Corporate Social Responsibility as a Signalling Device for Foreign Direct Investment

A rise in CSR (corporate social responsibility) has accompanied rise in foreign direct investment (FDI) to developing countries in the 1990s. CSR may be serving a signalling function when the entering firm is of an unknown type. Although countries are now competing keenly to attract foreign firms, even so, excessive tax or excess transfers by firms can still cause a Prisoner’s Dilemma structure to the payoffs resulting in an inefficient Nash equilibrium. CSR allows the accommodating firm to reveal its type, making cooperation the equilibrium outcome. The game differs from standard models since signalling changes the payoffs. A unique separating equilibrium exists where only the accommodating firms signal. But, under certain parameter values, a pooling equilibrium where all firms signal, becomes possible. A number of results are derived including the size of CSR expenditure required as a fraction of profits. An example demonstrates their relevance in practical situations.