Economics 101: Does Corporate Philanthropy Work?

Amazon CEO Jeff Bezos recently announced plans to donate $2 billion of his personal fortune to charity, following in the footsteps of contemporaries Bill Gates and Warren Buffet, as well as 19th century tycoons Andrew Carnegie and John Rockefeller.

In addition to wealthy individuals, large companies have also become regular philanthropists, with corporate social responsibility (CSR) generating billions of dollars of charitable contributions annually. Why do companies engage in CSR, and does it work?

A recent paper by Arthur Gautier and Anne-Claire Pache (Essec Business School, France) seeks to answer these questions. A key finding is that CSR increases the value of a company’s shares, thereby realising the board’s mission of serving the financial interests of shareholders. Therefore, choosing to allocate money to charitable causes may confer greater financial returns upon shareholders than distributing the funds in the form of dividends.

Moreover, as the actions of Mr Bezos suggest, over the course of the past century, boards have come to believe this and CSR has become an important component of a company’s corporate strategy.

Mr Gautier and Ms Pache identify four main reasons for the stock market gains associated with CSR. The first is consumer attitude: consumers base their purchasing decisions primarily on the price of the goods and services under consideration - but there are non-price factors, too, among them the belief that the company is behaving ethically. In fact, some companies, such as cosmetics giant the Body Shop, have made CSR as the defining characteristic of their brand. Others, including the National Football League (NFL) in the US, following a sequence of domestic violence scandals, uses it as a way of expressing contrition when seeking to make up for past transgressions.

A variety of studies support for the theory that consumers respond to corporate CSR by developing a more favourable attitude of the company and its products. However, CSR can backfire if it is perceived as insincere or self-serving. This is why CSR is usually managed by a team of experts with experience in marketing the charitable contributions as genuine expressions of community support, even if the reality is the traditional fixation on the company’s bottom line.

A second reason is employee morale. Productivity in large companies is threatened by worker disenchantment, as employees feel like replaceable cogs in a corporate machine. CSR can help reverse this tendency, by allowing employees to believe that they are contributing to an ethical goal rather than purely shareholder pockets. Moreover, there is some evidence suggesting that employee morale is most likely to be boosted by CSR when employees are actually involved in the decision about where to direct the charitable contributions, as this helps tie them to the firm emotionally and makes them feel that their views are valued.

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A third reason is local community welfare that benefits the company itself. For example, in small towns where a single company dominates employment, CSR projects such as investing in the local parks, improving roads, or establishing better schools, can help the company’s bottom line in the long run by improving the well-being of the workforce.

The final reason is a little more sinister, which is that CSR can be a means of securing political support, due to the grey area between philanthropic and political contributions. For example, defence companies are considered by some to be amoral; yet in some countries, they can be seen making superficially innocuous “charitable donations” to the favourite causes of the politicians who sign off on critical government arms contracts. In this sense, CSR is simply a hidden part of a potentially corrupt tender process.

In countries with both corporation tax and tax write-offs, it is tempting to classify CSR purely as an attempt to evade taxes. While this likely contributes to the CSR decision, it is unlikely to be the main factor, as disbursing dividends still means more money in shareholders’ pockets than giving it to charity. Instead, the four factors described above remain the cornerstone of CSR decisions.

Despite the extensive evidence surveyed by Mr Gautier and Ms Pache, a definitive demonstration of the benefits of CSR remains elusive, because it is almost impossible to isolate the effects of CSR on share prices from the variety of other factors that tend to change at the same time. For example, companies that allocate significant funds to CSR tend to be the ones that are more profitable, which means that they are intrinsically better managed. This makes it very difficult for a researcher analysing share price data to distinguish between the effect of the CSR vis-à-vis the effect of better management.

This is why CSR in practice can be quite unscientific, with decisions frequently being based on the hunches of executives. The process is rendered even more challenging by the fact that people can be very fickle and hence unpredictable, especially in terms of what they regard as a “sincere” act of CSR - Mr Bezos was probably expecting to be lauded rather than sneered at, by some, after announcing his philanthropic intentions. Don’t expect him to be the last one to make such a miscalculation.

Omar Al-Ubaydli (@omareconomics) is a researcher at Derasat, Bahrain.