Risk management and corporate social responsibility

Abstract

Research Summary We introduce an innovative method of identifying the risk‐management benefit of corporate social responsibility (CSR). Option‐implied volatility captures the financial markets' expectations of a firm's future risk, so if CSR is related to risk‐management benefits, it should be related to lower implied volatility. We find that CSR is associated with low implied volatility and that CSR's insurance benefit is larger for firms that have high leverage, growth opportunities, or uncertainty. However, CSR as an insurance mechanism is less beneficial to firms that are already sound (i.e., those that have high market value and good accounting and financial performance). The results reveal the “terms” of a CSR‐as‐insurance contract, confirm that CSR creates risk‐management benefits, and suggest that financial markets price this benefit in economically significant ways.

Managerial Summary We suggest a practical technique of evaluating a firm's CSR policy. For example, a manager would simply check how a firm's implied volatility changes as its CSR policy changes. Or, the manager can compare a firm's and its comparable firms' implied volatilities to knowhow financial markets perceive the firm's CSR differently. Option implied volatilities could guide a firm to identify proper CSR‐based risk‐management policies because they have the advantage of being ex ante, real‐time, and objectively observable market‐pricing information in identifying the risk‐management benefit of CSR. Our results also illustrate how a financial expert can use the valuable insight of strategic management literature about CSR‐as‐insurance to price derivative contracts.