Social reporting and its effects on firm
performance
Tibor Kalános, 11032782
BSc Accountancy and Control, bachelor’s thesis University of Amsterdam
Supervisor: Máté Széles, PhD Candidate Word count: 10,963
This document is written by Tibor Kalános who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Table of Contents
ABSTRACT ... 4
SAMENVATTING ... 5
INTRODUCTION ... 6
THEORETICAL BACKGROUND ... 8
THE SOCIAL PILLAR ... 11
THE ENVIRONMENTAL PILLAR ... 12
THE ECONOMIC PILLAR ... 12
LITERATURE REVIEW ... 13
THE ENVIRONMENTAL PILLAR ... 13
THE SOCIAL PILLAR ... 18
THE ECONOMIC PILLAR ... 23
CONCLUSION ... 27
Abstract
This paper examines the relationship between social reporting and firm performance. The foundation used to investigate this relationship is the triple bottom line approach (Elkington, 1994; 1997). The use of the triple bottom line approach is nowadays’ standard of reporting. All three separate pillars will be partly evaluated by looking at several aspects of these pillars. This is a new area to research, as previous research focuses on the entire triple bottom line or just one pillar. The positive relationship will be researched through a literature review. This paper concludes that there is a slightly positive relationship between social reporting and firm performance.
Samenvatting
Dit onderzoek heeft als doel een positieve relatie te vinden tussen social reporting en firm performance. Het is gebaseerd op de triple bottom line (Elkington, 1994; 1997). Het gebruik van de triple bottom line is overeenkomstig met de hedendaagse eisen aan verslaggeving. Alle drie de afzonderlijke pillaren worden apart geëvalueerd door te kijken naar verschillende aspecten van de pillaren. Dit is een nieuwe richting voor onderzoek, aangezien voorgaand onderzoek alleen naar de gehele triple bottom line kijkt of naar een enkele pilaar. De positieve relatie wordt onderzocht door middel van een literatuuronderzoek. Dit onderzoek vindt dat er een lichte positieve relatie is tussen social reporting en firm performance.
Introduction
Social reporting and CSR are two highly discussed and popular topics for research (Aras and Crowther, 2009; Tschopp and Huefner, 2015). Additionally, an increasing number of companies in an increasing number of countries decide to engage in social reporting, as various reports from KPMG (2011, 2013, 2015, 2017) and a paper by Marquis, Toffel and Zhou (2016) have shown. These reports also show a rising quality of disclosure (KPMG, 2011, 2013, 2015, 2017). The concept of ‘social reporting’ started in the 1970s when the first social reports got released by companies (Gond and Herrbach, 2006). Social reporting aims to focus on more than just financial data and its related stakeholders. Therefore, the social reports provide information on a variety of activities and fields, such as the environment, human rights, product responsibility, and society, among other things (Bouten, Everaert, Van Liedekerke, De Moor, Christiaens, 2011). The result is a broadened group of stakeholders.
Ever since its inception, social reporting has been through several phases before reaching its current state. Initially, companies used social reporting for sustainable development. According to the World Commission on Environment and Development’s Brundtland report (1987, p. 41), this is “a development that meets the needs of the present without compromising the ability of future generations to meet their own needs”. Now, social reporting meets Van Marrewijk’s (2003, p. 102) definition, where social reporting is the act of “demonstrating the inclusion of social and environmental concerns in business operations and interactions with stakeholders”. Nath, Holder-Webb and Cohen (2013) have identified other reasons for social reporting than the Brundtland report (1987) focused on which are in line with Van Marrewijk’s (2003) definition.
Over the past decade alone, there have been numerous cases of violations of human rights and environmental scandals. For instance, the recent Volkswagen scandal where the company’s technicians and managers manipulated emissions tests for their cars to be perceived as less harmful to the environment (Leggett, May 5th, 2018). Another example is
the environmental disaster involving BP in the Gulf of Mexico where millions of litres of crude oil spilt into the water near the coast of Mexico (Pallardy, April 13th, 2018). When it concerns
cases with violations of human rights, people often mention the Qatar 2022 World Cup. In this case, migrants from Asian countries like Bangladesh, Nepal, and India, are being forced to work on building stadiums for the 2022 World Cup in poor conditions (Amnesty
International, 2016). FIFA is directly related to the 2022 World Cup and therefore also to this scandal.
As mentioned before, an increasing number of companies choose to engage in social reporting due to increased demand from society (KMPG, 2015, 2017; Nath et al., 2013). Reasons to do so include increased visibility to consumers due to more and better publicity than a competitor that does not release social reports (Hahn and Kühnen, 2013). In other words, it can increase a company’s reputation. In addition to that, Cho, Lee and Pfeiffer (2013) show that social reporting and CSR can decrease information asymmetry which is beneficial for companies.
On the other hand, social reports are not always of perceived good quality. According to Cho, Guidry, Hageman and Patten (2012) companies can forge a social report by making it seem of good quality through the use of biased language in their reports. This way they can influence the user’s perception of the contents of the report. Moreover, as mentioned above, there are instances where companies do not live up to society’s expectations or rules and regulations. In addition to that, various researchers have shown through meta-analyses of research on social reporting that the effects remain unclear (e.g. Griffin and Mahon, 1997; Margolis, Elfenbein and Walsh, 2007; Orlitzky, Schmidt and Rynes, 2003). The findings of researchers on the effect diverge. Some researchers find a positive relation (e.g. Waworuntu, Wantah and Rusmanto, 2014; Rodriguez-Fernandez, 2016), some find a negative relation (e.g. Galbreath, 2006; Lioui and Sharma, 2012) and others find no relation at all (e.g. Arlow and Gannon, 1982; Galbreath, 2006).
Therefore, the question arises whether social reporting is beneficial for companies at all. The remainder of this paper will seek to answer the question of whether social reporting is positively related to firm performance. To examine this, this paper will be a literature review of the prior literature with the aim to combine existing knowledge on separate parts of social reporting with financial performance. The next section will start with further elaboration on social reporting. Here, the foundation for research on the link between social reporting and firm performance gets explained. This is followed by an elaboration on that foundation to show the differences between existing research and this particular paper, before explaining the factors this paper focuses on when analysing the effect of social reporting on firm performance. Then, the literature review follows, followed by the discussion of results and the conclusion.
Theoretical background
Social reports are released due to demand from society, as Nath et al. (2013) mentioned in their paper. Companies allegedly have no incentives to engage in social reporting. Social reporting emerged because society wanted more information about a company’s environmental, social and economic activities – the Triple Bottom Line (Elkington, 1997). Therefore, one would think that companies have no incentives of their own to release social reports. Thus, there must be a link between social reporting and firm performance that makes companies increasingly release such reports.
Various researchers have researched the link between social reporting – or corporate social responsibility (CSR) – and firm performance and have shown that a relation exists (e.g. Clarkson, Fang, Li, Richardson, 2013; Mackey, Mackey, Barney, 2007). In addition to that, to narrow the link further down, some researchers investigating the relation between social reporting and firm performance have based their research on the idea of the Triple Bottom Line (Elkington, 1994; 1997) to make their contribution more specific (e.g. Fortanier, Kolk and Pinkse, 2011; Hollos, Blome and Foerstl, 2012). According to Hahn and Kühnen (2013), this is becoming an increasingly popular foundation to start from. Researchers choose to do so because the triple bottom line is an often-used view on organisations, which emphasises the importance of paying attention to not just a company’s economic bottom line, but also the environmental and social bottom line. Therefore, it provides a broader view of the organisational context, and it takes into account more factors which can influence firm performance.
Initially, it might seem illogical to use two other pillars – i.e. environmental and social – that have no direct relation to firm performance in economic terms. Therefore, it is important to stress why I will use reporting on environmental, social and economic activities to explain an accounting-related link. Such activities, especially when they are non-financial, are not directly related to firm performance. Since triple bottom line reporting is the standard for firm reporting (Milne and Gray, 2013), I use all three pillars of the triple bottom line and relate these to firm performance. Solely assessing the economic pillar would leave out two-thirds of social reporting. Therefore, utilising all the pillars of the triple bottom line is necessary to generate a comprehensive view of social reporting and its effect on firm performance.
There is another reason for using the triple bottom line as the foundation for research in the link between social reporting and firm performance. Doing so is in line with the current stage of social reporting. According to Marlin and Marlin (2003), social reporting has evolved through various stages since the late 1960’s and early 1970’s. The current phase of social reporting follows a multi-stakeholder approach, meaning that social reporting does not solely focus on shareholders, but also on other stakeholders, such as suppliers or employees. Besides that, Tschopp and Huefner (2015) add that social reporting is characterised by specific reporting guidelines and requirements, e.g. The Global Reporting Initiative (GRI). Lodder (2015) also adds that increasing demand for non-financial information characterises the current stage and that a multi-stakeholder approach is necessary to improve the credibility and quality of social reports. Concluding, she states that several countries, including the Netherlands and France, have made social reporting mandatory to attain a certain level of quality and credibility.
In prior literature, researchers use one of two approaches. On the one hand, papers examining the link between social reporting and firm performance only focus on the triple bottom line as a whole – they make no distinction between the three pillars of the triple bottom line in examining the effect. These papers often use a specific generalised index on corporate social responsibility and social reporting – the MSCI KLD 400 Social Index (KLD). This index is used to assess the Environmental, Social and Governmental (ESG) ratings of companies (MSCI KLD 400 Social Index, May 2018). The KLD was launched in 1990 as one of the first social indices and is now one of the most popular indices to use for company comparisons regarding ESG activities (Berry and Junkus, 2013). The index always consists of 400 companies, which are evaluated based on a framework developed by the MSCI consisting of three main pillars – Environment, Social, and Governance (MSCI Ratings Methodology, 2018). These pillars are further divided into ten themes – four relating to the environment, four to social, and two to governance. For all the themes there are related ESG key issues, 37 in total. MSCI uses a framework to attach weights to scores of the individual issues, after which it generates a weighted average of all the key issues. This is further normalised and standardised to individual industries, which ultimately results in a letter-based rating, with AAA being the highest (a leader) and CCC the lowest (a laggard). All the results are relative to a company’s industry’s competitors. Researchers then use the resulting index to analyse if a relation exists. They do so by comparing the firm performance of companies that are present
in the index with companies from the same industry that are absent. The influence of being present is identified by comparing firm performance before being added to the list and after. On the other hand, papers examine the link through looking at a single pillar of the triple bottom line and then looking for a relation between this pillar and firm performance (e.g. Seifert, Morris and Bartkus, 2003; Plumlee, Brown, Hayes, and Marshall, 2015). In that case, researchers pick one pillar of the triple bottom line and look for a relation between that single pillar and firm performance through a wide range of variables. For instance, researchers can use the Toxics Release Inventory to assess the influence of carbon dioxide emissions by companies on firm performance (Dowell, Hart, and Yeung, 2000). If researchers analyse the effect of a variable from the social pillar, they can, for example, use a proxy for product reliability or product safety (Barber and Darrough, 1996). Finally, when analysing the economic pillar, researchers can look at a company’s green investments (Martin and Moser, 2016) and assess the influence disclosure of such investments has on firm performance.
These two methods of research are two extremes. That is where this paper contributes to the current literature on this topic. This paper focuses on the three pillars, but rather than looking at the entire triple bottom line with all its factors, it picks specific activities of triple bottom line reporting per pillar and attaches a weight to each of these indicators. Then, it combines results on these separate indicators to create an impression of the effect of social reporting on firm performance. So, rather than either using a generalised index like the KDL for the three pillars or only looking at one pillar in total, this research investigates the area right in the middle. It focuses on looking at one to two variables per pillar to analyse the influence of those individual variables on firm performance. Then, it combines these individual variables from the individual pillars to end up with a more detailed view of the influence of the separate pillars of the triple bottom line on firm performance.
The influence of the three separate pillars gets assessed individually. In their paper, Bouten et al. (2011) list several factors that influence a company’s performance. Combining this with Nath et al.’s (2013) research that shows what information from social reports society mostly uses gives the most influential factors. These factors can be divided into three areas – social, environmental and economic – the three pillars of the triple bottom line (Elkington, 1994; 1997).
The social pillar
The link between a company’s social activities and firm performance can be divided into several factors (Bouten et al., 2011). Firstly, respecting human rights has been proven by Nath et al. (2013) to be the essential part of any social report. Their research shows that human rights got a Likert scale score of 4.565 out of 7, which is the highest of the factors they tested. Therefore, I expect reporting on information about this factor to be the most influential for firm performance among the social factors since society deems it most important. I expect this influence to be positive. Respecting human rights means adhering to all rules and regulations regarding human rights and therefore not breaching any of the thirty rights from The Universal Declaration of Human Rights (United Nations General Assembly, 1948).
The second indicator for social activities is labour practices (Nath et al., 2013). This also includes health and safety records, product safety and quality, and diversity and equal opportunity. The International Labour Organisation has identified eight fundamental labour conventions and four high-priority governance conventions to which all companies must adhere (International Labour Organisation, 1998). Some of these conventions cover the minimum age – which also touches upon human rights – equal remuneration or the right to organise through labour unions. Companies can go beyond adhering to the conventions, e.g. by trying to improve its employees’ lives by providing above statutory remuneration packages. These activities result in employees that feel appreciated and fairly treated, which users of social reports perceive as important, as shown by Nath et al. (2013).
However, they have shown that in comparison to human rights, labour practices are less important, with a cumulative score of 0.812 out of 7 on the Likert scale. For this reason, I expect reporting on labour practices to have a positive, yet smaller, influence on firm performance than human rights. Therefore, benefits of labour practices will be less potent than benefits of human rights when evaluated in the literature review.
The environmental pillar
The second pillar of the triple bottom line is the environmental pillar (Elkington, 1997). The environment is a topic that nearly always returns in social reports. Gray, Kouhy and Lavers (1995) found an increasing trend in reporting on environmental activities. In 1991, more than 80% of the companies sampled in the UK had an environmental section. According to Nath et al. (2013), the importance and influence have continued to increase.
They also state that a company’s environmental activities can be best assessed by looking at the environmental ratings a company has received and programmes in which it participates. For example, if a company follows a strict programme of reducing its emissions, this will result in a higher environmental rating. Thus, a way of assessing the environmental influence on firm performance is by looking at the effect of emissions or pollution.
In a survey held by the World Economic Forum (WEC) named the ‘Global Shapers Survey’ (2017), they found that 48.8% of the 24270 participants – aged 18-35 – think climate change is the most significant global issue. Following this are large-scale conflict and wars (38.9%), and inequality (30.8%). Besides that, Nath et al. (2013) found that future environmental ratings and programmes scored 0.612 out of 7 on the Likert scale, making it the third highest of the researched factors. This combination of findings leads me to expect that reporting on environmental activities has a strong positive influence on firm performance, placing it on the same importance as human rights and thus above labour practices.
The economic pillar
Finally, to best observe the economic aspect of the link between social reporting and firm performance, this paper looks at financial impacts on non-financial stakeholders (Bouten et al., 2011) – donations to charity, future social and environmental risks and issues. According to Mescon and Tilson (1987), charitable donations, also known as corporate giving or corporate philanthropy, is one of the oldest, if not the oldest form of social activities. Therefore, this paper will be using this as an indicator to look at the influence of the economic pillar on firm performance. Nath et al. (2013) do not mention charitable donations in their paper, but Bouten et al. (2011) do. Despite being one of the first forms of social responsibility,
due to the lack of convincing support for the importance of charitable donations, I expect the influence of reporting on these donations to be as influential as labour practices, therefore classifying it less potent than human rights and the disclosure about emissions but still positive.
Finally, it is important to stress why I will use environmental, social and economic activities and the reporting of those activities to explain an accounting-related link, as such activities, when they are non-financial, are not directly related to firm performance. Since triple bottom line reporting is the standard for firm reporting (Milne and Gray, 2013), I use all three pillars of the triple bottom line and relate these to firm performance. Just assessing the economic pillar would leave out two-thirds of social reporting. Therefore, utilising all the pillars of the triple bottom line is necessary. I expect that firm performance will increase through the indirect act of releasing social reports regarding the environmental, social, and economic non-financial activities, as mentioned above.
Literature review
In the previous section, I assessed which factors from social reporting might influence firm performance. To better individually analyse the influence of the separate pillars of the triple bottom line, weights of potency have been attached to the indicators of each pillar. This section will use those individual indicators of social reporting to link these to firm performance and to discover the nature of the relation. It starts with the relation between the environmental pillar and firm performance. Here, the effect of reporting on emissions and pollution is analysed and explained. This is followed by an analysis of the social pillar – consisting of reporting on human rights and labour practices – and its link. Finally, it analyses the economic pillar, which consists of reporting on charitable donations, and its link to firm performance.
The environmental pillar
The effect of reporting on environmental activities on firm performance can be identified by looking at data concerning emissions or pollution. The logic is as follows; the worse a company performs in these activities, the more significant the effect on its firm performance. This
means that if company A causes more pollution than company B, company A should be punished by the market, or, in other words, not rewarded. If this logic does not apply, this section seeks to find an explanation for that.
Lioui and Sharma (2012) looked into environmental concerns and strengths and their influence on both a company’s ROA and Tobin’s Q for the period 1991 to 2007. Their dataset comprised 17,465 firm-year observations over this period. They looked at both the direct and the indirect impact of these activities. To identify the direct impact, they used ROA, for the indirect impact they used Tobin’s Q.
They used the KLD index to assess the general impact of a firm’s environmental activities to identify a general relation. This index consists of strengths and concerns. They found that for environmental strengths and concerns in general, there is a significantly negative indirect effect at a p-value of 0.001. Thus, a negative relation to Tobin’s Q and firm performance. This means that, regardless of the nature of the environmental activities, it decreases firm performance. However, it should be noted that environmental concerns have a significantly bigger negative effect on Tobin’s Q than strengths.
Concerning the direct effect – the effect on ROA – Lioui and Sharma (2012) found that, again, both environmental strengths and concerns have a significantly negative effect at a p-value of 0.001. The negative effect is smaller than the effect on Tobin’s Q. One would think that strengths, or positive activities, have a positive influence on ROA. However, since environmentally friendly activities are by nature expensive, the costs incurred can result in a negative relation with ROA, for instance, costs related to emissions reduction programmes. Since this requires a significant amount of funds, this reduces ROA in the short run. There is, however, a flaw to this theory. When it concerns budgeting or expensing for environmental activities, as Ackerman and Heinzerling (2002) argue in their paper, the costs are often overstated. They give an example from 1990, where the anticipated cost of sulphur reductions was $1,500 per tonne. After implementation, this turned out to be less than $150 per tonne. However, environmental activities can increase ROA in the long run, when a company’s reputation and demand increase as a result.
This also works contrarily – a company's reputation can explain the fact that environmentally unfriendly activities have a more detrimental effect on ROA. If a company is known to be polluting, society views that as undesirable. This can be explained by reversing the outcomes of Nishitani, Kaneko, Gujii and Komatsu’s research (2011). They found that
when a company actively tries to prevent pollution emissions, this has a positive effect on demand for that company’s products, besides also having a positive influence on productivity. The increased demand for a company’s products results in a higher value added and a higher firm performance. Following this logic, if a company is known for being polluting, this can decrease demand for the company’s products, thus decreasing value added and firm performance. The findings of Nishitani et al. (2011) are also supported by Cucchiella, Gastaldi, and Miliacca (2017), who show that firms that attempt to reduce emissions see higher demand. Therefore, reporting about increasing emissions can decrease firm performance due to lower demand. On the other hand, reporting on decreasing emissions may decrease ROA in the short run due to costs, as argued by Ackerman and Heinzerling (2002), but increase ROA in the long run due to increased customer demand.
It is possible to split the general KLD index into separate variables that make up the strengths and concerns to obtain more specific results. By doing this, Lioui and Sharma (2012) found more different and more specific results. The useful individual strengths variables for this paper are pollution prevention and clean energy. The useful individual concerns variables are the use of ozone depletion chemicals, substantial emissions, and the negative contribution to climate change. These variables are useful because they are related to emissions or pollution.
It seems that there is a positive relationship with ROA for both pollution prevention and clean energy (Lioui and Sharma, 2012). However, neither of these variables has a significant effect on ROA. Once again, for the pollution prevention, this can be explained by Nishitani et al. (2011) and Cucchiella et al. (2017) as they showed that pollution prevention has a positive impact on demand, resulting in higher value added and firm performance. Clean energy can be related to this too, depending on the nature of the clean energy. If this is a result of pollution prevention, then the positive effect of clean energy can also be explained by the logic of Nishitani et al. (2011) and Cucchiella et al. (2017).
Concerning the effect of concerns on ROA, Lioui and Sharma (2012) found that all three relevant variables had a negative effect on ROA. The most potent variable is ozone depletion chemicals, which is significant at a p-value of 0.001. This is followed by substantial emissions, which is also significant at a p-value of 0.001. The least potent variable is the negative contribution to climate change, which has an insignificant effect on ROA. For both ozone depletion chemicals and substantial emissions, the logic of Nishitani et al. (2011) and
Cucchiella et al.’s (2017) research can be followed to understand why these variables have a negative influence on ROA. All in all, it makes sense to see that environmentally unfriendly activities have a significantly negative impact on a company’s ROA. As Nath et al. (2013) mentioned in their research, environmental ratings and programmes – or activities – are deemed third most important to end users of social reports. Therefore, it is unsurprising to find a negative effect of environmentally harmful activities on ROA. The reverse can also be explained by following this logic, despite the environment strengths having an insignificant influence on ROA. The insignificant positive effect might be caused by the costs involved, which could mitigate the positive effect the activities have. Once more, this might be thanks to overstating costs related to positive environmental activities (Ackerman and Heinzerling, 2002).
Furthermore, the effect of individual strengths and concerns on Tobin’s Q can be analysed. This is the indirect link with firm performance. Surprisingly, Lioui and Sharma (2012) found a negative relationship between both pollution prevention and Tobin’s Q and clean energy and Tobin’s Q. Of these two, only the latter has significant influence at a p-value of 0.001. This means that, regarding environmental strengths, the effect on Tobin’s Q is contrary to the effect on ROA. The cost of research and development (R&D) related to pollution prevention and clean energy activities is a potential reason for the negative influence of pollution prevention and clean energy on a firm's ROA. If, for instance, companies want to implement sustainable tools or environmentally friendly devices, they can develop these themselves. This entails high costs. Therefore, when accounted for, the costs of R&D cause environmental strengths to have a significantly negative effect on Tobin’s Q and cause this effect to be more negative than when not accounted for these costs.
Concerning the effect of environmental concerns, all three individual variables have a negative effect on firm performance, as found by Lioui and Sharma (2012). The most potent of the three is ozone depletion chemicals, which is statistically significant at a p-value of 0.001. This is followed by substantial emissions, which also has a significantly negative effect on firm performance at a p-value of 0.001. Similar to the effect on ROA, the negative contribution to climate change has no significant negative effect on Tobin’s Q. These negative relations can once again be explained by following the logic of Nishitani et al.’s (2011) findings, combined with Nath et al.’s (2013) findings stating the importance of environmental activities.
Lee, Min and Yook (2015) partly explain the significant negative effect of ozone depletion chemicals and substantial emissions. According to Dameris (2010), CO2 is a
contributor to the depletion of the ozone layer and one of the most common, if not the most common form of emissions. Therefore, to assess the effect of ozone depletion chemicals and substantial emissions, one can use data on CO2 emissions. Lee et al. (2015) identified the effect of CO2 emissions on Tobin’s Q. Their findings support the significantly negative relation
of ozone layer depletion chemicals and substantial emissions with firm performance. They found that for every year over the period 2003-2010, the effect of CO2 emissions on Tobin’s
Q is statistically significantly negative at a p-value of at least 0.05. For the years 2004, 2005, 2007, 2009 and 2010, this effect is significant at a p-value of 0.01.
In other research and using a different proxy for firm performance, Matsumura, Prakash and Vera-Muñoz (2014) have found supporting evidence that the influence of carbon emissions – CO2 – on firm performance is negative. The more CO2 a company emits, the lower
that company’s firm performance. In their research, Matsumura et al. (2014) gauged firm performance through the market value of common equity. They calculate this number by multiplying a company's stock outstanding by the market price per share. Matsumura et al. (2014) found that the effect of CO2 emissions on a company’s market value is significantly
negative at a p-value lower than 0.01. This means that firm performance decreases by $212,000 per thousand metric tonnes of CO2 emissions (2014, p. 713). This result is in line
with the findings of Lee et al. (2015) and Lioui and Sharma (2012).
Concluding, King and Lenox (2002) found that the effect of emissions on both Tobin’s Q and ROA is negative. The negative effect on Tobin’s Q is significant at a p-value of 0.01, and the same applies to the negative effect on ROA. Adding to this, they found that emissions prevention has a positive impact on both Tobin’s Q and ROA, with p-values of 0.05 and 0.01. This is in line with the findings on pollution prevention related to ROA of Lioui and Sharma (2012). However, their findings were not significant. King and Lenox (2002) also found that emissions treatment has a negative effect on both Tobin’s Q and ROA. These negative relations were not significant. Similar to the effect of environment strengths on Tobin’s Q in Lioui and Sharma’s (2012), the potentially high costs related to treating emissions can explain the negative relation, as explained by Ackerman and Heinzerling (2002).
The findings of Lioui and Sharma (2012), Matsumura et al. (2014), and Lee et al. (2015), all strongly support each other. In my opinion, their findings all point in the same direction
and their validity is strong due to their support of empirical evidence. Especially the research by Lioui and Sharma (2012) is elaborate and in-depth. It seems that reporting on decreasing emissions increases firm performance. This is explained through increased demand as a result of increased reputation, as argued by Nishitani et al. (2011) and Cucchiella et al. (2017), who provide substantial evidence for that. Combining their thoughts with the collection of findings of the above-mentioned empirical research provides even stronger support. On the contrary, the findings suggest that reporting on positive environmental activities can negatively affect firm performance through high and often overestimated costs, as argued by Ackerman and Heinzerling (2002) and found by Lioui and Sharma (2012). The arguments of Ackerman and Heinzerling (2002) are strongly backed by their examples, which make them convincing and a serious consideration when analysing social reports. Additionally, in line with the findings of Lioui and Sharma (2012) are the findings of King and Lenox (2002). However, since these results are insignificant, I cannot say they contribute to the other findings of this section. Finally, the findings of the empirical research by Lee et al. (2015) and Matsumura et al. (2014) suggest a negative influence of reporting on increasing emissions. Once again, these findings are strongly backed by statistical findings.
The social pillar
The second pillar to be analysed is the social pillar. As mentioned in the second section of this paper, the variables used to evaluate the effect of reporting on the social pillar on firm performance are adherence or violation of human rights and labour practices and standards. There has not been much research on just human rights or labour practices and standards, which makes identifying a relation more difficult. First, this section focuses on the impact of adherence to or violations of human rights. Afterwards, it will analyse the impact of labour practices and standards.
Carberry, Engelen and Van Essen (2018) investigated the influence of coverage on human rights violations on a company’s stock price. Their data comprised information on corporate misconduct in the period 1995-2005 and resulted in 345 events of misconduct. They assessed the effect of human rights violations by looking at the change in cumulative abnormal returns over a specified period. This period entailed two days before the media coverage until two days after the media coverage.
In their research, Carberry et al. (2018) find that, on average, media coverage of corporate misconduct causes a decline in stock price of 1.41%. This can be seen as a stock market penalty awarded by investors to show their displeasure with the company’s activities. Furthermore, Carberry et al. (2018) looked at specific factors that belong to corporate misconduct and reported on those individual factors too. Their findings suggest a negative relationship between human rights violations and cumulative abnormal return which is significant at a p-value of 0.05.
In addition to the findings of Carberry et al. (2018), Chen, Feldmann and Tang (2015) did research into the effect of reporting on human rights and firm performance. Their data consists of 75 different companies from various industries and uses eight different categories of human rights activities. They calculate the effect of these various activities on ROE, sales growth and cash flow/sales ratio. The results vary. On average, there is a significantly positive relationship between human rights activities and ROE at a p-value of 0.05. There are no significant relations with both sales growth and the cash flow/sales ratio. There are only significant relationships with two categories.
The first category – investment and procurement practices – contains various activities, with the number of a company’s business partners that have undergone human rights screening and have taken actions as the most important. These three indicators should all have a positive effect on the proxies of financial performance since these are by nature positive indicators of human rights. Chen et al. (2015) found that this category has a significantly positive relation with ROE at a p-value of 0.01. The relations with the other measures were both positive, but insignificant.
The second category is the ‘assessment’ category. This category contains the percentage and number of operations a company has performed which were subjected to a human rights review. The higher this percentage, the more of a company’s operations were reviewed on its human rights performance. Thus, the better the adherence to human rights. Chen et al. (2015) found a significantly negative relation between this category and sales growth at a p-value of 0.01. Regarding the other two indicators, they found a negative relation which was insignificant. A potential reason for a negative relationship can be that there are high costs involved in critically assessing as many operations as possible, resulting in higher overall operational costs.
It seems like the findings of Nath et al. (2013) don’t hold under real-life investing decisions. Their research found that users of social reports value human rights highest of all their researched factors. Therefore, one could expect reporting on human rights to have a positive influence on indicators of firm performance. However, it seems that reporting on human rights does not have such a significant effect on firm performance as you would expect from their findings. A reason for this could be the composition of the sample of Nath et al. (2013). Their sample mainly consists of people that have bought shares a maximum of ten times (74.9% of the sample). This may not be representative of major investors that use ROE for their decision to invest or not. In practice, investors do not attach much weight to reporting on human rights activities, hence the weak significant relationship with firm performance.
Contrary to the findings of Chen et al. (2015) and Carberry et al. (2018) are the findings of Stoian and Gilman (2017). They researched the influence of reporting on human rights activities on company growth and find statistically negative relations. Their research looked at three different strategies a company can pursue, namely a cost leadership strategy, a differentiation strategy, and quality-driven strategy. Then, they assessed the effect of reporting on human rights activities on company growth by comparing the probabilities of different ways of growth, being decline versus fast growth, stagnation versus fast growth, and slow growth versus fast growth. Regarding all these three comparisons, they found that reporting on human rights activities makes fast growth less likely than its counterparts. It should be noted that their research focused on SME firms. Concerning a cost leadership strategy, this relation was positive but insignificant. For the differentiation strategy, reporting on human rights activities made decline significantly more likely than fast growth at a p-value of 0.01, while slow growth was significantly more likely to happen than fast growth at a p-value of 0.05. Finally, for the quality-driven strategy, these results where similar. According to Stoian and Gilman (2017), the fact that reporting on activities regarding human rights can be viewed as diverting resources and attention from the primary strategy explains this.
Friedman first discussed this problem in his article in The New York Times Magazine (1970). He states that the only responsibility of companies is to maximise shareholder value. If a company engages in human rights activities, which are not directly related to the core business, shareholders can view this as the company using the shareholders’ resources to do non-core activities which do not contribute to maximising shareholder value. This explains
why Stoian and Gilman (2017) find stagnation, decline or slow growth more likely than fast growth. Shareholders have no message for reporting on human rights activities.
It seems that, overall, reporting on human rights has no significant positive relationship with firm performance. Based on Chen et al. (2015), Carberry et al. (2018), and Stoian and Gilman (2017) reporting on human rights has either a weakly positive relationship with firm performance or a negative one, depending on the nature of the human rights. Scandals cause this negative relationship. The findings of Chen et al. (2015) are contrary to what I expected from the findings from Nath et al. (2013), whereas the results of Stoian and Gilman (2017) are in line with the shareholder maximisation theory of Friedman (1970), thus also contradicting the findings of Nath et al. (2013). I find the results of Stoian and Gilman (2017) combined with the theory of Friedman (1970) to be more potent than the relatively weak positive relations found by Chen et al. (2015) and Carberry et al. (2018). A negative relation for human rights is more likely than a positive one.
In addition to human rights, the effect of reporting on labour practices is a part of the social pillar. On this field, Stoian and Gilman (2017) also investigated the effect of reporting on good or bad labour practices on firm performance. They coded activities concerning labour practices as activities that see upon, among other things, good staff recruitment and development, promoting a culture of work-life balance, support for working parents, and reporting on health and safety issues. Once again, they assessed the effect on company growth with three different strategies.
Their findings suggest negative relations all across the board, meaning that fast growth is more likely to happen than decline, stagnation or slow growth for all the three strategies. However, despite showing a negative relation, most of these results were insignificant. Regarding a cost leadership strategy, there was no significant relation. For the differentiation strategy, fast growth was only significantly more likely than decline at a p-value of 0.05. Finally, concerning a quality-driven strategy, they found that fast growth is significantly more likely to happen than decline at a p-value of 0.01. Their results imply that reporting on labour practices increases firm performance through fast growth.
This can be explained by combining the findings of Hosie, Willemyns, and Sevastos (2012) and Nishitani et al. (2011). Hosie et al. (2012) found that satisfied employees and managers increase productivity. Delighted employees and managers can be caused by implementing good labour practices. Besides that, the findings of Nishitani et al. (2011) – as
discussed for the environmental pillar – suggest that increased productivity caused increased firm performance. Therefore, good labour practices result in content employees and managers, higher productivity and this higher firm performance.
Furthermore, Brammer, Brooks and Pavelin (2006) investigated the effect of reporting on various activities, including labour practices, coded as employment, on stock returns over a period ranging from one to three years. They looked for a significant difference in stock returns between companies that do not report on labour practices and those that do. To further deepen the research, they split companies that report on their social activities into three levels – low scoring companies, mid-table companies, and high scoring companies. Their findings show that companies with low or zero scores on social reporting perform significantly worse when it comes to stock returns than companies that perform in the middle or the top. However, this does not mean that reporting on social activities regarding employment increases firm performance. Despite performing better, even middle and top scoring companies have negative returns as a result of their social activities. It seems that reporting on labour practices mitigates the negative effect on stock returns for middle and top reporting companies. Reporting on labour practices leads to a decrease in firm performance. This is contrasting with the findings of Stoian and Gilman (2017). Since Brammer et al. (2006) look at stock returns, this contradiction can be caused by following the reasoning of Friedman (1970), which states that companies’ primary goal is shareholder value maximisation. This is not achieved in the eyes of shareholders when a company spends many resources on good labour practices.
Concluding, when it comes to reporting on labour practices, it seems that reporting on labour practices has an unclear effect on firm performance. I find the findings of various researchers too diverse to give a clear answer. On the one side, the findings of Stoian and Gilman (2017), supported and explained by Hosie et al. (2012) and Nishitani et al. (2011) suggest a weak significant positive relationship. The findings of Stoian and Gilman (2017) are statistically proven to have a positive influence on growth and thus firm performance. The findings of Hosie et al. (2012) and Nishitani et al. (2011) provide a solid explanation for this influence by their logical theories. On the other side are the findings of Brammer et al. (2006), which suggest the contrary – there is a negative influence on stock returns. The renowned theory of Friedman (1970) supports this outcome, which increases its potency. I cannot find a reason to explain these diverging results, as both are equally backed by strong arguments.
Therefore, I conclude that there is an unclear effect of reporting on labour practices on firm performance.
The economic pillar
Reporting on charitable donations will assess the effect of the economic pillar on firm performance.
In their paper, Liang and Renneboog (2016) have found that a company’s total charitable donations influence three financial measurements, namely ROA, Tobin’s Q and sales growth. Their sample consisted of 2,026 firms, selected over the period 2004-2013, which resulted in 8,976 observations concerning total charitable donations.
They show that the relation between charitable donations and firm performance measured by Tobin’s Q is significantly positive at a p-value of 0.01. This applies to both the current Tobin’s Q and the future Tobin’s Q. The relation between charitable giving and the current Tobin’s Q is stronger than with the future Tobin’s Q. Then, for ROA, the results are similar to the extent that the effect of charitable donations is positive for both the current ROA and the future ROA. However, where the relationship with current ROA is significant at a p-value of 0.05, the positive relation with future ROA is insignificant. Finally, the effect of charitable donations on current sales growth is negative but insignificant. On the contrary, the relation with future sales growth is positive and significant at a p-value of 0.05. The authors find no explanation for the sign-change of sales growth. They do mention that positive relations between charitable donations and the financial measurements imply that charitable donations are in line with the value-enhancement theory (2016, p. 304).
A possible explanation for the sign-change of sales growth can be found in a paper by Lev, Petrovits and Radhakrishnan (2010). They investigated 1,618 firms over a nine-year period across various industries. Their research focused on the effect of corporate giving on revenue growth, but also the other way around. Regarding the relationship between charitable donations and revenue growth, Lev et al. (2010) found a significantly positive effect of charitable donations at a p-value of 0.02, thus proving that donations work revenue-enhancing. Concerning the link between sales growth and charitable donations, they found a positive relation, but this result was insignificant.
It makes sense for charitable donations to have a positive effect on future sales growth but not on current sales growth. One manner in which charitable donations affect sales growth is through customer satisfaction. If companies release social reports which show that a company has spent much money on charitable donations, consumers will – perhaps subconsciously – appreciate this. This causes customer satisfaction to increase. Lev et al. (2010) found that charitable donations have a significantly positive effect on customer satisfaction, which in turn has a significant effect on sales growth. The fact that this applies to future sales growth is because social reports reflect past information. Therefore, there is a lagged response from consumers, resulting in a negative relation with current sales growth – due to the costs incurred – and a positive relation with future sales growth.
Furthermore, there seems to be a difference in the nature of donations. Liang and Renneboog (2016) split total donations into in-kind donations and cash donations to gain better insight into the influence of the nature of the donations. First, they analysed the effect of in-kind donations – non-monetary donations, like food. They found that future Tobin’s Q is statistically significant at a p-value of 0.05, whereas the influence on future ROA and sales growth is significant at a p-value of 0.1. For current performance, there is a positive relation, but this is insignificant for all the measures. Liang and Renneboog (2016) explain the relatively weak positive statistical influence of in-kind donations on financial variables. This form of donations is less value-enhancing since it works worse as a problem-solving mechanism than other forms of donations. Simply put, in-kind donations only serve one specific purpose. If, for instance, a company donates food as humanitarian aid, then this food can only serve one purpose – feeding the victims. Money, on the other hand, can serve more than one purpose, which makes it more widely applicable. Another reason can be that, just as with customer satisfaction, there is a lagged response from in-kind donations, as these donations might only become public once they are being reported in a social report. This also causes in-kind donations to take longer to affect firm performance.
Regarding the influence of cash donations, it seems this is more positive than in-kind donations. For instance, Liang and Renneboog (2016) found that all of the financial measures, except for future ROA, are positively affected by charitable cash donations. Tobin’s Q, both current and future, is significant at a p-value of 0.05. Current ROA is significant at a p-value of 0.01, and sales growth is significant at a p-value of 0.05. Again, current sales growth is negatively influenced by charitable donations, whereas it positively influences future sales
growth. The explanation for this can be found in Lev et al.’s (2010) paper on the influence of charitable donations on revenue growth. Just as mentioned in the sign-change for sales growth when analysing total charitable donations, customer satisfaction and the lagged response from consumers can cause a negative relation to turn into a positive one. The difference in influence between in-kind and cash donations can be explained by the fact that money is more widely applicable than in-kind donations, which usually serve only one purpose.
Contrary to the findings of Liang and Renneboog (2016) and Lev et al. (2010) are the findings of Fich, Garcia, Robinson and Yore (2009). They find that corporate philanthropy has a negative effect on firm performance. Besides that, it also decreases shareholder value. The sample of Fich et al. (2009) consisted of 1,686 firms, resulting in 9,133 firm years to analyse. They found that corporate donations lead to taking money away from shareholders to other activities. This money could be reinvested in the company or given back to shareholders in the form of dividends. In other words, the company does not exist to fulfil the value-maximisation principle. Since, in the eyes of shareholders, this money is being given away to charitable institutions, their valuation of the company decreases. This is in line with the logic of Friedman (1970), who states that the primary goal of corporations is to maximise shareholder value, as mentioned in the analysis of the social pillar too. This logic is also statistically supported. Fich et al. (2009) find that the change in shareholder wealth is negatively related to charitable donations at a p-value lower than 0.00. Additionally, they find that shareholder distributions are also negatively affected by charitable donations at a p-value that is lower than 0.00. Thus, Fich et al. (2009) conclude that charitable donations are detrimental to shareholder value.
Besides that, it also seems that charitable donations negatively affect financial performance. Fich et al. (2009) compared Tobin’s Q, ROA, operating margin, and future stock returns. All these measures are negatively affected by corporate philanthropy. For all but future stock returns, the effect is significant at a p-value lower than 0.00. For future stock returns, the effect is significant at a p-value of 0.02. Their results imply that firms that do not engage in charitable donations outperform firms that do. Following the idea of value-maximisation for shareholders, the ideas of Friedman (1970), these results make sense. However, it is contrasting with the findings of Liang and Renneboog (2016). This could be
caused by the fact that Fich et al.’s (2009) research used data ranging from 1998 to 2006, whereas the data used by Liang and Renneboog (2016) covers the period 2004-2013.
In the first couple of years of the sample used by Fich et al. (2009), Elkington had just coined the term "triple bottom line". This means that, for companies, the notion of triple bottom line reporting was a relatively new concept to implement. Therefore, the quality of social reporting may have been poorer at the beginning of the triple bottom line than in the later years. This difference in quality can also be caused by the increased use of social reporting frameworks like the GRI and the UN Global Compact, as Morf, Flesher, Hayek, Pane and Hayek (2013) found in their paper. Ahmed-Haji also supports the increased quality of social reporting (2013). His paper researches the change in quality and extensiveness of social reporting disclosures in the period 2006-2009. He found significant increases in both quality and extensiveness. It should be noted that these results only apply to Malaysia, which does not make them generalisable per se.
Concerning the influence of reporting on charitable donations on firm performance, both Liang and Renneboog (2016) and Lev et al. (2010) find a positive relationship, which gets explained by an increase in customer satisfaction and revenue growth thanks to a better corporate image. Besides that, it seems that the effect of charitable donations depends on the nature of the donations. I find their findings strong, especially since they are elaborate and divided into different kinds of donations, which shows the influence of the nature of donations. Contrasting these thoughts are the findings of Fich et al. (2009), who find that charitable donations decrease shareholder value, which is in line with the shareholder value maximisation theory by Friedman (1970). These opposing thoughts can be attributed to the evolution of triple bottom line reporting, as described by Morf et al. (2013) and Ahmed-Haji (2013), and shortly by Marlin and Marlin (2003). This explains the changing influence of reporting on charitable donations – from negative to positive – and also shows the growing positive relationship. This combination of findings leads me to believe that reporting on charitable donations increases firm performance.
Conclusion.
This paper aimed to identify a positive influence of social reporting on firm performance. It analysed prior literature on separate pillars of the triple bottom line and combined these to provide a comprehensive view of the effect of social reporting. I expected the separate pillars to all have a positive influence on firm performance, as all these pillars are, as shown by prior research, critical parts of a company’s bottom line reporting. The results were not all according to my expectations, and they differ per pillar.
Firstly, the environmental pillar. The indicator used for the influence of social reporting on firm performance was emissions. I expected that reporting on decreasing emissions leads to an increase in firm performance. My expectations mostly got confirmed by proving the opposite, meaning that reporting on an increase in emissions negatively affects firm performance. Therefore, reporting on a reduction of emissions leads to a positive effect on firm performance. Concluding for the environmental pillar, the effect of reporting on emissions depends on the nature of the report – whether it reports an increase or decrease.
Regarding the second pillar – the social pillar – I found less distinct results. Concerning reporting on human rights, the results are opposite of my expectations with a strong negative effect of reporting on human rights on firm performance. However, for labour practices, the results were inconclusive. On the one hand, reporting on labour practices implies fast growth over slow growth, stagnation and decline. On the other hand, the results suggest that companies that engage in social reporting on labour practices experience negative returns. Both these outcomes are statistically backed, which makes the results for labour practices inconclusive.
Finally, I discussed the economic pillar, where I expected a positive influence of reporting on charitable donations on firm performance. The results lead to confirm my initial expectations partly. Initially, it seemed like the effect of reporting on charitable donations on firm performance was negative. However, due to developments in social reporting and the increased use of social reporting, this negative influence turned into a positive one, therefore confirming my expectations.
Concerning the overall influence of social reporting on firm performance, I conclude that there is a slightly positive relationship. I expected a clearer outcome. I claimed that the
effect of human rights and emissions are both equally more potent than labour practices and charitable donations. The results of human rights and emissions cancel each other out. Since the results for labour practices are inconclusive, the results of charitable donations cause the overall influence of social reporting on firm performance to be positive. In my opinion, this result is weak.
The findings of this research are interesting for investors, as they can forecast the effect of the decision of companies to release social reports. Besides that, it is useful for companies themselves when they need to decide whether or not to release a social report and on which fields to report.
This research is limited in that it uses data mostly only focuses on one industry or country. Additionally, I encourage future research to broaden the dataset to make the results more generalisable. This applies to research on the individual pillars, on specific activities, and on the triple bottom line as a whole.
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