Non-‐Market Strategies, Corporate Governance and Corporate
Financial Performance: An Integrated Statistical Analysis
University: University of Amsterdam, Amsterdam Business School Department: Economics and Business
Master: MSc Business Administration: International Management Thesis supervisor: Dr. Ilir Haxhi
Second reader: Dr. Francesca Ciulli Student: Michiel Blomaard Student number: 10520953
Date: January 25, 2017
Abstract
This study explores the relation between the two non-‐market strategies, i.e. corporate social responsibility (CSR) and corporate political activity (CPA), and corporate financial performance (CFP). Previous studies have investigated the isolated effects of either CPA or CSR on CFP, however, recent scholars theoretically claim that aligning these two non-‐market strategies enhances CFP. They advocate that complementarities exist between the non-‐market strategies. Building on this line of research, in the current study, we empirically explore whether aligning both non-‐market strategies would enhance CFP, measuring CPA by cumulating lobby expenditure and political action committee (PAC) contributions and divide CSR total into internally and externally focussed strategies. Since isolated research did not lead to conclusive outcomes, other crucial explanatory variables were possibly omitted. Since corporate governance (CG) influences both the non-‐market strategies and CFP, we argue that CG positively moderates the relation between the non-‐market strategies and CFP. For a sample of 472 Fortune 500 firms, we first test the non-‐market strategies separately and aligned on CFP and then how CG moderates this relation. Our findings are threefold: first, we find that lobby expenditure and CSR extern have a direct positive effect on CFP, both in the short-‐term and in the long-‐term. Second, the cumulative CPA and CSR total have a positive effect in the short-‐term (ROA), but not in the long-‐term (Tobin’s Q) on CFP. Third, we do not find a positive effect on CFP when aligning the non-‐market strategies; however, we do find that CG negatively moderates the relation between CSR extern and CFP. Furthermore, this study finds that the notion of complementarity between the non-‐market strategies on the long-‐term exists, which should support future research to develop this argument further. This study is one of the first empirical attempts, using multiple regression and interaction analyses, testing the alignment effect of non-‐market strategies on CFP, following the latest theoretical recommendations. Furthermore, we empirically test both non-‐market strategies in the same study, we take short-‐term and long-‐term effect into account and we use a PROCESS moderation analyses to test the moderating effect of CG. Scholars can use this study to further develop the empirical evidence for an integrated non-‐market strategy. Managers can use this study to get a better understanding of which combination of non-‐market strategies has a direct financial impact and in which situations CG practices enhance firm value and in which not.
Keywords: Non-‐Market Strategy, Corporate Social Responsibility (CSR), Corporate Political Activity
(CPA), Corporate Governance (CG), Corporate Financial Performance (CFP), Fortune 500, Kinder Lydenburg Domini (KLD), Tobin’s Q
Statement of originality
This document is written by M.A. Blomaard who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is 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 content
1. Introduction………. 6
2. Literature review……….. 10
2.1 Corporate social responsibility………. 10
2.2 Corporate political activity……… 12
2.3 Bridging CSR & CPA………. 14
2.4 Corporate governance………. 15
3. Theoretical framework……… 19
3.1 Hypothesis 1: CSR-‐CFP………. 20
3.2 Hypothesis 2: CPA-‐CFP………. 21
3.3 Hypothesis 3: Aligning-‐CFP……… 22
3.4 Hypothesis 4: CG as moderator………. 23
4. Research design……… 25 4.1 Data collection……….. 25 4.2 Sample………. 25 4.3 Dependent variables………. 26 4.3.1 ROA……….. 26 4.3.2 Tobin’s Q……….. 26 4.4 Independent variable……… 27 4.4.1 CPA……… 27 4.4.2 CSR……… 27 4.5 Moderator………. 28 4.6 Control variables……….. 28 4.7 Methodology……….. 29 4.8 Model equations……….. 30 5. Results………. 32 5.1 Descriptive analysis……… 32
5.2 Correlations and multicollinearity……… 33
5.3 Regressions and moderator analysis………. 37
5.3.1 CPA……… 38
5.3.2 CSR……… 42
5.3.3 Interaction analyses………. 43
5.4 Control variable: Firm size………... 45
6. Discussion………. ………… 46
6.1 Findings……….. 46
6.2 Theoretical implications………. 50
6.3 Practical implications……… 51
6.4 Limitations……… 51
6.5 Directions of future research……….. 52
7. Conclusion………. 54
8. References……… ………… 56
9. Appendices……… 61
9.1 Appendix 1: Tables with summery of regression analyses………. 61
9.2 Appendix 2: Regression analyses with firm size: revenues………. 62
List of tables and figures
Figure 1: Conceptual model………... 24
Table 1: Descriptive statistics variables………. 33
Table 2: Correlation matrix………. 35
Table 3: Variation inflation factor (VIF) ……… 37
Table 4: Multiple regression analysis CPA – ROA – assets ……….. 39
Table 5: Multiple regression analysis CPA – Tobin’s Q – assets ……….. 40
Table 6: Multiple regression analysis CSR – ROA – assets………. 41
Table 7: Multiple regression analysis CSR – Tobin’s Q – assets………. 43
Table 8: Multiple regression analysis aligned – ROA – assets………. 44
Table 9: Multiple regression analysis aligned – Tobin’s Q – assets………. 45
Table 10: Summery of regression analysis – CPA……… 61
Table 11: Summery of regression analysis – CSR………. 61
Table 12: Summery of regression analysis – Aligned……… 61
Table 13: Multiple regression analysis CPA – ROA – revenues……….. 62
Table 14: Multiple regression analysis CPA – Tobin’s Q – revenues……….. 62
Table 15: Multiple regression analysis CSR – ROA – revenues……….. 63
Table 16: Multiple regression analysis CSR – Tobin’s Q – revenues……….. 63
Table 17: Multiple regression analysis aligned – ROA – revenues……….. 64
Table 18: Multiple regression analysis aligned – Tobin’s Q – revenues……….. 64
1. Introduction
The corporate environment, including the institutional and societal environment, is getting more and more complex, challenging firms to create sustainable financial performance (Pache & Santos, 2010; Den Hond et al., 2014). Besides dealing with the traditional market environment, including economic transactions and the exchange of property, firms at the same time have to manage their non-‐market environment, including social, political and legal arrangement (Baron, 1995). To do so, managers are becoming responsible for formulating both the firm’s market and non-‐market strategy in order to realize positive corporate financial performance (CFP) (Baron, 1995).
Several studies have explored the impact of non-‐market strategies on CFP (Baron, 1995; Doh et al., 2012; Mellahi et al., 2016) by identifying two main corporate strategies: corporate social responsibility (CSR) and corporate political activities (CPA) (Den Hond et al., 2015; Liedong et al., 2015; Mellahi et al., 2016). First, the CSR strategy encompasses “firms’ policies, processes and practices that meet the societal demands and expectations and which go beyond the legal requirement” (Den Hond et al., 2014: 7). This could include both external strategies, for example product safety and environmental performance, and internal strategies such as employee involvement, fair compensation and corporate governance (CG) (Tang et al., 2012). Since CSR is broadly defined, the concept encompasses many areas. For example, corporate philanthropy enhances firms’ trustworthy behaviour by creating social and political legitimacy giving access to society and policymakers, which in turn would result in positive CFP (Hadani & Coombes, 2015; Wang & Qian, 2011; Liedong et al., 2015). However, recent literature argues that internal and external intangible assets such as reputation (Den Hond et al., 2014: Cochran & Wood, 1984), trust (Liedong et al., 2015), knowledge (Hillman & Hitt, 1999), innovation, human capital and corporate culture, are the main components of CSR creating positive CFP (Surocca et al., 2010).
Second, the CPA strategy “captures firms’ policies and practices that are intended to influence governmental policies and processes” (Den Hond et al., 2014: 8). CPA is an umbrella concept as well and is often conceptualized as firms’ self-‐interest by meddling in politics, promoting their own corporate interests and agendas (Hadani & Schuler, 2013), or as a corporate attempt to shape governmental policies favourable to the firm (Hillman et al., 2004). The well-‐known and key component of CPA is lobbying; influencing policymakers by
information exchange or by financial incentives (Hillman et al., 2004) as well as campaign contributions and hiring formal public officials. It is often described as an attempt to influence policy by creating a favourable environment for the firm (Hadani & Schuler, 2013; Claessens et al., 2008).
However, the literature is inconclusive on whether the two non-‐market strategies have a positive or negative impact on CFP. Previous studies find both positive (Cochran & Wood, 1984; Hillman et al., 2004; Lux et al., 2011; Wang & Qian, 2015; Gupta et al., 2016) and negative effect of CSR and CPA on CFP (Hadani & Schuler, 2013; Perrini et al., 2011; Surocca et al., 2010). A possible explanation for these mixed findings is that the non-‐market strategies are empirically analysed in isolation, omitting other crucial explanatory factors (Den Hond et al., 2015; Mellahi et al., 2016). Recently, studies claim that the two non-‐markets strategies complement and possibly synergize each other and should therefore be researched in combination (Den Hond et al., 2015; Mellahi et al., 2016).
Building on the recent line of research, we follow the theoretical argument that the negative characteristics of CPA, such as reputation and self-‐interest, are likely levelled by the good characteristics of CSR, including legitimacy and trust. At the same time the strong characteristics of CPA, such as political access and lobbying, are likely complemented by positive CSR characteristics, including trustworthiness and reliability (Den Hond et al., 2015; Liedong et al., 2015). To untangle this relation and to uncover the possible aligning effect of the two non-‐market strategies on CFP, this study addresses the following question:
Research question 1: To what extent do CSR and CPA, aligned and non-‐aligned, impact CFP?
Another explanation for the inconsistent findings of the impact of non-‐market strategies on CFP is that the relation is caused by other corporate factors (Tam & Tan, 2007; Hadani et al., 2015; Den Hond et al.; Liedong et al, 2015; Zhao et al., 2016). CSR and CPA have one thing in common: they both study the link between firms and politics (Rasche, 2015). This relation is also explored in the corporate governance (CG) research, which refers to the “mechanisms in which agency costs are minimized so that the interests amongst members of the supervisory and/or executive board are aligned” (Rose, 2016: 203). Studies on CG find both the link with CFP and with the two non-‐market strategies. On the one hand, scholars find
that good CG in combination with one of the non-‐market strategies can positively impact CFP (Bhagat & Black, 1999; Marthur et al., 2013; Hong et al., 2016). They find that good CG mechanism increase the relationship between managers, shareholders and stakeholders, for example due to increasing transparency or stricter regulations, which leads to positive CFP (Coates, 2010; Dahan et al., 2013; Hadani, 2013). On the other hand, scholars find that CG impacts CFP (Bhagat & Bolton, 2007; Neal & Cochran, 2008). Neal and Cochran (2008) find that firms that apply good CG are rewarded on the financial markets and have better CFP compared to firms with poor CG. Since good CG positively impacts the non-‐market strategies and CFP, it is expected that CG positively moderates the relation between CSR, CPA and CFP. Therefore, this study addresses the second question:
Research question 2: To what extent does CG moderate the relation between the non-‐
market strategies and CFP?
For a sample of 472 firms, selected from the US Fortune 500 list published between 2012-‐2015, we use a quantitative approach in order to empirically test if aligned or non-‐ aligned non-‐market strategies positively impact CFP. Besides, we test the moderating effect of CG on the relation between non-‐market strategies and CFP. In order to measure CSR, this study adopts the Kinder Lydenburg Domini (KLD) social rating database and follows the method of Tang, Hull and Rothenberg (2016), separating the CSR strategy into internal and external strategies. We measure CG by using a CG quality score, divided into a low and moderate quality and a high quality, based on an aggregated ESG dataset of CG scores of firms (Ueng, 2016). Furthermore, in order to measure the direct impact of CPA on CFP, we use cumulative CPA data, including lobby expenditure and political action committee (PAC) contributions, following the approach of Hadani and Schuler (2013).
This study contributes to the existing literature in several ways: first, we follow the recommendation of the most recent literature to empirically test the aligning effect of the non-‐market strategies on CFP, using an interaction effect (Den Hond et al., 2014). Second, we extend the existing literature by using a PROCESS moderating analysis, analysing CG quality score as a moderator on the relation between CSR, CPA and CFP (Hadani et al., 2015; Zhao et al., 2016; Heyes, 2012). Finally, since previous studies researched the non-‐market strategies mainly in isolation, this study contributes by empirically testing the impact of both the non-‐
market strategies on CFP in the same study, using new data. The outcome gives managers insight into which combination of the non-‐market strategies creates the best strategy for firms and positively impacts CFP. Besides, this study contributes to managers’ understanding of the impact that CG has on their behaviour towards shareholders and on their governance and strategy policies.
The remainder of this study proceeds in the following way: this study starts with an overview of the existing literature on the impact of non-‐market strategies and corporate governance on CFP. Then, it formulates the theoretical framework, hypotheses and methodology. Based on the existing literature and the theoretical framework, the study proceeds by analysing the results from the variable correlation and regression analyses and discusses them together with the limitations and suggestions for future research. This study concludes with a summary of the findings and gives some thoughts for future research avenues.
2. LITERATURE REVIEW
This part reviews the existing non-‐market literature. First, it will provide an overview of the two strands in the two non-‐market literature, including CSR and CPA. Second, it presents a summery of the most recent literature advocating the alignment of the non-‐market strategies. Finally, an overview of the impact of CG on CFP and the moderating role of CG on the relation between CSR, CPA and CFP are presented.
2.1 Corporate Social Responsibility
The first strand of the non-‐market strategies, CSR, looks at the social responsibility of firms and is used as a strategy to create positive financial performance. The broad idea is that firms’ principles and processes lead to specific social performance outcomes (Mattinlgy & Berman, 2006). Often CSR as a concept is used in combination with strategy. Since a firms’ strategy and social goal are often not aligned, this might lead to the impression that the implementation of CSR activities is not always sincere (Fooks et al., 2013). For example, the extensive CSR policies of the world’s two largest tobacco firms bring them positive political, social and therefore economic gains, even though their product negatively impacts the public social welfare (Fooks et al., 2013). Gupta, Briscoe and Hambrick (2016) look if CSR behaviour is ideologically motivated or if it is used purely instrumentally. They find that the political-‐ ideological base of organizations, conceptualized in liberalism or conservatism, plays an important role in adopting CSR activities and policies. Especially when industry norms for CSR do not exist, liberal firms adopt CSR policies much quicker under weak isomorphic pressure than conservative firms do (Gupta et al., 2016).
Since scholars regard CSR as one of the drivers of CFP, they investigate which aspects of CSR matter most for corporate social and financial performance (Den Hond et al, 2014, Leidong et al, 2015). Multiple scholars divided CSR into external and internal strategies (Orlitzky et al, 2003, Tang et al, 2012). The former refers to the activities such as environmental performance, product safety or the added social features on products or services, while the latter sort refers to employee involvement, fair compensation and corporate governance (Tang et al., 2012). Orlitzky, Schmidt and Reyens (2003) use a similar method. They measure internal CSR strategies by effective resource utilization, and the external strategies by reputation and disclosure (Orlitzky et al, 2003).
First, internal CSR strategies are likely to improve the efficient utilization of resources and learning and enhance the firm’s organizational culture, structure and human resources (Orlitzky et al, 2003). Recently, scholars discovered that internal intangible assets such as innovation, employee loyalty, reputation and organizational culture, are main drivers for positive financial performance (Surocca et al., 2010; Perrini et al., 2011, Den Hond et al., 2014). The irresponsible behaviour of managers, not investing in CSR, could lead to negative consequences of the intangible assets such as decline in employee loyalty, internal innovation, or external reputation (Surocca et al., 2010). Furthermore, CSR policies enhance a firms’ trustworthiness and reliability, which strengthen the relationship between managers and key stakeholder, both internally and externally (Den Hond et al., 2014).
Second, external CSR strategies enhance firms’ competencies and resources (Orlitzky et al., 2003). One of the key external aspects of CSR is philanthropy. Corporate philanthropy is conceptualized as the “non-‐obligatory and voluntary transfer of wealth or resources from the firm to outside entities” (Hadani & Coombes, 2015: 860). The concept in itself proclaims an intrinsic goal to improve something humanitarian or social. However, even philanthropy becomes increasingly strategic. Philanthropy is used to enhance firms’ reputation, gain trust with policymakers and directly or indirectly increase social and political legitimacy (Hadani & Coombes, 2015; Liedong et al., 2015). In that way, corporate philanthropy is a means to strengthen firms’ CFP by enabling firms to improve their stakeholder strategy and gain political resources (Wang & Qian, 2011).
Recently, scholars find that the external intangible assets of firms such as trust and reputation, also have an important role in creating CFP (Den Hond et al., 2014, Liedong et al., 2015). The reputation of firms is often built on the perception of the stakeholders, which has a direct impact on the firms’ capital or revenue stream (Den Hond et al., 2014). Since reputation signals the trustworthiness and reliability of firms, CSR can enhance CFP by contributing to a better environment in which firms can thrive (Den Hond et al., 2014). Trust is an essential mechanism to influence important decision makers such as policymakers, shareholders and other key stakeholders (Liedong et al., 2015). However, since trust does not have the financial leverage to change the rules of the game, it only has a moderate effect on policy outcomes (Liedong, et al., 2015).
The existing literature is contradictory with regard to the ways in which CSR and CFP are related to each other (Waddock and Graves, 1997; Zhao & Murell, 2016). Waddock and
Graves (1997) find that the relation of corporate social performance and CFP is bidirectional: they both strongly influence each other. Zhao and Murell (2016) replicate this study and find that the relation is unidirectional: CFP is a precondition for social performance and only if there is positive CFP, it is positively related to social performance and not the other way around (Zhao & Murrel, 2016). Furthermore, Surocca, Tribo and Waddock (2010) find that intangible assets mediate the relation between corporate responsible performance and CFP, causing a virtuous loop (Surocca et al., 2010). They state that there is no direct relation between CSR and CFP, but that intangible assets mediate CFP instead (Surocca et al., 2010, Perrini et al., 2011).
2.2 Corporate Political Activity
The second strand of non-‐market strategies looks at the political activity as strategy for firms to increase their financial performance. More directly formulated, a CPA strategy is a corporate attempt to shape governmental policies in way which is favourable to the firm (Hillman et al., 2004). Firms have several characteristics that enable them to use CPA as strategy. Lux, Russel and Woehr (2011) researched which factors make firms likely to engage in CPA. They find that the level of government regulation, level of contract and sales with government, level of politician dependency, firm size and firm diversification stimulate firms to engage in CPA. Overall, they find that CPA is positively related to CFP. However, they did not discover the causality behind it (Lux et al., 2011).
Hillman & Hitt (1999) try to discover ‘how’ firms engage in political behaviour. They define three CPA strategies that can be used to compete in the public policy process. First, they distinguish the information strategy, which targets policymakers by providing specific information in line with the firm’s strategy. This could include activities such as lobbying, reporting, research and information exchange. Second, the financial incentives strategy also targets decision makers by using direct pressure through financial inducements such as party contributions, speaking honoraria or travel expenses. Third, in the constituency building strategy firms try to create support from voters and citizens by creating indirect and bottom-‐ up pressure to change policy, for example by advertisements or petitions (Hillman & Hitt, 1999).
To untangle the impact of these strategies on CFP, this study discusses the findings of each strategy in the literature to this day. First, for the information strategy, lobby expenditure is mainly used as measurement. On the one hand, Mathur, Singh and Thompson (2013) find a positive relation between the lobby intensity and the market value of a firm. On the other hand, Hadani and Schuler (2013) find contrasting outcomes and do not discover a relation between corporate political investment and market value -‐ CFP. However, they do find that cumulative political investments have a significant impact on CFP for regulated industries. This indicates that firms in regulated industries could gain from longstanding relationships with decision makers (Hadani & Schuler, 2013).
Second, financial incentive strategies are mainly measured by party contributions, and campaign contributions such as financial contributions to special political action committees (PAC’s), which are institutionalized lobby groups (Hadani & Schuler, 2013). Claessens, Fejjen and Leaven (2008) investigate if campaign contributions in Brazilian elections would lead to future firm-‐specific political favours. They find that higher election contributions to close-‐ related decision-‐makers’ increase finance access and increase the stock market value of firms after the election. This impact is even bigger if the sponsored decision maker is a winning candidate (Claessens et al., 2008). However, Hadani and Schuler (2013) look at firms listed in the Standards and Poor (S&P) database but do not find a relation between corporate financial investment and market value. Moreover, they find that campaign contributions do not lead to increasing market value or CFP (Hadani & Schuler, 2013).
Third, the constituency building theory is often measured by firms’ advertising expenditures. Other features of this strategy are public policy advertisements, press conferences, grassroots mobilization and education programs (Hillman & Hitt, 1999). Wang and Qian (2011) find strong support that the relation between philanthropy and CFP increases if the advertising intensity increases. Singer (2013) also advocates that advertising is an important feature of political communication to influence decision and policymakers. Often the constituency strategy is used in combination with one or two of the other CPA strategies (Hillman & Hitt, 1999).
With more than 2 billion US dollars yearly being spent on lobbying, CPA is a widely used strategy in order to change policies in a favourable way for the firm (Milyo et al., 2000). However, which instruments reap the greatest benefit remains inconclusive. Firms should figure out which combination of instruments benefits themselves the most. Politicians are
responsive to CPA, so not engaging in CPA could mean that another firm is deciding the political direction (De Figueiredo & Siverman, 2000).
2.3 Aligning CSR and CPA
A huge competitive market for non-‐market strategies exists with enormous amounts of money being spent. In the US, firms spent yearly more than 2 billion of US dollar on lobbying (CPA) and more than 17 billion on US dollar on charity (CSR), forcing firms to engage in these non-‐market strategies (Milyo et al., 2000). However, the literature finds contrasting outcomes on the success of these strategies (Orlitzky, 2011; Surocca et al., 2010; Perrini et al., 2011; Hadani & Schuler, 2013). On the one hand, scholars find that the impact of CSR on CFP has a bidirectional causality and that intangible assets enhance CFP (Orlitzky et al., 2003; Surocca et al., 2010, Perrini et al., 2011). On the other hand, many characteristics are found to improve CPA’s success, yet often no relation to CFP is found (Hadani & Schuler, 2013). The lack of explanation of the individual strategies brought researchers to look into the combination of the two non-‐market strategies. A growing number of scholar’s advocate that the non-‐market strategies cannot be seen separately, but should be applied in combination (Singer, 2013; Den Hond et al., 2014; Hadani & Coombes, 2015; Liedong et al., 2015; Rasche, 2015; Mellahi et al., 2016).
Hadani and Coombes (2015) made a first step in analysing the combining of the two non-‐market strategies. They find that corporate philanthropy (CSR) and CPA do share common characteristics. One could consider philanthropy and CPA to be opposites because they both compete in an uncertain and competitive market for limited political access. However, the possible synergies between the two strategies can solve the uncertainty on the market for both. For example, CPA can use CSR activities in order to enhance a firm’s reputation by increasing legitimacy and trust (Hadani & Coombes, 2015).
Liedong, Ghobadin, Rajwani and O’Regan (2015) research how CSR and CPA can complement each other with regard to firms’ trust levels. They find that both non-‐market strategies have a moderate trust level towards decision makers because CSR is missing the ability to influence policy and CPA is missing benevolence in their action. However, combining both strategies could lead to synergies, which would help both strategies to overcome their weaknesses and contribute to the trustworthiness of the firms and success in the political
arena. Moreover, they find that CPA on its own can influence only low and moderate salience policy issues, but combined with CSR can also influence high salience issues (Liedong et al., 2015). The saliency of issues, or the importance of a political issue, is also acknowledged by other scholars to have a positive impact on the success of non-‐market strategies (Hillman et al., 2004; Lux et al., 2011).
Den Hond, Rehbein, Bakker and Kooijmans (2014) research firms’ reputation, advocating that firms’ reputation depends on its strategy to align, non-‐align or misalign CSR and CPA. They find that aligning the non-‐market strategies amplifies the positive and mitigates the negative reputation of firms. Non-‐alignment leads to additive reputation since stakeholders evaluate the firm on both on their non-‐market strategies. However, at the same time non-‐alignment gives firms the possibility to create alignment. Misalignment has the opposite effect of aligning, leading to a reduction of positive benefits and increases negative effects (Den Hond et al., 2014). The alignment of strategies can cause stakeholder to see the firm as trustworthy and reliable. Based on the interpretation of stakeholders, a firms’ reputation is created or destroyed with its consequences for CFP. Furthermore, they find that the configuration of CSR and CPA is moderated by the transparency and openness of firms’ expenditures (Den Hond et al., 2014).
In sum, firms’ motivation to engage in CSR can be just as instrumental as to engage in CPA (Rasche, 2015). However, CSR and CPA can complement each other to get political access or can be used to form a multi-‐stakeholder coalition (Rasche, 2015). What stands out is that in the non-‐market environment stakeholders are susceptible to internal and external intangible assets. In order to compete in the policy arena, both the ability to influence policy and having a reliable, trustworthy and legitimate reputation forces firms to align their non-‐ market strategies (Den Hond et al., 2015).
2.4 Corporate Governance
The inconclusive and contradicting outcomes for the isolated effect of the two non-‐market strategies on CFP can also be caused due to possible omitted variables that can provide an alternative explanation. Another area of research that involves both non-‐market strategies and which also finds the link with CFP is the literature on corporate governance (CG) (Neal & Cochran, 2008; Dalton & Dalton, 2011; Mathur et al., 2013, Rasche, 2015). CG arises under
external political and judicial pressure such as regulations and laws, or come from the industry itself (Aguilera & Cuervo-‐Cazurra, 2004).
On the one hand, firms become political actors because governance gaps, arising due to the global scale of businesses, exist. On the other hand, governments can only protect their citizens from corporate misconduct if they are able to regulate them (Rasche, 2015). For firms, this means that the external institutional environment is changeable. The external environment can vary in level of regulations, which offers opportunities for firms to engage in political activity in some situations (Hillman & Hitt, 1999). In order to understand the role of CG, this study first looks at the impact of CG on CFP. After which it looks at how CG influences the relation between the two non-‐market strategies and CFP. Finally, it looks at which moderating role CG can have on the relation between non-‐market strategies and CFP
First, the literature finds that good CG impacts CFP (Neal & Cochran, 2008; Ueng, 2016). A large number of scholars examined whether board composition drives CFP (Bhagat & Black, 1999; Nicholson & Kiel, 2003; Dalton & Dalton, 2011; Mathur et al., 2013). The CG regulations in US law describe that corporate boards should consist of both dependent board members, directors working in the firms, independent board members and non-‐affiliated board members (Fuzi et al., 2016). Because of contradicting findings on the impact of independent board members on CFP (Bhagat & Black, 1999; Tam & Tan, 2007; Nicholson & Kiel, 2003; Fuzi et al., 2016), the question remains how the composition of a board is liky to enhance CFP.
Bhagat and Black (1999) find that an optimal board consists of a mix of dependent, affiliated and independent directors that enhance CFP. This finding opposes the trend for a high majority of independent board members (Bhagat & Black, 1999). However, Fuzi, Syahrin and Julizaerma (2016) find that independent board members do not necessarily enhance CFP but do enhance better CG and corporate social performance. Independent directors can monitor the possible opportunistic behaviour of managers and mitigate the relations between managers and shareholders (Fuzi et al., 2016). In response to this, Ueng (2016) states that these mixed findings are due to different measurements. He finds that firms with better CG quality enhance CFP more than their counterparts with lesser CG quality do. He defines the quality of a firm by whether a firm has a formal governance policy, board ratings, compensation policy, takeover defence strategy and accounting practices (Yueng, 2016).
Second, the literature finds that CG influences the relation between CPA and CFP (Coates, 2010; Mathur et al., 2013; Hadani, 2012). Mathur, Singh, Thompson and Nejadmalayeri (2013) look at the impact of CG on lobby strategies and firm value. They find that firms with a greater degree of management entrenchment have a greater tendency to engage in lobbying. At the same time, because of the agency problem, they predicted that firms that engage in lobbying have weaker shareholder rights. However, their agency explanation was not supported because management entrenchment was negatively associated with value creation, while lobbying was positively related to value creation. Therefore, the state that lobbying can be seen as an instrument to align management and shareholder interests enhancing the firms CFP (Mathur et al., 2013).
Hadani (2012) however states that managers may have unrealistic expectations regarding their firms’ CPA since CPA increases the information asymmetry and reduces the transparency between the managers and shareholders. He finds that the relationship between institutional owners and CPA has a negative association. Furthermore, he finds that the response of institutional owners is important to a firm’s CPA strategy because it impacts the legitimacy of the firm. Therefore, transparency to shareholders, and especially institutional shareholders is important to mitigate this negative effect of CPA. Coates (2010) goes even further and finds that CPA is negatively related to firm value and that unobservable CPA is even more harmful to shareholders’ interest. Therefore, he states that tighter CG laws protect the rights and interests of shareholders (Coates, 2010).
The negative outcomes of CPA can be explained in two ways: the first explanation states, that firms are in an ‘arms race’ on political spending in order to keep up with the competitors. The second explanation states, that a weak corporate governance system allows firms to set their own standards and allows managers to misbehave by taking too much risk or misdirect. Solutions contain stricter ethical standards for firms’ self-‐regulation or a tighter corporate governance policy (Dahan et al., 2013).
Third, the literature finds a strong influence of CG on the relations between CSR and CFP (Neal & Cochran, 2008; Jo & Harjoto, 2011; Jizi et al., 2013; Young & Thyil, 2015). Neal and Cochran (2008) even regard CSR as an integrated part of CG, determining how firms look at their stakeholders. They especially focus their research on shareholder responses towards firms’ implementation of CG. They find that the market and thus the shareholder’s reward firms with good governance, being cross-‐listed on stock exchanges and having an auditor, and
punishes firms with poor governance (Neal & Cochran, 2008). Furthermore, Jizi, Salama, Dixon and Stratling (2013) find that the board characteristics, including size, independence and duality, are positively related to CSR disclosure. Jo and Harjoto (2011) support this argument and find that CG characteristics drive CSR engagement. Furthermore, they find that CSR activities, engagement and intensity are positively related to firm value (Jo & Harjoto, 2011).
Besides, Hong, Li and Minor (2016) find that good CG is an important mechanism determining whether firms implement executive compensation for CSR activities in order to increase the firms’ social performance. In that sense, CSR activities are more likely to be beneficial to shareholder and should not be seen as agency costs at the expense of shareholders (Jo & Harjoto, 2011). Overall, scholars see CG as the protection of shareholders’ and stakeholders’ interests, which leads to positive CFP (Neal & Cochran, 2008; Jizzi et al., 2013).
Finally, studies have looked at the moderating role of CG on the relation between CSR, CPA and CFP (Hadani et al., 2015; Zhao, et al., 2016). Hadani, Dahan and Doh (2015) find that CEO duality moderates the impact of CPA on CFP. CEO duality has a negative impact and reduces the association of high levels of CPA and return on assets (ROA) (Hadani et al., 2015). At the same time, Zhao, Chen and Xiong (2016) find that CEO duality positively moderates the relations between social issues and corporate social performance. Besides CEO duality as moderator, they also find that state ownership and tradable shares all have a positive moderating effect on the relation between attention given to social issues and corporate social performance (Zhao et al., 2016). Den Hond, Rehbein, Bakker and Kooijmans (2014) find that when the two market strategies are aligned, transparency moderates the impact on CFP. Transparency positively moderates the expectation of shareholders, which increases the trust and reputation, which in turn enhances CFP (Den Hond et al., 2014).
3. THEORETICAL FRAMEWORK
One of the possible explanations why the literature is inconclusive on the effect of the two non-‐market strategies on CFP is that they are mainly researched in isolation (Cochran & Wood, 1984; Hadani et al, 2015; Wang & Qian, 2015; Gupta et al., 2016; Mellahi et al., 2016). Recent scholars find that combining the two non-‐market strategies are likely to cause positive CFP, due to complementarities and synergies (Liedong et al., 2015; Den Hond et al., 2015; Mellahi et al., 2016). The increasing awareness that CSR and CPA may complement each other, leads to the call for an integrated model of firms’ non-‐market strategies (Mellahi et al., 2016).
Singer (2013) already proposed a first integrated model, in which he tried to connect both CSR and CPA with corporate strategy, combining three theoretical disciplines namely; business ethics, strategic management and political theory respectively. He finds six main types of corporate activity, i.e. political communication, NGO relations, tax strategy, CSR, lobbying and corporate strategy, that firms should jointly manage in order to formulate their strategy (Singer, 2013). However, this strategic problem definition of the corporation is missing the link with CFP.
Another explanation for the inconsistent findings is that the effect of the non-‐market strategies on CFP is caused by other corporate factors. (Hadani et al., 2015; Den Hond et al.; Liedong et al, 2015; Zhao et al., 2016). The literature on corporate governance (CG) finds both the link between the two non-‐market strategies and with CFP (Neal & Cochran, 2008; Rasche, 2015). On the one hand, scholars find that good CG positively influences CFP (Jo & Harjoto, 2012; Ueng, 2016; Fuzi et al., 2016). On the other hand, scholars find that that CG has a mixed effect on the two non-‐market strategies (Neal & Cochran, 2008; Jo & Harjoto, 2011; Hadani, 2012; Jizzi et al., 2013; Mathur et al., 2013, Dahan et al., 2013). Both links are triggered by the fact that good CG in most cases improves the relationship between managers, shareholders and stakeholders (Jo & Harjoto, 2012; Hadani & Schuler, 2013; Mathur et al., 2013; Fuzi et al., 2016).
Filling the two gaps in the literature, this study follows the latest theoretical recommendation to align the two non-‐market strategies (Den Hond et al, 2015) and extends the literature testing CG as moderator on the relation between the two non-‐market strategies and CFP, creating an integrated model (see Figure 1). In order to untangle these voids, four
hypotheses are formulated to test the relation between CSR, CPA and CFP and the moderating effect of good CG on these relations.
3.1 CPA à CFP
The impact of CPA on CFP leads to mixed result in the literature (Hillman et al., 2004; Lux et al., 2011; Hadani et al., 2015). Positive relations that are found indicate that CPA activities create a favourable condition by attracting contracts, obtaining subsidies, getting approvals and obtain trade protections (Hillman et al., 2004, Lux et al., 2011, Hadani et al., 2015). On the opposite, negative relations that are found indicate that CPA activities have only a minor effect on policy outcomes and do not create more financial capital (Hadani et al., 2015). Reasons for these inconclusive outcomes between CPA and CFP can be caused due to several factors: first, due to a variety of measurement types and dataset used, heterogeneous outcomes are found (Bhagat & Black, 1999; Orlitzky et al., 2003, Orlitzky, 2011). Second, because researching the relation in isolation, neglects the possibility that other variables from a broader environment could influence or cause the relation (Hillman et al., 2004).
To overcome these measurement problems, this study follows Hadani and Schuler (2013) adopting a cumulative CPA investments method in order to test an overall and direct impact on CFP. As outlined above in the literature review, the three main CPA strategies, including informational, financial and constituency strategy, are broadly measured by lobby expenses, party contributions and advertisement costs, respectively (Hillman & Hit, 1999). Because the constituency strategy has an indirect effect on policy change it is difficult to measure. Besides, since it is often included in one of the other two CPA strategies, it is likely that it could have caused a similar effect. Furthermore, the constituency strategy of CPA overlaps with the CSR extern strategy, including reputation among others. Therefore, this study leaves the constituency strategy out of this analysis.
Although Hadani and Schuler (2013) find partial evidence that cumulative CPA activities lead only to higher CFP in regulated industries, it is expected that the cumulative approach provides a stronger outcome on the relation. Combing both the financial and informational strategies will bundle its strengths and scope and creates a stronger effect on CFP (Hillman & Hit, 1999). Therefore, the following hypothesis is formulated:
