The relationship between Corporate Social Responsibility (CSR) and Corporate Financial Performance (CFP)

Transcription

1 The relationship between Corporate Social Responsibility (CSR) and Corporate Financial Performance (CFP) Master thesis Finance By Emal Ahmadi Name: Emal Ahmadi ANR: Supervisor: Prof. Dr. L.D.R. Renneboog Date: Department: Program: School of Economics and Management MSc Finance Page 1

2 Abstract This study examines the relationship between Corporate Social Responsibility and Corporate Financial Performance for 233 Fortune 500 companies over the period In order to examine the relationship several OLS regressions have been performed to establish a correlation between CSR and CFP. Also Vector Autoregressions and Granger causalities have been performed to establish a causal relationship between CSR and CFP. The OLS regressions resulted in a positive correlation between CSR and CFP, and also in the opposite relation CFP and CSR. With these OLS results the virtuous circle theory is supported, and indicated that both the stakeholder theory and the theory of slack resources are correct. OLS regressions provided correlation and not causation; therefore the Vector Autoregressions and Granger causality results are more appropriate. The Granger causalities resulted in a much weaker virtuous circle theory, since only the market measurement Tobin s Q resulted in bidirectional causation with the CSR. Also the Granger causalities concluded that the accounting measurement Return on Assets, Granger-causes the CSR score. The other accounting measurements Return on Equity and the Return on Sales have no Grangercausality with the CSR. Page 2

3 Table of contents Abstract Introduction Research Problem and objectives Thesis Structure Literature review Concept of CSR Concepts of CFP Literature overview Variables that play a mediating role/control variables Reverse Causality and Endogeneity problem Financial crisis Hypotheses Data description and Methodology Data description Variables Methodology OLS regressions Vector Autoregression (VAR) and Granger causality method Empirical results Summary statistics Regression results and hypothesis testing OLS regressions results Granger causality results Conclusions, Limitations and Recommendations Conclusions Limitations Recommendations References Page 3

4 1. Introduction According to Business for Social Responsibility, corporate social responsibility is defined as achieving commercial success in ways that honor ethical values and respect people, communities, and the natural environment. One of first studies about social responsibility was by Howard Bowen s (1953) publication of social responsibilities of a businessman. Thanks to his contribution the 1960 s became the era of the start of CSR. In the last decade there has been more focus on being corporate social responsible, and more companies are defining CSR into their companies. With expectations that it will have in some way a positive effect on their companies. There have been a lot of previous studies to link Corporate Social Responsibility (CSR) with the Corporate Financial Performance (CFP). The outcomes of these previous studies have not been consequent. Cochran & Wood (1984) were one of the first that studied the relationship with a new methodology: using the Moskowitz relation index. They concluded that there is a positive correlation between CSR and CFP. Waddock and Graves (1997), also found a positive relationship between CSR and CFP. They concluded that corporate social performance is positively related to prior financial performance and future financial performance, which supports the theories that slack resource availability and corporate social performance are positively related. They also concluded that good management and CSR are positively linked. They used the KLD rating (which is an independent rating service that focuses exclusively on the assessment of corporate social responsibility) to measure the CSR. Orlitzky et al. (2003) conducted a Meta-analysis of 52 studies and concluded that CSR has a positive relationship with CFP and that the CFP has a positive influence on the CSR. This means that they concluded that the relationship is bidirectional. Barnett and Salomon (2006) also concluded that there is a positive relation between CSR and CFP, but they concluded that their hypothesis, that the relation has a U-shape, is correct. This means that firms with low CSR have higher CFP than firms with moderate CSR, but that firms with high CSR have the highest CFP. Aupperle et al (1985) found no significant relationship between CSR and CFP. They had created their own measurement of corporate social performance and their results indicated that the methodology for measuring the CSR is of highly importance between the relationship of CSR and CFP. According to McWilliams, A. and Siegel, D. (2000) these previous outcomes of studies have not been consequent because of a misspecification: the Page 4

5 investment in R&D has not been taken in control in the models, which is an important determinant of financial performance. When the investments in R&D are taken in to control, the model according McWilliams, A. and Siegel, D. (2000) shows that CSR has a neutral impact on CFP. Lopez et al (2007) found a negative relationship between CSR and CFP. They measured the CSR with the Dow Jones Sustainability Index. Their conclusion was that companies that engage in CSR have extra costs and therefore are correlated with lower CFP. Moore (2001) tested this relationship between the corporate social performance (CSP) and CFP on the supermarket-industry in the UK and concluded that the social responsibility and financial performance are negatively related in the supermarket-industry. This study was conducted on a single industry (supermarket), and therefore the richness of understanding was enhanced. In the majority of the studies the results seem to have a positive relation, but it s not consistent. Therefore further investigation is necessary in order to take in to control some of the most important variables, like investments in R&D for the financial performance, and the size or industry of the company for its corporate social responsibility. The method of measurement of CSR seems to be different across the various studies, which can create different conclusions. In the previous studies the CSR has been measured with different methods: a survey ( Aupperle 1985), the Moskowitz reputation index (Cochran & Wood 1984), Social responsibility index, and the KLD index rating (Waddock & Graves 1997). The different measurement methods and the sizes of the samples used in the different studies can be the reasons for the different obtained conclusions. An important theory by Freeman (1984) is the stakeholder s theory, which is of influence on the relation between CSR and CFP. The shift from shareholder management, to stakeholder management was the beginning of the stakeholder theory. According to Freeman (1984) the stakeholder s theory consists of three dimensions: Stakeholders power Strategic posture of managers Economic performance of firms The stakeholder theory argues that the CSR determines the CFP. According to van Beurden & Gossling (2008) the idea behind the stakeholder theory is that the success of an organization depends on the extent to which the organization is capable of managing its relationship with key groups, such as financers and shareholders, but also customers, employees and even Page 5

6 communities and societies. This idea already gives an indication that CSR possibly has a relation with the CFP of a company. Roberts (1992) conducted empirical tests in order to test the ability of stakeholder theory to explain the corporate social disclosure. He concluded that measures of stakeholder power, strategic posture and economic performance are significantly related to levels of corporate social disclosure. 1.1 Research Problem and objectives From previous literature the main research question that will be examined is formulated: What is the main relation between corporate social responsibility and corporate financial performance? In order to find an answer to this research question several OLS regressions, Vector Autoregressions and Granger causalities will be performed on a sample of the Fortune 500 firms for the years Also several hypotheses will be formed and tested with the help of the empirical methods, in order to find significant results for the correlation and causality between CSR and CFP. 1.2 Thesis Structure The thesis is structured as follows. Section 2 will contain the literature review, in which first the concept of CSR and CFP will be explained, then a literature review of previous studies will be shown. Also some mediating variables will be explained, the endogeneity problem will be discussed and lastly the influence of the financial crisis will be elaborated. In section 3 the hypotheses that are formed based on section 2 will be shown. Section 4 will explain the data and methodology. Section 5 contains the empirical results of this research. And at last the conclusion will be given in section 6. Page 6

7 2. Literature review In this section first the concepts of Corporate Social Responsibility and Corporate Financial Performance will be explained, and then a literature review of past studies will be shown. Next other variables that can influence the relationship and also the endogeneity and reverse causality problem will be explained. The last section elaborates the influence of the financial crisis on Corporate Social Responsibility. 2.1 Concept of CSR In order to fully understand the concept of CSR we have to go back to the beginning of CSR, so the developments over time can be fully understood. The best known literature review about CSR definitions in academic literature is Carroll s (1999). A small recap of this literature review will be shown and more papers that have discussed the definitions of CSR will be discussed. The modern social responsibility as we know it has its start in the 1950 s. The publication of Howard R. Bowens book Social responsibilities of the businessman announced the beginning of the modern social responsibility. Bowen (1953) set a first initial definition for social responsibility: it refers to the obligations of businessman to pursue those policies, to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society. According to Carrol (1999) Howard Bowen should be considered the father of Corporate Social Responsibility (CSR). According to Rahman (2011), Heald (1957) was also important; he provided a review of CSR. Heald (1957) also provided a definition of CSR: CSR is recognition on the part of management of an obligation to the society it serves not only for maximum economic performance but for humane and constructive social policies as well. These two definitions that are given by Bowen (1953) and Heald (1957) can be seen as the foundation of CSR. In the 1960 s the literature of CSR was expanded since there became a growth in research in CSR. In the 1960 s Keith Davis became an important leader on increasing the awareness on CSR. His definition of CSR was: business man s decisions and actions taken for reason at least partially beyond the firm s direct economic or technical interest. His views were widely accepted in the 1970 s and 1980 s, especially his relation between social responsibility and Page 7

8 business power: social responsibility of businessman need to be commensurate with their social power. According to Carroll (1999) Howard Bowen and Keith Davis are the two most prominent writers about CSR. In the 1970 s the definitions of CSR flourished and a great influence came from Harold Johnson s book business in contemporary society: framework and issues. According to one of his views one should incorporate CSR in a company in order to maximize your profit in the long-run. And according to another view of him called utility maximization, suggests that the most important goal of a company should be utility maximization. During the 1970 s Milton Friedman, a Noble Prize economist stated that CSR can also be seen from a different angle: Friedman (1970) stated that there is only one social responsibility for a company, and that is to use its resources in order to increase its profits, as long as there is no deception and/or fraud. These views are somewhat different than the views incorporated in the 1950s and the 1960s since there is more emphasis on the goals of the company than on social responsibility, since maximizing the profit and the utility are being seen as great importance. The 1980s gave room for more research on CSR and less emphasis on definitions. This lead to the findings of alternative concepts and themes, like corporate social performance, corporate social responsiveness and the stakeholder theory. According to Jones (1980) we should not see CSR as a set of outcomes but as a process. This lead to a new redefined concept of CSR. Which also lead to the linkage of CSR and firms profitability. One of the first studies about the relation of CSR with financial performance was done by Cochran and Wood (1984). This study increased the interest to find out if socially responsible firms are also profitable and also made way for corporate social performance (CSP), instead of corporate social responsibility (which can be a subset of CSP). The 1990s made way for more alternative themes like, CSP, stakeholder theory, business ethics theory and corporate citizenship. The CSR formed the base point of these alternative themes. Wood (1991) revisited the CSP model and created a model that captures the CSR concerns. The principles of social responsibility are at the institutional, organizational and individual levels. According to Wood (1991) there are three processes of social responsiveness: environmental assessment, stakeholder management and issues management. And the outcomes of CSP can be social impact, social programs and social policies. Wood was one of the first that lead to the three dimensional aspects of CSR as we know them by Page 8

9 know: economic aspect, social aspect and the environmental aspect. CSR has a purpose to make a business sustainable in these three aspects. These three aspects of CSR are also called the triple bottom line (Elkington 1997): People (Social aspect) Planet (Environmental aspect) profit (Economic aspect) Economic aspect For a wide time span the economic aspects of CSR have been neglected, because they were assumed to be well managed. This assumption was wrong and therefore understanding the economic impact of the operations of a business is very important. There is a big difference between the economic aspects and the financial aspects of a firm. People tend to think that they are the same, but the financial aspects are meant to show if a firm is financially stable and accountable. The economic aspects (dimension) consider the direct and indirect economic effects that the firm has on the community and the stakeholders. According to Uddin, Hassan and Tarique (2008) this effect can be called the multiplier effect. Because the effect of the company on its employers and stakeholders will continue to have an impact on their community. Another great impact of the business on the community comes from its taxes. Taxes paid by the firm/business contribute to a great deal to the community. The organization should also try to avoid actions that may harm or damage the trust that is established in the community. According to Wood (1991) within the economic aspect, a firm must try to balance its own interests of maximizing its profits with the interest of the stakeholders and the social interests, like maximizing jobs and production. Social aspect The significance and importance in the social aspect has shown a strong increase in the past years. One of the reasons for this enhanced attention is the fact that firms are becoming more active in addressing social concerns. The definition of being socially responsible is: being accountable for the social effects that the company has on people, directly and indirectly. According to Uddin, Hassan and Tarique (2008) the responsibilities towards the customers, employees and communities are the most important factor for the social aspect of CSR. Responsibility towards the customers, does not only mean being respectful towards the customers, but also means providing good value for money, like safety and durability of Page 9

10 products. And often this has a positive effect on a firm s profit. Responsibility towards the employees means more than only providing jobs, it means that the firm should have equal treatments towards al employees and that there will be no discrimination of some sort. Responsibility towards the community can be the most important responsibility, since most of the customers and employees are from the community. This means that the firm is highly dependent on its community and therefore should feel responsible towards the community. According to Steven and Cochran (1985) the social aspect means that the emphasis must be shifted away from social obligations to social responsiveness. With social responsiveness is meant the capacity of a firm to react to social pressures (Frederick, 1978). With social responsiveness managers are lead to a stronger importance on implementation and policy development. Environmental aspect The environmental aspect of CSR is of great importance. Most of the time the environmental effect that is caused by the firm are negative effects to the environment: pollution, overuse of resources etcetera. But according to Uddin, Hassan and Tarique (2008), in order for firms to obey to CSR they should take the following steps: first they should measure their environmental impact, in order to know what damage they are creating to the environment. And second they should have environmental management, so they are more focused on their environment, and increase their environmental performance. Some firms even have had positive effects on their company, since their environmental performance has increased. A reason for this can be the lowering of the operational costs, because of less waste of resources. These improvements are a win-win situation for both the environment and the company itself. Wood (1991) concluded that better knowledge of the environment could pay off by increasing the social and financial performance of a firm. CSR in the 21 st century lead to a more global awareness of CSR. Also a United Nations Global Compact was created which promotes CSR in Europe and worldwide. And the European Commission s Green paper was also established, which concerns about human right, the environment, society and labor. In the studies that were performed in the 21 st century more emphasis was placed on theoretical developments and measurement methods of CSR and less emphasis on definitions of CSR. Page 10

11 Stakeholder relation Another important aspect of CSR is the relation with the stakeholders. There are 2 types of stakeholders according to the Social Economic Council: primary and secondary stakeholders. Primary stakeholders are the employees and the shareholders of the corporation and secondary stakeholders are consumers, suppliers, competitors and government. The definition that is given by the Social Economic Council is: the need to provide sufficient focus on its contribution to public wealth on the long run and to optimize the relationship with its stakeholders and society. This definition shows us that it is important for the firm to create value and maximize its shares, and also optimizing the relation with its stakeholders. This is a combination of the three aspects of CSR (triple bottom line). Freeman (1984) elaborated the stakeholder s theory. The shift from shareholder management, to stakeholder management was the beginning of the stakeholder theory. According to Freeman (1984) the stakeholder s theory consists of three dimensions: Stakeholders power Strategic posture of managers Economic performance of firms These three dimensions are all related to CSR: the economic performance of firms is part of the economic aspect of CSR. The stakeholder s power is part of the social aspect of CSR. And the strategic posture of managers is also part of the economic aspect of CSR. According to van Beurden & Gossling (2008) the idea behind the stakeholder theory is that the success of an organization depends on the extent to which the organization is capable of managing its relationship with key groups, such as financers and shareholders, but also customers, employees and even communities and societies. This is again the same combination like the tripe bottom line (three aspects of CSR). Corporate social performance Carrol (1979) was one of the first that described the corporate social performance, and concluded that CSP exist of a three dimensional integration of corporate social responsibility, corporate social responsiveness, and social issues. The integration of these three dimensions is what makes the CSP distinctive. Page 11

12 According to Turban and Greening (2000) corporate social performance is defined as: a construct that emphasizes a company s responsibilities to multiple stakeholders, such as employees and the community at large, in addition to its traditional responsibilities to economic shareholders. How firms score on their CSR is measured by the corporate social performance (CSP). According to Preston (1975) corporate social performance describes the effort of a firm to meet changing societal conditions. Wood (1991) continued with the model obtained by Carrol (1979) and elaborated the model.. And according to Wood (1991) this is the complete model of corporate social performance. Figure 1.Model of Corporate Social Performance according to Wood (1991). This model is more complete than a corporate social responsibility model, because it also includes the identification of the domains of an organization s social responsibility, the development of processes to evaluate environmental and stakeholder demands and the implementation of programs to manage social issues (Thomas and Simerly, 1995). As can be seen from the model the first component is based on the principles of social responsibility like legitimacy. The second component is comprised of the processes like stakeholder management. And the third component are the outcomes of corporate behavior, like social issues. These components indicate that CSP is of great importance for a firm. According to Wood (1991) social issues, environmental pressures and stakeholder concerns are sure to affect corporate decision making and behavior far in to the future. This indicates Page 12

13 that CSP has a long term effect for a firm. Wood (1991) also concluded that the basic idea of corporate social responsibility is that business and society are linked rather than distinct units. 2.2 Concepts of CFP Corporate financial performance of firms can be based on two different measures: accounting based measures and market based measures. With the help of these measures we can measure the economic performance of firms. These both methods measure different financial aspects of the firm, and therefore have different outcomes. Orlitzky (2003) shows that using the different measurement methods leads to various outcomes. When accounting based measures are used, usually measures like profitability, Return on Assets (ROA), Return on Sales (ROS) and Return on Equity (ROE) are being used. With the use of market-based measures, most used are Tobin s Q and the market return. Previous studies have tried to find out the relatedness between the two different measurement methods. It is generally accepted among researches that accounting based measures are there to research the past or the short term financial performance. And market based measures are being seen as reflections of long term financial performance. Venkatraman and Ramanujam (1986) suggest that these two measures don t have to be related with each other, since the short term goals are different from the long term financial goals. Combs et al (2005) debate in their paper whether the relationship between the two measures is high enough, so that they can be treated equally. The results of previous studies, checking for the relationship between market based and accounting based measures provides us with different outcomes. Mcguire and Matte (2003) conclude a positive relationship between the two measures, Nelson (2003) concludes a negative relation, and some conclude that there is no relation between the two measures (Hillman 2005). In order to find out if the accounting and market based measures are equivalent, it is of highly importance to know their relationship with each other. Gentry and Shen (2010) researched the relationship between accounting and market measures of firm financial performance, and concluded that they are positively correlated among industries, but that their covariance is less than 10%. This means that there is no evidence of convergence for the measurement methods. They also concluded that it is inappropriate to combine accounting and market based measures into a single financial performance measure. Page 13

14 This indicated that we should not see the corporate financial performance as a single dimensional construct but as a multi-dimensional construct that consists of both accounting and market bases measures. According to Thaler (2004) the market performance does not show the firms fundamental value, but it shows the investors perceptions of it. This also indicated that only the use of market based measures could give a wrong conclusion, since it is miss specified. The same goes for only the use of accounting measures, because the market outcomes will be neglected and the investors perception will not be included. 2.3 Literature overview There have been many studies conducted in order to find out the relationship between CSR and CFP. In this section an overview of these previous researches will be shown. The relation between CSR and CFP has been going on for a long time. The first study was conducted by Dodd (1932). This was the beginning of the start in interest in CSR. Despite the fact that the research has been going on for more than 70 years, still no conclusive relationship is discovered between CSR and CFP. In the last 30 years the amount of studies focusing on the relationship has increased significantly. There are three types of relations that can occur between CSR and CFP: first there may be a neutral of mixed relation, second there can be a positive relation and third there can be a negative relation. These three different relations will be further elaborated and results of previous studies will be shown: Neutral or mixed relation Some studies resulted in the conclusion that there is no relationship between CSR and CFP, or an insignificant relation, because there are too many mediating variables that influence the relationship, and therefore a relationship between CSR and CFP should not exist ( Ulman 1985). The study performed by Alexander and bucholz (1978) examined the relation between social responsibility and the stock market performance, as a measure of corporate financial performance. They concluded a low insignificant relationship between the risk adjusted performance and the social responsibility. This indicates that CSR has no influence on the financial performance, here measured by the stock market. As a measurement method for CSR they used surveys. Cochran and Wood (1984) found a mixed relation between CSR and CFP. They examined the relationship using a new methodology and with the use of Page 14

15 control group variables for specific industries. In order to measure the CSR they had used the Moskowitz s reputation index. They first tested the impact of CSP on CFP and secondly they tested the impact of CFP on CSP. They concluded that the average age of corporate assets is found to be highly correlated with the social responsibility ranking. And after they had controlled this correlated factor, they still found a mixed relationship between CSR and CFP. And the direction of the causality was still not clear, since their conclusion only was that there seems to be correlation between these two variables. In their paper it is advised that further research focusses more on the direction of the causality. According to Ruf et al (2001) one of the reasons for the obtained mixed relationship by Cochran and Wood (1984) can be the mismatch between social and financial variables. Aupperle et al (1985) found no significant relationship between CSR and CFP. They had created their own measurement of corporate social performance and their results indicated that the methodology for measuring the CSR is of highly importance between the relationship of CSR and CFP. They used a survey as a method for measuring the CSR. In their study the tradeoff hypothesis was expressed. With the tradeoff hypothesis is meant that: social performance is the independent variable and that social accomplishments involve financial costs. Aupperle et al (1985) show that activities that require social responsive may lower the capital and other resources of the firm. And therefore have a disadvantage in comparison to firms that do not engage in socially responsive activities. This means that according to Aupperle et al (1985) CSR influences CFP, but they neglected to check for the opposite causality. Thus not controlling the endogeneity of the variables. Their results did not correspond to their theory, since they expected a negative relation based on their theory, but obtained no significant relationship. Ulman (1985) came to the conclusion that there is no clear relationship between social performance and economic results. One of the main reasons that they could not find a relationship was because there was a lack of empirical material and because of wrong definitions. Aupperle and Pham (1989) also concluded that there is no relationship between CSR and CFP. They concluded that things like business management and strategy influence the financial performance and that CSR has no direct impact on the financial performance. But they do conclude that CSR has an indirect impact on the financial performance, since the business management and the strategy are influenced by the CSR. In their study they took CSR as dependent variable and used the financial measures as independent variables. Indicating a causal relationship that CFP influences the CSR according to their theory, but Page 15

16 their results concluded that there is no relation. Their study investigates the relationship of CSR and CFP, with long term financial measures, which includes both accounting and market based measures. Welch and Wazzan (1999) also found no relationship between CSR and financial performance. They examined the impact of the South Africa boycott in the mid-80s on the financial performance indicators, like equity ownership and the impact on the stock prices. They concluded that despite the publicity of the boycott and the multitude of divesting companies, political pressure had little effect on the financial markets. Positive relation Secondly there can be a positive relation between CSR and CFP. This means that the benefits of CSR outweigh the costs. And that socially irresponsible firms incur higher costs. This indicated that socially responsible firms have less chance of having negative events, and less downside risk for value. According to the Network for business sustainability there is also a positive relationship between CSR and Financial performance. This is because positive CSR acts as insurance for a firm, since it protects its reputation and reduces the impact of negative publicity. According to their results firms with weak CSR suffered twice as harder stock declines than firms with strong CSR in 1999 after the riots in Seattle. Bragdon and Marlin (1972), and Parker and Eibert (1975) concluded that there is a positive relation between CSR and financial performance. The financial performance was measured by using accounting based measures and not the use of market based measures. But these results may be inconclusive since other variables were not controlled in the measurement. And the reverse causality problem was also not controlled, thus only the influence of CSR on CFP was researched and not the possibility of an opposite relation. Moskowitz (1972) also found a positive relationship between CSR and CFP. The conclusion obtained by Moskowitz was that being more socially responsible and therefore obtaining a higher social score, leads to attracting and retaining more employees. This will enhance the CFP. Thus indicating that CSR influences CFP. Wokutch and Spencer (1987) established a positive link between CSR and CFP. They examined the relation between CFP and ratings of CSR. The CSR was measured by a two dimensional concept of CSR: compliance/non-compliance with the law and involvement/non- Page 16

17 involvement in philanthropic contributions. They had a small sample of 74 corporations from a Fortune survey. And their data was from In this study the opposite relation was being tested: the influence of the financial performance on the social performance. In order to find out if having more financial resources leads to being more socially responsible. Mcguire, Schneeweis and Sundgren (1988) used Fortune s magazine ratings of corporate reputations as a measurement method for CSR, and researched the relation between the financial performance and CSR. Their results show that a firm s prior performance is more closely related than the subsequent performance. This indicates that a positive relation exist between CFP and CSR. In order to measure the CFP they used both market and accounting based measures. They also concluded that risk measures are more closely related to CSR. In this study the financial performance was used to predict the CSR, which means that in this study the CFP influences the CSR, and not the other way around. Preston et al (1991) partially confirmed the results obtained by Mcguire et al (1988), since they also concluded that a positive relation exists. Cornell and Shapiro (1987) conclude that there is a positive relationship between CSP and CFP, and their main reason for this is the instrumental stakeholder theory. This theory explains that it is very important to keep the various stakeholders satisfied, since they have a large influence on the financial performance of a firm. This shows that CSR has a positive influence on the CFP, when the stakeholders are kept happy with the help of being socially responsible. According to Rowley (1997) high network density can reduce the financial performance; therefore it is for strategic reason important to keep the various stakeholders happy, in order to avoid getting stuck in a high-density network. Waddock and Graves (1997) concluded that there is a significant and positive relationship between social performance and the number of institutions holding the shares of a company. They explained two theories for the relation between CSR and CFP: slack resource theory, and good management theory. With slack resource theory is meant that a company with good financial performance has excess funds in order to increase the CSP. Thus according to this theory CFP influence CSP and not the other way around, and CFP is the independent variable. With good management theory is meant that CSP influences CFP and that CSP is the independent variable. With this theory a company that has good CSP will be more attractive and therefore it will increase the CFP. They also concluded that good management and CSR are positively linked. In this study they evaluated the relation between financial and social performance when CSP was both a dependent and an independent variable. This was done in Page 17

18 order to check which way the causality runs, and to find out which theory (slack resource theory or good management theory) is correct. The conclusion was that CSP depends on the financial performance and the slack resources theory is supported. They used the KLD rating (which is an independent rating service that focuses exclusively on the assessment of corporate social responsibility) to measure the CSR. Chen and Wang (2011) researched the relation between CSR and CFP from Chinese firms, and they came to the conclusion that being socially responsible can increase the financial performance of the current year and have significant effects on their financial performance of the next year. Hence CSR influences the CFP. Orlitzky et al. (2003) conducted a Meta-analysis of 52 studies which included a sample size of 33,878 observations and concluded that CSR has a positive relationship with CFP and that the CFP has a positive influence on the CSR. This indicates that there is an endogeneity problem. This endogeneity problem will be further elaborated in the next pages. Their findings suggested that corporate virtue and environmental responsibility are likely to pay off. According to their results CSP is more highly correlated with accounting based measures and less correlated with market based measures. Their conclusion indicates that the relationship works in both ways, and that it is not perfectly clear if good CSR leads to higher CFP or higher CFP leads to better CSR. Barnett and Salomon (2006) measured the relation between social performance and financial performance within mutual funds that practice socially responsible investing (SRI). They empirically tested 61 SRI funds from They concluded that there is a positive relation between CSR and CFP, but they concluded that their hypothesis that the relation has a U-shape is correct. This means that firms with low CSR have higher CFP than firms with moderate CSR, but that firms with high CSR have the highest CFP. They suggested that further researches should not be based on the debate about the benefits on financial performance of being CSR. But that more focus should be put on examination of the benefits of different social-screening strategies. Page 18

19 Negative relation There can also be a negative relation between CSR and CFP. This means that being socially responsible decreases the financial performance of a firm. According to Preston et al (1997) a manager can possibly reduce its investments in CSR in order to increase its short term profit. According to Wright and Ferris (1997) there is a negative relation of CSR and CFP. They used the event study methodology, to measure the abnormal returns on a short term in relation with CSR. Lopez et al (2007) also found a negative relationship between CSR and CFP. They measured the CSR with the Dow Jones Sustainability Index. Their conclusion was that divestments have a negative effect on the shareholder value; therefore companies that engage in CSR have extra costs and are correlated with lower CFP. Hence in this study the CSR influenced the CFP. Moore (2001) tested this relationship between CSP and CFP on the supermarket-industry in the UK and concluded that the social responsibility and financial performance are negatively related in the supermarket-industry. This study was conducted on a single industry (supermarket), and therefore the richness of understanding was enhanced. In this study it was concluded that the financial performance influences the social performance of a firm. Which agrees with the available funding hypothesis; this hypothesis indicates that having a good financial performance, allows a firm to allocate more resources on CSR. This hypothesis is the same as the slack resource theory. Waddock et al (2002) made the assumption that companies who engage in socially responsible behavior have unnecessary costs and therefore have a competitive disadvantage. This leads to a decline in the shareholder wealth and the profit. This results in a lower financial performance, and thus indicates that the CSR influences the CFP and a negative relation exists between CSR and CFP. Bellevance (2009) performed an empirical analysis on 179 publicly held Canadian firms. They measured the CSP with the help of Canada Social Investment Database for the years 2004 and Their results concluded a significant negative impact of CSR on the financial performance, namely on return on assets, return on equity and market returns. This indicates that CSR influences the CFP. This is consistent with the trade-off hypothesis. The trade-off hypothesis suggests that it is a cost to be CSR and that these costs decrease the CFP. And that Page 19

20 a trade-off should be made: you can either be CSR and have lower CFP, or you can neglect CSR and have higher CFP. Fu et al (2012) examined the relationship between CSR and CFP for listed companies in China. Their empirical research came to the conclusion that there is a negative relationship between CSR and CFP. The CFP was measured with Tobins Q. They used the social performance as the independent variable in the study and the financial measures as dependent variables. Thus indicating that CSR influences the CFP. According to Fu et al (2012) there were some limitations to the study which may have caused the negative effect to happen: proxy variables of measure CSP, lack of continuous year s data and the control variables used. Margolis et al. (2001), concluded that: When treated as an independent variable, corporate social performance is found to have a positive relationship to financial performance in 42 studies (53%), no relationship in 19 studies (24%), a negative relationship in 4 studies (5%), and a mixed relationship in 15 studies (19%). We can conclude that the evidence is mixed in the previous empirical literatures. Also there is some discussion on whether CSR influences CFP or CFP influences CSR, since in previous studies some researchers used the social performance as the independent variable and others used the social performance as dependent variables. But in most of the studies conducted the CSR was used as the independent variable that influences the dependent variable financial performance. But still the direction of the causality remains a problem. Page 20

21 Table 1. In the table can be seen an overview of the outcomes of previous named studies about the relation between CSR and CFP and the direction of the causality can be seen: twelve find a positive relationship, six papers find neutral relationship, and six find a negative relationship. Author and Year Relationship Causality Bragdon and Marlin (1972) Positive CSR CFP Moskowitz (1972) Positive CSR CFP Parker and Eibert (1975) Positive CSR CFP Alexander and bucholz (1978) Neutral No causality Cochran and Wood (1984) Neutral No causality Ulman (1985) Neutral No causality Aupperle et al (1985) Neutral No causality Cornell and Shapiro (1987) Positive CSR CFP Wokutch and Spencer (1987) Positive CFP CSR Mcguire, Scheeweis and Sundgren (1988) Positive CFP CSR Aupperle and Pham (1989) Neutral No causality Preston et al (1991) Positive CFP CSR Waddock and Graves (1997) Positive CSR CFP Rowley (1997) Positive CSR CFP Wright and Ferris (1997) Negative CSR CFP Welch and Wazzan (1999) Neutral No causality Moore (2001) Negative CFP CSR Waddock et al (2002) Negative CSR CFP Orlitzky et al. (2003) Positive both ways Barnett and Salomon (2006) Positive CSR CFP Lopez et al (2007) Negative CSR CFP Bellevance (2009) Negative CSR CFP Chen and Wang (2011) Positive CSR CFP Fu et al (2012) Negative CSR CFP Benefits and costs of CSR The main benefit that arises of being CSR is that the negative effects of events are diminished on the impact to financial performance. This is consistent with findings of previous studies; (Blacconiere and Patten, 1994), (Bowen, Castanias, and Daley, 1983). A second benefit of being CSR is that it creates goodwill for the firm which attracts more customers. This is supported by Arora and Gangopadhyay (1995). They provide arguments that link corporate giving, goodwill and the financial performance together. Also a benefit can be the efficiency that is gained by the firm and the cost reductions. According to Heal (2005) socially responsible firms show more costs savings in comparison to less socially responsible firms. Page 21

22 Weber (2008) researched how to measure the impact of CSR activities from a company perspective. A CSR impact model was created that shows the main clusters of CSR benefits from their current research Figure 2. In the figure can be seen the benefits of CSR according to their nature of benefits and the nature of the possible indicators. Source: Weber, Manuela. "The business case for corporate social responsibility: A company-level measurement approach for CSR." European Management Journal 26.4 (2008): As can be seen from the figure according to Weber (2008) CSR can lead to both monetary benefits and non-monetary benefits. There are also costs attached to being CSR. The main cost is the incremental costs of being CSR. These costs can reduce the short term profits of the firm, and therefore managers may not want to engage in being CSR. Secondly CSR firms have a higher chance of engaging in bigger upfront cash outflows. For example to increase the monitoring of facilities, a high amount of upfront cash flows is necessary. Measurement problem CSR There hasn t been a clear relationship between CSR and CFP in the previous studies, but the results were mixed. One of the main reasons for these mixed results is the measurement methodology, because most researchers have used different methods to measure the CSR, therefore different outcomes were derived. Alexander and Bucholz (1978) and Aupperle et al (1985) used surveys to measure the CSP, these surveys were subjective indicators. Also subjective indicators are the Fortune rankings that were used by Mcguire, Scheeweis and Sundgren (1988). Page 22

23 Cochran and Wood (1984) did not use surveys, but were one of the first to use the Moskowitz reputation index. This index distinguishes three categories on being socially responsible: best, honourable mention, or worst reputation. Wokutch and Spencer (1987) measured the CSR with use of a two dimensional concept: compliance/non-compliance with the law and involvement/non-involvement in philanthropic contributions. Waddock and Graves (1994) used KLD ratings to measure the CSR. These ratings come from the KLD social ratings database. This database provides a summary of CSP of firms across time. In this database each company of the S&P 500 is rated on multiple characteristics. Based on these characteristics and information, the Domini 400 Social index was created, which is the index for socially responsible firms. Lopez et al (2007) used the Dow Jones Sustainability Index (DJSI) to measure the CSR. This DJSI evaluates the sustainability performance of the largest 2500 companies listed on the Dow Jones. Bellevance (2009) used Canada Social Investment Database to measure the CSR. These are just some examples of measurement methods of CSR and as can be seen, there is a wide variety in methodology: there are surveys, Moskowitz reputation index, Fortune ratings, KLD ratings, and the use of Dow Jones Sustainability Index. There are disadvantages for some measurement methods. For instance surveys have no consistency of raters across different firms (Waddock and Graves 1997). Fortune ratings need to be more specific, since it is more viewed as a measure of overall management, and not only CSR. The problem with these methodologies is that there is a big chance that it does not contain the overall CSP of the firm, but that it measures only a part of this. As can be noticed from earlier studies, most empirical studies only focus on a small part of CSP and neglect the rest (Wokutch and Spencer 1987). Therefore the CSP of a firm is not entirely represented in the empirical study, which leads to mixed results. It is important to have instruments that represent multiple dimensions of CSP, so that it will not be limited in its information. Chatterji, A. K., Levine, D. I. and Toffel, M. W. (2009) studied how well social ratings actually measure corporate social responsibility. They examine how well Kinder, Lydenberg, Domini Research & Analytics (KLD) ratings provide information about environmental performance. They chose to examine KLD, since this is the most widely used database to measure the CSR. Their study leads to three main results: Page 23

24 1. KLD ratings do a reasonable job of collecting pas performance. 2. KLD s net environmental score and KLD s total environmental concerns ratings are good indicators to predict the future pollution levels. 3. KLD is not optimally collecting historical data and is not optimally using the available data from the public. Their conclusion is that the validity of KLD ratings could be improved if more weight was being put on past environmental performance. This shows that even the most widely used database for CSR is not flawless. But KLD Research & Analytics still is considered the leading authority on social research for institutional investors. 2.4 Variables that play a mediating role/control variables Another factor that has a strong influence on the relationship are the control/mediating variables. These variables have also caused for mixed results in previous studies. Therefore it is important to understand which variables and why these variables have been used in the past. According to Ullman (1985) size, risk and industry have affected both CSR and CFP. Therefore these factors must be taken under control. Size is an important control variable, since larger firms tend to be more CSR then smaller firms. Burke et al (1986) concluded that firms attract more attention from their shareholders as they grow, and therefore more pressure on being CSR is put. According to Beurden and Gossling (2008) size is the most significant factor between CSR and CFP. Surroca, Tribo and Waddock (2010) examined the effects of firm s intangible resources, and the relationship of the intangible resources with CSR and CFP. They indicated that the positive relation that was found by previous studies was not well examined, because they forgot to account for the mediating effects of the intangible resources. They performed their study based on 599 companies from 28 countries, and concluded that there is no relationship between CSR and CFP. They also concluded that there is an indirect relationship because of the mediating effect of the intangible resources. According to McWilliams, A.,and D. Siegel (2000) intangible resources, in this study R&D costs, should be included as control variables when the relationship between CSR and CFP is examined. Page 24