Should Corporate Governance and Corporate Social Responsibility Work in Tandem?

Abstract

In addition to financial returns, investors and creditors are increasingly focused on corporate governance and corporate social responsibility (CSR) practices of their portfolio firms. Economic theories, such as agency theory and enlightened stakeholder theory explain the effects of corporate governance or CSR on corporate outcomes (Jensen and Meckling, 1976; Jensen, 2010). However, these economic theories do not adequately address the effects on corporate outcomes of interrelationships between corporate governance and CSR in a sophisticated manner. Koonce and Mercer (2005) note that psychology theories enable researchers to examine the behaviors of managers, auditors, investors and analysts in a concrete way. They further note that archival accounting researchers neglect psychology theories — despite their usefulness — for their research. Building on sensemaking theory from psychology (Starbuck and Milliken, 1988; Weick, 1995) and analyzing US firms from 1993 to 2006, I show that incongruent practices between corporate governance and corporate social responsibility causes investors and credit agencies to have equivocality about firms, leading to their negative identification of the firms which, in turn, decreases firm value and credit ratings. I show that having a balance between corporate governance and CSR is important for firm value and credit ratings. This study makes contributions in terms of firm policy implications, in that management and board members of US firms often pay attention to shareholder value maximization, but disregard stakeholder concerns. This study also helps correct misconceptions of some investors who focus too much on short-termism — believing that firms’ engaging in CSR destroys firm value — by providing evidence that encouraging firms to pursue balanced corporate governance and CSR benefits investors and creditors, as well as society.