When Is Social Responsibility Socially Desirable?

When Is Social ResponsibilitySocially Desirable?

Jean-Etienne de Bettignies, Queen’s University

David T. Robinson, Duke University and National Bureauof Economic Research

We study a model in which corporate social responsibility arises inresponse to inefficient regulation. In ourmodel, firms, governments,and workers interact. Firms create negative spillovers that can be at-tenuated through government regulation, which is set endogenouslyand may not be socially optimal. Companies can hire socially re-sponsible employees who enjoy correcting spillovers. Because firmscan capture rents created by allowing this, they sometimes find it op-timal to lobby for inefficient rules and then encourage socially re-sponsible behavior in their midst. Thus, social responsibility can ei-ther increase or decrease social welfare, depending on the costs ofpolitical capture.

I. Introduction

Milton Friedman, in his classic bookCapitalism and Society, calls corpo-rate social responsibility (CSR) a “fundamentally subversive doctrine,” ar-

We thank ShawnCole,NavinKartik, RamanaNanda, TomNicholas, Jeff Zwiebel,and seminar participants at Brigham Young University, Cornell, Duke, Fordham,Harvard Business School, HEC Montréal, INSEAD, National University of Singa-pore, Université duQuébec àMontréal, Université Paris 1 Panthéon-Sorbonne, Uni-versity of Miami, University of New South Wales, Stanford, University of Toronto,andUniversity of Victoria for helpful feedback. The expert research assistance of JingLiang, Huafang Liu, and David Rosé is gratefully acknowledged. Contact the corre-sponding author, Jean-Etienne de Bettignies, at [email protected] David T. Robinson at [email protected].

[ Journal of Labor Economics, 2018, vol. 36, no. 4]© 2018 by The University of Chicago. All rights reserved. 0734-306X/2018/3604-0005$10.00Submitted October 8, 2015; Accepted July 20, 2017; Electronically published August 17, 2018

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guing instead that the goal of business should be solely to maximize profits.In his analysis, a democratic political process should implement laws andother strictures to constrain corporate behavior, and corporations in turnshould be left free to maximize shareholder returns within these confines.In essence, he argues that it is better to ask a zookeeper to cage a lion thanit is to ask a lion to refrain from eating the other animals in the zoo.Despite the suspicion expressed by Friedman (1963, 1970), Levitt (1958),

and other economists, CSR has become a pervasive feature of the moderncorporate landscape. For example, a recent study by the consulting firmKPMG indicates that 95% of the 250 largest global companies now reporton their CSR activities (KPMG 2011). Indeed, many large multinationalcorporations view CSR as an essential component of good business prac-tice.1

One reason why modern corporations embrace CSR might simply bethat shareholders aremotivated by altruistic preferences; with global supplychains and a high degree of digital interconnectedness, the social distancebetween shareholders and other stakeholders has narrowed, increasingthe shareholder’s altruistic motives (Baron 2010). In such a world, the zoo-keeper/lion metaphor breaks down. But what if shareholders are purelyself-interested? Would a purely self-interested firm ever voluntarily chooseto hire workers in order to pursue socially responsible business strategies,knowing that these strategies may not be profit maximizing? And whenCSR does emerge, under what circumstances is it preferred to governmentaction? Put differently, when is social responsibility socially desirable?These questions are the focus of this paper.To address these questions, we develop a simple model in which govern-

ments, citizens, and firms interact. Our analysis delivers an answer to thepositive question of when CSR arises endogenously as a response to certaineconomic forces, like the strength of social preferences and the quality ofalternative forms of governance. It also answers the normative questionof whether society is better or worse as a result.In our model, businesses unavoidably generate negative externalities

when they operate. The role of government is to set regulatory thresholdsthat balance a firm’s profits against the social costs of these negative exter-nalities. Firms are standard profit maximizers, and they can choose to hireself-interested workers, who care only about wages, or socially responsibleworkers, who derive extra utility from taking actions that improve socialwelfare. The firm can choose to engage in CSR by hiring a socially respon-sible worker, allowing the worker to operate the firm in a manner that gen-

1 The following quote from Nike’s 2010/2011 fiscal year Sustainable BusinessPerformance Summary expresses this view nicely: “Over the past 15 years, we havemoved from an approach of simply reacting to criticisms to pursuing sustainabilityas an integral driver of our long-term growth” (Nike 2011, 4).

1024 de Bettignies/Robinson

erates fewer negative externalities than the law requires. Although this ap-pears to generate lower financial profits, firms may be able to capture othereconomic rents by behaving this way.Our model turns on the incentives of government. In our baseline anal-

ysis, the objective of government is simply to maximize social welfare. Inthis version of the model, the fact that firms have the option to hire sociallyresponsible workers is irrelevant. CSR never emerges because the govern-ment naturally sets the first-best regulatory standard. In such a world, a so-cially responsible worker could never improve on the production choicethat a purely profit-seeking firm would choose facing the constraints im-posed on it, and indeed, socially minded and self-interested workers wouldalways behave in exactly the same manner.This portion of the analysis illustrates an important point, which is that

for CSR to arise from the (exogenous) availability of socially minded work-ers, it must be the case that some inefficiency prevents the government frommaximizing social welfare. In the second part of our analysis, we build onthis insight and focus specifically on a model in which governments maxi-mize a combination of social welfare and influence payments along the linesof Stigler (1971, 1974), Peltzman (1976), and Becker (1983). This opens thepossibility for firms to lobby governments to choose a regulatory standardthat no longer coincides with the social optimum.This modeling approach draws on the fact that many modern corpora-

tions simultaneously pursue CSR alongwith other forms of political action,such as lobbying. Indeed, recent evidence suggests that CSR activity andcorporate lobbying are commonly observed in the same firms (Richter2011) and points to a positive association between firms’ degree of social re-sponsibility and their ability to lobby policy makers (Werner 2015). In fact,many policy makers and industry observers express concern that firms en-gage in lobbying that is at cross-purposes to their CSR activities. For exam-ple, AccountAbility and the UN Global Compact (2005) point to numer-ous examples of companies that, either indirectly or directly, lobby forlegislation that is directly at odds with their stated CSR agenda. Take, forinstance, British Petroleum: according to SustainAbility and WWF-UK(2005), “BP was a signatory to the Corporate Leaders Group on ClimateChange . . . but was subsequently alleged to have been lobbying in the USagainst . . . compulsory limits on carbon dioxide emissions.”2 Thus, our anal-ysis of the trade-offs of CSR versus government action is cast against abroader backdrop in which CSR and corporate political action are allowedto interact.

2 Moreover, scholars in corporate strategy and political science have shown thatfirms and other organizations earn high returns to political contributions (seeAnsolabehere, de Figueiredo, and Snyder 2003; de Figueiredo 2002; de Figueiredoand Silverman 2006).

When Is Social Responsibility Socially Desirable? 1025

The degree of government efficiency, captured by the weight that thegovernment places on social welfare relative to influence payments, is akey ingredient in the model. It determines the cost of purchasing inefficientregulation through lobbying. Even without socially responsible workers inthe model, introducing an imperfectly efficient government creates an in-centive for all firms to engage in some lobbying to have more business-friendly regulation.Importantly, however, the presence of socially responsible workers can

augment firms’ incentive to lobby. Below a threshold level of governmentefficiency, when lobbying is “cheap enough,” firms artificially create rentsfor the socially responsible worker by lobbying the government for veryloose regulatory standards and then letting the worker enjoy utility by pro-ducing fewer externalities than the law permits, capturing these rentsthrough contractual means.3 Thus, in our model a firm’s decision to engagein CSR—through regulatory overcompliance—emerges endogenously as aresult of government inefficiency.In the final part of the analysis, we turn to normative questions and con-

sider the impact of socially responsible workers on social welfare. At highlevels of government efficiency, lobbying is too expensive to make rent ex-traction from these workers worthwhile, and CSR does not occur in equi-librium. As in our baseline analysis of perfect government efficiency, heresocially responsible workers have no impact on social welfare.At moderate levels of government efficiency, welfare depends on whether

socially responsible workers are available. If they are not, then because thecost of lobbying is still high enough that regulatory standards remain fairlystringent, negative externalities remain fairly low. On the other hand, if so-cially responsible workers are indeed available, in this region the cost of lob-bying is low enough to make CSR optimal, which leads to loose regulationand more negative externalities being produced even after accounting forovercompliance. Thus, at moderate levels of government inefficiency sociallyresponsible workers and the CSR they engage in have a detrimental effect onsocial welfare.Finally, at low levels of government efficiency the cost of lobbying is so

low that regulatory standards are very loose and the production of external-ities is very high when socially responsible workers are unavailable—higher,in fact, than the production of externalities that would emerge from over-compliance if the firm engaged in CSR with socially responsible workers.Thus, in that case socially responsible workers and CSR have a positive im-pact on social welfare.

3 This result is consistent with the aforementioned concern by policy makers andindustry observers that firms engage in seemingly inconsistent lobbying and CSRstrategies. It is also consistent with empirical evidence suggesting that workers ac-cept lower wages to work in socially responsible organizations. This is discussed inmore detail in Sec. V.


We also explore several extensions of our model that allow us to askwhether CSR is desirable from a shareholder perspective. The empirical lit-erature is divided on this point: for example, Cheng, Hong, and Shue (2012)argue that agencymotives drive CSR activity, offering as evidence a numberof distinct results linking exogenous increases in incentives and governanceto reductions in CSR activity. In contrast, Edmans (2011) finds that compa-nies recognized for the quality of employee treatment earn risk-adjustedrates of return that are higher than other, nonfriendly companies. In ourmodel, whether CSR is good for shareholders hinges on how the rents ex-tracted from socially responsible managers are distributed within the firm.The setting in which rents can be distributed to shareholders (through, e.g.,lower wages that manifest in higher profits) is one in which CSR unambig-uously improves shareholder welfare. In contrast, if rents are captured in-side the firm as private benefits, then our model predicts exactly the resultsoffered in Cheng, Hong, and Shue (2012). By nesting competing sets of em-pirical findings, our analysis helps to shed light on the mechanisms bywhich CSR affects shareholder value.Our work connects to a broader literature in economics examining CSR

from positive and normative perspectives.4 The positive strand examinesplausible explanations for CSR and conditions under which it might emerge.These conditions may arise in labor market environments, where CSR mayserve as a screening (Brekke and Nyborg 2004) or signaling (Greening andTurban 2000) mechanism to attract desirable employees or as entrenchmentby inefficient managers protecting their jobs (Cespa and Cestone 2007). Al-ternatively, these propitious conditions for CSR may be present in productmarkets where consumers have social preferences. In this type of environ-ment, CSR may emerge as a result of optimal managerial incentive design(Baron 2008), of competition in these markets (Arora and Gangopadhay1995; Bagnoli andWatts 2003; Besley andGhatak 2007;Galasso andTombak2014), or of reputation insurance (Minor andMorgan 2013; Minor 2015). Fi-nally, CSR may arise in political environments, as a hedging response to athreat posed by the “politician” who could be an activist (Baron 2001, 2009;Baron and Diermeier 2007; Lyon and Maxwell 2011) or a lobbyist influ-encing government policy (Maxwell, Lyon, and Hackett 2000; Lyon andMaxwell 2004).5 This positive strand of the literature points to a distinctionbetween the strategic reasons forCSR just discussed and the altruisticmotivesmentioned at the beginning of this introduction. Our paper contributes tothis discussion of altruistic versus strategic CSR by providing a setting in

4 For excellent recent overviews of this literature, see Benabou and Tirole (2010)or Kitzmueller and Shimshack (2012).

5 Our analysis, on the other hand, shows that firms engaging in CSR may alsostrategically lobby governments to increase their payoffs from CSR rather than en-gage in CSR in response to lobbying by others.


which afirm is behaving strategically even though it is taking an action that onthe face of it appears to be purely profit reducing. More generally, our papercontributes to this positive strand by proposing a theory of endogenousCSRemergence as a rational response to government inefficiency.The normative strand of the literature focuses onwhether the overall level

of a public good in society increases or decreases based on whether the pri-vate provision of the public good crowds out its public provision.6 Our pa-per proposes a different way to examine the normative aspects of CSR,which focuses on the interaction among government efficiency, socially re-sponsible workers, and social welfare and suggests that social responsibilitymay have an ambiguous impact on social welfare.The balance of the paper is organized as follows. In Section II we lay out

the basic setup of the model. In Section III we study a version of the modelin which government maximizes social welfare. Then in Section IV we ex-plore a version of themodel inwhich governments maximize a combinationof social welfare and lobbying contributions they receive. Section V dis-cusses the empirical implications of the model. Section VI explores a varietyof extensions to the model, while section VII concludes. Robustness con-siderations are examined in the appendix.

II. Basic Setup

At the core of our model is a firm whose operations unavoidably imposenegative externalities on the government’s citizens. The firm is engaged intwo strategic interactions. The first is the interaction between the firm andits labor force, which specifies employee compensation as well as the actionworkers should take conditional on government-mandated regulations de-termining themaximum level of externalities. The second is the potential stra-tegic interaction between the firm and the government to influence the equi-librium level of regulation. This section describes the actors involved in theseinteractions in greater detail.

A. Firms

A firm seeks a worker to run the company’s operations. Once hired, theworker’s main task is to take action a ∈ R1, which is expected to affect thefirm’s profits.The firm’s expected profits p(a) are positive, continuously differentiable

overR1, and strictly concave in a, with ðdp=daÞð0Þ > 0 and ðdp=daÞðxÞ < 0for some x ∈ R11. Hence, there exists a unique ap 5 arg max pðaÞ > 0, suchthat the firm’s expected profits are maximized.To keep the analysis as simple as possible, we assume that the production

technology and the nature of the CSR opportunity are tightly coupled. In

6 See Kotchen (2006), Besley and Ghatak (2007), Graff Zivin and Small (2005), orNilsson and Robinson (2017).


particular, as we make clear below, we posit that larger values of a generatemore negative externalities for citizens. In other words, the CSR is specif-ically modeled as the act of doing less harm while producing: developersare choosing to cut down fewer trees, textile manufacturers are dumpingfewer chemicals into lakes, and so forth.The tight connection between the nature of the CSR and the nature of the

productive activity is assumed purely for concreteness and expositionalsimplicity. Nothing in our analysis hinges on the specific nature of the con-nection between the spillover and the main productive activity of the firm.All that matters for our analysis is that some corporate actions are associatedwith potentially lower profits but potentially greater social benefit.In the main model, firms maximize the sum of the standard profits they

obtain from operations as well as any rents they can extract through CSRactivity. In Sections III and IV we put aside the question of who owns thefirm, which allows us to sidestep any differences in how these two sourcesof rents can be distributed or shared. Then in Section VI we consider severalmodel extensions that allow us to examine the welfare implications of CSRfor different corporate stakeholders.

B. Citizens

Citizens take no action on their own behalf but are negatively affected bythe actions taken by the firm. Thus, their preferences are important for un-derstanding social welfare.The citizenry’s utility Vða, qÞ depends on action a and on a vector q of

other exogenous factors. For simplicity, we set ∂ 2V=∂a∂q 5 0 (i.e., themar-ginal utility of a is independent of other factors) and henceforth omit q inour notation. As mentioned above, action a creates a negative externality onthe citizenry in that it negatively affects the citizenry’s utility: dV=da < 0for all a ∈ R1. One can think of a as representing a price or a pollution level,for example. Clearly, then, the level of a that maximizes V(a) is ac 5 0.In the main analysis, we simply assume that the citizenry is disconnected

from the firm and its workers. Although somewhat stark, this framingwould be well suited to the case of a citizenry of a country that was hometo one piece of a larger global supply chain operated by a multinational cor-poration. Later we discuss extensions to the model that allow for citizens tobe connected to the firm’s workers explicitly or to hold an ownership stakein the firm. Because these extensions do not affect the main results of themodel, we postpone them to Section VI.

C. Workers

There are two types of risk-neutral workers available in the labor market:self-interested or selfish workers (s) and socially responsible (or simply “re-sponsible,” for convenience) workers (r). Neither of the workers is wealthconstrained. The firm can costlessly detect which type of worker they face


in the labor market. We abstract away from whether the firm is hiring oneor many workers and use the term “worker” to refer to the firm’s laborforce generally. Furthermore, we assume that the firm can verify the actiona selected by the hired worker and makes a take-it-or-leave-it, action-contingent contractual offer W(a) to the worker it wishes to hire.7 Bothtypes of workers have reservation wage W 0 normalized to zero.Self-interested and responsible workers differ in terms of their prefer-

ences.Worker s cares only about his own payoff: if he is hiredwith compen-sationWs(a), his utility isUs 5 WsðaÞ. If he is not hired, his reservation util-ity is U0

s 5 W0 5 0.In contrast, worker r cares not only about his compensation but also

about what we call the “core” social surplus associated with action a, S(a),which we define as the sum of (1) the citizenry’s utility, (2) the firm’s profitsnet of compensation cost, and (3) the hired worker’s compensation:

S að Þ 5 V að Þ 1 p að Þ 2 Wj

� �1 Wj, (1)

with j 5 s, r, or simply

S að Þ 5 V að Þ 1 p að Þ: (2)

We use this notion of “core surplus” for expositional convenience. As shallbecome clear below, total social surplus (social welfare) will turn out to be asimple function of the core surplus. We assume that V(a) and p(a) are suchthat S(a) is “well behaved,” that is, positive, continuously differentiable overR1, and strictly concave in a, with ðdS=daÞð0Þ > 0 and ðdS=daÞðxÞ < 0 forsome x ∈ R11.We specify the utility of a worker r hired with compensation Wr(a) and

choosing action a as UrðaÞ 5 WrðaÞ 1 rSðaÞ, with r ∈ ð0, 1Þ, where rS(a)is the “responsible” component of his preferences. If he is not hired, worker r’s

7 We assume symmetric worker-type information, wealth-unconstrained work-ers, and verifiable action for simplicity, in order to abstract away from issues relatedto hidden information or hidden action between firm and worker. This is in con-trast to Carlin and Gervais (2009), e.g., who explore an agency model in whichsome agents suffer from agency costs and some do not. That some agents do notrequire high-powered incentives to exert effort, in equilibrium, induces sorting be-tween firms and employees. A recent literature has also examined agency problemswhen agents have special preferences, such as, for instance, intrinsic motivation orprosocial preferences. See, e.g., Benabou and Tirole (2003, 2006), Besley and Ghatak(2005, 2007), Prendergast (2007, 2008), Ellingsen and Johanesson (2008), and Delf-gaauw and Dur (2008). We make the aforementioned simplifying assumptions in or-der to bring into sharper focus the connection among social preferences, lobbying,and regulation. We relax these assumptions and discuss wealth-constrained workers,action contractability, and worker-type information asymmetry in some detail inapp. secs. A1, A3, and A4, respectively. The results of our model are robust to relax-ing these assumptions.


reservation utility is (the sum of his zero reservation wage and) a functionof the core social surplus associated with action a0 selected in that case (e.g.,by worker s if he is hired): U0

r 5 W0 1 rSða0Þ 5 rSða0Þ. Thus, responsibleworkers experience utility that is increasing in the core social surplus regard-less of whether they are engaged in the alleviation of negative externalities.

D. Social Responsibility

The parameter r ∈ ð0, 1Þ captures the r employee’s degree of social re-sponsibility. If r 5 0, Ur 5 Wr, and worker r is purely self-interested. Asr increases, however, he applies more weight to the core social surplus rel-ative to his personal compensation.

E. Government

We argue that transaction costs prevent direct Coasian bargaining be-tween the firm and the citizenry8 and that as a result a government emergesthat plays an important role as an intermediary between the citizenry andthe firm. The government examines both points of view and then affectsequilibrium action through regulation.For simplicity (and in our opinion not unrealistically) we assume that un-

like the firm, the government is too far removed from the activities of theworker to be able to verify the exact value of a and therefore cannot specifya particular action value through regulation. On the other hand, regulatoryceilings on a are assumed to be verifiable, and hence the government canregulate by imposing a ceiling �a ∈ R1 for action a.9 (Because negative exter-nalities are monotonically increasing in a, it is never optimal for the govern-ment to set a regulatory floor.)We follow Stigler (1971, 1974), Peltzman (1976), Becker (1983), and others

and assume that instead of maximizing core surplus S(a), the governmentseeks to maximize a political support function M, which depends primarilyon two factors: the number of votes N that it may receive and political con-tributionsC. For expositional convenience, in ourmodel the number of votesdepends directly on the core surplus, andN is normalized toN 5 SðaÞ. Thisleads to the following reduced-form government political support function:

M a,Cð Þ 5 gS að Þ1C, (3)

8 For instance, the citizenry’s “fragmentation” may imply high coordinationcosts for the group’s members, which may hinder efficient bargaining and indeedprevent bargaining altogether.

9 As detailed in our discussion of action contractability in app. sec. A3, even if thegovernment could verify the exact value of a and hence had the ability to require aspecific action level to be selected, a ceiling rather than a specific value of a wouldstill be stipulated in equilibrium because it would be in the date 0 decision-maker’sinterest to do so. Hence, the results of our model would continue to hold in thatcase.


where g ∈ ð0, gmax� and gmax is an extremely large but finite number. Param-eter g represents the degree of government efficiency: as g increases, thegovernment places more weight on satisfying voters relative to politicalcontributions.When g is close to zero, the government is almost completelybeholden to lobbyists, while as g becomes very large, the government be-comes almost like a core surplus maximizer.

F. Timing of the Game

At date 0, the government examines the citizenry and the firm’s pointsof view and imposes a ceiling �a on action a. At date 1, the firm makes atake-it-or-leave-it contractual offer to the worker. At date 2, the worker se-lects action a. At date 3, profits and utilities are realized, and contracts arehonored.

G. Social Welfare and the First Best

Social welfare is the grand total surplus generated, which includes thepayoffs of all of the economic agents included in the model—not only thecore surplus SðaÞ 5 VðaÞ 1 pðaÞ but also the responsible component ofworker r’s preferences rS(a) and the government’s preferences. More spe-cifically, social welfare here includes (1) the citizenry’s utility, (2) the firm’sprofits net of compensation cost and of lobbying cost, (3) the hired work-er’s compensation, (4) the responsible component of worker r’s preferences(rS(a)), and (5) the government’s utility:

TS að Þ 5 V að Þ 1 p að Þ 2 Wj 2 C� �

1 Wj 1 rS að Þ 1 gS að Þ 1 C½ �, (4)

with j 5 s, r, or more simply

TS að Þ 5 1 1 r 1 gð ÞS að Þ: (5)

We define the first-best benchmark as the situation in which (1) the gov-ernment is perfectly efficient, that is, does not value political contributionsand places maximum value gmax on the core surplus, thus enjoying utilitygmaxS(a), and (2) social welfare is maximized. The strict concavity of S(a), to-gether with ðdS=daÞð0Þ > 0 and ðdS=daÞðxÞ < 0 for some x ∈ R11, ensurethe existence and uniqueness of a first-best action a* that maximizes bothcore surplus S(a) and social welfare TS(a). The first-best social welfare canthus bewritten asTS*ða*Þ 5 ð1 1 r 1 gmaxÞSða*Þ.Note that a* dependsnei-ther on who is hired nor on parameter r or g. Also note that a* ∈ ð0, apÞ,which follows directly from three observations: (a) ðdS=daÞð0Þ > 0,(b) ðdS=daÞðapÞ 5 ðdV=daÞðapÞ < 0, and (c) the strict concavity of S(a).Because equation (5) captures the overall welfare of citizens, firms, man-

agers, and the government, it forms the reference for welfare comparisonsthroughout the remainder of our analysis.


III. CSR under Efficient Government

To set the baseline for our analysis, we begin by considering first anefficient government, which as defined above does not value political con-tributions and places maximum value gmax on the core surplus, thus maxi-mizing payoff gmaxS(a). We begin by analyzing the case where only a self-interested worker is available for hire, and then we examine the case wherethe firm can choose between hiring a self-interested or a responsible worker.This enables us to highlight the marginal impact of responsible workers inour model. The main result in this section is essentially an irrelevance result:under efficient government, responsible workers are of no consequence foreither the firm or social welfare.

A. Equilibrium with Self-Interested Workers Only

We beginwith the casewhere only the self-interestedworker s is availablefor hire and determine the subgame-perfect Nash equilibrium by back-ward induction. As is well known, since the worker faces no direct costassociated with a, he selects the firm’s preferred action as long as he re-ceives compensation Ws ≥ 0. Thus, in equilibrium the firm pays the workerWs 5 0 and can choose the action as to be selected by the employee. Clearly,the action that maximizes the firm’s payoff Ps 5 pðaÞ 2 Ws 5 pðaÞ is theprofit-maximizing action ap > a*. The difference between ap and the first-best action a* captures the externality at play here: the firm does not inter-nalize the negative impact of a higher action choice on the citizenry and henceselects an action level that is too high from a social point of view.Here, however, the firm’s choice of action may be constrained by govern-

ment regulation. Suppose that at date 0 the government has imposed ceiling �afor action a. Then, taking �a as given, at date 1 the firm requests the followingaction from the worker:

as 5�a if �a ≤ ap,

ap if �a > ap:

((6)

If the action ceiling is not binding, the firm chooses her preferred action ap;if the ceiling is binding, then the best the firm can dowhile remaining withinthe law is to request action as from the worker exactly equal to the ceiling.Accordingly, the firm’s equilibrium payoff Ps can be expressed simply as

Ps �að Þ 5p �að Þ if �a ≤ ap,

p apð Þ if �a > ap:

((7)

Moving back 1 period, the government chooses ceiling �as* to solve the fol-lowing program:

max�a

S asð Þ 5 max�a

V asð Þ 1 p asð Þ, (8)


subject to condition (6). Clearly, the optimal ceiling is �as* 5 a*: since a* ∈ð0, apÞ, this forces the firm to request action as 5 a* from the worker atdate 1 and ensures that first-best core surplus S(a*) is achieved. Indeed,the equilibrium can be described as follows:

LEMMA 1:Under efficient government andwith a profit-maximizing firmand a self-interested employee: At date 0, the government sets regulatoryceiling �as* 5 a*. At date 1, the firm hires worker s and requests actionas 5 a*. At date 2, worker s takes action a* and receives compensationWs 5 0, and the firm obtains payoff p(a*).

An immediate implication of lemma 1, of course, is that this equilibriumgenerates the first-best social welfare, TSða*Þ 5 ð1 1 r 1 gmaxÞSða*Þ. Themain result of this section thus follows:

PROPOSITION 1: Even with a profit-maximizing firm and a self-interestedworker, an efficient government can circumvent problems associatedwith externalities through regulation and can achieve first-best socialwelfare.

B. Equilibrium with Both Self-Interested and SociallyResponsible Workers

Suppose now that at date 1 the firm can choose to hire a self-interestedemployee or instead a responsible worker. If the firm makes an offer toworker s, the remainder of the game is as described in Section III.A: for agiven ceiling �a, the requested action as is defined as in condition (6), andthe firm’s payoff Ps is defined as in condition (7).Now suppose the firm makes a contractual offer Wr(a) to worker r. As

discussed above, if he accepts the offer and chooses action a, his utility isUrðaÞ 5 WrðaÞ 1 rSðaÞ. If he is not hired, worker r’s reservation utility de-pends on the action a0 chosen in that case:U0

r 5 rSða0Þ. For simplicity, weassume that if the r employee turns down the offer, the firm hires worker s(since this gives the firm a positive payoff Ps) who selects a0 5 as, and this inturn implies that U0

r 5 rSðasÞ.10Consider first the “government-unconstrained” scenario in which no reg-

ulatory ceiling is constraining the action requested by thefirm fromworker r.Suppose thefirmwishes to elicit an action a. In that case, the optimal contractoffered to the r type includes a base salary wr and an action-contingent bo-nus br such that

10 The results of the model would continue to hold under a much weaker as-sumption as long as, should worker r turn down the firm’s offer, the firm wouldhire worker s with nonzero probability.


Wr að Þ 5wr 1 br if a 5 a,

wr if a ≠ a:

((9)

The action a, the base salarywr, and the bonus br are chosen tomaximize thefirm’s program pðaÞ 2 ðwr 1 brÞ, subject to the incentive compatibility(IC) constraint,11

br 1 rS að Þ ≥ rS a*ð Þ, (10)

and to the individual rationality (IR) constraint,

wr 1 br 1 rS að Þ ≥ rS asð Þ: (11)

One can easily verify that in equilibrium br andwr are chosen as solutionsto binding the IC and IR constraints, respectively, and that the equilibrium“unconstrained” action au

r is the solution that maximizes the following sim-plified program:

maxa

p að Þ 1 r S að Þ 2 S asð Þ½ �: (12)

The intuition is simple and well known: the firm chooses the action aur

that maximizes the joint firm-worker surplus, ensures that the employeehas an incentive to select this action through the appropriate choice of br sat-isfying constraint (10), and extracts all rents from the worker by choosingthe base salary wr such that constraint (11) is binding.The firm’s payoff for a given requested action au

r thus includes two compo-nents: gross profit pðau

r Þ and the social responsibility wedge r½Sðaur Þ 2 SðasÞ�

extracted from worker r. This wedge is the difference between the respon-sible components of worker r’s utility (a) if he is hired to take action au

r and(b) if instead worker s is hired to take action as. In other words, by allowingthe worker to “save the world” by choosing relatively low action au

r , thefirm artificially creates rents for worker r (the social responsibility wedge),which it can then extract from the worker through lower wages.Given the strict concavity of p(.) and S(.) and hence of pð:Þ 1 rSð:Þ,12 the

unique unconstrained action aur maximizing program (12) can be expressed

as the solution to

dpda

aurð Þ 1 r

dSda

aurð Þ 5 0: (13)

11 Conditional on not choosing a, the worker anticipates that he will receive apayoff of wr 1 rSðaÞ. And the action that maximizes this payoff is a*.

12 To be precise, our assumptions that ðdp=daÞð0Þ > 0 and ðdS=daÞð0Þ > 0 andthat ðdp=daÞðxÞ < 0 and ðdS=daÞðxÞ < 0 for some values of x ∈ R11, together withthe strict concavity of pð:Þ 1 rSð:Þ, ensure the existence of a unique au

r maximizingprogram (12).


Note that aur ∈ ða*, apÞ. This follows directly from the strict concavity of

pð:Þ 1 rSð:Þ, alongwith the fact that ðdS=daÞða*Þ 5 0 and ðdp=daÞða*Þ > 0,ðdp=daÞðapÞ 5 0 and ðdS=daÞðapÞ < 0, and a* < ap, as shown previously.Intuitively, equilibrium unconstrained action au

r maximizes a linear combi-nation of two strictly concave functions, S(.) and p(.); thus, the argmax ofthis linear combination should be between the argmax a* of S(.) and theargmax ap of p(.).Clearly, as in the case of worker s, here again the equilibrium action cho-

sen depends on whether the firm is constrained by the previously deter-mined ceiling �a. This equilibrium action with worker r can be expressedas follows:

ar 5�a if �a ≤ au

r ,

aur if �a > au

r :

((14)

Using conditions (6) and (14), we can express the firm’s equilibrium pay-off if it hires worker r, Pr, as follows:

Pr �að Þ 5p �að Þ if �a ∈ 0, au

r½ �,p au

rð Þ 1 r S aurð Þ 2 S �að Þ½ � if �a ∈ au

r , apð �,p au

rð Þ 1 r S aurð Þ 2 S apð Þ½ � if �a ∈ ap,1∞ð Þ:

8>>><>>>:

(15)

Comparing the firm’s payoffs defined in conditions (7) and (15), we cannow determine the firm’s optimal choice of employee type and the associ-ated equilibrium action for a given ceiling �a.For all �a ∈ ½0, au

r �, it follows directly from conditions (6) and (14) that theequilibrium action selected is the same regardless of the type of workerhired: ar 5 as 5 �a. This in turn implies Prð�aÞ 5 Psð�aÞ 5 pð�aÞ: the firm isindifferent between the two types of workers. Since both types choosethe same action �a, worker r derives no additional utility from selecting amore responsible action—the social responsibility wedge r½Sð�aÞ 2 SðasÞ�collapses to zero—and hence there are no additional rents to be extractedby the firm.For all �a ∈ ðau

r ,1∞Þ, in equilibriumwe have ar 5 aur and as 5 minð�a, apÞ,

with aur < as. Note that in this case the firm could choose to elicit action as

from worker r, in which case the payoff would be the same from eitherworker. Yet the firm chooses to elicit au

r ≠ as from worker r, which impliesthat the payoff from doing so is strictly superior to the payoff from elicit-ing as (by the strict concavity of pð:Þ 1 rSð:Þ). And this in turn implies thatPrð�aÞ > Psð�aÞ: the firm is strictly better off by hiring worker r over worker s.Intuitively, when worker r is hired and the ceiling �a is not too restrictive, apositive social responsibility wedge r½Sðau

r Þ 2 SðasÞ� is created that can be ex-tracted by the firm via lower compensation for that worker.


In sum, for a given ceiling �a, we can express the firm’s hiring choice andthe equilibrium action ac as follows:13

if �a ∈ 0, aur½ � : the firm is indifferent between types, requests action ac 5 �a;

if �a ∈ aur ,1∞ð Þ : the firm hires worker r, requests action ac 5 au

r :

(

(16)This logic is depicted graphically in figures 1 and 2, which capture equi-

librium actions and profits, respectively, as functions of ceiling �a, dependingon whether the s or the r type is hired.The critical value for ceiling �a in both figures is au

r , the ceiling value atwhich the equilibrium actions of the s and the r type begin to differ. Tothe left of au

r , the ceiling is binding and the equilibrium action is the sameregardless ofwho is hired, as shown infigure 1.Accordingly, thefirm’s pay-off is also independent of the type being hired, as depicted in figure 2.To the right of au

r , the firm deliberately requires a lower action ar fromworker r than it would from the self-interested type. It does so to generatethe social responsibility wedge r½SðarÞ 2 SðasÞ� for worker r, which it ex-tracts through contractual means, thus increasing its overall payoff. Thelower equilibrium action arð�aÞ < asð�aÞ and greater profits Prð�aÞ > Psð�aÞ un-der r management are depicted in figures 1 and 2, respectively.

13 Subscript c refers to situations when the firm has a choice between hiring eithertype of manager.

FIG. 1.—Equilibrium actions for actors s and r, as functions of ceiling �a. A colorversion of this figure is available online.


Anticipating all this, at date 0 the government chooses ceiling �ac* to solvethe following program:

max�a

S acð Þ 5 max�a

V acð Þ 1 p acð Þ, (17)

subject to condition (16). As in the previous scenario where only worker swas available, the optimal ceiling for the government is �ac* 5 a*: sincea* ∈ ð0, au

r Þ, this forces the firm to request action ac 5 a* from either typeat date 1 and ensures that the first-best core surplus S(a*) is achieved.We summarize these results in the following lemma:

LEMMA 2: Under efficient government, when the firm can choose be-tween a self-interested or a responsible worker: At date 0, the govern-ment sets regulatory ceiling �ac* 5 a*. At date 1, the firm hires either type,requesting the same action a* either way. At date 2, the hired workertakes action a* and receives compensation Ws 5 Wr 5 0, the firm ob-tains payoff p(a*), and social welfare TS(a*) is generated.

As lemma 2 implies, again here the first-best social surplus TSða*Þ 5ð1 1 r 1 gmaxÞSða*Þ is achieved in equilibrium. Thus, two primary resultsemerge from this section:

PROPOSITION 2: Under efficient government, the presence of socially re-sponsible workers is irrelevant: it neither makes the firm better off norhas any impact on social welfare.

FIG. 2.—The firm’s payoff as a function of ceiling �a, depending on the type ofworker (s or r) hired by the firm. A color version of this figure is available online.


Qualitatively, this irrelevance result is altogether different from those ex-plored in Graff Zivin and Small (2005) or Baron (2007). In their analysis nogovernment exists, but consumers have preferences over direct or delegatedphilanthropy. In thesemodels, the irrelevance result stems from the fact thatCSR can crowd out individual philanthropy.In our model, the direct philanthropy channel is suppressed, and the ir-

relevance stems from the fact that awell-functioning government is a perfectsubstitute for CSR. Of course, this results hinges critically on the fact thatthe government maximizes social welfare. As the next section illustrates, theanalysis changes considerably when it does not.

IV. CSR under Imperfectly Efficient Government

We now relax the assumption of government efficiency and consider agovernment that maximizes the political support functionMða,CÞ definedin expression (3) and hence can be influenced by political contributions.Werefer to a government that is prone to lobbying pressure as an imperfectlyefficient government.As discussed in Section II, we assume that the government’s ceiling �a is

verifiable. Hence, the firm can offer, at date 0, a (take-it-or-leave-it) ceiling-contingent contract to the government consisting of a political contributionC** if a specific ceiling �a** is chosen and zero otherwise.14 As we shall seebelow, lobbying may cause the equilibrium level of regulation to deviatefrom thefirst best, creating scope for thefirm to pursueCSR in equilibrium.

A. Equilibrium with Self-Interested Workers Only

For a given ceiling �a, from date 1 onward the analysis proceeds exactly asin Section III.A. The key difference is that now the firm can contract withthe government at date 0. The firm chooses a ceiling level �as** and politicalcontribution C**

s that maximize the following program:

max�a,C

Ps �að Þ 2 C 5p �að Þ 2 C if �a ∈ 0, ap½ �,p apð Þ 2 C if �a ∈ ap,1∞ð Þ,

((18)

subject to the government’s IR constraint. This IR constraint can be ex-pressed as gSð�aÞ 1 C ≥ gSða*Þ for all �a ∈ ½0, ap�,15 but it changes togSðapÞ 1 C ≥ gSða*Þ for all �a ∈ ðap,1∞Þ because it is anticipated that theequilibrium action will be as 5 ap if the ceiling is superior to ap. Naturally,for any given �a the firm choosesC such that the government’s IR constraintis binding, and hence the firm’s date 0 program simplifies to

14 In app. sec. A2, we show that the equilibrium outcomes of the model are iden-tical if the government has full bargaining power instead.

15 If it does not accept the firm’s offer, the government ends up maximizing gSð�aÞ,and we know from Sec. III.A that this yields �a 5 a*.


max�a

Us �að Þ 5p �að Þ 2 g S a*ð Þ 2 S �að Þ½ � if �a ∈ 0, ap½ �,p apð Þ 2 g S a*ð Þ 2 S apð Þ½ � if �a ∈ ap,1∞ð Þ:

((19)

One can readily show that the unique equilibrium ceiling maximizing thefirm’s program is �as**ðgÞ ∈ ða*, apÞ for all g ∈ ð0, gmax� and can be expressedas the solution to16

dpd�a

�as**ð Þ 5 2g

dSd�a

�aa**ð Þ: (20)

In other words, thefirmnegotiates equilibrium ceiling �aa**ðgÞ such that themarginal benefit dp=d�a from an increase in the ceiling above the first-best ac-tion a* is exactly equal to the marginal lobbying cost dC=d�a 5 2gðdS=d�aÞassociated with such an increase.Note that equilibrium regularity ceiling �as**ðgÞ is a continuous and strictly de-

creasing function of government efficiency: d�as**=dg < 0 for all g ∈ ð0, gmax�.17Intuitively, as g increases, the government cares more about welfare rel-ative to political contributions, and the firm’s marginal cost of raising theceiling above a* (2gðdS=d�aÞ with dS=d�a < 0 for all �a > a*) rises. Accord-ingly, the firm’s optimal response to this is to lobby for a lower ceiling�as**.At one end of the spectrum, when the government is almost perfectly in-

efficient and g→ 0, the firm’s marginal cost of lobbying tends toward zeroand the contracted ceiling �as** approaches the firm’s profit-maximizing ac-tion ap. At the other end of the spectrum, when the government is extremelyefficient and g 5 gmax, the firm’s marginal cost of lobbying to raise the ceil-ing above a* is extremely high, and hence the contracted ceiling �sa** ap-proaches the first-best action a*.One implication of the foregoing analysis—in particular of the fact that

�as** > a*—is that C**s ðgÞ 5 g½Sða*Þ 2 Sð�as**Þ� > 0: influence payments

are strictly positive in equilibrium. Another implication from this and from

16 To see this, note that the strict concavity of p(.) and S(.) implies strict concavityforUs(.) for all �a ∈ ½0, ap�. The solution �as**ðgÞ to expression (20) therefore maximizesUs(.) over �a ∈ ½0, ap�, which implies Usð�as**ðgÞÞ > UsðapÞ. Moreover, since Usð�aÞ 5UsðapÞ for all �a ∈ ðap,1∞Þ, we must also have Usð�as**ðgÞÞ > Usð�aÞ for all�a ∈ ðap,1∞Þ. Hence, �as**ðgÞmaximizesUs(.) over �a ∈ R1. Finally, since by definitionðdp=d�aÞðapÞ 5 0 and ðdS=d�aÞða*Þ 5 0, expression (20) yields �as**ðgÞ ∈ ða*, apÞ forall g ∈ ð0, gmax�.

17 Regarding continuity, let g 5 f ð�as**Þ with f ð�as**Þ 5 2½ðdp=d�aÞð�as**Þ�=½ðdS=d�aÞð�as**Þ�. Since p(.) and S(.) are continuously differentiable and sinceðdS=d�aÞð�as**Þ > 0 for all �as**ðgÞ > a*, g 5 f ð�as**Þ is continuous in �as**. Accordingly,�as** 5 f 21ðgÞmust be continuous in g. Regarding the impact of g on �as**, it followsdirectly from applying the implicit function theorem to expression (20).


condition (6) is that the equilibrium ceiling is binding (since �as** < ap) andthat therefore at date 1 the firm requests action as 5 �as** from worker s.The firm’s net equilibrium payoff can then be obtained from condition (7),and with the worker’s compensation remaining constant at Ws 5 0 we canstate the equilibrium as follows:

LEMMA 3: Under imperfectly efficient government, for any given g ∈ð0, gmax� and when only worker s is available in the labor market: At date 0,the firm makes political contribution C**

s ðgÞ > 0 to the government inexchange for setting regulatory ceiling �as**ðgÞ, with �as**ðgÞ ∈ ða*, apÞ andd�as**=dg < 0. At date 1, the firm hires worker s and requests actionasðgÞ 5 �as**ðgÞ. At date 2, worker s takes action �as**ðgÞ and receives com-pensationWs 5 0, and the firm obtains payoff pð�as**ðgÞÞ.

We underline two consequences of lemma 3. First, as long as the govern-ment is not perfectly efficient, some lobbying will occur in equilibrium.Thus, introducing government inefficiency to the analysis creates a back-groundmotivation for firms to engage in lobbying, even in a world withoutresponsible workers. This can be stated more formally as follows:

PROPOSITION 3: Under imperfectly efficient government, some lobbyingalways occurs in equilibrium: that is, for any given g ∈ ð0, gmax� the firmoffers the government Cs**ðgÞ > 0 in exchange for raising the regulatoryceiling �as** above the first-best level a*.

The reason for this is simple. At the first-best ceiling a*, social surplus ismaximized and a small increase in the ceiling has little impact on social sur-plus. Hence, as long as the government cares even a little bit about influencepayments, it can be convinced to raise the ceiling a bit beyond the first-bestlevel, to �as** > a*, in exchange for some political contribution C**

s ≈ 0. Forthe firm this is worth doing, since at a* themarginal cost of the contributionis negligible and it stands to gain a lot—ðdp=daÞða*Þ > 0—from raising theceiling above a*.Second, lemma 3 also implies that the social welfare TS**s ðasðgÞÞ generated

in equilibrium, obtained by substituting the equilibrium action asðgÞ 5 �a**s ðgÞinto expression (5), can be expressed as

TS**s as gð Þð Þ 5 1 1 r 1 gð ÞS �as** gð Þð Þ 8 g ∈ 0, gmaxð �: (21)

For all g ∈ ð0, gmax�, the firm’s lobbying leads to an equilibrium ceilingstrictly greater than the first best: �as**ðgÞ > a*. The worker then selects ac-tion asðgÞ 5 �as**ðgÞ that is “too high” relative to the socially optimal actiona*, leading to suboptimal social welfare TS**s ðasðgÞÞ < TS*ða*Þ. Thus, wehave the following:


PROPOSITION 4: Government inefficiency leads to inefficiently high reg-ulatory ceilings and actions and in turn to a decrease in social welfare.

B. Equilibrium with Both Self-Interested and Responsible Workers

Now suppose again that the firm can choose whether to hire worker s orworker r at date 1. For a given ceiling �a, from date 1 onward the equilibriumis exactly the same as in Section III.B. If �a ≤ au

r , with aur ∈ ða*, apÞ, as stated

in condition (16) the firm is indifferent between the two worker types.Whomever is hired, the firm must ask the worker to select action ac equalto the binding ceiling �a, yielding gross profit pð�aÞ. In contrast, if �a > au

r ,the ceiling is no longer binding if the firm hires worker r, and doing so en-ables the firm to extract the social responsibility wedge r½Sðau

r Þ 2 SðasÞ�,with as 5 minð�a, apÞ, from the r type. Accordingly, the firm strictly prefersto hire worker r in that case.Anticipating all this, when lobbying the government at date 0 the firm

chooses a ceiling level �ac** and political contribution C**c that maximize

the following program:

max�a,C

p �að Þ 2 C if �a ∈ 0, aur½ �,

p aurð Þ 1 r S au

rð Þ 2 S �að Þ½ � 2 C if �a ∈ aur , apð �,

p aurð Þ 1 r S au

rð Þ 2 S apð Þ½ � 2 C if �a ∈ ap,1∞ð Þ,

8>>><>>>:

(22)

subject to the government’s IR constraint. This IR constraint can be ex-pressed as in the previous scenario as gSð�aÞ 1 C ≥ gSða*Þ for all �a ∈½0, au

r �, but it changes to gSðaur Þ 1 C ≥ gSða*Þ for all �a ∈ ðau

r ,1∞Þ becauseit is anticipated that the equilibrium action will be ac 5 au

r if the ceiling issuperior to au

r .18 As before, for any given �a the firm chooses C such thatthe government’s IR constraint is binding, and hence the firm’s date 0 pro-gram simplifies to

max�a

Uc �að Þ5p �að Þ 2 g S a*ð Þ 2 S �að Þ½ � if �a ∈ 0, au

r½ �,p au

rð Þ1 r S aurð Þ 2 S �að Þ½ � 2 g S a*ð Þ 2 S au

rð Þ½ � if �a ∈ aur , apð �,

p aurð Þ1 r S au

rð Þ2 S apð Þ½ �2 g S a*ð Þ2 S aurð Þ½ � if �a ∈ ap,1∞ð Þ:

8>>><>>>:

(23)

The equilibrium value �ac** of the ceiling selected at date 0 can be deter-mined as the solution to program (23). To that end, let us first considertwo parametric regions in turn.

18 More precisely, the firm is indifferent between any �a ≥ ap, and we assume thatwithin this set of possibilities it would select the Pareto optimal point ap.


Region Where g ∈ ½r, gmax�The firm effectively has two options at its disposal. First, it can lobby

for an equilibrium ceiling �ac** ≤ aur . In this case, the firm would select

�ac1**ðgÞ > a* such that its marginal benefit from an increase in ceiling �a abovethe first-best action a* is exactly equal to the marginal lobbying cost asso-ciated with such an increase:

dpd�a

�ac1**ð Þ 5 2g

dSd�a

�ac1**ð Þ: (24)

This option generates payoff U**c1 ð�ac1**ðgÞÞ 5 pð�ac1**ðgÞÞ 2 g½Sða*Þ 2

Sð�a**c1 ðgÞÞ� for the firm. Since expressions (20) and (24) are isomorphic,the ceiling in this case is the same as in Section IV.A, and as shown above�ac1**ðgÞ is a continuous function of g, with d�ac1**=dg < 0 for all g ∈ ð0, gmax�.Continuity of �ac1**ðgÞ implies continuity ofU**

c1 ð�ac1**ðgÞÞ as a function of g.A second option for the firm is to lobby for an equilibrium ceiling �ac** > au

r .In that case, it is optimal to select ceiling �ac2** 5 ap because this would allowthe firm to maximize the social responsibility wedge r½Sðau

r Þ 2 SðapÞ� it canextract from worker r, with the cost of political contributions to the govern-ment remaining constant at g½Sða*Þ 2 Sðau

r Þ� for any �a > aur . The payoff to the

firm in that scenario would be Uc2**ð�ac2**ðgÞÞ 5 pðau

r Þ 1 r½Sðaur Þ 2 SðapÞ� 2

g½Sða*Þ 2 Sðaur Þ�, a continuous function of g.

Importantly, under both of these options the firm’s lobbying cost is sim-ply the loss of core surplus associated with the action chosen in equilibrium,scaled by the degree of government efficiency. Option 2 is associated witha greater equilibrium action than option 1 and hence with a greater lossof core surplus: au

r > �ac1**ðgÞ implies Sða*Þ 2 Sðaur Þ > Sða*Þ 2 Sð�ac1**ðgÞÞ. Ac-

cordingly, an increase in government efficiency g increases the firm’s lob-bying cost by a greater amount under option 2 than under option 1 andhence reduces the appeal of option 2 relative to option 1:19 dU**

c2 =dg 2dU**

c1 =dg 5 2½Sða*Þ 2 Sðaur Þ� 1 ½Sða*Þ 2 Sð�ac**ðgÞÞ� < 0.

Next, let us examine the case of extremely high government efficiencyg 5 gmax. Under option 1, the optimal ceiling �ac**ðgÞ approaches first-bestaction a*, generating payoff Uc1**ð�ac1**ðgÞÞ ≈ pða*Þ for the firm. Under op-tion 2, negotiating ceiling ap would be extremely costly for the firm, yield-ing strictly negative payoffU**

c2 ð�ac2**ðgÞÞ ≪ 0. Clearly, in that case the firmwould select option 1.Finally, let us consider the case of g 5 r. It follows directly from condi-

tions (13) and (24) that under option 1 the optimal ceiling is �ac1**ðrÞ 5 aur ,

generating payoff U**c1 ð�ac1**ðrÞÞ 5 pðau

r Þ 2 r½Sða*Þ 2 Sðaur Þ� for the firm.

Under option 2, the firm’s payoff can be obtained by simply replacing g

with r: U**c2 ð�ac2**ðrÞÞ 5 pðau

r Þ 1 r½Sðaur Þ 2 SðapÞ� 2 r½Sða*Þ 2 Sðau

r Þ�. Evi-

19 This follows directly from the envelope theorem.


dently,U**c2 ð�ac2**ðrÞÞ > U**

c1 ð�ac1**ðrÞÞ, and hence option 2 is optimal at g 5 r.This is because while the lobbying cost is the same under both options atg 5 r, option 2 has the advantage of allowing the firm to extract social re-sponsibility wedge r½Sðau

r Þ 2 SðapÞ� from worker r.What we have just shown is that, for all g ∈ ½r, gmax�, (a) an increase in

government efficiency g decreases the appeal of option 2 relative to option 1and (b) option 1 is optimal when g 5 gmax, while option 2 is preferred wheng 5 r. Since as discussed aboveU**

c1 ð�ac1**ðgÞÞ andU**c2 ð�ac2**ðgÞÞ are both con-

tinuous functions of g over ½r, gmax�, there must exist a threshold level of gov-ernment efficiency gr ∈ ðr, gmaxÞ such that the firm optimally selects option 1for all g ∈ ½gr, gmax� and option 2 for all g ∈ ½r, grÞ.20

Region Where g ∈ ð0, rÞGiven the foregoing analysis, the equilibrium ceiling in this region is

easily determined. Option 2 is the same as above, with an optimal ceil-ing �a**c2 5 ap yielding payoff U**

c2 ð�ac2**ðgÞÞ 5 pðaur Þ 1 r½Sðau

r Þ 2 SðapÞ� 2g½Sða*Þ 2 Sðau

r Þ�. As for option 1, it is clear from condition (13) that thefirm’s payoff in that case is strictly increasing in the ceiling �a for allg ∈ ð0, rÞ and hence that the optimal ceiling is �ac1**ðgÞ 5 au

r , generating pay-offU**

c1 ð�ac1**ðgÞÞ 5 pðaur Þ 2 g½Sða*Þ 2 Sðau

r Þ� for the firm. Clearly, option 2is optimal for all g ∈ ð0, rÞ, as it allows the firm to extract the social respon-sibility wedge r½Sðau

r Þ 2 SðapÞ� from worker r.Thus, bringing together regions where g ∈ ð0, rÞ and g ∈ ½r, gmax�, the

equilibrium ceiling �ac**ðgÞ determined at date 0 can be expressed as follows:

8 g ∈ gr, gmax½ � : the firm sets ceiling �a**c gð Þ 5 �ac1** gð Þ ∈ a*, aurð Þ, with d�ac1**=dg < 0,

8 g ∈ g ∈ 0, grð Þ : the firm sets ceiling �a**c gð Þ 5 �ac2** 5 ap :

(

Based on this equilibrium ceiling, political contributions can be expressed as

C**c gð Þ 5 g S a*ð Þ 2 S �ac1

** gð Þð Þ½ � 8 g ∈ gr, gmax½ �,C**

c gð Þ 5 g S a*ð Þ 2 S aurð Þ½ � 8 g ∈ g ∈ 0, grð Þ:

8<: (25)

The firm’s hiring choice, the worker’s action, his compensation, and thefirm’s net payoff can be obtained from conditions (16), (14), (9), and (15),respectively. We state the equilibrium in the following lemma:

20 Note that in equilibrium the ceiling set by the firm is �ac**ðgÞ < aur for all

g ∈ ½gr, gmax�—this will be useful below. This follows directly from (i) �ac1**ðrÞ 5 aur ,

(ii) gr > r, and (iii) d�ac1**=dg < 0.


LEMMA 4: Under imperfectly efficient government, when both worker sandworker r are available in the labor market, there exists a gr ∈ ðr,1∞Þsuch that:

• For all g ∈ ½gr, gmax�: At date 0, the firmmakes political contributionC**

c ðgÞ > 0 to the government in exchange for setting regulatoryceiling �ac**ðgÞ, with �ac**ðgÞ ∈ ða*, au

r Þ and d�ac**=dg < 0. At date 1,the firm hires either type and requests action ac 5 �ac**ðgÞ. At date 2,the hired worker takes action �ac**ðgÞ and receives compensationWs 5 Wr 5 0, and the firm obtains payoff pð�ac**ðgÞÞ.

• For all g ∈ ð0, grÞ: At date 0, the firm makes political contributionC**

c ðgÞ > 0 to the government in exchange for setting regulatoryceiling �ac**ðgÞ 5 ap. At date 1, the firm hires worker r and requestsaction ac 5 au

r . At date 2, the hired worker r takes action aur and re-

ceives compensationWrðaur Þ 5 2r½Sðau

r Þ 2 SðapÞ�, and the firm ob-tains the total payoff pðau

r Þ 1 r½Sðaur Þ 2 SðapÞ�.

Lemma 4 highlights one of the key results of the model:

PROPOSITION 5: Under imperfectly efficient government, if responsibleworkers are available in the labor market, then below government effi-ciency level gr CSR endogenously emerges in profit-maximizing firms,which deliberately overcomply by taking actions strictly lower than theregulatory ceiling.

Intuitively,when thegovernment is relatively efficient (g ∈ ½gr, gmax�), lob-bying the government to raise the ceiling above a* is expensive for the firm,and hence in equilibrium the ceiling remains “close” to the first-best action.The ceiling thus remains binding regardless of the type of worker hired, andhence there is no social responsibilitywedge to extract fromworker r and noparticular incentive to hire him. In equilibrium, no CSR emerges because re-gardless of the type of worker hired, the action selected in equilibrium is sim-ply the ceiling. The equilibriumactionmaybe low,but this is due to a low andbinding ceiling rather than to a deliberately responsible action by the firm.In contrast, when government efficiency drops below gr, it becomes

cheap enough for the firm to lobby for a “very high” ceiling ap. Once thisceiling is set, the firm has a lot to gain by hiring the responsible worker be-cause it can extract maximum social responsibility wedge r½Sðau

r Þ 2 SðapÞ�from him through lower equilibrium wages if it allows him to “do good”and select action au

r < ap once hired. Indeed, CSR emerges endogenouslyin this case, as the firm and worker overcomply and select an equilibriumaction strictly lower than that mandated by law.Another implication of lemma 4 is that the social welfareTS**c ðacðgÞÞ gen-

erated in equilibrium, obtained by substituting the equilibrium action ac(g)into expression (5), can be expressed as


TS**c ac gð Þð Þ 51 1 r 1 gð ÞS �ac

** gð Þð Þ 8 g ∈ gr, gmax½ �,1 1 r 1 gð ÞS au

rð Þ 8 g ∈ 0, grð Þ:

((26)

For all g ∈ ð0, gmax�, the firm’s lobbying leads to an equilibrium ceilingstrictly greater than thefirst best: �ac**ðgÞ > a*. The hiredworker then selectsequilibrium action acðgÞ 5 �ac**ðgÞ for all g ∈ ð0, grÞ and acðgÞ 5 au

r for allg ∈ ½gr, gmax�. Either way, equilibrium action ac(g) is “too high” relative tothe socially optimal action a*, leading to suboptimal social welfareTS**c ðacðgÞÞ < TS*ða*Þ.

C. Impact of Socially Responsible Workers

What impact—if any—do responsible workers have on the firm and onsocial welfare? To address these questions, we compare the case where onlyworker s is available in the labor market with the case where both worker sand worker r are available.

Impact on the Firm

When the government is relatively efficient (g ∈ ½gr, gmax�), then as dis-cussed above if both types of workers are available to the firm it is never op-timal to lobby for a ceiling �a > au

r . Hence, comparing expressions (19) and(23) it is easy to see that the firm’s maximization program at date 0 is the samewhether it can hire worker s only or either type of worker at date 1. In eithercase, the firm lobbies for the same (relatively) low ceiling �as**ðgÞ 5�ac**ðgÞ ≤ au

r and elicits the same equilibrium action aiðgÞ 5 �ai**ðgÞ, i 5 s, c,at the highest level consistent with regulation. Unsurprisingly, then, the firmreceives the same payoff under both scenarios:U**

c ð�ac**ðgÞÞ 5 U**s ð�as**ðgÞÞ

for all g ∈ ½gr, gmax�.In contrast, when government efficiency drops below gr, the availability of

worker r in the labor market clearly makes the firm better off because thefirm can use lobbying to create a social responsibility wedge r½Sðau

r Þ 2 SðapÞ�for worker r, which it then extracts through contractual means. Thus,U**

c ð�ac**ðgÞÞ > U**s ð�as**ðgÞÞ for all g < gr.

PROPOSITION 6:When the government is relatively efficient (g ∈ ½gr, gmax�),responsible workers have no impact on firm profits. Below efficiencylevel gr, responsible workers make the firm strictly better off.

The main intuition behind these results is illustrated in figure 3, whichcaptures equilibrium regulatory ceilings and equilibrium actions as func-tions of government inefficiency g when only worker s is available andwhen both types of workers are available, respectively.


The critical government inefficiency threshold is gr ∈ ðr, gmaxÞ. To theright of gr, the government is well functioning and lobbying is quite costly.Lobbying does occur in equilibrium, as the firm negotiates a ceiling supe-rior to a*, but the level of lobbying is below what is required to makeCSR desirable. Regardless of whether responsible workers are availablein the labor market, the equilibrium level of lobbying remains the same:�as**ðgÞ 5 �ac**ðgÞ.To the left of gr, the availability of responsible workers in the labor mar-

ket dramatically changes the picture. Under relatively inefficient govern-ment, the firm now has an incentive to augment lobbying from a ceilingof �as**ðgÞ to a ceiling of �ac**ðgÞ 5 ap. The firm couples this with a respon-sible action au

r , creating a social responsibility wedge that it captures con-tractually. Thus, in this region the firm’s payoff is the profits from regularoperations plus the value of the social responsibility wedge it extracts.

Impact on Social Welfare

The impact of responsible workers on social welfare can be expressedsimply as the difference between the social surplus generated when bothworkers s and r are available and the social surplus generated when onlyworker s is available:

FIG. 3.—Main model: equilibrium regulatory ceilings and actions as functions ofgovernment efficiency g, in the case where only worker s is available (s subscript)and in the case where the firm has a choice (c subscript) between hiring either typeof worker (s or r). A color version of this figure is available online.


DTS** gð Þ 5 TS**c ac gð Þð Þ 2 TS**s as gð Þð Þ5 1 1 r 1 gð Þ S ac gð Þð Þ 2 S as gð Þð Þ½ � 8 g ∈ 0, ymaxð �:

(27)

We know from lemmas 3 and 4 that equilibrium actions as(g) and ac(g) arestrictly greater than the first-best action a*, for all g ∈ ð0, gmax�. Since S(.) iscontinuous and strictly decreasing over ða*,1∞Þ, an analysis of DTS**(g)then simplifies to a comparison between equilibrium actions:

DTS** gð Þ > 0 iff ac gð Þ < as gð Þ,DTS** gð Þ5 0 iff ac gð Þ 5 as gð Þ,DTS** gð Þ < 0 iff ac gð Þ > as gð Þ:

8>>><>>>:

(28)

Thus, consider again figure 3, which depicts equilibrium actions as func-tions of government efficiency. How does the availability of worker r (inaddition to worker s) in the labor market affect the equilibrium action im-plemented in the firm? To address this question, let us first underline thepotential opportunity that the availability of worker r brings about forthe firm: the creation of a social responsibility wedge r½Sðau

r Þ 2 SðapÞ� forworker r, which can then be extracted from him through lower wages.To achieve this, however, the firm must lobby the government for a highceiling ap and elicit overcompliant action au

r < ap from worker r. The intu-ition behind the impact of responsible workers on equilibrium actions de-rives from this insight, as shall now become clear.At high levels of government efficiency g ∈ ½gr, gmax�, the cost of lobbying

for ceiling ap is prohibitively high for the firm, and the creation of the socialresponsibility wedge is suboptimal. Accordingly, in this case the availabilityofworker r does not in fact bring any special opportunity for thefirm. Indeed,the firm lobbies for the same ceiling �ac**ðgÞ 5 �as**ðgÞ ≤ au

r and elicits thesame ceiling-bounded equilibrium action acðgÞ 5 �ac**ðgÞ 5 �a**s ðgÞ 5 asðgÞ,regardless of whether worker r is available. This explains why responsibleworkers have no impact on social welfare at high levels of government effi-ciency: DTS**ðgÞ 5 0 for all g ∈ ½gr, gmax�.At moderate levels of government efficiency g ∈ ðr, grÞ, lobbying costs

have two key characteristics.On the one hand, they are now low enough thatit is optimal for thefirm to create social responsibilitywedge r½Sðau

r Þ 2 SðapÞ�when worker r is available—a strategy that implies action acðgÞ 5 au

r beingchosen in equilibrium. On the other hand, lobbying costs in this intervalare still high enough that if only worker s is available, the equilibrium,ceiling-bounded action asðgÞ 5 �as**ðgÞ remains fairly low, lower in fact thanacðgÞ 5 au

r . Thus, under moderately efficient government, having access to


responsible workers is socially detrimental because the resulting firm’s at-tempt to create a social responsibilitywedge leads to a greater equilibrium ac-tion acðgÞ 5 au

r > �as**ðgÞ 5 asðgÞ than would prevail if only self-interestedworkers were available: DTS**ðgÞ < 0 for all g ∈ ðr, grÞ.Finally, at low levels of government efficiency g ∈ ð0, r� lobbying costs

further decrease, and hence the creation of social responsibility wedger½Sðau

r Þ 2 SðapÞ� remains the optimal choice for the firm when worker r isavailable, along with associated equilibrium action au

r . Under inefficient gov-ernment, however, lobbying costs are so low that if onlyworker s is available,it is now cheap enough for thefirm to lobby for a high ceiling, and the ceiling-bounded action asðgÞ 5 �as**ðgÞ that emerges in equilibrium is nowveryhigh,higher in fact than acðgÞ 5 au

r . Thus, under very inefficient government,having access to responsible workers is socially beneficial because the firm’sattempt to create a social responsibility wedge leads it to elicit a lower equi-librium action acðgÞ 5 au

r ≤ �as**ðgÞ 5 asðgÞ than would prevail if only self-interested workers were available: DTS**ðgÞ > 0 for all g ∈ ð0, r�.We summarize these key results in the following proposition:

PROPOSITION 7: At high levels of government efficiency g ∈ ½gr, gmax�,having access to a responsible worker in addition to a self-interestedworker has no impact on social welfare. At moderate levels of govern-ment efficiency g ∈ ðr, grÞ, access to a responsible worker has a negativewelfare impact. At low levels of government efficiency g ∈ ð0, r�, accessto a responsible worker has a positive welfare impact.

Other comparative statics behind proposition 7 are interesting and pointus again back to Friedman (1963). Note that the more responsible worker ris—that is, the higher the worker’s r—the larger the region ð0, rÞ overwhich having access to worker r is socially beneficial.Conversely, if the preference for social responsibility is low in the econ-

omy, then the corresponding value of r will be low. One can readily verifythat as r approaches zero, so does critical threshold gr, which as shown infigure 3 means that the region over which the firm lobbies for inefficientregulation and absorbs the surplus through contractual means will shrink.This point is relevant because it harkens back to the analysis provided byFriedman (1963): a necessary condition for firms to engage in regulatorycapture is that there is a sufficient aggregate preference for social responsi-bility.

V. Empirical Implications

At the broadest level, ourmodel implies connections between governmentefficiency and the strength of social preferences that seem to square with theobserved emergence of CSR. Combining the results of Sections III and IV, a


time-series interpretation of our analysis would frame the emergence of CSRas follows: with efficient government, there is little reason to consider CSR,but as government efficiencybegins todeteriorate, corruption rises. It contin-ues to rise as the quality of government deteriorates until some point afterwhich the clamoring about government quality grows so great that firmsare compelled to act in place of governments by engaging in CSR. In thatsense, our model is one example of what Benabou and Tirole (2010) havein mind when they write, “Society’s demands for individual and corporatesocial responsibility as an alternative response to market and distributivefailures are becoming increasingly prominent” (1). What our analysis makesclear, however, is that the ultimate welfare consequences of the pendulumswing toward social responsibility are not as clear cut.But at a more focused level, our model makes a number of specific empir-

ical predictions that are consistent with available empirical evidence. Wediscuss these in the four points below.First, in our model, when the firm engages in CSR, it encourages the re-

sponsible worker to “do good,” thereby artificially creating rents for him—

the social responsibility wedge—that it can extract from him through lowerwages. Thus, one key implication of our model is that employees workingin firms engaging in CSR should on average receive lower compensationthan employees working in similar firms not engaging in CSR—an implica-tion consistent with empirical evidence. Frank (2004), for example, uses sur-vey evidence from Cornell graduates to point to a compensating salary dif-ferential for CSR. The more recent work of Nyborg and Zhang (2013)shows that firms with a strong reputation for social responsibility pay38% less than firms with a weak reputation for CSR. This difference dropsto about 24% when one accounts for industry and gender/demographiccomposition of theworkforce. Finally, in a compelling new study using nat-ural field experiments, Burbano (2016) identifies a negative causal effect ofreceiving information about an employer’s social responsibility on prospec-tive workers’wage requirements for a job. Indeed, she finds a 44%decreasein the wage bids submitted by workers after learning about the employer’sCSR activity.21

21 It is reasonable to ask whether responsible workers, knowing that their pro-spective employer is at once lobbying for looser regulation and encouraging themto behave responsibly, are being willingly exploited by accepting lower wages. Giventhat lobbying will occur even among firms that do not hire socially responsible em-ployees, it seems reasonable to assume that a worker is unlikely to know about thefirm’s exact lobbying choices or the strategic reasons behind these choices. (In prac-tice, many firms conduct lobbying through trade associations, which would make itdifficult for a worker to infer a firm’s actual lobbying activity.) Instead, theymay sim-ply be aware of regulatory standards and confident in their ability to make more re-sponsible decisions should they be hired. In this case, all of the results of our modeldo carry through.


Second, in our model the firm engages in CSR by overcomplying withregulation. Hence, we should expect to see overcompliance in practice,whereby firms choose actions that are below regulatory standards. Over-compliance has been studied extensively in the context of environmentalregulation—water pollution regulation in particular—and consistent withour model, empirical evidence suggests that overcompliance is exceedinglycommon in this context. For example, using 1992 data from US pulp andpaper plants, McClelland and Horowitz (1999) find that biochemical oxy-gen demand (BOD) emissions (a common measure of pollution) that yearwere about 50% of the amount allowed under the Clean Air Act. Similarly,data from 1989 suggest that Swedish pulp and paper plants also producedemissions far below regulatory standards (Brannlund and Lofgren 1996).Indeed, more recent data paint a similar picture: tracking 251 “major” pulpand paper plants across 28 US states over the period 1990–2004, ShimshackandWard (2008) find BOD discharges at less than 40% of permitted levels,while Bandyopadhyay andHorowitz (2006) assess BOD emissions at 60%of permitted levels in US sewage treatment plants over the period 1991–99.Third, our model predicts a negative relationship between the stringency

of regulation faced by a firm and its propensity to engage in CSR. As dis-cussed above, efficient government leads to low lobbying and stringent reg-ulation as well as to no or little CSR. In contrast, inefficient governmentyields more lobbying and looser regulation, together with more CSR en-gagement. This prediction is consistent with Nakamura, Takahashi, andVertinsky’s (2001) study of Japanese firms’ managerial responses to envi-ronmental issues—which points to a negative relationship between govern-ment pressure to improve environmental performance and firms’ decisionsto seek ISO 14001 environmental certification. In addition, Arora andCason(1995) and Uchida and Ferrero (2007) find that firms with substantial toxicreleases and firms in industries with large chemical emissions—arguablyfirms in a loose regulatory environment—are significantly more likely toovercomply and engage in voluntary environmental management, a findingalso consistent with our model’s prediction.Last but not least, our model points to a positive relationship between lob-

bying and CSR activities: firms may lobby for loose regulation because, cou-pledwith engaging inCSR activities, itmay enable them to create and capturethe social responsibility wedge discussed above. Consistent with this predic-tion, Bernhagen, Kollman, and Patsiurko (2016) find—using a hand-collectedsample of 2,000 firms from around the world—that firms engaging in cor-porate political action (i.e., lobbying) are significantly more likely to employCSR-related strategies, such as signing on to the human rights, environmental,and good governance principles of the UN Global Compact.Also consistent with our model is the recent work of Werner (2015),

which points to a positive relationship between firms’ CSR ratings in theKLD database (a widely used database for social responsibility research)


and their ability to lobby policy makers. Werner’s informal theory under-lining this result is that policy makers want to grant access to firms withgood “sociopolitical reputations” and that CSR helps policy makers iden-tify these reputable firms. Our model proposes a distinct and complemen-tary theory to explainWerner’s results and implies that a third factor—gov-ernment inefficiency—may positively affect both lobbying and CSR.Finally, Richter (2011)finds thatCSR activity and corporate lobbying are

commonly observed in the same firms. He finds that about 28% of firms onthe KLD database also engage in lobbying, based on data from the Centerfor Responsive Politics. He documents the fact that on average firms that doboth have higher Tobin’s q than firms that do only one or the other, and hesuggests that CSR and lobbying may be complements to each other. This isbroadly consistent with the predictions of our model, although as we dis-cuss in the next section, whether the social responsibility wedge is reflectedin equity prices hinges critically on the nature of the CSR activity and theability to pledge it to the owners of the firm.Note that given the empirical evidence suggesting that lobbying costs are

actually quite small as a fraction of firm value, it is quite easy to imagine thatthey are an order of magnitude below the social responsibility rent extrac-tion that occurs with workers at all levels of the organization—justifyingwhy firms may be willing to engage in extra lobbying in order to achievegains fromCSR. In particular, resources likeOpenSecrets.org, which trackspolitical contributions in the United States, suggest that firms’ lobbyingcosts are only a tiny fraction of their overall profits. For example, the topinsurance company in terms of lobbying in 2012 was Blue Cross BlueShield, which paid a little over $6 million in lobbying costs. Total lobbyingcontributions by all firms in the finance sector were $500 million in thatyear. General Motors spends around $10million per year in lobbying costs.These anecdotes comport with a large body of empirical evidence on the

magnitudes of political contributions, lobbying, and their associated re-turns. Ansolabehere, de Figueiredo, and Snyder (2003) document the factthat influence payments in the form of campaign contributions seem rathermodest; Milyo, Primo, and Groseclose (2000) show that lobbying expensesare about 10 times larger than all other forms of political contributions butargue that indeed the dollars that flow into lobbying are small relative to thepolitical returns from lobbying. De Figueiredo and Silverman (2006) showthat the returns to lobbying for earmarks are on the order of $10 for every$1 of lobbying expenses. Somemultinational corporations operate at a scalecomparable to that of many small national governments. For example, theDanish shipping line Maersk employs around 100,000 people globally,while the Danish workforce comprises around 2.8 million people. Its globalrevenues in 2011 were about half as large as the Danish national govern-ment’s budget. In situations like this, the firm presumably has significantlobbying power, in which case the lobbying costs may be trivial relativeto the gains from CSR.


VI. Interpretations and Extensions

The model presented thus far is intentionally stark to stress its main in-sights. In particular, we have suppressed any discussion to this point ofwhether workers and citizens are one and the same as well as any agencyconsiderations arising from disbursed ownership of the firm and whetherthe social responsibility wedge created through judicious lobbying is sharedamong different stakeholders of the firm.We take up these issues in this sec-tion and explore other interpretations based on related but distinct organi-zational arrangements that relate to our main analysis.

A. Outside Equity and Managerial Agency

A natural question that arises in the analysis of our model is what wouldhappen if we allowed citizens to instead be shareholders of the firm that ischoosing to engage in social responsibility. There are two distinct issues thatarise here. One is that their ownership of the firm may partly compensatethem for the utility loss associated with the firm’s production activities, ef-fectively narrowing the wedge between what is privately optimal for thefirm and what is socially optimal.In the main analysis of the model, there is no distinction between the two

alternative sources of firm value: profits associated with production (p(a) inthe analysis) and rents that accrue to the firm associated with allowing a re-sponsible worker to take a less socially destructive action. No such distinc-tion is required because the main analysis is not concerned with how therents and profits are shared between the firm and its owners. In the simplestpossible formulation, allowing citizens to be owners of the firm would ef-fectively lower the cost of the negative spillovers that citizens experience,narrowing the distance between ap and a*. Under this formulation, noneof the model’s results would change as long as outside shareholders do notown 100% of the firm.Perhaps a more interesting case arises when the pledgeability of produc-

tion profits and social responsibility rents differs. At one extreme, considerthe case inwhich the profits associatedwith production can be fully pledgedto outside shareholders, while the rents extracted from responsible agentsare purely captured by the firm’s managers. If this is the case, then share-holders are strictly worse off under socially responsible than under pureself-interestedmanagement: they receive a fraction of pðas*Þ in the latter casebut a fraction of pðar*Þ < pðas*Þ in the former case. Thus, under this formu-lation pursuing CSR destroys shareholder value.This version of the model delivers the exact predictions tested in recent

empirical work byCheng,Hong, and Shue (2012). They use shocks toman-agerial ownership induced by dividend tax cuts as well as regression discon-tinuities around close shareholder votes to find that firms engage in less so-cial responsibility when the level of agency problems inside the firm drops.That is, among firms in which effective managerial ownership increased as a


result of the 2003 dividend tax cuts, CSR activity dropped. Likewise, CSRactivity is lower in firms just above the 50% shareholder vote cutoff than inthose just below it. Both of these results square with a version of our modelinwhich the rent extraction associatedwithCSR accrues to insiders, and it istherefore inconsistent with shareholder value maximization.Alternatively, if we assume that the rents from CSR activity can be

pledged to outsiders, then outside shareholders have a stake not only onp(a) but also on P(a). At this opposite extreme, what is good for the firmis also good for its shareholders. Formulations along these lines are supportedby work like that done by Edmans (2011), who shows that firms that behaveresponsibly toward employees earn higher abnormal returns.More generally, our model stresses the fact that the welfare implications

for shareholders of CSR are not straightforward but depend onwhether thesocially responsible actions flow through to the net profits of the firm or aredissipated as private benefits inside the firm. While ultimately it may be anempirical question as to which scenario dominates, the same basic incentivestructures among firms, the government, and other stakeholders give rise toeither set of predictions.

B. Contrasting Social Entrepreneurship and CSR

The welfare implications of our model hinge critically on whether theCSR that we observe has been purchased through inefficient regulation.In our analysis, we have considered a situation in which a firm can lobbyfor inefficient regulation and then partly capture the rents associated withthe provision of social welfare. This balance between the deadweight costof inefficient regulation and social welfare creation associated with CSR isprecisely what poses difficulties for the welfare analysis.What if instead firms were too small to have an effect on government be-

havior? If regulation is exogenously inefficient, then it is straightforward tosee from our analysis that CSR is unambiguouslywelfare increasing. In otherwords, if we simply fix an exogenously specified regulatory ceiling and con-trast social welfare before and after the introduction of socially responsibleworkers in the labor market, the welfare implications are clear.This invites a broader discussion of alternative types of corporate social

behavior. In particular, social entrepreneurship—the phenomenon in whichentrepreneurial start-ups focus solely or partly on social, nonprofit objec-tives—has emerged in tandem with CSR as another mode of corporate so-cial behavior. Given the limited ability of small entrepreneurial organizationsto be implicated in setting the equilibrium level of regulation to which theyrespond, our model suggests that firm size is related to the welfare conse-quences of social responsibility. Our model predicts that social firms—thosethat operate small-scale organizations aimed at alleviating social ills, butwith a profit motive—are much more likely to be welfare increasing for so-ciety as a whole than CSR initiatives undertaken by large organizations that


could reasonably be expected to affect the equilibrium behavior of regula-tory institutions.

C. A Social Venture Capital Interpretation of the Model

An alternative interpretation of our model is in terms of the relationshipbetween a social entrepreneur and her source of funding. In particular, by re-casting the firm/worker relationship in ourmodel as a relationship between aventure capitalist and a social entrepreneur, our model offers predictionsabout the nature of their funding relationship. Under this formulation ofthe model, the firm is a venture capital organization that funds start-ups,and a worker of a particular type is an entrepreneur seeking funding.For instance, assume that two identical entrepreneurs seek outside fund-

ing to start their firms. One venture focuses solely on maximizing profits,while the second venture operates in the same sector but pursues a “multi-stakeholder” approach and trades off profit maximization against other ob-jectives, such as worker happiness and socially responsible supply chains.That is, the self-interested venture intends to operate its business plan in aprofit-maximizing way, while the socially responsible venture operates asimilar business model but trades off monetary profits for social consider-ations.Our model predicts that the social entrepreneur will bear the entire cost

of deviating from profit maximization.22More precisely, ourmodel predictsthat the venture capitalist, acting as principal, will allow the socially respon-sible firm to operate its business plan according to a multistakeholder ap-proach but in doing so will extract more concessions from them such thattheir expected returns are at least as high as theywould be if they only fundedprofit-maximizing firms. In the eyes of the social entrepreneur, the venturecapitalist appears to claim that he or she intends to fund socially mindedstart-ups but make the start-up bear the cost of the social benefits in the formof lower valuations.

VII. Conclusion

The rise of CSR raises important questions about the motivations ofprofit-maximizing firms and the consequences of their actions. Why woulda profit-maximizing firm hire workers and allow them to stray from profitmaximization in order to serve a larger social purpose? What happens as aconsequence? In this paper, we study issues directly connected to thesequestions. First, we derive conditions under which CSR arises endogenously

22 Baron (2007) makes a very similar point in his analysis of CSR and social en-trepreneurship when he points out that shareholders of CSR-oriented ventures whoanticipate the CSR activity fully charge the entrepreneur for the cost of the CSR andbear none of it themselves.


as a response to other economic forces. In this respect, our analysis offers apositive theory of CSR. Second, we askwhether society’s increased demandsfor such behavior are welfare improving. In that respect, it offers a normativetheory of CSR.Ourmodel helps to clarify the distinction between the endogenous emer-

gence of CSR as a social phenomenon and an exogenous preference for so-cial responsibility that is manifest in society. The emergence of CSR in ourmodel hinges on the incentives of government. Crucially, in a world inwhichgovernments maximize social welfare, the presence of workers who are pos-itively inclined toward social action is irrelevant: CSR never occurs. Indeed,for CSR to arise as a manifestation of social preferences, governments musteither suffer from incentive problems that cause them to deviate from socialwelfaremaximization or lack the technology to ensure compliance.Our anal-ysis focuses on the case in which incentive problems in regulation createscope for CSR, but similar results would obtain in a world in which well-intentioned governments lacked the technology to monitor regulatory com-pliance effectively.23

Although our analysis shows how CSR can emerge as an equilibrium re-sponse to a government that strays from the objective of social welfare max-imization, our model makes it clear that whether this is good for society as awhole is far from obvious. In a narrow sense, the emergence of CSR raisessocial welfare relative to what would be obtained under a similar degree ofregulatory inefficiency. But the ability to capture economic rents associatedwith CSR can create an incentive for firms to engage in influence behaviorthat affects the regulatory behavior of the government in the first place. Thisconcern is captured in sentiments expressed by observers like former UnitedNations Secretary General Kofi Annan, who wrote that “business must re-strain itself from taking away, by its lobbying activities,what it offers throughcorporate responsibility” (AccountAbility and UN Global Compact 2005,11). Comments like this stress a dark side to CSR even in a setting in which,all else equal, society is seemingly better off with it than without it.In that sense, the tension in our model is related to what is sometimes re-

ferred to as the cobra effect.24 Holding constant the amount of inefficientregulation, introducing CSR may be welfare improving, but at the sametime CSR may itself create broader social forces that divert resources awayfrom institutions that would otherwise promote the adoption of efficientregulation.

23 We demonstrate this point in ongoing work, in a model where corporationsvoluntarily comply with regulations and are subject to random inspections.

24 Allegedly, the British rulers of India, frustrated by the great number of cobrasin the area, offered a reward for every cobra carcass brought to the authorities. Thereward created a thriving market for the farming of baby cobras. On learning thattheir policies had backfired, the reward was banished, which in turn caused scoresof baby cobras, now worthless, to be released, greatly exacerbating the problem.


To keep the analysis simple, our model casts CSR, in its regulatory over-compliance, as unambiguously prosocial corporate behavior; however, ourresults generalize to settings in which CSRmay be a form of catering to cer-tain special interest groups. It is possible to recast ourmodel as one inwhichalternative interest groups, some of whomwant one thing and some another,compete for social action through the corporate sector instead of throughpolitical channels. In this broader sense, firms can be seen as using politicalinfluence to purchase a right that they then give away to a special interestgroup in exchange for some surplus that they capture from that group.Overall, our analysis is both an explication and a critique of Friedman’s

original analysis. His concern was that social responsibility causes businessto become “unwitting puppets of the intellectual forces that have been under-mining the basis of a free society these past decades” (Friedman 1970, 33).Our model illustrates how CSR, when viewed as a form of corporate self-policing, can create incentives that undermine the quality of oversight. Butin our analysis, the concern is not that businesses are unwitting puppets ofbroader social forces but rather that they arewillful puppetmasters exploitingbroader social forces. Regardless of whether exploiting these forces benefitsshareholders or is purely a form of managerial agency, the mere presence ofCSR cannot be viewed as a benefit or a cost without a careful examination ofthe root causes of the underlying inefficiencies that give rise to its preva-lence in the first place.

Appendix

Robustness

While our main arguments are developed with the simplest model possi-ble, in this section we consider a number of extensions to show that ourmain analysis is robust to various technical considerations: worker limitedliability, ex ante bargaining power, action contractability, and asymmetricinformation.

A1. Limited Worker Liability

In this appendix, we examine the scenario in which workers have limitedwealth w0 ∈ R11. We show that the results of the main model remain verysimilar under this assumption. As in themainmodel, we determine the equi-librium by backward induction.

A1.1. Hiring Worker sClearly, when worker s is hired, nothing changes in our model: the firm

continues to pay the workerWs 5 0, the action as that it asks the worker toselect remains determined by condition (6), and its payoff as a function ofceiling �a, Psð�aÞ, is still determined by condition (7).


A1.2. Hiring Worker rLet us now examine the case in which a wealth-constrained worker r

is hired. As in the main model, we consider first the government-unconstrained scenario in which no ceiling is constraining the action re-quested by the firm from worker r. Similar to the main model, the firm’sprogram involves choosing worker action a, base salary wll, and bonus bll

to maximize its program pðaÞ 2 ðwll 1 bllÞ, subject to the IC constraintbll 1 rSðaÞ ≥ rSða*Þ and to the IR constraint wll 1 bll 1 rSðaÞ ≥ rSðasÞ.We denote the worker’s total compensation Wll 5 wll 1 bll .The main difference with the main model is that the firm faces an additional

constraint—the worker’s limited liability (LL) constraint: wll 1 bll ≥ 2w0.Indeed, the IR and LL constraints can be merged into one constraint, ex-pressed as

wll 1 bll ≥ max 2r S að Þ 2 S asð Þ½ �;2w0f g: (A1)

Thus, we can express the firm’s government-unconstrained maximizationprogram in a simplified way as follows:

maxa

p að Þ 1 min r S að Þ 2 S asð Þ½ �;w0f g, (A2)

with as 5 �a if �a ≤ ap and as 5 ap if �a > ap.It follows directly from constraint (A1) and from the analysis of the main

model that whenw0 ≥ r½Sðaur Þ 2 SðapÞ�, the LL constraint is never binding.

This is because the agent’s wealthw0 is greater than the maximum social re-sponsibility wedge r½Sðau

r Þ 2 SðapÞ� that the firm may wish to extract fromhim. Thus, in that case the results remain exactly as in the main model. Tokeep the analysis interesting in this appendix, we impose the following para-metric restriction:

w0 ∈ 0, r S aurð Þ 2 S apð Þ½ �ð Þ: (A3)

To simplify the analysis going forward, let us define the following vari-ables and functions. First, we define �a1 as the value of the ceiling �a suchthat r½Sðau

r Þ 2 Sð�a1Þ� 5 w0. We also define allð�aÞ 5 f ð�aÞ as the value ofthe selected worker action a such that, for any given ceiling �a,r½SðallÞ 2 Sð�aÞ� 5 w0 for all �a > �a1. The implicit function theorem andthe fact that S0ð:Þ < 0 for all a > ap imply immediately that f 0ð�aÞ > 0 andallð�aÞ > au

r for all �a > �a1. Moreover, condition (A3) implies aur < �a1 < ap

and aur < allðapÞ < ap.

In this and the following subsections, we prove a series of results that willhelp determine the equilibrium of the game. The first result pertains to thefirm’s optimal choice of action all to be requested from worker r as a func-tion of the ceiling �a.


RESULT E1: For a given regularity ceiling �a, the firm’s optimal choice ofaction all to be requested from worker r is

all 5

�a if �a ∈ 0, aur½ �,

aur if �a ∈ au

r , �a1ð �,all �að Þ if �a ∈ �a1, apð �,all apð Þ if �a ∈ ap,1∞ð Þ:

8>>>>>><>>>>>>:

(A4)

Proof: Let �a ∈ ½0, aur �. Then all 5 �a for the same reasons as in the main

model: the ceiling is binding, and there is no social responsibility wedgeto extract from the worker.

Let �a ∈ ðaur , �a1�. Then all 5 au

r for the same reasons as in themainmodel:setting all 5 au

r allows the firm to extract social responsibility wedger½Sðau

r Þ 2 Sð�aÞ� from the worker.Let �a ∈ ð�a1, ap�. Then r½Sðau

r Þ 2 Sð�aÞ� > w0, and the LL constraint isbinding at a 5 au

r . It follows directly from constraint (A1)—andfrom the fact that p0ð:Þ > 0 for all a < ap and p0ð:Þ 1 rS0ð:Þ < 0 for alla < au

r—that the optimal strategy for the firm is to raise the requested ac-tion a to the point where r½SðaÞ 2 Sð�aÞ� 5 w0, that is, to a 5 allð�aÞ.

Let �a ∈ ðap,1∞Þ. Then as 5 ap, and thefirm’s objective function can ex-pressed as pðaÞ 1 minfr½SðaÞ 2 SðapÞ�;w0g. Since r½Sðau

r Þ 2 SðapÞ� > w0,the LL constraint is binding at a 5 au

r . For the same reasons as in the casewhere �a ∈ ð�a1, ap�, the optimal strategy for the firm is to raise the requestedaction a to the point where r½SðaÞ 2 SðapÞ� 5 w0, that is, to a 5 allð�aÞ.QED

Note that when the ceiling �a > �a1, we have allð�aÞ > arð�aÞ, for the reasonsprovided in the proof of result E1. When �a > �a1, the LL constraint is bind-ing at au

r , and the firm will not be able to extract the entire social responsi-bility wedge r½Sðau

r Þ 2 Sð�aÞ� from the worker, extracting instead onlyw0 < r½Sðau

r Þ 2 Sð�aÞ�. By increasing the requested action from aur to allð�aÞ

such that r½Sðallð�aÞÞ 2 Sð�aÞ� 5 w0, the firm continues to extract w0 fromthe worker but increases its profit from pðau

r Þ to pðallð�aÞÞ.

RESULT E2: For a given regularity ceiling �a, the firm’s equilibrium payoffPll if it hires worker r is

Pll �að Þ 5

p �að Þ if �a ∈ 0, aur½ �,

p aurð Þ 1 r S au

rð Þ 2 S �að Þ½ � if �a ∈ aur , �a1ð �,

p all �að Þð Þ 1 w0 if �a ∈ �a1, apð �,p all apð Þð Þ 1 w0 if �a ∈ ap,1∞ð Þ:

8>>>>>><>>>>>>:

(A5)


Proof: Follows directly from result E1. QED

Note that when the ceiling �a > �a1, we have Pllð�aÞ < Prð�aÞ. Beyond ceilingthreshold �a1, the worker’s wealth constraint prevents the firm from extract-ing the entire social responsibility wedge from him, leading to a lower equi-librium payoff for the firm.

A1.3. Optimal Hiring Choice as a Function of Regulatory CeilingComparing payoffs Psð�aÞ and Pllð�aÞ, defined in conditions (7) and (A5),

respectively, it follows directly that

if �a ∈ 0, aur½ � : the firm is indifferent between workers, requests action �a;

if �a ∈ aur ,1∞ð Þ: the firm hires worker r, requests action all �að Þ:

(

(A6)

The logic behind this result is identical to that presented in the main textand is omitted here.A1.4. Regulatory Ceiling, Hiring, and Actions in EquilibriumLet us define Vð�aÞ as follows:

V �að Þ 5 p all �að Þð Þ 1 r S all �að Þð Þ 2 S �að Þ½ � 2 g S a*ð Þ 2 S all �að Þð Þ½ �5 p all �að Þð Þ 1 w0 2 g S a*ð Þ 2 S all �að Þð Þ½ �:

(A7)

For simplicity, we assume that p(.) and S(.) are such that V(.) is strictlyconcave in �a.

RESULT E3: Let us also define �a2ðgÞ as the value of regulatory ceiling �asuch that dVð�aÞ=d�a 5 0. Then �a2ðgÞ is strictly decreasing in g.

Proof: Differentiating V(.) with respect to �a yields:

dVd�a

5∂p∂all

∂all

∂�a1 g

∂S∂all

∂all

∂�a5

∂p∂all

1 g∂S∂all

� �∂all

∂�a: (A8)

Using the implicit function theorem, we can write d�a2=dg 5 2½ð∂S=∂allÞð∂all=∂�aÞ�=ðd2V=d�a2Þ < 0 by the strict concavity of V(.). QED

RESULT E4: Let us define ceiling thresholds gll and gp such that�a2ðgllÞ 5 �a1 and �a2ðgpÞ 5 ap. Then r ≥ gll > gp > 0.

Proof: Showing that r ≥ gll . Consider expression (A8) at ceiling value r:

dVd�a

5∂p∂all

1 r∂S∂all

� ∂all

∂�awhen g 5 r:


As shown above, allð�aÞ > aur for all �a > �a1. Together with condition (13)

and the strict concavity of pð:Þ 1 rSð:Þ, this implies ð∂p=∂allÞ 1rð∂S=∂allÞ < 0 for all �a > �a1. We have also shown above that ∂all=∂�a > 0.Accordingly, when g 5 r, dV=d�a < 0 for all �a > �a1. By the strict concav-ity of V(.), we must have �a2ðrÞ ≤ a1, which implies �a2ðrÞ ≤ �a2ðgllÞ. Re-sult E3 then yields r ≥ gll .

Showing that gll > gp. As discussed above, condition (A3) implies �a1 <ap, which by definition implies �a2ðgllÞ < �a2ðgpÞ. Result E3 then yields gll >gp.

Showing that gp > 0. Note that limg→ 0 dV=d�a 5 ð∂p=∂allÞð∂all=∂�aÞ 50 iff ∂p=∂all 5 0, iff allð�aÞ 5 ap. It then must follow that limg→ 0 �a2ðgÞ 5f 21ðapÞ is strictly superior to ap by definition of f(.): limg→ 0 �a2ðgÞ > ap. Re-sult E3 then implies gp > 0. QED

RESULT E5: There exists a threshold level of government efficiencyg0r > r such that the optimal regulatory ceiling �all**ðgÞ lobbied by the firm

at date 0 can be expressed as follows as a function of g:

�a**ll gð Þ 5

�ac1** gð Þ if g ∈ g0

r, gmax½ �,�a1 if g ∈ gll , g0

r½ Þ,�a2 gð Þ if g ∈ gp, gll½ Þ,ap if g ∈ 0, gpð Þ:

8>>>>><>>>>>:

Proof: We define Ull as the firm’s payoff from a date 0 viewpoint:

Uu �að Þ 5

p �að Þ 2 g S a*ð Þ 2 S �að Þ½ � if �a ∈ 0, aur½ �,

p aurð Þ 1 r S au

rð Þ 2 S �að Þ½ � 2 g S a*ð Þ 2 S aurð Þ½ � if �a ∈ au

r , �a1ð �,p all �að Þð Þ 1 w0 2 g S a*ð Þ 2 S all �að Þð Þ½ � if �a ∈ �a1, apð �,p all apð Þð Þ 1 w0 2 g S a*ð Þ 2 S all apð Þð Þ½ � if �a ∈ ap,1∞ð Þ:

8>>>>>><>>>>>>:

(A9)

Note that Ullð�aÞ 5 UllðapÞ for all �a ∈ ½ap,1∞Þ, making the firm indif-ferent between any value of �a ∈ ½ap,1∞Þ. As in the main text, we as-sume that when indifferent the firm selects the Pareto optimal courseof action, which in this case is �a 5 ap. Hence, we can rule out �a ∈ðap,1∞Þ as a possible choice by the firm. Furthermore, note that withininterval ðau

r , �a1�, the cost of lobbying remains constant at g½Sða*Þ 2 Sðaur Þ�,

and hence the unique optimal ceiling choice for the firm is �a 5 �a1. There-fore, for any g ∈ ð0, gmax�, the firm in effect lobbies for ceiling �a ∈ ½0, au

r �,�a 5 �a1, or �a ∈ ð�a1, ap�. We prove result E5 in several steps.


Let g ∈ ½gll, gmax�. By definition ofVð�aÞ and of gll such that �a2ðgllÞ 5 �a1,it is clear that dV=d�a < 0 for all �a > �a1. Hence, �a ∈ ð�a1, ap� is never opti-mal for all g ∈ ½gll , gmax�, and the firm in effect has a choice between twooptions similar to those described in the main text. Under option 1, thefirm lobbies for an equilibrium ceiling �all1**ðgÞ 5 �ac1**ðgÞ ∈ ða*, au

r Þ de-fined in expression (24), generating payoffU**

ll1 ð�all1**ðgÞÞ 5 pð�all1**ðgÞÞ 2g½Sða*Þ 2 Sð�all1**ðgÞÞ� 5 U**

c1 ð�ac1**ðgÞÞ. Under option 2, the firm lobbiesfor ceiling �all2** 5 �a1, generating payoff U**

ll2 ð�a1Þ 5 pðaur Þ 1 w0 2

g½Sða*Þ 2 Sðaur Þ�. Using a proof almost identical to that used in main text

(omitted here for the sake of concision), one can readily show that thereexists a threshold level of government efficiency g0

r > r such that�all**ðgÞ 5 �all1**ðgÞ 5 �ac1**ðgÞ if g ∈ ½g0

r, gmax� and �all** 5 �all2** 5 �a1 if g ∈½gll , g0

rÞ. Note that the same proof also suggests that �all1**ðgÞ is a strategythat is strictly dominated by �all2** 5 �a1 and thus that this strategy can beignored for all g ∈ ð0, g0

rÞ. It then follows that, in the discussion belowabout equilibrium ceiling choice for g ∈ ð0, gllÞ, the firm in effect lobbieseither for ceiling �a 5 �a1 or for �a ∈ ð�a1, ap�. Either way, the firm’s payofffunction is Vð�aÞ for all �a ∈ ½�a1, ap�.

Let g ∈ ½gp, gllÞ. As just discussed, over this interval the firm max-imizes payoff function Vð�aÞ and hence selects �all**ðgÞ 5 �a2ðgÞ for all g ∈½gp, gllÞ. By definition of gll and gp such that �a2ðgllÞ 5 �a1 and �a2ðgpÞ 5ap, respectively, we know that ðdV=d�aÞð�a1Þ 5 0 at gll andðdV=d�aÞðapÞ 5 0 at gp. Moreover, we know from result E2 that �a2ðgÞis strictly decreasing in g. Hence, we must have �a**ll ðgÞ 5 �a2ðgÞ ∈ ð�a1, ap�,with d�all**=dg for all g ∈ ½gp, gllÞ.

Let g ∈ ð0, gpÞ. Over that interval, cleary dV=d�a > 0 for all ceilings�a ∈ ½�a1, ap�. But the firm’s pay off stays constant at V(ap) for all �a ∈ðap,1∞Þ, and hence as discussed above in that case the firm lobbies forthe Pareto optimal ceiling �a 5 ap. QED

We state the resulting equilibrium in the following lemma:

LEMMA 5: When the firm can choose between a self-interested workerand a responsible worker and workers are wealth constrained withwealth w0, the following equilibrium emerges:

• For all g ∈ ½g0r, gmax�. At date 0, the firm makes contribution

C**ll ðgÞ 5 g½Sða*Þ 2 Sð�ac1**ðgÞÞ� to the government in exchange for

setting regulatory ceiling �all**ðgÞ 5 �ac1**ðgÞ, with �ac1**ðgÞ ∈ ða*, aur �

and d�ac1**=dg > 0. At date 1, thefirmhires eitherworker and requestsaction all 5 �ac1**ðgÞ. At date 2, the hired worker takes action �ac1**ðgÞand receives compensation Wllð�ac1**ðgÞÞ 5 0, and the firm obtainspayoff pð�ac1**ðgÞÞ.


• For all g ∈ ½gll, g0rÞ. At date 0, the firm makes contribution

C**ll ðgÞ 5 g½Sða*Þ 2 Sðau

r Þ� to the government in exchange for set-ting regulatory ceiling �all**ðgÞ 5 �a1. At date 1, the firm hires wor-ker r and requests action all 5 au

r . At date 2, the hired worker r takesaction au

r and receives compensation Wrðaur Þ 5 2w0, and the firm

obtains payoff pðaur Þ 1 w0.

• For all g ∈ ½gp, gllÞ. At date 0, the firm makes contributionC**

ll ðgÞ 5 g½Sða*Þ 2 Sðallð�a2ðgÞÞÞ� to the government in exchangefor setting regulatory ceiling �all**ðgÞ 5 �a2ðgÞ. At date 1, the firmhires worker r and requests action all 5 allð�a2ðgÞÞ. At date 2, thehired worker r takes action allð�a2ðgÞÞ and receives compensationWllðallð�a2ðgÞÞÞ 5 2w0, and the firm obtains payoff pðallð�a2ðgÞÞÞ1w0.

• For all g ∈ ð0, gpÞ. At date 0, the firm makes contributionC**

ll ðgÞ 5 g½Sða*Þ 2 SðallðapÞÞ� to the government in exchange forsetting regulatory ceiling �a**ll ðgÞ 5 ap. At date 1, the firm hires wor-ker r and requests action all 5 allðapÞ. At date 2, the hired worker rtakes action allðapÞ and receives compensation WllðallðapÞÞ 5 2w0,and the firm obtains payoff pðallðapÞÞ 1 w0.

Proof: Follows directly from results E1–E5. QED

The intuition behind lemma 5 can be illustrated with figure A1.When g ∈ ½g0

r, gmax�, the situation is the same as in themainmodel: the gov-ernment is efficient, and lobbying is costly. The equilibrium ceiling �all**ðgÞ isbelow au

r , and the firm is indifferent between the two types of workers.For all g < g0

r, the firm anticipates it will hire worker r. When g ∈ ½gll, g0rÞ,

the firm sets the ceiling at �a1 such that, by requesting action aur from the

worker, it can extract rents from him equal to his entire wealth w0 5r½Sðau

r Þ 2 Sð�a1Þ�. When g ∈ ½gp, gllÞ, government inefficiency increases fur-ther, and lobbying becomes “cheaper.” It then becomes optimal for thefirmto raise the ceiling to �a2ðgÞ > �a1 and to raise the requested worker actionallð�a2ðgÞÞ in order to generate and extract a social responsibility wedge ex-actly equal to the worker’s wealth. Finally, when g ∈ ð0, gpÞ, lobbying is socheap that the highest ceiling ap becomes optimal, with equilibrium actionallðapÞ still chosen so as to make the social responsibility wedge exactlyequal to w0. In other words, for all g < g0

r, the firm extracts all of worker r’swealth through the social responsibility wedge, with the ceiling weaklyincreasing with government inefficiency.Importantly, the key results from the main model continue to hold over-

all when we assume wealth-constrained workers: propositions 3–6, for ex-ample, are robust to the wealth-constrained worker assumption, albeit re-placing threshold level of government efficiency gr with g0

r (proofs follow


directly from the above analysis). Moreover, similar to proposition 7, wecan show the following:

PROPOSITION 8: When worker r is wealth constrained, there exist thresh-old levels of government efficiency glo and ghi with 0 < glo ≤ ghi < g0

r

such that for all g ∈ ðghi, g0rÞ social responsibility has a negative impact

on social welfare and for all g ∈ ð0, gloÞ social responsibility has a positiveimpact on social welfare.

Proof: Consider the scenario in which both types of worker are availablein the labor market. As in the main text, the social welfare TS**ll ðacðgÞÞgenerated in equilibrium can be obtained by substituting the equilibriumaction all (g) into expression (5). In the scenario in which only worker sis available, social welfare TS**s ðasðgÞÞ is the same as in the main text.Hence, the welfare impact of responsible workers can be expressed as

DTS**ll gð Þ 5 TS**ll all gð Þð Þ 2 TS**s as gð Þð Þ5 1 1 r 1 gð Þ S all gð Þð Þ 2 S as gð Þð Þ½ � 8 g ∈ 0, gmaxð �:

(A10)

As in the main text and for the same reasons, a comparison between so-cial surpluses in the presence or absence of worker r simplifies to a com-

FIG. A1.—Model with wealth-constrained worker: equilibrium regulatory ceil-ings and actions as functions of government efficiency g, in the case where onlyworker s is available (s subscript) and in the case where the firm has a choice (c sub-script) between hiring either type of manager (s or r). A color version of this figureis available online.


parison between equilibrium actions. It is easy to verify from the aboveanalysis and from figure A1 that

limg→ g02

r

as gð Þ 5 aur and lim

g→ g02r

all gð Þ 5 �a1 > aur ;

hence,

limg→ g02

r

DTSll gð Þ 5 1 1 r 1 gð Þ S �a1ð Þ 2 S aurð Þ½ � < 0:

(A11)

Similarly, one can verify that

limg→ 0

as gð Þ 5 ap and limg→ 0

all gð Þ 5 all < ap;

hence,

limg→ 0

DTSll gð Þ 5 1 1 r 1 gð Þ S all apð Þð Þ 2 S apð Þ½ � > 0:

(A12)

It then follows directly that there must exist threshold levels of govern-ment efficiency glo and ghi with 0 < glo ≤ ghi < g0

r such that for all g ∈ðghi, g0

rÞ, DTSllðgÞ < 0, and for all g ∈ ð0, gloÞ, DTSllðgÞ > 0. QED

A2. Ex Ante Bargaining Power

In the main model, we assume that, in its regulatory ceiling negotiationwith the government at date 0, the firm has full bargaining power andmakesa take-it-or-leave-it offer to the government. We now consider the casewhere the government has full bargaining power at date 0 and makes atake-it-or-leave-it ceiling offer to the firm.We show that our model is robust to changes in bargaining power allo-

cation: the equilibrium outcomes of the model are identical regardless ofwhether the firm or the government has bargaining power at the beginningof the game. Intuitively, whoever has bargaining power can extract all rentsfrom the other party using efficient bargaining transfer (i.e., political contri-bution)C. Since they can extract the entire “pie,” they have the same incen-tives to create as large a pie as possible, leading to the same equilibrium out-come.

A2.1. Equilibrium with Self-Interested Workers OnlyFor a given ceiling �a, from date 1 onward the analysis proceeds exactly as

in Section III.A. At date 0, the government offers contract f�ays ,Cy

sg to thefirm and chooses ceiling level �ay

s and political contribution Cys to maximize


max�a,C

gS �að Þ 1 C, (A13)


subject to the firm’s IR constraint, which can be expressed as pð�aÞ 2 C ≥pða*Þ for all �a ∈ ½0, ap� and as pðapÞ 2 C ≥ pða*Þ for all �a ∈ ðap,1∞Þ.25For any given �a, the government chooses Cð�aÞ such that the firm’s IR con-straint is binding. Replacing the equilibrium value ofCð�aÞ into the govern-ment’s program, we can simplify it to

max�a

gS �að Þ 1 p �að Þ 2 p a*ð Þ½ � if �a ∈ 0, ap½ �,gS apð Þ 1 p apð Þ 2 p a*ð Þ½ � if �a ∈ ap,1∞ð Þ:

((A14)

Note that for simplicity we expressed the government’s date 0 programgross of the opportunity cost of making the contractual offer to the firm,namely, the payoff the government would obtain if it did not make the offerto the firm and instead simply set the ceiling at the first-best level: gS(a*).Similarly in the main text, the firm’s date 0 program in expression (19) is

represented gross of the opportunity cost of making the contractual offerto the government, namely, the payoff the firm would obtain if it did notmake the offer to the government. In that case, the government would sim-ply set the ceiling at the first-best level, generating payoff p(a*) for the firm.Obviously, these opportunity costs are constants and hence have no im-

pact on the date 0 decisions (and equilibrium payoffs net of opportunitycosts are positive for all g ∈ ð0, gmax�) in either case. And subtracting p(a*)from expression (19) and gS(a*) from program (A14) makes it clear thatnet of these opportunity costs, the date 0 maximization programs are iden-tical regardless ofwhether bargaining power is allocated to thefirm or to thegovernment. Clearly, then, the two cases yield the exact same results.

A2.2. Equilibrium with Both Self-Interested and Responsible WorkersFor a given ceiling �a, from date 1 onward the analysis proceeds exactly as

in Section III.B. At date 0, the government offers contract f�ayc ,Cy

cg to thefirm and chooses ceiling level �ay

c and political contribution Cyc to maximize


max�a,C

gS �að Þ 1 C, (A15)

subject to the firm’s IR constraint, which can be expressed as

p �að Þ 2 C ≥ p a*ð Þ for all �a ∈ 0, aur½ �,

p aurð Þ 1 r S au

rð Þ 2 S �að Þ½ � 2 C ≥ p a*ð Þ for all �a ∈ aur , apð �,

p aurð Þ 1 r S au

rð Þ 2 S apð Þ½ � 2 C ≥ p a*ð Þ for all �a ∈ ap 1 ∞ð Þ:

8>>><>>>:

(A16)

25 If the firm does not accept the government’s offer, the government sets the reg-ulatory ceiling at a*, generating payoff p(a*) for the firm.


For any given �a, the government chooses Cð�aÞ such that the firm’s IRconstraint is binding, and hence the government’s date 0 program simplifiesto

max�a

gS �að Þ 1 p �að Þ 2 p a*ð Þ½ � for all �a ∈ 0, aur½ �,

gS aurð Þ 1 pj au

rð Þ 2 p a*ð Þ½ � 1 jp S aurð Þ 2 S �að Þ½ � for all �a ∈ au

r , apð �,gS au

rð Þ 1 p aurð Þ 2 p a*ð Þ½ � 1 r S au

rð Þ 2 S apð Þ½ � for all �a ∈ ap 1 ∞ð Þ:

8>>><>>>:

(A17)

As in section A2.1, note that for simplicity we expressed the govern-ment’s date 0 program gross of the opportunity cost gSða*Þ of makingthe contractual offer to the firm. Similarly in the main text, the firm’s date0 program in expression (23) is represented gross of the opportunity costp(a*) of making the contractual offer to the government.Subtracting constants p(a*) from expression (23) and gS(a*) from pro-

gram (A17) makes it clear that net of these opportunity costs, the date 0maximization programs are identical regardless of whether bargaining poweris allocated to the firm or to the government. Thus, as in the case with worker sonly, in this scenario with workers s and r the allocation of bargaining powerbetween firm and government at the beginning of the game has no impact onthe results of the model.

A3. Contractability of Actions

Recall that in the main model we assume for simplicity that the firm canverify the worker’s action a and hence offer an action-contingent contractW(a) to the worker it wishes to hire. Suppose instead that the firm cannotverify action a and therefore cannot make the contract contingent on it.Clearly, in the case of worker s, nothing changes: since the action is costless,he selects the firm’s preferred action, as in the main model.In the case of worker r, the only difference is that—when unconstrained

by ceiling �a—the worker chooses his preferred action, first-best action a*,instead of the firm’s preferred action au

r . One can easily verify that all of theresults of the model continue to hold in this case, simply replacing au

r by a*.Conversely, in the main model we assume that the government is too far

removed from the activities of the firm to be able to verify the exact value ofa and therefore cannot specify a specific action value through regulation. In-stead, in our main model the government regulates by imposing a ceiling�a ∈ R1 for action a. But even if an action-contingent contract could bewrit-ten between thefirm and the government, such a contract would not specifya specific action to be selected but a ceiling �a for the action, just as in themainmodel. Indeed, having the option to stipulate a specific action in a con-tract does not obligate the contracting parties to do so. And while the firm


can lobby for a specific action to the government when a is contractible, ithas no incentive to do so. The firm benefits from stipulating a ceiling ratherthan a specific action because it allows the worker to select an action belowthe ceiling, generating rents that can then be extracted.Note that this intuition continues to hold when—as in section A2 above—

the government has full bargaining power at date 0 because in that case thegovernment also anticipates the benefits from stipulating a ceiling rather thana specific action.

A4. Asymmetric Information in Agent Type

Another implicit assumption in the mainmodel is that the firm can identifywhether the worker is self-interested or socially responsible. But as argued byCarlin andGervais (2009), in practice itmay be difficult for thefirm to identifyworker types. Thus, a natural extension to ourmodelwould be to examine theasymmetric information scenario in which the worker’s type is unknown tothe firm. While such an extension is beyond the scope of this paper, we con-jecture that the results of our model would remain qualitatively the same.Intuitively, worker swould have no incentive tomasquerade as a worker r,

since that would lead to a lower wage, without any benefit: worker s doesnot value the lower action ar that would be associated with this reducedcompensation. On the other hand, in some circumstances worker r maywant to masquerade as a worker s if the increase in wages associated withdoing somore than offsets the decrease in utility associatedwith a greater actionas. In equilibrium, the firm would offer a menu of contracts to screen betweenworkers. We anticipate that while worker s’s chosen contract would likely re-main similar to his full-information contract, worker r’s chosen contract wouldinclude a greater action and/or a greater wage than in the full-informationcase. This would ensure incentive compatibility—that is, it would elimi-nate worker r’s incentive to mimic worker s—but would force the firm toleave a so-called information rent to worker r. This loss of expected rent ex-traction for the firm would likely reduce its incentive to lobby the govern-ment in the first place, much as in the limited liability extension discussedabove. Nevertheless, despite these minor differences, we believe that the maininsights of the paper—that access to responsible workers would lead to so-cially superior actions but to more wasteful lobbying—would continue tohold.

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When Is Social Responsibility Socially Desirable?

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