Corporate Social Responsibility as a Signaling Device for FDI

Abstract

A rise in CSR (corporate social responsibility) has accompanied the rise in FDI (foreign direct investment) going to developing countries since the nineties. CSR may be serving a signaling function when the entering firm is of unknown aggressive or accommodating type. Countries are now competing keenly to attract foreign firms, but excessive tax or excess transfers made by firms can still cause a Prisoner's Dilemma structure to the payoffs and lead to an inefficient Nash equilibrium. But CSR with a longer-term commitment allows the accommodating firm to design signals to reveal its type, so that cooperation becomes the equilibrium outcome. The game differs from standard models since signaling changes the payoffs. It implies a unique separating equilibrium where only the accommodating firms signal, but under certain parameter values a pooling equilibrium, where all firms signal, is possible. A number of results are derived including the size of CSR expenditure required as a fraction of profits. An example demonstrates the relevance of the results.

Keywords: Foreign Direct Investment, Corporate Social Responsibility, Signaling

JEL Classification: O19, F23, C72, D82