Corporate Social Responsibility and Financial Performance

ABSTRACT:-The field of corporate social responsibility (CSR) has grown exponentially in the last decade. Nevertheless, there remains a protracted debate about the legitimacy and value of corporate responses to CSR concerns. There are different views of the role of the firm in society and disagreement as to whether wealth maximization should be the sole goal of a corporation. Using extensive data over a period of five years, this study explores and tests the sign of the relationship between corporate social responsibility and financial performance. The dataset includes most of the S&P 500 firms and covers the years 1996-2000. The relationship is tested by using empirical methods. The results indicate that the sign of the relationship is positive and statistically significant; supporting the view that socially responsible corporate performance can be associated with a series of bottom-line benefits. ---------------------------♦---------------------------- INTRODUCTION The field of corporate social responsibility has grown exponentially in the last decade. More than half of the Fortune 1000 companies issue corporate social responsibility (CSR) reports. A larger number of companies than at any time previous are engaged in a serious effort to define and integrate CSR into all aspects of their businesses. An increasing number of shareholders, analysts, regulators, activists, labor unions, employees, community organizations, and news media are asking companies to be accountable for an ever-changing set of CSR issues. There is increasing demand for transparency and growing expectations that corporations measure, report, and continuously improve their social, environmental, and economic performance. The definition of corporate social responsibility is not abstruse. According to Business for Social Responsibility (BSR), corporate social responsibility is defined as ―achieving commercial success in ways that honor ethical values and respect people, communities, and the natural environment.‖ McWilliams and Siegel (2001:117) describe CSR as ―actions that appear to further some social good, beyond the interest of the firm and that which is required by law.‖ A point worth noticing is that CSR is more than just following the law (McWilliams & Siegel, 2001). Alternatively, according to Frooman (1997:227), the definition of what would exemplify CSR is the following: ―An action by a firm, which the firm chooses to take, that substantially affects an identifiable social stakeholder’s welfare.‖ A socially responsible corporation should take a step forward and adopt policies and business practices that go beyond the minimum legal requirements and contribute to the welfare of its key stakeholders. CSR isviewed, then, as a comprehensive set of policies,practices, and programs that are integrated into businessoperations, supply chains, and decision-making processesthroughout the company and usually include issues relatedto business ethics, community investment, environmentalconcerns, governance, human rights, the marketplace aswell as the workplace. Each company differs in how it implements corporatesocial responsibility, if at all. The differences depend onsuch factors as the specific company’s size, the particularindustry involved, the firm’s business culture, stakeholderdemands, and how historically progressive the company isin engaging CSR. Some companies focus on a singlearea, which is regarded as the most important for them orwhere they have the highest impact or vulnerability—human rights, for example, or the environment—whileothers aim to integrate CSR in all aspects of theiroperations. For successful implementation, it is crucial thatthe CSR principles are part of the corporations values andstrategic planning, and that both management andemployees are committed to them. Furthermore, it isimportant that the CSR strategy is aligned with thecompany’s specific corporate objectives and corecompetencies. The Dean of Rotman School of Management, Roger L.Martin (2002), developed the ―virtue matrix‖ as aframework for how socially responsible behavior entersbusiness practice. The matrix is framed by four quadrants.The two bottom quadrants include socially responsible

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conduct in which corporations engage by choice, by following norms and customs, or by compliance to existing laws or regulations. Those actions both promote social responsibility and enhance shareholder value. On the other hand, the two top quadrants of the matrix include the strategic and structural frontiers, which include activities whose value to shareholders is either clearly negative or not immediately apparent. The boundaries between the different categories of socially responsible conduct are porous, since a change in the law or in common practices can cause an activity to migrate from the upper quadrants to the bottom ones.

There is a protracted debate about the legitimacy and value of corporate responses to CSR concerns. As CSR comes into contact with many of the issues traditionally addressed by government, like human rights and community investing, there is strong criticism that societal problems are best solved by freely elected governments. The resources of a corporation are poorly suited for addressing those social problems, and therefore, it is argued, they should not be misallocated. According to Friedman (1970), in a free society, ―there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.‖ He prefers that the state address social problems, arguing that an executive, by taking money and resources that would otherwise go to owners, employees, and costumers, and allocating them according to the will of the minority, fails to serve the interests of her or his principal. In this way, the executive imposes a tax and spends the proceeds for ―social‖ purposes, which is intolerable, since she or he has neither the skills nor the jurisdiction to do so. On the other hand, there are many appeals by others for corporate adoption of the CSR principles. Although the government is mainly responsible for addressing those issues, the contribution of private firms can be substantial. There is also the argument of the shifting balance of power. According to the OECD, of the 100 largest global economies, as measured by GDP, 51 of them are US corporations, and only 49 are nation states. So economic power has shifted to the corporations; they, therefore, should have an increasing role in and responsibility for addressing social problems. For example, the government sets the regulations and the minimum standards for the workplace, but a company can further improve the work environment and the quality of living of its employees. A firm cannot ignore the problems of the environment inwhich it operates. The poverty of a nation state’s citizens,political unrest, and the exhaustion of natural resourcescan have destructive effects for a corporation. Forexample, resources that are inputs in the productionprocess and which, at the beginning of the industrialrevolution, were abundant are now in many regions of theplanet scarce, polluted, or diminishing. Naturally, thisimposes an extra cost to the corporations and may forcethem to relocate or to cease operations. From oneperspective, companies may be poorly equipped toaddress some of the social or environmental problems, butfrom another perspective, no matter how poorly equipped,companies may still be best positioned to ameliorate theproblems. Certainly, adopting the CSR principles involves costs.These costs might be short term in nature or continuousoutflows. These costs might involve the purchase of newenvironmentally friendly equipment, the change ofmanagement structures, or the implementation of stricterquality controls. Since being socially responsible involvescosts, it should generate benefits as well in order to be asustainable business practice. A corporation could notcontinue a policy that constantly generates negative cashflows. The shareholders invest their money in acorporation, expecting the highest possible risk adjustedreturn. Therefore, being socially responsible should havebottom-line benefits in order to be sustainable. Socially responsible corporate performance can beassociated with a series of bottom-line benefits. But inmany cases, it seems that the time frame of the costs andbenefits can be out of alignment—the costs are immediate,and the benefits are not often realized quarterly.Nevertheless, many benefits can be identified. Firstly,socially responsible companies have enhanced brandimage and reputation. Consumers are often drawn tobrands and companies with good reputations in CSRrelated issues. A company regarded as sociallyresponsible can also benefit from its reputation within thebusiness community by having increased ability to attractcapital and trading partners. Reputation is hard to quantifyand measure; it is even harder to measure how much itincreases a company’s value. But since companies havedeveloped methods to measure the benefits of theiradvertisement campaigns, similar methods can and shouldbe able to be applied in the case of corporate reputation. Socially responsible companies also have less risk ofnegative rare events. Overlooking negative social andenvironmental externalities when valuing a company mightbe equal to ignoring significant tail risk. The risks related toCSR could be grouped into three categories: corporategovernance, environmental aspects, and social aspects.

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Companies that adopt the CSR principles are more transparent and have less risk of bribery and corruption. In addition, they may implement stricter and, thus, more costly quality and environmental controls, but they run less risk of having to recall defective product lines and pay heavy fines for excessive polluting. They also have less risk of negative social events which damage their reputation and cost millions of dollars in information and advertising campaigns. The scandals about child–labor and sweatshops that affect the clothing industry are two fine examples. Thus, socially responsible businesses should have more stable earnings growth and less downside volatility. Since companies that adopt the CSR principles carry less risk, when valuing those companies, a lower discount rate should be used. In the company valuation this lower tail risk should be taken into account. There are also other cases in which doing what is good and responsible converges with doing the best for the particular business. Some CSR initiatives can dramatically reduce operating costs. For example, reducing packaging material or planning the optimum route for delivery trucks not only reduces the environmental impact of a company’s operation, but it also reduces the cost. The process of adopting the CSR principles motivates executives to reconsider their business practices and to seek more efficient ways of operating. Companies perceived to have a strong CSR commitment often have an increased ability to attract and to retain employees (Turban & Greening 1997), which leads to reduced turnover, recruitment, and training costs. Employees, too, often evaluate their companies CSR performance to determine if their personal values conflict with those of the businesses at which they work. There are many known cases in which employees were asked, under pressure of their supervisors, to overlook written or moral laws in order to achieve higher profits. These practices create a culture of fear in the workplace and harm the employees’ trust, loyalty, and commitment to the company. Companies that improve working conditions and labor practices also experience increased productivity and reduced error rates. Regular controls in the production facilities throughout the world ensure that all the employees work under good conditions and earn living wages. These practices are costly, but the increased productivity of the workers and improved quality of the products generate positive cash flows that cover the associated costs. Thus, firms may actually benefit from socially responsible actions in terms of employee morale and productivity (Moskowitz, 1972; Parket & Eibert, 1975; Soloman & Hansen, 1985). As mentioned earlier, although it is rather straightforwardto identify the above benefits as being socially responsiblefor businesses, it is an arduous task to quantify andmeasure them. Since CSR is integrated into the businesspractices, it is by definition complicated to try to measureits effects separately. Ideally, it should be possible to keepall other factors constant and measure a company’sfinancial performance and volatility of cash flows beforeand after adopting the CSR principles. As this is notpossible, however, empirical methods are used to identifythe relationship between a company’s socially responsibleconduct and its financial performance.

According to Margolis and Walsh (2002), one hundredtwenty-two published studies between 1971 and 2001empirically examined the relationship between corporatesocial responsibility and financial performance. The firststudy was published by Narver in 1971. Empirical studies of the relationship between CSR andfinancial performance comprise essentially two types. Thefirst uses the event study methodology to assess the short-run financial impact (abnormal returns) when firms engagein either socially responsible or irresponsible acts. Theresults of these studies have been mixed. Wright andFerris (1997) discovered a negative relationship; Posnikoff(1997) reported a positive relationship, while Welch andWazzan (1999) found no relationship between CSR andfinancial performance. Other studies, discussed inMcWilliams and Siegel (1997), are similarly inconsistentconcerning the relationship between CSR and short runfinancial returns. The second type of study examines the relationshipbetween some measure of corporate social performance(CSP) and measures of long term financial performance,by using accounting or financial measures of profitability.The studies that explore the relationship between socialresponsibility and accounting-based performancemeasures have also produced mixed results. Cochran andWood (1984) located a positive correlation between socialresponsibility and accounting performance after controllingfor the age of assets. Aupperle, Carroll, and Hatfield(1985) detected no significant relation between CSP and afirm’s risk adjusted return on assets. In contrast, Waddockand Graves (1997) found significant positive relationshipsbetween an index of CSP and performance measures,such as ROA in the following year. Studies using measures of return based on the stockmarket also indicate diverse results. Vance (1975) refutes

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previous research by Moskowitz by extending the time period for analysis from 6 months to 3 years, thereby producing results which contradict Moskowitz and which indicate a negative CSP/CFP relationship. However, Alexander and Buchholz (1978) improved on Vance’s analysis by evaluating stock market performance of an identical group of stocks on a risk adjusted basis, yielding an inconclusive result.

Determining how social and financial performances are connected is further complicated by the lack of consensus of measurement methodology as it relates to corporate social performance. In many cases, subjective indicators are used, such as a survey of business students (Heinze, 1976), or business faculty members (Moskowitz, 1972), or even the Fortune rankings (McGuire, J. B., A. Sundgren, and T. Schneeweis 1988; Akathaporn and McInnes, 1993; Preston and O’Bannon, 1997). Significantly, it is unclear exactly what these indicators measure. In other cases, researchers employ official corporate disclosures—annual reports to shareholders, CSR reports, or the like. Despite the popularity of these sources, there is no way to determine empirically whether the social performance data revealed by corporations are under-reported or over-reported. Few companies have their SCR reports externally verified. Thus, information about corporate social performance is open to questions about impression management and subjective bias. Still other studies use survey instruments (Aupperle, 1991) or behavioral and perceptual measures (Wokutch and McKinney, 1991). Waddock and Graves (1997) drew upon the Kinder Lydenberg Domini (KLD) rating system, where each company in the S& P 500 is rated on multiple attributes considered relevant to CSP. KLD uses a combination of surveys: financial statements, articles on companies in the popular press, academic journals (especially law journals), and government reports in order to assess CSP along eleven dimensions1. Based on this information, KLD constructed the Domini 400 Social Index (DSI 400), the functional equivalent of the Standard and Poors 500 Index, for socially responsible firms.

Although measuring financial performance is considered a simpler task, it also has it specific complications. Here, too, there is little consensus about which measurement instrument to apply. Many researchers use market measures (Alexander and Buchholz, 1978; Vance, S. C., 1975), others put forth accounting measures (Waddock and Graves 1997; Cochran and Wood 1984) and someadopt both of these (McGuire, J. B., Sundgren, A.,Schneeweis, T., 1988). The two measures, whichrepresent different perspectives of how to evaluate a firm’sfinancial performance, have different theoreticalimplications (Hillman and Keim, 2001) and each is subjectto particular biases (McGuire, Schneeweis, & Hill, 1986).The use of different measures, needless to say,complicates the comparison of the results of differentstudies. In other words, accounting measures capture onlyhistorical aspects of firm performance (McGuire,Schneeweis, & Hill, 1986). They are subject, moreover, tobias from managerial manipulation and differences inaccounting procedures (Branch, 1983; Brilloff, 1972).Market measures are forward looking and focus on marketperformance. They are less susceptible to different accountingprocedures and represent the investor’s evaluation of theability of a firm to generate future economic earnings(McGuire, J. B., A. Sundgren, and T. Schneeweis, 1988).But the stock-market-based measures of performance alsoyield obstacles (McGuire, Schneeweis, & Branch, 1986).

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