“Why Do Countries Matter So Much in Corporate Social Performance?”
Updated: Oct 7, 2022
“Why do countries matter so much in corporate social performance,” written by Ye Cai, Carrie H. Pan and Meir Statman, was published in the Journal of Corporate Finance in 2016. The paper examines the corporate social performance (CSP) ratings of more than 2600 companies across 36 countries and finds that country factors are much more important than firm characteristics in explaining the variations in CSP ratings. Country factors include institutions and culture, which are defined in the following aspects in the paper: stages of economic development, corruption, civil liberties and political rights, cultures (harmony, egalitarianism, and autonomy), and power distance.
Specifically, the paper finds that CSP ratings are high in countries with high income-per-capita, strong civil liberties, and political rights, and cultures oriented toward harmony and autonomy (Cai, Pan and Statman, 2016).
Corporate managers must balance the benefits and costs when they choose to invest in CSP levels for two reasons. First, while a lower cost of capital can enhance corporate financial performance, a higher CSP rating tends to be associated with lower systematic risk, higher corporate financial performance, and lower capital constraints. Second, increasing the CSP level beyond an optimal level may reduce corporate financial performance, so managers often manually adjust the CSP ratings to maximize earnings and valuations. The country factors play a significant role as these benefits and costs vary from country to country, by culture, institutions, and stages of economic development. The optimal level of CSP is relatively high in countries where the benefit of investing in CSP is high, and the cost of circumvention is high.
This paper uses the five different aspects of country factors for analysis.
The first aspect is the stages of economic development. As CSP metrics capture mostly satisfaction for upper needs, such as a clean environment, safe working conditions, and the absence of child labor, resources for such needs are limited in countries with lower levels of economic development. Therefore, Hypothesis 1: CSP is high in countries with high economic development levels.
The political system determines the cost of circumventing CSP in a country and includes corruption and civil liberties, and political rights.
The second aspect is corruption. Companies employ corruption to circumvent CSP if the cost of doing so is lower than the cost of investing in CSP to the level that meets regulatory requirements. Since the cost of corruption is low in countries where corruption is rampant and punishment is light, Hypothesis 2a. CSP is low in countries where corruption is high.
The third aspect is civil liberties and political rights. Companies face scrutiny and pressure to increase CSP from civil society, non-governmental organizations (NGOs), and activist groups, which is often amplified by the media. As civil society can counter deflection and press companies toward CSP when civil liberties and political rights are strong, Hypothesis 2b. CSP is low in countries with weak civil liberties and political rights.
The fourth aspect is culture, which includes harmony, egalitarianism, and autonomy.
Harmony: As individuals in a harmonious society appreciate and fit in the natural and social environment, the cultures of harmony constrain companies from stinting on CSP. Therefore, Hypothesis 3a. CSP is high in harmonious countries.
Egalitarianism: Individuals in egalitarian cultures recognize one another as morally equal and cooperate for everyone’s welfare. They constrain companies by demanding companies maintain high CSP, provide good treatment to their employees, as well as promote and protect human rights, so Hypothesis 3b. CSP is high in egalitarian countries.
Autonomy: As individuals with autonomy do not distinguish their closed ones from the others of humanity, they are more likely to challenge the status quo and care about the consequences and harm of global warming for them as individuals and for humanity in general. Therefore, Hypothesis 3c. CSP is high in countries where autonomy is high.
The fifth aspect is power distance. As power is distributed unequally, higher power distance allows managers to significantly value the interest of their own and their shareholders over that of the stakeholders because the shareholders generally possess more power. Therefore, Hypothesis 3d. CSP is high in countries where power distance is low.
The paper validates that all the provided hypotheses are correct using ESG ratings of companies from the MSCI ESG Intangible Value Assessment (IVA) database and other databases. In conclusion, CSP ratings are high in countries with high income-per-capita, strong civil liberties, and political rights, and cultures oriented toward harmony and autonomy.
Click here to view the full paper.