CSR signals reveal more than a company’s values  

Firms often deploy CSR campaigns to signal they are healthy enough to make investments and attract new long-term investors 
Illustration of a male executive watering a forest that is pushing up a stock price graph arrow into the sky

Debates about ESG or corporate social responsibility (CSR) campaigns often pit a company’s shareholders against its stakeholders, but evidence from the markets paints a different picture.  

Jie “Jack” He, who serves as the Mercer W. Hull Professor in Finance at the University of Georgia Terry College of Business, found companies were more likely to exert new CSR efforts when they needed to signal their financial health.  

“Firms can engage in CSR activities to alleviate the concerns from both their shareholders and stakeholders about their fundamentals and to help the firms survive a difficult period,” said He, who co-authored a study of CSR activities with Lei Gao of George Mason University and Juan Wu of the University of Nebraska-Lincoln.  

There are times when a fundamentally strong company sees a threat to its stock price because of market frictions, He said. His team found when healthy companies are in this situation, they often turn to CSR campaigns to signal their health, strengthen their stock price and attract socially responsible — often institutional — investors. They found companies with less public visibility and more competitors were more likely to adopt CSR behaviors to signal financial health.  

Their paper, “Standing Out from the Crowd via CSR Engagement: Evidence from Non-Fundamental-Driven Price Pressure” was published in the Journal of Financial and Quantitative Analysis earlier this year.  

Corporate social responsibility is the concept a firm has a responsibility to its stakeholders — its employees, customers, community and environment — in addition to its shareholders. The term ESG has recently been used somewhat interchangeably with CSR, but refers to a company’s specific CSR metrics: its performance on environmental, social and good governance issues.  

The Debate  

Some critics say companies taking on CSR or ESG missions are abandoning their fiduciary commitment to shareholders or engaging in virtue signaling at the expense of profits.  

In this view, all CSR activities are a threat to the company’s bottom line.  

“Another view in the literature says it’s not one versus the other, and taking on these corporate projects for social good can actually bring good things to the firms,” He said. “It says that these CSR activities help firms maintain better customer relationships, retain their best talent, and help firms build their reputation. Ultimately, CSR activities will benefit the bottom line.” 

He thought there might be a third argument. Maybe CSR activities serve a more concrete purpose for publicly traded companies; something beyond an amorphous boost to the company’s reputation. 

Natural Experiment 

The research group believed firms employed CSR activities to telegraph financial health to investors, employees and customers. They found a natural experiment to test their hypothesis in the form of a 20-year-old policy change by the Securities and Exchange Commission.  

In 2005, the SEC ran a pilot study loosening regulations on short selling. The pilot study affected about 1,000 stocks and exposed them to increased short selling and volatile pricing.  

For their study, He and his team looked at firms facing this external pressure on their stock prices and evaluated whether they were more likely to launch CSR campaigns and what types of campaigns they adopted.  

The team tracked firms’ scores on community activities, diversity, employee relations, human rights, product and environmental efforts, and found pilot firms engaged in these CSR activities much more than control firms (those not included in the pilot study) after the implementation of the SEC’s pilot study. 

They found firms in the pilot group were in danger of downward pressure on their stock prices and thus adopted more CSR activities to signal their fundamentals. They also found firms tended to launch costly environmental improvements instead of social or community projects because expensive environmental efforts would only be taken on by financially healthy firms. 

“You could increase the number of the female directors on the corporate board or maybe do more community services and receive reputational benefits,” He said. “Environmental changes are more costly … We find that firms opt for these more costly CSR activities because they are more credible to signal their financial health to the market.” 

In exchange, the companies saw lower cost of capital and an influx of new socially conscious and institutional investors.  

“These investors understand the firm’s socially responsible behavior, and they are better able to evaluate a company,” He said. “This can bring down the cost of capital for the firm. It helps fight against undervaluation caused by external factors, so their stock price can bounce back.”