Annex F. Framework conditions and sustainability

Fostering the accountability of firms

Agency theory stresses that firms’ sustainability behaviour is the result of internal and external pressures (Aguilera et al., 2007[1]). The impact and balance of these pressures heavily depends on the context (for instance the competitive environment, see below) and the governance structure of the firm.

The literature considers that three important factors are shaping the strength of external pressures: the liability framework (Alberini and Austin, 2002[2]; Akey and Appel, 2020[3]), the degree of transparency on the firms’ actions and its ownership structure (Shive and Forster, 2020[4]).

The liability of stakeholders has been shown to significantly limit the negative impact of firms on the environment. Alberini and Austin (2002[2]) show that stricter liability reduces the frequency and severity of pollution releases in the United States. Shapira and Zingales (2017[5]) describe the impact of limited liability on the decision by DuPont to release C8 (a toxic chemical) and explore some policy options to improve incentives (notably regarding settlements, penalising delays between the damage and the penalty and personal responsibility of managers). Akey and Appel (2020[3]) demonstrate that the reduction of parent firms’ liability for their subsidiaries in the United States resulted in an increase in toxic emissions by the subsidiaries and a reduced investment in abatement technologies.

The degree of transparency is likely to increase the prosocial behaviour of firms, as the available information increases the scrutiny on firms’ actions and mitigates a moral hazard problem. Nevertheless, high-frequency reporting may increase the pressure to deliver financial and social performance rapidly, potentially sacrificing long-term results. Whereas, in theory, disclosure is likely to improve the outcomes under scrutiny, this may be more complex in practice (Dranove and Jin, 2010[6]). For instance, firms may boost their performance on the reported dimensions while evading or not addressing the others.

The ownership structure also matters. With a diffuse ownership, shareholders are less likely to consider themselves as responsible for a firms’ social behaviour (Hart and Zingales, 2017[7]). The type of shareholders (e.g. individuals or mutual funds, public or private investors) and their board representation (Bolourian, Angus and Alinaghian, 2021[8]; Kim et al., 2019[9]) can also affect the intensity of external pressures.

As a consequence of these last two forces, the pressures are not necessarily higher on public firms as compared to private firms. Whereas the former are likely to provide more reporting, including on sustainability, the latter have a more concentrated ownership structure:

• Shive and Forster (2020[4]) show that US private firms emit less GHG than comparable public firms. Moreover, they confirm that public firms with a larger board or larger share of mutual funds ownership are found to emit less. In the same vein, public Turkish firms with a larger board, more independent members or institutional ownership are found to score higher in terms of corporate sustainability (Aksoy et al., 2020[10]).

• Cohn, Nestoriak and Wardlaw (2021[11]) show that private-equity buyouts of public firms reduce the workplace injury rate.

Whereas for larger firms, transparency and the ownership structure are pivotal for improving the social impact of firms, SMEs may face a lower level of external pressures because they have fewer external shareholders and stakeholders (e.g. consumers). In contrast, their commitment to social goods is instead determined by internal pressures, with a greater role of management (Brammer, Hoejmose and Marchant, 2011[12]) and of implicit contracts with employees.

The position in the value chain is also likely to affect the external pressure. For instance, some case studies show that upstream industries are less likely to report customers as a motivation to adopt innovations to reduce GHG emissions (Chappin, van den Oever and Negro, 2020[13]). It suggests that ensuring the transmission of external pressure from the consumers to upstream industries in the value chain may be a way to foster sustainability investments in these sectors.

Competition policies and sustainability

In theory, competition has an ambiguous impact on sustainability. Shifting to sustainability is a way to escape competition, as a factor of horizontal differentiation. However, tougher competition reduces room to manoeuver for sustainability investments and efforts. The relationship between sustainability and competition is therefore an empirical matter.

The literature finds a positive impact of competition on sustainability. Graafland and Noorderhaven (2019[14]) show that the level of technological competition perceived by managers increases the probability of CSR adoption. Fernández-Kranz and Santaló (2010[15]) and Flammer (2014[16]) find that a higher level of competition (for instance through an import shock) increases the CSR rating by a significant amount. Leong and Yang (2020[17]) confirm a positive impact of competition on social performance for US firms, but show that the positive impact only channels through reduced concerns, and not through positive actions. Ding et al. (2020[18]) show that, using a cross-country firm-level dataset, more stringent competition laws increase the CSR level of firms.

Even if the issue has attracted less scrutiny in the literature, sustainability can also affect competition, again with an ambiguous impact. While, by fostering innovation, sustainable behaviours can increase horizontal differentiation, by diversifying the firms’ objectives, it can also increase the number of dimensions that firms are competing on.