What conditions enable firms to create economic value in the marketplace via corporate social responsibility policies? The value creation question is a time-honored debate within the CSR research community, yet remains far from being solved.
Research to date has mainly focused on the “whether” question, i.e. whether socially-responsible firms prove more profitable (Margolis and Walsh 2003; Orlitzky, Schmidt and al. 2003; Smith 2003). All these papers have in some way responding to Nobel Prize-winner Milton Friedman’s famous 1970 article stating that the sole responsibility of business was to make profits (Friedman 1970). The echo of this bitter denunciation of CSR experimentations was such that the quest for proof of responsible profitability remained the sole visible path for CSR researchers to survive the neo-classical win-lose argument (Levitt 1958; Friedman 1962; Drucker 1984; Walley and Whitehead 1994; Kapstein 2001). Consequently, at the end of the 90s, researchers started to join mainstream multinationals and CSR consultants in asserting the virtues of the triple bottom line (Elkington 1997).
Nevertheless this statement may appear counterintuitive on a number of counts (McWilliams and Siegel 2000; Vogel 2006; Davis, Whitman and al. 2008). If integrating social responsibilities carried zero costs or was even a systematically win-win mechanism of value creation, as it is purported to be in the ‘CSR industry’ and its ‘business case’ concept (Elkington 1994; Elkington 1997), the subject would long since have become hackneyed and the problems resolved by firms whose primary function is to maximize shareholder profits (Friedman 1962; Jensen and Meckling 1976; Jensen 2001).
This apparent paradox inherent to CSR is being increasingly emphasized by commentators across the board, from critical schools of thought (Gray 2001) to institutional economists (Campbell 2007) and back to sociologists researching social movements (Davis, Whitman and al. 2008).
This paper approaches the problem from a different angle, investigating the requisite conditions for profitable society-and-market-based value creation. Our arguments are not anchored on Friedman’s statement but instead on another “Nobel Prize” winner, Kenneth Arrow, whose 1973 article “Social responsibility and economic efficiency” defined CSR as the capacity of firms to rectify market failures (Arrow 1973). Arrow listed different ways “the economic activity of one firm may affect other members in the economy” (1973: 303) and concluded that “The question of social responsibility takes very different forms with regard to the different items on this varied list. It is not a uniform characteristic at all.” (1973: 304). He then called for a research that could take into account the variety of CSR issues and concluded that “some effort must be made to alter the profit maximizing behavior of firms in those cases where it is imposing costs on others which are not easily compensated through an appropriate set of price.” (1973: 307).
Starting out from this statement, we draw on externality theory to study the question of profitable social issues management. Our paper contends that this economic theory has still many insights to bring to current strategic thinking on CSR, especially the analytical grids proposed for categorizing types of market failures and thus classifying the types of externalities that companies shed onto their stakeholders.
We mirror a recent article by C. Crouch reframing the CSR dilemma in new terms: “for any firm, reducing negative externality (…) will inevitably involve actions that will incur costs yet for which there is no payment. This issue is pivotal to CSR: how can a profit-maximizing firm be expected to engage in this kind of action?” (Crouch 2006: 1534). Our article responds to this apparent contradiction by investigating the possibilities for a CSR-driven strategy of externality internalization while highlighting the market conditions governing its real-world implementation. We provide insight into how far a firm can be expected to demonstrate social responsibility through the profitable internalization of the negative externalities they previously offloaded onto stakeholders, and under what conditions. We thus intend to contribute to the Strategic CSR thread while highlighting the conditions for an alignment between social performance and competitive advantage.
Our argument begins by setting out clear conceptual points. We draw on externality theory to synthesize conceptual ties between externalities, social issues, and CSR. Then, starting out from research published by a number of commentators, we go on to show that CSR can be defined as the voluntary internalization of negative externalities. We then sharpen the definitions set by incorporating specifics on the concept of negative externality by building a framework of externalities types (I). We go on to envision the requisite condition-sets that would enable the internalization of negative externality to benefit society and generate added market revenue for the internalizer-business at the same time. We highlight the three requisite conditions pinpointed: a willingness among some stakeholders to pay, low transaction costs, and social acceptability for the transactions made. We then cross-match these three conditions to the pre-established externality categories to sketch out in detail the strategies available enabling a business to profitably internalize its negative externalities (II).