**2. Literature review**

States (USSIF) also showed that socially responsible investing (SRI) currently expanded to 6.57 trillion in 2014, representing 17.9% of all assets under management in the United States (USSIF, [5]). Moreover, developments such as the signature of the Principles for Responsible Investment (PRI) agreement by major market players and the increasing institutionalization of B Corp as a legal entity class in the United States (e.g., [6]) serve to showcase CSR's increas-

Despite a surging interest in CSR, a seemingly fundamental question remains unresolved does CSR create value for firm? Traditional shareholder theory suggests that CSR can create value only if it increases the firm's expected future cash flows and reduces firm risk (e.g., [2, 7, 8]). In contrast, opponents predict that CSR is inherently value destroying, driven by selfish motives (e.g., [9]). We aim to reconcile the differences in the literature by performing a

We use the international CSR data from Morgan Stanley Capital International (MSCI), which is an independent rating agency with extensive experience in analyzing firms based on a wide range of CSR dimension assessments. Firms are rated on their environmental, social, and governance (ESG) performance, by receiving numerical ESG index scores (from 1 to 100, with 100 being the highest). The MSCI's ESG ratings have been extensively used in recent studies (e.g., [7, 10]). We measure firm value by Tobin's Q. This measure is popular because it captures both the expected tangible and intangible value of the firm (e.g., [11–13]). Our final sample consists of 134,823 monthly observations of 2542 companies across 44 countries and

Our first result shows that CSR is associated with higher firm value on average, but the economic significance is small. Specifically, a one standard deviation increase in the ESG score will lead to an increase in Tobin's Q by 28 basis points. This is about 0.17% of the mean value of Tobin's Q measure at 1.63. The weak economic result prompts us to delve into three subdi-

Our second result shows that the environment score is positively and significantly related to firm value, whereas the social and governance scores are both negatively and significantly related to firm value at the 1% significance level. Although similar findings have been documented in the United States (e.g., [2, 14]), our results have expanded the research scope to 49 countries.

Given that our sample firms span across different countries, we wonder whether the CSRfirm value relation is affected by different institutional environments that these firms operate in. The literature has provided some indications on the relation between firm valuation and institutional frameworks. For example, the quality of country-level governance is shown to have a material impact on financial markets and firm-level corporate policy (e.g., [15]). Firms in countries with better investor protection have easier access to external funding (e.g., Doidge et al. [16, 17, 18]). Moreover, investors seem to take into account environmental and social risks when making investment decisions (e.g., [19, 20]). Since firms are not operating in a vacuum and are affected by the institutional framework within their home countries, same argument may apply to the CSR-firm valuation relation. Our empirical setting allows for a

mensions of the ESG scores (environmental, social, and governance scores).

deep investigation since we have firms from many different countries.

comprehensive cross-country empirical study on CSR and firm valuation relation.

ing relevance in modern business world.

76 Firm Value - Theory and Empirical Evidence

128 industries from 2009 to 2014.

#### **2.1. Existing theories on CSR-firm value relationship**

Traditionally, researchers believe that the responsibility of a business is "to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game and engages in open and free competition without deception or fraud" [25]. This implies that a firm's voluntary pursuance of CSR incurs unnecessary costs and thus reduces its financial performance, resulting in additional firm risk borne by shareholders. A firm's spending on CSR is a manifestation of managerial agency, as managers use corporate resources to confer managerial benefits instead of adding to firm value (e.g., [10, 26]).

On the other hand, Freeman's [27] seminal stakeholder theory argues that businesses do not exist as isolated units in a vacuum, and, thus, the presence and interactions with other actors<sup>1</sup> who are able to affect the firm follows that an increase in firms' CSR will result in improved stakeholder

<sup>1</sup> As Jiao [12] has noted, there has been an ongoing debate regarding an accurate depiction and definition of the term stakeholders (e.g., [25]). However, Jiao [12] concedes that studies generally consider employees, customers, suppliers, governmental bodies, competitors, and investors as notable stakeholders, among others.

relationships, eventually resulting in a better financial performance (e.g., [7, 28, 29]) and reductions in firm risk (e.g., [20]). It follows that stakeholder welfare is thus a means for firms to invest in intangible assets that would add value to the firm (e.g., [13]). Notably, Porter and Kramer [8] suggest that valuable benefits are created when firms approach societal issues from a "shared value perspective" and invent new ways of operation to address them, which could manifest through various avenues, such as a reduction in transaction costs [30] or the creation of nouveau market opportunities [31]. This notion of CSR as a strategic advantage is supported by a variety of studies (e.g., [32, 33]). For example, some scholars have drawn links between a firm's CSR and its resulting capital structure (e.g., [34]), fewer capital constraints [14], lower costs of capital (e.g., [20]), or increased employee attractiveness (e.g., Greening and Turban [35]).

systematically undervalues how a firm's CSR can influence its expected future cash flows. The opacity of results could also reflect the inherent difficulty in evaluating and quantifying CSR (e.g., [44]), such that conflicting findings across studies may arise through sampling or measurement errors (e.g., [45]) or a lack of sophistication when measuring stakeholder effects (e.g., [28, 46]). Researchers could also be operating under the assumption of a level of firm homogeneity, disregarding important granular firm-level or individual-level variations that may be mediators or moderators of CSR (e.g., [47, 48]). Last but not least, scholars suggest that this variation points toward the significant knowledge gap that still exists regarding the

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Institutional environments matter for firms because they influence the firm's costs and benefits associated with pursuing various activities (e.g., [17, 21]). In particular, the literature highlights the importance of three country-level institution frameworks, namely, financial,

First, firms are affected by the degree of financial market development. In this case, firms without access to developed financial markets may face capital constraints, such that firms may be forced to forgo worthwhile investments (e.g., [14]). Further, firms operating in markets that are financially globalized have superior access to foreign capital markets and are less dependent on the extent of financial market development in their own country. For example, Doidge et al. (2007) show that firms find it costlier to improve corporate governance in coun-

Second, firms are affected by the degree of economic development. For example, firms situated in countries lacking in critical infrastructure (i.e., security services, telecommunication, utility services, etc.) might find themselves unable to pursue beneficial opportunities due to these constraints (e.g., [19]). Another example is the effect of an underdeveloped labor market, where a labor market in short supply of skilled employees or lacking contract-enforcing mechanisms puts firms who are unable to obtain and retain a robust workforce at a competi-

Lastly, firms are affected by the degree of governmental institution development. For example, government ineffectiveness can significantly affect firms through poor regulation quality and lax contract enforcement. This may subsequently limit firm innovation, cause the exploitations of companies, or discourage firms from engaging in potentially beneficial ventures (e.g., [8, 21, 49]).

In summary, extant research to date on both the theoretical and empirical fronts has yet to converge toward a consensus on the underlying mechanisms that link CSR with its observed outcomes (e.g., [28, 29]). While theoretical links between CSR and firm value have been established, whether or not this phenomenon is reproduced in different institutional frameworks

mechanisms through which CSR affects the firm (e.g., [1]).

**2.3. The impact of country-level institutional frameworks**

economic, and governmental institutions.

tries with poorly developed financial markets.

tive disadvantage (e.g., [21, 22]).

**2.4. Hypothesis development**

remains an empirical question. Thus, we hypothesize that:

The literature has also put forward conceptual theories on how CSR can positively affect the firm. Firstly, the risk management theory proposes that the pursuance of CSR has the ability to mitigate the risk experienced by firms (e.g., [20]) by being less prone to social and regulatory changes, for example. Secondly, the shunned stock theory assumes that socially responsible investors select assets on different reasons unrelated to profit motives (i.e., a "value-driven" investor). This preferential selection then results in investors requiring a return premium due to the increased risk that nonsocially responsible firms bear (e.g., [23, 36]). This preference for socially responsible firms also manifests as an increase in investor demand, leading to a premium in firm valuation (e.g., [37]), and may also improve firm performance via avenues such as a more favorable cost of equity (e.g., [14]).

Researchers who are in favor of a neutral relationship between CSR and firm performance argue that the relationship between a firm's corporate social performance and the benefit that it imparts (e.g., financial performance and stock price) is complex in nature rather than strictly positive or negative (e.g., [38, 39]). Along this train of thought, McWilliams and Siegel [40] outline a supply and demand model of CSR, concluding that each firm will select an optimal level of CSR at each point in time determined via cost–benefit analyses.

### **2.2. Empirical evidence on CSR-firm value relationship**

Empirically, investigations into the CSR-firm value relation have resulted in a series of mixed findings. However, multiple literature reviews suggest that the CSR-firm performance relationship is generally positive in nature (e.g., [1, 28, 29]), such that higher levels of CSR can result in lower idiosyncratic risk (e.g., [41]), higher market to book ratios (e.g., [37]), and higher valuations (e.g., [13]).

The large degree of variability inherent in the literature could be symptomatic to a suite of underlying causes. For example, market actors could disagree on the inherent value of a firm's CSR and its corresponding impact (e.g., [2, 23]) or fail to fully incorporate the value of a firm's intangible assets into their valuations (e.g., [42]). Other scholars suggest that these results could be due to the time lag between the operationalization of CSR and the realization of its benefits (e.g., [43]), with Brammer and Millington [26] noting that firms with unusually poor social performance do best in the short run and unusually good social performance do best over longer time horizons, alongside Derwall et al. [36] who observed that the market systematically undervalues how a firm's CSR can influence its expected future cash flows. The opacity of results could also reflect the inherent difficulty in evaluating and quantifying CSR (e.g., [44]), such that conflicting findings across studies may arise through sampling or measurement errors (e.g., [45]) or a lack of sophistication when measuring stakeholder effects (e.g., [28, 46]). Researchers could also be operating under the assumption of a level of firm homogeneity, disregarding important granular firm-level or individual-level variations that may be mediators or moderators of CSR (e.g., [47, 48]). Last but not least, scholars suggest that this variation points toward the significant knowledge gap that still exists regarding the mechanisms through which CSR affects the firm (e.g., [1]).

### **2.3. The impact of country-level institutional frameworks**

relationships, eventually resulting in a better financial performance (e.g., [7, 28, 29]) and reductions in firm risk (e.g., [20]). It follows that stakeholder welfare is thus a means for firms to invest in intangible assets that would add value to the firm (e.g., [13]). Notably, Porter and Kramer [8] suggest that valuable benefits are created when firms approach societal issues from a "shared value perspective" and invent new ways of operation to address them, which could manifest through various avenues, such as a reduction in transaction costs [30] or the creation of nouveau market opportunities [31]. This notion of CSR as a strategic advantage is supported by a variety of studies (e.g., [32, 33]). For example, some scholars have drawn links between a firm's CSR and its resulting capital structure (e.g., [34]), fewer capital constraints [14], lower costs of capital (e.g.,

The literature has also put forward conceptual theories on how CSR can positively affect the firm. Firstly, the risk management theory proposes that the pursuance of CSR has the ability to mitigate the risk experienced by firms (e.g., [20]) by being less prone to social and regulatory changes, for example. Secondly, the shunned stock theory assumes that socially responsible investors select assets on different reasons unrelated to profit motives (i.e., a "value-driven" investor). This preferential selection then results in investors requiring a return premium due to the increased risk that nonsocially responsible firms bear (e.g., [23, 36]). This preference for socially responsible firms also manifests as an increase in investor demand, leading to a premium in firm valuation (e.g., [37]), and may also improve firm performance via avenues

Researchers who are in favor of a neutral relationship between CSR and firm performance argue that the relationship between a firm's corporate social performance and the benefit that it imparts (e.g., financial performance and stock price) is complex in nature rather than strictly positive or negative (e.g., [38, 39]). Along this train of thought, McWilliams and Siegel [40] outline a supply and demand model of CSR, concluding that each firm will select an optimal

Empirically, investigations into the CSR-firm value relation have resulted in a series of mixed findings. However, multiple literature reviews suggest that the CSR-firm performance relationship is generally positive in nature (e.g., [1, 28, 29]), such that higher levels of CSR can result in lower idiosyncratic risk (e.g., [41]), higher market to book ratios (e.g., [37]), and

The large degree of variability inherent in the literature could be symptomatic to a suite of underlying causes. For example, market actors could disagree on the inherent value of a firm's CSR and its corresponding impact (e.g., [2, 23]) or fail to fully incorporate the value of a firm's intangible assets into their valuations (e.g., [42]). Other scholars suggest that these results could be due to the time lag between the operationalization of CSR and the realization of its benefits (e.g., [43]), with Brammer and Millington [26] noting that firms with unusually poor social performance do best in the short run and unusually good social performance do best over longer time horizons, alongside Derwall et al. [36] who observed that the market

[20]), or increased employee attractiveness (e.g., Greening and Turban [35]).

level of CSR at each point in time determined via cost–benefit analyses.

**2.2. Empirical evidence on CSR-firm value relationship**

higher valuations (e.g., [13]).

78 Firm Value - Theory and Empirical Evidence

such as a more favorable cost of equity (e.g., [14]).

Institutional environments matter for firms because they influence the firm's costs and benefits associated with pursuing various activities (e.g., [17, 21]). In particular, the literature highlights the importance of three country-level institution frameworks, namely, financial, economic, and governmental institutions.

First, firms are affected by the degree of financial market development. In this case, firms without access to developed financial markets may face capital constraints, such that firms may be forced to forgo worthwhile investments (e.g., [14]). Further, firms operating in markets that are financially globalized have superior access to foreign capital markets and are less dependent on the extent of financial market development in their own country. For example, Doidge et al. (2007) show that firms find it costlier to improve corporate governance in countries with poorly developed financial markets.

Second, firms are affected by the degree of economic development. For example, firms situated in countries lacking in critical infrastructure (i.e., security services, telecommunication, utility services, etc.) might find themselves unable to pursue beneficial opportunities due to these constraints (e.g., [19]). Another example is the effect of an underdeveloped labor market, where a labor market in short supply of skilled employees or lacking contract-enforcing mechanisms puts firms who are unable to obtain and retain a robust workforce at a competitive disadvantage (e.g., [21, 22]).

Lastly, firms are affected by the degree of governmental institution development. For example, government ineffectiveness can significantly affect firms through poor regulation quality and lax contract enforcement. This may subsequently limit firm innovation, cause the exploitations of companies, or discourage firms from engaging in potentially beneficial ventures (e.g., [8, 21, 49]).

#### **2.4. Hypothesis development**

In summary, extant research to date on both the theoretical and empirical fronts has yet to converge toward a consensus on the underlying mechanisms that link CSR with its observed outcomes (e.g., [28, 29]). While theoretical links between CSR and firm value have been established, whether or not this phenomenon is reproduced in different institutional frameworks remains an empirical question. Thus, we hypothesize that:

#### *Hypothesis 1: CSR creates value for the firm.*

Scholars have also put forth evidence that CSR is heterogeneous in nature such that the inherent dimensionality of CSR has implications for value creation (e.g., [2, 13]). Thus, we hypothesize that:

To validate the significance of cross-country variation valuation exposure to CSR, we observe the results of our investigations under differing institutional and macroeconomic conditions in later tests. In this study, we use MSCI's market classification criteria, which segregate our sample of 44 countries into 23 developed markets and 21 emerging markets. **Table 1** provides

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For our analyses, we exploit a firm-level measurement of how much CSR a firm undergoes to empirically test our hypotheses. The source of this data is MSCI's ESG database, which independently rates firms on their environmental, social, and governance (ESG) performance,

**Country Freq. Firms Percentage (%) Country Freq. Firms Percentage (%)**

AUS 4416 85 4.40 BRA 3810 87 11.01 AUT 550 11 0.55 CHL 1143 21 3.30 BEL 794 14 0.79 CHN 4576 84 13.23 CAN 6077 118 6.07 COL 552 11 1.60 CHE 2109 38 2.11 CZE 204 3 0.59 DEU 3046 56 3.04 EGY 433 10 1.25 DNK 741 17 0.74 GRC 414 11 1.20 ESP 1632 32 1.62 HUN 248 4 0.72 FIN 983 17 0.98 IDN 1410 27 4.08 FRA 4705 80 4.70 IND 4011 84 11.59 GBR 6208 122 6.17 KOR 5681 104 16.42 HKG 1808 33 1.81 MAR 117 3 0.34 IRL 279 5 0.27 MEX 1461 30 4.22 ISR 733 15 0.73 MYS 2107 46 6.09 ITA 1672 36 1.67 PER 71 2 0.21 JPN 20,381 346 20.34 PHL 779 19 2.25 NLD 1324 25 1.32 POL 1049 26 3.03 NOR 468 8 0.47 RUS 1093 23 3.16 NZL 341 8 0.34 THA 1073 24 3.10 PRT 417 9 0.41 TUR 1285 25 3.71 SGP 1817 31 1.81 ZAF 3078 55 8.90

**Total 100,228 1843 100 Total 34,595 699 100**

extracted from the MSCI AC World Index between 2009 and 2014 with sufficient firm-level and CSR data.

This table displays the number of firms by country for the time period of 2009 to 2014. The sample includes all firms

the number of firms by country.

SWE 1925 32 1.93 USA 37,802 705 37.73

**Table 1.** The list of firms in each country.

*Developed markets Emerging markets*

*Hypothesis 2: The CSR-valuation relation is heterogeneous in nature and CSR dimension is dependent, such that there is significant heterogeneity in valuation effects across different groups of stakeholders.*

Khanna and Palepu [21] introduce the notion of institutional voids, which they define as the absence of institutions or intermediaries that are instrumental in supporting business operations in the context of a country's capital, labor, and product markets, its regulatory system, and its mechanisms of contract enforcement. For example, in an environment with underdeveloped financial institutions, the absence of mechanisms such as financial reportage, watchdog oversight, and analyst coverage works to increase informational asymmetry and decrease market efficiency. It follows that these financial markets will experience a decrease in investor willingness, negatively impacting capital access and forcing firms to seek alternative means (e.g., [50]). Similarly, an environment with underdeveloped economic institutions may force firms to find innovative ways to obtain skilled labor. Anecdotally, Khanna and Palepu [21] describe how Microsoft was compelled to collaborate with local firms and other stakeholders to aid the development of China's software industry and subsequently demonstrated how this has led to significant benefits for the firm. Lastly, an environment with underdeveloped governmental institutions might require firms to leverage their relationship with the government and reputation established by prior dealings, as they cannot rely on the robustness of the judicial system. Indeed, Khanna and Palepu [49] theorize that a key motivation behind a firm's engagement in CSR arises from a need to fill these institutional voids to subsequently allow their business to thrive in these markets. Thus, we hypothesize that:

*Hypothesis 3: The CSR-valuation relation is moderated by the institutional frameworks that firms operate in, such that the presence of greater (lesser) institutional voids in financial, economic, and governmental institutions will result in a greater (lesser) valuation effect.*
