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Author: Ming Henn Chai
In recent years, corporate social responsibility has emerged as a critical element of business strategies, moving beyond mere profit maximization to include the welfare of various stakeholders such as employees, communities, and the environment. Many scholars have recognized the dual objectives of firms in aligning economic and social goals. Porter and Kramer (2002) emphasized that companies that can successfully integrate these dual objectives tend to gain a competitive advantage over their rivals. This study builds on that framework by focusing on a specific managerial characteristic known as overconfidence and its influence on CSR engagement. The paper addresses an important question: when managers exhibit overconfidence, does their engagement in CSR activities promote innovation, or does it lead to overinvestment that harms the firm’s long-term performance? Citation Chih, H-.H., Lin, Y-.E., Chang, S-.W., & Chih, H-.L. (2022). Innovation or overinvestment overconfident managers, corporate social responsibility, and operating performance. Management Review, 41(1), 127-147. https://doi.org/10.6656/MR.202201_41(1).ENG127
Paper Inquiry Taiwan Citation Index-Humanities and Social Sciences Airiti Library (English Paper) |
Preface
Overconfidence, as defined in behavioral finance, refers to a tendency of individuals to overestimate their capabilities while underestimating risks. This cognitive bias has significant implications for corporate decision-making, particularly in terms of investments. Studies such as those by Goel and Thakor (2008) and Hirshleifer, Low, and Teoh (2012) have documented that overconfident managers tend to take on high-risk investment projects, expecting greater returns, even when the likelihood of failure is significant. This overconfidence can lead to a greater focus on research and development (R&D) and higher levels of innovation. However, it can also result in excessive spending, particularly when managers fail to accurately assess the risks involved. The paper identifies two opposing outcomes of managerial overconfidence: it can lead to innovation and value creation through CSR-related initiatives, or it can manifest as overinvestment, especially in non-innovative CSR activities, such as community welfare or diversity initiatives, which might not yield immediate financial returns. The challenge, therefore, lies in distinguishing between beneficial innovation and harmful overinvestment.
Introduction to the Research
The paper titled “Innovation or Overinvestment? Overconfident Managers, Corporate Social Responsibility, and Operating Performance” investigates the relationship between overconfident managers, their engagement in corporate social responsibility (CSR), and the resultant impact on firms’ operating performance. This research explores whether overconfident managers’ involvement in CSR activities leads to innovation that benefits the company or whether it results in overinvestment that negatively affects long-term performance.
Empirical Analysis and Key Findings
To analyze these dynamics, the authors used data from U.S.-listed firms between 1993 and 2012, employing various financial databases such as CRSP, Computstat Execucomp, and the KLD CSR database. They measured managerial overconfidence using the unexercised value of stock options, as established by Malmendier and Tate, and categorized overconfident managers into low, moderate, and high degrees of overconfidence.
Despite the potential for overinvestment, the study identifies a clear path for channeling overconfidence into positive outcomes: innovation-driven CSR. Innovation-driven CSR activities are those that align a company’s social and environmental efforts with its core business strategies. For example, CSR initiatives focused on sustainable product innovation, clean energy, or environmental responsibility are often seen as essential to a company’s long-term success. These activities not only fulfill social responsibilities but also provide tangible business benefits such as product differentiation, enhanced brand reputation, and access to new markets. The research highlights that when overconfident managers focus their CSR efforts on these types of innovative activities, they are more likely to improve long-term financial performance. This aligns with the broader argument in corporate governance literature that innovation-driven CSR creates shared value of benefits to both the company and society. For instance, firms that invest in environmentally sustainable products or energy-efficient technologies can reduce operational costs, enhance their appeal to eco-conscious consumers, and mitigate regulatory risks. Tesla is a prominent example of this approach, as its focus on developing electric vehicles and advancing renewable energy technology is both an environmental responsibility and a core business strategy that has contributed to its market success.
On the flip side, the study warns that overconfident managers can drive companies toward CSR activities that do not yield financial returns, resulting in overinvestment. Non-innovative CSR activities such as broad community engagement, employee diversity initiatives, or philanthropic efforts are vital from a social perspective, but they may not directly contribute to a firm’s financial performance. Overconfident managers, who underestimate risks, may disproportionately allocate resources to these activities, expecting them to enhance the firm’s reputation without considering the long-term financial impact. For instance, a firm might invest heavily in community welfare projects or diversity programs that, while socially beneficial, do not offer immediate or clear financial benefits. Without a direct link to the company’s core business objectives, these investments can erode shareholder value over time, especially if the company faces financial constraints or operates in a highly competitive market. The study shows that while firms should not neglect these aspects of CSR, they must be strategic about where and how they invest their resources. Overconfident managers, driven by their belief in the positive impact of all CSR activities, may fail to recognize when such initiatives become a financial drain. This is especially relevant in sectors where innovation is not the primary driver of CSR. For example, industries such as construction, mining, and traditional manufacturing may struggle to see direct financial returns from certain CSR activities that are unrelated to their business. For firms in these industries, the challenge lies in balancing the social need to engage in CSR with the financial need to avoid overinvestment. If overconfident managers focus too heavily on non-innovative CSR, the firm may face diminishing returns, ultimately weakening its competitive position.
The Implications of Overinvestment
The paper makes a compelling argument about the risks associated with overinvestment in CSR. Overinvestment occurs when resources are misallocated to projects that do not generate value equivalent to the investment. In the context of CSR, this can happen when managers, driven by overconfidence, engage in activities that are socially commendable but do not align with the company’s strategic goals. Overconfident managers are likely to underestimate the costs associated with these activities and overestimate the positive impact they will have on the firm’s reputation or financial performance. This scenario is particularly dangerous in industries that operate on thin profit margins or face intense competition. Companies that overinvest in CSR may find themselves diverting resources away from critical areas such as product development, marketing, or operational efficiency. In the long run, this can erode the firm’s competitive advantage and harm shareholder value. The study’s findings are consistent with previous research on agency problems, where managers prioritize their own interests, for example, engaging in high-profile CSR activities to enhance their own reputation over the financial well-being of shareholders.
How These Findings Affect the Contemporary Business Landscape
In today’s business world, CSR is no longer an optional or peripheral concern. Consumers, investors, and regulators increasingly expect companies to operate in a socially and environmentally responsible manner. Companies that fail to meet these expectations risk losing market share, facing regulatory penalties, or damaging their reputation. As a result, CSR has become an integral part of business strategy for many firms. However, as this study highlights, not all CSR activities are created equal. While some CSR initiatives, particularly those focused on innovation and sustainability, can enhance a company’s long-term financial performance, others may lead to overinvestment and erode shareholder value. The challenge for companies is to strike the right balance between fulfilling their social responsibilities and maintaining financial discipline.
The rise of socially responsible investing (SRI) and environmental, social, and governance (ESG) criteria has further intensified the pressure on companies to engage in CSR. Many institutional investors now prioritize ESG factors when making investment decisions, and companies that fail to meet these standards may find themselves excluded from investment portfolios. This trend has led to an increase in CSR activities, but it has also raised concerns about overinvestment. The study’s findings suggest that while companies should continue to engage in CSR, they must do so strategically, focusing on initiatives that align with their business objectives and deliver both social and financial returns. For example, companies like Unilever have successfully integrated CSR into their business model, focusing on sustainability and social responsibility as core components of their strategy. By developing products that are environmentally friendly and reducing their overall carbon footprint, Unilever has not only enhanced its reputation but also generated significant financial returns. On the other hand, companies that engage in CSR without a clear strategy may find themselves overinvesting in activities that do not contribute to their long-term success.
Conclusion
The paper presents a nuanced view of the relationship between managerial overconfidence, CSR, and firm performance. It highlights both the opportunities and risks associated with CSR, particularly when overseen by overconfident managers. On the one hand, overconfident managers can drive innovation and value creation through strategic CSR initiatives that align with the company’s long-term goals. On the other hand, they are also prone to overinvestment, allocating resources to CSR activities that do not deliver financial returns. For companies in today’s business environment, where CSR is an essential component of corporate strategy, the challenge is to engage in CSR in a way that balances social responsibility with financial performance. This requires a strategic approach to CSR, where companies focus on initiatives that create shared value for both the firm and society. Overconfident managers, in particular, must be guided toward innovation-driven CSR efforts that can enhance long-term competitiveness without compromising the company’s financial health.