Winning Us with Trifles: Adverse Selection in the Use of Philanthropy As Insurance

Jiao Luo (University of Minnesota)
Aseem Kaul (University of Minnesota)
Haram Seo (University of Minnesota)

Abstract: We study the use of corporate philanthropy as a form of reputation insurance, developing a formal model of such insurance in a market with clean and dirty firms and examining how the equilibrium conditions change depending on how active and informed social stakeholders are, how altruistic firms are, and how much control they have over the probability of accidents. We then test the predictions from this model in the US Petroleum industry, and find that philanthropic donations offer insurance-like benefits but are also positively associated with subsequent oil spills—firms that give more, spill more. These results are consistent with an adverse selection / moral hazard equilibrium and suggest that the use of philanthropy as reputation insurance may benefit firms at the cost of society.