly, while itwill be the case that a responsible firms. However, it is possible to re
firm that maintains its socially responsible ac lax many of these simplifying assumptions.
tivities when another firm switches from tradi While relaxing these assumptions does not alter
tional profit maximizing to socially responsible the central conclusion of the model, it does sug
will see its market value fall, it does not follow gest some potentially interesting extensions.
that this firmwill abandon its socially respon We discuss five of these possible extensions
sible activities. This firm's market value may be here.
lower than it was before the traditional profit
maximizing firm switched its strategy, but that
market value may still be greater than what
When Equity Holders Vary in the Capital They
would be the case if it abandoned its socially
Have to Invest
responsible status and became a traditional
profit-maximizing firm. In its current form the model assumes that all
For example, using the parameter values from investors have the same amount of capital to
earlier, when demand for socially responsible invest. Suppose this was not the case?that
investment opportunities is greater than supply, some current and potential equity investors had
a firm switching its strategy from traditional much more money to invest than others. How
profit maximizing to socially responsible will would this concentration of investment capital
see its price per share jump from $8 to $15.38. A affect the socially activities of
responsible
firm that maintains its socially responsible ac firms?
tivities in this setting will see its price per share In general, holding trading levels equal
fall from $16 to $15.38. However, $15.38 per share (Coyne & Witter, 2002), the effect of this concen
is much higher than the price per share of this tration of investment capital would depend on
firm if itwere to abandon its socially responsi the preferences of these powerful investors. If
ble strategy. If this firm became a traditional these large investors had a preference for the
profit-maximizing firm, its price per share would firms they invest in to engage in socially respon
drop from $15.38 to $8. sible activities, regardless of the negative cash
Similar calculations can be done for firms flow implications of these activities, then de
contemplating switching from social
responsi mand for these kinds of investment opportuni
bility to traditional profit maximizing when the ties would increase, and beginning such actions
supply for socially responsible investment op would increase the market value of a firm?
portunities is greater than the demand for those even if these activities reduced the present
opportunities and when one firm has switched value of the firm's cash flows. Conversely, if
from social responsibility to traditional profit these large investors did not have such a pref
maximizing. In this case, the firm that maintains erence, then demand for these kinds of socially
its traditional profit-maximizing strategy will responsible investment opportunities would be
see its market value fall, but itwill still have an lower, and firms that began such activities
incentive to maintain that strategy until the would likely see their market value drop.
economy approaches equilibrium. It is interesting to note that this concentration
of investment capital into funds that invest in
MODEL EXTENSIONS socially responsible companies may actually be

occurring, at least in some economies. In the
As suggested earlier, in this model of the re United States, for example, certain very large
lationship between a firm's socially responsible pension funds have adopted investment criteria
activities and itsmarket value, we have adopted that emphasize social responsibility?for exam
several The ple, CalPERS (Lavelle, 2004). These
simplifying assumptions. purpose large funds
of most of these assumptions has been to facil can have the effect of increasing demand for
itate the exposition of the model and to focus these kinds of investment opportunities, with
attention on its central conclusion: the impact of subsequent effects on the market value of firms.
socially responsible activities that reduce the In deciding whether or not to engage in socially
present value of a firm's cash flows on the mar responsible activities, firmmanagers will have

to estimate the potential effect of this increased tivity or any bundle of socially responsible ac
demand on their market value. tivities that reduces the present value of a firm's
cash flow. However, we have assumed that all
When Firms Vary in Their Ability toMake current and potential equity holders prefer to
Socially Responsible Investments invest in firms pursuing the same socially re
we sponsible activities, whatever they are. Obvi

In the model have alsoadopted the sim
ously, in reality, the social responsibility invest
plifying assumption that all firms making so
ment preferences of current and potential equity
cially responsible investments are equally investors might vary dramatically. Three ways
skilled in doing so. This assumption is reflected
that these preferences might vary are consid
in the fact that C, the negative impact that mak ered here.
ing socially responsible investments has on a
First, suppose that different groups of inves
firm's cash flow, is assumed to be constant
tors prefer to invest in firms pursuing different
across firms.
socially responsible activities and that these ac
However, socially responsible investments
tivities are not substitutes for each other. This
are like any other investments. Firms may vary
would be the case, for example, if those that
in their ability to conceive of and implement made their investment choices looking at a
these investments (Barney, 1991). If a firm is firm's environmental were
policy indifferent to
more effective than others in making socially the firm's employment policies, and vice versa.
responsible investments, it can gain a competi
In this setting the supply and demand parame
tive advantage (Peteraf & Barney, 2003). If the ters that are relevant in the model are not the
resources the firm uses to gain this competitive
overall supply of and demand for socially re
advantage are path dependent, socially com
sponsible investment opportunities but, rather,
plex, or causally ambiguous (Barney, 1986; Dier the supply of and demand for specific socially
ickx & Cool, 1989), they may be a source of sus investment opportunities
responsible (e.g., the
tained competitive advantage. A firm with a
supply of and demand foropportunities to invest
sustained competitive advantage in funding so
in environmentally responsible firms, the sup
cially responsible activities will attract a larger
ply of and demand for opportunities to invest in
proportion of socially conscious investors in the
firms with socially responsible employment pol
economy than other firms making these invest
icies, and so forth). However, within the market
ments. This will lead this firm to have a higher
segment defined by equity investor preferences,
market value than would otherwise be the case.
the central conclusions of the model will still
Indeed, itmay
be possible for a firm with a
hold: the supply of and demand for opportuni
sustained competitive advantage in funding so
ties to invest in, say, firms pursuing environ
cially responsible activities to have a relatively
mentally responsible activities determine the
high market value, even when the supply of
relationship between pursuing these activities
socially responsible investment opportunities is
and a firm's market value. In choosing which
greater than the demand for these opportunities.
particular socially responsible activities to con
This is because among all the firms "selling"
tinue or discontinue, managers seeking to max
socially responsible investment opportunities, a
imize the market value of their firmwill have to
firmwith a competitive advantage will be able
estimate the supply and demand parameters for
to differentially attract investors.12
each of these segments of the market for socially
responsible investment opportunities.
When Equity Holder Preferences Are that different groups of in
Second, suppose
Heterogeneous vestors prefer to invest in firms pursuing differ
The model, as it has been developed so far, ent socially responsible activities but that these
can be applied to any socially ac different activities now are partial substitutes
responsible
for each other. In this setting the supply of and
demand for specific socially responsible invest
12
Of course, firms maydiffer in their ability to actually
ment opportunities would have to be condi
conceive of andimplement socially responsible activities, or
to publicize activi
tioned by the demand for and supply of invest
they may differ in their ability whatever
ties they may be engaging in. Either can be the source of ment opportunities in firms pursuing socially
competitive advantage in this context. responsible activities that are partial substi

tutes. Estimates of the cross-elasticity of de cially responsible activities. Any empirical in

mand between these different investment op vestigation of the relationship between a firm's
tions would have to be included to estimate the adoption of socially responsible corporate poli
effect of a firm's decision to begin, or to cease, cies and that firm's market value will have to
engaging in a particular socially responsible take into consideration the frequency with
activity on that firm's market value. which the firm changes its policies and the lag
While this extension of the model signifi between when the firm changes its policies and
cantly complicates the estimate of the supply of when socially conscious investors come to be
and demand for socially responsible investment lieve that the traditionalprofit-maximizing firm
opportunities, it might nevertheless generate has transformed itself into a socially responsi
important insights into the relationship between ble firm (Whetten & Mackey, 2004).
socially responsible activities and firmmarket This logic also suggests that firms that are
value, especially as this model is tested empir truly committed to engaging in socially respon
ically. However, these complications do not alter sible activities will be reluctant to change, even
the central conclusion of the simple model: the when demand for those activities falls. Ironi
supply of and demand for socially responsible cally, this can actually improve the market
investment opportunities determine the effect of value of these firms, for as less committed firms
these activities on a firm's market value. change from socially responsible to traditional
Finally, suppose that only a small number of profit-maximizing firms, the total supply of so
current or potential investors prefer to invest in cially responsible investment opportunities in
firms pursuing a particular socially responsible the economy falls, and the market value of firms
activity and that these investors do not consider that do not abandon their traditional socially
alternative socially responsible activities as responsible activities will rise.
substitutes. In this setting the demand for this
particular investment opportunity is not likely to When Activities Have No
be large, will rarely be greater than supply, and Socially Responsible
Material Impact on a Firm's Cash Flows
relatively few firms will find it in their wealth
maximizing interests to pursue these activities. Finally, the model has thus far examined the
Such "specialist investors" will either have to economic consequences of only those socially
increase of investors with this in
the number responsible activities that reduce the present
vestment preference or join with other investors, value of a firm's cash flows. However, Margolis
by relaxing their "no substitutes" stance, to have and Walsh (2003), in their review, found that
an impact on the market value of firms. most corporate investments in socially respon
sible activities are very small. Few have any
When to a Social
material impact on a firm's reported accounting
Commitments Responsibility
performance, including the present value of its
Strategy Are Costly to Change
cash flows. What impact will investments in
In its current form the model also assumes socially responsible behavior have on a firm's
that firms can change their social responsibility market value when those investments have no
strategy?either beginning to invest in socially material impact, positive or negative, on the
responsible activities or ending such activi value of the firm's cash flows?
ties?without cost. Of course, in reality, such Answering this question depends on under
changes are likely to be costly. The cost of these standing that socially conscious investors have
changes in strategy might have implications for, interests besides the present value of a firm's
among other things, how quickly investors will cash flows in making their investment deci
respond to corporate announcements of corpo sions. Socially responsible activities, even if
rate social responsibility initiatives. they have no materialimpact on a firm's ac
For example, changing its social responsibil counting performance, can still have an impact
ity strategy too frequently is likely to signal to on the market value of the firm as determined by
potential investors that a firm's commitment to the demand for and supply of socially responsi
social responsibility is not genuine. This can ble investment opportunities. In this context the
lead socially conscious investors to underinvest model suggests that, when the conditions are
in the firm, even if the firm is engaging in so right, investing in socially responsible activities

that have no impact?positive or negative?on a However, the model developed here sug
firm's cash flow can nevertheless have a posi gests that efforts to examine the "overall" cor
tive impact on the firm's market value. relation between socially
responsible activi
ties and firm performance may be less
interesting than examining the relationship
IMPLICATIONS AND DISCUSSION
between the supply and demand conditions
The central assertion of this paper is that the under which these decisions are made and a
opportunity to invest in a firm engaging in so firm's market value. Sometimes, so
beginning
cially responsible activities is a "product" firms activities will increase a
cially responsible
sell to current and potential investors. Some firm's market value; sometimes itwill reduce
times, current and potential equity holders may its market value. Sometimes, ending socially
prefer to invest in firms pursuing such activities, responsible activities will decrease a firm's
even if those activities reduce the present value market sometimes it will increase its
value;
of the firms' cash flows. The central conclusion market value. And, sometimes, cur
continuing
of this paper is that the supply of and demand rent socially either
responsible activities?by
for these investment opportunities determine to invest in these activities or con
continuing
when socially responsible activities that reduce to not invest in
tinuing these activities?will
the present value of a firm's cash flows will be increase a firm's market it
value; sometimes
positively or negatively related to that firm's
will decrease a firm's market value. Only by
market value.
examining the supply of and demand for so
Beyond this central assertion and conclusion,
cially responsible investment opportunities at
the arguments developed here have a variety of
the time these decisions are made can the
other empirical, theoretical, and practical impli
relationship between a firm's social responsi
cations. We examine some of these other impli
bility strategies and its market value be un
cations below.
derstood.
Of course, itwill often be difficult to directly
Empirical Implications measure the supply of and demand for socially
responsible investment opportunities. However,
Overall, the model suggests that there will be
a correlation between firm choices
it may be possible to develop surrogate mea
positive sures of these concepts. For example, changes
about investing in socially responsible activi
in the number of firms who score high on vari
ties and firm value. This is because the model
ous aggregate measures of social responsibility
adopts the assumption that managers make
might indicate changes in the supply of socially
these choices?to begin socially responsible ac
cease responsible investment opportunities. Also,
tivities, to socially responsible activities,
or to maintain changes in the total dollars invested in so
their current strategies whether
or not?in a way cially responsible mutual funds as a percent
they are socially responsible
that maximizes the market value of a firm. Re age of the total dollars invested in all mutual
cent reviewsof the empirical social funds might be an indicator of changes in total
corporate
literature are consis demand for socially responsible investment
responsibility generally
tent with this expectation (Orlitzky et al., 2003), opportunities. Public opinion polls on the im
and Walsh portance of various social issues in an econ
although Margolis (2003) suggest
omy might also some indication of the
that the empirical results, while positive overall, provide
are nevertheless mixed.13 level of demand for socially responsible in
vestment opportunities.
Whatever measures are ultimately developed,
13
Note that in previous work researchers have
the model presented here suggests that under
empirical
examined the financial impact of socially responsible activ standing the relationship between the supply of
ities that have a positive impact on the present value of a and demand for socially responsible investment
firm's cash flows, along with those that have a negative
opportunities is central to understanding the re
impact on these cash flows. Additionally, much of this prior
lationship between socially responsible activi
work has relied on accounting-based measures of perfor
mance, which would not be comparable to the theory we ties and firm performance, at least as measured
develop in this paper. by a firm's market value.

Theoretical Implications It is this demand for opportunities to invest in

socially responsible firms, and its relationship
The model also has a variety of theoretical
to the supply of these investment opportunities,
implications, both for the study of firm value
that determines the market value of a firm. Thus,
more broadly and for the study of the relation
even though the present value of the cash flows
ship between corporate social responsibility firms may
generated by socially responsible
and firm value.
suffer, the market value of these firms can still
Decoupling cash flow and firmmarket value. increase.
Traditional financial logic suggests that firms and
Managerial values socially responsible
maximize their market value
by maximizing the investments. This also has
analysis implica
present value of their cash flows (Copeland et tions for the study of the relationship between
al., 1994). This link between a firm's market senior managers and socially responsible activ
value and the present value of its cash flows is ities. In particular, it suggests that senior man
based on the often unstated assumption that all agers do not have to have particularly strong or
of a firm's equity holders have the same inter unusual moral or value-based commitments to
ests: to see their wealth maximized in making lead their firms to engage in socially responsi
their investment decisions
(Brealey & Myers, ble activities that reduce the present value of
2003). However, by recognizing that some equity their cash flows. Rather, as long as demand for
holders may sometimes have interests besides socially responsible investment opportunities is
simply maximizing their wealth inmaking their greater than supply, managers looking to max
investment decisions, we decouple "maximizing imize the market value of their firmwill find it in
a firm's market value" from "maximizing the their self-interest to make such investments.
present value of a firm's cash flows." Here, a Managerial or corporate altruism is not required
firm's market value is determined to explain firms may sometimes make
by the supply why
of and demand for the kind of investment these kinds of investments.14
oppor
tunities created Indeed, throughout this paper we adopt the
by the firm's strategies?in this
case, the opportunity to invest in firms imple standard economic assumption that firms are
menting different corporate social responsibility trying tomaximize their market value. Because
firms are profit maximizing, they are willing to
strategies.
In fact, there is some reason to believe change their type?from socially responsible to
that at
least some current and potential traditional profit maximizing and back?to the
equity inves
extent that these actions maximize their market
tors may be willing to sacrifice some of their
value. In other words, this is a theory of social
wealth-maximizing interests to invest in firms
responsibility that does not depend on the exis
pursuing socially responsible activities. For ex
tence of agency conflicts between a firm's man
ample, there continues to be significant and
agers and its equity holders (Wright & Ferris,
steady demand formutual funds that specialize
1997).
in investing in firms that meet certain corporate
social responsibility criteria. Indeed, in 2003 one
out of every ten dollars under professional man Practical Implications
agement in the United States was invested in
Finally, the theory developed here has practi
these kinds of mutual funds (Social Investment
cal implications, both for those charged with
Forum, 2005). Moreover, those who invest in
making decisions about whether or not invest in
these funds often pay a financial penalty for
socially responsible activities?managers?and
doing so. This penalty can be as high as 3.5 those who would like to see the absolute level of
percent for actively managed socially responsi such investments in society increase.
ble mutual funds
(Geczy, Stanbaugh, & Levin,
2003). Thus, least some investors are appar
at
ently willing to invest in firms that engage in
14
socially responsible activities even though Although
managerial morality is not required to moti
vate corporate social responsibility in the model we present
these investments may generate lower returns
here, such considerations may nevertheless influence firm
than investments without regard to a firm's so decisions such activities et al.,
concerning (Aguilera 2007;
cially responsible activities. Schneider, Oppegaard, Zoilo, & Huy, 2005).

The managerial task. At first, the task manag does suggest a way that these decisions can be
ers face in firms contemplating whether or not to significantly simplified. In particular, the model
change their social responsibility policies suggests that the only time a firm seeking to
seems daunting. After all, in the model, manag maximize its market value should its
change
ers are required to estimate the supply of so social responsibility is when either the
policies
cially responsible investment opportunities in demand for or the supply of these investment
an economy and the demand for these invest Thus, man
opportunities changes dramatically.
ment opportunities, and then evaluate whether agers need not estimate the size of this
directly
or not they should change their social responsi demand or supply?only in
significant changes
bility policies accordingly. these parameters.
While daunting, this task is actually not ma Shifts in demand for these investment oppor
terially different from the task managers face tunities will often reflect specific exogenous
when estimating the supply of and demand for shocks in the economy. Thus, for example, when
any of their products or services in the product the government in South Africa abandoned its
market. While the product?socially responsible activ
apartheid principles, socially responsible
investment opportunities?and the market? ities that supported a ban on business in South
current and potential equity investors?are dif
Africa were no longer in demand. Obviously, in
ferent, the essential challenge of discovering
this kind of setting, continuing tomaintain these
the level of supply and demand is very similar.
policies, because they reduced the present
Thus, itwould not be surprising to see man
value of a firm's cash flows without any com
agers adopt many of the same mechanisms and
pensating firm value advantages, would have
tools they use to gauge supply and demand in
reduced a firm's market value. More
to gauge recently,
the product market supply and de various business
scandals may have increased
mand in the market for socially responsible in
demand for socially responsible activities, as
vestment opportunities. For example, firms often
investors look to put their money into companies
use customer focus groups and product tests to
estimate demand in the product market. In the
whose management they respect and trust.
Firms can also create their own "exogenous
market for socially responsible investment op
shocks" by becoming more international in
portunities, it is likely that firms will use focus
scope. While equity holders in one country mar
groups with current and potential investors,
ket may have one set of preferences for invest
along with smaller tentative changes in their
social responsibility to estimate the de ing in socially responsible firms, equity holders
policies,
in a second country market may have a different
mand for these types of investment opportun
set of preferences. By beginning to trade in dif
ties.
ferent markets, firms may have to adjust their
Ascertaining the current level of supply of
social responsibility policies to be more consis
these investment opportunities may be more dif
ficult. Managers can attempt to measure this tent with the preferences of the new stockhold
activities ers they are trying to attract. Of course, this
supply through benchmarking the and
disclosures of their product market and equity could mean that a firmwill become either more
or less socially on the
market competitors. Indeed, it seems reasonable responsible, depending
to expect that the relationship between the sup preferences of equity holders in the markets into
of and demand for in which it is entering.
ply socially responsible
vestment opportunities will change over time. In Estimating in supply and demand
changes for
some economic conditions?for when socially responsible investment opportunities is
example,
there are and likely to be more challenging when these pa
significant earnings pressures
of unfriendly takeovers?there rameters evolve slowly over time in an economy.
large numbers
In these settings it would not be surprising to
may well be a shortage of socially responsible
investment opportunities. In other settings there see managers change their policies toward so
may be an excess number of these investment cial responsibility only very slowly and incre
opportunities. mentally. In this way firms can estimate the
While at first the decision about whether or total demand for and supply of socially respon
not to invest in socially responsible activities sible investment opportunities in an economy
seems very complex, the model presented here and adjust their own policies accordingly.

Changing the demand for socially responsi cially responsible activities, especially when
ble investment opportunities. Finally, this those activities reduce the present value of a
model also has implications for those interested firm's cash flows.
in increasing the level of socially responsible
firm activities in the economy (Waddock, 2006).
we
CONCLUSION
Thus far, have assumed that the demand for
socially responsible investment opportunities We began this paper by arguing that efforts to
was given, and the task facing firms was to examine how socially responsible activities can
estimate that demand and the relevant supply increase the present value of a firm's cash flows
of these investment opportunities in determin do not address a central issue in the corporate
ing their strategic actions. However, the actions social responsibility literature?that sometimes
of various individuals and groups in an econ firms should invest in socially responsible ac
omy could have an impact on this demand. Suc tivities, even if those activities reduce the
cessful efforts to increase the demand for so present value of a firm's cash flows.
cially responsible investment
opportunities This paper provides an explanation of when
would have the effect of making it in the value investments in these kinds of socially responsi
maximizing interests of more firms tomake such ble activities will occur. In developing this the
investments. ory, we suggest that some investors may have
According to the model developed here, the interests besides wealth maximization in mak
task facing those interested in seeing the level ing their investment decisions. If the demand for
of socially responsible investments made by socially responsible investment opportunities
firms in an economy increased is to engage in generated by these investors is greater than the
activities that change the preferences of poten supply of these investment opportunities, then
tial investors. Marketing campaigns that high such investments can create economic value for
light the social responsibility failures of some a firm.However, the paper also suggests that if
firms, the social responsibility successes of supply and demand conditions are not favor
other firms, and how investment dollars are able, engaging in the same socially responsible
used to either help or hurt society may have the activities can actually reduce the market value
effect of increasing the number of people look of a firm.
ing for socially responsible investment opportu
nities in an economy over time. When demand
for these
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Alison Mackey (ali.mackey@gmail.com) is an assistant professor of management at

the Orfalea College of Business at California Polytechnic State University. She re
ceived her Ph.D. from The Ohio State University. Prior to joining the faculty at Cal Poly,
she taught at Texas A&M. Her research focuses on executive labor markets and
corporate social responsibility.
Tyson B. Mackey (tymackey@gmail.com) is an assistant professor of management at

the Orfalea College of Business at California Polytechnic State University. He re
ceived his Ph.D. from The Ohio State University. Prior to joining the faculty at Cal Poly,
he taught at Texas A&M. His current research interests include corporate diversifica
tion as well as topics related to corporate social responsibility.
Jay B. Barney (barney.8@osu.edu) is the Professor and Chase Chair for Excellence in
Corporate Strategy at the Fisher College of Business, The Ohio State University.
Educated at Brigham Young University and Yale, he taught at UCLA and Texas A&M.
Since 1994 Professor Barney has taught organizational strategy and policy toMBA and
Ph.D. students at The Ohio State University.


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Corporate Social Responsibility and Firm Performance: Investor Preferences and Corporate

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socially responsible investment opportunities determine whether these activities will

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firm to differentiate its products in its product ASSUMPTIONS AND DEFINITIONS

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What Is Firm Performance? managers seek to maximize the value of their

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pact of nonrational elements in equity holder decision mak Firm Characteristics

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initiatives. The decision to economy (i.e., ON is the total number of socially

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where DSR is the total amount of money con

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When Demand for Social Responsibility Is

aThe signs of these

? 1< (1-0)N+0N+1 N+l

denominator has increased and numerator has not changed

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One Firm Switches from One Firm Switches from

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MODEL EXTENSIONS socially responsible companies may actually be

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we sponsible activities, whatever they are. Obvi

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tutes. Estimates of the cross-elasticity of de cially responsible activities. Any empirical in

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Theoretical Implications It is this demand for opportunities to invest in

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T. 1994. Valuation sibility: theory of the firm perspective.

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Alison Mackey (ali.mackey@gmail.com) is an assistant professor of management at

Tyson B. Mackey (tymackey@gmail.com) is an assistant professor of management at

This content downloaded from 188.72.127.163 on Thu, 12 Jun 2014 04:56:34 AM

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