Corporate social responsibility and cost of financing—The importance of the international corporate governance system

• Author: Pierpaolo Pattitoni,Mónica LópezPuertas‐Lamy,Kurt A. Desender,Barbara Petracci
• Published date: 01 May 2020
• Date: 01 May 2020
• DOI: http://doi.org/10.1111/corg.12312

ORIGINAL ARTICLE

Corporate social responsibility and cost of financing—The

importance of the international corporate governance system

Kurt A. Desender

1

| Mónica LópezPuertas-Lamy

1

| Pierpaolo Pattitoni

2

|

Barbara Petracci

3

1

Department of Business Administration,

Universidad Carlos III, Getafe, Spain

2

Department of Statistical Sciences “Paolo

Fortunati”,University of Bologna, Bologna,

Italy

3

Department of Management, University of

Bologna, Bologna, Italy

Correspondence

Mónica LópezPuertas-Lamy, Department of

Business Administration, Universidad Carlos III,

Calle de Madrid, 123, 28903 Getafe, Spain.

Email: mlopezpu@emp.uc3m.es

Funding information

Spanish Ministry of Economy, Grant/Award

Numbers: FEDER UNC315-EE-3636, 2018-

00117-001, 2016-00454-001, 2016-00463-

001

Abstract

Research Question/Issue: Our study examines whether international corporate gov-

ernance systems shape the relationship between a firm's engagement in corporate

social responsibility (CSR) and their cost of financing (both equity and debt).

Research Findings/Insights: Using a large international sample, our findings reveal

that although the link between CSR performance and the cost of equity is negative in

a shareholder-oriented system, this relationship is positive in a stakeholder-oriented

system. Furthermore, the link between CSR performance and the cost of debt is neg-

ative for firms that are close to default in both systems.

Theoretical/Academic Implications: Our study highlights the importance of consider-

ing the shareholder/stakeholder orientation at the country level to explain the link

between CSR performance and the cost of financing. Our findings help to explain

and place into context the previous mixed findings on the relationship between CSR

and the cost of equity and debt and add to the debate about whether CSR is benefi-

cial or detrimental to corporate governance.

Practitioner/Policy Implications: The analysis of how the country corporate gover-

nance system influences the effect of CSR performance on the cost of financing

allows for a deeper understanding of how investors respond to CSR initiatives world-

wide and offers managers, directors, and policy makers context-specific recommen-

dations. Our analysis also highlights the limitations of transferring insights regarding

CSR from one corporate governance system to another.

KEYWORDS

corporate governance, corporate social responsibility, cost of debt, cost of equity

1|INTRODUCTION

Corporate social responsibility (CSR) consists of a set of environ-

mental and social activities that companies implement on a volun-

tary basis to address the environmental and social impact of their

business and the expectations of their stakeholders (Arjaliès &

Mundy, 2013; European Commission, 2001). Distinct from corpo-

rate governance mechanisms that allocate power between share-

holders and managers, firms' CSR is sometimes seen as a form of

self-regulation that limits the set of acceptable actions that corpo-

rations can engage in when interacting with their stakeholders

(Matten & Moon, 2008; Scherer & Palazzo, 2011). Despite the

growing body of research on CSR (Jain & Jamali, 2016), the recent

growth in socially responsible investments and shareholder pro-

posals on social and environmental issues (Institutional Shareholder

Services, 2019), there is still an important debate on its desirability

from the investor's perspective (Devinney, Schwalbach, & Williams,

2013).

Received: 7 March 2018 Revised: 21 December 2019 Accepted: 26 December 2019

DOI: 10.1111/corg.12312

Corp Govern Int Rev. 2020;28:207–234. wileyonlinelibrary.com/journal/corg © 2020 John Wiley & Sons Ltd 207

Traditionally, scholars have considered two opposing perspectives

on CSR, highlighting that CSR can be either beneficial or detrimental

to corporate governance (Aguinis & Glavas, 2012; Albuquerque,

Koskinen, & Zhang, 2018; Flammer, 2015; Lys, Naughton, & Wang,

2015). From a resource-based perspective, CSR is suggested to create

shareholder value by maximizing stakeholder value, a result known as

“doing well by doing good”(Edmans, 2011; Ferrell, Liang and

Renneboog, 2016). Stakeholders, in exchange for CSR initiatives,

reward firms with enhanced reputation, increased loyalty, and other

forms of support that may develop into a strong “business case”for

CSR (McWilliams & Siegel, 2001). Yet the difficulty of indisputably

establishing the business case for CSR (Aguinis & Glavas, 2012; Mar-

golis, Elfenbein, & Walsh, 2009; Orlitzky, Schmidt, & Rynes, 2003) has

led critics, adopting an agency perspective, to suggest that, instead of

contributing to more shareholder value, CSR may actually be negative

for corporate governance as managers may use their discretion over

CSR to seek private benefits or to avoid being disciplined by investors

(Surroca & Tribò, 2008). The empirical evidence on these two oppos-

ing views is mixed. Hawn, Chatterji, and Mitchell (2018) argue that,

despite the extensive research on the link between CSR and financial

performance, it is not yet clear whether investors believe it pays off.

In addition, Albuquerque et al. (2018, p. 1) argue that “CSR's increased

popularity inside boardrooms has outpaced the research needed to

justify it. Specifically, the mechanisms through which CSR may affect

firm value are not fully understood.”

We respond to these calls by exploring how CSR performance

shapes the cost of equity and debt, an important underlying mecha-

nism linking CSR performance and firm value, and we argue that the

international corporate governance system is an important missing

piece in this relationship. In particular, we differentiate between

shareholder-oriented and stakeholder-oriented systems to address

the following research question: How does a country's corporate gov-

ernance system shape the effect of a firm's engagement in CSR on the

cost of equity and debt? Our research question links to the recent call

by Larry Fink, the founder of BlackRock (one of the most important

investment management corporations in the world), who states in his

2018 annual letter to CEOs, that companies need to do more than

make profits and contribute to society if they want to receive their

support, emphasizing the importance of CSR and stakeholder needs in

order to reap long-term rewards (The New York Times, January

15, 2018). We ask whether this call is supported by a negative relation

between CSR performance and the cost of financing in a shareholder-

oriented system and whether this call also extends to CEOs in a stake-

holder-oriented system.

Although prior research on the link between the firm's engage-

ment in CSR and the cost of equity and debt (e.g., Chava, 2014; El

Ghoul, Guedhami, Kim, & Park, 2018; El Ghoul, Guedhami, Kwok, &

Mishra, 2011; Goss & Roberts, 2011; Gregory, Whittaker, & Yan,

2016; Hoepner, Oikonomou, Scholtens, & Schröder, 2016; Plumlee,

Brown, Hayesa, & Marshall, 2015) reports conflicting results, little

attention has been paid to how CSR performance interacts with the

national corporate governance system to influence the cost of equity

and debt. This neglect is noteworthy because, as argued by several

comparative scholars, one cannot understand the CSR strategy and

policies of organizations without understanding the nature of the

institutional environments in which they operate (Aguilera,

Filatotchev, Gospel, & Jackson, 2008; Devinney et al., 2013). Thus,

understanding the effect of a country's corporate governance system

on the relationship between CSR performance and the cost of equity

and debt is important for academics, managers, investors, and policy

makers as it allows for a better understanding of the consequences of

firms' engagement in CSR and how they are context specific. It also

helps to interpret some of the mixed findings in this literature, by

showing that positive or negative effects are possible depending on

the context.

Building on the resource-based view and agency theory, we argue

that in a shareholder-oriented system, organizations are viewed as

shareholder value-maximizing economic entities and thus, corporate

governance mechanisms are focused on reducing agency problems

resulting from the separation of ownership and control, which include

concerns that CSR is employed to forward the interests of managers

(or stakeholders) at the expense of shareholder value. Consequently,

in a shareholder-oriented system, we expect the relationship between

CSR performance and the cost of equity to be negative because

shareholders are likely to view an increase in firms' engagement in

CSR as a mechanism for gaining sustainable competitive advantage

and creating value by better managing risks associated with the firms'

stakeholders. Similarly, debtholders, in this system, may view CSR per-

formance as a mechanism that allows firms to increase the available

funds to repay any debt obligations or to reduce the variance of their

future cash flows (Ashbaugh-Skaife, Collins, & LaFond, 2006). Given

that the benefits for debtholders are capped at face value of debt

(Brealey, Myers, & Allen, 2016) and that debtholders primarily care

about the likelihood that the firm's future cash flows will allow the

firm to meet its debt obligations (Ashbaugh-Skaife et al., 2006), we

argue that a significant link between CSR performance and the cost of

debt is only expected for firms that are close to default because only

in these firms would CSR initiatives significantly affect the firms' likeli-

hood of debt repayment. In addition to increasing the available funds,

an increase in CSR performance may also have a positive effect for

debtholders in firms that are relatively close to default through a

reduction in the business risk and risk of takeovers and an increase in

the likelihood of survival through strong stakeholder support.

In contrast, in a stakeholder-oriented system, we argue that

there is a more prominent agency concern by the shareholders that

the CSR is not being employed to maximize shareholder value, as

institutional pressure may induce managers to sacrifice shareholder

value to address the demands of a broad set of stakeholders

(Aguilera & Jackson, 2003; Matten & Moon, 2008). If CSR initiatives

go beyond what is optimal from shareholders' perspective, we expect

an increase in CSR performance to be positively related to the cost

of equity.

As in the shareholder-oriented context, we argue that only debt-

holders in firms that are close to default would be affected by CSR

activities, which could significantly influence the likelihood of debt

repayment. In particular, we claim that in a stakeholder-oriented

208 DESENDER ET AL.