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RESEARCH BRIEF: Corporate citizenship enhances access to finance

Takeaway: Research suggests that firms with better environmental, social, and governance (ESG) performance achieve better access to capital in two ways: Better corporate citizenship is associated with superior stakeholder engagement and disclosure. Both of these mechanisms create levels of transparency, reduce conflicting information, and thus, mitigate perceived risk so that firms are able to more easily obtain financing in the capital markets.

Suggested audience: Chief financial officers and corporate citizenship managers.

Prior literature has documented a critical link between capital constraints and firm performance. Financially constrained companies are more likely to diminish investments in a wide range of strategic activities, including investments in inventory and R&D. This study suggests that firms with better CSR performance faced lower capital constraints, and companies with lower capital constraints typically enjoy better firm performance.

Researchers studied data on 327 publicly listed firms from around the world between 2002 and 2009. The data provided information on firms’ social performance on three dimensions: environmental, social, and corporate governance. Researchers created a “composite CSR Index” by weighting each of the three equally and used the KZ index (Kaplan and Zingales, 1997) as a measure of capital constraints. The KZ-Index is a relative measurement of reliance on external financing. Companies with higher KZ-Index scores are more likely to experience difficulties when financial conditions tighten since they may have difficulty financing their ongoing operations. 

The researchers measured stakeholder engagement by the annual average of indicator variables that measure whether each of 29 ESG policies has been adopted by the corporation. They also recorded disclosure, which they measured by the average of indicator variables that measure whether a company has disclosed an item or not in any given year.

Key findings:

  • Firms that score on the 75th percentile of the CSR index have a KZ Index (measure of capital constraints) that is lower by 0.40 when compared to firms that score on the 25th percentile of the CSR index.  (75 percentile scores are typically lower than -2.6)
  • Firms with better ESG performance face lower capital constraints through two distinct mechanisms:
  1. Better ESG performance is associated with superior stakeholder engagement that, in turn, significantly reduces the likelihood of opportunistic bad behavior and introduces a more efficient form of contracting with key constituents. It also enhances the revenue or profit generating potential of the firm through the higher quality of relationships with customers, business partners, and employees. Firms with better stakeholder engagement appeared to benefit from lower capital constraints
  2. Firms with better ESG performance are more likely to publicly disclose their ESG activities and consequently become more transparent and accountable. Higher levels of transparency reduce conflicting information between the firm and investors, thus mitigating risk that might have been inferred from conflicting information. Firms with better CSR disclosure appear to benefit from lower capital constraints.

If citing, please refer to the original article: “Corporate Social Responsibility and Access to Finance”, Harvard Business School working Paper, May 9, 2012, Beiting Cheng, Ioannis Ioannou, and George Serafeim

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