10/06/2007
Corporate Social Responsibility in Oligopoly

Corporate Social Responsibility in Oligopoly

This paper studies firms owners' incentives to engage in Corporate Social Responsibility (CSR) activities in an oligopolistic market, in a strategic delegation and vertical product differentiation context.

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This paper has been motivated by the ongoing debate about the market and welfare implications of Corporate Social Responsibility (CSR hereafter), that is, “a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stake- holders on voluntary basis” (European Commission, 2001). This discussion was initiated by the rapid growth of firms like ‘The Body Shop’, whose products are strongly connected to social and ecological considerations. This is a well documented case of a CSR oriented company (Klein, 1999).

The aforementioned stylized facts reveal that private firms make consider- able efforts to become, or at least to appear as, socially responsible. Given this evidence, the question that arises is the following: “Why would the owner(s) of a private firm be willing to engage in activities that promote social values?”. The present paper addresses and formalizes this question in an oligopolistic market for a final good, where CSR effort and market decisions are delegated from owners to “socially responsible”(SR hereforth) managers, while 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 characteris- tics of the goods, but heterogeneous towards the valuation of the CSR aspects of each product. More socially conscious consumers have 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. This is the rational why some consumers show strong preference for “The Body Shop” products, even though these products are more expensive than other conventional cosmetics. On the other hand, engaging in CSR activities includes costly actions by the firm in order to operate in the interests of other stakeholders such as its employees (by improving working and safety conditions related to the production process), the broader community (by ordering more expensive inputs from local suppliers, by financing local cultural events and by contributing to charities) and the environment (by introducing “green” technologies or by financing recycling programs).

Our envisaged duopolistic market follows Häckner (2000) along with Garella and Petrakis (2005), using a utility function that combines horizontal and vertical differentiation aspects of firms’ products. The vertical differentiation represents the CSR aspects of the production process that are perceived as quality improvement of the final product by socially conscious consumers. In this context, firms’ owners have two alternative strategies: either to delegate market competition decisions to a “SR” manager, or not. This reflects a common practice in the real business world, that is employing a manager with a strong background in CSR activities to undertake not only the CSR activities of the firm but also an active role in the overall decision making of the firm. Delegation of authority from owners to “SR” managers is obviously a signal about the CSR activity policy that the firm is intended to follow, which is, to a large extent, credible to the consumers. Hence it will increase consumers’ valuation for their firm’s product. 

The idea of firms’ owners employing managers with different objectives than strict profit-maximization, in order to achieve competitive advantage against their rivals, has been formalized in the theory of strategic manage- rial delegation.6 Following Miller and Pazgal (2001; 2002; 2005) we further consider that managers have a range of different stances towards CSR and this is captured by their “type”. Each manager tries to maximize his utility which is the sum of his firm’s profits plus the additional utility of engaging in CSR activities. Our main point is that each manager is committed to his own type, and by employing him, firm’s owners do commit to CSR of that type also. Therefore, delegation may be strategically used by a strict profit-maximizing owner so as to strengthen his firm’s competitive position in the market.

We examine two candidate equilibrium configurations. The first is Universal CSR in which both firms’ owners employ a SR manager (thus they engage in CSR activities) and the second is the Asymmetric case where only one owner hires a SR manager, while his rival does not hire a manager and thus does not undertake any CSR activities. Our main finding is that in equilibrium, each firm’s owner employs a SR manager, because by doing so he has the opportunity to increase his profits by obtaining competitive advantage. This interaction causes owners to strategically hire managers who undertake CSR activities.

Thus, Universal CSR is the only endogenously emerging equilibrium. Any unilateral deviation from the Universal CSR configuration, would result the deviant firm to earn lower profits than those earned previously, since in equilibrium output and profits under CSR activities are always higher compared to the benchmark case without CSR efforts. With respect to the societal ef- fects of CSR activities, the strategic behavior of owners to hire SR managers increases consumers’ surplus and total welfare too. 

Our findings contribute 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 responsible because they anticipate a benefit from such a behavior. Baron (2001, 2003) examines CSR under the prism of the 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 reg- ulation to firms incentives to provide socially friendly goods as a response to increased activism on behalf of consumers. They argue that substituting formal regulation with firms CSR actions may cause an inefficiency, in which non activist consumers free-ride the willingness to pay of activist consumers, lowering formal regulation.

McWilliams and Siegel (2001) model firms’ incentives to engage in CSR activities in oligopolistic markets with homogeneous goods. In the context of the Resource Based View of the firm, managers contact cost-benefit analyses to determine the level of firms’ resources that should be allocated to CSR activities. They argue that firms undertaking CSR activities will earn profits equal to those earned by their strictly profit-maximizing rivals. Bagnoli and Watts (2003) examine the case in which an oligopolistic firm links the provision of a public good (such as CSR activities) to the sale of their private product, in the context of unit demands and homogeneous socially responsible consumers. They find that the provision of CSR by firms is negatively related to the number of the firms in the market and positively related to the consumers’ willingness to pay for the supply of the public good. The present paper, focuses on the strategic interactions that arise between oligopolistic firms engaging in CSR activities by assuming heterogeneous consumers towards CSR and individual consumers can buy in variable quantities from both brands. 

 

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