Corporate Social Responsibility and Foreign
Direct Investment: Intertwined or not?
Thesis
Student number: S3250385 Name: Lisa Mulder Study Programme: MSc IFM
Field keywords: Corporate Social Responsibility, CSR, Foreign Direct Investment, FDI, Environmental and Social Governance, ESG, Merger and Acquisition, M&A
Abstract
1. Introduction
Since the nineties there has been a rise in Corporate Social Responsibility (CSR) as well as in Foreign Direct Investment (FDI). In 1990 the worldwide level of FDI was 0.908% of the world’s GDP, in 2016 this was 3.1% (The World Bank, n.d). With 5.271% this level was even higher before the crisis. Globalization came with new concerns on environmental sustainability and the interest for improvement of social structures made by the multinational companies (Gonzalez-Perez et al., 2011). According to Gonzalez-Perez et al. (2011) there are three factors that have facilitated CSR at a international level. First, the formulation of the field of Business Ethics since the 1960s by academics, policy makers and business firms. Second, the decline in influence from the state in the public sphere and the conversion of governing power to civil society. The last factor is the rapid economic globalization and its effects on societies, the environment, and business strategies.
Since the start of the new millennium, CSR became the key to achieving good governance (Lévy, 2005). In the last decade, more and more multinational companies developed CSR programs and initiatives to comply with the increasing expectations of their stakeholders (Midttun et al., 2006). Although multinational companies are willing to undertake actions in the field of CSR, they still need rules from governments. Nowadays, governments more often require companies to address CSR through guidelines and more recently with the creation of mandatory regulation.
suggest that dirty firms will migrate to developing countries with low environmental regulation (Dam and Scholtens, 2008). It thus says that countries with low CSR standards experience higher cash inflows.
The Empirical evidence on the relationship between the inflow of FDI and CSR is mixed. On the one hand it is found that countries with low CSR standards have higher inflows of CSR, while other studies found that the level of FDI inflow is higher countries with high CSR standards (Dam and Scholtens, 2008; Cole et al., 2006; Eskeland and Harrison, 2003). Therefore this paper investigates the relationship between FDI inflow and CSR. To measure the inflow of FDI in a country the net merger and acquisition (M&A) values are used and to measure CSR at a firm level the Thomson Reuters combined ESG scores are used. This study finds a positive relationship between CSR and FDI, this implicates that firms rather invest in countries that have high CSR standards.
The remaining of this paper is organized as follows. In section two the literature on this topic is discussed as well as the hypotheses of this research. Section three describes the data collection method and the empirical model of this research. Section four discusses the results. Finally, section 5 is the conclusion.
2. Literature and hypotheses
Multiple definitions are used to describe CSR. Carroll (1979) defines CSR as “ the
social responsibility of business that encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time ”. The
World Business Council for Sustainable Development (WBCSD) defines CSR as “a
of the local community and society at large ” (Holme and Watts, 2000: p8). According to Hopkins (2003) the aim of CSR should be to create higher standards of living for people within and outside the firm, while preserving the profitability of the firm. The British government defines CSR as “ the voluntary actions that business can take, over and above
compliance with minimum legal requirements, to address both its own competitive interests and interests of wider society ” (Business Innovation and Skills, 2008: p.5). Finally, the
European Commission defines CSR as “ the responsibility of enterprises for their impacts on society, with the aim of maximizing the creation of share value for all stakeholders and society at large ” (EC, 2011). All these definitions suggest that CSR is a complex and dynamic concept, that is continuously evolving. CSR refers to firms assuming and fulfilling responsibilities that extend beyond their profit-making functions, with the aim to enhance social objectives (Boulouta and Pitelis, 2011). CSR often refers to actions with respect to employees, communities, and the environment taken by the firm (Dam and Scholtens, 2008). Stakeholders demand that firms address a wider range of CSR issues (Steen Knudsen, 2017). Large multinational companies find it necessary to develop CSR strategies and initiatives to comply with the expectations of their stakeholders. The expectations of responsible behaviour by firms is also embedded in some initiatives from governments and global organizations (Midttun et al., 2006). Since 2000, more than 5000 firms subscribed to the UN Global Compact’s call to engage in self-regulation to fill the regulatory vacuum that emerged as a result of globalization (Scherer, 2011).
strategies are carried out for several reasons. Goyal (2006) suggests that foreign companies use CSR to be able to adapt to the host countries environment and to exploit opportunities. According to Javorcik (2004) foreign firms use CSR activities as a strategy to gain legitimacy and to be able to compete in the foreign market. Furthermore, Frost and Ho (2005) suggest that foreign companies carry out CSR activities in order to comply with international standards. Boulouta and Pitelis (2013) found that the national CSR performance can contribute to an improved national competitiveness. This impact is stronger for countries with a relatively low innovative standing. CSR also contribute to the competitiveness of the firm, when a firm collaborates with local communities this will improve the quality of its resources in the long term and will thus contribute to the competitiveness of the firm.
be enforced through the legal system. These criteria are not flexible and are not open to the interpretation of the firm.
According to Buhmann (2006), CSR regulation can be issued by government bodies at different levels. Local, regional, and national regulation addresses firms directly, while supranational legislation also addresses national governments that must implement the directives into national law. The OECD’s Guidelines for Multinational Enterprises are an example of recommendations made by governments and that are addressed to corporations.
According to OECD (2008), FDI is the key driver for international economic integration. FDI can provide financial stability, promote economic development, and enhance the well being of societies when the policy framework is right. “ FDI reflects the objective of establishing a lasting interest by a resident enterprise in one economy in an enterprise that is resident in an economy other than that of the direct investor ” (OECD, 2008). Where the
lasting interest refers to a long term relationship and a significant influence on the management of the firm. Any direct or indirect ownership that includes ten percent or more of the voting power in the foreign firm, is seen as evidence of foreign direct investment. There are two types of FDI: mergers and acquisitions (M&A) and greenfield investments. M&A is the most well known form of FDI. It is the purchase or sale of existing equity (OECD, 2008). Greenfield investments are less well known as M&A. It is a new investment that provides fresh capital and additional jobs, these investments are likely to add new dimensions to the economic performance of the host country and to the earnings of the foreign investor.
On the basis of the previous results this thesis tries to disentangle the contribution of CSR in generating the inflow of FDI. This study will investigate the relation between CSR and FDI by analyzing the inflow of M&A in relation to the ESG scores at a firm level. Because of ambiguity on the direction of the relation in previous studies it is expected that there is a relation. However, the direction is not specified. Therefore, the following hypotheses are formulated:
Hypothesis 1a: There is a positive relationship between the inflow of FDI and CSR. Hypothesis 1b: There is a negative relationship between the inflow of FDI and CSR.
In the case of a positive relation, firms rather invest in countries with high CSR standards and in the case of a negative relation firms rather choose for countries low CSR standards.
3. Methodology 3.1 Sample collection and data
The ESG combined scores are used as a measure for CSR. The ESG score is based on 178 firm level measures that are grouped under three pillars: Environmental, Corporate Governance and Social. The combined score is the weighted average of the ESG scores and ESG controversies score per fiscal period. The ESG controversies are based on 23 controversy topics (Thomson Reuters Eikon, 2018). The data on the ESG combined scores is collected from Thomson Reuters Eikon.
country. The sum of the sales and the purchases is divided by GDP, this way the variable is comparable across countries. The data on GDP is collected from the World Bank.
The sample consists of 10200 observations from 680 firms. All observations were made between 2003 and 2017. This time frame is used because data on ESG scores is available since 2003. The headquarters of these firms are located across 22 countries (appendix 1). Most firms are located in the US (42.9%) and the UK (11.5%). Of the 22 countries in this sample, fifteen countries have a civil law system, five countries have a common law system and two countries use a combination of both law systems.
3.2 Empirical model
The relation between ESG scores and FDI is measured using the following regression model:
, DI ESGscore CONT ROL
F c,t = α + β1 f,t+ β2 c,t+ εt (1)
where FDIc,t is the level of FDI inflow in country c as a percentage of GDP at time t;
ESGscoref,t is the Thomson Reuters ESG combined score for firm fat time t; CONTROLc,t are the control variables in country c at time t. Section 3.3 elaborates on the control variables; ε is the error term.
3.3 Control variables
score the lower the level of corruption. The second control variable is competitiveness. A highly competitive country is less attractive for foreign firms than a country where is less competition. The Global Competitiveness Index of the World Economic Forum is used to collect this data. The final control variable is the legal system that a country uses. For this control variable two dummy variables are used one for common law systems and one for civil law systems. For this variable, 1 means that a country uses that system and 0 means that a country does not use that legal system. Only one of the two dummy variables is used in the regression model, this way the dummy variable trap will not be a problem.
4. Results
4.1 Descriptive statistics
Table 1. Descriptive statistics
M&A/ GDP
ESG score Competiti veness
Corruption Civil law Common law Mean 2.43 49.68 10.22 76.08 0.45 0.56 Median 1.70 46.40 6.00 75.00 0.00 1.00 Maximum 64.36 93.95 96.00 97.00 1.00 1.00 Minimum -9.10 12.18 1.00 5.00 0.00 0.00 Std. Dev 3.65 15.83 13.39 10.55 0.49 0.49 Observations 8629 8629 8629 8629 8629 8629
Table 2. Correlation matrix
(1) (2) (3) (4) (5) M&A/GDP (1) 1.0000 - - - - ESG-score (2) 0.0528* 1.0000 - - - Corruption (3) 0.1912* 0.0056 1.0000 - - Competitiveness (4) 0.0044 0.1269* -0.6604* 1.0000 - Common law (5) 0.0064 -0.1687* -0.0219** -0.3855* 1.0000
This table provides the correlation coefficients between all variables used in this study. * and **denotes the significant level of 1% and 5%, respectively. When the correlation coefficient is significant this means that the correlation is significantly different from zero.
there is a positive relationship between the inflow of FDI and the level of CSR. Thus, firms rather move to countries with higher CSR standards than to countries with lower CSR levels.
4.2 Regression results
Table 3. OLS Regression analysis
Dependent variable: M_A_GDP Method: Panel Least Squares Sample: 2003 2007
Cross-section included: 680
Total panel (unbalanced) observations: 8629
White cross-section standard errors and covariance (d.f. corrected)
Variable (1) (2) C 1.7565*** (0.3117) -10.3049* (0.5084) ESG score 0.0130*** (0.0029) 0.0077** (0.0024) Corruption - 0.1422* (0.0053) Competitiveness - 0.0896* (0.0046) Common law - 1.0874* (0.3264) R-squared 0.0032 0.0829 Adjusted R-squared 0.0031 0.0824
Table 3 provides the regression results. The first regression (1) does not include the control variables. In this regression M&A/GDP is regressed on the independent variable ESG score. The ESG score is positively significant at a 1% level, with a coefficient of 0.0024. This supports hypothesis 1a that there is a relation between the inflow of FDI and the ESG score.
This analysis shows that the relationship between CSR and FDI is positive. When the ESG score of companies in a country go up by 1 the level of FDI will go up by 0.0073. Thus it can be said that firms rather invest in countries with high CSR standards. However, it is important to note that the adjusted R-squared is only 0.0031, which means that the ESG score can only explain 0.31% of the inflow of FDI. The CSR standard of a country thus has some effect the firm’s decision where to invest, but there are other variables that also influence this decision.
Both the control variables corruption and competitiveness are positive and significant at a one percent level. This suggests that when the level of corruption and competitiveness go up by one the level of FDI will increase by respectively 0.14 and 0.09. Firms thus rather invest in countries with a higher level of corruption and a lower level of competition.
Prior literature was not clear on the direction of the relationship between CSR and FDI. The results of this study agree with the prior literature that rejected the pollution haven hypothesis, and with the prior research that concluded that firms prefer to invest in countries that have higher CSR standards.
5. Conclusion
and more multinational companies developed CSR programs and initiatives. CSR is seen as a response to the social disparities that result from globalization. In order to maintain and attract FDI, countries want to create favorable conditions for foreign companies.
The rise in FDI and CSR, has raised the question whether there is a relation between FDI and CSR. However, the empirical evidence is mixed. Therefore, this paper analysed this relationship once more. The relationship between CSR and FDI is a positive one. This means that firms rather migrate to countries with high CSR standards than to countries where the CSR standards are lower.
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Appendix
Appendix 1. Country count
Value Count Percentage
