NOTE CORPORATE SOCIAL RESPONSIBILITY: A THEORY OF THE FIRM PERSPECTIVE ABAGAIL MCWILLIAMS University of Illinois at Chicago DONALD SIEGEL University of Nottingham We outline a supply and demand model oi corporate social responsibility (CSR). Based on this framework, we hypothesize that a firm's level of CSR will depend on its size, level of diversification, research and development, advertising, government sales, consumer in- come, labor market conditions, and stage in the industry life cycle. From these hypothe- ses, we conclude that there is an "ideal" level of CSR, which managers can determine via cost-benefit analysis, and that there is a neutral relationship between CSR and financial performance. Managers continually encounter demands from multiple stakeholder groups to devote resources to corporate social responsibility (CSR). These pressures emerge from custom- ers, employees, suppliers, community groups, governments, and some stockholders, espe- cially i nst i t ut i onal sharehol ders. With so many conflicting goals and objectives, the def- inition of CSR is not always clear. Here we define CSR as actions that appear to further some social good, beyond the interests of the firm and that which is required by law. This definition underscores that, to us, CSR means going beyond obeying the law. Thus, a com- pany that avoi ds di scri mi nat i ng agai nst women and minorities is not engaging in a socially responsible act; it is merely abiding by the law. Some examples of CSR actions include going beyond legal requirements in adopting progres- sive human resource management programs, developing non-animal testing procedures, re- cycling, abating pollution, supporting local businesses, and embodying products with so- cial attributes or characteristics. We limit the scope of our analysis to satisfying the burgeon- ing demand for CSR through the creation of product attributes that directly support social responsibility (e.g., pesticide-free produce) or that signal the firm's commitment to CSR (e.g., dolphin-free-tuna labels). Many managers have responded to height- ened stakeholder interest in CSR in a very pos- itive way, by devoting additional resources to promote CSR. A primary reason for positive re- sponses is the recognition of the relevance of multiple stakeholders (Donaldson & Preston, 1995; Mitchell, Agle, & Wood, 1997). Other man- agers have a less progressive view of stake- holder relevance. They eschew attempts to sat- isfy demand for CSR, because they believe that such efforts are inconsistent with profit maximi- zation and the interests of shareholders, whom they perceive to be the most important stake- holder. This divergence in response has stimulated an important debate regarding the relationship between CSR and financial performance. It has also raised two related questions regarding the provision of CSR: 1. Do socially responsible firms outperform or underperform other companies that do not meet the same social criteria? 2. Precisely how much should a firm spend on CSR? In existing studies of the relationship between CSR and financial performance, researchers have primarily addressed the first question, and the results have been very mixed. Recent stud- ies indicate no relationship (McWilliams & Sie- gel, 2000), a positive relationship (Waddock & Graves, 1997), and a negative relationship 117 118 Academy of Management Review January (Wright & Ferris, 1997).' This leaves managers without a clear direction regarding the desir- ability of investment in CSR. More important, the second question, which is of greater impor- tance to managers, has not been directly exam- ined in the academic literature. The purpose of our study is to fill this void. We propose a methodology that enables managers to determine the appropriate level of CSR in- vestment, based on a theory of the firm perspec- tive. This perspective is based on the presump- tion that managers of publicly held firms usually attempt to maximize shareholder wealth, with a vigorous "market for corporate control" as* the primary control mechanism (Jensen, 1988). Our framework applies generally to publicly held firms but not necessarily to pri- vately held companies that may have alterna- tive objectives and are not subject to the market for corporate control. Based on this framework, we derive hypotheses regarding the demand and supply of CSR attributes across industries, firms, and products. Because these hypotheses and the conclusions we draw from them are relevant to the extent that managers wish to enhance shareholder wealth, we are able to in- fer managerial implications. THEORETICAL PERSPECTIVES ON CSR Several theoretical frameworks have been used to examine CSR. Friedman (1970) asserts that engaging in CSR is symptomatic of an agency problem or a conflict between the inter- ests of managers and shareholders. He argues that managers use CSR as a means to further their own social, political, or career agendas, at the expense of shareholders. According to this view, resources devoted to CSR would be more wisely spent, from a social perspective, on in- creasing firm efficiency. This theory has been tested empirically by Wright and Ferris (1997), who found that stock prices reacted negatively to announcements of divestment of assets in South Africa, which they interpreted as being consistent with agency theory. The agency theory perspective has been chal- lenged by other researchers, such as Preston ' For a review of theoretical and empirical studies of the relationship between corporate social performance and fi- nancial performance, see Griffin and Mahon (1997). (1978) and Carroll (1979), who outline a corporate social performance (CSP) framework. As expos- ited by Carroll (1979), this model includes the philosophy of social responsiveness, the social issues involved, and the social responsibility categories (one of which is economic responsi- bility). An empirical test of the CSP framework is presented in the work of Waddock and Graves (1997), who report a positive association be- tween CSP and financial performance. The CSP model has much in common with the stake- holder perspective, which is the most widely used theoretical framework. In a seminal paper on stakeholder theory. Freeman (1984) asserts that firms have relation- ships with many constituent groups and that these stakeholders both affect and are affected by the actions of the firm. Stakeholder theory, which has emerged as the dominant paradigm in CSR, has evolved in several new and inter- esting ways. According to Donaldson and Pres- ton (1995), three aspect of this theorynorma- tive, instrumental, and descriptiveare "mutually supportive." Jones and Wicks propose "converging" the social science (instrumental) and ethics (normative) components of stake- holder theory to arrive at a normative "theory" that illustrates "how managers can create mor- ally sound approaches to business and make them work" (1999: 206). The instrumental aspect and its relationship to conventional theories in economics and cor- porate strategy have also received considerable attention in the literature. For instance, Jones (1995) developed a model that integrates eco- nomic theory and ethics. He concluded that firms conducting business with stakeholders on the basis of trust and corporation have an incen- tive to demonstrate a sincere commitment to ethical behavior. The ethical behavior of firms will enable them to achieve a competitive ad- vantage, because they will develop lasting, pro- ductive relationships with these stakeholders. Russo and Fouts (1997) examined CSR from a resource-based view of the firm perspective. Using this framework, they argue that CSP (spe- cifically, environmental performance) can constitute a source of competitive advantage, especially in high-growth industries. Although these frameworks are useful, we outline an alternative theoretical perspective that further develops instrumental aspects of CSR. This framework allows us to develop a set 2001 McWilliams and Siegel 119 of hypotheses regarding the determinants and consequences of CSR. Additionally, managers can use this framework to determine precisely how much they should spend on CSR. INVESTMENT IN CSR AT THE FIRM LEVEL We begin our analysis of CSR by relating it to a theory of the firm, in which it is assumed that the management of publicly held firms attempts to maximize profits (Jensen, 1988). Based on this perspective, CSR can be viewed as a form of investment. One way to assess investment in CSR is as a mechanism for product differentia- tion. In this context there are CSR "resources" and "outputs." A firm can create a certain level of CSR by embodying its products with CSR attributes (such as pesticide-free fruit) or by using CSR-related resources in its production process (such as naturally occurring insect inhibitors and organic fertilizers). As such, it seems natural to consider the nature of the mar- kets for CSR attributes and CSR-related re- sources. Our analysis of these markets is based on a simple supply and demand framework, which we outline below. Demand for CSR We hypothesize that there are two major sources of demand for CSR: (1) consumer de- mand and (2) demand from other stakeholders, such as investors, employees, and the commu- nity. We begin by describing the nature of con- sumer demand for CSR. CSR investment may entail embodying the product with socially responsible attributes, such as pesticide-free or non-animal-tested in- gredients. It may also involve the use of signals, such as the union label in clothing, that convey to the consumer that the company is concerned about certain social issues. This results in the belief that, by using these products, consumers are indirectly supporting a cause and rewarding firms that devote resources to CSR. Consumer- oriented CSR may also involve intangible at- tributes, such as a reputation for quality or reli- ability. Fombrun and Shanley (1990) and Weigelt and Camerer (1988) have described how reputa- tion building is an integral component of strat- egy formulation. A reputation for quality and reliability may be especially important for food products. Thus, McDonald's employs the handi- capped and supports such organizations as the Ronald McDonald House, establishing a reputa- tion for CSR. The presumption is that firms that actively support CSR are more reliable and, therefore, their products are of higher quality. There is strong evidence that many (although certainly not all) consumers value CSR at- tributes. A growing number of companies have incorporated CSR into their marketing strate- gies, because they wish to exploit the appeal of CSR to key segments of the market, such as baby boomer or "generation X" shoppers. We need only look at the rapid growth of such so- cially responsible companies as Ben & Jerry's, the Body Shop, and Health Valley to confirm the importance of CSR in marketing. CSR as a differentiation strategy. Product (ser- vice) differentiation is used to create new de- mand or to command a premium price for an existing product (service). Firms that adopt a differentiation strategy often pursue multiple means of differentiation. An example is Ben & Jerry's, which differentiates its products by cre- ating unique flavors, using high-quality ingre- dients, supporting the local community, and pro- moting diversity in the workplace. CSR may be a popular means of achieving differentiation, be- cause it allows managers to simultaneously sat- isfy personal interests and to achieve product differentiation. For example, Ben Cohen of Ben & Jerry's may have a personal, as well as a professional, commitment to diversity. Differentiating through the use of CSR re- sources, such as recycled products or organic pest control, may also include investment in re- search and development (R&D). R&D investment may result in both CSR-related process and product innovations, which are each valued by some consumers. For example, the "organic, pesticide-free" label simultaneously indicates the use of organic methods, which constitutes a process innovation by the taimei, and the cre- ation of a new product category, which is a prod- uct innovation of the natuial foods letailei. Ii the natural foods company is vertically integrated, it engages in both CSR-related process and product innovation simultaneously. This exam- ple underscores the point that some consumers want the goods they purchase to have certain socially responsible attributes (product innova- tion), while some also value knowing that the goods they purchase are produced in a socially responsible manner (process innovation). 120 Academy of Management fleview January An additional example is New United Motor Manufacturing, Inc. (NUMMI), the innovative joint venture between Toyota and General Mo- tors, which was established in Fremont, Califor- nia, in 1984 to build small cars for both compa- nies. The NUMMI plant implemented many of the latest Japanese "lean manufacturing" meth- ods (process innovation) and produced the Geo Prism, the prototype for GM's new generation of small cars (product innovation). These processes and the product innovations were the result of R&D investment undertaken by General Motors. Furthermore, through its unique partnership with the United Auto Workers (UAW), NUMMI also implemented a number of progressive workplace practices, such as a strong emphasis on teamwork and employee empowerment. Con- sequently, some consumers perceived that NUMMI cars, such as the Geo Prism, were supe- rior to traditional, American-made cars, in terms of quality and reliability. More important, many customers also believed that by purchasing these cars, they were demonstrating their sup- port of progressive human resource manage- ment practices and the UAW. Although R&D may result in both process and product innovation, the vast majority of R&D is devoted to product innovation (Link, 1982). The role of CSR in product differentiation leads to our first hypothesis. Hypothesis 1: There is a positive corre- lation between the level of product differentiation (a proxy for which is the ratio of R&D expenditures to sales) and the provision of CSR attributes. CSR and advertising. For CSR differentiation to be successful, potential customers must be fully aware of CSR characteristics; otherwise, they will purchase a similar product without such attributes. Some of these characteristics might not be evident to the buyer at first glance. Thus, advertising plays an important role in raising the awareness of those individuals who are interested in purchasing products with CSR attributes. The literature on advertising distinguishes between two types of goods: search and experi- ence (Nelson, 1970, 1974). Search goods are prod- ucts whose attributes and quality can be deter- mined before purchase. For example, furniture is usually considered to be a search good. Con- sumers search for the appropriate style and quality. These attributes can be established by examining the product before purchase. Cloth- ing is another example of a search good. With accurate labeling as to the textile content, the consumer can establish the quality of the good before purchasing it. For search goods, most ad- vertising will be limited to informing the con- sumer as to the availability of the product and its price. Experience goods are products that must be consumed before their true value can be known. For example, food is an experience good. The consumer cannot determine from viewing the product how it will taste or whether it will be safe to consume. Advertising for experience goods, therefore, will provide more information, usually tying the product to an established brand name, such as Heinz. The association with brand name provides the consumer with information about the product through the rep- utation of the brand. As noted above, support of CSR creates a rep- utation that a firm is reliable and honest. Con- sumers typically assume that the products of a reliable and honest firm will be of high quality. Advertising that provides information about CSR attributes can be used to build or sustain a reputation for quality, reliability, or honesty all attributes that are important but difficult to determine by search alone. For example, Heinz advertises its Starkist brand tuna as being dol- phin free. This provides the consumer with in- formation that the product has CSR attributes but also that the company is trustworthy. By implication, the product will be of high quality. This type of advertising is used to foster product differentiation, allowing the firm to charge a premium price. The link between advertising and CSR leads to our next two hypotheses. Hypothesis 2: Because consumers rely more on firm reputation when pur- chasing experience goods than when purchasing search goods, CSR at- tributes are more likely to be associ- ated with experience than with search goods. Hypothesis 3: Because consumers must be made aware of the existence of CSR attributes, there will be a positive correlation between the intensity of 2001 McWilhams and Siegel 121 advertising in an industry (a proxy for which is the ratio of advertising to sales) and the provision of CSR. Additional determinants of consumer de- mand. We hypothesize that income is another determinant of consumer demand for CSR. Whereas low-income shoppers generally are quite price sensitive, affluent consumers can more easily pay a higher price for additional CSR attributes. Goods whose demand increases as income increases are called normal goods. We conjecture that CSR attributes are normal goods, which means that greater levels of afflu- ence, as reflected in higher disposable income, will result in greater demand for CSR.^ Hypothesis 4: Because CSR attributes are normal goods, there v/ill be a pos- itive correlation between consumer income and the provision of CSR at- tributes. Other determinants of demand include tastes and preferences, demographics, and the price of substitute products. Consumer taste and prefer- ences may be affected by mass media, and CSR has become a hot topic in media circles. Jour- nalists often provide free publicity of a firm's commitment or lack of commitment to CSR. The media closely scrutinize some sectors, such as the film industry and professional sports. Celeb- rities and sports figures often use the media to highlight their commitment to social responsi- bility. Journalists also closely follow the work of social activists. Fedderson and Gilligan (1998) contend that media attention devoted to social activists provides the public with access to new information regarding social attributes and methods of production. This free publicity, whether positive or negative, helps heighten public awareness of CSR, reduces information asymmetry, and, thus, influences demand for CSR. Demographics can also affect the demand for CSR. For instance, baby boomers have smaller families, greater household incomes, and more social awareness than previous generations. Thus, they have the means to purchase products with CSR attributes and are increasingly likely to make consumption choices based on social grounds. Savvy firms will capitalize on this trend. Because not all consumers place a high value on CSR attributes, the price of competing goods will still affect the demand for goods and ser- vices provided by firms that embrace CSR, if these competing goods are lower-cost alterna- tives. Although most consumers might choose a good with CSR attributes if its price were equal to that of another good and many might choose a good with CSR attributes if its price were only a little higher, some consumers will switch away from the CSR good if there is a substantial price difference. Therefore, there is a positive relationship between the demand for goods with CSR attributes and the price of competing, or substitute, products (the higher the price of com- peting goods, the higher the demand for goods with CSR attributes). This leads to an additional hypothesis. Hypothesis 5: There is a positive corre- lation between the price of substitute goods and the demand for goods with CSR attributes. To summarize, we conjecture that the key de- terminants of the demand for a product with CSR attributes are the product's price, advertis- ing to promote consumer awareness of CSR at- tributes, the level of consumers' disposable in- come, consumers' t ast es and preferences, demographics, and the price of substitute prod- ucts. Table 1 presents the determinants of demand and the predicted effect of each determinant on TABLE 1 Determinants of Consumer Demand for CSR Attributes ^ Some CSR attributes may even have the properties of a "luxury" good. That is, an increase in income may induce greater than proportional increases in the demand for CSR attributes (e.g., if income increases by 10 percent, the de- mand for CSR attributes will increase by more than 10 per- cent). Determinant Price of goad with CSR attributes Advertising Income Tastes Demographics Price of substitute goods Hypothesized Effect on Demand Negative Positive Positive Indeterminate Indeterminate Positive 122 Academy of Management Review January the demand for CSR attributesthat is, whether demand increases or decreases when the deter- minant increases (as designated by a positive or negative sign). As shown in the table, for some determinants, such as tastes and demographics, the effect is not easily predicted. Other stakeholders' demand. Employees are another important source of stakeholder de- mand for CSR. For example, they tend to support progressive labor relations policies, safety, fi- nancial security, and workplace amenities, such as child care. Workers search for signals that managers are responding to causes they sup- port. Unions often play an important role in en- couraging firms to adopt these CSR policies. Note that unions can also influence CSR policies at nonunion firms in the same industry. This is analogous to the well-documented "threat ef- fect" of unions on nonunion wages (Freeman & Medoff, 1983; Mills, 1994). For example, nonunion firms may adopt progressive work practices to avoid unionism (Foulkes, 1980). Firms that sat- isfy employee demand for CSR may be re- warded with increased worker loyalty, morale, and productivity (Moskowitz, 1972; Parket & Eibert, 1975). There is also some evidence that firms in industries with skilled labor shortages have used CSR as a means to recruit and retain workers (Siegel, 1999). Other stakeholder groups, including minority and community groups and local and state gov- ernments, can contribute to the demand for products with CSR attributes as well. For exam- ple, governments may encourage proactive en- vironmental practices, and community groups may desire support for local social services, such as those provided by United Way. These groups will then reward the firms by increasing their consumption of the firms' products. For in- stance, government contracts might require that firms undertake a certain level of CSR invest- ment, such as minority set-asides. Ultimately, these groups affect demand through consump- tion, either their own or that of the consumers they influence. The characteristics of demand from stakeholder groups other than consumers lead to the following hypotheses. Hypothesis 6; There is a positive corre- lation between unionization of the workforce and the provision of CSR: that is, in industries that are highly unionized, there will be more CSR provided. Hypothesis 7: There is a posifive rela- tionship between the shortage of skilled workers in an industry and the provision of CSR: that is, in industries with shortages of skilled labor, more CSR will be provided. Hypothesis 8: There is a positive corre- lation between government contracts and the provision of CSR. The demand from all stakeholders can be summed to arrive at the overall demand for products with CSR attributes. Recognizing the demand for CSR, managers can make decisions on the number and level of CSR attributes and how to produce them. Supply of CSR According to the resource-based view of the firm, resources are "all assets, capabilities, or- ganizational processes, firm attributes, informa- tion, knowledge, etc. controlled by the firm" (Bar- ney, 1991: 101). The resource-based view leads us to a supply-side perspective, which begins with the realization that firms must devote re- sources to satisfy the demand for CSR. This in- dicates that we can modify the microeconomic concepts of the production and cost functions to include CSR-related resources and output. Thus, we assume that firms use CSR-related capital (land and equipment), labor, materials, and pur- chased services to generate output. In Table 2 we describe the inputs used in generating CSR attributes and the attendant costs. As shown in the table, additional capital might be required to generate CSR characteris- tics. For example, pollution abat ement to achieve an environmental standard beyond that required by law will require the purchase of additional equipment. Similarly, office space, supplies, computers, telephones, and other com- munications equipment may be devoted to CSR. To the extent that additional capital is required, capital costs will be higher. Although capital costs will be higher for firms that provide CSR, the costs will not increase uniformly across firms. The use of capital in the provision of CSR attributes may result in scale economies, because capital investment often 2001 McWilliams and Siegel 123 TABLE 2 Resources or Inputs Used in the Provision of CSR Resource or Input CSR-Related Resource or Input Additional Resource or Input Costs Capital Materials and services Labor Special equipment, machinery, and real estate devoted to CSR Purchase of inputs from suppliers who are socially responsible Progressive human resource management practices and staff to implement CSR policies Higher capital expenditures Higher-cost materials and services (intermediate goods) Higher wages and benefits and additional workers to enhance social performance entails substantial fixed costs. An example is a smokestack scrubber. The cost of a scrubber is fixed, once a particular piece of equipment is installed. The cost of the scrubber will be amor- tized over the number of units of output the firm produces. The higher the level of output, the lower the per unit cost of the scrubber, resulting in an economy of scale.^ Intermediate materials and services may also be related to the provision of CSR. For example, the Body Shop purchases special ingredients and formulas that have not been animal tested, Ben & Jerry's has a stated policy of purchasing dairy products from local Vermont farmers, and Wal-Mart advertises that its products are made in America. Locally produced goods and ser- vices may be more costly than those imported from other states and countries, resulting in higher costs for these socially responsible firms. There might be scale economies related to these costs, however, because of the ability of large firms such as Wal-Mart to obtain quantity dis- counts on CSR-related intermediate goods and materials. Firms may hire additional staff to advance CSR through affirmative action, improved la- bor relations, and community outreach. Exist- ing employees also may be asked to promote these efforts. At the 1997 Philadelphia "sum- mit" on voluntarism, sponsored by President Clinton and Colin Powell, numerous compa- nies pledged to dedicate additional human resources to CSR activities. Many large firms ^ There are limits to scale economies. After all economies of scale are exhausted, average cost will climb with addi- tional output. This diseconomy of scale is usually associated with physical capital constraints or with managerial limita- tions. Managerial limitations might, for example, result in less flexibility in responding to social issues in very large firms. have entire departments devoted to CSR con- cerns. The costs of personnel devoted to CSR and additional CSR-related benefits provided to workers increase the overall labor costs of firms. However, human resources may also generate economies of scale, because they represent a fixed cost that can be amortized over numerous units of output. When scale economies exist, large firms will have lower average costs for providing CSR attributes than small firms. This implies that there may be some differences in the return to firms within industries. Therefore, within in- dustries in which CSR attributes are provided (because the product/service can be differen- tiated), larger firms will provide more CSR attributes. We conjecture that there are economies of scope in the provision of CSR, or cost savings that arise from the joint production of CSR characteristics for several related products. A large, diversified firm can spread the cost of CSR provision over many different products and services. For example, the goodwill gen- erated from firm-level CSR-related advertising can be leveraged across a variety of the firm's brands. When scope economies exist, more di- versified firms will have lower average costs of providing CSR attributes than firms focus- ing on one particular industry. Thus, we ex- pect a positive relationship between firm di- versification and the provision of CSR attributes, all else being equal. Our discussion of the costs of providing CSR attributes has revealed that embodying prod- ucts with CSR attributes requires the use of ad- ditionql resources, which results in higher costs. When considering the appropriate level of CSR characteristics, managers must make critical decisions regarding the optimal use of inputs 124 Academy of Management Review lanuary that generate these attributes.^ Thus, a firm's cost of producing CSR attributes is positively related to the number of these characteristics. The cost function has the usual properties. First, it is monotonically increasing in CSR attributes; that is, it costs more to generate additional char- acteristics. Second, at some point there are in- creasing incremental costs of providing CSR, which results in a standard upward-sloping supply curve for CSR attributes. The nature of the supply of CSR attributes leads to the follow- ing hypotheses regarding the provision of CSR across industries and firms. Hypothesis 9: Firms that provide CSR attributes will have higher costs than firms in the same industry that do not provide CSR attributes. Hypothesis 10: The presence of scale economies in the provision of CSR at- tributes results in a positive correla- tion between firm size and the provi- sion of CSR attributes. Hypothesis 11: The presence of scope economies in the provision of CSR at- tributes results in a positive correla- tion between the level of diversifica- tion of a firm and the provision of CSR attributes. A caveat to Hypothesis 9 must be mentioned. As noted earlier, a firm may fundamentally change its production process in response to a CSR concern, such as conservation. Thus, it is conceivable that a CSR-oriented process innova- tion could result in the creation of a CSR char- acteristic at the same or even a lower level of cost. Examples of this, however, are difficult to find, whereas examples of higher costs for CSR products abound. For instance, a trip to the su- permarket reveals that goods with social char- acteristics (e.g., organic produce) typically cost more than similar goods without social charac- teristics (e.g., nonorganic produce). * In our model we assume that the two firms use the same production technology. This does not apply to a situation in which firms adjust their production processes to reflect CSR concerns. Determining the Appropriate Level of CSR Investment The supply and demand framework implies that there is some optimal level of CSR at- tributes for firms to provide, depending on the demand for these characteristics and the costs of generating them. Companies that do not sup- ply CSR attributes have lower costs, but they face a different (lower at every price) demand curve than firms that do provide them. 'Firms that supply CSR will have higher costs for every level of output than firms that do not supply CSR and produce similar goods. Those consumers who value CSR are willing to pay a higher price for a product with an additional social characteristic than for an identical product without this characteristic. This result is contin- gent on consumers being aware of the existence of the CSR attribute. If consumers are not aware of this additional social feature, they will choose the lower-priced product. Thus, advertising plays an important role in determining the optimal level of CSR attributes or outputs provided. Advertising also helps raise awareness regarding firms' use of CSR inputs, which may be of interest to several stakeholder groups. The provision of CSR attributes will depend as well on certain characteristics of the market, such as the degree to which firms can differentiate their products and the industry life cycle. Thus, one is likely to find CSR attributes in industries with highly differentiated products, such as food, cos- metics, Pharmaceuticals, financial services, and automobiles. In the embryonic and growth stages of the industry life cycle, we expect that there is little product differentiation, as firms focus on per- fecting the production process and satisfying rap- idly growing demand. As growth slows, and espe- cially as the industry matures, there is likely to be a great deal of differentiation. For example, in the ice cream industry, simple flavors, such as va- nilla, dominated in the embryonic and growth stages. As tastes and markets became more so- phisticated, more flavors were introduced. In the current maturity phase there is substantial prod- uct differentiation (flavors, fat content, modes of delivery, and so forth). Ben & Jerry's has capital- ized on the possibility of differentiation through flavors and CSR attributes. Demographic and technological changes also can stimulate demand for CSR attributes. The rapid rise in the number of working women has resulted in an increase in the demand for corpo- 2001 McWilliams and Siegel 125 rate-supplied day care, flexible work schedules, and telecommuting. On the supply side, the rise of the internet has made it much easier for firms to target consumers who have social goals. This is evident in the substantial growth in the number of web sites devoted to CSR activity. These have dramatically reduced the cost of transmitting CSR information to consumers and other interested stakeholders. Examples include the Toyota and Honda web sites, which are devoted to informa- tion about their electric cars. On the demand side, the internet makes it easier for groups who share common social goals to exchange information. For example, there are virtual communities (geocities) for those outside the mainstream of society. MANAGERIAL IMPLICATIONS Our analysis reveals that there is some level of CSR that will maximize profits while satisfying the demand for CSR from multiple stakeholders. The ideal level of CSR can be determined by cost- benefit analysis. To maximize profit, the firm should offer precisely that level of CSR for which the increased revenue (from increased demand) equals the higher cost (of using resources to pro- vide CSR). By doing so, the firm meets the de- mands of relevant stakeholdersboth those that demand CSR (consumers, employees, community) and those that "own" the firm (shareholders). On the demand side, managers will have to evaluate the possibility of product/service dif- ferentiation. Where there is little ability to dif- ferentiate the product or service, demand may not increase with the provision of CSR. On the supply side, managers will have to evaluate the resource costs of promoting CSR while being cognizant of the possibility that there may be scale and/or scope economies associated with the provision of CSR. In sum, managers should treat decisions regarding CSR precisely as they treat all investment decisions. DISCUSSION In this study we attempt to answer a question that has received inadequate attention in the CSR literature: Precisely how much should a firm spend on CSR? We addressed this issue using a supply and demand theory of the firm framework and found that there is a level of CSR investment that maximizes profit, while also satisfying stakeholder demand for CSR. This level of investment can be determined through cost-benefit analysis. Managers can use our framework to make decisions regarding CSR in- vestment by employing the same analytical tools used to make other investment decisions. We have also developed several hypotheses re- garding CSR activityfor example, the provision of CSR will depend on R&D spending, advertising intensity, the extent of product differentiation, the percentage of government sales, consumer in- come, the tightness of the labor market, and the stage of the industry life cycle. Additionally, the likelihood of economies of scale and scope in the provision of CSR implies that large, diversified companies will be more active in this arena. Most important, our model indicates that although firms providing CSR will have higher costs than firms not providing CSR, they will each have the same rate of profit. To assess the impact of CSR on profitability, we present the following simple example. As- sume there are two firms that produce identical goods, except one company adds a social char- acteristic to its product. Invoking the theory of the firm, we assume that each firm makes opti- mal choices, which means that each produces at a profit-maximizing level of output. It can be shown that, in equilibrium, both will be equally profitable. The firm that produces a CSR at- tribute will have higher costs but also higher revenues, whereas the firm that produces no CSR attributes will have lower costs but also lower revenues. Any other resultfor instance, one firm earning a higher rate of returnwould cause the other firm to switch product strategies. Note that our conclusion is based on the as- sumption that there are no entry barriers asso- ciated with providing the social characteristic. Our conclusion that profits will be equal may explain why there is inconsistent evidence re- garding the relationship between CSR provision and firm performance. According to our argu- ment, in equilibrium there should be no relation- ship. CSR attributes are like any other attributes a firm offers. The firm chooses the level of the attribute that maximizes firm performance, given the demand for the attribute and the cost of providing the attribute, subject to the caveat that this holds true to the extent that managers are attempting to maximize shareholder wealth. From this we predict that there will generally be a neutral relationship between CSR activity and firm financial performance. 126 Academy o/ Management Review January It appears that the lack of consistency in em- pirical studies of CSR is due to a lack of theory linking CSR to market forces. Our supply and demand framework fills this void, allowing us to predict that the provision of CSR will vary across industries, products, and firms. There- fore, those empirical studies in which research- ers have not controlled for all the firm or indus- try characteristics we have identified here are probably misspecified. 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She received her Ph.D. in economics from The Ohio State University. Her research interests include market structure and firm perfor- mance, strategic human resource management, gender issues in worker mobility, and corporate social responsibility. Donald Siegel is professor of industrial economics at the Nottingham University Business School in the United Kingdom. He received his Ph.D. in business economics from Columbia University. His research interests include productivity analysis, the economic and manageri al implications of technological change, university technol- ogy transfer, science parks, and corporate social responsibility.