Prior studies in business ethics highlight the role of philanthropy in shaping stakeholders’ perceptions of a firm’s underlying moral tendencies and values (“character”). Scholars argue that philanthropy-based character inferences influence whether and how stakeholders engage with firms. We extend this line of reasoning to examine the impact of philanthropy on firms’ contracting costs in the capital market. We posit that philanthropy-based character inferences reduce investors’ agency concerns, thereby reducing firms’ cost of capital. We also posit that the strength of the philanthropy–cost of capital relationship is contingent on uncertainty regarding a firm’s character, visibility of a firm, and prevailing philanthropic norms. We test and find support for our arguments in a longitudinal study of philanthropy and the cost of capital. Our findings have implications for business ethics research on corporate philanthropy and corporate social performance and for organizational research on social judgment.
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As Love and Kraatz (2009: 316) note, “this line of argument does not imply that corporate actions provide a window into a firm’s essential traits (or even that firms possess essential traits). … The point here is that people tend to apply these criteria and to look for such traits, regardless of whether firms actually ‘possess’ them”.
An alternative to the implied cost of capital approach is to use realized returns-based models (e.g., the CAPM or the Fama and French (1993) three-factor model). However, realized returns reflect changes in projected cash flows. Thus, in our setting, the cost of capital estimated using realized returns-based models could reflect investors’ assessments of strategic benefits reflected in projected cash flows that accrue to firm from philanthropy and/or philanthropy-based assessments of firm capability. In addition, as realized returns-based models focus on a predetermined set of systematic risk factors, estimates of cost of capital constructed using these models assume away the effect of firm-level attributes, such as philanthropic giving.
We do not include community strengths since these are mostly captured by Philanthropy.
We considered using a simple net CSR score (CSR strengths less CSR concerns) to capture cue availability. However, the merit of using of a net CSR score has been questioned as corporate social irresponsibility and corporate social responsibility are conceptually distinct and subject to different dynamics (Ioannou and Serafeim 2015; Lange and Washburn 2012; Tang et al. 2015).
As the correlation between Philanthropy greater than norm and Philanthropy less than norm is negligible (coefficient = 0.012), including both in our regression does not create serious multicollinearity concerns.
We conduct a difference-in-difference Fama–MacBeth regression-based test, where the treatment group is firms headquartered in an area where a mega-event (either the Super Bowl or a national convention) takes place. The average coefficient for the mega-event dummy is negative and significant suggesting that firms headquartered in an area that experienced a mega-event, on average, experienced a drop in their cost of capital compared to firms headquartered in other locations. Coupled with prior research showing that mega-events lead to an increase in philanthropy for locally headquartered firms (Tilcsik and Marquis 2013), these findings are consistent with the view that an increase in philanthropy leads to reduction in firm’s cost of capital.
This analysis addresses the possibility that our results can be explained by investors taking philanthropy as an indicator of business acumen. While prior work (e.g., Waddock and Graves 1997) suggests that observers may take philanthropy as an indicator of the capability—business acumen—of the firm’s management, in the current context, capability and business acumen are equivalent constructs.
Since our sample covers Fortune 1000 firms (i.e., large firms), to be classified as firm i’s industry peer the firm should be (a) in the same industry as firm i and (b) in the upper quantile in terms of firm size.
As an additional test of the insurance channel we examined whether the impact of philanthropy is amplified for firms with high levels of litigation risk—that is, firms for which such insurance is more valuable (Koh et al. 2014). To examine this issue, we modified Eq. (2) to include an interaction term between Philanthropy and the High litigation risk dummy variable, which took a value of one if a firm’s primary industry had a high level of litigation risk, and zero otherwise. Following Koh et al. (2014), we selected SIC codes 2833–2836 (biotechnology), 3570–3577 and 7370–7374 (computers), 3600–3674 (electronics), and 5200–5961 (retailing) as industries characterized by a high level of litigation risk. We found no evidence that the effect of philanthropy is amplified for firms with a high level of litigation risk. These results further support our conclusion that the relationship between philanthropy and the cost of capital cannot be explained by the insurance value of moral capital that firms can generate through philanthropy.
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Zolotoy, L., O’Sullivan, D. & Klein, J. Character Cues and Contracting Costs: The Relationship Between Philanthropy and the Cost of Capital. J Bus Ethics 154, 497–515 (2019). https://doi.org/10.1007/s10551-017-3475-9
- Social judgment
- Contracting costs