Corporate Social Responsibility and Financial Value Drivers
The moderating effect of industry sector.
Name: Bart Sandbergen 10112685 Version: final Date: July 1st, 2016University of Amsterdam Faculty of Economics and Business MSc in Business Administration Strategy track Thesis supervisor: Ms Dr Vishwanathan Lecturer: Dr Niccolò Pisani
Statement of originality
This document is written by Student Bart Sandbergen 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
Table of contents
1. Abstract 3 2. Introduction 4 3. Literature review 5 a. Origin of Corporate Social Responsibility 5 b. Relationship between CSR and CFP 6 c. Underlying drivers of CFP 7 d. CSR in controversial industries 11 4. Data and methods 14 a. Data sample 14 b. Methodology 17 5. Results 19 a. Descriptive statistics 19 b. General results 20 c. Controversial industry results 21 6. Discussion 23 a. Implications for management 24 b. Implications for future research 25 7. Conclusion 26 8. Appendix 29 9. List of references 30Abstract
Purpose – This thesis investigates the relationship between CSR rating and the five drivers of financial value. In the past, research has mostly used return on assets (ROA) and return on equity (ROA) as measures for CFP. By investigating the effect of CSR on the five underlying drivers of financial value, it can be determined where exactly financial value may be created by engaging in CSR activities.
Design/methodology/approach The sample consists of 506 firms from the S&P 500 index over the years 2009 to 2015. I examine crosssectional data through ordinary least squares (OLS) regression models. These models are used to test for a significant effect of CSR activities on the five financial value drivers. The data includes information from the Thomson Reuters Asset4, Datastream and Worldscope databases. I also control for industry, firm size, firm risk and lagged financial value driver effects.
Findings – I find significant negative relationships between CSR score and the financial value drivers sales growth and operating profit margin. For the financial value drivers cost of capital and capital expenditures, I do not find significant effects. Furthermore, I find a significant positive effect of CSR score on operating profit margin for firms active in controversial industries.
Originality/value – This thesis contributes to the existing CSRCFP literature by examining where exactly financial value is created, as most research is focused on examining which CSR activities are needed to improve CFP. Furthermore, this thesis investigates a moderating industry effect on this relationship.
Introduction
Since the turn of the millennium, interest in corporate social responsibility (CSR) in Western countries has significantly increased (Jamali et al., 2015). Although there is some indication that there is a positive relation between CSR and CFP, results are still inconclusive after hundreds of studies (Margolis & Walsh, 2003). Therefore it is still a question whether or not firms that engage in CSR activities outperform other firms that do not do this (Margolis & Walsh, 2003). Differences in research outcomes have been tried to resolve through multiple metaanalyses (Margolis & Walsh, 2003; Godfried & Hatch, 2007).
There is an extensive number of articles on the relation between CSR and CFP. Many studies on CSR are about how different types of CSR influence CFP. However, there is not much empirical CSR research done on how CSR activities influence the underlying drivers of financial performance. Rappaport (1987) identified five drivers of financial value: operating profit margin, sales growth, working capital investment, fixed capital investment (e.g. capital expenditures) and cost of capital. CSR is expected to be influencing the five financial value drivers in different manners.
In recent years, CSR initiatives of firms in controversial industries is receiving increased
attention (Cai et al., 2012). According to Wilson & West (1981), these industries include firms that produce products or provide services that lead to environmental, social or ethical issues. It is questionable whether firms active in the industries of alcohol, tobacco, weapon and oil can be corporate socially responsible (Hong & Kacperczyk, 2009). However, in a recent analysis amongst firms in controversial industries in the United States, Cai et al. (2012) found that CSR initiatives are positively affecting firm value.
This thesis contributes to the existing CSR literature in multiple ways. It investigates the effect of CSR activities on the underlying financial value drivers. Furthermore, this study will research a moderating effect of CSR on the different value drivers in controversial industries versus noncontroversial industries. Therefore, the research question of this thesis will be:
“To what extent is Corporate Social Responsibility affecting the underlying drivers of Corporate Financial Performance and how is this relationship moderated by industry sector?”
Theories and hypotheses
The origin of Corporate Social Responsibility
Over the last several decades CSR has become an increasingly important topic in corporate decision making and many firms including CSR activities into their business strategies. According to Luo and Bhattacharya (2006), already more than ninety percent of the Fortune 500 companies have explicitly started to engage in CSR activities. One of the first publications on the topic was by Bowen (1953). In his book Social Responsibilities of the Businessmen he states that businessmen are obliged to act in a way that is in line with the values and objectives of society. Hereafter, the concept of businessmen having ethical obligations began to spread further and Bowen (1953) his definition of CSR became broader.
Two main perspectives on CSR are found in the existing literature. These are the stakeholder view and the shareholder view. In the shareholder view, Friedman (1970) argues that firms only have one responsibility, which is making profit. They should solely aim to generate most profits for shareholders, In order to do this, they might even be acting socially irresponsible. Later, in the stakeholder view, Freeman (1984) extends the shareholder view by
stating that firms ought to create value for all stakeholders. Corporate social responsibility activities serves other goals next to maximizing profit, such as acting sustainable and preserving the environment.
A little more than a decade later, Caroll (1999) started to redefine CSR by questioning what it means for society. He included business ethics and stakeholder theory, where he argues that firms should pursue corporate citizenship norms and values. This was in line with the stakeholder view of Freeman (1984). Caroll (1999) defined CSR as a concept with four layers, which are presented as a pyramid. The four layers stand for the different types of responsibilities firms have when conducting CSR activities, which are a firm its philanthropic responsibilities, ethical responsibilities, legal responsibilities and economic responsibilities. Firms can perform well on CSR if they fulfill these four responsibilities simultaneously (Caroll, 1999).
The relationship between CSR and CFP
Many different papers have been written on the effect of corporate social responsibility on financial performance, which have resulted in many different outcomes. I will use both metaanalyses and more specific papers to provide a broad overview. Existing research on the effect of CSR on CFP can be categorized into three groups, those with a positive, negative or neutral relation.
A number of researchers have found a positive correlation between CSR and CFP (Orlitzky et al., 2003; Lo & Sheu, 2007; Kitzmueller & Shimshak, 2012; Margolis & Walsh, 2003). In a 52 studies metaanalysis, Orlitzky et al. (2003) they found that CSR is positively affecting CFP. They claim that the studies that expect a negative effect are mostly based on old
data or based on surveys. Furthermore, Kitzmueller & Shimshak (2012) state that CSR drives CFP during economically favorable times.
There are also theories that find a negative relation (Davidson et al, 1987; Lopez et al., 2007; Friedman, 1970). Friedman (1970) argued that engaging in CSR activities adds operational costs and therefore has a negative effect on profit.
Lastly, Margolis et al. (2007) did a metaanalysis where they combined the findings of 251 studies. They discovered that the majority of 59 percent of the studies did not find a significant relationship. 28 percent of the studies found a positive correlation and only 2 percent found a negative correlation of CSR on CFP. Margolis et al. (2007) conclude that, based on their findings, there is some evidence for a positive relation but no consensus yet in the existing literature.
Underlying drivers of Corporate Financial Performance
One of the possible reasons why the existing literature can not reach consensus on the relation between CSR and CFP might be a lack of a specific way to define these concepts (Brammer & Millington, 2008). For this thesis I choose to define Corporate Financial Performance by using Rappaport (1987) his value drivers. He linked his value drivers to Porter (1998) his framework for competitiveanalysis. Porter (1998) associated CSR performance with competitive advantage in previous research. The value drivers that Rappaport (1987) describes are: operating profit margin, sales growth rate, working capital investment, fixed capital investment and cost of capital. Prior research has mostly used return on assets (ROA) and return on equity (ROA) as
measures for CFP. However, by using the value drivers of Rappaport (1987) it is possible to identify where exactly financial performance is improved.
The first value driver, operating profit margin, is a commonly used accounting variable to test the relationship between CSR and CFP (Waddock & Graves, 1997). It calculates the share of operating income of total revenue, meaning that the operating margin increases if revenues increases or costs diminish. A commonly used proxy for operating profit margin is earnings before interest, taxes, depreciation and amortization (EBITDA). According to Waddock & Graves (1997), firms that are active in CSR activities are likely to have an increased financial performance as a result of decreasing costs or increasing sales. Waddock & Graves (1997) mention the existence of a tension between the explicit (e.g. payments to bondholders) and the implicit costs of a firm (e.g. payments to bondholders). Firms might have a competitive disadvantage if they try to reduce implicit costs by engaging in socially irresponsible activities (Waddock & Graves, 1997). This irresponsible behavior is expected to result in increased explicit costs. Therefore, Waddock & Graves (1997) argue that the true benefits of CSR activities transcend the actual costs of CSR activities. For example, a firm can set very generous employee perks at a relatively low costs, but this can result in great benefits for the firm. Attracting talented new recruits will become easier if a company is labeled as one that is great to work for. Possibly, these new talents will bring productivity at a relatively low cost (Waddock & Graves, 1997). Furthermore, Berman et al. (1999) argue that if firms proactively engage in environmental CSR activities, this could result in lower costs of adhering to environmental laws, leading to an increase in efficiency. Opposed to this, CSR activities can also lead to an increase in costs, according to Aupperle et al. (1985). This will result in a lower EBITDA. Costs can arise
when a firm that acts responsively by engaging in CSR activities. These costs may otherwise be avoided or could be borne by other parties, such as the government (Aupperle et al., 1985). An example of a CSR activity is the purchase of pollution control equipment while other parties do not invest in this. This may lead to a competitive disadvantage. This is in line with Friedman (1970) his line of thinking. He states that the costs of socially responsible behavior exceed the benefits of this type of behaviour and are thus reducing shareholder value. There are also theories on a neutral effect of CSR on a firm its profit margin. Ullman (1985) states that it is impossible to measure the relationship between CSR and CFP, as there are many variables that interfere. Therefore, he argues that there are no reasons to expect a true correlation. Furthermore, he argues that the issues of measuring CSR performance will even make it more difficult to find a relation (Ullman, 1985). Based on these views, I expect the following:
Hypothesis 1: The relationship between CSR and operating profit margin is positive.
Second, CSR initiatives are assumed to be affecting the second value driver, sales growth rate. Lev et al. (2010) find consumers are increasingly demanding sustainable products. Furthermore, they state that firms that engage in CSR activities have more loyal and satisfied customers. Potentially this could have a positive effect on sales of firms producing sustainable products. Also, Brammer & Millington (2008) state that charitable donations are positively affecting sales. After donating significant amounts, stakeholders view generous firms differently than other firms. As a result, sales improve through increased employee motivation and increased loyalty from investors and customers. However, CSR actions can also negatively impact sales (Lo & Sheu, 2007). Investors can believe that CSR activities increase operational
and production costs and hereby decrease sales. This may result in investors becoming averse towards a firm its CSR activities. Concluding, I expect the following:
Hypothesis 2: The relationship between CSR and sales growth is positive.
Third, working capital investment is measured as the difference between current assets and current liabilities. There are no theories yet on the effect of CSR practices on the working capital investment level.
Fourth, fixed capital investment is stated to have a relationship with CSR activities. Fixed capital is considered fixed in the way that it is not used in the actual production of goods and services, but it has reusable value. According to Cochran & Wood (1984), CSR initiatives are expected to have a negative relationship with the average fixed assets age. Firms with high asset age have lower CSR scores. This may be because firms with older assets built plants in a time when there were less regulatory constraints. Managers of these kind of firms may be willing to respond to the social requests by society for a better environment and may be willing to spend more on upgrading its facilities opposed to firms that have built their facilities more recently. These results are also found by Gao & Bansal (2006). Therefore, I expect the following:
Hypothesis 3: The relationship between CSR and fixed capital investments is negative.
Finally, the cost of capital is expected to be negatively correlated with CSR practices. This can be done via two ways. For instance, firms active in CSR lower their nondiversifiable risk and hereby have lower risk of future environmental claims, which also decreases the cost of capital (Cai et al., 2015). Another often named reason is that firms involved in many CSR
projects have easier access to financing (Cheng et al., 2014). By engaging in CSR activities such as improving environmental policies, product strategies and better employee relations firms can reduce their cost of equity (El Ghoul et al., 2010). In summary, I expect the following:
Hypothesis 4: The relationship between CSR and cost of capital is negative.
CSR in controversial industries
Since firms are increasingly interested to engage in CSR activities, it is becoming important for firms to state their role in society (Lindgreen et al., 2009). According to the research of Lindgreen et al. (2009), firm must apply CSR standards to their business to indicate how they are approaching ethical, social, environmental and governance challenges. Especially firms that are active in industries with a bad image (e.g. firms in casino, tobacco, oil and gas industries) seem to be willing to start CSR activities in order to get a more positive image (Yoon et al., 2006). However, many firms believe in the naïve business theory that assumes that consumers will take the CSR activities at face value and will be likely to attribute favorable characteristics to the firm, resulting in a more positive reputation (Yoon et al., 2006).
There are diverse opinions about CSR activities of firms that are active in controversial industries. For instance, stakeholders of oil firms are demanding reporting on their developments regarding CSR challenges, according to the Oil & Gas monitor (2011). Firms that meet CSR expectations are more likely to be supported by their stakeholders (Du & Vieira, 2011).
Advocates of CSR activities in controversial industries argue that corporate social responsibility is necessary for these type of firms to improve their corporate image (Cai et al., 2012). In addition, Barnea & Rubin (2010) state that managers of firms in controversial
industries are immoral and therefore the CSR activities they are involved in are solely used to increase their personal reputation. Another view on CSR in controversial industries is the valueenhancement hypothesis by Porter & Kramer (2006). They state that CSR initiatives are useful for firms to meet with society. Firms that are active in controversial industries have more touch points with society then firms in noncontroversial industries. In these touchpoints, firms are able to target their clients by engaging in CSR related activities (Cai et al., 2012). This may lead to an increase in financial value.
I will assess the effect of CSR on the five financial value drivers as defined by Rappaport (1987). First, operating profit margin can increase by improving revenue or decreasing costs. According to El Ghoul et al. (2010), social responsible firms have cheaper access to financing. Furthermore, firms in controversial industries could have more benefits from positive CSR behavior, as it can make up for their “bad” products (e.g. tobacco). This will decrease firm risk and the costs of financing their activities. These beneficial effects are also found in the oil, gas and automotive industries (Cai et al., 2015). However, firms in controversial industries may be more willing to engage in CSR activities to improve their image (Goss & Roberts, 2011). Goss & Roberts (2011) argue that engaging in such activities is costly and therefore bear higher costs, which will lower the firm its profits. Furthermore, Ittner and Larcker (1998) state that firms in controversial industries could have the plan to increase sales by improving their CSR practices. However, this might result in the opposite. They find that consumers may not be convinced by the firm its motives and believe the firm is starting CSR activities for selfinterested purposes. In summary, I expect the following:
Hypothesis 5: The relationship between CSR and operating profit margin is moderated by industry, such that the relationship is negative for firms in controversial industries.
Second, sales growth is not expected to be influenced by CSR initiatives if the firm is active in a controversial industry (Palazzo & Richter, 2005). This was the reaction of financial analyst to a adoption of an international voluntary code of marketing by tobacco firms BAT, Philip Morris and Japan Tobacco. They stated it was simple an attempt to improve the image of the industry. Ittner and Larcker (1998) argue that even though firms may have a motive to increase sales growth by engaging in CSR activities, this might result in the opposite. They find that consumers may be disillusioned with a firm its motives if they believe the firm is engaging in CSR activities for selfinterested purposes. Customers had a lot criticism on the tobacco firm Philip Morris when it spent 100 million U.S. dollars to advertise 75 million U.S. dollars of charitable donations. This raises questions whether these donations are actually associated with sales growth (Ittner and Larcker, 1998). Concluding, I expect sales growth to be negatively correlated to CSR rating in controversial industries opposed to noncontroversial industries:
Hypothesis 6: The relationship between CSR and sales growth is moderated by industry, such that the relationship is negative for firms in controversial industries.
Third, there are no theories found on the moderating effect of industry of the relationship between CSR and fixed capital investments.
Fourth, El Ghoul et al. (2010) states that social responsible firms have cheaper access to financing and hereby lower their cost of capital . However, they also found that cost of capital
increases if firms are active in two controversial industries: tobacco and nuclear power. Cai et al. (2015) have also researched the relation between firm risk and environmental initiatives. Next to their finding of a negative correlation between environmental activities and firm risk, they state that firms that are environmental friendly have lower risk. However, they note that these environmental initiatives do not have a same effect in every industry. Firms in controversial industries could have more benefits from positive CSR behavior, as it can make up for their “bad” products (e.g. cigarettes) and hereby decrease firm risk and the cost of equity capital. These beneficial effects are also found in the oil, gas and automotive industries (Cai et al., 2015). For this reason, we expect cost of capital to be more negatively correlated to CSR rating in controversial industries opposed to noncontroversial industries. However, this may eventually backfire if investors find out that firms in controversial industries engage in CSR activities solely because of attempting to counter their sinful activities. In that case, investors will penalize the firms for their environmental activities and hereby increasing firm risk (Cai et al., 2015). Hypothesis 7: The relationship between CSR and cost of capital is moderated by industry, such that the relationship is more negative for firms in controversial industries.
Data & Methods
Data sampleTo collect data of the independent variables, I will use a panel dataset by Thomson Reuters Asset4. The time frame will be five years, from 2009 to 2015, to ensure that the sample covers enough observations to be representative. Thomson Reuters Asset4 has rated the CSR performance of the firms on three dimensions: social (S), environmental (E) and corporate
governance (G). I use the E, S and G scores to construct the annual CSR index for each firm. It can be assumed that the Thomson Reuters ASSET4 database is a reliable and valid source, as it has been been used extensively by financial professionals and is checked comprehensively through a multistep verification process (Ioannou & Serafeim, 2012). As I have not found research that provides theory on the weight specification of the separate dimensions, I assign them equal weights as described by Waddock & Graves (1997).
The dependent variables of our model will be the aforementioned value drivers of Rappaport (1987), namely the operating profit margin, sales growth rate, working capital investment, fixed capital investment and cost of capital. The data regarding these variables will be retrieved from Thomson Reuters Datastream. First, to find operating profit, I divide earnings before interest, taxes, depreciation and amortization (EBITDA) by total revenue. EBITDA profit margin is a better measure of profitability than net profit margin as it is not affected by nonoperating items, such as amortization and depreciation (Purnanandam & Swaminathan, 2004). Second, sales growth is determined by the year on year percentage sales growth. Third, I depict working capital investment as net working capital divided by sales. Fourth, I use annual capital expenditure divided by annual sales. Fifth, cost of capital is calculated as the cost of equity in the capital asset pricing model (CAPM) of Fama and French (1997), which uses the riskfree rate, the beta of the firm with the market and the S&P market return. As the firm beta, I used the one year beta correlated with the S&P 500 index.
Furthermore, I will use a dummy variable to indicate whether a firm is active in a controversial or a noncontroversial industry. I follow Cai et al. (2012) in their manner of labelling label industries as controversial. Our sample firms include firms in controversial
industries (e.g. alcohol, weapons, tobacco, gambling, nuclear, oil, biotech and cement). To label industries as controversial and noncontroversial, I used the 48 industry classifications by Fama and French (1997). Firms in the following FamaFrench industry groups are labeled as controversial: alcohol (SIC codes 21002199), tobacco (SIC codes 20802085), weapons (SIC codes 37603769, 3795, 34803489), oil (SIC codes 1300, 13101339, 13701382, 1389, 29002912, 29902999), biotech (SIC codes 28332836) and cement (SIC codes 32403241). In total I have 58 controversial firms in the sample, which is 14 percent of the total number of firms.
Finally, I use the the control variables firm size , firm risk, lagged corporate financial performance and industry. Firm size is needed to control for the possibility that large firms are more likely to be pressured by activist groups and need to respond faster to stakeholders (Waddock & Graves, 1997). Also, it may be possible that large firms have economies of scale in CSR (Johnson & Greening, 1999; McWilliams & Siegel, 2000). As proxies for firm size, I use two measures: number of employees and total sales (Waddock & Graves, 1997). I also control for firm risk (Ullman, 1985; Margolis et al., 2007). As a proxy for firm risk I divide total debt divided by total assets. Also, it is needed to control for previous corporate financial performance (Johnson & Greening, 1999). Waddock & Graves (1997) their research has shown that last years profit affects a firm its subsequent CSR performance. Therefore, I use the 1 year lagged values of every financial driver. Lasty, I control for industry sector based on the 4 digit industry SIC codes. Hereby, I follow Fu & Jia (2012) their recommendation to include industry as one of the most important variables in the CSR relationship with CFP. All the control variable data will be collected using Thomson Reuters Datastream.
Methodology
The data for this research is retrieved from the Thomson Reuters Asset4, Worldscope and Datastream databases. Appendix 1 describes the variables that are used in this research and how the variables are measured and collected. As the effect of CSR on CFP differs per geographic region and many scholars found a positive relation between CSR and CFP for companies listed in North America, I followed this by only using firms that are listed on the S&P 500. In total the dataset contains 504 firms over a period of six years. As the Asset4 database currently only contains CSR scores until 2014, the time frame of the sample is reduced from the original years 2009 until 2015 to the years 2009 until 2014. This, combined missing several CFP values and removing outliers led to a decrease of 9.542 observations. The firms are active in 36 different industries, which are divided into controversial and noncontroversial, based on their industry SIC code. The data from these three databases is linked in MS Excel by using the unique ISIN codes and the time period (years). Hereafter, the data is imported to SPSS. In SPSS, the missing values will be indicated and outliers will be removed to clean the CFP and CSR data before starting with statistical analysis. A total of 23.813 observations remained in the sample after firms that are missing CSR or CFP were removed.
In order to test the overall effect of CSR on CFP I will use the following model:
F P SR F P Control var)
C fxt= C sxt−1 + C fxt−1+ ( cxt+ ε
The variables in this model:
(1) F P C fxt= the indicators for corporate financial performance; namely operating profit margin, sales growth rate, fixed capital investment and cost of capital. These indicators are reflected by f. The x reflects company x, and t depicts time in year.
(2) SR C sxt= the indicators for the corporate social responsibility performance, namely the average of four indicators E, S, G and their overall scoring ESG. These are indicated by s. The x reflects company x, and t depicts time in year.
(3) CF P fxt−1= the indicators for the lagged corporate financial performance variable (4) Control var) ( cxt= the control variables, namely firm leverage, number of employees, industry and total assets. These are depicted by c. The x reflects company x, and t depicts time in year.
In order to test the moderating controversial industry effect in the relationship between CSR and CFP I will use the following model:
F P SR F P Control var) SR_Controversial
C fxt= C sxt−1 + C fxt−1+ ( cxt+ C sxt−1+ ε
The variables in this model:
(1) F P C fxt= the indicators for corporate financial performance; namely operating profit margin, sales growth rate, fixed capital investment and cost of capital. These indicators are reflected by f. The x reflects company x, and t depicts time in year.
(2) SR C sxt−1= the indicators for the corporate social responsibility performance, namely the average of four indicators E, S, G and their overall scoring ESG. These are indicated by s. The x reflects company x, and t depicts time in year.
(3) F P C fxt−1= the indicators for the lagged corporate financial performance variable to control for a lagged effect
(4) SR_ControversialC sxt−1= interaction variable to indicate the additional CSR effect for a firm active in a controversial industry. The x reflects company x, and t depicts time in year.
(5) Control var) ( cxt= the other control variables, namely firm leverage, number of employees, total sales and industry. These are depicted by c. The x reflects company x, and t depicts time in year.
Results
Descriptive statistics
In this model, the corporate social responsibility data and the financial value driver data are retrieved from the Thomson Reuters databases, namely Asset4 and Datastream. Table 1 presents the descriptive statistics for all the variables that are used in this research. This table shows the mean value, minimum and maximum values, standard deviation and the number of observations. Table 2 shows the correlations between the used variables. However, only the ESG, E, S and G variables show high correlation (e.g. higher than 0.5). Also capital expenditure and operating profit are relatively high correlated with a correlation coefficient of 0.466.
Table 1: Descriptive statistics
Variable Mean Minimum Maximum Std. Deviation Observations
CSR ESG 66.2 3 97.1 26.8 2881 E 57.2 8.3 95.1 31.6 2881 G 76.7 1.4 97 15.2 2881 S 57.8 3.6 97.3 27.4 2881 CFP Operating profit margin 24.50% 90.90% 96.40% 17.60% 2939 Capital expenditure 8.50% 0.00% 82.70% 13.00% 2922 Cost of capital 16.90% 11.80% 60.50% 12.60% 2994 Sales growth 7.40% 54.80% 132.50% 17.30% 2895 Net working capital 17.50% 106.10% 138.10% 26.30% 2855
Leverage 22.90% 0.00% 9414.20% 262.90% 2738
Employees 14,197 61 44,861 11334.891 2109
Sales 16,584,883 101,889 139,367,000 23,953,014 2948
Table 2: Correlation matrix of CSR and CFP variables
ESGxControv ESG E S G Net working capital Operating profit margin Capital expenditure Cost of capital Sales growth
ESGxControv 1.00 ESG .066** 1.00 E 0.04 .899** 1.00 S .074** .904** .799** 1.00 G .060** .715** .585** .590** 1.00 Net working capital 0.00 .054** 0.01 0.03 .068** 1.00 Operating profit margin .162** .191** .192** .223** .118** 0.01 1.00 Capital expenditure .255** .096** .070** .118** 0.01 .194** .466** 1.00 Cost of Capital .048** 0.00 0.02 0.00 0.01 .112** .130** .093** 1.00 Sales growth .038* .147** .134** .154** .147** .078** .185** .038* .200** 1.00 ** Correlation is significant at the 0.01 level (2tailed). * Correlation is significant at the 0.05 level (2tailed). General results
Table 3 shows the summary of the results of the regression analysis for the effect of CSR ratings on the CFP of firms. Overall, sales growth is significantly (1%) negatively affected by CSR rating. Every 1 point increase in CSR will decrease sales growth by 0.11% in the next year.
Operating profit margin is significantly (1%) negatively affected by CSR rating. Every 1 point increase in CSR will decrease the operating profit margin with 0.10% in the next year. In the overall results there were no significant relationships found between CSR score and capital expenditure as a percentage of sales and cost of capital.
Table 3: Overall results (unstandardized coefficients)
Dependent var. (t1) 0.415*** 0.945*** 0.250*** 0.001*** (0.015) (0.012) (0.022) (0.000) ESG (t1) 0.101*** 0.001 0.001 0.108*** (0.000) (0.000) (0.000) (0.015) Leverage 0.001*** 0.000 0.000 0.001 (0.000) (0.000) (0.000) (0.003) Employees 0.000*** 0.000*** 0.000 0.001 (0.000) (0.000) (0.000) (0.000) Sales 0.001*** 0.000 0.000 0.001*** (0.000) (0.000) (0.000) (0.000) Industry 4.5*** 0.000 0.000 0.001*** (0.000) (0.000) (0.000) (0.000) N= 1538 1499 1548 1513 Adj. R^2 .383 .214 .084 .211 ** Coefficient is significant at the 0.01 level (2tailed). * Coefficient is significant at the 0.05 level (2tailed). Controversial industry results
There are differences found in the relationship between CSR ratings and CFP in controversial industries versus noncontroversial industries. Table 4 shows the results for the moderating industry effect for the relation between CSR and CFP. Overall, CSR has a significant (1%) negative effect on operating profit margin . Every 1 point increase in overall CSR rating will increase operating profit margin with 0.01%. The interaction variable shows a positive effect of 0.01% for firms active in controversial industries. Thus, firms active in controversial industries experience a more positive effect of CSR score on operating profit margin, compared to firms active in noncontroversial industries. Sales growth is also significantly (1%) negatively affected by CSR rating. Every 1 point increase in ESG score leads to a decrease in sales growth of
industry effect of on sales growth. Cost of capital is not affected by CSR rating. Sales growth will not increase or decrease after a 1 point increase in ESG score. Also, there were no moderating industry effects found between CSR score and cost of capital. Table 4: Controversial industry effect (unstandardized coefficients) Dependent var. Operating profit margin Cost of capital Sales growth Dependent var. (t1) 0.411** 0.242** 0.102** (0.015) (0.020) (0.022) ESG (t1) 0.001** 0.000 0.126** (0.000) (0.000) (0.016) Leverage 0.000** 0.001 0.002 (0.000) (0.000) (0.003) Employees 0.000** 0.001* 0.001 (0.000) (0.000) (0.000) Interaction var. ESG (t1) and Controversial industry dummy 0.001** 0.000* 0.027 (0.000) (0.000) (0.021) Industry dummy 0.000** 0.001 0.027 (0.000) (0.000) (0.021) Sales 0.0001** 0.001 0.001* (0.000) (0.000) (0.000) N= 1538 1544 1478 Adj. R^2 .480 .084 .083 ** Coefficient is significant at the 0.01 level (2tailed). * Coefficient is significant at the 0.05 level (2tailed).
Discussion
effects on the financial value driver operating profit margin (Waddock & Graves, 1997; Berman et al., 1999; Aupperle et al.,1985). In my overall model, I find a negative effect of CSR score on two out of four CFP measures, namely operating profit margin and sales growth. This is in line with the theories of Waddock & Graves (1997), Lev et al. (2010) and Berman et al. (1999). For the two other CFP measures I do not find significant results, which contradicts Cochran & Wood (1984), Gao & Bensal (2006) and Cai et al. (2015). As a possible explanation for not finding results, I follow Ullman (1985), who states that it is impossible to measure the relationship between CSR and CFP as there are many more variables that interfere in this relationship.
In my second model, firms in controversial industries are experiencing a significant positive effect of CSR on operating profit. I therefore accept the hypothesis that the effect of CSR on operating profit margin is moderated by industry, such that the relationship is more positive for firms active in controversial industries. This is in line with the theory of Waddock and Graves (1997). Furthermore, I find that sales growth is not significantly affected by CSR if the firm is active in a controversial industry. I therefore drop the hypothesis that there is a moderating industry effect on the relationship between CSR and sales growth, such that the relationship is negative in controversial industries. This effect on sales growth is not in line with the theory of Lo and Shue (2007). They state that sales could decrease because of CSR activities, as these activities could increase operational and production costs, and hereby increase product prices which result in lower sales. For cost of capital, I find a significant neutral moderating industry effect of CSR activities on capital expenditure. This is not in line with the literature, which suggested that CSR is negatively correlated to cost of capital as it decreases the chance for
future environmental claims (Cai et al., 2015) and because firms that are engaging in CSR activities may have easier access to financing (Cheng, 2014).
Davidson and Worrell (1990) state a lack of effect of CSR on financial performance could be caused by three reasons. First, the reliability of the CSR index can be questionable. Second, financial performance is not correctly measured. Third, the sample may not be correct. Furthermore, Kim et al. (2010) states that it takes more than one year for CSR to affect financial performance. Therefore, they propose to use a lag of at least three to five years. Taking this into account could lead to different results.
Implications for management
As business managers continuously examine how to use and utilize their resources, they should take into account the findings from this research. This thesis provides managers handles to assess whether or not their investment in CSR activities can result in improved financial performance. More specifically, this thesis shows exactly where financial value can be achieved.
Overall, I find that CSR activities have a negative effect on sales growth and operating profit margin. However, if firms are active in controversial or sinful industries, the findings suggest a positive effect of CSR on operating profit margin. Managers of firms in controversial industries could therefore expect to increase their EBITDA margin of total revenue by initiating CSR activities. For the other financial value drivers we do not find significant beneficial effects for firms, even if I control for industry type.
Furthermore, according to Ittner and Larcker (1998), even if firms have a motive to increase sales growth by engaging in CSR initiatives, this may result in the opposite. They find
that consumers may be disillusioned with a firm if they believe the firm is engaging in CSR activities for selfinterested purposes. Managers should be on the lookout for this when considering to invest in CSR.
Lastly, it must be emphasized that firms may also engage in CSR activities to reach objectives other than financial value, for example to increase employee productivity or to improve government relations (Lev et al., 2010).
Implications for future research
There are some limitations to this research. For example, 9.542 observations have been lost due to missing CSR and CFP values. The exclusion of these observations can have changed the output of the regressions and the significance of the variables. This research has focussed on explaining the effect of the overall CSR score on the different financial value drivers of Rappaport (1987). This CSR score is a weighted average from the environmental (E), social (S) and the corporate governance score (G). Future research could investigate the individual effects of these three parts on the five drivers of financial value. This way, the analysis will be extended to the more specific dimensions of CSR.
Furthermore, it is important to notice that CSR measures are still improving and becoming more reliable. Although the Asset4 database is used by major investment houses worldwide, there have not been quality reviews of the Asset4 database by external parties. Therefore, as there is no comprehensive validity test done, the quality of the data could be a limitation to this research. However, based on the number of professionals and scholars that have been using the database, I maintain confidence in the validity of the Asset4 CSR data.
Much more remains to be researched about the effect of CSR activities on CFP. For example, it can be useful to investigate if the relationships found in this study hold over a longer time period. Furthermore, it may be useful to examine time lags longer than the one year time frame that I have used in this thesis. Also other additional research on the relationship between the CSR and the financial value drivers can be done in the coming years. What will happen in the coming years, as companies must follow up on the agreements they have made during the climate conference in Paris in 2015? I believe this has been a special event, which could improve the way firms engage in CSR activities. After these firms have fully implemented the plans which they have agreed on in Paris, academics should do empirical research on the effects on the five financial value drivers.
Conclusion
In this thesis, I have researched the effect of corporate social responsibility scores on corporate financial performance. Over the last decades, many scholars have researched this relation and found negative, neutral and positive effects.
In response to this variety in results, I researched the effect of CSR on the five individual financial value drivers of Rappaport (1987). The sample consisted of 504 companies from the S&P 500 index in the 20092014 period. There are several theories on the effect of CSR on CFP. Although there is still no consensus about the effect of CSR on CFP in existing literature, scholars tend to believe there is a positive effect of CSR on CFP (Orlitzky et al., 2003). However, in this research I investigated where exactly financial value is created. To identify the type of financial value that is driven by CSR activities, I used the five drivers of financial value
by Rappaport (1987). Furthermore, I investigated if firms that are active in controversial industries experience a moderating effect on the relation between CSR and CFP.
Consistent with findings of existing literature on the effect of CSR on financial performance, my findings include the presence of an overall negative effect of CSR rating on the financial value drivers sales growth and operating profit margin . However, if firms are active in controversial industries, the findings suggest a moderating industry effect, such that the relationship between CSR and operating profit margin is more positive. This implies that managers of businesses operating in these industries can improve their operating profit margin by initiating CSR activities. The effect of CSR on the financial value driver cost of capital has not been significant found in this research. There was no significant effect found for the relationship between CSR and capital expenditure . Future research could aim to investigate if these effects hold over a longer period of time. Furthermore, it may be useful to examine longer time lags than I have used in this thesis. Lastly, even if firms are aiming to increase profit by initiating CSR activities, this might result in the opposite, according to Ittner and Larcker (1998). Consumers might be disillusioned with a firm its motives if they are convinced the firm is starting CSR activities for selfinterested purposes. Next to this, firms can also engage in CSR activities to reach objectives other than financial value, for example to increase employee productivity or to improve government relations (Lev et al., 2010).
I would like to thank Pushpika Vishwanathan (the thesis supervisor) for the writing assistance
Appendix
Appendix 1: Variable definitions and data source
Variable Variable description Data source
Company Company ISIN code Datastream
Year Year Datastream
Country Country where the company is based Datastream
CSR Interaction variable of ESG score and industry type Asset4, Datastream
Controversial industry
dummy variable Controversial industry dummy based on SIC codes Datastream
ESG Overall equalweighted CSR rating Asset4
E Environmental score Asset4
S Social score Asset4
G Corporate Governance score Asset4
Operating profit Earnings before interest, tax, depreciation and amortization divided by revenue Datastream
Capital expenditure Capital expenditure divided by revenue Datastream
Sales Yearly sales in dollars Datastream
Sales growth Sales growth year over year (in percentage) Datastream
Net working capital Net working capital divided by revenue Datastream
Cost of capital
Cost of capital. Calculated as the riskfree rate plus the beta times the difference between the market premium and the riskfree rate.
Datastream & Bloomberg
Employees Number of employees at the firm Datastream
Leverage Debt divided by assets Datastream
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