By Isabel-María García-Sánchez, Nazim Hussain, Sana Akbar Khan, Jennifer Martínez-Ferrero

Business and society scholars and practitioners alike are increasingly trying to understand whether firms who make tall claims about their corporate social responsibility (CSR) do walk the talk. Both disclosure of CSR information and true engagement in CSR activities are pertinent to gain stakeholder legitimacy and attract investors who care about sustainability more than before. Hence, it is easily assumed that firms disclose their actual CSR performance. Ideally, yes, and it may be true for many firms. Other firms, on the contrary, may choose to disconnect CSR disclosure from their CSR performance, referred to as “CSR decoupling” or “CSR gap”. Consequently, they under- or over-state their environmental and social performance in the CSR reports.  In a study, recently published in Business & Society, we investigated the financial market’s reactions to such decoupling practices by firms and the monitoring role of financial analysts in reducing the CSR disclosure-performance gap.

In many parts of the world, such as the United States and Australia, CSR disclosure practices are voluntary and unregulated, making it possible for managers to report incomplete, biased, or selective information for several reasons. For instance, managers face contradictory requirements of being sustainable in the long-term yet profitable in the short-term due to shifting stakeholder preferences from economic profits to sustainability profits. At the same time, firms’ CSR-related promises elevate stakeholder expectations and further increase the pressures by attracting the attention of civil society towards the firm.

To manage stakeholder pressures, firms either a) overstate their CSR to seek external endorsement, also referred to as CSR faking or greenwashing, or b) understate CSR to avoid external pressures, reflecting the behavior of emerging green or silent green firms. Hyundai and Kia, South Korean companies, are examples of faking strategy because they overstated the gas mileage for their 1.2 million vehicles. Similarly, IKEA, a Scandinavian company famous for home furnishing products, had remained silent about sourcing its lumber from forests certified by the Forest Stewardship Council for years. Business and society scholars agree that any form of decoupling results in the loss of legitimacy in the eyes of stakeholders and deterioration of market value.

Our analysis of US firms for the period of 2006-2015 overall suggests that financial markets do punish firms for CSR decoupling. First, the finding confirms the CSR disclosure-performance gap increases analysts’ forecast error implying that it deteriorates the quality of forecast prepared by financial analysts. As a result, investors’ trust in the firm may be reduced or even lost.  Secondly, we show that the CSR gap increases firms’ cost of capital and decreases access to finance. Consequently, firms have to pay higher returns to investors and their access to financial resources is also restricted.

Our in-depth analysis further reveals that errors in the forecasts of financial analysts, caused by noisy CSR information, further strengthen the harmful effects of firms’ decoupling practices on the cost of capital and access to finance. It clearly suggests that the market punishes firms even more in the presence of poor quality forecasts. As a final note, our findings also suggest that firms reduce the disclosure-performance gap when they are followed and monitored by a higher number of external analysts. This is true because these external monitors provide investment recommendations to investors based on firms’ behavior, motivating firms to avoid any irresponsible behavior.

Our findings offer insights for shareholders and stakeholders such as, investor, regulators, and financial analysts. Firstly, the results caution them about the negative market-related outcomes when firms do create a disconnection between their CSR talk and walk. Secondly, we suggest that they choose better-monitored firms because the CSR reports of firms followed by a higher number of financial analysts may offer reliable insights for investment decisions.

References

Delmas, M. A., & Burbano, V. C. 2011. The drivers of greenwashing. California management review, 54(1): 64-87.

García-Sánchez, I. M., Hussain, N., Khan, S. A., & Martínez-Ferrero, J. 2021. Do markets punish or reward corporate social responsibility decoupling?. Business & Society, 60(6): 1431-1467.

Harjoto, M.A. & Laksmana, I., 2020. Do Socially Responsible Firms Walk the Talk? CSR Performance and Defined Benefit Pension Policies. In Academy of Management Proceedings 2020(1): 13289. Briarcliff Manor, NY 10510: Academy of Management.

Hawn, O. & Ioannou, I., 2016. Mind the gap: The interplay between external and internal actions in the case of corporate social responsibility. Strategic Management Journal, 37(13): 2569-2588.

Tashman, P., Marano, V., & Kostova, T., 2019. Walking the walk or talking the talk? Corporate social responsibility decoupling in emerging market multinationals. Journal of International Business Studies, 50(2):153-171.

Winn, M. L., & Angell, L. C. 2000. Towards a process model of corporate greening. Organization Studies, 21(6): 1119-1147.