1. Introduction
Studies on how corporate social responsibility (CSR) is shaped by financial performance have failed to gain consensus. Some studies have suggested that they could be positively related since financial performance is a driver of CSR activities [
1]. On the contrary, other studies have argued that firms could gain legitimacy and resources through CSR activities [
2,
3], thus firms experiencing poor financial performance are likely to engage in CSR activities. Since there are competing mechanisms, some studies have found that financial performance is not related with CSR activities [
4]. We think the way firms interpret their financial performance can attribute to such mixed findings: it is the gap between financial performance and some goals or targets, rather than the value of financial performance itself, that determines CSR activities.
The behavioral theory of firm may provide a promising lens to address such inconsistency. Based on bounded rationality assumptions, organizations will set goals or targets to simplify their evaluation of financial performance [
5]. Prior studies have investigated the impacts of the performance gap between financial performance and such goals or targets on research and development (R and D) search intensity [
6], strategy change [
7], mergers and acquisitions [
8], diversification [
9], and internalization [
10]. It is suggested by the behavioral theory of firm that there are two search models in the decision-making process: backward-looking and forward-looking [
6]. The backward-looking model suggests that firms could accumulate wisdom and experience from prior choices and make adjustments to their later decisions based on performance feedback [
11]. Firms will have the motivation to search for alternative plans if they have failed to reach corporate goals. In contrast, the forward-looking model suggest that firms will evaluate the possible outcomes of engaging specific planned behaviors, and likely losses in future will encourage firms to search for alternative plans [
12] to attain corporate targets. It is suggested that the right extent of CSR could benefit firms by the way of corporate reputation [
13], consumers’ evaluation and loyalty [
14,
15,
16], stakeholder relations [
17], financial performance [
18], attractiveness to institutional investors [
19], firm capabilities, such as operational efficiencies [
20], and other positive employee responses, such as organizational citizenship behavior [
21]. In this way, CSR could be used as an effective alternative choice if firms have failed to reach their financial performance goals or will fail to attain their targets in the future.
However, past and future underperformance may have different meanings to firms. Prospect theory suggests that loss in the past will make people more risk-averse and likely loss in the future will make people more risk-seeking [
22]. Since CSR activities usually involve lower risk-taking than R and D or internationalization behaviors, we assume that underperformance in the past will increase CSR activities and underperformance in the future will decrease such practices. Besides, we are interested in whether the value of financial performance will influence the impacts of different performance gaps on CSR activities. Chinese listed firms trading on Shenzhen or Shanghai stock exchanges during the period from 2011 to 2016 will be chosen as samples to test the aforementioned arguments. It is complementary to choose China as a research setting since most prior studies about performance gaps or CSR have chosen developed countries as contexts, and the impacts of CSR activities are indeed different in developing and developed countries [
23].
This paper may shed new light on the literature about CSR, the behavioral theory of firm, as well as organizational risk taking. First, this paper contributes to the literature on CSR by providing the behavioral theory of firm as a new theory explanation. Prior studies have found many important determinants of CSR activities such as the firm’s size, female directors, institutions, and competition intensity [
2,
4,
24,
25,
26,
27], but have failed to reach consensus on how CSR activities are influenced by financial performance. Thus, we can have a better understanding about CSR activities from the performance gap perspective. Second, we contribute to the behavioral theory of firm and organizational risk-taking by providing CSR as an alternative plan in the past underperformance situation. Prior studies have explored the influence of performance gaps on organizational behaviors, mostly in the form of R and D activities which are high risk-seeking [
6]. CSR activities are usually a lower risk burden on organizations. Thus, this paper aims to understand the impacts of performance gaps on organization behaviors from a different perspective. Finally, we contribute to the behavioral theory of firm by incorporating the value of financial performance and performance gaps into a more comprehensive framework. Based on bounded rationality, organizations would set some goals and targets to evaluate their financial performance [
5], but it does not guarantee that the value of financial performance itself doesn’t matter. By investigating the moderating role of the value of financial performance, we can better interpret the impacts of financial performance on organizational behaviors.
2. Theoretical Background and Hypotheses
2.1. Backward-looking Search and Corporate Social Responsibility (CSR)
The backward-looking search model was first described by the behavioral theory of firm by Cyert and March (1963). They assumed that organizational behaviors are history-dependent, goal-directed, and conducted by simple rules [
5]. Firms are goal-directed and are prone to set some goals to conduct their decisions and behaviors. Firms are history-dependent and they will adjust their goals based on their evaluation of performance history. That is to say, firms will stick to their routines if past performance has reached their goals and switch to search for other alternative plans if past performance has failed to reach their goals [
28]. This backward-looking logic has been widely reported in the literature on organizational risk taking [
29], strategic change [
7], and R and D actions [
30].
Even though there are many studies about the impacts of CSR practices on financial performance [
31], studies about the impacts of financial performance on CSR practices are inconclusive. The “available resource hypothesis” proposes that they are positively related since CSR practices could burden costs to firms [
32] and good financial performance guarantees enough resources that could be allocated to CSR practices [
1]. However, the “social exchange hypothesis” assumes that firms will increase CSR practices under poor financial performance conditions since CSR practices could play an important role to enhance organization legitimacy and exchange for key resources such as confidence of investors [
33], satisfaction of employees [
34], loyalty of customers [
35], and good relationship with governments [
36]. These two contradictory explanations could be attributed to the failure to distinguish different motivations behind CSR practices. The good-performance-based CSR practices may be motivated by corporate resources and generosity, and poor-performance-based CSR practices may be conducted to solve problems. To distinguish these two different motivations, we could use the backward-looking model from the behavioral theory of firm.
It is suggested that firms will evaluate and interpret their past performance against some goals to make decisions [
37]. If past financial performance has reached their goals, corporate social responsibility is more likely to be motivated by firms’ generosity, and if past financial performance has failed to reach their goals, corporate social responsibility is more likely to be conducted to solve problems and due to a wish to return to goals in the next evaluation round (generally next year). These two different patterns have been categorized as problem-driven and slack-motivated search when investigating organizational R and D search [
6].
Besides, it is suggested by the behavioral theory of firm that firms are goal-directed, history-dependent and conducted by simple rules [
37]. Firms will set simple, objective, and measurable goals to provide a reference point. These goals are usually connected to financial performance [
38]. It is the gap between past performance and these goals that help firms to make judgements about how well they have done in the past [
39]. Firms usually take financial performance from the past few years to set goals since environments in the long-term period are likely to be non-stationary and predictions are likely to be biased. Financial performance closer to the last year will be given higher weights.
It has been confirmed that the framing of an outcome would change subsequent levels of risk acceptance, and losses in the past will make people and organizations more risk-averse [
22]. Prior findings that underperformance in the past will make firms invest higher in R and D activities [
6] have failed to take organizational risk preference into consideration. R and D activities are more risk-laden than CSR practices. When facing underperformance in the last year and the choice between R and D activities and CSR practices, if possible, firms are more likely to choose CSR activities.
To summarize, firms will set simple goals dependent on a weighed combination of financial performance in past few years. Then, the gap between financial performance and these goals determines firms’ decisions about CSR practices: the higher the extent to which financial performance falls below goals leads to higher CSR. We will not make a proposition about CSR motivated by firms’ generosity since it is hard to determine how generous a firm is.
Hypothesis 1: CSR increases with the distance of past performance below goals.
2.2. Forward-looking Search and CSR
Based on prospect theory, Chen (2008) has developed the forward-looking search model of R and D investments. This study argued that technology development has armed firms with higher information processing and computation capability, which then enables firms to have a better understanding of future. Thus, many studies have attempted to investigate the effect of firms’ understanding of potential future [
40]. This forward-looking perspective assumes that firms will have a cognition of environments and consider all possible outcomes of different organizational behaviors before they decide which plan to engage [
12], thus, they have expectations of corporate performance in the future. In this way, firms are more likely to choose those plans which could reach their performance targets.
However, there may be two alternative choices that could help firms to reach future targets: R and D activities and CSR practices. How will firms choose? We think prospect theory could provide us with a useful framework. It is suggested by prospect theory that people are risk-averse if they are likely to gain in the future and risk-seeking if they are likely to lose in the future [
22]. Management literature has extended this logic from individuals to organizations and found that organizations are risk-averse when they are likely to reach or exceed their targets and risk-seeking when they are unlikely to reach organizational targets [
41]. From the literature on R and D activities, we see that R and D activities are high in risk-taking behaviors and that their failure rate could be up to 80%, and successful R and D programs still need time to be translated into profits to firms. In contrast, CSR practices would burden little risk to firms and can be translated into competition advantage both in the short-term by means of resources exchange [
33,
35], and in the long-term by means of reputation [
42]. Therefore, firms are less likely to choose CSR practices if they are likely to perform below targets. The results of Chen (2008) show that firms’ R and D activities will increase if firms are less likely to reach performance targets, and this could lend support to our arguments.
Hypothesis 2: CSR will decrease with the distance by which expected performance falls below targets.
2.3. Interactions of Backward- and Forward-looking Search
In the backward-looking model, underperformance in the last year will make firms more likely to be risk-averse and thus choose to have more CSR practices. In the forward-looking model, likely underperformance will make firms more likely to be risk-seeking and thus have less CSR practices. It is reasonable to argue that both the backward- and forward-looking perspectives will be taken into consideration in the decision-making process. Therefore, we are going to investigate whether the interaction of these two different performance gaps will influence firms’ CSR.
According to hypothesis 1, firms will choose to increase CSR practices if they have experienced underperformance in the last year. On the contrary, hypothesis 2 posits that firms will choose to decrease CSR practices if they will experience underperformance in the next year. What will firms do if they have experienced underperformance in the last year and will experience underperformance again in the next year? We argue that such a desperate situation will make firms more risk-seeking [
6] since it could not be worse off, and thus, firms will invest more in risk-seeking behaviors such as R and D activities.
Hypothesis 3: The performance gap against targets in the next year will weaken the effect of the performance gap in the last year on CSR.
2.4. Moderating Effect of the Value of Financial Performance
Based on behavioral theory of firm and prospect theory, above we have made propositions on the relationship between underperformance and CSR. However, this does not mean that the value of financial performance alone does not make sense to firms. A financial performance may be satisfactory even though it failed to reach the goals, or it will fall below targets, especially when the performance gap is small and acceptable. Attribution theory may be helpful to explain how the value of financial performance will coexist with performance gaps.
Attribution theory suggests that there is an “actor–observer effect” that we tend to attribute others’ failure to internal reasons and our failure to external reasons [
43]. Following this logic, firms that have experienced underperformance feedback or will fail to reach targets are likely to attribute underperformance to external reasons. One potential external reason may be that the goals or targets are inappropriately set and thus difficult to reach. This kind of attribution is likely to make sense when financial performance alone is good enough. In this way, a higher value of financial performance will weaken the effect of underperformance gaps.
Besides, a higher value of financial performance could also increase firms’ tolerance to risk. “Self-serving attribution bias” indicates that we tend to take responsibility for good outcomes and deny responsibility to poor outcomes [
44]. A higher value of financial performance is usually positively connected to managers’ confidence under the existence of the “self-serving attribution bias,” and managers will take responsibility of firms’ success [
45]. It is suggested that managers’ confidence or overconfidence could result in high risk-taking decisions such as R and D actions [
46]. In summary, a higher value of financial performance means more available resources and firms are prone to take more risks.
Hypothesis 1 suggests that CSR will increase with the distance by which past performance falls below goals since firms have motivations to search for alternative plans and are highly risk-averse at the same time. But the higher value of financial performance will decrease firms’ motivation to search for alternative plans and increase firms’ tolerance to risk. Therefore, the relationship between the distance by which past performance falls below goals and CSR will be weakened. Hypothesis 2 suggests that CSR will decrease with the distance by which expected performance will fall below targets since firms are risk-seeking and will search for other risk-taking investments such as R and D actions. Then, a higher value of financial performance will lead firms to be less likely to invest in low-risk practices such as CSR practices. Thus, we have made the following propositions:
Hypothesis 4: The value of financial performance will weaken the effect of the distance by which past performance falls below goals on CSR.
Hypothesis 5: The value of financial performance will strengthen the effect of the distance by which expected performance will fall below targets on CSR.
5. Discussion and Conclusion
5.1. Conclusions
Based on the behavioral theory of firm and prospect theory, we tried to investigate how CSR activities are influenced by financial performance. Prior studies on this relationship have led to mixed findings since they assumed that it is the value of financial performance that determines CSR activities. To address such mixed findings, this study assumes that it is the performance gaps against goals or targets that determines CSR activities due to the existence of bounded rationality. Besides, we found that underperformance in the past is more likely to encourage firms to engage in less risk-taking behaviors such as CSR activities, and likely underperformance in the future would encourage firms to engage in less CSR practices. Finally, this paper found that the value of financial performance is such an important boundary on the relationships in question that the impact of past underperformance would even be positive under the high value of the financial performance situation.
5.2. Theory Contributions
Our findings extend the literature on organization research in three ways. First, we contributed to CSR literature by finding its determinant as underperformance gaps. Even though there are dozens of studies on determinants of CSR activities, such as corporate governance [
67], firm size, and competition intensity [
4], little is known about the relationship between financial performance gap and CSR decisions. The inconsistent prior findings on the relationship between financial performance and CSR activities may result from their negligence of organizational bounded rationality. Specifically, we argued that organizations would set goals or targets as a reference point to evaluate their financial performance [
6] and it is the performance gaps between real financial performance and these reference points that determines CSR activities. It is a new perspective and can help gain better understanding on the determinants of CSR activities.
Second, we extend literature on the behavioral theory of firm and organizational risk-taking by providing CSR as a less risk-taking choice. Prior studies about performance gap and organizational behaviors mostly focused on high risk-seeking actions, such as R and D investment [
6]. We provide CSR as an alternative choice which is less risk-taking and thus, present a more completed picture. Though it has been predicted by prospect theory that losses in the past will make organizations more risk-averse and losses in the future will make organizations more risk-seeking [
22], most studies have tested this logic only by high risk-taking activities such as R and D actions. Prior findings that firms would increase R and D investments when facing underperformance in the last year [
6] actually contradicts the predictions of prospect theory. One possible explanation may be that these studies did not take the trade-off between CSR and R and D activities into consideration. This paper did control the R and D investment when exploring CSR activities and got results consistent with prospect theory. Therefore, future studies on CSR or R and D should take organizational trade-off between them into consideration.
Last but not least, we shed new light on the behavioral theory of firm by incorporating the value of financial performance as an important boundary. Prior studies have investigated the effects of performance gaps and the value of financial performance, respectively [
6,
65]. Mostly, they thought that performance gap was a better determinant of organizational behaviors than the value of financial performance alone [
41,
56] due to the existence of bounded rationality, implicitly or explicitly. We argued that the value of financial performance will influence the impacts of performance gaps on corporate decisions, which may be another form of bounded rationality. This study found that the value of financial performance will change the effect of underperformance gaps and increase organizational tolerance to risk. In this way, incorporating these two perspectives into a comprehensive framework and investigating their interactive effects is helpful to gain better understandings.
5.3. Implications for Practitioners
The results obtained in this paper have some implications for practitioners. First, managers could choose CSR as alternative plan when facing past failures. Great pressures are faced by managers when firms fail to attain performance goals, and managers need some effective alternatives to respond to these pressures [
28]. Prior studies may encourage firms to promote investment into R and D activities, for such behaviors can build competition advantage [
6]. However, managers may be less likely to take such suggestions since failure in the past makes them more risk-averse [
22]. We suggest managers in such a situation promote investment into CSR activities, for such behaviors can build competition advantage [
36] and satisfy managers’ needs of low risk-taking at the same time.
Second, managers could choose high risk-taking alternative plans when there is a possibility to fail expectations in the future. In line with prior studies, results from this paper suggest managers increase investment into R and D activities if firms are unable to reach performance targets in the future [
6]. In such a situation, managers should invest more in high risk-taking behaviors, such as R and D, to avoid possible failure in the future.
Third, managers should take both performance gaps in past and in future into consideration when making decisions. Both history experience and future expectations are useful and important reference points in the decision-making process. Thus, managers should take both backward- and forward-looking performance gaps into consideration when looking for effective alternative plans. Focusing on only one of these two perspectives may lead to unsatisfactory consideration of the need from another perspective.
Finally, managers should avoid the illusion of the value of financial performance. Judgments of business operation may be influenced by the value of financial performance even though firms failed, or are going to fail, reference points. However, reference points are set to cope with bounded rationality and the impact of the value of financial performance may distract firms far away from rationality. In this way, managers should make judgements and decisions based on performance gaps and avoid the illusion of the value of financial performance.
5.4. Limitations and Future Study Considerations
However, there are some limitations in our studies. First, we did not incorporate firms’ choice among high risk-taking behaviors such as R and D actions and less risk-taking behaviors such as CSR practices into a framework. The effect of performance gap on R and D actions has been investigated in a US setting [
1] and we assume that there will be consistent findings in Chinese settings during our hypotheses. This assumption needs further investigations and confirmations. Second, CSR activities can be conducted in different domains [
68] and different combinations of these domains may have different meanings to firms [
69,
70]. We only discussed the impacts of performance gaps on overall CSR activities in this paper. Future studies could try to investigate how firms will behave in these domains under different performance gaps situations. Third, we did not investigate the effect of outperformance on CSR. We argued that CSR could be used to solve problems since underperformance firms will have motivations to search for alternative plans. But it is likely that outperformance firms also have motivations to promote CSR to build competitive advantage. It is another story and future studies hold promise to have promising findings.