Business Groups and Corporate Social Responsibility

Abstract

There is a growing literature on corporate social responsibility (CSR), but few have focused on the implications of business groups for CSR. We examine the antecedents and outcomes of CSR behaviors of group firms in Korea. We find that group affiliation is associated with higher CSR overall and for its major societal and environmental components. However, the ownership disparity between cash flow and control by controlling inside shareholders is associated with lower CSR, consistent with opportunistic rent expropriation theory. We further find that CSR initiatives can impact group firms positively in the event of bad events, consistent with insurance theory. This motive for CSR as a means of enhancing reputation capital to buffer the bad events is pronounced for group firms because of group-wide dissemination of negative reputational externality.

Appendices

Appendix 1: A Simple Theoretical Model

There are two types of agency problem when it comes to CSR and corporate governance. Type I agency problem refers to the conflict of interests between managers and shareholders, and type II agency problem indicates those between controlling inside shareholders (such as founding family) and non-controlling outside minority shareholders. In this paper, we focus on type II agency problem.

Johnson et al. (2000) argue that measures of CSR and corporate governance, particularly the effectiveness of minority investor protections, can better explain the magnitude of depreciation and stock market decline in emerging markets open to capital flows during the Asian financial crisis of 1997–1998 than do standard macroeconomic variables. They further claim that in countries with weak corporate governance, worse economic prospects result in more expropriation by managers and thus a larger fall in stock prices. To support their claim, they construct a simple static theoretical model that helps understand the basic logic as to how corporate governance affects firm value. While Johnson et al. (2000) use type I agency problem, we modify it to type II agency problem and incorporate CSR.

Let α denotes the shares of controlling shareholders and (1 − α) those of minority shareholders. S indicates the amount of money the controlling shareholders attempt to transfer from the minority shareholders, i.e., transfer resources from a long-term oriented CSR project to a short-term profit-oriented project or to a project in the private interest of controlling insiders, increasing the probability of opportunistic rent-seeking. The cost function for the transferring money is assumed as

$$C\left( S \right)=\frac{{{S^2}}}{{2k}}$$

(A1)

The k term denotes the weakness of CSR engagement as well as corporate governance: the higher value of k represents the cost of weak CSR or corporate governance. Let I be retained earnings and R be gross rate of return. We can then see that the utility function for the controlling insider is

$$U=\alpha R(1 - S)+S - \frac{{{S^2}}}{{2k}}$$

(A2)

If we differentiate the utility function with respect to S,

$$\frac{{\partial U}}{{\partial S}}=\alpha R+1 - \frac{{{S^*}}}{k}=0$$

(A3)

Then, the optimal amount of money the controlling shareholder could transfer should be

$${S^*}=k(1 - \alpha R)$$

(A4)

Now the firm value, V, can be expressed as,

$$V=R(1 - {S^*})=R[I - k(1 - \alpha R)]$$

(A5)

When we differentiate the firm value with respect to k, we find that

$$\frac{{\partial V}}{{\partial k}}=R(\alpha R - 1)$$

(A6)

This result can be interpreted as follows.

If αR − 1 > 0, then

$$\frac{{\partial V}}{{\partial k}}>0$$

(A7)

On the other hand, if αR − 1 < 0, then

$$\frac{{\partial V}}{{\partial k}}<0$$

(A8)

This means that when α*R are larger (smaller) than one, the weakness of corporate governance or CSR will have a positive (negative) impact on firm value. The smaller α means bigger ownership disparity between controlling shareholders and minority shareholders, and the smaller R means that the firms are suffering a weaker value.

Our modified static model shows that CSR could play a major effect on firm value provided that corporate governance is a subset of CSR. Based on theoretical intuition given by Johnson et al. (2000), we postulate a proposition that the value of group firms is more significantly and negatively affected by ownership disparity than non-group firms, especially when the ownership disparity is large (smaller α) and controlling shareholders attempt tunneling such as transferring funds from a long-term oriented CSR project to a project for private benefit by the controlling insider.

Appendix 2: ASSET4 CSR composition

Corporate social responsibility (CSR) composition

	Pillars	Categories
CSR	Corporate governance performance (5 categories)	Board structure (11 items)
		Compensation policy (13 items)
		Board functions (13 items)
		Shareholders rights (34 items)
		Vision and strategy (10 items)
	CSR_E (environmental) performance (3 categories)	Resource reduction (32 items)
		Emission reduction (41 items)
		Product innovation (25 items)
	CSR_S (society) performance (7 categories)	Employment quality (11 items)
		Health and safety (26 items)
		Training and development (8 items)
		Diversity (11 items)
		Human rights (13 items)
		Corporate community involvement (30 items)
		Product responsibility (41 items)

Appendix 3: Variable definitions and data sources

CSR variables
CSR	Equally weighted average of the social and environmental index (ASSET4)
CSR_E (environmental)	A company’s impact on living and non-living natural systems, including the air, land and water, as well as complete ecosystems
Emission reduction	A company’s management commitment and effectiveness towards reducing environmental emission in the production and operational processes
Resource reduction	A company’s management commitment and effectiveness towards achieving an efficient use of natural resources in the production process
Product innovation	A company’s management commitment and effectiveness towards supporting the research and development of eco-efficient products or services
CSR_S (society)	A company’s capacity to generate trust and loyalty with its workforce, customers and society, through its use of best management practices
Employment quality	A company’s management commitment and effectiveness towards providing high-quality employment benefits and job conditions
Health & safety	A company’s management commitment and effectiveness towards providing a healthy and safe workplace
Training & development	A company’s management commitment and effectiveness towards providing training and development (education) for its workforce
Diversity	A company’s management commitment and effectiveness towards maintaining diversity and equal opportunities in its workforce
Human rights	A company’s management commitment and effectiveness towards respecting the fundamental human rights conventions
Community	A company’s management commitment and effectiveness towards maintaining the company’s reputation within the general community
Product responsibility	A company’s management commitment and effectiveness towards creating value-added products and services upholding the customer’s security
Firm value variable
Tobin’s Q	The sum of the market value of common stock, the book value of preferred stock and total debts, divided by the book value of total assets
Business group variables
Group	A dummy variable to indicate whether a firm belongs to one of the 30 largest business groups in South Korea. The Korea Fair Trade Commission (KFTC) updates the list of the 30 largest business groups annually (Group OPNI)
Group (Top 10)	A dummy variable to indicate whether a firm belongs to one of the 10 largest business groups in South Korea (Group OPNI)
Disparity	The disparity between control ownership and cash flow ownership of the controlling shareholder in a group firm (Group OPNI)
After negative event	A dummy variable to indicate whether a firm belongs to one of the business groups which underwent negative events (Maeil Kyungjae Daily News)
Firm-specific variables
Firm age	The numbers of years since a firm’s founding date (DART)
Firm size	The natural log of the total assets of a firm in South Korean won (Worldscope and DART)
Debt ratio	The ratio of total debts to total assets of a firm (Worldscope and DART)
Current ratio	The ratio of current assets to current liabilities of a firm (Worldscope and DART)
R&D intensity	The ratio of the research and development expenditures to total sales of a firm (Worldscope and DART)
Governance index	Korean Corporate Governance Institute (KCGI) index provided by Korean Corporate Governance service, using the normalized the KCGI index scores
Export to total assets	Export divided by total assets to control for firm’s internationalization magnitude (Compustat Global)

1. The Group OPNI dataset further provides group affiliation, variables necessary to compute group firms’ ownership disparity, group ranking, number of firms in the group, types of controlling group owners, and industry information of firms in the group

Appendix 4: The list of negative events of groups

Group name	Year	News
CJ	2013	The Chairman of CJ Group was sentenced for embezzlement, breach of trust and tax evasion
Daewoo Shipping	2010	CEO Daewoo Shipbuilding & Marine Engineering, Mr. Nam was prosecuted and later convicted on charges of expropriation
Doosan	2009	Former Chairman committed suicide after the “brothers’ war” and his business failure
Hanwha	2010	Chairman’s third son was arrested on charge of sexual assault. After this, the Chairman’s second son was arrested in charge of hit-and-run in 2011
	2012	The Chairman was sentenced to four years in prison and fined $4.5 million for embezzlement
Hanjin	2015	Korean Air scandal in which Ms. Cho, Hyun-ah, an airline senior executive and daughter of the company’s Chairman, asked the flight’s chief steward to kneel before her due to minor mistake. Ms. Cho was eventually sentenced to one year in prison for violation of airline code
Hyosung	2010	The Chairman’s second son was prosecuted on charge of embezzlement of 6.4 billion Korean Won (KRW)
Hyundai Motors	2006	Revelation of Secret fund. This caused a prison sentence for the Chairman for three years. Hyundai Motors group was accused of illegal bribing of a sub-contractor in 2011 again
Kumho Asiana	2011	The Chairman’s borrowed-name bank accounts were revealed (valuing total of 6–10 billion KRW). During that period, the business group had suffered from serious financial distress
LG	2010	Entire recall of ‘Drum Washing Machine’ due to a child’s fatal incident
Lotte	2009	Spread of a rumor about political and business circle related to the second Lotte World construction project. In 2010, Lotte started court dispute with Crown, a major competitor in food manufacturing and distribution
	2015	Brothers in the founding family squabble. Son ousts father in boardroom coup. Father strikes back. That is the gist of the family drama plaguing retail and hotel giant, Lotte Group, the fifth-largest chaebol, in South Korea
Posco	2009	Suspicion that the government intervened in the process of appointment of Chairman
Samsung	2005	Accusation from NGO that the Chairman inherited convertible bonds to his son illegally to avoid inheritance tax. This was followed by investigation into secret fund of the group (2008) and special inspection was initiated by Congress (2008)
	2008	Lee Jae-Yong, an heir to the Group, and his two sisters inherited convertible bonds at below-market prices
	2009	Chairman Lee was convicted for tax evasion
	2012	Family feud
	2015	Sabotage, espionage, succession battles, bribes, and sibling rivalries in the founding family
SK	2008	Chainman was sentenced a stay of execution with dereliction of duty, followed by the event that the Chairman’s family was seized and searched by the prosecutor on charges of embezzlement
	2013	Group Chairman was convicted of misappropriation of $43.6 million from two of the SK Group affiliates to make personal investments in stock futures and options
SSG	2010	Minority shareholders of SSG filed a compensation lawsuit against Vice Chairman of the group, Chairwoman’s son, for 18.9 billion KWR