Other people's money

When you're playing with other people's money, you have different incentives. Take Corporate Social Responsibility, for instance.

Suppose that there's a trade-off between profitability and CSR mandates. Why might this be the case? Any CSR initiatives that increased profitability would have already been adopted under normal profit-seeking strategies.

Managers want to think themselves good people and enjoy doing CSR things. They get approbation from others for doing so. They'll get in trouble with shareholders if profitability drops too much, so they won't do the nuttiest things. But they'll take some CSR as consumption.

NBER points to some relevant evidence. From the abstract of Cheng, Hong and Shue's new paper:

We find support for two key predictions of an agency theory of unproductive corporate social responsibility. First, increasing managerial ownership decreases measures of firm goodness. We use the 2003 Dividend Tax Cut to increase after-tax insider ownership. Firms with moderate levels of insider ownership cut goodness by more than firms with low levels (where the tax cut has no effect) and high levels (where agency is less of an issue). Second, increasing monitoring reduces corporate goodness. A regression discontinuity design of close votes around the 50% cut-off finds that passage of shareholder governance proposals leads to slower growth in goodness.

In short, the more skin that decision-makers have in the game, the less they go for CSR policies. And the more that those with skin in the game can monitor the decision-makers, the less they go for CSR policies. It's slack in the principal-agent relationship that allows managerial consumption of "do-good" benefits.

Sometimes, we need Larry the Liquidator.

Triple bottom line doesn't help the real bottom line

I've been skeptical about corporate social responsibility. Proponents argue that firms implementing triple bottom line accounting will reap all kinds of reputational benefits. A piece of research that runs counter to these arguments and instead confirms my priors comes from Reitenga, Linthicum and Sanchez, 2009, "Social Responsibility and Corporate Reputation: The Case of the Arthur Andersen Enron Audit Failure"

We examine the influence of social responsibility ratings on market returns to Arthur Andersen (AA) clients following the Enron audit failure. Chaney and Philipich (2002) found that AA's loss of reputation resulted in negative market returns to AA clients following the Enron audit failure. Proponents of social responsibility argue that social responsibility can improve the reputation of the firm, while detractors argue that social responsibility expenditures are a poor use of shareholder money. If social responsibility sends a signal to investors regarding the reputation/ethics of management, social responsibility could mitigate the negative returns to AA clients following the Enron audit failure. Using a matched sample of AA and non-AA firms, we do not find evidence that social responsibility mitigated the negative returns to AA clients following the Enron audit failure. Our results are inconsistent with claims that social responsibility can burnish a firm's reputation in a time of crisis and with prior research indicating a positive relationship between social responsibility and market value.

If the CSR folks were right, Arthur Anderson clients with strong CSR policies would not have taken as big a hit as their less responsible compatriots. Turns out not to have been the case. I suspect that proponents of CSR, at least in our Accounting department, would argue that this is evidence of the failure of markets to recognize the importance of CSR rather than of the failure of CSR and will promote triple bottom line accounting ever the more vehemently.