Corporate Social Responsibility as a Signaling Device for FDI

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