Financial Constraints on Corporate Goodness

Abstract:     
We model the firm's optimal choice of capital and goodness subject to financial constraints. Managers and shareholders derive benefits over profits and social responsibility. Goodness is costly and its marginal benefit is finite; as a result, less-constrained firms spend more on goodness. We verify that less-constrained firms do indeed have higher social responsibility scores. Our empirical analysis addresses identification issues that have long plagued the corporate social responsibility literature, establishing the causality of this relationship using a natural experiment. During the technology bubble, previously constrained firms experienced a temporary relaxation of their constraints and their goodness scores also temporarily increased relative to their previously unconstrained peers. This temporary convergence applies to all components of the goodness scores such as community and employee relations and environmental responsibility but not governance.

Number of Pages in PDF File: 44

Keywords: Corporate Social Responsibility, Socially Responsible Investing, Financial Constraints, Financial Slack, Externalities, Public Goods

JEL Classification: G30, H40, L20

working papers series