Rationale 1: Strategic but Risky Investments with Positive Externalities

Perhaps the greatest accomplishment of the CSR movement is that it has encouraged business leaders to think creatively and hard about ways to do well by doing good. That is to say that the CSR movement has encouraged entrepreneurs to search for ways of generating value by addressing social problems. As Drucker (Reference Drucker1984: 62) put it, “the proper ‘social responsibility’ of business is to tame the dragon, that is, to turn a social problem into economic opportunity and economic benefit, into productive capacity, into human competence, into well-paid jobs, and into wealth.” This vision gave rise to a vast literature investigating whether CSR pays; although as critics have pointed out, to the degree that it does, the socially responsible angle appears moot. However, the point of Drucker’s exhortation is that profit opportunities in social entrepreneurship may not be obvious or without risk. Only once an innovation is discovered and proven does a clear business case emerge that leads other firms to adopt the practice.

This explains the time and context dynamic of CSR that Rivoli and Waddock (Reference Rivoli and Waddock2011) have noted. Initially, only one or a handful of firms may be willing to take considerable risk investing in a business practice with positive externalities, in the hope that it will generate value for the firm. If indeed this proves successful in increasing consumer demand, improving employee morale, shifting industry norms, attracting support of investors, and so on, then other businesses may find it in their interest to follow suit. An important question, however, is what justifies the decision of a first mover.

Considered from the perspective of welfare economics, certain investments with positive externalities may yield a net gain for a society, even if their expected value is negative for a firm. Such investments are thus desirable from a welfarist perspective (they may provide tangible public goods as externalities, involve the prevention of negative externalities that would otherwise occur, or help with the entrepreneurial process of discovery). However, given the uncertainty surrounding the business case, early-stage investment looks more like philanthropy than strategy—but philanthropy that can be justified by overall welfare considerations.

From a welfarist perspective, a firm should invest if the expected value of the expenditure and positive externalities are, together, a net positive, all things considered.Footnote ² However, from a profit-maximizing firm’s perspective, the firm should invest only if the expected value of the expenditure is positive for the firm’s bottom line. (Note that if the expected value is negative and large enough to offset the value of positive externalities, even the welfarist would reject an investment.) Given this analysis, a specific rationale for corporate philanthropy emerges: the larger the ratio of positive externalities to expected net costs for the firm is, the more justification there is for a corporation to make a philanthropic investment.

We can describe this as the philanthropy multiplierFootnote ³ and formalizeFootnote ⁴ this ratio as follows:

$$ \mathrm{PM}\hskip0.35em =\hskip0.35em \mathrm{PE}(I)/\left(C(I)\hskip0.35em \hbox{--} \hskip0.35em \unicode{x1D53C}\left[I\right]\right)\hskip0.35em \mathrm{if}\hskip0.35em \unicode{x1D53C}\left[I\right]<C(I) $$

where PE(I) is a measure of the positive externalities associated with an investment, C(I) is the total cost of the investment, and $ \unicode{x1D53C} $ [I] is the expected value of the revenue from the investment for the firm, defined as the sum of the payoffs x of n possible outcomes multiplied by the probability p of each occurring, $ {\sum}_{i=1}^n{x}_i{p}_i $ .Footnote ⁵ Note that this applies only if $ \unicode{x1D53C} $ [I] < $ \hskip0.35em C(I) $ , because if the expected value of the revenue from investment were equal to or greater than the cost, there would be a clear business case for making the investment, and the question of philanthropy would not arise (risk aversion could complicate this calculation but does not alter the underlying logic).Footnote ⁶

For example, suppose that a company like Netflix, whose product is greatly enhanced by a high-speed internet connection, is considering whether to subsidize the installation of high-speed internet cables in rural towns at a cost of $100 million. For simplicity’s sake, assume that reliable market research suggests that there is a 50 percent chance that this will greatly increase the number of subscribers, yielding the company an additional $120 million of net revenue. But there is also a 50 percent chance that subscriber growth will be more modest, yielding the company only an additional $60 million of net revenue. The expected value of this investment for the company is $90 million (0.5 * 120 + 0.5 * 60 = 90), which is $10 million less than the required investment of $100 million. A profit-maximizing firm would thus judge that it is not in its interest to make this investment because it leads to an expected loss of $10 million.

However, this investment would generate a positive externality of $100 million of additional internet infrastructure. To establish that this infrastructure is genuinely valuable but something that would not otherwise be provided, let us stipulate that 10 million people will experience spillover benefits from this infrastructure valued at, at least, $10 per person but that transaction costs make it infeasible to capture this value directly. Overall, the society would be much better off with the investment—some $90 million better—at an expected cost of ~$10 million to Netflix shareholders. From a social welfare perspective, the company should make the investment (assuming that there are no alternative ways to invest the money that would be expected to produce even greater benefits, something we ensure by including the cost of capital in our calculation of overall costs).

We arrive at a situation in which a corporate expenditure would generate large social welfare benefits at a comparatively small net cost and with a decent chance of being profitable for the firm. Because of the riskiness of the investment, there is not a solid business case for making it (again, preferences for, or aversion to, risk could complicate the underlying analysis but would not change the overall logic). However, there is a philanthropic rationale for making the investment, which derives from the perspective of overall social welfare.

Moreover, we can identify and quantify the relevant factors. The positive externalities in this case are estimated to be $100 million. Second, we need a measure of the overall cost. Here we need to include both the direct cost of building the infrastructure ($100 million) and the cost of capital for the firm, which captures the opportunity cost of deploying $100 million to this project rather than alternative investments. Public estimates suggest that the cost of capital for Netflix is about 11 percent, which means that by investing $100 million in infrastructure, the firm would be giving up an approximate $11 million return that it would have received if it had invested this money in other business operations. In total, then, the total cost of this investment to Netflix would be approximately $111 million. As mentioned, the expected value of the investment to Netflix is $90 million (0.5 * 120 + 0.5 * 60 = 90).

Thus the philanthropy multiplier—the overall ratio of benefits to expected costs—in this case is 100 / (111 − 90), or approximately 4.76. Put another way, this suggest that every $1 that Netflix invests in this project is expected to generate $4.76 of value for society at large. Granted, there is uncertainty as to whether this investment will ultimately yield a $40 million loss for the firm (if one scenario obtains) or a $20 million profit (if the other scenario obtains). However, in either case, the net welfare of society will have increased.

In cases in which a firm is presented with additional profit opportunities, the cost of capital may not be the appropriate baseline for calculating the true opportunity cost of an expenditure. If directing money to one strategy requires forgoing a more profitable (legitimate) opportunity, this means a company will be leaving money on the table, which must be considered as a genuine cost. For example, if a beverage company decides not to use a standard low-cost bottle adopted by most of its competitors but rather adopts a more expensive bottle that will end up costing the company $1 million more but will result in $3 million less of a negative externality like pollution, this would indicate a philanthropy multiplier of 3. Even if the company still makes profit on each beverage sale, it is incurring a cost (forgone profit opportunity) that it need not bear, and this cost rightly serves as the relevant baseline for calculating the philanthropy multiplier.

The higher the philanthropy multiplier is for a particular investment, the more compelling is the social welfare justification. We can debate at what level a serious ethical obligation begins to emerge, but the underlying calculus is clear. Also, from a comparative statics perspective, the philanthropy multiplier goes up as a company’s cost of capital goes down, the expected value of an investment comes closer to the overall cost, and the positive externalities of an investment go up.

Finally, note that a firm that engages in philanthropy according to this first rationale may be sufficiently motivated to do so by the possibility that an investment will generate profits for the firm. The payoff isn’t certain, and indeed, the expected value doesn’t justify the cost. However, the firm may wish to roll the dice on a risky investment with a high philanthropy multiplier, both because of the hope that the investment will prove profitable (firms that have an appetite for risk may be less averse to this uncertainty) and because the firm is aware that, even if the investment fails to be profitable, it will still be welfare enhancing for society at large. Estimating and publicizing the philanthropy multiplier for a project could be useful for justifying the investment to skeptical shareholders and for showing the larger public that the firm is engaging in welfare-enhancing activity.

However, the logic of the philanthropy multiplier can be extended to cases in which the expected value of an expenditure to a firm is zero. If, all things considered, the welfare benefit to society were large enough, this might warrant an expenditure, even if the firm does not stand to benefit by making a profit at all. This is the logic that grounds the second rationale for corporate philanthropy, which occurs when firms have a comparative advantage that enables them to address problems at a lower social cost than other alternatives.

Rationale 2: Comparative Advantage That Lowers the Social Cost of Addressing Problems

The second kind of welfarist justification for corporate philanthropy derives from the comparatively low cost at which certain firms can address social problems. Kaul and Luo (Reference Kaul and Luo2018) and Morgan and Tumlinson (Reference Morgan and Tumlinson2019) have recently explored the implications of this insight in theoretical models. Focusing on the comparative efficiency of CSR, Kaul and Luo (Reference Kaul and Luo2018) develop a model of a market for social goods that illustrates conditions under which for-profit CSR initiatives provide more social goods than nonprofits alone would have achieved. Their model suggests that when a firm pursues CSR activities that are closely related to the firm’s core business and have little overlap with nonprofit efforts, these can be strongly Pareto optimal. The authors note that this insight is distinct from, yet potentially complementary to, an ethical rationale for CSR, and they propose their model as a “robust foundation for further theoretical and empirical work in this increasingly important area” (1653).

Morgan and Tumlinson (Reference Morgan and Tumlinson2019) propose a model of corporate provisions of public goods premised on the assumption that corporations can be more efficient than individual philanthropists, both in overcoming the collective action free rider problem and in preventing harms (e.g., pollution) ex ante rather than mitigating them ex post. In a frictionless world, the model suggests that firms will abandon profit/dividend maximization to provide public goods and/or refrain from public harms as a simple consequence of shareholder preferences if shareholders care about public welfare. However, the authors acknowledge that overcoming real-world frictions, particularly with regard to information, remains a challenge in practice.

At a more conceptual level, Bénabou and Tirole (Reference Bénabou and Tirole2010) have developed the idea of delegated philanthropy to describe a situation in which stakeholders desire that a corporation sacrifice some profits to engage in philanthropy on their behalf (see also Mejia, Reference Mejia2021). This raises the question whether this is a rational approach for stakeholders to prefer. Bénabou and Tirole argue that it may be, given that firms possess a unique advantage in terms of information and transaction costs:

Their key insight is that firms will have a comparative advantage in providing aid given the knowledge and efficiencies that accompany their business practices. Bénabou and Tirole suggest that firms engage in philanthropy in response to specific stakeholder demands, although it is unclear how these are expressed and how they then mobilize firms to action. However, from the perspective of social welfare, this mechanism doesn’t matter. Rather, an analysis of the overall costs and benefits provides strong justification for corporate philanthropy on the basis of comparative advantage, defined as “the ability of any given economic actor to produce goods and services at a lower opportunity cost than other economic actors” (1).Footnote ⁷

For example, consider a large bakery that closes at 5:00 pm. The bakery has to offer a wide assortment of freshly baked goods up until closing time to continue to attract and serve customers. However, at 5:01 pm, its excess inventory for the day becomes worthless (e.g., bread becomes stale and other products start to spoil, making them unsuitable for sale the next day). Suppose that on any given day, the bakery closes with $500 worth of baked goods still on the shelf and that for reasons of regulation (health codes) and transaction costs, it’s most cost-effective for the bakery simply to throw these away. However, a local food kitchen has asked the bakery to donate these excess baked goods at the end of each day so that they can be served to poor families later in the evening.

The problem is that doing so will generate small, additional costs for the bakery that the food kitchen cannot cover. For example, employees will have to stay later to package and transport the food at, say, an overall cost of $50. We arrive at a situation in which, if the bakery were willing to expend $50, this would generate a $500 benefit for others. Moreover, if an independent philanthropist or nonprofit wanted to feed the hungry and did not know about the bakery’s unique situation, it would cost $500 to purchase a similar amount of food at market prices. Thus letting the food go to waste arguably destroys $450 of value. Of course, if independent philanthropists did know about the bakery’s situation and the costs of donation, an advantageous deal could be struck. However, transaction costs and the localized nature of knowledge will often preclude this.

From a social welfare perspective, the bakery should donate the food at its own expense if there is no market mechanism to compensate it. Again, we can identify and quantify the relevant factors. Supposing the cost of capital is 10 percent, the bakery’s overall cost is $55, and the overall welfare benefit is $500. Because there is no expected benefit to the firm, the expected value of the investment from the firm’s perspective is zero. Thus the philanthropy multiplier—the overall ratio of benefits to costs—is 500 / 55, or approximately 9.09. Again, we can debate at what level a serious ethical obligation begins to emerge, but the underlying calculus is clear, as is the social welfare justification.

Finally, note that this expenditure does involve a comparative decrease in profitability, as was the case with the first rationale (from the ex ante perspective of expected value). This does not mean that the larger firm will cease to be profitable. Indeed, if such expenditures bankrupted or financially imperiled a firm, that would be a strong argument against them. However, what distinguishes these expenditures as being philanthropic is precisely that they involve a real opportunity cost for the firm. Compared to viable alternatives, the firm expects to lose money with these actions. What justifies the costs of such expenditures, however, is that they produce a much greater benefit in terms of overall welfare—thus the logic of the multiplier.

Calling attention to the normative import of this logic is not meant to discount or disregard many other laudable activities firms pursue that fly under the banner of CSR. For example, if a firm is able to capture sufficient value from externalities it generates or from its cost advantage to improve its own profits while contributing positively to social welfare, all the better. However, such win-win cases don’t generate normative or economic dilemmas. The question is what justifies expenses that do involve a genuine opportunity cost in terms of a firm’s bottom line. The philanthropy multiplier provides a compelling answer.

Benefits and Implications of the Philanthropy Multiplier

The philanthropy multiplier has two main benefits. First, at a conceptual level, it clarifies the welfare benefits that philanthropic corporate investments can have and, in so doing, provides a justification for these expenditures in terms that are commensurable with the welfarist framework Norman and other scholars have advanced. In particular, the philanthropy multiplier provides a detailed rationale for corporate expenditures that go beyond compliance and profitability, while not falling prey to Friedman’s critique that owners could do as well or better by making philanthropic investments on their own with the income they derive from a company (this is an important point that I will examine in more detail later). Although it remains an open question whether there is a threshold at which the potential for a large multiplier results in a philanthropic duty for a company, the underlying basis for the argument and evaluation is clear.

Second, at a practical level, the philanthropy multiplier provides a specific metric by which to assess the value of philanthropic corporate expenditures. The underlying calculus is transparent, generalizable, and comparable. Not only can companies calculate the multiplier and publicize it to justify expenditures to shareholders, stakeholders, and the public but those same audiences can use the multiplier to compare companies and their philanthropic activities. Indeed, the multiplier can serve as a mechanism to communicate information that would be needed to lower frictions in a manner needed to realize the optimistic implications of Morgan and Tumlinson’s (Reference Morgan and Tumlinson2019) model.

In addition to traditional metrics of productivity and value creation (such as return on equity, return on capital employed, or earnings per share growth), the philanthropy multiplier serves as a means to indicate the value of a firm’s philanthropic expenditures. So-called ESG investors (focused on environmental, social, and governance issues) are likely to be particularly interested in this metric, which can, in principle, capture a number of ESG concerns that are now reported on an ad hoc basis. However, equally if not more importantly, calculating the philanthropy multiplier can provide helpful discipline for a firm, leading it to make more socially valuable investments and to refrain from expenditures that do not provide efficient increases in welfare.

On this practical point, the philanthropy multiplier can help achieve many of the ideals of shared value that Porter and Kramer (Reference Porter and Kramer2006, Reference Porter and Kramer2011) have lauded and advance an aim similar to that of the effective altruism movement, which examines how money can be deployed to do the most good (Singer, Reference Singer2015b). A low multiplier suggests that there is not a strong rationale for a company to expend resources because the welfare benefits do not significantly outweigh the net costs as measured by the difference between the firm’s expenditure and benefit. Moreover, just as a firm’s cost of capital must be taken into account in calculating the philanthropy multiplier, so as to account for the opportunity cost of deployed resources, the effectiveness of individual philanthropy as evaluated by effective altruists—those who seek to ensure that charitable contributions are used most effectively—can serve as a sort of benchmark for valuable corporate philanthropic investments. This is because, as Friedman’s critique reminds us, those who receive a share of a firm’s profits can always deploy that cash toward philanthropy on their own. One way in which a firm’s philanthropy multiplier can be particularly compelling is if it reveals greater efficiency than opportunities available to private philanthropy or concerns an opportunity that isn’t possible for private philanthropy. Otherwise, Friedman’s challenge looms: why should corporate philanthropy be preferred to private philanthropy if the latter can do as well or better?

Indeed, one implication of this analysis is that donating cash to other philanthropic causes may not be the most welfare-enhancing activity from an efficiency perspective. It’s important to emphasize that the philanthropy multiplier does not enable us to adjudicate the ultimate worthiness of charitable causes but rather captures the efficiency of expenditures. Any positive multiplier has a prima facie claim to be a net improvement from an efficiency perspective because it means that we are getting more things of value at a lower net social cost than is otherwise possible.

One potential analogue within the traditional philanthropy space is a metric that the charity evaluator GiveWell calls “cost-effectiveness in multiples of cash transfers, after all adjustments,” which indicates “how many times more cost-effective a program is than using the same amount of funding to deliver unconditional cash transfers.”Footnote ⁸ Put simply, this is a measure of how much money (in terms of multiples of the amount expended by a charity) would have to be given to people to achieve the same outcome. For example, the Against Malaria Foundation (AMF) in Congo is estimated to have a cost-effectiveness multiple of 10.5, which is to say that a dollar given to the AMF is approximately ten times more effective in preventing malaria deaths than a dollar given directly to people in Congo for this purpose.Footnote ⁹ The multiplicative effect of such an expenditure could be a reason for a company to make a donation to this charity, particularly if a company has some special knowledge about this opportunity that it believes others are not aware of or have unjustly neglected. Incidentally, it is worth noting here that the most effective charities in the world as evaluated by GiveWell have cost-effectiveness multiples in the range of 5–15, which are rivaled by the multiplier of the foregoing simple bakery example (9.09).Footnote ¹⁰

The analogy between the philanthropy multiplier and this metric of cost-effectiveness multiples for charities is not perfect, however. Although this metric indicates how much more effective a donation to a charity is than the next best option of a direct cash transfer, these sorts of charitable opportunities are open to all, which opens them up to the Friedman critique. Moreover, counterfactual considerations are more complex in these cases, and above a certain point, additional donations may not generate efficiencies at the same level.

The concept of a Kaldor–Hicks improvement further illustrates why the philanthropy multiplier indicates efficiency improvements that may be superior to many conventional opportunities for charitable giving. Consider the case of a large food retailer that could expend $1 million of its own money to conserve food that is close to its expiration date that would otherwise be wasted in the supply chain and, in so doing, save $3 million worth of food to feed the homeless. This would effectively add $2 million of value/resources to the world. In a world of perfect knowledge and zero transaction costs, this could theoretically allow an extra $2 million to then be devoted to a high-impact charity like the AMF. This would clearly be twice as impactful as the company simply donating the million dollars it expended directly to the charity. Granted, Kaldor–Hicks reallocations often won’t be negotiable in the real world, but the net welfare-enhancing logic underlying this economic point is clear and compelling.Footnote ¹¹

Finally, it’s important to clarify that this does not preclude exercising judgment with regard to the worthiness of different causes. Expending $1 million to generate $3 million of food to feed the homeless (a philanthropy multiplier of 3) may be more compelling than expending it to enable $10 million of piano lessons for low-income children (a philanthropy multiplier of 10) if, for example, one believes learning piano is of little value or doubts that the resources saved will ultimately benefit more worthy causes. The philanthropy multiplier cannot tell us what we should value. Rather, it makes clearer how resources can be leveraged to obtain more than is otherwise currently possible and helps us evaluate the economic trade-offs between various outcomes that may be desired.

The value of corporate philanthropy ultimately derives from a firm’s unique knowledge, market niche, and comparative advantages. When a firm finds itself in a situation where it can produce a welfare gain that no other entity could achieve with similar resources, there is the potential for a high philanthropy multiplier.

In the case of a strategic but risky investment with positive externalities, the potential for a company to capture some value from that investment is what raises the multiplier, whereas other entities would find the investment infeasible, yielding less expected benefits for the same cost. In the case of a firm with a comparative advantage that enables it to provide some welfare benefit at a lower cost than others, this will generally be due to the firm’s specific technologies, capacities, and local knowledge, as well as transaction costs that make it infeasible for others to obtain similar knowledge or to contract on an independent basis. These two rationales are not meant to be exhaustive, and future work may identify and explore additional ones that are consistent with a welfare multiplier justification. However, these two rationales describe scenarios that are particularly important and common within business contexts.

Note that the examples provided earlier of hypothetical situations that a bakery or Netflix might face are neither rare nor far-fetched. Pharmaceutical companies and pharmacies routinely encounter situations akin to the bakery’s on a much larger scale in dealing with expiring drugs (see, e.g., Bornstein, Reference Bornstein2015; Marshall, Reference Marshall2017). More generally, many companies produce by-products or imperfect goods that have value but that are cheaper simply to dispose of rather than recycling them or performing costly searches for users who could benefit from them and figuring out transfer logistics. Under certain circumstances, such search costs, transfer costs, and/or recycling costs may pale in comparison to the welfare benefits that accrue from bearing them, in which case, a company may judge that the corresponding philanthropy multiplier justifies the expenditure.

Companies also routinely face opportunities similar to the hypothetical Netflix case. For example, Airbnb recently partnered with the Italian city Grottole to help revitalize the city. The arrangement is structured such that “the company provides funding for the city to buy three buildings to convert them to a new community center, owned by the city. It will also fund the sabbatical and local housing for four people” (Wilson, Reference Wilson2019:1). As the reporter covering the story noted, “these initiatives generate zero revenue for Airbnb. So is it a corporate social responsibility project? A business play? With Airbnb, those topics are bewitchingly intertwined” (Wilson, Reference Wilson2019: 1).

It’s not hard to imagine the business interest that Airbnb would have in this project. If the company’s investments in this city make the city a tourist hub, Airbnb can collect significant revenue from locals using its platform to host visitors. However, this payoff is far from certain. Even if the business case does not materialize (in part or in full), Airbnb’s investments will have provided public goods of significant value to residents of Grottole. The potential for revenue and net profit is what makes the investment worth considering for Airbnb. However, even if the venture does not prove profitable, the revenues that Airbnb collects and the value of the community center are, when considered together, likely to indicate a large philanthropy multiplier.

Though any expenditure can be evaluated on an individual basis during the period in which it is made, over time, certain sorts of expenditures could see their philanthropy multipliers change or disappear altogether. If a beverage company invests in research and development in the hope of producing a plastic bottle that costs less to produce and is also better for the environment, the logic of the philanthropy multiplier could justify those R&D expenditures if the initial prospect of success is low. If, after a year of research, the prospect of success becomes high, then additional investment might be a financial no-brainer, easily justified by its economic benefits for the firm. Though still laudable from a CSR perspective, this final round of investment would no longer be characterized as a species of philanthropy, nor would other firms’ adoption of the ultimate production process as a cost-saving measure. That outcome would, however, speak to the philanthropic value of the initial investment. Moreover, if the initial effort was not as successful and yielded a process that produces a bottle that is, say, 10 percent better for the environment but 1 percent more costly to produce, the company might then still choose to bear the higher cost (passing up a small profit opportunity) because of much larger environmental benefits, which could likewise be justified by its philanthropy multiplier.

The welfarist logic of the philanthropy multiplier can be extended to the domain of individual beneficence as well. It often happens that someone confronts a situation in which she can produce a large welfare gain for others by making a relatively small sacrifice of something to which she is otherwise entitled. To give a trivial but familiar example, imagine that you are pulling up to a congested airport during rush hour in an Uber, scheduled to be dropped off at Terminal 2. As your Uber approaches Terminal 1, you notice that the next passenger queued for the driver is located at the very end of Terminal 1. You realize that you could have the driver drop you off at that point, and it would take you only an easy, fifty-yard walk to get to your destination at Terminal 2. This would have the benefit of allowing the Uber driver to pick up the other passenger without any delay. However, you have every right to expect and demand that the Uber bypass the passenger and take you all the way to Terminal 2 as contracted. But this means that the Uber driver will have to loop around the entire airport, which is likely to take twenty minutes with current traffic. The other passenger will have his pickup significantly delayed and may even cancel and seek another ride. Either way, the Uber driver will waste twenty minutes, during which she could have otherwise been earning a fare. These nonnegligible costs could be avoided, however, if you simply speak up and offer to walk fifty yards. To put it crudely, you could effectively save two people a combined total of forty minutes if you’re willing to take a four-minute walk—a philanthropy multiplier of 10 of sorts (if those minutes are all commensurable, which admittedly may not always be the case). Although you have no contractual or moral obligationFootnote ¹² to do so, you may judge that the welfarist logic, and the ratio of benefits to others compared to costs to yourself, provides good reason for you to take the walk.

Note two conspicuous features of this example that likewise characterize corporate analogues. First, there is a knowledge problem that the agent is in a unique position to solve. Uber’s app is not able (at least yet) to recognize the costs imposed by the original drop-off point and to propose a Coasean bargain that would be mutually advantageous for you, the driver, and the next passenger. The knowledge needed to realize value and produce a welfare gain is only available locally, by virtue of your unique position in the market. Second, there is no doubt that you have the right to complete your original trip as planned, which is to say that you have no obligation under law and/or market norms to accept an early drop-off. However, you have the authority to voluntarily propose and bear that small cost, which you may believe is worth the larger gains that you will generate for others. Similarly, a corporation’s market niche or local knowledge is what generates the potential for a large philanthropy multiplier, and such expenditures go beyond the requirements of law and market norms, being properly characterized as voluntary.

These features counsel against instituting any legal mandate for companies to pursue philanthropic investments. Although it may be desirable, from a public policy perspective, for corporations to pursue projects with large philanthropy multipliers, the knowledge needed to identify such projects will be available only to insiders and is not something that public authorities will generally be in a position to evaluate (unless and until a company identifies and publicizes a worthy philanthropic investment). Furthermore, philanthropic investments do involve real costs, which many companies may rightfully be unwilling or unable to bear. However, for those companies that are able to bear such expenses, the ability to calculate and publicize their philanthropy multiplier can help incentivize a discovery process aimed at identifying the most valuable philanthropic investments and ensuring that those expenditures are disciplined and effective. This can also provide information to investors, donors, and customers who wish to support such efforts. Finally, the philanthropy multiplier is not intended to serve as a mindless decision rule that requires that a company always maximize the multiplier; rather, it is intended to serve as a tool to help companies evaluate and justify expenditures that can generate extraordinary benefits, making these more transparent and accountable. Companies may still wish to give to external charities, and such donations can be distinguished in reports and justified in terms of effectiveness. Likewise, companies may judge various projects worthy even if some have higher or lower multipliers than others.

The Uber example also raises a looming question about a potential difficulty with calculating and using the philanthropy multiplier in practice, namely, how is welfare to be measured? As with any utilitarian or welfare calculation, how one values benefits can be contested, and certain valuations may be incommensurable with others. However, this is true of all welfare considerations and has not prevented the informative use of cost–benefit analysis across the social sciences and policy world. Moreover, this is an area in which scholars are actively working to develop more informative methods of assessing welfare and social value (see Kroeger & Weber, Reference Kroeger and Weber2014, for both an informative overview of existing approaches and an insightful proposal for comparing social value creation).Footnote ¹³

Valuations do require justification, but corporations with local knowledge of their market niches will generally be in the best position to gather information and present the case for the value that a philanthropic expenditure yields. However, to provide a compelling estimate of a project’s philanthropy multiplier, a firm will have to evaluate the actual impact of its investment. Encouraging such evaluation is another positive aspect of encouraging the use of the philanthropy multiplier. The need to quantify the benefits generated by a philanthropic investment is likely to lead to both more accountability and more insights regarding the best way to deploy resources.

For example, the TOMS shoe company has been a paragon of a successful social enterprise, having donated some 60 million pairs of shoes to children in need. However, when TOMS recently collaborated with economists from the World Bank to run a randomized trial to measure the impact of donated shoes, the results were less impressive than anticipated. As Wydick, Katz, Calvo, Gutierrez, and Janet (Reference Wydick, Katz, Calvo, Gutierrez and Janet2018: 727) report, “in a context where most children already own at least one pair of shoes, the overall impact of the shoe donation program appears to be negligible.” In response to the insights this study provided, TOMS has made significant changes to the way it targets recipients to ensure that the program has the greatest positive effect (Leigh, Reference Leigh2018) and recently pivoted to a much broader philanthropic strategy.Footnote ¹⁴

A critic might object that firms may not always be able to accurately estimate the positive externalities created by their philanthropic expenditures or be motivated to report assessments accurately, but this is likewise true of many current ESG activities and traditional forms of corporate philanthropy, which are widely pursued. The systematic scrutiny that would likely accompany the formal reporting of philanthropy multiplier estimates could only improve the current situation.

Finally, if widespread consideration were given to the philanthropy multipliers reported by firms, and companies sought to compete and distinguish themselves on the basis of this metric, this could have profound implications for the larger political economy of market-based societies. As Matten and Moon (Reference Matten and Moon2008) have noted, countries have developed different institutional approaches to governing the relationship between business and society, and different national business systems have encouraged different types of CSR activities. Luo and Kaul (Reference Luo and Kaul2019) have also observed that for-profits, nonprofits, collectives, and bureaucracies all have unique advantages in addressing social issues, based on the market frictions associated with them. However, there is a very specific challenge to the creation of social value that all market systems face and that Lazzarini (Reference Lazzarini2020) has recently elucidated in an important article on the nature of the social firm, and that use of the philanthropy multiplier can potentially help resolve.

In brief, Lazzarini (Reference Lazzarini2020) notes that different organizational forms will have different capacities and incentives to appropriate economic rents. In many cases, enterprises may find it in their interest to focus exclusively on customer segments that are highly profitable, while neglecting poorer segments, despite the fact that social value could be realized if those disadvantaged segments were served (and various problems of contracting, measurement, and enforcement were overcome). Lazzarini examines how public bureaucracies, public–private partnerships, and social enterprises can potentially address this problem through better organizational alignments of incentives. He concludes with a call for future research that explores specific mechanisms for incentive realignment to realize social value through a variety of organizational forms.

Within the domain of for-profit enterprises, consideration given the philanthropy multiplier can potentially serve as a powerful incentive for firms to expend resources in ways that create social value, even when that value can largely not be expropriated by firms. In effect, the philanthropy multiplier provides firms with a means of measuring and reporting the uncaptured social value they create. Competition among firms trying to distinguish themselves on this metric could thus provide an incentive for them not to neglect feasible, efficient opportunities for social value creation, adding to the reasons they have to behave in socially responsible ways (Campbell, Reference Campbell2007). The philanthropy multiplier can thus potentially serve as a mechanism that helps address a long-standing concern expressed by management scholars that businesses lack a meaningful framework for motivating and evaluating their contributions to social welfare beyond their profit-seeking activities (Jones et al., Reference Jones, Donaldson, Freeman, Harrison, Leana, Mahoney and Pearce2016; Walsh, Weber, & Margolis, Reference Walsh, Weber and Margolis2003) and a mechanism that serves as a way of addressing voids in market‐based institutions (Gatignon & Capron, Reference Gatignon and Capron2020). Finally, note that these insights do not require taking any position on larger political debates about whether the state or private philanthropic institutions should shoulder more responsibility for providing welfare-enhancing social services; rather, the point is that to the degree that any business is engaged in expending resources beyond conventional profit-increasing strategies, we can investigate the social value of such expenditures and, in so doing, potentially encourage them to be deployed in more beneficial ways.

Limitations of the Philanthropy Multiplier

The foregoing considerations hint at both conceptual and practical limits to the potential usefulness of the philanthropy multiplier, and these limits merit clear articulation.

First, the knowledge needed to identify opportunities for a company to generate a large philanthropy multiplier will often not be public but rather will involve local insider knowledge. Thus, from an external observer’s perspective, it generally won’t be possible to monitor and penalize a company for failing to take advantage of such opportunities. Although this may not be a concern if one considers corporate philanthropy to be entirely supererogatory, to the degree that the ability to generate a large multiplier does indicate a compelling ethical warrant for doing so, this will often not be something that outsiders can observe and shame or punish companies for having avoided; rather, the hope is that companies can be incentivized to discover, execute, and report such activities because of the positive publicity that this can generate, buttressed by the ethical conviction that these activities are a justified use of resources.

Second, there are practical challenges to conceptualizing and measuring welfare, and thus the metrics used to calculate the philanthropy multiplier may be contested or gamed. Although this is not a new challenge, it is a serious one for anyone who wants to use the multiplier in practice. The burden of articulating and defending calculations should fall on the companies that want to publicize and claim credit for their philanthropy multipliers. This is not an exact science but rather an exercise in transparency and persuasion. Analysts and investors already scrutinize other claims that companies make, and these outsiders have an important role to play in keeping companies accountable for the claims that inform the reporting of their philanthropy multipliers. It is always possible that these claims will remain highly contestable and not persuasive to many market participants.

Third, and most important, the philanthropy multiplier cannot resolve questions about how to commensurate what is of ultimate value. The multiplier can help us make comparative assessments regarding the efficiency of expenditures, but in so doing, it can only be one tool among others in evaluating opportunities for philanthropy. Disagreements are likely to persist with regard to judgments about what are the worthiest ends for anyone to support—be they individual philanthropists or corporate executives. The fact that a corporation could, for example, provide $5 million of food for the homeless at the cost of only $1 million of its own resources does not necessarily mean that it should not spend those million dollars on something else if someone is convinced that something else is intrinsically more valuable. The philanthropy multiplier can bring better analytic clarity to such debates regarding what trade-offs are involved, but it does not resolve the question of value itself.