Do shareholders value corporate social performance? : an emperical test of the cost of equity capital hypothesis

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Do Shareholders Value Corporate Social

Performance?

An Emprirical Test of the Cost of Equity Capital Hypothesis

Student: Jim Hubert Student Number: 10371303

Date: June 29th_{, 2016}

Bachelor Thesis

BSc Economics and Business, Business Administration Faculty of Economics and Buisness

University of Amsterdam

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ABSTRACT

Although previous literature has focused on the influence of corporate social responsibility (CSR) on cost of equity capital, the mediation effect of this relationship on corporate financial performance (CFP) has not been studied extensively yet. This paper develops and analyzes a conceptual framework around a sample of firms in the U.S. chemical industry, dividing and comparing corporate social performance (CSP) in two distinctive categories, namely primary stakeholder management (PSM) theory and corporate philanthropy (CP). It is hypothesized that PSM negatively influences cost of equity, which would partially mediate the relationship between CSP and shareholder value. Contrary to the preceding effect, CP is predicted to positively influence cost of equity capital, which would also have a partly mediating effect. Based on a large-scale secondary dataset, the findings verify the first expectation. Surprisingly however, the opposite effect was found with regard to the second hypothesis but without significance for the mediation effect. The results of this contingency setting relationship may deepen the theoretical understanding of the CSP-CFP relationship and offer practical implications as to stakeholder management issues for managers in the U.S. chemical industry.

Keywords: primary stakeholder management, corporate philanthropy, shareholder value, cost of

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STATEMENT OF ORIGINALITY

This document is written by Jim Hubert, 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.

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INTRODUCTION

"There is one and only one social responsibility of business: to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game” (Friedman, 1970, p. 6). Through the previous citation from his book Capitalism and Freedom, Milton Friedman opened a serious discussion about the role of social responsibility within a corporation. According to the author, the major stakeholder group that always needs to be satisfied is shareholders. Resources spent on any other form responsibility towards society would be detrimental to value creation. Over time however, strategic management theories have developed to better suit the ever-changing business environment. Presently, it is believed that the influence of stakeholders on the firm and the reciprocal influence the firm possesses on stakeholders, have the potential to create a complex “webs of interdependencies”(Harrison & St. John, 1996) that can lead to competitive advantage and value creation. However, The relationship between CSR and corporate financial performance (CFP) has been ambiguous in research. No significant relationship has been found between these two variables in Alexander and Buchholz’s (1978) study. Moreover, if supply and demand for socially responsible investments (SRI) is not favorable, engaging in CSR could have a negative effect on market value (Mackey, Mackey & Barney, 2007, p. 833). Another view however, is that CSR activities can insure against risk, foster strategic resources and possibly create shareholder value (Hillman & Keim, 2001; Orlitzky et al., 2003; Godfrey, Merrill & Hansen, 2009).

The findings of previous research are essentially drawn from broad corporate social performance (CSP) measures encompassing highly deferring CSR elements. Also, these measures are often studied with a direct link to corporate financial performance, such as shareholder value. This circumstance is rather surprising, as results and opinions vary considerably in this field of study. Consequently, increasing contingency approaches seem to be necessary to gain further understanding of the latter relationship. Interestingly, the effect of CSR on cost of equity has been extensively researched (Dhaliwal, Li, Tsang & Yang, 2011; Jo & Na, 2012; Cheng, Ioannou & Serafeim, 2014; Bénabou & Tirole, 2010). Moreover, cost of equity capital is believed to have a negative relationship, and thus advantageous effect on market value (El Ghoul et al., 2011). However, the linking effect of cost of equity on the CSR-CFP has been omitted in previous research. Yet it is vital to evaluate a firm’s financial health, in particular shareholder value, to establish whether these social initiatives are strategically and financially relevant in this relationship. Also, results vary quite widely between countries and industries.

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Research seems to requisite additional situational analyses in order to narrow down the broad and varying conclusions drawn on CSP-CFP relationship in literature so far.

The latter is attempted in this study by analyzing and comparing the effect of two CSP scores on shareholder value, with cost of equity capital as mediating factor. Hillman and Keim (2001) write a relevant paper to this matter by separating CSR activities in two corporate social performance (CSP) measures based on a large database. On the one hand, they argue that primary stakeholder management positively influences shareholder value. On the other hand, social issue participation including secondary stakeholders presents a negative relationship. Previous research has indicated that a firm’s stakeholders can be divided in two hierarchical categories (Freeman, 1984; Donaldson & Preston, 1995; Clarkson, 1995; Goodpaster, 1991; Hill & Jones, 1992). The former category, primary stakeholders can be considered as a group, whose ongoing participation is vital for a company’s survival (Freeman, 1984). This group consists of parties that are directly involved in a firm’s business: employees, customers, investors and suppliers, and parties that affect a company’s concern from the public group: the governments and communities (Clarkson, 1995). The latter class, secondary stakeholders are parties, which are not imperative for a corporation’s survival. Godfrey (2005) advances another important measure of CSP, namely corporate philanthropy. The author states that value can be created for the firm when philanthropy, charitable activities towards communities, is strategically involved with major business operations. However, this relationship has not yet been extensively researched on its own.

Moreover, this research is contextualized in the U.S. chemicals industry, which has currently not been studied in a detailed manner as to the CSR-CFP relationship. This is due to the fact that companies within this industry operate mostly among businesses and do not trade actively with households. However, corporations from these sectors are classified to have high environmental impacts and report more information of their CSR activities to mitigate the negative effects. A negative effect was found in the disclosure of philanthropic CSR activities and cost of equity capital (Reverte, 2012). Nevertheless, the industry faces considerable ethical pressures and is believed to invest in CSR only to improve its public image and goodwill, which would not be favorable in the CSP-CFP relationship. Thus, I argue that corporate philanthropy has a positive effect on cost of equity capital, which leads to lower shareholder value. The opposite seems to be the case for an increase in primary stakeholder management, which is predicted to be positively related to shareholder value as a result of lower cost of equity, which in

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turn leads to higher shareholder value. This would be due to the combination of insurance against risk, easier access to finance and moral capital primary stakeholder management provides with a strong strategic orientation and focus on sustainable competitive advantage. For a sample of 177 firms in the U.S. chemical and pharmaceutical industries, the latter described prediction was validated as expected. Interestingly however, it was found that corporate philanthropy has a significant negative relationship to cost of equity capital, which was not predicted and can have noteworthy implication for CSR activities related to philanthropy for firms in these particular industries.

In order to effectively analyze the previous described relationships, a theoretical discussion is next presented. Followed by the conceptualization of the research variables and the analysis of the results on the relationships between primary stakeholder management, corporate philanthropy cost of equity capital and shareholder value.

CONCEPTUAL FRAMEWORK AND HYPOTHESES

It seems critical to state that this study is based on a “business-case” perspective (Barnett & Salomon, 2006). The latter proposes a focus on whether the cost of contributing to social welfare is exceeded by the financial value it creates. In order to create value nevertheless, investments should have the potential to lead to a competitive advantage (Porter, 1991). With the evolution in strategic management theory, CSR activities have become a field of interest in achieving competitive advantage. However, the divergence on the focus of CSP and CFP and the processes by which these measures are determined, has led to varying results and implications (Wood, 1991). In this study, four dimensions are taken into account when analyzing corporate social performance (Carroll, 1979): economic obligations to consumers and investors, legal responsibilities to authorities, societal and ethical duties, and discretionary responsibility to the community. In addition, Clarkson (1995) narrows the definition down from CSP being a measure of the impact of business on society as a whole to a measure on stakeholder issues management, where the level of analysis is the corporation itself. From this context, the literature advances two main elements of CSP, which are potentially the basis for competitive advantage and could create value: primary stakeholder management and corporate philanthropy. Both variables are conceptualized as comparison to improve the understanding of the CSP-CFP link in more depth. The following conceptual framework serves as frame to clarify our thesis, which states that cost of equity has a significant mediating effect on the relationship between CSP and CFP.

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CSP and Shareholder Value

Does financial performance benefit when a company’s management decides to allocate resources to CSR activities? There are conflicting views as to the relationship between a firm’s financial performance and CSR investments. Where some studies find return on CSR investments to be positive (Hillman & Keim, 2001; Preston & Sapienza, 2009; Godfrey, 2005), other research shows a negative relationship (Luo & Bhattacharya, 2006; Cochran & Wood, 1984). Consequently, the CSP-CFP relationship can be qualified as miscellaneous and needs further specific investigation. There are two main clarifications in previous literature as to these mixed results.

Firstly, the answer to the latter question differs considerably as to the measure used to determine CFP. Previous research exhibits a substantial dichotomy between market measures and accounting measures of financial performance. In their study, Gentry and Shen (2010) find that the two measures are correlated but there is no evidence that they are convergent. This means that the decision of using either measure should be provided with clear argumentation to clarify the reason it fits to the research. Market measures such as Tobin’s Q and market returns are not limited to different aspects of financial performance (Lubatkin & Shrieves, 1986). Indeed, assuming that financial markets are efficient, market measures could determine the present value of a firm’s expected future cash flows and thus, provide the fundamental value of the company. Where accounting measures conceptualize as past and short-term performance (Keats & Hitt, 1988), market measures can theoretically be used as future or long-term reflections of financial performance. In the case of the relationship between CSR and CFP, CSR activities seem to profit from a long-term approach according to Wang and Bansal (2010). Thus, where existing literature has a considerable focus on backward-looking accounting-based measures, there is a need for consolidation in research to concentrate on forward-looking market values. Consequently, this research adopts a market measure for financial performance, namely shareholder value.

To elaborate on the correct measure needed, it seems important to explain that variation in shareholder value is the percentage change in the price of a share surrounding an investment or event that was not expected by the market, also called abnormal returns (Godfrey, Merrill & Hansen, 2009, p. 433). Shareholder value creation can also be operationalized as Market Value Added (MVA), as used in Hillman and Keim’s (2001) study on the relationship between stakeholder management, social issues and shareholder value. According to the authors, the difference between a firm’s market value and capital is in fact “the difference between the cash

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that both debt and equity investors have contributed to a company and the value of the cash that they expect to get out of it” (p. 129). This would mean that MVA could be seen as the stock market’s estimation of a firm’s net present value. The year-by-year change in MVA effectively describe if there is shareholder value creation, or not. In consequence, this study proposes that the previous measure can make it possible to reduce the ambiguity between the CSP-CFP relationships by focusing on actual market value creation.

The second justification of the highly differing results in this field of research seems to be the ignoring of contingency settings that may clarify the different aspects of the relationship (Sen & Battacharya, 2001). For example, a large number of studies research the direct relationship with control variables to verify for confounding effects. When modeling a research in that fashion, the CSP-CFP link might not be better understood. Therefore, this paper contains a more complex framework, which attempts to resolve the latter research issues. More precisely, the framework proposes that the link between social and financial performance is better explained by the mediating connection of cost of equity capital. Moreover, a comparison in this model between the two main variables of CSP, primary stakeholder management and corporate philanthropy, further details the contingency settings of the research.

CSP and Cost of Equity Capital

For what reasons would better corporate social performance lead to lower cost of equity? There are at least two main arguments in previous research that argue in favor of this effect. First of all, research has indicated that investing in CSR initiative can serve as a company’s insurance mechanism. For example, Dhaliwal et al. (2011) investigate whether deliberate disclosure of CSR investments leads to a lower cost of equity capital. In their study, they measure voluntary disclosure using a dummy variable that scores “1” when a company first issues a standalone CSR report, while controlling for corporate social performance. CSP is determined with the KLD database, which will be further elaborated in the methodology section. The findings of their study show that firms with a large cost of equity capital tend to issue standalone CSR reports. More interestingly, organizations with superior CSP scores consequently experience an advantageous decline in their cost of equity capital. There seems to be an insurance effect with these CSR initiatives because they have the possibility to avoid future governmental regulations and possible increases of compliance costs (Dhaliwal et al., 2011; Jo & Na, 2012) Moreover, this deliberate form of issues CSR reports is found to reduce information asymmetries (Cheng, Ioannou & Serafeim, 2014) about CSP and works in favor of the insurance effect.

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Secondly, a stream of literature outlines the effect of improved social performance of a company’s access to financing. In the article written by Cheng, Ioannou and Serafeim (2014), it is hypothesized that improved access to finance can not only be contributed to lower agency costs with improved stakeholder engagement, but also reduced information asymmetry because of higher levels of transparency. Indeed, high CSP scores related to engagement with stakeholders and more transparent information are found to improve mutual trust and cooperation (Hillman & Keim, 2001), which may counter the possibility of short-term opportunistic behavior (Benabou &

Tirole, 2010). These mechanisms are critical in reducing a firm’s capital constraints and thus,

there seems to be an increased access to finance. In line with this view are El Ghoul et al. (2010), with their study based on a large sample of U.S. firms. The latter authors expanded the cost of equity variable by using different measurement approaches, which resulted in the finding that highly ranked CSR firms have cheaper and more facilitated access to financing. The previous two arguments would contribute to the social identity of the company (Ashforth & Mael, 1989), which is a theory suggesting that an organization with high moral capital may attract socially responsible stakeholders, which would result in the reputation of a good corporate citizen.

While the previous arguments would indicate that CSR related activities and investments in general would decrease cost of equity capital, there is not much focus on specific elements of CSP measures and how these would compare. As stated previously, this study distinguishes and compares two streams of CSP variables found in previous literature. The first one focuses on primary stakeholder management (PSM). Besides the fact that effectively managing relations with primary stakeholders can assure a company’s survival, it has the potential to aggregate valuable intangible resources, which may be the basis of the outperformance of its competitors. In his article, Barney (1991) advances the resource-based view of the firm, which explains that the complex and unique interconnection of physical, organizational, human and other intangibles within a company can result in a competitive advantage. According to the author however, resources should possess the qualities of being valuable, rare, inimitable and non-substitutable (VRIN) in order for a competitive advantage to be sustainable. The latter means that the firm is implementing a unique value creating strategy, which could not be reproduced by the competition or potential entrants. Does primary stakeholder management have the possibility to achieve this? Harrison and St. John (1996) state that “webs of interdependencies” can be created among stakeholders, which can indeed serve as value creating means in uncertain and changing environments. For example, Inoue and Lee (2011) find that within the tourism industry, airlines

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that invest in developing a unique primary stakeholder strategy by focusing on employee relations and product issues, may secure long-term profitability and effectively manage environmental risks compared to the competition. Moreover, Hillman and Keim (2001) argue “sustainable organizational advantage may be built with tacit assets that derive from developing relationships with key stakeholders” (p. 135). The latter writers explain that competitors cannot easily imitate the personalized development of a company’s relational investments in primary stakeholders because they are not transactional investments, which can be accessed through market or accounting information. The combination between the features of PSM and the arguments explaining the CSR and cost of equity link lead to the following hypothesis:

Hypothesis 1a: Primary stakeholder management is negatively related to cost of equity

capital.

Thus, a company that successfully invests in its primary stakeholders would have a lower cost of equity capital and vice versa. However, how would this relationship compare with our second measure of CSP, namely corporate philanthropy? Godfrey (2005) enlightens that strategic philanthropy can be a possible source for competitive advantage leading to value creation. The previous view is shared by Porter and Kramer (2002), who propose that corporations should reconsider where and how they engage in charitable deeds. Companies should focus on contextual conditions related to their strategies and industries. By applying a screening process on the possible philanthropic activities in their environment, companies would be able not only to create goodwill and live up to outside pressures, but also to exceed these and hence contribute to both society and the business. In their article, a relevant example is given with the charitable giving the film production company Dreamworks SKG engages in. The firm is collaborating with schooling institutions in Los Angeles to create a curriculum for low-income students. Not only does this benefit society by providing the opportunity for young people with training in skills needed in the entertainment industry, and thus increasing employment opportunities and the level of the educational system, but it could also be profitable for the firm in the sense that the talent pool would consist of better trained prospective employees incited to work at Dreamworks.

Although there is some evidence that doing well for the community could have strategic advantages, philanthropy remains widely regarded upon as a conscience related concept with the aim of creating goodwill. Porter and Kramer (2002) argue that some industries, notably the chemical and pharmaceutical industries, are being confronted with a considerable amount of

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societal controversies and hence concentrate excessively on improving their corporate image without actually contemplating strategizing these philanthropic activities (p.16). Moreover, companies in the chemical and pharmaceutical sector are believed to have lower propensity to philanthropy (Porter & Kramer, 2002; Reverte, 2012). Interestingly, philanthropy should have a greater effect on a firm’s reputation in industries that present considerable social externalities such as crime and health, whereas philanthropy should have a lower effect on reputation of firms in industries with higher environmental impact because it does not succeed in addressing primary concerns of stakeholders. The previous argumentation leads to the conclusion that corporate philanthropy would not possess the qualities to advantageously influence a company’s cost of equity capital and it is thus predicted that:

Hypothesis 1b: Corporate Philanthropy is positively related to cost of equity capital.

The Mediating Role of Cost of Equity Capital

It is believed that a considerably important driver of shareholder value creation is the minimization of the weighted average cost of capital (WACC), which consists of the proportions of costs of debt and equity capital (Modigliani & Miller, 1958). This variable helps answering the question: will the project, with this particular way of financing, raise the market value of the company's shares? This is no different when looking at investing in primary stakeholders or corporate philanthropy investments. The existing finance literature shows increasing evidence that a lower cost of equity capital leads to a positive growth effect on market value or shareholder wealth. The cost of equity capital is an important determinant of the previously mentioned rate and thus one of the primary constituents for investors to determine firm value. Indeed, it measures the rate of return required by investors to encourage them to preserve their equity in the

company. Moreover, it suggests the apparent volatility of the firm’s future cash flows (Reverte,

2012). Often accompanied with lower information asymmetries between investors and managers, a lower cost of equity capital makes it easier to produce more accurate valuation estimates, which in turn could lead to an increase in market value (El Ghoul et al., 2011).

In connecting the evidence for the negative relationship between cost of equity capital and shareholder value with our first predictions on the influence of CSR on cost of equity capital, a mediating effect of cost of equity capital in the CSP-CFP relationship may be expected. Thus, CSP scores would affect the value of cost of equity capital, which would then affect shareholder value represented by the MVA variable.

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However, as stated by our first hypotheses, a different mediational pathway might be expected with the two separate predictor variables, primary stakeholder management and corporate philanthropy. As stated by Godfrey (2005), the impact of CSR is different depending on the stakeholder in question. More precisely, positive moral capital coming from CSR initiatives has the potential to immediately influence the market value of a firm, by enhancing employee productivity and morale (Godfrey, 2005, p.777). It is possible to link this aspect of moral capital directly to the definition of the primary stakeholders studied in this paper. Moreover, incorporating successful stakeholder management into core business operations and strategy, through the creation of moral capital for example, has the potential to create competitive advantage. By integrating society and business, a company could establish “shared value” (Porter & Kramer, 2007). The latter means that investing in stakeholder management as previously described could not only create value for society, but also for the operations of the business. The reasoning presented in this section concerning the mediating effect of cost of equity capital on the primary stakeholder management and market value relationship leads to the following hypothesis:

Hypothesis 2a: Companies that enjoy higher scores for primary stakeholder management enjoy higher shareholder value, and a firm’s cost of equity capital at least partially mediates this relationship.

Concerning corporate philanthropy however, the literature would suggest another pathway. Corporate social responsibility is matched with the sacrifice of funds (Halme & Laurila, 2009). In the U.S. for this reason, philanthropy would be regarded as the sincerest form of CSR (Godfrey, 2005). Consequently, it could be qualified as the most simple and effective fashion of exercising CSR. Some studies show that creating public goodwill by investing in the well being of the community, leads to insurance-like protection and could lead to an increase in shareholder value (McGuire, Sundgren & Schneeweis, 1998). Nevertheless, philanthropy is not associated with primary stakeholder management and thus concerns secondary stakeholders. Investments such as charitable donations are transactional and can be reproduced by competition fairly easily, which is not in line with the VRIN resources described by Barney (1991). It seems that philanthropy is generally used to achieve greater goodwill in communities and distanced from business and strategy practices. In addition, Halme and Laurila (2009) criticize the philanthropy orientation arguing that the activities happen outside of the firm. Hence, there is no tie to core business and

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no direct business benefits, being “extra activities” (p.329). Also, they compare their philanthropy measure with social issue participation (SIP) in the Hillman and Keim (2001) article, explaining that it is negatively associated with shareholder value. Consequently, this leads to the final hypothesis of this study:

Hypothesis 2b: Companies that enjoy higher scores for corporate philanthropy experience lower shareholder value, and a firm’s cost of equity capital at least partially mediates this relationship.

DATA AND METHODS

Sample

The sample for this study was drawn from the 2011 MSCI ESG KLD STATS database, which will be further explained in the next section. Companies that made it into the sample of this research must contain data availability of at least one of the social scores, which are fundamental for the analysis of the hypotheses. Because the link to core strategy and business purposes is of considerable importance in this study, firms with fewer than 10 employees were excluded from the dataset. According to Covin, Green and Slevin (2006), firms with this amount of employees do not possess a clear and concise strategy. The initial sample contained 2848 individual U.S. based companies with data of at least one social score for the year 2011. However, previous studies have outlined the importance of the industry influence on outcomes between CSP and CFP (Inoue & Lee, 2001; Porter & Kramer, 2002; Halme & Laurila, 2009; Jo & Na, 2012). These authors mention that instead of controlling for industry ex-post of the analysis of the main effects, it would be rewarding for research to focus on specific industries of order to gain better insights of the characteristics of the relationship. Moreover, some specific industries remain fairly alienated as to investing this CSP-CFP connection. As advanced by Brammer and Millington (2005) and Porter and Kramer (2002) in the theoretical framework of this paper, the chemical and pharmaceutical sectors possess features that cause philanthropy and perhaps stakeholder activities in general to contain less potential for competitive advantage and value creation. However, following the literature outlining the increasing globalization of business activities and the importance of strategic philanthropy and stakeholder management in this process, this research investigates whether these propositions hold true. Subsequently, only companies in the chemicals industry were selected for the analysis of our research questions. In consequence, we identified 189 U.S. companies within our initial sample, which were active participants of the chemical

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industry in the year 2011 and complied to the earlier described criteria. Finally, within the latter group, information in other databases needed to determine either shareholder value or cost of equity capital was lacking for some of these companies. Consequently, our final sample consists of 177 businesses.

Data Sources

In this study, three databases are combined. Firstly, in order to measure corporate social performance, the previously mentioned MSCI ESG KLD STATS database is used. KLD Research and Analytics, Inc. construct this database by researching CSR activities of firms. Since it started its activities in 1991, the investment research firm has assembled a large collection of data on the CSR strengths and weaknesses of mostly U.S. based firms. Indeed, the database currently contains CSR data of several relevant indexes and has recently expanded its reach outside of the United States. The dataset contains the following universes: all firms from the S&P500 Index and the Domini 400 Social Index, the Russell 1000 and the Russell 2000 Index. Moreover, the research firm recently added the MSCI indexes of several countries outside of the United Stated to its database. Consequently, it is no revelation that the dataset is a common source of measuring corporate social performance. Indeed, a large number of studies have made use of KLD in order to quantify their CSR variables (Hillman & Keim, 2001; Nelling & Webb, 2009; Waddock & Graves, 1997; Inoue & Lee, 2011; Berman et al., 1999). In order to capture a sufficient amount of data for this research, the base year 2011 was chosen. However, in line with the reasoning of Nelling and Webb (2009), firms within the Domini 400 Social Index are excluded from our sample. The inclusion of these firms could lead to selection bias, as they are tracked on the basis of CSP and CFP already. Hence, companies in this index and those not included in the other described indexes are not identified in the final sample.

The database focuses on 13 main areas of CSR performance until the year 2013. Namely, the following categories: community, diversity, employment, environment, human rights, product, alcohol, gaming, firearms, military, nuclear, tobacco, and corporate governance. In the official methodology of KLD, it is stated that these areas are divided in four main categories of indicators: environmental, social, governance and controversial business involvement indicators. As governance evolves around the principal-agency problem, mostly the influence of shareholder on management, it is not included in our analysis (Hill & Jones, 1996). Furthermore, environmental and involvement with sin industries issues are mainly externalities and affect secondary stakeholders, hence it is also excluded (Hillman & Keim, 2001). The remaining

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category, which investigates social matters, contains the indicators of community, diversity, product and employee issues. These indicators seems to be aligned with the propositions made in the theoretical framework about primary stakeholder management and corporate philanthropy.

For each of the selected categories, there is data related to the strengths and concerns of the social indicators, which are scored by means of a simple binary scoring model. If a firm meets the assessment criteria, it is signified with a “1”. However, in case a company does not meet the established standards, it is scored with a “0”. For each indicator, the numbers of strengths and concerns are added up to arrive at a total score for each of the indicators. For example, in 2011, there are 7 feasible strengths and 5 possible concerns underlying the “diversity” social indicator. As these characteristics have changed on almost a yearly basis, this study focuses on the recent year 2011 in particular that offered enough assessment points to determine our variables. Several researchers simply subtracted the concerns from the strengths in order to arrive at a net score of the indicators or to compare social indicators (Orlitsky & Swanson, 2012; Barnett & Salomon, 2006; Bechetti & Ciciretti, 2009). Nevertheless, the fact that the number of each can vary across indicators prevents us from doing so. Instead, a scale from 0 to 1 is obtained for every category, by dividing the number of actual strengths or concerns by the maximum amount of strengths or concerns (Servaes & Tamayo, 2013). With these results, the scaled concerns are subtracted from the scaled strengths to obtain a valid net score ranging from [-1; +1] for every individual indicator. This process is central to assure reliability and construct validity of our constructs. Lastly, the categories used for our analysis are assumed to have equal importance in this research, since research has not identified an importance ranking of the indicators as to today (Hillman & Keim, 2001).

The second database consulted for this research is the merged COMPUSTAT and CRSP database (WRDS, 2016). The latter contains financial accounting and controlled market data for active and inactive companies worldwide. To fit this research, only market and capital related data from the U.S. was selected. These firms and their respective information were merged with the companies from the KLD database to obtain the initial sample. Only companies with fiscal year ending in December 2011 were merged in order to assure that CSP and CFP were measured synchronously and the potential causality is measured from CSP to CFP (Servaes & Tamayo, 2013). In order to filter the companies active in the chemicals industry, a screen was executed on the basis of Standard Industrial Classification (SIC) codes available in COMPUSTAT. In the

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official classification of the U.S. Securities and Exchange Commission (SEC)1, the chemicals industry falls under the two digit code “28”. Consequently, the databases were successfully merged and filtered to our final sample.

Measures

Shareholder Value (DV)

As explained in the theoretical framework, shareholder value is based on Hillman and Keim’s (2001) approach of determining MVA. Market values and capital measures of the companies in the final sample were extracted from COMPUSTAT. In the database, consolidated company-level market value is defined as the sum of all issue-company-level market values, including trading and non-trading issues. Whereas market value for single-issue companies equates common shares outstanding multiplied by the month-end price of every month. Total invested capital represents the sum of the following data: total long-term debt, the carrying value of preferred stock, minority interest on the balance sheet and total common equity. Both measures can be found on an annual base for the fiscal year 2011, which is employed in this research.

𝑀𝑉𝐴 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 − 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 (1)

This measure can be summarized as the stock market estimation of NPV and captures intangible relationships. Referring back to the discussion of the theory about value creation, this is precisely what our dependent variable should measure. However, there is a technicality that needs to be addressed as to calculating MVA. The measure is not used as means of cross-sectional analysis, but rather by analyzing the change in MVA between one year and the next (Hillman & Keim, p.129). In this fashion, the measure captures the changes in MVA due to events in the prior year. In our case, these events are defined by the independent variables “primary stakeholder management” and “corporate philanthropy”. A stand-alone measure of market value captures capitalizations across time. However, the analysis in this study isolates the market value that is added during our sample period and thus, can be effectively performed in our causality analyses.

Lastly, the dependent variable is constructed with a lagged effect. As KLD measures are spread out over the year, the reporting of them takes place in the subsequent year. With a lagged effect of one year, assuming that the observed social indicators of base year 2010 (reported on

1_{available at: https://www.sec.gov/info/edgar/siccodes.htm}

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KLD in 2011) take effect rather quickly (Hillman & Keim, 2001), our dependent variable reflects the change in MVA form 2011 to 2012.

Primary Stakeholder Management (IV)

Primary stakeholders are assumed to not only assure the survival of a firm, but are also potential sources of sustainable competitive advantage. Presuming the normative concept of the stakeholder theory, primary stakeholders have direct influences on the company’s business and are directly influenced by its activities. As a measure of CSP based on the KLD database, three social indicators are in line with that definition: diversity issues have influences on a corporation’s human capital, employee issues directly affect the supply chain amongst others, and product issues straightforwardly have an effect on a firm’s customers and financing. Since this independent variable encompasses three categories of the KLD database, it is represented by an index ranging from -3 to +3.

Corporate Philanthropy (IV)

Based on Godfrey’s (2005) study on the relationship between corporate philanthropy and shareholder wealth, this study characterizes philanthropy by charitable activities towards a firm’s communities. Consequently, the social indicator of “community” can be utilized as estimator of the second independent variable. The reason that this measure cannot be integrated in primary stakeholder management is the uncertainty if the activities are related to the strategy and core business of a company or merely an effort to create goodwill towards the public (Porter &

Kramer, 2002).

Furthermore, this uncertainty seems to be particularly present in the chemical and pharmaceutical industries. As explained formerly, chemical companies face considerable pressures from outside related to ethical behavior. Thus, the tendency is to respond with charitable donations in order to improve reputational aspects. As this variable contains one category of the KLD database (community), its index ranges from -1 to +1.

Cost of Equity Capital (M)

As explained previously, the cost of equity represents the expected return of a company’s shareholders. A widely used estimator of this variable is the Capital Asset Pricing Model

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(CAPM) (Sharpe, 1964). In this model, several components determine the expected return on equity as shown in the following formula.

𝑟_! = 𝑟_!+ 𝛽_!(𝑟_!− 𝑟_!) (2)

where

𝑟! = the risk-free rate;

𝑟_! = the return on the market portfolio;

𝛽_! = !"#(!!,!!)

!"#(!!) = systematic or market risk of a firm

Thus, the CAPM model assesses the return on equity as the risk-free interest rate plus firm beta times market risk premium (Sharfman & Fernando, 2008, p. 576). As a proxy for risk-free rate,

one-month Treasury bills of 2011 and 2012 were used2. In comparison to longer-term U.S.

Treasury bonds, these securities issued by the Federal Reserve are found to have lower market and inflation risk (Mukherji, 2011) and make it a more precise estimator. In order to compute firm beta, we used the covariance of the 2011 and 2012 daily common stock returns and market returns found in CRSP, divided by the variance of the daily market returns. Finally, market risk premium was determined by subtracting the returns of the risk-free rates of 2011 and 2012 from the daily market returns of the same years.

Control Variables

Three other variables are included in the regressions to ensure that the relationships found are a result of our dependent, independent and mediation variables and not of other confounding ones. First of all, size seems to be a factor that affects corporate financial performance and corporate social performance (Waddock and Graves, 1997). Net income of 2010 is included as control variable for firm size, which has been related to the salience of stakeholder relations and the risk of equity (Hillman & Keim, 2001; El Ghoul et al., 2011). Secondly, we control for R&D intensity. The latter variable controls for the effect of R&D expenditures on company performance and cost of equity because R&D facilitates innovation actions and investors’ perception and valuation of the firm (Luo & Bhattacharya, 2006). It is computed by the ratio of R&D expenditures to total assets of 2010. Finally, we control for return on assets (ROA) of the sample firms in 2010 because it is a considerably important item of financial information utilized

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by investors (Luo & Bhattacharya, 2006). All data necessary for the three control variables were derived from the merged CSRP/COMPUSTAT database. Table 1 presents all summary statistics analyzed in this research, in which shareholder value and net income are stated in millions of U.S. dollars.

ANALYSES AND RESULTS

Regressions and Coefficients

In order to test the hypotheses, several regressions are needed through SPSS. A simple mediation model serves as pathway to assess the thesis in this study. There are two consequent variables for which two linear models are required. As there are two models that need to be analyzed for both of the predictors, the OLS regressions analyses must be performed using the four main variables: shareholder value (sh), primary stakeholder management (pri), corporate philanthropy (ph) and cost of equity capital (ce). The first regression tests whether primary stakeholder management has a significant negative relationship with the mediator cost of equity capital, which will test hypothesis 1a. To do so, cost of equity capital and primary stakeholder management scores will be the dependent and the independent variables respectively. This regression is as follows:

𝐶𝐸 = 𝑖1 + 𝑎𝑃𝑅𝐼 + 𝜀_!" (1)

The second regression verifies hypothesis 2a by regressing shareholder value on both the investment in primary stakeholders and the cost of equity. This allows verifying for the mediational pathway between primary stakeholder management scores and shareholder value, through cost of equity capital.

𝑆𝐻 = 𝑖2 + 𝑐!_{𝑃𝑅𝐼 + 𝑏𝐶𝐸 + 𝜀}

!" (2)

Finally, similar regressions with a comparable mediational pathway must be executed for the second independent variable “corporate philanthropy” in order to assess hypotheses 1b and 2b. In this fashion, the effect of the two predictors can be compared to verify the four hypotheses and reach a conclusion for the thesis of this study.

𝐶𝐸 = 𝑖3 + 𝑎𝑃𝐻 + 𝜀_!" (3)

𝑆𝐻 = 𝑖4 + 𝑐!_{𝑃𝐻 + 𝑏𝐶𝐸 + 𝜀}

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In the above equations, 𝑖_! to 𝑖_! are the regression intercepts, 𝜀_!" and 𝜀_!" are the errors in the estimation of ce and sh, respectively, and a, b, and c’ are the regression coefficients given to the antecedent variables in the model in the estimation of the consequents. In equations 2 and 4, 𝑐′ estimates the direct effect of the predictor on shareholder value and b provides the same interpretation but with the mediation as antecedent. Moreover, a quantifies the effect of the predictor on cost of equity and the indirect effect can thus be found with the product of coefficients a and b. The latter direct and indirect effects partition how differences in the predictors map onto differences in shareholder value, which is then the total effect denoted as 𝑐. Assuming these relationships hold, the total effect is equal to the sum of direct and indirect effect. These pathways can be retrieved in the conceptual framework representations in Figures 1 and 2. Certainly, these effects describe the association between variables in the sample specific data available. However, the aim of this study is to generalize the results and hence, statistical inference for the effects is needed. In order to achieve the latter, the PROCESS add-in constructed by Hayes (2013) is used for the OLS regressions. With this macro, all three effects are computed. In addition, a bias-corrected bootstrapping confidence interval is produced for the indirect effect, which sampling distribution is non-normal, to test the significance of this effect. The mentioned statistical inference method treats the sample of this study as the population and simulates other samples from it. In this analysis, observations are re-sampled with replacement 5000 times to infer an empirically constructed sampling distribution of the indirect effect. Of this distribution, 95% will fall between two numbers. If the value of zero is not present in this bias-corrected bootstrapping interval, the effect is significant. The significance results are verified with the normal theory based Sobel test (Z-score).

The values of the coefficients in the above-mentioned formulas will show if the hypotheses are correct. On the one hand namely, for primary stakeholder management to have a negative significant effect on cost of equity capital, 𝑎 should be negative and significantly different from zero. On the other hand, for corporate philanthropy to have a positive significant relationship on the mediator, 𝑎 should be positive and significantly different from zero. This allows for hypothesis 2 and 4 to be written as follows:

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Hypotheses 2a and 2b will each be split up in two parts. Firstly, it must be shown that investment in stakeholders has a positive effect on shareholder value by decreasing the cost of equity. For this to be correct, 𝑏 must be significantly smaller than zero as a decrease in cost of equity increases shareholder value. Furthermore, the direct effect 𝑐′ must be smaller than the total effect 𝑐 to confirm that investment in primary stakeholders influences the shareholder value partly through the cost of equity. The same counts for coefficient b with corporate philanthropy as a predictor.

H2a: 𝑏 < 0 and 𝑐! _{< 𝑐}

H2b: 𝑏 < 0 and 𝑐! _{< 𝑐}

In order to analyze all the pathways and hypotheses, a summarizing regression table and conceptual framework is presented for each of the two predictors in the upcoming sections. First, the descriptive statistics and correlations are displayed for all the mentioned variables above in Table 1. Then, the results concerning the primary stakeholder management independent variable are presented in Table 2 and Figure 1. Finally, the findings related to the second independent variable corporate philanthropy are exhibited in Table 3 and Figure 2.

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Ta bl e 1 De sc ript ive st at isti cs and cor re la ti ons No te . N =1 77 . * p < .0 5. ** p < .01 V ar iab le s M SD 1 2 3 4 5 6 7 N 1 S har eh ol de r val ue 3966.345 13044.206 1.000 177 2 C os t of e qu ity 2.155% 0.731% -0.397 ** 1.000 3 P ri mar y Stak eh ol de r M an age me nt -0.180 0.392 0.629** -0.411 ** 1.000 177 4 C or por ate P hi lan th rop y 0.011 0.274 0.444** -0.378** 0.450** 1.000 177 5 N et I nc ome 421. 893 1677.909 0.912** -0.334** 0.582** 0.333** 1.000 177 6 R &D in te ns ity 18.592% 19.667% -0.168* 0.225** -0.237** 0.007 -0.181** 1.000 177 7 ROA -10.417% 34.791% 0.172* -0.215** 0.198** 0.051 0.179** -0.696** 1.000 177

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Results for Primary Stakeholder Management

First, it is relevant to analyze the correlations in Table 1 between the three variables in question here. I assumed there would be a negative correlation between Primary stakeholder management and cost of equity capital. The significant correlation, 𝑟 177 = −0.411 provides an indication that the first hypothesis might be true. The same would occur for the second prediction with this particular independent variable, with a significant correlation between cost of equity and MVA, 𝑟 177 = −0.397 and a significant positive correlation, 𝑟 177 = 0.629 between PSM and MVA. However, correlation does not mean causation and the mediation effect cannot be induced from this preliminary analysis.

In order to test the mediating role of cost of equity capital in the primary stakeholder and market value relationship, PROCESS was used to determine the coefficients of the direct, indirect and total effects of the models. This allows for a comprehensive test of the predictions related to mediation. The standardized results of this regression analysis are summarized in Table 2 and Figure 1. Hypothesis 1a predicted that primary stakeholder management scores would negatively affect cost of equity capital. When looking at the first model in Table 2 with cost of equity as the outcome, pathway a has a negative coefficient of −0.301 and a p-value below 0.001. It can be concluded that the social score of primary stakeholder management would negatively affect cost of equity capital and hence, hypothesis 1a is supported.

The second model of Table 2 depicts the direct effect c’ and the effect of cost of equity capital b with MVA as the outcome. As anticipated, there is a significant positive direct effect

from primary stakeholder management and shareholder value, 𝑐! _{= 0.129, 𝑝 < .001. The latter}

coefficient is the estimated difference in shareholder value between two companies experiencing the same level of cost of equity capital, but who differ in one unit of PSM. The coefficient is negative, which means that the company with a higher PSM score but with an equal cost of equity is estimated to have 0.129 standardized units higher in MVA.

The indirect effect is computed by multiplying pathways a and b, 𝑎𝑏 = −0.301 −0.077 = 0.023. This means two firms that differ by one standardized unit of PSM are estimated to vary by 0.023 standardized units in their shareholder value as a result of the lower cost of equity if PSM scores increase (a is negative), which in turn leads to greater

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Table 2 Model coefficients for the primary stakeholder predictor

Consequent

M (Cost of equity) Y (Shareholder value)

Antecedent Coeff. SE p Coeff. SE p

X (PS) a -0.301** 0.0680 < .001 c’ 0.129** 0.038 <. 001 M (CE) --- --- --- b -0.077* 0.033 0.021 CV (NI) -0.1306 0.084 0.122 0.815** 0.037 < .001 CV (R&D) 0.073 0.096 0.446 0.031 0.041 0.461 CV (ROA) -0.081 0.095 0.393 0.005 0.041 0.907 Constant i1 0.000 0.068 1.000 i2 0.000 0.0294 1.000 𝑅! _{= 0.201} _𝑅! _{= 0.851} 𝐹 4, 172 = 10.838, 𝑝 < .001 𝐹 5, 171 = 196.17, 𝑝 < .001 Note. N=177. * p<.05. ** p<.01 Cost of equity Shareholder value Primary stakeholder scores

Figure 1 Simple mediation model for primary stakeholder predictor (statistical diagram)

Note. Total indirect effect ab=0.023 and total effect c=0.152. Non-significant effect of

control variables ROA and R&D on MVA and cost of equity. Significant effect of Net Income control variable. See Table 2.

𝑎 =-0.301** 𝑏 =-0.077*

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shareholder value (because b is negative). The indirect effect is statistically different from zero as revealed by a 95% bias-corrected bootstrap confidence interval that is entirely above zero (0.0081 to 0.0499). However, the normal theory-based Sobel test in not completely in line with the previous significance test. Indeed, with a Z-score of 1.900 and p-value of 0.057, the results do not provide enough statistical inference power and cannot be defined as unquestionably significant. Nonetheless, I assume the results of the Sobel test to be marginally significant and conclude that the indirect effect holds statistically.

Finally, the total effect of PSM scores on shareholder value is calculated by summing the direct and indirect effects or just by regressing MVA on PSM scores. The coefficient c for the

total effect is equal to 0.152 (𝑐 = 𝑐!_{+ 𝑎𝑏 = 0.129 + 0.023). With a p-value below 0.001, this}

effect is statistically different from zero with 95% confidence. As the coefficient for b is negative and c’ is lower than c, hypothesis 2a is supported. Hence, a company with higher PSM scores enjoys more shareholder value, and cost of equity capital partially mediates this relationship. In both models of Table 2, control variables net income had a significant effect but R&D and ROA do not.

Results for Corporate Philanthropy

The correlations in Table 1 between the three variables corporate philanthropy, cost of equity capital and shareholder value are first considered. There was assumed there would be a positive correlation between corporate philanthropy and cost of equity capital. The significant correlation, 𝑟 177 = −0.378 provides an indication that the first hypothesis might be false. The same could be the case for hypothesis 2b, with a significant correlation between cost of equity and MVA, 𝑟 177 = −0.397 and a significant positive correlation, 𝑟 177 = 0.444 between corporate philanthropy and MVA. However, regression analysis is needed is order to determine the causal relationship to reach a conclusion about the results.

The standardized results of this regression analysis are summarized in Table 3 and Figure 2. Hypothesis 1b predicted that corporate philanthropy would positively affect cost of equity capital. Results shown in the first model in Table 3 with cost of equity as the outcome, pathway a has a negative coefficient of −0.312 and a p-value below 0.001. Interestingly, the CSP score of corporate philanthropy cannot be stated to positively affect cost of equity capital and hence, hypothesis 1b is not supported.

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Table 3 Model coefficients for the corporate philanthropy predictor

Consequent

M (Cost of equity) Y (Shareholder value)

Antecedent Coeff. SE p Coeff. SE p

X (Phil) a -0.312** 0.066 <.001 c’ 0.139** 0.032 <.001 M (CE) --- --- --- b -0.062 0.033 0.062 CV (NI) -0.192** 0.072 0.009 0.845** 0.032 <.001 CV (R&D) 0.149 0.094 0.112 -0.004 0.041 0.912 CV (ROA) -0.061 0.094 0.514 -0.003 0.041 0.943 Constant i1 0.000 0.066 1.000 i2 0.000 0.0298 1.000 𝑅! _{= 0.229} _𝑅! _{= 0.857} 𝐹 4, 172 = 12.753 𝐹 5, 171 = 204.614 Note. N=177. * p<.05. ** p<.01 Cost of equity Shareholder value Corporate philanthropy scores

Figure 2 Simple mediation model for primary stakeholder predictor (statistical diagram)

Note. Total indirect effect ab=0.019, n.s. and total effect c=0.158. Non-significant effect of

control variables ROA and R&D on MVA and cost of equity. Significant effect of Net Income control variable. See Table 2.

𝑎 =-0.312** 𝑏 =-0.062

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The other model of Table 2 displays the direct effect c’ and the effect of cost of equity capital b with MVA as the outcome. Contrary to my expectations, there is a significant positive direct

effect from corporate philanthropy and MVA, 𝑐! _{= 0.139, 𝑝 < .001. The latter coefficient is the}

estimated difference in shareholder value between two firms experiencing the same level of cost of equity capital, but who differ in one unit of corporate philanthropy CSP scores. The coefficient is negative, which means that the company with a higher philanthropy score but with an equal cost of equity is estimated to have 0.139 standardized units higher in market value.

The indirect effect is computed by the product of a and b, 𝑎𝑏 = −0.312 −0.062 = 0.019. Hence, two companies differing by one standardized unit of corporate philanthropy are estimated to vary by 0.019 standardized units in MVA as a result of the lower cost of equity if philanthropy scores increase (a is negative), which in turn leads to higher MVA (b is negative). The indirect effect is statistically different from zero as revealed by a 95% bias-corrected bootstrap confidence interval that is entirely above zero (0.0041 to 0.0397). However, the normal theory-based Sobel test does not verify the preceding significance test. Indeed, with a Z-score of 1.687 and p-value of 0.092, the results do not provide statistical inference and cannot be defined as significant. Consequently, the results of this regression are non-significant and the indirect effect does not hold statistically.

Lastly, the total effect of philanthropy scores on shareholder value is calculated by the sum of direct and indirect effects or just by regressing MVA on corporate philanthropy. Pathway

c for total effect is equal to 0.158 (𝑐 = 𝑐! _{+ 𝑎𝑏 = 0.139 + 0.019). With a p-value below 0.001,}

this effect is statistically different from zero with 95% confidence. The coefficient for b is negative and c’ is lower than c. Moreover, the indirect is not significant so the mediation effect does not hold statistically. Thus, hypothesis 2b is not supported.

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DISCUSSION AND CONCLUSION

Hypotheses Analysis

The aim of this study is to gain further understanding of the CSP-CFP relationship, by incorporating cost of equity capital as a mediator. Moreover, separating the corporate social performance scores in two clear variables responds to the call of needed contingency analysis in research of this academic field. This study does not predict a modest, unconditional link between CSR and financial performance. Rather, I present two considerably critical but distinctive indicators of the stakeholder issues management (Clarkson, 1995) in a specific contextual setting, and their comparative effects on corporate financial health through a mediation effect. Based on a comprehensive secondary dataset, the results of this “business-case” (Barnett & Salomon, 2006) study offer several theoretical and practical implications within the U.S. chemical and pharmaceutical industries.

First, primary stakeholder management seems to negatively influence cost of equity capital. Consisting of diversity, employee and product issue related stakeholder management, a higher score of this CSP variable may lead to lower cost of equity capital. The latter relationship is in line with results in previous research on the effect of CSR in general. This is not surprising, as primary stakeholders are often directly linked to a firm’s core strategy and favorable management of these parties could lead to sustainable competitive advantage (Porter & Kramer, 2002). For example, the diversity issue management constituent could lead to moral capital (Godfrey, 2005). Not only could a positive high score mean that minorities and women are well represented in a company, but it could also mean that work-life balance is promoted and different cultures and religions are taken into consideration. Positive employee and product related issues could lead to both easier access to finance and insurance against future risks (Cheng, Ioannou & Serafeim, 2014; McGuire, Sundgren & Schneeweis, 1998). On the one hand, encouraging relations with employee unions, improving employee health and insurance, good supply chain labor standards and CSR features in products could lead to both avoiding detrimental governmental regulations and compliance costs (Dhaliwal et al., 2011; Jo & Na, 2012). On the other hand, a better quality product and decent human capital management could lead lower agency costs, lower information asymmetries and thus improved mutual trust, finally facilitating access to financing for a firm (Dhaliwal et al., 2011; Jo & Na, 2012; Cheng, Ioannou & Serafeim, 2014). Consequently, it seems clear that improved primary stakeholder management can lower cost of equity capital.

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More importantly however, does the previously described relationship in its turn provide the opportunity to advantageously influence shareholder value? The results support the partial mediation effect of cost of equity capital in the PSM-CFP affiliation. Thus, higher scores of primary stakeholder management leads to an increase in shareholder value as a result of lower cost of equity capital, which in turn leads to higher market value. The literature shows that a lower cost of equity is an indication for investors that future cash flows are possibly less volatile (Reverte, 2012). In addition, information asymmetries between managers and investors are believed to decrease when cost of equity capital is lower (El Ghoul et al., 2011). The previous reasons can be motives for investors to sustain their equity in a firm and can potentially attract other investors. Naturally, the effect of this study is qualified as partially mediated by the expected return on equity required by investors. The net income control variable influences the model significantly, which means that size could be a confounding variable in this model.

Second and intriguingly, the corporate philanthropy social score also seems to negatively influence cost of equity capital. Thus, not only is the hypothesis predicting this link not supported, the exact opposite significant effect results from the analysis of this study. In the expectations of this specific social indicator, it was indicated that because of the desire to create public goodwill facing large ethical pressures, companies in the chemical industry would engage in philanthropic activities without direct link to business strategy (Godfrey, 2005; Porter & Kramer, 2002). Moreover, charitable deeds are often seen as transactional activities that happen outside of the firm and seem to be effortlessly imitable (McGuire, Sundgren & Schneeweis, 1998; Barney, 1991). Contrary to the first CSP variable, corporate philanthropy is not necessarily associated with primary stakeholders and could thus be related to secondary stakeholders. As shown in Hillman and Keim (2001) and other studies, secondary stakeholders are not predicted to lead to sustainable competitive advantage and could have a negative influence on shareholder value. However, the results of this study do not provide evidence to support the mediation effect in the hypothesized negative relationship between corporate philanthropy and financial performance. Indeed, the results indicate that a higher corporate philanthropy score could negatively influence cost of equity capital and the direct effect was found to be significantly positive between the predictor and outcome variable. However, the positive mediation effect was found to be non-significant by the Sobel test.

An alternative explanation might provide support for the findings in this paper. In his

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philanthropy can lead to shareholder wealth creation. The author explains that “adherence to known and explicit requirements (economic and legal) and obligations (ethical) may generate satisfaction and imputations of responsibility among a firm's stakeholders; however, the voluntary and discretionary nature of philanthropic activity (doing good above and beyond what is expected) may lead to imputations of exemplary, as opposed to merely good, behavior” (p. 778). Thus, by displaying intentions of philanthropy, a company could create moral capital among communities and other stakeholders, including primary stakeholders. It is stated that stakeholders consider the exchanges between the company and stakeholders in the firm specific context. The assessment of the latter by stakeholders is what creates philanthropic moral capital, which seems to be effective, since philanthropic activities are beyond what stakeholder expect a firm to do (Halme and Laurila, 2009). When moral capital can be defined as positive, it can serve as insurance when bad events occur. The author (Gofdrey, 2005) relates moral capital to be the coverage of wealth created by relations of the firm, assuming the resource-based view of the firm by Barney (1991). Consequently, through this pathway of risk management insurance, there lies a potential source of value creation for shareholders and decrease in the cost of equity capital. Moreover, if a company presents positive corporate philanthropy scores, it could be that the social identity theory holds true by attracting socially responsible stakeholders and pursuing the expected CSR activities that come along with such an identity (Ashforth & Mael, 1989). In the chemical industry that faces substantial ethical pressures, the previous argumentation could be the reason for our results. Indeed, when companies within this sector realize that corporate philanthropy could potentially be beneficial in the cost of equity and shareholder value relationship, perhaps charitable activities are not only meant as an attempt to improve public goodwill, but also strategized in line with a company’s core business.

Managerial Implications

Findings of this study can contribute to management practice in at least two manners. Firstly, there is substantial competition in the world market for investment capital (Sharfman & Fernando, 2008). Investors select their investments precariously, which increases competition between firms to attract equity. The latter could incite companies to create organizational and strategic advantage in comparison to competitors, and thereby offer the threshold for potential shareholders to invest. The previously mentioned competitive edge might be reached by investing in corporate social performance, as outlined in this paper. In particular, favorable primary stakeholder management seems to be considerably advantageous for the financial health of a

Do shareholders value corporate social performance? : an emperical test of the cost of equity capital hypothesis