17/06/2008
Private CSR Activities in Oligopolistic Markets: Is There Any Room for Regulation?

Private CSR Activities in Oligopolistic Markets: Is There Any Room for Regulation?

The present paper examines the conditions under which the regulator can complement the provision of Corporate Social Responsibility (CSR) activities by private firms in an oligopolistic market.

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The large publicity on Corporate Social Responsibility (CSR hereafter) over the last few years has led many companies to account for the social consequences of their activities. As a result, CSR has emerged as a prime issue among firms, seeking ways to benefit society and at the same time, receive a benefit from this new challenge. Following the terminology of Porter & Kramer (2006), potential firms’ benefits from engaging in CSR actions may be moral obligation, sustainability, “license to operate” and reputation.2 For these benefits to be effective, firms have to convince potential consumers about their social orientation.

However, CSR effort by firms may involve cost increasing actions within their value chain, which are difficult - if not impossible - to be observed by a large scope of consumers, even after consumption. For instance, the firm may operate with respect to the interests of its stakeholders such as its employees (investing in workplace safety), suppliers (by supporting local suppliers rather than cheaper alternative sources in order to support the local economy), and the environment (by reducing emissions of pollutants). Therefore, the SR attribute of a product can be characterized as a credence good. It becomes obvious that, in the absence of a credible information disclosure system, firms may fail to persuade socially conscious consumers about their true commitment to social values, hence they will have no incentives to undertake any costly CSR activity.

Given this evidence, the following question arises: "Which are the policy instruments that a regulator can employ in order to promote firms’ engagement in CSR activities, and what are their effects on market outcomes and social welfare?". The present paper addresses and formalizes this question in an oligopolistic market for a final good, where consumers differ with respect to their valuation towards CSR activities. The basic idea behind our model is that firms strategically engage in CSR activities in order to create a "socially friendly image" for their product. We consider that consumers are homogeneous regarding the physical characteristics of the goods, but heterogeneous towards the valuation of the CSR aspects of each product. More socially conscious consumers have a higher valuation for the product of the firm that engages in CSR activities, hence, they are willing to pay a higher price for the "socially friendly" good. 

Since CSR is defined as: “firms’ commitment to social and ecological considerations, beyond the law requirements” there cannot be any “command and control” measures, such as compulsory CSR standards, in order to impose socially conscious behavior by firms. We thus consider certification as a policy instrument, i.e. the regulator sets certain social and environmental criteria that should be respected during the firm’s operational activities and then provides a certification to any firm that fulfills those criteria. Following Bottega & De Freitas (2006) we consider that certification from, either a profit-maximizing private organization or the regulator, is an effective system of information disclosure that allows consumers to distinguish the social characteristics of the products they purchase.

We investigate two possible scenarios. The first one is the "Certification by a private orga- nization", which assumes that a voluntary certificate, provided by a private profit maximizing organization, is an appropriate system of information disclosure that allows consumers to distinguish the social characteristics of the products they purchase, without the need for a policy intervention. We find that in this case, both firms’ endogenous choice will be to engage in CSR, seeking for a competitive advantage at the market competition stage via an increase of consumers’ willingness to pay for their final product. The above interaction between competing firms, increases the consumers’ surplus and total welfare comparing to the benchmark case without CSR activities.

The second scenario refers to the case in which the regulator intervenes in order to solve the ensuing “market of lemons” problem, by proposing a certain standard of CSR effort to the firms, and providing a certification to the firms that comply with the standard voluntary. Similar to the previus scenario, this certification endows consumers with credible information  about the CSR aspects of each firm’s product, otherwise unobservable. Our main finding is that the regulator will set a standard of positive CSR effort up to a level, at which both firms will have incentives to comply. This standard will be higher than the one set by the private certifier. Hence, in equilibrium, consumers surplus and total welfare increase comparing with the benchmark case without CSR activities and the "certification by a private organization" configuration.

Unlike the present paper, the vast majority of the literature on quality certification is based on the seminal paper of Gabszewich and Thise (1979) and concentrates on oligopolistic models in which firms’ products differ only in their vertical quality characteristics, which are observable by consumers. Moreover, in the aforementioned literature, the cost to increase quality is assumed to be zero, or fixed. Our duopolistic market is based on Häckner (2000) along with Garella and Petrakis (2008), therefore assumes a utility function that combines horizontal and vertical differentiation aspects of the products of the firms. The vertical differentiation represents the CSR aspects of the production process that are perceived as a quality improvement of the final product by socially conscious consumers. The present paper contributes to this branch of the literature assuming that, since CSR is considered as a credence good, there is no ex ante mechanism that can credibly inform consumers about the CSR characteristics of each product. Hence, in the absence of such an information disclosure mechanism, firms will fail to persuade consumers about their true commitment to social values, thus, a “market of lemons” problem arises.8 Additionaly we assume that engaging in CSR increases variable costs, also.

This paper also built on a recent branch of the certification literature, that examines the effects of alternative certification regimes, considering that the true quality of the final products is difficult to be observed by consumers. Bottega and De Freitas (2006) examine the welfare implications of the coexistence of public and private environmental quality certification schemes, in a monopolistic context. Our work is closer to the work of Bonroy and Constantatos (2008), in the sense that an oligopolistic market for final products is assumed, in which the strategic interactions between the competing firms are investigated. They examine the certification of credence goods’ quality, in a Bertrand competition context, focusing on the difference between mandatory and voluntary certification, where labelling does not always reveal perfect information. Conversely, in our work we examine firms’ incentives for engaging in CSR (hence providing a credence attribute of a higher quality to their final product), focusing on different sources of certification (public or private) and assuming that certification is always voluntary and reveals perfect information.

Our work also contributes to the existing literature on "strategic CSR", a term that was introduced by Baron (2001) and refers to the case where firms are assumed to be socially re- sponsible because they anticipate a benefit from such a behavior. Baron (2001, 2003) examines CSR under the prism of a strategic choice between public and private politics. His main finding is that private politics and CSR affect the strategic position of a firm in an industry under the existence of activist consumers, who can boycott firms with non-socially friendly behavior. In the same vein, Calveras et al. (2006), assuming a perfectly competitive supply of inputs, compare the effects of formal regulation to firms’ incentives to provide socially friendly goods as a response to increased activismfrom the consumers. They argue that the substitution of the formal regulation with firms CSR actions may cause inefficiency, in which non activist consumers free-ride the willingness to pay of activist consumers, because of a lower formal reg- ulation. Nevertheless, the above literature focuses on the difference between the provision of CSR by private firms and by the regulator. The main difference between the present work and the above literature is that the our paper examines the conditions under which the regulator can complement the provision of CSR by private firms, via the provision of certification to the firms that engage in CSR. 

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