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STAKEHOLDER GROUPS AND FIRMS’ CORPORATE SUSTAINABILITY DECISIONS
Nicholas Reksten and Ranjula Bali Swain
June 18, 2020
Reksten: University of Redlands, California, USA (nicholas_reksten@redlands.edu); Bali Swain, Stockholm School
of Economics and Department of Economics, Södertöorn University, Stockholm (Ranjula.Bali@hhs.se). Research
funding for Bali Swain from Swedish Research Council for Sustainable Development (Formas) is gratefully
acknowledged. Usual disclaimer applies.
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Abstract
We develop a novel theoretical framework to explain the mechanism through which firms
make decisions on corporate sustainability (CS). CS is modeled as the proportion of clean capital
that firms use in their production process. Stakeholder groups such as consumers, communities
(activists and non-governmental organizations), regulators, workers and shareholders have
preferences for CS, which impact a firm’s profit function and constraints. When firms are
confronted with stakeholders who have knowledge about the negative externalities generated by
their production, they choose a mix of clean capital to maximize profits given stakeholder
constraints. The impact of the stakeholders depends on characteristics such as the size of the firms,
market structure, firm’s location, composition of the shareholders, and whether the firm makes a
final or intermediate goods. Our framework illuminates why different firms may pursue varying
levels of CS action even when they make similar products.
Keywords: Corporate Sustainability, clean capital, stakeholders
1. Introduction
Corporations are increasingly expected to have social and environmental performance
standards and practices while maintaining their financial and legal obligations, given the urgency
of addressing climate change. (Lankoski 2016; Dyllick and Hockerts 2002; Baumgartner and
Rauter 2017). Indeed, recent years have witnessed a growing move towards sustainability
initiatives by businesses. However, if their objective is profit maximization for shareholders as
traditionally defined, why they would embrace these standards is unclear. How do firms decide to
make pledges regarding environmental standards, and what determines how strict those standards
are? This paper argues that firms work to maximize profits given constraints placed upon them by
stakeholder groups such as communities of activists and non-governmental organizations,
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customers (consumers or other firms), workers, and regulators that manifests as a demand for
incorporating “clean capital” with lower environmental impact into their production processes.
We examine these questions through the lens of corporate sustainability (CS), the
application of sustainable development at the firm/corporate level for short- term and long-term
economic, environmental and social performance of a corporation (Steurer et al. 2005;
Baumgartner and Ebner 2010; Lozano 2011; Dyllick and Muff 2015; Hahn et al. 2017). It requires
corporations to embed sustainability strategies into their business model through adopting new
governance strategies and performances that involve stakeholders’ responsibility and contribute to
the continuous improvement of social, environmental, and economic conditions on a regional
and/or global scale (Dyllick and Muff 2015; Szekely and Vom Brocke 2017).
CS has been defined by the largest global corporate initiative called Global Compact1 as a
company’s delivery of long-term value in financial, environmental, social, and ethical terms. The
group advocates five features of CS: Principled Business, which follows basic principles of human
rights, labor, environment and anti-corruption; Strengthening Society by taking action and
collaborating with others to advance global challenges; Leadership Commitment for effecting
long-term change with a company’s leadership; Reporting and Transparency in business practice;
and Local Action (Global Compact, 2014).
Such statements, though, are not limited to Global Compact. On Aug 19, 2019, CEOs of
181 large US corporations who are part of the Business Roundtable group issued a statement of
purpose in which they pledged to lead their companies for the benefit of all stakeholders including
customers, employees, suppliers, and communities and not just shareholders. The pledge includes
a promise to “respect the people in our communities and protect the environment by embracing
1 Global Compact is the world’s largest global corporate initiative towards sustainability, with over 8,000
companies and 4,000 non-business participants based in over 160 countries.
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sustainable practices across our businesses” (Business Roundtable, 2019). This statement and a
follow-up initiative by a group of investors, academics and lawyers is pushing large companies to
provide details on how they will “profitably achieve a solution for society” (Edgeclife-Johnson,
2019) are examples of how the concept of corporate sustainability (CS) is being acknowledged
and mainstreamed.
In this paper, we investigate why firms engage in corporate sustainability, focusing on the
role of stakeholder groups in firm decision-making. More specifically, we examine how firms
make their choice between the use of ‘clean capital’ and that of standard capital, and how this
choice may be influenced by stakeholder groups such as investors, communities, consumers,
workers and regulators etc. We define clean capital as capital that produces CS in addition to the
firm’s production good. Clean capital is more efficient in terms of environmental impact than
standard capital and is treated as a third input into production. This implies that output is a product
of capital and labor, and capital is a mixture of clean and standard capital.
We construct a theoretical framework on how firms make decisions on whether or not to
take on corporate sustainability and identify ways in which the firm’s operation is influenced by
the preferences of various stakeholders. We begin with the firm’s choice in production inputs,
specifically clean and standard capital, in the context of their profit maximization objective. We
then extend the model in order to explore how different stakeholders (consumers, communities,
workers and shareholders) may influence the decision of the firm to engage in corporate
sustainability by replacing some or all of its standard capital with clean capital. The impact of
legislation and regulation by the government on corporate sustainability is also discussed.
The paper contributes to the literature at several levels. First, it brings together a number
of heretofore disparate issues within the business studies literature, which have traditionally
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focused on stakeholder groups separately. Second, it investigates why firms choose to or engage
in corporate sustainability using the novel concept of corporate sustainability as the proportion of
clean capital used in production. Third, it provides a guide to understanding why firms may have
different levels of corporate sustainability.
The paper is organized as follows. Section two reviews the emerging literature on corporate
sustainability. In section three, we first present a simple model of firms’ decision regarding the use
of clean capital, standard (‘dirty’) capital, alongside labor, in the production process. Subsequently,
we include stakeholders in the framework and examine their likely impact on the decision-making
by the firms. The paper concludes with some reflections and ideas for future research.
2. Literature Review
An outgrowth from the concept of sustainable development, CS may be defined as meeting
the interests of the corporation’s shareholders and stakeholders without compromising the
corporation’s ability to meet the needs of the future generations (Dyllick and Hockerts, 2002;
Schwartz and Carroll, 2008; Montiel and Delgado-Ceballos, 2014; Hahn et al., 2017). In early
literature, CS was usually discussed as environmental sustainability, ecological sustainability, or
environmentally friendly activities (Reinhardt, 2000; Shrivastava, 1995; Chisholm et al., 1999).
Over time there was an emphasis on a multidisciplinary business strategy with balance between
the three pillars of social, environmental, and economic sustainability (Székely and Vom Brocke,
2017; Lozano, 2011).
Recent literature has adopted this multidisciplinary concept of CS, making reference to
the short-term and longer-term economic, environmental and social performance of a corporation
(Steurer et al., 2005; Baumgartner and Ebner, 2010; Lozano, 2011; Dyllick and Muff, 2015; Hahn
et al., 2017; Ashrafia et. al, 2018). It requires corporations to embed sustainability strategies into
their business model by adopting new governance strategies and operations that involve a broader
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group of stakeholders beyond the shareholders, thereby making a contribution to the continuous
improvement of social, environmental, and economic conditions at a regional and/or global scale
(Dyllick and Muff, 2015; Székely and Vom Brocke, 2017).2 These stakeholders include local and
national governments (via implementation of regulations), customers, civil society and NGOs,
financial partners (through external pressure), workers (pressure from within the corporation), and
other rival and/or upstream firms (pressure from the business sector) (Keijzers, 2002; Lozano,
2015; Székely and Vom Brocke, 2017). It is also possible that corporate executives learn from the
growing evidence of climate change and the impact of environmental degradation, so that even
without external or internal pressure, they voluntarily decide to switch to clean capital. 3
CS and Corporate Social Responsibility (CSR) are voluntary business activities with the
objective of contributing to better performance of corporations in social, environmental, and
economic spheres (Lo, 2010 ).They may be used individually or in combination, however, CS is
usually considered CSR plus sustainable development (De Bakker et al., 2005). Van Marrewijk
(2003) associates CSR with ‘the communion aspect of people’, such as stakeholder dialogue and
sustainability reporting, and CS with ‘the agency principle’, such as value creation, environmental
management etc. Steurer et al. (2005), for example, describes CS as a normative micro-level
approach and CSR as management practices concerned with implementing CS in the short-term.
Other researchers perceive that CSR is a social strand of CS, which is mainly built on a sound
stakeholder approach (Ebner and Baumgartner, 2006; Linnenluecke et al., 2009). Lozano (2012)
states that CSR definitions may be confusing and contradicting, which is sometimes perceived as
2 The benefits and challenges of adopting sustainable practices have been widely discussed in the literature
(Azapagic 2003, Haanaes et al. 2012, Kiron et al. 2013). These studies conclude that economic success alone is
insufficient for attaining corporations’ success in the long run (Dyllick and Hockerts 2002; Bansal 2005, Rego et al.
2017). A growing number of corporations have begun to mitigate environmental risks and improve their reputation
through sustainability practices. 3 Intercorrelation between multi-stakeholders also impact CS (Sharma and Henriques 2005).
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philanthropy and/or social dimension, for example, stakeholder engagement with links to
assessment and communication. Other scholars suggest that the two concepts are converging
(Montiel, 2008; Bansal and Song, 2017; Doh and Tashman, 2014).
A large body of literature explores the motivations of companies for undertaking some sort
of corporate social or environmental responsibility commitment. In most cases, they focus on the
dynamics between a firm and a particular stakeholder group such as activists, consumers,
employees, managers, shareholders, or regulators that explains CSR/CS investments.
The first of these frameworks has been developed by Kitzmuller and Shimshack (2012),
who argue that corporate responsibility can be categorized depending on the types of preferences
one assumes for stakeholders and shareholders. If shareholders have social preferences (that is, the
well-being of potential victims of pollution is included in their utility function), CSR may be
undertaken as a strategic tool even if it is not profitable for the firm. On the other hand, if
shareholders have classical (selfish) preferences, CSR becomes relevant only if there is a
possibility of increasing profits.4 Using a similar framework, Schmitz and Schrader (2013) suggest
that for profit-seeking corporations, motivation for corporate responsibility is explained as a
response to the interests of other stakeholders such as consumers, communities, and workers. In
the case without social preferences, corporate responsibility can act directly as an advertisement
signaling product quality, a strategy to avoid regulations, or a response to government failure.5 If
4 CSR is considered strategic in the sense that it allows a firm to capture a higher market share and
differentiate itself from competitors. 5 By government failure, Schmitz & Schraeder (2013) mean that CSR can be seen as the provision of public
goods or reduction in “public bads” provided by a firm. Governments may be unable to provide all of the public
goods that are desired due to regulatory capture, for example, or if the pollution in question originates in another
country. It may also be that the citizenry has different preferences for public good provision. If a large group, but not
a majority, wants to have a public good provided, they may be able to convince a company to provide it rather than
the government.
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however, the stakeholders have social preferences, the firm may undertake corporate responsibility
in an effort to appease these groups.6
Moving from abstract notions of stakeholder and shareholder preferences, Kitzmuller and
Shimshack (2012) argue that CSR addresses these preferences through three mechanisms: markets
(for both products and labor), politics (both public and internal to the firm), and isomorphism (i.e.
social norms).7 Crifo and Forget (2015) make a similar argument, suggesting that corporate
responsibility is driven by considerations about regulation, competition, and incomplete contracts.8
However, they also argue that the existence of social preferences is not sufficient to explain the
range of actions that are observed. Instead, social preferences are assumed but corporate
responsibility is ultimately driven by market imperfections, such as the under-provision of public
goods, incomplete contracts, or imperfect competition.
There are however, several cases where CS can be profitable. In such cases, it is rational
for a firm to undertake corporate sustainability, regardless of the types of preferences that the
shareholders and managers have. This could be due to an accidental coincidence of outcomes, i.e.
companies that are improving the efficiency of their production process happen to reduce their
environmental impact with it (Lyon & Maxwell, 2002; Busch-Pinkse, 2012). Alternatively, it may
be that pressure to reduce emissions (whatever the source of that pressure) can prompt the firm to
innovate, improving its production process technology in an effort to reduce emissions that also
6 Schmitz & Schraeder (2013) consider shareholders to be a stakeholder group, while Kitzmuller and
Shimshack (2012) treat them separately. In this paper, the former approach is adopted. 7 For example, firms may use CSR in markets as a form of signaling to attract productive workers. They
use CSR in politics as a means to pacify activists who may threaten the firm with negative publicity. CSR may also
operate through social norms within communities or industries, as those that are relatively organized may be able to
impose their preferences on others. 8 Regulation can be thought of as analogous to Kitzmuller & Shimshack’s (2012) political motivations;
competition relates to the market drivers; contracts are analogous to isomorphic drivers. Because contracts are
typically incomplete, the discretion of executives can be needed to induce stakeholders to work with the firm (Crifo
and Forget, 2015).
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reduces costs (Porter and van der Linde, 1995). This is also known as the Porter hypothesis, though
it has traditionally been discussed in the context of mandatory environmental regulations only
(Ambec et. al, 2011). However, some researchers question why the firm would be so ignorant of
its production process that it would leave cost-reducing changes undone (Prakash and Potoski,
2012) or permit their techniques and input mixes to be unsettled (Lyon and Maxwell, 2002). That
is, if there were a set of input choices that could both improve profitability and reduce emissions,
should not the firm know it and choose it? The growing attention to greenhouse gases (GHG)
emission impact has received has also spurred the development of new renewable energy
(especially wind and solar power generation) and energy-efficient technologies that allow firms,
in some cases, to both reduce emissions and costs.
Pressure to reduce emissions can also come from other stakeholder groups (Busch-Pinkse,
2012). Consumers may be considered “socially responsible,” and therefore motivate firms to
provide more of a public good, for example, cleaner air or water alongside a private good (Bagnoli
and Watts, 2003; Lyon and Maxwell, 2002). Corporate responsibility may also be driven by
activist threats, leading them to provide more socially responsible goods (Baron 2001, 2012;
Fedderson and Gilligan, 2001; Calveras, Ganuza, and Llobet, 2007). Firms operating in an area
with regulatory uncertainty, especially with respect to climate change, may make CS investments
in an effort to pre-empt or influence future regulations or avoid the enforcement of existing
regulations (Lyon and Maxwell, 2002; Lyon and Maxwell, 2004; McCluskey and Winfree, 2009;
Engau and Hoffman, 2011).
Agreement or consensus regarding the incentives for shareholders and managers to
undertake corporate sustainability is limited. For example, Baron (2007) argues that when
investors anticipate CSR, they do not bear its cost in the form of reduced dividends. Instead,
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managers go through lowered income, and shareholders only pay for CSR when it is a surprise
(i.e. not approved by them in advance). Cespa and Cestone (2007), portray CSR as an
entrenchment strategy used by inefficient CEOs. These managers build relationships with
stakeholders to maintain their position against shareholders. Clark and Hebb (2005) take a more
positive view of the role of shareholders, postulating that they use corporate responsibility to
manage reputational risk.9 This has the added benefit of promoting transparency of the firm’s
behavior and allowing it to be more easily observed both by shareholders and other stakeholders.
To summarize, a number of mechanisms and relationships that encourage corporate
responsibility among firms have been identified. It is clear that various stakeholder groups are
thought to affect a firm’s decision to engage in corporate responsibility. However, there does not
seem to be a single, unifying framework that can explain holistically how this might push firms to
do more through different stakeholder channels.
3. Analytical Framework
Environmental externalities like greenhouse gas emissions are produced because the
private and social costs of emissions diverge. Thus, excessive emissions that lead to climate
change, considered a negative externality, could theoretically be corrected through a Pigouvian tax
or some similar regulation that would equalize the private and social costs and benefits of the
emissions. Voluntary reductions in GHG emissions therefore indicate that either the private
marginal costs and/or benefits of polluting have changed. That is to say, voluntary reductions are
made in response to new pressures or to new information that the firm receives about its production
9 For example, in the 1990s, after revelations that children were employed in its factories, Nike promised
improvements in standards, such as setting minimum ages of employment, expanding worker education programs,
and inviting NGOs to inspect factories (Wazir, 2001).
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process. The firm then seeks ways to change the techniques or input mix used in order to reduce
emissions. Such actions are akin to technical innovations and may or may not be profitable.
Additionally, stakeholders’ preferences can cause the firm to internalize a portion of the
externality as it becomes more profitable in the long run to respond. It can lead to higher revenues
in the medium term, decreased risk of costly regulation, and/or more motivated employees. By
undertaking actions that reduce GHG emission, the severity of the market failure is lessened in a
manner that is consistent with the firm’s long-run profit maximizing objective. Such voluntary
actions address the environmental problem of over-pollution without being required by law and
are considered CS.
The goal of this framework is to understand the firm’s decision-making process regarding
voluntary reduction goals in the context of a firm’s profit and cost functions. We focus on large
firms and assume that they are in imperfectly competitive industries with differentiated products
and facing a downward-sloping demand curve.10 Given this market structure, CS can be a potential
tool for product differentiation (Bagnoli and Watts, 2003).11 We will use climate change as an
example of an environmental issue to which this framework can be applied, but it could be used
to analyze other areas of environmental impact with little change.
Crucially, one can think of this framework as proceeding in two stages between which
information regarding emissions is “revealed” to the firm about its own production process. In the
first stage (the simple or naive framework), the firm maximizes profits in the conventional manner
10 We would expect many firms to be in oligopolistic industries, though this is not the case exclusively. As
will be made clear below, in contrast to typical models of oligopolistic firms, we do not explicitly include actions
taken by competitors as a constraint for the representative firm analyzed here. Instead, competitive pressures can be
thought of as operating through consumer preferences for clean production. Modelling the effects of competition
more directly would be beyond the scope of this work. 11 The assumption of monopolistic firms is not necessary for assuming the existence of CSR. Even firms in
a perfectly competitive market will not necessarily maximize profits unless a number of relatively specific conditions
are met (Feinberg, 1975 & 1980). However, it will be used here as this better reflects real-world market conditions
for large firms.
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i.e. without consideration of the environment impact, using two standard inputs: (standard) capital
and labor. Neither the issue of climate change nor the notion of clean capital is understood by the
firm’s shareholders and managers. Thus, clean capital use is not considered in the profit-
maximizing decision. Other stakeholders are also unconcerned about the issue because the issue
has not yet been publicized by scientists, governments, and/or activists, or they are simply not
aware of it. None of the external costs of GHG emissions are internalized by the firm unless they
happen to come from regulated co-pollutants, such as ozone depleting chemicals.12 The case
involving lack of knowledge or concern about climate change aptly describes the state of the world
for most firms before the mid-1990s- mid-2000s in most countries. Since the mid-1990s, a growing
number of firms began to pay attention to climate change. In the second stage, the firm becomes
aware of climate change and the possible effects of existing mitigating technologies on costs and
revenues.13
The model in the first stage is straightforward. First, the firm faces a downward-sloping
demand curve in an imperfectly competitive industry, producing a differentiated product, selling
at price p. The firm produces quantity, q, of its good according to a measure of responsiveness to
demand to price, B, and a measure of popularity of the good, A. Both A and B are positive. That
is, the quantity produced is:
𝑞 = 𝐴 − 𝐵𝑝 (1)
12 That is, the firm may engage in some GHG emissions abatement as a by-product of reducing other
emissions, but GHG emission reduction is not measured or considered by the firm. 13 This is similar to the Lyon and Maxwell (2004) firm decision-making model, where regulators
administering a voluntary environmental program provide the firm with information about green technology, which
is costly. Because this process has occurred in the case of many firms that have not joined a government-run voluntary
program, it is not modeled in the same way here. Instead, scientists or activists become aware of the problem, and
then activists work to educate consumers, policy makers, and managers about the issue and its impacts. Additionally,
some managers are educated by activists, and this group in turn attempts to educate all other parts of the company,
from upper management in order to influence the strategic plan of the business, to employees to influence behavior.
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Re-writing this as an inverse demand curve, we solve equation (1) for p and substitute 𝛼 =𝐴
𝐵 and
𝛽 =1
𝐵:
𝑝 = 𝛼 − 𝛽𝑞 (1)
Total revenue for the firm is:
𝑇𝑅 = (𝛼 − 𝛽𝑞)𝑞 (2)
𝑇𝑅 = 𝛼𝑞 − 𝛽𝑞2 (3)
For simplicity, we assume that the firm faces a constant marginal cost, c. This is a function
of the costs of capital and labor, K and L. However, once the firm is made aware of the issue of
climate change, it becomes aware that there are two types of capital: standard capital and clean
capital, denoted by 𝐾𝑠 and 𝐾𝑐, respectively.14 They represent two different types of machines that
firms can employ, where clean capital produces CS in addition to the firm’s production good.
Clean capital is in some way more efficient (in terms of the environmental impact of interest) than
standard capital, either because it uses a cleaner fuel, employs energy efficiency improvements
and or employs sustainable processes and practices. Clean capital is treated as a third input into
production, meaning that while we assume that output is a product of capital and labor, capital is
a mixture of clean and standard capital. Additionally, clean capital is always a substitute for
standard capital. Clean capital, standard capital, and labor have exogenous prices 𝑟𝑐, 𝑟𝑠, and 𝑤,
respectively.
Both clean capital and standard capital have a declining marginal rate of technical
substitution. That is, in an operation where only standard capital is used, the first units of clean
14 This follows Acemoglu et al. (2012) who assume that firms can use either clean or dirty inputs in their
production process. For example, firms may be able to choose from two types of machines or processes for producing
output, and one of these may use less energy and therefore release fewer emissions than the other. The more energy-
efficient machinery would be considered clean capital.
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capital can be substituted in for relatively low cost.15 The opportunities to easily replace some
standard capital with clean capital is typically referred to by managers in firms as “low-hanging
fruit.” Technology can be biased towards a particular type of capital, which brings about a higher
marginal productivity, and thus leads to a change in the type of capital that firms use. Additionally,
the firm is choosing between capital types with different prices, 𝑟𝑐 and 𝑟𝑠, which here are
exogenous. The firm will use clean capital to the extent that the ratio of marginal products between
clean and standard capital is equal to the ratio between the prices of the two inputs. Therefore,
𝑀𝑃𝐾𝑠
𝑀𝑃𝐾𝑐
=𝑟𝑠
𝑟𝑐 (4)
To understand how technology can impact the tradeoffs between clean and standard capital,
we will discuss a case where a firm might have a Cobb-Douglas production function.16
Additionally, total capital, 𝐾 is made up of standard and clean capital: 𝐾 = 𝐾𝑠𝜏 + 𝐾𝑐
𝜈 where 𝜏 +
𝜈 = 1 and represent the proportion of each type of capital used. Technology can impact the ratio
of clean to standard capital in two ways. First, there are some processes for which there may be no
clean capital available. 17 In that case, there is an absolute limit set on 𝐾𝑐 in the production process,
so 𝐾𝑐𝜈 < 𝑙, where 𝑙 represents the maximum amount of clean capital that may be used to produce
a good. Changes in technology may increase 𝑙 as clean capital can be used in more processes.
Alternatively, technology may evolve that makes clean capital relatively more cost-efficient. In
15 A simplifying assumption is made here to not consider changes in the use of labor that result from changes
in the types of capital employed. Often, clean capital is more labor intensive than standard capital. One example of
this is the use of wind turbines instead of coal to generate electricity. A large coal-fired power plant requires fewer
workers to maintain than many windmills scattered over a larger area. 16 The use of a Cobb-Douglas production function here is meant to illustrate a broader theoretical point only.
It is impossible to characterize the production of all firms with a general function, but the logic demonstrated here
should hold even in the case of other functions. 17 This assumption implies that there are limits to the amount of clean capital the firm can use to maintain
production in the medium-run. In this case, the medium-run is a period in which the firm could replace much of its
capital structure but where costs of lower-emission technologies do not change significantly.
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that case, the parameter 𝜈 will increase, indicating that the same amount of output can be produced
using less clean capital. This is illustrated in Figure 1.
Figure 1: Tradeoffs between Clean and Standard Capital
The firm will choose its inputs in such a way that minimizes total costs, given the level of
output chosen. Profits for the firm can thus be estimated as:
𝜋 = 𝛼𝑞 − 𝛽𝑞2 − 𝑇𝐶(𝑟𝑠, 𝑟𝑐, 𝑤, 𝐾𝑠, 𝐾𝑐, 𝐿) (5)
The profit-maximizing quantity of output, 𝑞∗, where marginal revenue is equal to marginal
cost is:
𝜕𝜋
𝜕𝑞= 𝛼 − 2𝛽𝑞 − 𝑐 = 0 (6)
𝑞∗ =𝛼−𝑐
2𝛽 (7)
Before an environmental issue such as climate change is understood by the firm, this is the
process through which it chooses output levels and an input mix. It is unconcerned with the
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distinction between clean capital and standard capital for any environmental purpose. It is also
unconcerned with CS (or clean capital) investments explicitly. Instead of defining CS related to
greenhouse gas emissions as its own separate entity, it can be defined based on the nature of the
type of capital that the firm uses. That is, it can be thought of as the ratio of clean capital to total
capital used by the firm, or y.
𝑦 =𝐾𝑐
𝐾𝑠+𝐾𝑐=
𝐾𝑐
𝐾 (8)
Note that a firm may have a high level of CS simply by choosing a high level of clean
capital that happens to be profit-maximizing.18 For example, a firm may claim that an upgrade of
a plant that reduces electricity usage is reducing air pollution (which may be true), but the firm is
driven to upgrade the plant because it will be cost-saving over a given time horizon, not out of any
concern for the environment or pollution damages. Because of efficiency gains that reduce overall
costs, the use of some clean capital may be profit-maximizing, even in the absence of other
incentives.
4. Stakeholder Roles in CS Motivation
So far, the decision-making process of the firm is based on the notion that the primary
concern of corporations is to satisfy only their shareholders’ interests by maximizing profits. Given
a high discount rate, this translates into short run profit maximization. Now, suppose that other
stakeholders such as consumers, communities, workers, etc. who have knowledge about the
negative externality on the environment and are concerned about the impact put pressure on the
company to address CS. Concerned stakeholders can affect corporate behavior in two ways. One
is a direct response in terms of consumer boycott leading to sales decline, workers’ dissatisfaction
18 That is, the firm appears to be making efforts to be environmentally friendly when such actions are simply
the profit-maximizing option for managers.
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leading to lower productivity, and communities’ complaints and protests leading to negative
publicity and damaged reputation.19 A second approach is indirect in that the concerned
stakeholders pressure the government to undertake regulations that compel corporations to change
behavior or else face prosecution or substantial fines. Both types of response by concerned
stakeholders involve knowledge sharing with corporations about the effects of their production
activities on the environment/ecosystem.
In response to this new information, firms recalculate their optimal choice of inputs,
according to the additions to their costs and revenue functions described in subsequent sections.20
Such a two-stage approach explains why firms do not begin with a given amount of clean capital,
but instead choose it through a decision making process that, in reality, involves setting greenhouse
gas reduction goals. In order to meet such goals, firms start considering a switch from standard to
clean capital in a manner that is both profit-maximizing and emissions-minimizing.21 Firms that
already choose a high level of clean capital that they find to be profit maximizing will be less likely
to succumb to this pressure.
Previous studies reveal that different firms have various considerations when it comes to
choosing a level of CS, as discussed above. Therefore, a series of cases will be examined in which
19 In the beginning, only a few stakeholders will be involved. But as the frequency, intensity and magnitude
of the climate change and related information becomes available, there will be a greater impact on the direct
response. 20 This framework suggests that firms are able to make instantaneous and unlimited changes to their input
mix, but this can be thought of as occurring over a number of years. There are a number of examples of firms reducing
greenhouse gas emissions on the order of 30% to 50% within a decade of setting reduction goals. 21 A similar story has been told in the context of public voluntary programs (PVPs; another term for voluntary
environmental programs) by Lyon and Maxwell (2010). These programs for GHG emissions reductions usually offer
firms a framework for setting reduction goals (that is, establishing a level of clean capital to use) and offer technical
assistance for taking emissions inventories, which can be thought of as an examination of their production and cost
functions through a new lens. As Lyon and Maxwell (2010) argue: “We believe that progress in the empirical analysis
of PVPs will be facilitated if researchers emphasize that PVPs are information-oriented programs designed to diffuse
abatement technologies and practices. In this view, many firms are not operating on the production possibilities
frontier and environmental process improvements can be studied as a form of technology diffusion that may be
enhanced by PVPs” (70).
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the firm faces different external constraints and makes profit-maximizing decisions based on these
constraints. The above framework will be used to illustrate how the firm chooses the ratio of clean
capital to total capital (CS), and the types of firms that the case might represent will be discussed.
However, it is important to note that what is considered “socially responsible” in this
framework is based on a general notion of a production process that produces less pollution or
reduces a negative externality. That is, in the absence of a carbon price to correct for the
externality, a socially responsible firm will be one where the marginal private cost of production
is closer to the marginal social cost of production. It is important to note as well that CS investment
in the framework refers to a given level of clean capital and is therefore a continuous variable,
whereas in much of the literature, and when many voluntary programs are considered, it is more
of a binary choice: a firm either makes a given commitment to the environment or it does not.22
Given that the levels and aggressiveness of voluntary goals can vary among firms, a continuous
conceptualization of CS commitments is considered appropriate.23 It should also be remembered
that while the framework presented here is static aside from the trivial first stage described above,
CS commitments and goals take place over time. They usually involve a pledge by the firm to
change from the current, lower proportion of clean capital to a higher level.24
The types of firms that typically pursue purely profit-maximizing CS (the only case
considered so far) without having to pay attention to stakeholders are primarily capital-intensive
with relatively old capital stock (Reksten, 2015; Reksten, 2018). This is not because there is no
22 For example, incorporating clean capital into the production process may involve re-tooling an entire
factory to run more efficiency or, perhaps, to be able to incorporate intermittent, renewable energy sources. The
firm cannot choose literally any proportion of its capital to convert; it must do so in discrete “chunks.” 23 The standard practice, depending on the growth trajectory of the firm, is to either have an absolute reduction
goal (that is a reduction of total emissions by a certain percentage by a given year) or a normalized goal, such that
emissions fall per-unit of something (such as per-dollar of revenue or per-unit of production). 24 One could think of the first stage as being pre-goal, the time between stages as the period in which a firm
enacts the goal, and the second stage as the immediate post-goal time. This assumes that the firm works to set a goal
as soon as the new information about its production process is “revealed.”
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scope for labor-intensive firms to pursue CS, but rather because the benefits from stakeholder
groups that desire CS are relatively small in comparison to the investments that need to be made
to boost the level of CS in the firm.25 Capital-intensive firms would be most likely to benefit from
the fuel switching and energy efficiency improvements that come with the greater use of clean
capital, and the presence of old capital stock means that the firm will need to replace capital
regardless of considerations of sustainability. Obviously, since the use of more clean capital is
profit-maximizing, these firms will tend to pursue their intended level of clean capital use without
any additional incentives from a program. However, they would no doubt take advantage of such
incentives, and voluntary programs can induce additional investments on the margin.
4.1 Consumer Preferences
In many cases, such as when a firm produces intermediate goods or electricity, most
consumers will care little about the proportion of clean to total capital (Reksten, 2018). If one
defines ‘consumers,’ however, to include the buyers of intermediate products which may be other
businesses, the factor of consumer pressure may become important. Increasingly, firms are asking
questions to their suppliers about GHG emissions in order to measure the “upstream” emissions
of their products.26 These buyer firms are often responding to their own customer inquiries or
submitting disclosure forms to investor groups such as CDP or the Dow Sustainability Index.
There are many other cases where CS is done to appeal to more traditional conceptions of
consumers, even in the case of greenhouse gas emissions targets. Several retail firms joined EPA’s
Climate Leaders program, such as Abercrombie & Fitch, Best Buy, GAP, and Tiffany & Co. This
25 For example, firms in industries such as insurance and banking have set voluntary goals for their own
emissions, even though their production footprint is very small. 26 In this way, the paper addresses the supply chain considerations of firms. That is, a firm interested in
reducing the environmental impact of its production process would desire cleaner inputs, which would manifest,
from the perspective of the supplier, as higher willingness to pay for a product with a higher level of y.
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was likely done in an effort to build a reputation among consumers as a “green” company. Also
found in Climate Leaders are many major government contractors, who may have wished to appear
proactive on climate change in order to cater to their government customer. Lockheed Martin,
Northup Grumman, Raytheon, General Dynamics, Boeing, and Honeywell, consistently the largest
recipients of Federal contracting money, were all members of the voluntary program in the 2000s
(Reksten, 2015).
The addition of consumer preference for CS to the framework is straightforward; the
strength of consumer preference for higher levels of CS in terms of willingness to pay is shown
through the parameter 𝛿. Thus, demand is now:
𝑝 = 𝛼 − 𝛽𝑞 + 𝛿𝑦 𝑤ℎ𝑒𝑟𝑒 𝛿 ≥ 0 (9)
The resulting profit estimation equation is given below:
𝜋 = (𝛼 + 𝛿𝑦)𝑞 − 𝛽𝑞2 − 𝑇𝐶(𝑟𝑠, 𝑟𝑐, 𝑤, 𝐾𝑠, 𝐾𝑐, 𝐿) (10)
Maximizing profits and finding optimal quantity, we now have:
𝜕𝜋
𝜕𝑞= (𝛼 + 𝛿𝑦)𝑞 − 2𝛽𝑞 − 𝑐 = 0 (11)
𝑞∗ =𝛼+𝛿𝑦−𝑐
2𝛽 (12)
The incorporation of consumer preferences for CS in this way both directly boosts demand and
reduces the price elasticity of demand for the product.27 Additionally, because 𝜕𝑞
𝜕𝑦= 𝛿 and 𝛿 ≥ 0,
a greater willingness to pay will boost production by the firm. Therefore, assuming a nonzero
willingness to pay by consumers, 𝑞∗ > 𝑞.
Here, marginal cost, c, appears to be independent of y. However, recall that y is actually a
measure of the ratio of clean capital to total capital inputs. That choice of inputs does directly
27 Price elasticity of demand is 𝜂 = |−
1
𝛽
𝑝
𝑞| = |−
𝑝
𝛼−𝑝+𝛿𝑦|. Therefore, as 𝛿 increases, |𝜂| falls.
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figure into the cost function and thus 𝑐 = 𝑓(𝑦). This formulation simply describes the additional
benefits that the firm can receive from CS investments or choosing a cleaner set of inputs. This
may cause the firm to choose to increase costs in order to take advantage of the even greater
revenues to be gained from selling “green” products. That is, the firm may decide to employ more
clean capital that would raise costs but have a positive impact on its reputation and sales that justify
this.
Note, too, that path dependence would play a role here outside of the strict context of the
framework. If a firm has been building a reputation among consumers as a company that “cares”
about the environment in the past, for example, consumers will expect the firm to maintain that
level of clean capital or use even more in the future. These expectations may set the company on
a new path where investing in more CS and publicizing it is a route to higher profits. This also
suggests the importance not only of stakeholders’ preferences but also those who are employed by
the firm as managers and their preferences; firms, after all, are composed of individuals working
in concert who have a particular set of beliefs about the state of the world. Such preferences will
be discussed further below.
4.2 Pressure from communities (activists and NGOs)
Closely related to the notion that consumers care about CS is the idea that activists in the
form of environmental NGOs can organize to affect demand for a firm’s products if a desired level
of CS investment (clean capital) is not reached. This could happen through measures such as direct
calls for a boycott, or, more likely in recent years, a media campaign and negative publicity for the
firm.28 Here, activists can be viewed as a special actor; they are informed citizens and groups of
NGOs who pay close attention to environmental issues emerging from the scientific community.
28 In this paper, the confrontational activist threat is treated in a very similar fashion to Baron (2001), which
is the seminal work in this area and with a model that goes into more detail on this point than will be considered here.
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Baron (2012) notes that the public has high trust in NGOs relative to other institutions, suggesting
that at least some will take purchasing cues from them. Reksten (2018) finds that some firms make
decisions about sustainability goals in order to diffuse potential activist threats.
In the framework, the activist threat impacts the demand curve in the following manner,
increasing the willingness of consumers to pay for CS by 𝜇. Threats therefore have the potential
to encourage CS investment by causing the firm to fail to maximize profits if it does not choose
the new and higher appropriate level of clean capital.
𝑝 = 𝛼 + (𝛿 + 𝜇)𝑦 − 𝛽𝑞 𝑤ℎ𝑒𝑟𝑒 𝜇 ≥ 0 (13)
Optimal quantity is now simply:
𝑞∗ =𝛼+(𝛿+𝜇)𝑦−𝑐
2𝛽 (14)
Because 𝜕𝑞
𝜕𝑦= (𝛿 + 𝜇), a greater activist threat that makes CS more valuable can also increase
output for the firm.
Through their activities, activists make CS, in the form of an increase in 𝑦, more valuable
for the firm. Therefore, the firm will be forgoing additional profits if it fails to invest in CS when
activists are demanding it. In practice, the ability of activists to impact demand depends on the
credibility of the threat. This, in turn, depends on the preference that consumers have for CS, as
well as the ability of the activists to organize in order to carry out their threat. That is, activists
may intend to carry out their threat, but they may not be able to effectively communicate their
message to the public.
4.3 Employees
The above cases assume that firms are relatively capital intensive, meaning that changes
occur in the composition of capital, which can impose significant costs or benefits upon the firm.
In reality, many firms that are not capital intensive also set environmental goals. In the case of
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retail firms and service providers that have contact with consumers, this could be an effort to
improve reputation and promote the firm’s “green” brand. There are a number of business service
firms, though, which do not have significant contact with consumers or whose business customers
do not exert pressure for emissions reductions. Primarily, these are in the information technology
and financial service industries. They may decide to set GHG reduction goals in order to appeal to
their workers, who presumably prefer working for a “green” employer (Reksten, 2018).
Additionally, workers themselves may organize to put pressure on the firm to invest in CS,
threatening lower productivity if the firm does not comply (Sendlhofer, 2019).
To introduce this idea into the framework, the marginal product of labor is dependent on a
productivity measure, 𝜃(𝐾, 𝜎𝑦), which is in turn dependent on the amount of capital used by the
firm, the level of y, and 𝜎, an exogenous variable representing worker interest in CS. Additionally,
we assume that 𝜕𝑀𝑃𝐿
𝜕𝐾> 0,
𝛿𝑀𝑃𝐿
𝛿𝑦> 0,
𝜕2𝑀𝑃𝐿
𝜕𝑦2 < 0. That is, the productivity of labor is higher with
additional capital, and it is higher with additional investment in CS through the choice of higher
levels, but productivity increases at a declining rate with higher levels of CS. This also impacts the
marginal cost, as more productive workers make the labor input more efficient. Therefore, it
becomes:
𝑐 = 𝑓(𝐾, 𝜎𝑦) (16)
And profits are now:
𝜋 = 𝛼𝑞 + (𝛿 + 𝜇)𝑦𝑞 − 𝛽𝑞2 − 𝑇𝐶(𝑟𝑠, 𝑟𝑐, 𝑤, 𝐾𝑠, 𝐾𝑐, 𝐿(𝜎𝑦)) (17)
Optimal quantity of output simply becomes:
𝑞∗ =𝛼+(𝛿+𝜇)𝑦−𝑐(𝐾,𝜎𝑦)
2𝛽 (18)
If workers have a strong preference for CS, profits will be higher with greater investments
in CS through the use of more clean capital. The extent to which this occurs depends on the
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relationship between the price of clean capital, the strength of worker preference for further CS,
and the specific cost and production functions of the firm. Similarly, as in the previous cases,
higher levels of CS boost optimal output because more productive labor lowers the need for a labor
input and reduces costs at any level of output.
4.4 Legislation and Regulation
Some firms may be more wary of additional regulations that could be imposed by the
government than threats from activists. This threat would take the form of a mandated proportion
of clean to standard capital that would yield the minimum allowed level of emissions of the
pollutant in question.29 The regulations in question take the form of an economy-wide pollution
tax or fee or may target a specific product (such as regulations of refrigerants, which are mostly
also greenhouse gases, often done under the Montreal Protocol).
In order to meet standards set by the government for emissions, the firm is forced to set
clean and standard capital at 𝐾𝑐𝑟 and 𝐾𝑠
𝑟, which are the levels required by regulations. This ensures
that emissions will fall within the acceptable range set by the government. We assume that non-
compliance incurs fines that raise costs to the point where firms will always choose to comply with
mandatory regulations. Such standards can be expressed in the following way. We define the
optimal level of clean and standard capital for the firm as 𝐾𝑐∗ and 𝐾𝑠
∗, respectively. The ratio of
clean to total capital, 𝑦, would be set in such a way that in order to meet the emissions standard,
the firm must use a higher-than-optimal level of clean capital (and thus a lower-than-optimal level
of standard capital):
𝐾𝑠𝑟 < 𝐾𝑠
∗ (19)
29 We use regulatory efforts and legislation somewhat interchangeably. Typically, legislators will develop
broad frameworks for addressing an environmental issue and then leave to civil servants the task of setting more
specific guidelines. The behavior that we detail from firms could be designed to placate either legislators or regulators,
depending on the stage of the rulemaking process and the specific framework of concern.
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𝐾𝑐𝑟 > 𝐾𝑐
∗ (20)
This means that the level of CS investment will be greater than the profit-maximizing level of the
clean to total capital ratio, y, for the firm.
𝑦∗ < 𝑦𝑟 =𝐾𝑐
𝑟
𝐾 (21)
This may still increase the firm’s revenue and therefore offset the higher costs brought about by
clean capital investment. This will occur if the CS investment increases demand by convincing
consumers that it is due to the firm’s socially responsible actions even though it is simply
complying with mandatory regulations. However, for increased regulations to be a credible threat
that may change firm behavior, fines must be high enough to lower non-compliance profits and
the emissions reduction they must go beyond what the firm would have done on its own.
It may be that in order to stave off additional regulations, the firm can use a higher
proportion of clean capital than it might have done with no threat, but that is still less than the
regulatory amount, 𝑦𝑟. Let us suppose that a firm uses clean capital such that y is more than some
minimum that will trigger additional regulations, defined as 𝑦𝑚 < 𝑦𝑟. It is then assumed that 𝑦𝑚
will still be high enough to convince regulators that there is no need to impose additional
regulations on the firm. If the firm believes this is a possibility, then it will maximize profits
according to:
𝜋 = 𝛼𝑞 + (𝛿 + 𝜇)𝑦𝑞 − 𝛽𝑞2 − 𝑇𝐶(𝑟𝑠, 𝑟𝑐 , 𝑤, 𝐾𝑠, 𝐾𝑐 , 𝐿(𝜎𝑦)) (22)
subject to the following constraint:
𝑦 ≥ 𝑦𝑚 (23)
and choose the corresponding optimal 𝑞 and 𝑦.
Deriving further optimization conditions would require specifying a production function
for the firm that would act as an additional constraint, but this is not necessary to do for the
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purposes of this paper, which focuses on specifying the role of CS. From this, it can be assumed
that a credible regulatory threat will induce investment in clean capital even in the absence of
mandatory regulations. However, it is also assumed that this level is lower than what would be
required with mandatory rules.
4.5 The Role of Shareholders and Production Choices
Choosing the profit-maximizing level of output given stakeholder preferences requires
several steps. This framework assumes that the firm has perfect information about the
stakeholders’ preferences and their potential impact on costs and revenues as a result of their
choice of 𝑦. Thus, the firm can calculate its cost and revenue functions according to the stakeholder
preferences and choose the appropriate level of output. Firms may not face pressure from all
stakeholders, but if they do, the higher preferences of one group for action may cause the firm to
“over-comply” with the preferences of other groups. For example, if a firm is concerned that it
faces potential regulations, such that it sets 𝑦 > 𝑦𝑚 but also faces pressure from activists that push
it to use even more clean capital, its ultimate level could be 𝑦 > 𝑦𝑟 > 𝑦𝑚, rendering mandatory
regulations irrelevant.30
This process to choose the appropriate level of clean capital ultimately means that the firm
believes it is maximizing profits in each of the periods described in the framework. However, as
Baron (2001) considers, it may be the case that the company’s shareholders have non-pecuniary
preferences such as gaining some non-monetary benefits from the knowledge that they own
“green” companies.31 If they do have a preference for CS that can only be acquired by sacrificing
30 One could also consider the case of a three period framework, where a higher level of 𝑦 in period 2
persuades regulators that the firm could meet even stricter standards and thus the threat of limits on emissions would
increase for the third period. 31 Baron (2001) refers to this as altruism. It is an impossible task to understand the “true” motivations of
shareholders that claim to have an interest in environmentally sustainable firms. They may simply have relatively
long time horizons and wish to ensure that the firm remains profitable even in the face of climate change and a future
price on carbon. Still, there is a case that at least some shareholders, such as institutional investors like state pension
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profits, utility maximization is at odds with profit maximization, as shown by Feinberg (1975).
That is, investors may pressure a firm to use more clean capital, even though the resulting 𝑦 is sub-
optimal from a profit-maximizing perspective. The shareholders will, through an internal
negotiation process at meetings and through votes, determine their average preference for CS. If
they have no social preference for it or a preference that is less than or equal to 𝑦, they will simply
accept the profit-maximizing level that the firm has presented to them.32 This is because the level
of 𝑦 is assumed to be compatible with their goal of profit-maximization for the firm. However, if
their preference for CS is higher than what the firm arrives at through simple profit maximization,
they will ask the firm to produce a level of CS that maximizes their utility, despite the lower returns
to investment. That is,
𝑈𝑠 = 𝜌𝜋 + (1 − 𝜌)𝑦 (24)
where 0 < 𝜌 ≤ 1 represents the relative weights placed on profits and CS. Shareholders are willing
to accept a lower return because they will get satisfaction from knowing that the firm uses more
clean capital.
5. Determinants of CS Investment & Conclusions
The amount of CS (clean capital) investment by the firm therefore depends on several
things. First, clean capital can be thought of as a standard third input into production, one that is a
very good substitute for standard capital until a large proportion of standard capital has been
replaced (for example, use of electricity generation using renewable resources instead of fossil
funds or universities, have non-pecuniary preferences because of the occasional practice of divestment from socially
controversial firms. 32 Following Feinberg (1975), profit-maximization here is considered to be a useful assumption rather than a
necessary result.
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fuels). Because of this, the absolute level of clean capital used will depend on technology, its
relative price, and the firm’s production decision.33
Second, firm characteristics determine which stakeholders matter. That is, a firm can be
described by a series of attributes, such as size, location, industry, composition of shareholders,
and whether it makes final or intermediate goods. These characteristics will then determine the
value of the parameters above, namely consumer (including business customer) willingness to pay
(𝛿), the degree of activist threat (𝜇), the degree of worker preference for CS (𝜎), and the preference
of shareholders for CS (𝜌). These shape the ultimate costs and benefits of using more clean capital
because they can act as institutional coordinates. A firm that has the characteristic of producing
final goods, for example, may set stronger reduction goals to appeal to consumers. A firm that has
the characteristic of being in the utility industry may be driven to reduce emissions by the fear of
regulations.
Stakeholders will then have an impact on the firm’s profit function through their
preferences for CS in the form of the ratio of clean to standard capital. It may be that consumers
will purchase more of the firm’s product with higher levels of CS, or activists will less aggressively
campaign against the firm, sparing it from reduced revenues. Capital-intensive firms may face
regulatory threats unless they appear to be making efforts to incorporate clean capital into their
production process, or they may find that workers are more productive if they believe they are
working for a “green” company. Finally, it may be that shareholders have non-pecuniary
preferences and wish for the firm to use a higher level of clean capital. Firms that build a reputation
for being environmentally friendly will be expected to maintain that image, meaning that there is
33 Just as in standard profit-maximization models, the firm’s choice here is to determine the profit-
maximizing quantity given the costs and revenues of different levels of production. The level of clean capital is simply
a byproduct of this process, though the appropriate level of clean capital is chosen by the firm in the same sense that
it chooses the appropriate level of any other input.
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an element of path-dependence, especially if one imagines generalizing the framework to more
than 2 periods.
This framework is admittedly general in nature and only provides a basic rubric of the areas
in a firm’s decision-making process in which CS considerations are taken into account. Future
research can help refine it in order to arrive at more specific propositions regarding the types of
firms that would be likely to have stakeholders with CS or social preferences and explore in greater
depth the role of path dependence and discounting. Another fruitful area of research is a deeper
examination of the interaction of time and information about the environmental issue that enables
us to identify and assess the firm’s strategic reaction to the issue at hand.
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