The financial gains of CSR can be high – a recent study estimated that $1 invested in 1993 in high sustainability companies would have grown to $22.6 by the end of 2010, while $1 invested in low sustainability companies would have only reached $15.4. There are many choices of CSR dimensions including the whole set of environmental, social, and governance (ESG) areas: everything from carbon footprint to human rights to workplace diversity. No company has the resources to invest equally in all CSR dimensions, and most are limited in how many dimensions they can invest. So, which should companies choose to invest in, and how should they decide?
CSR decisions and benefits
We wanted to investigate the impact of CSR dimension choices to help in the decision-making process. With the International Sustainability Standards Board (ISSB) currently establishing a global baseline of financial disclosures on sustainability that are set to be finalized in 2023, this is timely. As a result, organizations will increasingly need to report more consistently on what they are doing on the different dimensions.
Our first goal was to explore if firms are incentivized to strategically choose certain CSR dimensions. We set out to understand if the uniqueness of CSR dimension choices made a difference. We also investigated how the financial materiality of the various CSR dimensions –– that is, each dimension’s capacity to directly benefit the firm’s financials –– influenced these strategic choices. As we saw it, choices were not just about what firms invested in, but also what they did not invest in.
Our research shows a positive association between CSR uniqueness and market value.
Our study pinpointed a positive association between CSR uniqueness and market value. But we also showed that the positive market returns to CSR uniqueness decrease as the number of material CSR dimensions increases: the association was not as strong in industries where the firms had many dimensions of high materiality. This is because materiality constrains the set of valuable differentiation opportunities, since all firms in the industry are expected to perform well in high-materiality dimensions. We illustrated this mechanism in a real-life scenario by studying the case of the Deepwater Horizon disaster.
How materiality constrains differentiation choices: the BP Deepwater Horizon case
Putting our theory to the test, we examined how an exogenous event that increased the financial materiality of certain CSR dimensions affected firms’ differentiation choices. More specifically, we used the BP Deepwater Horizon disaster as an empirical context. The disaster resulted from an explosion on a drilling rig in the Gulf of Mexico in April 2010 and led to one of the worst offshore oil spills in history. A total of 11 workers died and four million barrels of oil flowed into the ocean. Communities in the Gulf Coast states of the USA were hard-hit through the shutting of fisheries and lost employment opportunities. In all, BP agreed on a $20 billion claims fund for the spill.
What we saw was that certain CSR dimensions became non-optional, or downright required, following the incident. Companies had to deliver on CSR goals relating to health and safety – a CSR dimension that became critical for oil companies. Another dimension that became a “must” was community. With BP having to pay extensive reparations to communities affected by the spill, investors wanted to see that other oil companies were on top of this dimension.
Therefore, after the Deepwater Horizon disaster, other companies competing in oil-related sectors started paying much closer attention to these dimensions that had gained materiality. As a result, these companies opted for less unique CSR strategies: the need to perform well in dimensions such as health and safety or community constrained their ability to compose differentiated positions by investing in other dimensions.
How can companies make unique CSR choices?
Companies cannot invest in every single CSR dimension equally. With limited budgets, choices must be made about the best strategic options for the organization. Our research shows that firms can benefit from choices of CSR dimensions that are unique in their sector. Mimicking what other companies do is likely to be of limited value, except for dimensions where there is no choice (e.g., dimensions of high materiality).
As seen, oil companies must now focus CSR on health and safety and community impact. Yet in areas of lower materiality there may be greater scope for differentiation. While returns will be lower on investments in health and safety, companies can still find opportunities to be unique on other dimensions, gaining greater returns there. For example, an oil company might choose to position itself as being the “most diverse” to attract better talent, differentiating from another oil firm that might perhaps focus instead on a dimension eliminating child labor in the supply chain. This can improve firm performance by focusing attention on stakeholders that other firms may be overlooking.
In emphasizing CSR strategy in dimensions that are different from the competitors, firms can attract investor attention by showing they are building long-term relationships with varied stakeholders.
Taking the example of a professional service consulting firm, diversity is very material for such companies and most have good incentives for focusing on diversity to attract top talent. Firms in this sector need to differentiate in other ways. One such approach might be positioning as the most environmentally friendly company. This could be achieved by encouraging consultants to lower their carbon footprint by using Zoom or traveling by train, or they might differentiate by stating they will not engage with companies that do not respect human rights in their supply chains. In emphasizing dimensions that are different from the competitors, firms can attract investor attention by showing they are building long-term relationships with varied stakeholders.