Journal of Business Ethics (2011) 103:351–383 Ó Springer 2011
DOI 10.1007/s10551-011-0869-y
Corporate Governance and Firm Value:
The Impact of Corporate Social Hoje Jo
Responsibility Maretno A. Harjoto
ABSTRACT. This study investigates the effects of corporate America is more heterogeneous than ever
internal and external corporate governance and moni- before. The recent collapse of many firms has not
toring mechanisms on the choice of corporate social only proven to be a watershed momentum in U.S.
responsibility (CSR) engagement and the value of firms corporate governance, it also has highlighted the
engaging in CSR activities. The study finds the CSR importance of information transparency. Informa-
choice is positively associated with the internal and
tion problems and managerial incentives typically
external corporate governance and monitoring mecha-
nisms, including board leadership, board independence,
limit the effectiveness of corporate governance in
institutional ownership, analyst following, and anti- public corporations (Jensen, 1993; Miller, 2005). As
takeover provisions, after controlling for various firm a result, there has been a tremendous acceleration of
characteristics. After correcting for endogeneity and corporate governance activities, as well as a con-
simultaneity issues, the results show that CSR engage- vergence of certain trends in corporate governance
ment positively influences firm value measured by over the last few years (Hermalin, 2005). While the
industry-adjusted Tobin’s q. We find that the impact of literature indicates that effective corporate gover-
analyst following for firms that engage in CSR on firm nance curtails managerial self-interest and protects
value is strongly positive, while the board leader- shareholder interests, this study posits that corporate
ship, board independence, blockholders’ ownership, and governance manages the interests of multiple stake-
institutional ownership play a relatively weaker role in holders and resolves the conflicts of interest between
enhancing firm value. Furthermore, we find that CSR
shareholders and non-investing stakeholders.
activities that address internal social enhancement within
the firm, such as employees diversity, firm relationship
Along with the acceleration of corporate gover-
with its employees, and product quality, enhance the nance issue, one of the most significant and con-
value of firm more than other CSR subcategories for tentious corporate trends of the last decade is the
broader external social enhancement such as community growth of Corporate Social Responsibility (CSR).
relation and environmental concerns. In essence, CSR is an extension of firms’ efforts
to foster effective corporate governance, ensuring
KEY WORDS: corporate social responsibility, corpo- firms’ sustainability via sound business practices that
rate governance, analyst following, firm value promote accountability and transparency. However,
there are various definitions of CSR. Friedman
JEL CLASSIFICATION: G34, L2, M14 (1970) first defines CSR as follows: ‘‘Corporate so-
cial responsibility is to conduct the business in
accordance with shareholders’ desires, which gen-
Introduction erally will be to make as much money as possible
while conforming to the basic rules of society, both
Although there has been a noteworthy discussion those embodied in law and those embodied in eth-
among scholars and practitioners over the last two ical custom.’’ Carroll (1979) and Hill et al. (2007)
decades on what constitutes the best corporate define the hierarchical CSR as economic, legal,
governance practices, corporate governance across moral, and philanthropic actions of firms that
,352 Hoje Jo and Maretno A. Harjoto
influence the quality of life of relevant stakeholders. and find that the number of social objectives posi-
While the definitions of CSR vary, it generally refers tively affects firms’ board size. Fisman et al. (2005)
to serving people, communities, and society in ways examine the link between firms’ CSR engagement
that go above and beyond what is legally required of and accounting profit. They find that the effect of
a firm. According to Barnea and Rubin (2010), CSR on profitability is stronger for firms in more
however, if CSR initiatives do not maximize firm competitive industries. Barnea and Rubin (2010)
value, such initiatives are a waste of valuable re- examine the relation between firms’ CSR ratings and
sources and a potentially value-destroying proposi- their ownership and capital structures and find that
tion. CSR has continued to be a highly topical insiders tend to over-invest in CSR. Goss and
subject regarding whether investments in CSR are Roberts (2007) analyze the association between CSR
value-enhancing, value-destroying, or even value- and the cost of bank loans. They find that firms with
irrelevant. The debates about CSR continue to grow the worst social responsibility scores pay higher loan
without a clear consensus on its meaning or value. costs while firms with good scores do not receive
In this paper, we first examine the empirical lower loan costs. Hong and Kacperczyk (2009) find
association between various corporate governance sin stocks from publicly traded firms that produce
and monitoring mechanisms and U.S. firms’ choice alcohol, tobacco, and gambling have higher risk and
of CSR involvement. We then explore how CSR returns indicating that social norms affect stock prices
engagement and various governance mechanisms and returns. Although these studies enhance our
affect firm value after correcting for endogeneity and understanding of the important benefits and costs of
simultaneity. Well-designed corporate governance CSR engagement, in our view, the previous research
systems would align managers’ incentives with those on this issue is still premature to provide any definite
of stakeholders. Hence, firms with effective corpo- conclusions regarding the impact of CSR engage-
rate governance should place a greater emphasis on ment on firm value.3
value maximization. We examine two categories of To correctly examine the relationship between
governance devices: internal (ownership concentra- CSR and firm value, we need to consider potential
tion and board structure) and external (institutional simultaneity bias and endogenous treatment effects.
ownership and monitoring by security analysts). Since better quality firms tend to choose CSR
Given that the relations among CSR, corporate engagement, the contribution of CSR engagement
governance, and firm value are mixed, and that to firm value will be overstated (Greene, 1993) if we
previous studies do not control for the simultaneity do not correct for the simultaneity and endogeneity
bias and endogeneity, this study explores the impact problems. In this paper, we conduct our endoge-
of various governance mechanisms on firms’ choice neity and simultaneity analyses in two stages. We
of CSR engagement and the effect of this engage- examine the factors determining CSR engagement
ment on firm value after controlling for both the extensively in the first stage, and then compare the
simultaneity bias and endogeneity.1 firm values of CSR engaging versus CSR non-
As one of the essential rationales behind CSR engaging firms in the second stage. Based upon a
engagement is to build trust relationships and social large sample of 12,527 firm-year (2952 firms)
capital, increasing attention is being paid to the effects observations, including both CSR and no-CSR
that social capital has on economic variables.2 Several firms during the 1993–2004 period, we initially
studies analyze the relation between social capital and perform a first-stage probit regression analysis of
economic growth (Knack and Keefer, 1997); social CSR engagement. Consistent with the conflict-
capital and trust building (La Porta et al., 1997a, b); resolution hypothesis, the results show that the
social capital and government performance (La Porta likelihood of opting for CSR involvement is sig-
et al., 1999; Putnam, 1993); and social capital and nificantly and positively related to governance
financial development (Guiso, et al., 2004). In spite characteristics such as board leadership, board inde-
of the increasing attention given to social capital, pendence, institutional ownership, analyst following,
however, only a few studies in finance examine CSR and anti-takeover provisions after controlling for
engagement. Aggrawal and Nanda (2004) investigate such firm characteristics as firm size, leverage, prof-
the relation between board size and social objectives itability, R&D, a firm’s diversification, and risk.
, Corporate Governance and Firm Value 353
In the second-stage analysis, we find that after tion Services (I/B/E/S) database during the 1993–
correcting for the endogenous treatment effect and 2004 period. Second, we consider more extensive
simultaneity bias, respectively, firm value, measured governance and monitoring mechanisms to examine
by industry-adjusted Tobin’s q, is positively the impact of CSR on firms’ value and revisit the
related to the CSR choice or the CSR-combined over-investment hypothesis and the conflict-resolu-
scores, suggesting that CSR engagement positively tion explanation in light of CSR. By appropriately
influences firm value. The results support the controlling for the endogenous treatment effects and
conflict-resolution hypothesis, as opposed to the simultaneity bias, we are able to determine whether
overinvestment explanation, and remain robust firms over-invest in CSR activities. We postulate
under various specifications, including the OLS, the that the role of corporate governance in the choice
Heckman two-stage regressions, and the instru- of CSR engagement and the impact of that choice
mental variables approach. Our results also suggest on firm value might be different for each of the
that the value enhancement of firms’ CSR engage- internal and external governance mechanisms. We
ment comes from firms’ internal social enhance- believe that this is the first empirical study to for-
ment, such as diversity, employee relations, and mally address both the simultaneity and endogeneity
product issues more than their CSR involvement in issues. Third, we provide further evidence that the
broader external enhancement, such as activities impact of security analyst following on firm value is
related to community and environmental issues. In one of the most significant among several considered
addition, after controlling for a potential simultaneity governance and monitoring mechanisms in the
bias, our inferences concerning the positive associ- presence of CSR engagement.
ation between CSR and firm value remain intact.
Furthermore, we maintain that security analysts
are important information intermediaries who Hypotheses
improve the transparency of a firm’s CSR activities.
Accordingly, the impact of CSR activities are Why do firms engage in CSR?
stronger when analyst following is higher, and the
impact of analyst following on firm value is also Despite large literature on CSR (Bowen, 1953;
strongly positive in all models. However, the mon- Donham, 1927; and for an overview, see Whetten,
itoring impact of institutional investors is occasion- et al., 2002), there is no unified theory behind CSR
ally positive, but relatively weaker than that of engagement, and there are at least two alternative
security analysts, presumably because of their dual explanations regarding its existence. First, based on
roles of monitors and investors. Overall, our results Jensen and Meckling’s (1976) agency theory, Barnea
suggest that firms’ engagement in CSR activities, and Rubin (2010) consider CSR engagement as a
together with external monitoring by security ana- principal-agent relation between managers and
lysts, is value enhancing. Furthermore, the positive shareholders, and argue that affiliated insiders have
impact of CSR activities on firm value implies that an interest in overinvesting in CSR in order to
U.S. firms do not over-invest in CSR activities in obtain private benefits of building reputation as good
the sample period. social citizens, possibly at a cost to shareholders.
This paper contributes to the literature on CSR As reputation improves, top management will
and corporate governance in three distinct ways. enjoy better outside career opportunities and greater
First, we conduct a full examination of the deter- negotiation power, which will eventually lead them
minants of CSR engagement and provide insights to have overconfidence. Malmendier and Tate
into how corporate governance influences firms’ (2005) suggest that there is some evidence of over-
choice to engage in CSR by using all CSR firms investment by overconfident CEOs. Goel and
and no-CSR firms available from the Kinder, Thakor’s (2008) theoretical model also shows that
Lydenberg, and Domini’s (KLD) Stats database, overconfident managers sometimes make value-
RiskMetrics (formerly, the Investor Responsibility destroying investments. In a related vein, Bertrand
Research Center’s (IRRC) governance and direc- and Mullainathan (2003) argue that when manag-
tor) database, and the Institutional Brokers Estima- ers are not closely monitored and insulated from
, 354 Hoje Jo and Maretno A. Harjoto
takeovers, active empire building may not be the CSR and financial performance, and the results are
norm and managers may prefer to enjoy a quiet life. largely inconclusive. They suggest that previous
If overconfident CEOs tend to over-invest in order studies are subject to various imperfections, such as
to build their reputations as good social citizens measurement problems related to both CSR and
without monitoring, we expect an inverse associa- financial performance, a lack of necessary analyses of
tion between monitoring and CSR choice because causality and/or endogeneity, omitted variable
the higher internal and external monitoring through problems, a lack of methodological rigor, and a lack
various governance mechanisms should reduce the of theory. While it is hard to draw a definite con-
insiders’ incentive for CSR over-investment. clusion because of the imperfect nature of many
Second, while it may not be completely possible studies, the review of the empirical CSR literature
to satisfy all related stakeholders, there is a growing conducted by Margolis and Walsh (2003) indicates a
literature on conflict resolution based on stakeholder generally positive association between investing in
theory (e,g., Calton and Payne, 2003; Harjoto and socially responsible activities and financial perfor-
Jo, 2011; Jensen, 2002; Sherere et al., 2006), in mance.
which the role of the corporation is to serve the The impact of CSR engagement on firm value,
interests of other non-investing stakeholders as well. however, is relatively less examined.4 In particular,
According to the conflict-resolution hypothesis, there is less evidence regarding how corporate
to the extent that managers use effective monitor- governance and the CSR engagement jointly affect
ing/governance mechanisms together with CSR firm value after controlling for both the simultaneity
engagement to resolve conflicts among stakeholders, bias and endogeneity. According to the over-
CSR engagement should be positively related to investment hypothesis, insiders such as the CEO and
effective governance mechanisms. Alternatively, if the board have a natural motivation to over-invest in
various governance and monitoring mechanisms CSR activities if doing so enhances their reputation
view the firm’s CSR engagement as an effort of building process (Barnea and Rubin, 2010). Then,
potential conflict resolution among various stake- firm value will be negatively influenced by the
holders, then we would expect a positive association CSR engagement. In contrast, the conflict-resolu-
between corporate governance and CSR engage- tion hypothesis suggests that if managers use effective
ment. governance and monitoring mechanisms in con-
junction with CSR engagement to resolve conflicts
Hypothesis 1: According to the over-investment among stakeholders, then firm value could be posi-
hypothesis, we expect that the choice of CSR tively associated with CSR engagement and effective
engagement is inversely associated with gover- governance mechanisms through reduced conflict-
nance and monitoring mechanisms after control- of-interests among various stakeholders.
ling for confounding factors, while according to Since there is no clear monitoring mechanism to
the conflict-resolution hypothesis, we expect a prevent firms from over-investing in various CSR
positive association between the choice of CSR activities, we postulate that there should be some
engagement and governance and monitoring effective monitoring mechanism out of all consid-
mechanisms. ered internal and external governance mechanisms
for the checking and balancing of CSR investments.
Board independence can be important in monitoring
the behavior of top management. Fama and Jensen
CSR, corporate governance, and firm value (1983) maintain that boards can be effective mech-
anisms to monitor top management on behalf of
The impact of CSR engagement on accounting dispersed shareholders by effectuating management
performance (i.e., return on assets (ROA)), is a long- appointments, dismissals, suspensions, and rewards.
standing, but still unresolved question. According to Other studies, however, point toward a paradoxical,
the management literature summarized by Margolis insignificant, or negative association between gov-
and Walsh (2003), over 120 studies between 1971 ernance quality, as proxied by the percentage of
and 2001 examine the empirical relation between outside directors on the board, and firm value.
