Baron-2009-Journal of Economics & Management Strategy

A Positive Theory of Moral Management,
Social Pressure, and Corporate Social

Performance
D AVID P. B ARON
Graduate School of Business
Stanford University
Stanford, CA 94305-5015
[email protected]
This paper provides a theory of firm behavior motivated by moral duty, self-
interest, and social pressure. A morally managed and a self-interested firm
compete in a market in which their corporate social performance (CSP) provides
product differentiation. Some citizens have altruistic or warm glow preferences
for products with associated CSP, personal giving to social causes, holding
shares in firms providing CSP, and contributing to social pressure to increase
CSP. Social pressure is delivered by an activist NGO funded by voluntary
contributions by citizens. The model characterizes an equilibrium in the product
market, the capital market, and the market for social pressure. The equilibrium
establishes a price for CSP and for activist-induced social pressure. The theory
provides predictions of the market values of firms, the prices of products, firm
profits, target selection, contributions to the activist, and the amount of CSP
supplied. For example, if citizens do not distinguish between morally motivated
CSP and CSP induced by social pressure, the activist is more likely to target
the softer, morally motivated firm. Higher quality activists are better funded,
target self-interested firms, and obtain greater corporate social performance.
Lower quality activists target morally managed firms.
1. Introduction
Corporate social performance (CSP) may be thought of as the private
provision of public goods or the private redistribution of profits to
social causes. It may be motivated by a moral duty or by self-interest
and may be voluntary or in response to social pressure. This paper
presents a positive theory of CSP based on alternative motivations by
providers and responses by the public to both CSP and its underlying
motivation. The term moral management as used here refers to the
voluntary fulfillment of a moral duty to provide the public good or
redistribute profits and constitutes corporate social responsibility. In the
model the public good takes the form of the mitigation of an externality

C 2009, The Author(s)
Journal Compilation C 2009 Wiley Periodicals, Inc.
Journal of Economics & Management Strategy, Volume 18, Number 1, Spring 2009, 743
8 Journal of Economics & Management Strategy
associated with the operations of a firm where the mitigation goes

beyond the requirements of regulation or law.
Moral management yields CSP, but CSP can also be strategic and
motivated by self-interest (Baron, 2001). As an example of strategic CSP,
a self-interested firm could market a green product because it can charge
a high price and increase its profits. Alternatively, a self-interested
firm could mitigate the externality or redistribute profits to lessen
potentially harmful social pressure. Social pressure could come from
public politics and government in the form of regulation or legislation
as in Maxwell et al. (2000), but it could also come more directly
from private politics in which private parties attempt to influence the
economic behavior of other private parties.1 The theory presented here
focuses on private politics and does not incorporate government. Free-
rider and coordination problems impede participation by citizens in
private politics, but NGOs and activist organizations help overcome
these problems. In the model social pressure is delivered by an activist
NGO funded by contributions from citizens.
CSP includes self-regulation as manifested in environmental pro-
grams to reduce toxic emissions (Lyon and Maxwell, 2004), safety and
pollution abatement in the chemical industry (King and Lenox, 2000),
sustainability as in the case of participation in Forest Stewardship Coun-
cil and Sustainable Forestry Initiative programs (Cashore et al., 2005),
and improvements in managerial practices relating to the environment,
health, and safety (Prakash and Potoski, 2006). Firms also participate in
voluntary government programs as in the case of the EPAs private-
public program to reduce carbon dioxide emissions (Delmas, 2006)
and industry-NGO voluntary organizations such as the Fair Labor
Association.
The supply of CSP ultimately depends on the preferences of citi-
zens. Citizens may view the public good or corporate redistribution as a
form of product differentiation. Citizens may also have a preference for
personal giving to social causes and holding shares in firms that provide
CSP. In addition, citizens may contribute to social pressure to encourage
the private provision of public goods and corporate redistribution.
The firms in the theory thus are embedded in three markets. They
compete in the product market, their shares are traded in the capital
market, and they are influenced by the market for social pressure.
Citizens also participate in the three markets: they are consumers in
the product market, donors in the market for social pressure though
contributions to the activist, and investors in the capital market. The
model is specified to favor tractability over generality so as to generate
specific predictions, such as identifying which firm will be targeted by
1. Baron (2001, 2003) provides an introduction to private politics.

Corporate Social Performance 9
the activist, quantifying the effect of moral management on the value

of the firm, and identifying which citizens engage in which activities
such as contributing to social pressure and holding shares in morally
managed firms.
In their consumption and investment decisions, citizens may be
able to distinguish between morally motivated CSP and CSP motivated
by self-interest or social pressure. CSP motivated by social pressure
can be identified by observing the campaigns of activists against firms.
The news media frequently covers these campaigns, and activists use
the Internet to publicize them. Moreover, in the theory presented here
firms want their motivations to be public as part of their product
differentiation strategies. From a normative perspective identifying
the motivation of a firm matters because a morally managed firm
can be expected to respond to new issues in the absence of social
pressure or profit incentives, whereas a self-interested firm acts only
when pressured or sufficiently rewarded.2 From a positive perspective
if citizens do not distinguish between moral management and CSP
induced by social pressure, morally managed firms are softer targets
than self-interested firms, social pressure is more likely to be directed
to them, and the demands made on them are higher.
Citizens may have altruistic or egoistic, or warm glow, preferences
for CSP, using the terminology of Andreoni (1990).3 Altruistic prefer-
ences pertain to the societal benefits from mitigation of the externality
and the good done by personal giving and corporate redistribution.
Egoistic preferences pertain to the private good aspect of personal
giving, holding shares in a firm providing CSP, and contributing to
social pressure. If the model were to include government provision of
public goods financed by lump-sum taxes, personal giving motivated
by altruistic preferences could be crowded out (Andreoni, 1988).4 To
focus on private rather than public politics, government provision
is not included in the model. Nevertheless, personal giving can be
crowded out by moral management. That is, the social impact of moral
management is offset if in response citizens who hold shares in the
morally managed firm personally give less to social causes.
In the theory moral management goes beyond normal business
activity, or beyond what makes business sense, and hence is costly.
The cost of moral management and CSP, however, could be offset by
2. This perspective is presented in Baron (2006) and in earlier editions of the book.
3. Becker (1974) and Andreoni (1989, 1990) consider social satisfaction and warm
glow preferences. Videras and Owen (2006) analyze the World Values Survey and find
evidence that personal contributions to environmental activities are positively correlated
with satisfaction and happiness. They conclude that some portion of the correlation is
causal; i.e., personal contributions increase satisfaction and happiness.
4. Nyborg and Rege (2003) survey alternative theories that give rise to crowding out.
benefits, five of which are incorporated in the model.5 As a result of

moral management or CSP a firm could benefit in the product market,
first, if additional consumers are attracted or, second, if consumers
willingness to pay is greater. Third, moral management or CSP could
benefit a firm if it shifts social pressure away from the firm. Fourth, if
moral management builds a favorable reputation among citizens, the
threat from social pressure could be mitigated. For example, a boycott
could be less effective or reputation damage could be less if a firm
had favorable reputational capital with citizens. Fifth, a firm could
benefit if citizens obtain satisfaction from holding its shares, and the
theory provides a market valuation for moral management and CSP.
Unfortunately, little is known empirically about whether such benefits
accrue only to morally managed firms or more broadly to firms that
generate CSP based on other motivations.
A morally managed firm and a self-interested firm compete in
a product market in which CSP provides product differentiation. The
firms have an incentive to differentiate their products to lessen the
intensity of price competition, so competition strengthens incentives
for CSP for some firms and weakens incentives for other firms. In the
theory the morally managed firm attracts a consumer clientele that has
a high valuation of CSP, and the firm sets a high price in response to
its clienteles preferences. A self-interested firm then prefers maximal
product differentiation and hence does not provide CSP. The morally
managed firm thus markets its CSP, and the self-interested firm has none
to market. The cost of moral management is mitigated by the consumer
clientele attracted, but the morally managed firm is more profitable
than the self-interested firm only if in the product market a majority
of consumers has a preference for CSP, and the majority required is
increasing in the cost of CSP.
Citizens also fund social pressure to increase the provision of the
public good. Product market competition makes the morally managed
firm a softer and more attractive target for the activist, because its
profits increase with greater product differentiation, which offsets a
portion of the cost of responding to the social pressure. If the morally
managed firm is protected against social pressure by a reputation
for responsible conduct, however, the self-interested firm may be the
more attractive target. Citizens contributions to social pressure are
greater the higher is the quality of the activist, and higher quality and
better funded activists choose tougher targetsself-interested firms
and morally managed firms with strong reputations. Lower quality
5. Other benefits of moral management and CSP might include improved employee
morale, more successful recruiting, and improved relations with government.
and poorly funded activists target softer morally managed firms with
weak reputations. Moreover, a self-interested firm has little incentive
to mitigate social pressure proactively unless doing so would shift the
activist to a different target.
Citizens can contribute personally to social causes, hold shares in
the firms, and contribute to the activist. These opportunities allow the
social performance of the morally managed firm to be priced in the
capital market, and the market value of the morally managed firm is
greater than the value of its financial return. That price also determines
the aggregate contributions to the activist.
Research on corporate social responsibility has emerged from two
directionsmanagement and public economics. From the management
perspective Vogel (2005) evaluates the arguments for and against
corporate social responsibility and reviews the evidence on its effects.
He concludes that corporate social responsibility measures have been
modest and had little effect on the performance of firms.6
Much of the management literature on corporate social respon-
sibility is normative and qualitative, and only the formal theory is
reviewed here. Baron (2001) presents a model of an activist campaign
against a target firm whose motivation may be profit maximization,
altruism, or avoiding harm, where the firm can engage in strategic
corporate social responsibility. This paper introduces competition in
which firms differentiate their products through their CSP, the activist
campaigns against a target, and citizens play an explicit role in reward-
ing firms for their CSP. Bagnoli and Watts (2003) consider strategic
corporate social responsibility that appeals to consumers with warm
glow preferences for the public good aspects of the private goods
provided by firms. They conclude that the provision of the public good
is inversely related to the competitiveness of the market, and although
the public good is undersupplied in most circumstances, they identify
circumstances in which it is oversupplied.
Baron (2007a) considers the formation of firms that can engage
in costly corporate social responsibility and shows that social en-
trepreneurs and not shareholders bear the cost, unless the corporate
social responsibility is a surprise. A social entrepreneur is willing to
bear the cost either because doing so expands the opportunity sets
of citizens in consumption-social giving space or because there is an
entrepreneurial warm glow from the firms social responsibility. A social
entrepreneur carries strategic corporate social responsibility beyond
profit and market value maximization. Baron (2007b) considers the
6. A bibliography with over 500 recent studies on corporate social responsibil-
ity is available at http://environment.yale.edu/profile/9827/workshop on research in
corporate social.
incentives of managers to provide CSP as structured by a compensation

contract chosen by shareholders in the presence of hidden information,
hidden action, and private observability of the opportunities of the firm.
Three explanations are provided for compensation systems that encom-
pass social performance. First, consumers may reward the firm for its
social expenditures; second, managers may have personal preferences
for contributing to social causes; and third, the shareholder clientele a
firm attracts may prefer social expenditures.
Kotchen (2006) considers a model in which a citizens consumption
of a private good diminishes the quantity of a public good to which the
citizen can contribute directly. He shows that in the limit as the number
of identical citizens increases individual citizens directly provide a
positive quantity of the public good and that quantity offsets the effect
of their private consumption of the public good.
Cespa and Cestone (2007) consider an incumbent manager who
can use CSP to favor the firms stakeholders over its shareholders in
exchange for their support. The stakeholders can engage in private and
public politics to protect their CSP benefits by supporting the manager
against replacement by a higher ability manager who would better serve
shareholder interests.7 The interests of the entrenched manager and the
stakeholders are thus aligned. In contrast, in this paper the interests of
the firm and the activist NGO are opposed and cannot be aligned.
Because CSP involves private redistribution and the private pro-
vision of public goods, it is an alternative to public provision. Calveras
et al. (2007) consider consumers with warm glow or altruistic pref-
erences who can mitigate a negative externality associated with their
consumption. The citizens choose under majority rule to regulate the
externality, but a majority may prefer not to do so if enough consumers
privately mitigate the externality. They argue that private politics can
crowd our public politics (regulation) when those consumers with weak
preferences for private mitigation free ride on consumers with strong
preferences. In this paper consumers also have differing preferences for
CSP and can support private regulation through social pressure applied
by an activist funded by voluntary contributions.
Graff Zivin and Small (2005) present a model in which investors
have preferences for both financial and social returns and can invest in
firms that engage in corporate social responsibility. They show that if
citizens are indifferent between personal giving to social causes and
their ownership share of corporate social expenditures, the market
7. They argue that government protection of stakeholder interests can improve the
quality of management by encouraging the replacement of entrenched managers by better
managers.
values of firms are independent of their social expenditures. Corporate

social expenditures thus perfectly crowd out personal giving.
Alternative means of providing public goods, including public,
private, and nonprofit organizations, have been studied in the public
economics literature with a focus on efficiency. Francois (2000) focuses
on a public service motivation as an explanation for government
provision. A private firm can pay its agent based on his services,
whereas a bureaucracy cannot. He identifies conditions under which
the bureaucracy is more efficient and attracts agents who have a public
service motivation and explains why low-powered incentives would be
provided.
Besley and Ghatak (2006) consider a model in which a subset
of consumers have a demand for the public good attributes of private
goods, and firms use strategic corporate social responsibility to respond
to those preferences. Firms differentiate their offerings, and Bertrand
competition leaves the surplus with consumers, but the public good
is undersupplied relative to the first-best. They also compare private
provision to public provision and provision by nonprofits and identify
a role, albeit a limited one, for private provision.
The next section provides an overview of the model, and the
following section considers competition in the product market. Section 4
considers private politics and the market for social pressure. Section 5
introduces a capital market, which provides a valuation for moral
management and CSP. Conclusions are offered in the final section.
2. Overview of the Model

2.1 Moral Management
Moral management as considered here refers to a pattern of conduct that
goes beyond normal business management and compliance with the
law. Actions taken by a firm to maximize its market value represent nor-
mal business activity and constitute shareholder responsibility. Strategic
corporate social responsibility is thus normal business activity. Similarly,
actions required by law or regulation would be taken by any firm.
Normal business activity and compliance with the law may be viewed
as CSP by some citizens but need not be morally motivated nor represent
corporate social responsibility. Vogel views CSP as requiring actions
beyond normal business activity and compliance with government
requirements, but he does not distinguish between morally motivated
actions and actions motivated by self-interest or social pressure. In
the terminology used in this paper, he addresses CSP. Heal (2005)
focuses on situations in which private and social costs diverge and
views corporate social responsibility as taking actions which reduce

the extent of externalized costs or avoid distributional conflicts. This
definition similarly corresponds to CSP.
The normative framework underlying moral management may
be thought of as utilitarianism, where the moral issues pertain to
corporate redistribution and an externality associated with production.
The externality could be associated with climate change, voluntary
information disclosure, or requirements for suppliers to meet sustain-
ability standards. Corporate redistribution could include paying a living
wage, improving working conditions in suppliers plants in developing
countries, and refraining from taking advantage of the poorly educated,
unsuspecting, or elderly. The externality and the redistribution are
assumed not to be optimally addressed by the government, so there
is a government failure and a social welfare improvement that can be
made. That is, economic incentives are not in place to lead firms to
internalize the externality or redistribute a portion of their profits. For
example, the firms may not be subject to liability for carbon dioxide
emissions or for practices of suppliers that result in deforestation in a
developing country and are not obligated to pay higher wages than
required by law or provide higher levels of safety for workers than
required by regulation or induced by the liability system.
In addition to identifying a social welfare improvement, a nor-
mative framework must identify which parties have the duty or
responsibility to respond to it. Coase (1960) observed that externalities
are reciprocal, so there is more than one way to address an externality.
If bargaining were costless, the assignment of duty or responsibility
would be a distributive rather than an efficiency matter. The situation
considered here is one in which there are substantial transactions
costs associated with Coasean bargaining over the externality, as in
the examples above. From a utilitarian perspective when transactions
costs are high, the duty should be assigned to the party that can
most efficiently mitigate the externality. Calabresi and Melamed (1972)
provide a test to determine which party should be assigned the duty,
and here firms are assumed to be the best-placed party. The morally
managed firm is assumed to fulfill voluntarily this duty, whereas the
self-interested firm mitigates the externality only in response to social
pressure or profit incentives.8 In addition, the morally managed firm
may have a moral duty to redistribute a portion of its profits. Once
the morally managed firm has fulfilled its moral duty, it responds to
economic incentives to maximize its market value.
8. Brekke et al. (2003) provide a theory in which individuals trade off against economic
incentives a disutility for failing to fulfill a moral obligation.
The morally managed firm is assumed to have a reputation,

developed through a pattern of conduct, that can be recognized by
the public and commits the firm to moral management. The firm could,
for example, make a public statement about its duty, fulfill that duty
through its actions, and agree to an independent social audit.
The maintained hypothesis is that moral management is not
coincident with market value maximization because of the costs of
addressing the externality and of corporate redistribution. That is,
citizens do not reward the firm sufficiently in the product market or the
capital market to offset fully the costs of moral management. Mitigating
the externality to the extent of the moral duty thus does not make
business sense. If it made business sense, every firm would fulfill the
moral duty and there would be nothing to explain.
2.2 Social Pressure

Social pressure is a manifestation of the preferences of society for social
performance by firms. Assessing societys preferences is difficult at
best, because expressed preferences for responsible conduct may not be
consistent with the actions of citizens. Responses to polls are cheap talk
and are seldom put to the test of whether citizens would act in accord
with their responses. In particular, poll questions about protecting the
environment, improving human rights, and redistribution may not
identify the costs associated with those actions, and if they do, the
poll respondent does not face the actual test of paying that cost.
The model grounds social pressure in the preferences of citizens by
requiring citizens to back their preferences with financial contributions.
Those contributions support NGOs that work for social causes through
private politics. The NGOs are thus an instrument of their supporters,
and they serve their supporters by directing social pressure to economic
agents, which in the model are firms. The focus is on activist NGOs that
select a target firm and campaign against it with a threat of harm if the
target does not concede to their demands.
The social pressure manifested through activists is assumed to
be credible because it is backed by the threat of harm and funded by
contributions from citizens. Harm could take many forms ranging from
decreasing product demand as in a boycott, impairing employee morale,
deterring potential partners, and affecting the ability to hire or the wages
that must be paid. In the theory the threat of harm can induce increased
CSP by the target.
Social pressure thus flows from citizens preferences, but citizens
could also reward firms for their conduct. In the model rewards flow
from altruism and the warm glow a citizen may experience from
purchasing products of, or holding shares in, a firm whose conduct

is in accord with their preferences. Although not incorporated in the
model, the reward in the capital markets may be thought of as flowing
through socially responsible mutual funds that hold shares in firms
whose conduct meets certain criteria. The Social Investment Forum
reported that the total net assets of socially screened mutual funds
increased from $12 billion in 1995 to $179 billion in 2005.
2.3 Players
The players are a continuum of citizens, two firms, and an activist.
Citizens make investment and consumption decisions and also may
personally give to social causes and fund social pressure by contributing
to the activist. Citizens differ in their preferences for the firms responses
to the externality and corporate redistribution.
The two firms are identical except that one is morally motivated
and the other self-interested. The morally managed firm mitigates the
externality ex ante to fulfill a moral duty. Once the morally managed
firm has satisfied its moral duty, it maximizes its market value. The
self-interested firm may also mitigate the externality but only if doing
so increases its market value. If a firm is targeted by the activist, it
may mitigate the externality ex post because of the social pressure
from private politics. The firms can also improve their reputation by
mitigating the externality ex ante, and that reputation may be stronger
if citizens distinguish between a moral motivation and a self-interested
motivation to lessen pressure from private politics.
The activist has preferences for the extent to which the externality
is addressed, and those preferences are assumed to extend beyond
efficiency and include redistribution that favors citizens over firms.
That is, the activist prefers greater mitigation of the externality than the
morally required response because, for example, that would mitigate
some of the remaining harm borne by citizens from the externality.
The activist requires funding for its campaign, and the contributions
received from citizens determine the amount of social pressure that can
be imposed on a target.
2.4 Timing
In stage 1, firms decide whether to mitigate the externality and redis-
tribute profits. In stage 2, citizens allocate their endowments among
savings, shares of the firms, personal giving to social causes, and a
contribution to the activist. In stage 3, the activist chooses a target firm
and launches a campaign against the target. The target can fight the
campaign or concede to the activists demand. In stage 4, the firms

choose prices for their products, and in stage 5 consumers allocate their
financial returns to consumption. The notation is introduced as each
stage of the game is introduced and analyzed. Information is complete
and perfect, and a subgame perfect Nash equilibrium is sought.
3. The Product Market

The product market includes a morally managed firm, denoted by m,
and a self-interested firm, denoted by s. The appropriate model of
competition in the product market depends on the products and the
market structure. To focus on CSP, both firms are assumed to produce
identical products that can be vertically differentiated by their CSP.9
That is, citizens preferences for a firms product may depend on its CSP,
such as the conditions under which the product is made, its responses
to global warming, and its redistribution.10
To simplify the notation and exposition, citizen consumers are
assumed to respond only to mitigation of the externality. Consumers
preferences for CSP may be based on altruistic or warm glow preferences
and are manifested in a higher willingness to pay for the product. Let
consumer preferences be indexed by [0, ], which represents the
surplus or value a consumer receives from the perceived benefits B from
the CSP of the firm from which he purchases.
A consumer has a demand for one unit and chooses between the
two products to maximize her surplus v(, I ) given by
v(, I ) = v o + I ( Bs ps ) + (1 I )( Bm pm ), (1)
where v denotes the utility from consumption of the product, pi denotes
o
the price of the product of firm i, Bi is the consumers perceived

benefits from the CSP of firm i, and I {0, 1} is an indicator variable
that identifies the choice of the consumer. A consumer will purchase a
product if v(, I ) is nonnegative.11
Because moral management does not make business sense, the
morally managed firm will have the higher CSP, so Bm > Bs and hence
pm > ps . The consumer indifferent between the two products is denoted
by and identified by
pm ps
= .
Bm Bs
9. Fisman et al. (2005) and Navarro (1988) consider CSP as advertising.
10. Feddersen and Gilligan (2001) refer to such a product as a credence good.
11. See Tirole (1988, pp. 2968) and Shaked and Sutton (1982) for a discussion
of vertical differentiation models. Shaked and Sutton find that unless the support of
consumer types is large, only two firms have positive market shares in equilibrium.
Consumers with a high valuation ( > ) prefer the product of the

morally managed firm, and those with a low valuation ( < ) prefer
the product of the self-interested firm.
The operating profits i , i = s, m, of the two firms excluding the
sunk cost of CSP are given by

s = ( ps c s ) dH()
0
and

m = ( pm c m ) dH(),

where c i , i = m, s, is a constant marginal cost and H() is the distri-

bution function of consumer preferences for CSP, where the number
of consumers is normalized to 1. The marginal cost c m of the morally
managed firm is assumed to be at least as great as c s , because moral
management fulfills a duty beyond profit maximization and that could
entail higher marginal costs.
The firms choose prices to maximize their profits, and to obtain a
closed-form characterization of the equilibrium, let H() be

H() = + (1 ) , [0, ],
[0, 1).

This specification represents a mass of consumers who do not value
CSP and 1 who value it to varying degrees. To simplify the analysis,
assume that v o > 13 (2c s + c m + (B
m Bs )) so that in equilibrium all
consumers purchase from one of the firms, and assume that c m c s <
m Bs ) so that some consumers purchase from both firms.
2(B
The equilibrium prices pi , i = s, m, are
1
ps = [2c s + c m + (B
m Bs )] (2)
3
1
pm = [c s + 2c m + 2(B
m Bs )], (3)
3
and
1 cm cs
= + .
3 Bm Bs
Both prices are increasing in Bm and decreasing in Bs . As the product
differentiation Bm Bs decreases, price competition intensifies, and in
the limit as Bm Bs , the firms engage in Bertrand competition.
The difference in the prices is
1
pm ps = [c m c s + (B
m Bs )]
3
= ps c s 0,
so the self-interested firm sets the lower price. The morally managed
firm takes advantage of consumers preferences for CSP by charging a
higher price.
The operating profits i , i = s, m, of the firms are
(c c s + (B
m Bs ))2
s = m Bs )) + (1 ) m
(c m c s + (B (4)
3 9(B m Bs )
and
(c s c m + 2(B
m Bs ))2
m = (1 ) . (5)
9(B
m Bs )
The prices and profits of both firms are strictly increasing in , so the
stronger are consumers preferences for CSP the higher are prices and
profits. CSP allows the firms to differentiate their products, which weak-
ens the intensity of price competition, allowing the morally managed
firm to obtain a price premium for its product. The self-interested firm
then can raise its price. The product differentiation thus enables both
firms to increase their prices and profits.12
The operating profits i in (4) and (5) are convex in own perceived
benefits Bi , and m is strictly increasing in Bm and s is strictly
decreasing in Bs unless c m c s is large.13 The CSP of the morally
managed firm is fixed by its moral duty, and the self-interested firm
has an incentive to maximally differentiate its CSP and hence supplies
no CSP. The morally managed firm thus markets its CSP, and the self-
interested firm has no CSP to market.14 The benefits Bm are determined
by the moral duty, and the morally managed firm has no incentive
to do more, because moral management requires a response to the
externality that goes beyond that which makes business sense. This is
formalized in Section 5. The self-interested firm or the morally managed
firm could mitigate the externality further as a result of social pressure,
as considered in Section 4.
12. In a study of firms producing experience and credence goods, Siegel and Vitaliano
(2007) found that some provided CSP and others did not, and the firms in both sets earned
higher profits than if they switched to the other group. This is consistent with the product
differentiation identified here.
13. A sufficient condition is (B
m Bs ) > c m c s .
14. If a third, self-interested firm were in the market, one of the two self-interested
firms could have a profit incentive to choose a level of CSP between 0 and that of the
morally managed firm.
The difference in the profits of the two firms depends on the

proportion of consumers with preferences for CSP, the strength of their
preferences, the extent of the product differentiation, and the differences
in the costs of the firms. The profits of the self-interested firm are higher
than those of the morally motivated firm if (B m Bs ) < 2(c m c s ) and
lower if (Bm Bs ) > 2(c m c s ) and

2(c s c m ) + (B
m Bs )
> , (6)
c s c m + 2(B
m Bs )
where = 12 if c m = c s . The morally managed firm thus has higher profits

than the self-interested firm when both have the same marginal cost only
if a majority of consumers value CSP. If it has higher marginal costs, a
larger share of consumers must value CSP for the morally managed
firm to have higher profits; that is, in (6) is strictly decreasing in c m .
Consequently, for the morally managed firm to be the more profitable
firm a majority of consumers must be willing to pay for CSP and that
majority must be larger the more costly is CSP.
The principal results of this section are summarized in the follow-
ing proposition.
Proposition 1: If products are differentiated by CSP, the morally managed

firm sets the higher price and serves a clientele of citizen consumers who have
a high valuation for CSP, whereas the self-interested firm sets a lower price
and serves a clientele with a low valuation for CSP. Product differentiation is
maximal. The prices and profits of both firms are increasing in the strength of
consumer preferences for CSP. The morally managed firm is the more profitable
only if the difference in marginal cost is less than half the product differentiation
price premium and then only if a majority of consumers has a preference for
CSP. The majority required is increasing in the marginal cost of the morally
managed firm.
4. The Market for Social Pressure

4.1 The Activist and Its Target
Social pressure is assumed to come not from government but from
citizens, and their instrument is an activist NGO. The activist demands
that its target mitigate the externality and threatens the target with
harm. This confrontation represents private politics; that is, efforts by
private parties to affect the behavior of other private parties.
The activist is assumed to be an imperfect agent of citizens and
has preferences for mitigating the externality beyond that assumed by
the morally managed firm. Those preferences may correspond to a
desire to punish its target, compensate citizens for any remaining harm
associated with the externality, or redistribute from the firms owners
to citizens. The activists preferences are assumed to be represented by
a utility function UA = x, where x is the additional mitigation of the
externality by the target as a result of the campaign. The activist is
rational and takes what it can get, which depends on the strength of its
threat and the actions of the target.
The activist chooses a campaign to which it is assumed to be able
to commit credibly. For example, the activist may have an unmodeled
reputation for following through on its threats. A campaign is composed
of the selection of a target firm, a demand xid on firm i, and a credible
promise of harm h(A) if the firm does not concede to the demand, where
A denotes the funds available to the activist to implement the campaign.
These funds are contributed by citizens and thus do not represent a
cost for the activist. The harm is assumed to be strictly increasing in
A with h(0) = 0. The harm, for example, could come from a boycott
organized by the activist, public criticism, disruption of operations, or
reputation damage. The demand by the activist is to be interpreted as
additional mitigation of the externality, so if firm i took ex ante measures
xi and subsequently conceded to the activists demand, its response to
the externality is xi + xid . Initially, xs = 0 and xm = x , where x is the
mitigation undertaken ex ante by the morally managed firm.
Given a campaign, the target can fight or concede. If it concedes,
the target implements the demand xid . If it fights, which has a lump-sum
cost y, the campaign is assumed to succeed with probability q [0, 1).15
The probability q can be interpreted as the quality of the activist; that
is, a higher quality activist is more likely to have a successful campaign.
If the campaign fails, the target incurs no harm; that is, the
harm is neutralized or does not materialize. If the campaign succeeds,
the target bears harm i h(A), where i [0, 1], i = m, s, reflects
the protection provided by citizens attitudes toward the firm. The
parameter i could, for example, reflect the reputation of the target
for moral management or CSP, where that reputation is earned by its
ex ante mitigation of the externality. A lower i represents a stronger
reputation; that is, a reputation that is more difficult for the activist to
harm. More specifically, let i = (xi ) be strictly decreasing in the ex ante
mitigation xi of the externality with (0) = 1. That is, a target that does
not mitigate the externality ex ante bears the full brunt of the campaign,
whereas a target that mitigates the externality ex ante may bear less of
15. Baron and Diermeier (2007) present a model in which the probability of a successful
campaign is endogenous to the expenditure of the activist on the campaign and the targets
expenditure to counter the campaign. Baron (2001) and Innes (2006) also provide models
of campaigns focusing on boycotts.
the brunt, because citizen-consumers have a more favorable view of it.

Thus, s = 1 and m = (x ).
If the target firm concedes to the activist demand, citizen-
consumers may give it credit in the product market for its CSP. Let
[0, 1] denote the credit citizen-consumers give to the target for
its social pressure-induced response to the externality. To simplify the
analysis, the perceived benefits in the product market from CSP for
the morally managed firm are specified as Bm (x + xm ) and for the
self-interested firm as Bs ( xs ), where xi , i = m, s, denotes the ex post
mitigation of the externality as a result of being targeted.
The activist is assumed to expend A at the time it announces
the campaign and makes its demand on the firm. The activist must
hire personnel to manage the campaign, take out advertisements to
announce the campaign, coordinate the delivery of pressure, create an
Internet site, launch the campaign, and so on. It is the commitment of A
that makes the campaign credible. This means that A is sunk when the
firm makes its response to the demand of the activist.16 The activist is
assumed to have a limited capacity to conduct campaigns and thus can
target only one of the two firms.
4.2 The Campaign

Given a campaign (m, xdm , h(A)) targeting the morally managed firm, if
the firm fights its profit if the campaign succeeds is m (x + xdm )
(x + xdm ), whereas if it fails its profit is m (x ) x m h(A),
where is the constant marginal cost of mitigating the externality. It
is always in the interest of the activist to make a demand such that
the firm concedes, because the cost of fighting can be avoided through
immediate concession. The firm concedes immediately if and only if the
demand xdm satisfies

m x + xmd x + xmd m (x ) x q m h(A) y, (7)
where m () is the operating profit in (5) expressed as a function of the
arguments of Bi (). The analogous condition when the self-interested
firm is targeted is

s xsd xsd s (0) q s h(A)) y. (8)
The maximum demands xid of the activist are defined by (7) and (8) as
equalities.
16. The alternative assumption is that some portion of A is expended only if the target
decides to fight the campaign. This would leave the issue of what the activist does with
the funds if the firm conceded to the activists demand.
To obtain closed-form expressions for the demands, let c m = c s and

Bm () = (x + xdm ) and Bs = xsd , 0. The demand from (7) then is
q m h(A) + y
xmd = , (9)
(1 ) 49

where (1 ) 49 > 0 because mitigating the externality beyond

x does not make business sense. From (8) the demand on the self-
interested firm is
q s h(A) + y
xsd = . (10)
+ (1 + 2) 9

The demands in (9) and (10) are strictly increasing in q and h(A),
so social pressure is increasing in the quality of the activist and the
contributions by citizens. Similarly, social pressure results in higher
demands when firms have higher costs y of countering the pressure or
have weaker reputations. The demands are decreasing in , because a
smaller proportion of citizens value CSP. The more costly (higher ) is
mitigation of the externality the stronger is the incentive of the target to
resist social pressure.
The demand xdm in (9) is strictly decreasing and xsd in (10) is
strictly increasing in ,
reflecting the different incentives for prod-
uct differentiation in the product market. That is, targeting the self-
interested firm decreases product differentiation, and hence decreases
the operating profit s , so the demand is decreasing in .
In contrast,
targeting the morally managed firm increases product differentiation
and the operating profit m . Because the operating profit of the morally
managed firm increases when it is targeted, part of the cost xdm is offset,
which allows the activist to make a higher demand. In this sense, the
morally managed firm is a softer target.
4.3 Target Selection

Given contributions A the activist targets the firm that will concede
to the higher demand. Comparing (9) and (10) the activist targets the
morally managed firm rather than the self-interested firm if and only
if17
17. The cutpoint m in (11) is strictly increasing in s , q, , , and h(A) and strictly
decreasing in , , , and y. The cutpoint is decreasing in the parameters reflecting the
profitability of the morally managed firm, because the operating profit is increasing in ,
, and when the morally managed firm is targeted.
s ( (1 ) 49 )
(52)
y
m m 9
< s .
+ (1 + 2) q h(A)( + (1 + 2)

9 9
)
(11)
The cutpoint m is less than s for the self-interested firm when

> 0, so to avoid being targeted, the morally managed firm must
have a reputation advantage accorded by citizens that reduces the harm
from an activist campaign. That is, the softer, morally managed firm is
targeted unless it has a sufficiently strong reputation.
The morally managed firm can be a more attractive target because
the cost of mitigating the externality is partially offset by the increased
profit from greater product differentiation when > 0. Morally man-
aged firms thus can be more attractive targets for activists and hence
face social pressure. Argenti (2004, pp. 110111) explained the decision
by the activist organization Global Exchange to target Starbucks to sell
Fair Trade Coffee: truly socially responsible companies are actually
more likely to be attacked by activist NGOs than those that are
not , . . . Our interviews with Global Exchange suggested that Starbucks
was a better target for the fair trade issue because of its emphasis on
social responsibility, as opposed to a larger company without a socially
responsible bent.
The selection of a target depends importantly on whether citizen-
consumers give credit in the product market for activist-induced CSP.
That is, to what extent do citizen-consumers distinguish between moral
management and CSP motivated by social pressure? Suppose they
distinguish and give credit only for (ex ante) moral management. Then,
for = 0, (11) reduces to m s . Consequently, if citizen-consumers
distinguish in the product market between activist-induced CSP and
moral management, social pressure is directed to the self-interested firm
if and only if it has a weaker reputation. The bound m is decreasing in
, so the more credit citizen-consumers give for an ex post concession to
an activist campaign, the more likely is the morally managed firm to be
targeted. That is, if citizens do not distinguish between the motivations
for CSP, morally managed firms are softer, more attractive targets and
hence are more likely to be the target of social pressure. Consequently,
the challenge for responsible citizens is to distinguish between ex ante
moral management and ex post responses to social pressure.
When consumers reward ( > 0) the firm in the product market
for its ex post response to social pressure, the targeting choice by the
activist affects not only the target but the other firm as well. Targeting
the morally managed firm increases the operating profit of the self-
interested firm because of greater product differentiation, which allows
the self-interested firm to set a price in (2) that is higher than it could
otherwise set. In contrast, targeting the self-interested firm decreases
the operating profit of the morally managed firm because product
differentiation decreases.
The condition in (11) can be used to identify the industrial
organization of activism; that is, where social pressure will be directed
and by which activists. Consider a collection of morally motivated firms
that vary in their reputations m and an array of activists differentiated
by their quality q. Because m is strictly increasing in q and A, higher
quality and better funded activists target self-interested firms with
higher probability, and lower quality and poorly funded activists target
morally managed firms with higher probability. Lower quality activists
thus are more likely to target the softer morally managed firms, and
higher quality activists target the harder self-interested firms. Activist
quality is thus positively correlated with the hardness of their targets.
The stronger (lower m ) is the reputation of a morally managed firm the
more likely it is to be targeted by a higher quality activist, and weaker
reputation morally managed firms are more likely to be targeted by
low quality activists. This is also consistent with higher quality activists
targeting tougher firms than lower quality activists target.
ing proposition.
Proposition 2: The demands made by the activist are strictly increasing
in the stake of the target, the quality of the activist, and the resources A available
to the activist and are strictly decreasing in the strength of the reputation of
the target. Morally managed firms are softer targets ( m < s ) because their
operating profit is increasing whereas the operating profit of self-interested
firms is decreasing in the demand of the activist. The more credit (higher )
citizens give for CSP undertaken in response to an activist campaign, the higher
is the demand made on the morally managed firm and the lower is the demand
made on the self-interested firm. Higher quality activists are more likely to
target self-interested than morally managed firms, and morally managed firms
with a strong reputation (low m ) are more likely to be targeted by high quality
than low quality activists. That is, higher quality and better funded activists
target tougher firms, and lower quality activists target softer firms.
5. The Capital Market: Valuing Moral Management

5.1 The Citizen-Investors Problem
This section introduces a capital market in which citizens social
preferences yield a price for moral management and CSP.18 Even though
18. Graff Zivin and Small introduced the basic model of a capital market used here.
ex ante mitigation of the externality and corporate redistribution of

profits to social causes are untraded goods, they can be priced in the
capital markets because the financial and social returns of the morally
managed firm are spanned by a portfolio of savings and personal giving
to social causes. In a similar manner, social pressure can be priced in the
capital market. To simplify the notation, the contribution of a portion of
profits to social causes will be suppressed, but its effect on the market
value of the firm will be noted.
In the second stage of the model a citizen allocates her endowment
among savings with a return of 1, a share m of the morally managed
firm, a share s of the self-interested firm, personal giving g to social
causes, and a contribution a to the activist. Personal giving represents
direct redistribution, volunteering, expenditures of costly effort for
social causes, gifts to charities and providers of social services, and so
forth. Independent Sector reported that in 2005 1.5 million organizations
received $260.3 billion in contributions, and it estimated that the dollar
value of volunteer time was an additional $280 billion.19 The citizens
budget constraint is
s s + m m + g + a w + so s + m
o
m , (12)
where m is the market value of the morally managed firm, s is the
market value of the self-interested firm, w is initial wealth, (os , om )
are the initial shares held by the citizen, and savings is the difference
between the right and left sides of (12).20 Although only two firms are
included in the model, they are to be understood as representative of
many firms, each of which is small relative to the capital market.
The financial return on the morally managed firm is m x and
its social return is x .21 In addition, let J = 1 indicate that the morally
managed firm is (anticiapted to be) targeted by the activist and J = 0
denote that the self-interested firm is targeted, where the target incurs
a cost xid from (9) and (10). The financial return R of a citizen is thus

R = s s (1 J )xsd s + m m x + J xmd m
g a + w + so s + m
o
m ,
where the dependence of targeting in s and m is not separately
denoted. In the final stage a citizen receives her financial return R and
allocates it to a composite consumption good and one unit of the product
19. www.independentsector.org.
20. Baron (2007a) considers firms established by entrepreneurs, who hold the initial
shares.
21. If the firm redistributes a portion m , [0, 1], of its operating profit to social

causes, its social return is m + x .
produced by one of the two firms. Consumption k of the composite good

thus is R less the price p s or p m from (2) and (3), respectively.
Social preferences could be due to altruism or a warm glow
from the actions themselves: personal giving to social causes, holding
shares in the morally managed firm, and contributing to the activist.
The social satisfaction from holding shares in morally managed firms
may be reflected in the growth of socially responsible mutual funds.
Citizens differ in their social preferences for direct (e.g., their personal
giving to social causes) and indirect (e.g., holding shares in the morally
managed firm and contributing to the activist) provision of social
goods.22 Because providing social satisfaction through holding shares
in the morally managed firm and contributing to the activist is less
personal and less direct than through personal giving, those actions
may be imperfect substitutes for personal giving g. To represent this,
let [0, 1], with distribution function F ( ) across citizens, denote
the social satisfaction from shareholdings and contributions relative to
personal giving. If = 1, shareholdings and contributions to the activist
are perfect substitutes for personal giving, and if = 0, there is no social
satisfaction from holding shares and contributing to the activist.
Citizens are assumed not to receive any social satisfaction through
share ownership from the ex post mitigation of the externality due to
social pressure from the activist. That is, the social satisfaction from
the ex post mitigation is credited to the activist rather than to a firm.
The satisfaction from contributing a to the activist is specified as Aa x d ,
where A is the aggregate giving to the activist and x d = Jxdm + (1 J )
xsd denotes the outcome of social pressure.23 Social satisfaction S thus is
a
S = g + m x + x d , (13)
A
where the social satisfaction from personal giving is normalized to 1.

Note that in this specification the citizen views moral management and
the accomplishments of the activist as imperfect substitutes for personal
giving when < 1, since they are less personal. That is, another party, a
firm or the activist, acts as an intermediary, and hence the effect of the
citizen is less direct than with personal giving.
22. A fraction of citizens could have no preference for social goods and be concerned
only with financial returns. The market value of the morally managed firm will be
independent of the preferences of those citizens provided that the 1 fraction of
citizens with social preferences have sufficient funds to hold the shares of the firm. This
will be assumed to be the case.

23. Citizens are assumed to have rational expectations about A .
5.2 The Capital Market Equilibrium

To provide tractability, the preferences of a citizen are assumed to be
represented by a quasi-linear utility function
u = k + v(( ), I(( ))) + S ,
where (0, 1), > 0, v(( ), I(( ))) is given in (1) where I(( ))
is the optimal product choice, and ( ) relates citizens product market
preferences to their type .24 Substituting for k and R yields

u = s s (1 J )xsd s + m m x + J xmd m
+w + so s + m
o
m g a + v((
), I(( ))) + S ,
where v(( ), I ) is the net surplus from consumption of the product.
A citizen chooses (a , g, m , s ) to maximize u, and an equilibrium is
assumed to exist.
The necessary conditions for the optimal allocation (a ( ), g ( ),
s ( ), m ( )) for a citizen of type are
u xd u
= 1 + S1 0; a ( ) = 0, (14)
a A a
u u
= 1 + S1 0; g ( ) = 0, (15)
g g
u u
= m x + J xmd m + S1 x 0; ( ) = 0,
m m m
(16)
u u
= s (1 J )xsd s 0; ( ) = 0, (17)
s s s
where m and s are the equilibrium market values of the firms.
Let denote the citizen-investor who is indifferent between
personal giving and holding shares in the morally managed firm. Then,
(15) and (16) hold as equalities at = , which is the marginal rate of
substitution of social return for financial return of the indifferent citizen-
investor as determined in the capital market equilibrium. A closed-
form characterization of is presented in the Appendix along with the
market clearing conditions for shareholdings m ( ) and contributions
24. The distribution function H() in Section 3 is to be understood as the uncon-

ditional distribution defined by H() = 0 ( 0 H( | ) d F ( )) d ,
where H( | ) is the
conditional distribution of consistent with ( ). Because preferences are specified as
additively separable the product market preferences do not affect the capital market
equilibrium.
a ( ). The equilibrium is characterized in the following proposition, and

the proof is given in the Appendix.
Proposition 3: The capital market equilibrium for [0, ) has
g ( ) > 0, m ( ) = a ( ) = 0 and for [ , 1] has g ( ) = 0, m ( ) > 0
and a ( ) > 0, where is characterized in (A4) in the Appendix. Citizens
with [0, ) have s ( ) > 0, and citizens with [ , 1] also may hold
shares in the self-interested firm. The equilibrium aggregate contributions A to
the activist satisfy
A = x d , (18)
and the equilibrium personal giving g by a citizen with < is
g ( ) = ( ) 1 .
1
(19)
In the capital market equilibrium citizens with < give

personally and hold shares in the self-interested firm. They neither
hold shares in the morally managed firm nor contribute to the activist
because both are poor substitutes for personal giving. For citizens with
> , holding shares in the morally managed firm and contributing
to the activist are good substitutes, so they hold shares in the morally
managed firm and contribute to the activist. They may also invest in
the self-interested firm, but they do not give personally. The morally
managed firm thus attracts a clientele of citizen-investors for whom
indirect social satisfaction is a good substitute for personal giving.
That clientele also contributes to the activist and social pressure. In
equilibrium the contributions A to the activist in (18) equal the ex post
mitigation x d by the target priced at the capital market valuation
of indirect social satisfaction. Contributions to the activist thus equal
the market value of the induced response by the target firm. The same
price is used in (18) and in valuing the morally managed firm in
(20) below because the satisfaction from x d due to social pressure is a
perfect substitute for the social satisfaction from the ex ante mitigation
x of the externality by the morally managed firm.25
The contributions in (18) to the activist depend on which firm is
the more attractive target. Because the activist targets the firm that will
25. The financial return-social satisfaction (R, S)-space is spanned by the financial
return on the self-interested firm and the social return from contributing to the activist.
The return on the morally managed firm thus can be written as a linear combination of the
return on the self-interested firm and the social return from contributing to the activist. The
absence of arbitrage opportunities means that the market price m and the contributions

A to the activist must equilibrate with s . That is, substituting (20) below into (16) and
(18) into (14) yield identical expressions. More formally, a citizen of type [ , 1] who
(x +J x d )
m m
invests $1 in the morally managed firm obtains a financial return
m
and a
make the larger ex post reduction x {xdm , xsd } in the externality, the
activist attains the maximal possible contributions. That is, if xsd >xdm ,
then A = xsd > xdm .
The quality q of the activist affects the contributions it receives.
Higher quality activists receive greater contributions, because from (18)
and (9) and (10)
A xd
= > 0,
q q
assuming that the activist is small relative to the capital markets, so that
is constant in q. Higher quality activists make higher demands on
firms, and this results in greater contributions from citizens who have
strong preferences ( ) for mitigation of the externality. In addition,
stronger preferences for social expenditures among the citizenry means
is greater which increases the contributions to the activist. Activism
is thus a normal good. In addition, contributions are increasing in the
harm the activist can cause.
ing proposition.
Proposition 4: The morally managed firm attracts as its shareholder
clientele those citizen-investors for whom moral management is a good
substitute for personal giving to social causes, and those citizen-investors
also contribute to the activist to generate social pressure. Citizen-investors for
whom moral management is a poor substitute give personally to social causes
but neither hold shares in the morally managed firm nor contribute to social
pressure. Higher quality activists attract greater contributions, as do those
that can deliver greater harm. In selecting its target, the activist maximizes its
contributions.
x
social return m . The citizen can obtain the same social return by contributing
x

m
A = d
xm
A
to the activist and the same financial return by investing
(x +J x d )
m m

m
s =
1
in the self-interested firm which has a financial return of 1. The absence of arbitrage
opportunities implies that
(x +J x d )
x m m
m
m
1 = A + s = x
+ .
A
1
This condition is satisfied only by (18) when J = 1.
5.3 Market Values

Investing in the self-interested firm is equivalent to savings, so its market
value is
s = s (1 J )xsd .
If the self-interested firm is targeted by the activist (J = 0), its

shareholders bear the full cost xsd of the ex post mitigation of the
externality. Substituting (15) into (16) yields an expression for the
market value of the morally managed firm26, 27

m = m x + Jxmd + x , (20)
where x is the market value of the ex ante mitigation of the
externality. The price of the morally managed firms social contribution
is thus . The market values of the firms do not include a valuation of
the social satisfaction J xdm or (1 J ) xsd from activist targeting, because
the result of the campaign is credited to the activist as given in (18).28
The market value m equals the financial return m (x +
Jxm ) plus the capital markets valuation x of the CSP of the morally
d
managed firm. The morally managed firm is thus rewarded by citizens

in three ways. First, in the capital market shareholders provide a
premium x . Second, consumers reward the firm in the product
market by paying a higher price, which increases m . In addition,
citizens do not penalize the firm if in the market for social pressure
the activist is anticipated to target (J = 0) the self-interested firm.
If shares m x of the mitigation of the externality and contribu-
tions to the activist were perfect substitutes for personal giving, then
= 1. Moral management would then be costless; that is, it has no
effect on the market value of the firm. Graff Zivin and Small refer to this
as a Modigliani-Miller result in the sense that an increase in corporate
giving is exactly offset by a reduction in aggregate personal giving
by citizens. Corporate social performance thus perfectly crowds out
26. The assumption of quasi-linear preferences is not necessary for the valuation
expression in (20). If citizen preferences were represented by a strictly increasing, strictly
concave utility function u(k + u(( )), S), then (20) is implied by (15) and (16) for a citizen
indifferent between personal giving and holding shares of the morally managed firm.
27. If the morally managed firm contributed a portion m of its operating
profits to
social causes, its market value would be m = (1 ) x + J x d + + x .
m m m
28. If investors were to double count the social satisfaction from their contribution to
the activist and the social satisfaction from the response by the target to social pressure,
then S in (13) incudes the term m Jxdm and the term s (1 J)xds . The market value

s then includes the valuation (1 J)xds and the market value m in (20) includes the

valuation J xdm .
personal giving when = 1.29 Conversely, moral management is fully

rewarded by those citizens who purchase shares. When < 1, moral
management has a capital market cost to shareholders. If = 0 for all
citizens, the morally managed firm receives no credit for its mitigation
of the externality, and the market value m equals only its financial
return.
The comparative statics of are straightforward, because the
right side of (A4) is decreasing in . Consider an economy with many
firms and many activists, and interpret m as the aggregate profit of
all morally managed firms, x as their aggregate ex ante mitigation of
the externality, and x d as the aggregate outcome of social pressure.
Then, an increase in aggregate profits m decreases . That is, as the
financial return on the morally managed firm increases, a larger set of
citizens hold shares in those firms, and those citizens contribute less
to the activist. Similarly, an increase in the moral duty x increases the
social return x from the morally managed firms, which decreases ,
offsetting a portion of the market valuation of the social return. Similarly,
more effective social pressure that increases x d decreases , so there is
broader citizen support for the morally managed firm and the activist
but aggregate contributions to the activist are lower.
Comparative statics on the distribution of citizen preferences can
also be conducted. Let F 1 ( ) stochastically dominate F 2 ( ) in the first
degree; that is, F 1 ( ) F 2 ( ), and for some , F 1 ( ) < F 2 ( ). Then,
1 > 2 , where i is the indifferent citizen corresponding to Fi ( ), i = 1,
2. Because 1 > 2 , the higher valuation is reflected in a higher market
value m in (20) and greater contributions to the activist. Also, if citizens
value the social satisfaction more highly in the sense of first-degree
stochastic dominance, more citizens rely on personal giving and fewer
hold shares in the morally managed firm and contribute to the activist.
This results because citizens with > have a higher demand for social
satisfaction from moral management and social pressure, and market
clearing then involves some citizens at the margin shifting to personal
giving. An example is provided in the Appendix.
The results of this section are summarized in the following
proposition.
Proposition 5: The market value of the self-interested firm equals its
financial return, whereas the market value of the morally managed firm equals
its financial return plus the market value of its ex ante mitigation of the
externality. As citizen-investors view CSP as a better substitute for personal
giving in the sense of first-degree stochastic dominance, the market value of
29. To see this, note that (15) as an equality implies that S is a constant for all . Then,
from (13) an increase in x reduces g by the corresponding amount.
the morally managed firm increases as do the contributions to the activist. If

= 1, the ex ante mitigation is costless to the morally managed firm.
The market value of the morally managed firm could be higher or
lower than that of the self-interested firm, depending on the operating
profits m and s , target selection by the activist, the moral duty x , and
the markets valuation . The difference in the market values is
m s = m s x (1 ) + (1 J ) xsd J xmd .
If the activist will target the morally managed firm, it must have higher
operating profits than the self-interested firm to have the higher market
value.
The morally required mitigation x of the externality extends
beyond normal business management in the sense that the market value
m is decreasing at x = x . That is, in the absence of social pressure

dm
dm

= (1 )

d x x=x dx x=x
is assumed to be negative, where is taken to be constant in x because

d
the firm is small relative to the economy. Because d xm > 0 from (5) when
consumers reward the firm for mitigating the externality, a necessary
and sufficient condition for moral management not to make business
sense is

1 dm
> . (21)
1 d x
x=x
The condition in (21) means that the morally managed firm does not
mitigate the externality more than is morally required, unless it is
targeted by the activist.
5.4 A Proactive, Social Pressure-Induced Response

by the Self-Interested Firm?
The self-interested firm that anticipates being targeted by the activist
may have an incentive to mitigate proactively the externality. This
would have effects in the product market and the capital market, and it
could contribute to a more favorable reputation that reduces the harm
from the activist campaign. Citizens, however, may distinguish between
mitigation of the externality induced by social pressure and morally
motivated mitigation, so it will be assumed that in the product market
the morally motivated firm continues to attract the high valuation
( > ) consumers.
Suppose that citizens receive social satisfaction from some portion
[0, 1] of the social pressure-induced proactive mitigation xs of the
externality. If citizens do not distinguish between moral management

and social pressure-induced CSP, = 1, and if citizens reward only
moral management, = 0. The social satisfaction is then
a
S = g + m x + s xs + xsd ,
A
where as above the social pressure-induced mitigation xsd is credited to
the activist.
The shares of the self-interested and morally managed firms are
not perfect substitutes, but the market value s of the self-interested
firm can be shown to be30

s = s xs + xsd + xs , (22)
where s from (4) and xsd from (10) depend on xs .31 The cost of the
proactive ex ante mitigation xs is thus (1 ) xs , where for < 1,
1 > . The self-interested firm chooses xs to maximize its market
value. The derivative of the market value from (22) is32

ds ds d xd
= 1 + s , (23)
d xs d xs d xs
30. Consider a portfolio of savings and shares in the self-interested firm. Investing
o in the self-interested firm yields the same social return as investing $1 in the morally
managed firm when
x
m
o = xs
.
s
The financial return from the investment o is

xs s xs x
o s =
.
s m xs
Let be the difference between the financial return from the morally managed firm and
that from o , so

x s xs m h + x
=
,
m m xs
The absence of arbitrage opportunities implies that + o = 1, which implies (22).
31. Because of the arbitrage condition the share demands of the two firms and the
contribution to the activist cannot be separately identified. The share demands, however,
can be shown to satisfy
a ( ) d 1
1

s ( ) xs + m

( ) x +
xs =
1 .
A
Integrating and using the market clearing conditions in (A2) and (A3) in the Appendix
yields
1 1
xs + m h + x + zs =
1
1 d F ( ).

32. A similar analysis can be conducted for redistribution by the self-interested firm.
where the firm is assumed to be small relative to the market in which

case is constant in xs .
A proactive measure has four effects, three of which are reflected
d
in (23). The first is the effect d xss on profits in the product market. This is
zero if = 0 and negative if consumers give the firm credit ( > 0) in the
marketplace, because a proactive measure by the self-interested firm
reduces product differentiation which reduces profits s .33 If citizens as
investors give the self-interested firm credit ( > 0) in the capital market,
it seems reasonable to assume that those citizens also give it credit in
the product market, in which case > 0. A self-interested firm that
benefits from product differentiation thus has an incentive to make it
clear that it is taking the proactive measure only because of anticipated
social pressure if that may cause consumers to give it less credit (lower
) in the product market for being proactive.34
The second effect is the added valuation xs from investors
because of the proactive measure. This reduces the marginal cost of xs
and encourages a proactive response.
The third effect is through reputation enhancement, which can
shield the firm from some of the potential harm from the activist
d xd
campaign. This is reflected in the term d xss , which depends on the
reputation credit (xs ) earned from the mitigation of the externality
undertaken in anticipation of targeting by the activist. If there is no
d xd
reputation credit, then d xss = 0. Then, because 1 > , the market
value is a decreasing function of xs , so the self-interested firm does not
proactively mitigate the externality. In this model, a reputational credit
is a necessary but not sufficient condition for the self-interested firm to
be proactive.
The effect of the proactive measure on the activist demand xsd is
from (10)
d xsd (xs )h(A )

= .
+ (1 + 2)

d xs
9
33. If the proactive measure also increases marginal cost, profit is reduced further.
d
34. The effect d xss on the operating profit of the self-interested firm is negative in the
duopoly model in Section 3. If, however, the industry had three firms, only one of which
was morally managed, one of the other two firms could have an incentive to mitigate
proactively the externality to differentiate its product from the product of the other firm.
d
In this case, d xss could be positive, making a proactive response more attractive to the
self-interested firm. The analysis then pertains to the third firm.
A necessary condition for the ex ante mitigation of the externality to

increase market value is thus
d xsd (xs )h(A)
1 + = 1 + < 0. (24)
+

d xs
9
(1 + 2)
d xd
This condition requires that the cost savings d xss from the decrease in
the activists demand be greater than the marginal cost (1 ) of that
demand. For proactive mitigation to increase the market value of the
self-interested firm, the difference in (24) must outweigh the decrease
in profit, which is
ds

= (1 + 2) .
d xs 9
This seems unlikely, in which case the self-interested firm has no
incentive to mitigate the externality proactively when it anticipates
being the subsequent target of the activist.
The self-interested firm, however, may be able to mitigate suffi-
ciently to shift the activist to the morally managed firm. This fourth
effect requires that m (x ) > m from (11), where m is a decreasing
function of xs . The greater the credit (lower (xs )) and the greater the
mitigation xs the lower is m .
If the self-interested firm were able to shift the activist, the morally
managed firm could counter by increasing its own ex ante mitigation
of the externality beyond x . The two firms then could be in a race
to the top. The race is costly in terms of both the cost of mitigating
the externality and the possible reduction in product differentiation.
The incentive to avoid social pressure thus can put the firms in a
dilemma. The firms then have an incentive to act collectively against
the activist to avoid the dilemma.35 This provides an explanation for
industry collective action such as the Sustainable Forest Initiative by the
U.S. timber industry and the Equator Principles by banks that provide
project finance.
The results of this section are summarized in the following
proposition.
Proposition 6: When < 1, the market value of the self-interested
firm when it will be targeted by the activist is strictly decreasing in proactive
mitigation unless the activists demand decreases sufficiently; that is, (23) is
positive. The activist could have an incentive to proactively mitigate if that
would lead the activist to target the morally managed firm, but that could lead
to a race to the top.
35. In a different model Baron and Diermeier consider a race to the top and the
incentives to act collectively in the face of potential targeting by an activist.
6. Conclusions
Corporate social responsibility or moral management can be rewarded
if citizens have altruistic preferences or warm glow preferences for the
act of supporting social causes. That support could come from personal
giving to social causes, holding shares in firms that provide CSP, and
contributing to activist NGOs that pressure firms. Furthering social
causes through shareholdings and contributions to activists is indirect,
however, and hence less personal, so it may be only an imperfect
substitute for personal giving. The theory allows for both altruistic and
warm glow preferences and yields a value for social pressure as priced
in a capital market in which citizens allocate their endowments among
savings, corporate shareholdings, personal giving to social causes, and
contributions to activists. The market value of the morally managed
firm is the sum of its financial return and the market value of its social
performance.
Social pressure arises from citizen preferences, and the instru-
ments of citizens increasingly are NGOs and activists. Activist NGOs
engage in private politics by targeting firms with demands and threats
of harm made credible by the commitment of funds. Citizens fund
these organizations in addition to contributing directly to social causes,
and the equilibrium contributions equal the market value of the social
performance that results from the social pressure funded by those
contributions. Those contributions to the activist are increasing in the
quality of the activist and the strength of its threat. Moral management
and proactive corporate social performance can redirect social pressure
to other firms provided that citizens give the firm a reputational credit
that shields it from social pressure. Both social pressure and the credit
arise from citizen preferences, but social pressure is directed by the
activist.
Citizens may distinguish among CSP motivated by moral duty,
self-interest, or social pressure. The first represents moral management
and differs from business as usual, whereas CSP motivated by self-
interest is strategic and represents business as usual. Similarly, CSP un-
dertaken in anticipation of, or in response to, social pressure represents
business as usual. It is moral management that constitutes corporate
social responsibility.
The extent to which citizens distinguish between moral manage-
ment and CSP induced by self-interest or social pressure affects both
where social pressure is directed; that is, which firm is targeted, and
how intense the pressure is. If citizens fail to distinguish between the
two, the morally managed firm is the softer target and the demand on
it is higher.
Moral management and corporate social responsibility thus

should be understood in the context of an equilibrium in the product
market, the market for social pressure, and the capital market. From a
positive perspective the theory yields the following results.
1. Even if all consumers are willing to reward firms for their CSP, some
firms will have no CSP absent social pressure, even if the cost is 0.
Those firms prefer to reduce the intensity of price competition by
increasing product differentiation due to CSP. Firms thus differ in
their corporate social performance.
2. A morally managed firm charges a high price and attracts a clientele
of consumers with a high willingness to pay for products with CSP
attributes. The self-interested firm charges a low price and attracts
a clientele with a low willingness to pay.
3. Higher quality and better funded activists make stronger demands
on their targets, and demands are stronger the more susceptible the
target is to harm. Social pressure is a normal good; that is, the more
effective is social pressure the greater are contributions by citizens
and the more social pressure is supplied.
4. If citizens distinguish ( = 0) between moral management and CSP
induced by social pressure, a morally managed firm avoids social
pressure only if it has a reputational advantage among citizens
relative to a self-interested firm. If citizens do not distinguish ( > 0),
the morally managed firm is a softer target and more likely to be the
recipient of social pressure. Social pressure then increases the cost
of moral management.
5. If citizens do not distinguish between moral management and CSP
induced by social pressure, both firms have lower operating profits
when the self-interested firm is targeted and higher operating profits
when the morally managed firm is targeted.
6. Higher quality and better funded activists choose tougher targets,
which are self-interested firms and morally managed firms with
strong reputations, and lower quality and poorer funded activists
choose weaker targets which are morally managed firms with weak
reputations. Higher quality activists attract greater contributions,
and target selection maximizes contributions.
7. Moral management and CSP are nontraded goods but can be priced
in the capital market. If citizens receive social satisfaction from
holding shares in a morally managed firm, its market value is the
sum of the value of its financial return and the value of its social
performance. In that case, moral management (partially) crowds out
personal giving. The market values of morally managed firms and
the crowding out of personal giving are thus positively correlated.
8. A morally managed firm attracts a shareholder clientele for whom

holding shares is a close substitute for personal giving. Citizens
with strong altruistic and warm glow preferences (high , high
) support moral management by paying premiums for the firms
product and for its shares. That clientele also contributes to social
pressure.
9. The market value of the morally managed firm and the con-
tributions to the activist are increasing (in the sense of first-
degree stochastic dominance) in the distribution of citizens social
preferences for holding shares of the morally managed firm and
contributing to the activist.
10. Self-interested firms have little incentive for proactive CSP unless
they can shift social pressure to morally managed firms. A race
to the top could ensue, providing incentives for the firms to act
collectively to resist social pressure.
Appendix
Market Clearing Conditions and Characterization of
A closed-form characterization can be obtained for the equilibrium
indirect social contribution of a citizen with > . From (14) or (16) it
follows that
x 1
1

m ( ) x + a ( ) =
1 . (A1)
A
The right-hand side of (A1) is increasing in , so citizens for whom moral
management and CSP induced by social pressure are closer substitutes
for personal giving invest more in those activities.
The market clearing conditions are
1

m ( ) dF( ) = 1 (A2)

and
1
a ( ) dF( ) = A , (A3)

where the number of shares of the morally managed firm is normalized

to 1, and (A3) is a rational expectations condition.36 Integrating (A1)
36. The market clearing condition for shareholdings in the self-interested firm is

analogous to (A2), but s ( ) and savings for an individual citizen with < are
indeterminant.
and using (A2) and (A3) yields

1 1
1
m h + x + x = 1 dF( ). (A4)

This condition identifies , and A is then obtained from (18).

As an example of the comparative statics with respect to citizen
preferences for the social return, let F 2 ( ) be given by
F2 ( ) = + (1 )F1 ( ),
where is the fraction of citizens who receive no social satisfaction
from moral management or contributing to social pressure through
the activist. An increase in thus results in a stochastically dominated
distribution. Then, (A4) is
1 1
1
m h + x + z = (1 ) 1 dF1 ( ). (A5)
2
2
An increase in in (A5) reduces 2 and hence reduces the market value of

the firm. A first-order stochastic dominance shift in citizen preferences
thus results in a higher market value for the morally managed firm.
Proof of Proposition 3. The proposition is established by the following three
lemmas.
Lemma 1: In an equilibrium g ( ) m ( ) = 0 and g ( )a ( ) = 0,
[0, 1].
Proof. Suppose g ( ) > 0, so (15) holds as an equality on a nonempty
interval. This implies that S is constant in on a nonempty interval.
Suppose that m ( ) > 0 for in that interval, so (16) holds as an
equality on a nonempty subinterval. But, S constant in implies that
u
the derivative m
is linear in , so (16) cannot hold as an equality
on any nonempty interval on which g ( ) > 0. Then, g ( ) > 0 implies
m ( ) = 0. Reversing the argument establishes g ( ) m ( ) = 0, [0, 1].
Similarly, if a ( ) > 0 on some nonempty subinterval, substitute
(15) into (14) which yields
u z
= 1 + ,
a A
which cannot equal 0 on any nonempty subinterval of . Thus, g ( ) >
0 implies a ( ) = 0. Reversing the argument establishes g ( )
a ( ) = 0.
Lemma 2: For [0, ), g ( ) > 0, and for ( , 1], g ( ) = 0 and
m ( ) > 0.
Proof. Suppose that g ( ) = 0 for [0, ), > > 0. Then, the

derivative in (15) is infinite at = 0, so g ( ) > 0 for = 0. Similarly,
g ( ) > 0 for all [0, ). Next, suppose that g ( ) > 0 for an interval
of ( , 1]. Then, from Lemma 1, m ( ) = 0 and hence (16) is negative.
Substituting (15) into (16) yields

m x + Jzm
m + x < 0, (B1)
but because > and the expression in (B1) is increasing in , there

is a contradiction. This argument also establishes that m ( ) > 0 for
( , 1].
Lemma 3: In an equilibrium (18) holds and a ( ) > 0, ( , 1].
Proof. Consider ( , 1]. Substituting (20) into the equality in (16)
yields
+ S1 = 0. (B2)
Substituting (B2) into (14) yields

u z
= 1 + (B3)
a A
If u
a
> 0, a ( ) is unbounded and hence there is no equilibrium. If u a
< 0,
then a ( ) = 0, [ , 1]. Then, using Lemma 1, a ( ) = 0, [0,
1], so A = 0. But, this implies that u a
> 0 in (B3), a contradiction.
Hence, (18) holds. Then, a ( ) > 0 for ( , 1] is an equilibrium
contribution.
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A Positive Theory of Moral Management,

Social Pressure, and Corporate Social

associated with the operations of a firm where the mitigation goes

1. Baron (2001, 2003) provides an introduction to private politics.

the activist, quantifying the effect of moral management on the value

benefits, five of which are incorporated in the model.5 As a result of

incentives of managers to provide CSP as structured by a compensation

values of firms are independent of their social expenditures. Corporate

2. Overview of the Model

views corporate social responsibility as taking actions which reduce

The morally managed firm is assumed to have a reputation,

2.2 Social Pressure

purchasing products of, or holding shares in, a firm whose conduct

campaign or concede to the activists demand. In stage 4, the firms

3. The Product Market

the price of the product of firm i, Bi is the consumers perceived

Consumers with a high valuation ( > ) prefer the product of the

where c i , i = m, s, is a constant marginal cost and H() is the distri-

The difference in the prices is

The difference in the profits of the two firms depends on the

where = 12 if c m = c s . The morally managed firm thus has higher profits

Proposition 1: If products are differentiated by CSP, the morally managed

4. The Market for Social Pressure

the brunt, because citizen-consumers have a more favorable view of it.

4.2 The Campaign

To obtain closed-form expressions for the demands, let c m = c s and

where (1 ) 49 > 0 because mitigating the externality beyond

4.3 Target Selection

The cutpoint m is less than s for the self-interested firm when

5. The Capital Market: Valuing Moral Management

ex ante mitigation of the externality and corporate redistribution of

produced by one of the two firms. Consumption k of the composite good

where the social satisfaction from personal giving is normalized to 1.

5.2 The Capital Market Equilibrium

24. The distribution function H() in Section 3 is to be understood as the uncon-

a ( ). The equilibrium is characterized in the following proposition, and

In the capital market equilibrium citizens with < give

5.3 Market Values

If the self-interested firm is targeted by the activist (J = 0), its

managed firm. The morally managed firm is thus rewarded by citizens

personal giving when = 1.29 Conversely, moral management is fully

the morally managed firm increases as do the contributions to the activist. If

is assumed to be negative, where is taken to be constant in x because

5.4 A Proactive, Social Pressure-Induced Response

externality. If citizens do not distinguish between moral management

where the firm is assumed to be small relative to the market in which

d xsd (xs )h(A )

A necessary condition for the ex ante mitigation of the externality to

Moral management and corporate social responsibility thus

8. A morally managed firm attracts a shareholder clientele for whom

where the number of shares of the morally managed firm is normalized

and using (A2) and (A3) yields

This condition identifies , and A is then obtained from (18).

An increase in in (A5) reduces 2 and hence reduces the market value of

Proof. Suppose that g ( ) = 0 for [0, ), > > 0. Then, the

but because > and the expression in (B1) is increasing in , there

Substituting (B2) into (14) yields

, 2007b, Managerial Contracting and Corporate Social Responsibility, Journal of

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