Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis

Could CSR be an insurance policy during economic downturns?

In a paper published in the Journal of Finance, Karl Lins, Henri Servaes and Ane Tamayo study the impact of social capital, on firm performance during the 2008-2009 financial crisis.

The authors used regression models on 1,673 non-financial firms, controlling for various characteristics, including governance and transparency, to isolate the effect of CSR on stock returns.

Their conclusions include:

• Firms with high social capital, measured by Corporate Social Responsibility (CSR) intensity, experienced stock returns 4% to 7% higher during the 2008-2009 financial crisis compared to firms with low social capital.
• During the crisis period, high-CSR firms also demonstrated higher profitability, growth, and sales per employee relative to low-CSR firms.
• These firms were able to raise more debt, suggesting that stakeholders and investors were more willing to support firms perceived as trustworthy.
• The study found that the economic importance of social capital in explaining stock returns was at least half as large as the effect of traditional financial variables like cash holdings and leverage.
• The positive impact of CSR on firm performance was specific to the crisis period: CSR did not significantly affect returns during non-crisis periods.
• Additional tests confirmed that the observed outperformance was due to a decline in market-wide trust rather than other factors, such as credit supply shocks.
• High-CSR firms also outperformed during the Enron/Worldcom crisis, reinforcing the robustness of the results.

The 2008-2009 financial crisis period was marked by a significant erosion of public trust in corporations and financial markets, providing a natural experiment to test the value of social capital.

The study concludes that investments in social capital through CSR activities act as an insurance policy that pays off during times of low trust.

Firms can consider CSR investments as a strategic tool to build social capital and enhance stakeholder trust and cooperation, leading to better financial outcomes in adverse conditions.

The study's reliance on CSR as a proxy for social capital may however be questioned, as CSR encompasses a broad range of activities that may not uniformly contribute to social capital.