UNIVERSITY OF GRONINGEN
Environmental corporate social responsibility and
corporate financial performance: An empirical study
of United States manufacturing firms
Master’s Thesis FinanceAnqi Yu s2459299 August 2014
Abstract
This paper aims to examine the relationship between environmental corporate social responsibility and corporate financial performance of firms in United States manufacturing industries by carrying out a multi-regression analysis. This study finds that, as taking timing factor into consideration, adopting environmental protection strategies brings economic benefits to firms in the long run, although it exerts negative effect in the short term. Along with time, the effects of innovation measures shift from negative into positive and innovation itself plays a more important role in firms’ financial performance.
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1. Introduction
For firms in the United States, it reveals that the costs of environmental protection grow substantially since 1970s and thus firms are supposed to take the effect of environmental factors into account when considering business strategies (Clarkson, Li, Richardson, and Vasvari, 2011). Actually, with intentions to comply with the environmental regulation, transmit an environmental commitment image as well as satisfy the most demanding customers, the environmental corporate
social responsibility (ECSR) is turned into a strategic variable which increasingly influences corporate financial performance (CFP) (Macauley, 1999). Hence, the relationship between the
ECSR and CFP becomes crucial issue in business decision making.
Some scholars have long advocated that investments in environmental protection bring few financial benefits back (King and Lenox, 2001). In the traditionalist view, environmental cost (e.g. pollution control) is seen as an extra cost and thus a competitive disadvantage (Cohen, Fenn, and Naimon, 1995). However, environmental performance, as an indispensable part of corporate social
responsibility (CSR), could be a potential source for firms to improve competitive advantage and
financial performance. Actually, in the long run, improved environmental performance could lead firms to obtain more efficient processes, lower production cost, and exploit new market opportunities (Porter and van der Linde, 1995). Two major reasons that support this argument. For one reason, increasingly higher cost of polluting activities stimulates firms to develop new efficient technologies that can reduce the cost and company innovation culture can also be developed during this period. From a long-term perspective, innovation ability plays a more important role in firms’ development (Porter and van der Linde, 1995). For another reason, firms can obtain first mover advantage (e.g. technological leadership, and preemption of scarce assets) which undoubtedly will improve firms’ financial performance (Porter and Esty, 1998).
This paper attempts to discuss the relationship between ECSR and CFP in United Stated manufacturing industries. For this purpose, data has been collected from Thomson Reuters Datastream ASSET4, which provides in-depth, objective and comparable ESG (environmental, social and governance) data on over 3,500 firms worldwide (Elsayed and Paton, 2005). After screening out manufacturing industries and removing data outliers, it ends up with 362 firms’ data.
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firm's efficiency at generating profits from every unit of shareholders' equity and shows how well a company uses investment funds to generate earnings growth. On the other hand, environmental performance is revealed by three types of measure (emission reduction related measure, energy efficiency measure, and product innovation measure). The first measure, emission reduction, is one of the widely used measures of environmental performance (Spicer 1978, Hamilton 1995, Hart 1996). Energy efficiency is also an important measure that reveals firms’ ability to create more value while using fewer energy resources (Derwall, Guenster, Bauer, and Koedijk, 2006). The last one, product innovation measure, is used to indicate firms’ investment in innovation development, which is crucial for better environmental protection and firm’s long-term development (Lioui and Sharma, 2012).
As this paper intends to analyze the effect of timing factor in mediating the relationship between ECSR and CFP, our empirical study is based on the multiple regression approach, which is suitable for measuring long-term (in months or years) correlation (Horváthová 2010). The results support our hypotheses that adopting environmental protection strategies is beneficial for firms’ financial performance in the long run, although it poses negative effect in the short term. Also, as timing factor is considered, some findings are valuable for business decision makers in manufacturing industries. Firstly, from long term perspective, the effect of emission reduction related measures are more likely to be beneficial toward financial performance since the majority of them are positive, but due to the limitation of data, this conclusion is not decided. In future work, more efforts will be paid to discuss this question further. Secondly, the measure, energy efficiency policy (EEP), shows a strongly positive effect on firms’ financial performance which is shown to be a very right policy to adopt. Thirdly, as time goes by, the effects of innovation measures are in a strong tendency, changing from negative factor into positive factor. This result is consistent with previous work that innovation gradually plays a more important role in firms’ long term financial performance. Decision makers should pay more attention to the investment of innovation development.
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2. Literature review
2.1 Brief review of CSR history
The theory of corporate social responsibility (CSR) originated from the formation of American industrialization and the development of Western enterprises system at the beginning of 20th century. It was Oliver Sheldon, who first mentioned the concept of CSR in 1924. In his book
The Philosophy of Management, he points out that one goal of corporate social responsibility is
economic responsibility which produces valuable goods for human beings and another goal is moral responsibility which is formulated by social objective.
In 1930s, the question about who is the fiduciary of the corporate managers aroused the famous debate between Professor Berle and Dodd. To be specific, Berle believes that corporate managers could only be the trustees of shareholders. However, Dodd conceives company was an economic institution with the function of profit making and social service. Similarly, from 1970s to 1980s, there is also a famous debate between Milton Friedman’s shareholder theory and Edward Freeman’s stakeholder theory. Milton Friedman holds that the only individuals that have a moral claim on the corporation are the people who own shares of the stock, namely, shareholders. In other words, manager has no right to give the profits or residual earnings to other parties because of social causes when doing so will reduce shareholder’s profits dividends, or reinvested in the firm, since that money does not belong to the manager but to shareholders (the decision-making power is hold in shareholders’ hand). Hence, of course, in another aspect, managers can spend more on environmental control, pay higher wages to employees, or provide better products for customers, or donate money to charity organizations or any other causes under the prerequisite that if doing so will make more profits for shareholders.
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criticism is against the point that maximizing shareholder’s profits will ultimately trigger social benefits. Actually, competitiveness sometimes fails to guide firms in a socially beneficial way, but, instead, mislead them in a socially harmful direction. For instance, in order to lower the environmental management cost and thus increase price advantage, a company is likely to discharge of pollutants with as little treatment as possible.
On the other hand, Edward Freeman’s stakeholder theory proposes that other stakeholders (e.g., employees, suppliers, customers, local community, environment, and even the world community) also should be considered in corporate’s objective. In other words, business leaders’ duty is to balance all stakeholders’ interests including shareholder’s interests. Stakeholder theory claims that the managers have the responsibility to run the company in a way that will best serve the interests of all stakeholders. But one thing should be noticed is that stakeholder theory does not claim that managers should not try to make more profits.
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2.2 Corporate citizenship theory
Apart from stakeholder theory, another important theory base of CSR is corporate citizenship theory, which is proposed in 1996 when President Clinton called a group of leading business people to join a conference in Washington (Porter and Kramer, 2006). At this conference, they discussed the notion of corporate citizenship and corporate social responsibility and President Clinton encouraged business leaders to do well for their employees as well as earn more money for shareholders. He also announced the newly created Corporate Citizenship Award to honor the excellent American firms which performed well to support their workers.
Corporate citizenship theory inherits and develops corporate social responsibility. It advocates that businesses are socially responsible for undertaking legal, ethical and economic responsibilities. The aim for businesses is to create higher standards of living in communities where they operate, while still preserving profitability for stakeholders. In corporate citizenship theory, society is the basis of corporations, since society is the source for corporations to make profits. On the other hand, corporation is also a part of society because all the infrastructures, natural resources, and environment the corporations use during the operation come from society. Therefore, corporation should also take relevant social responsibility to serve for the society. Archie B. Carroll (1998) summarizes four faces of corporate citizenship including economic face, legal face, ethical face, and philanthropic face. In simple terms, firms should fulfil their economic income in legal and ethical way, and eventually give back the obtained resource to the society. Crane and Matten (2010) extended concept of corporate citizenship to a definition as a set of rights comprising of three entitlements: social rights, civil rights and political rights. The role for firms in the administration of civil, social, and political rights gives an extended view of corporate citizenship: Corporate citizenship describes the corporate function for governing citizenship rights for individuals.
2.3 The relationship between CSR and CFP
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responsibility and financial performance has been widely discussed. Not surprisingly, there are various opinions about the relationship between financial and social performance, but the empirical research has not yet reached to a consensus (Scholtens, 2008).
Some researches revealed that there is a positive relationship between financial and social performance. For instance, Bragdon and Marlin (1972) find a strong correlation between the good pollution control and good financial performance in pulp and paper industry. Freeman (1984) holds that satisfying stakeholders' interests will result in an improvement of the firm's financial and economic performance. He broadens the concept of strategic management beyond its traditional economic roots, by defining stakeholders as “any group or individual who is affected by or can affect the achievement of an organization’s objectives”. Besides, Margolis et al. (2009) concluded that higher corporate financial performance is gained after philanthropic donations.
In contrast, some scholars discover a negative CSP-CFP relationship. Williamson (1964) finds that a negative link exists between social and financial performance when managers pursue their own objectives, which may conflict with shareholder and stakeholder objectives. Friedman (1970) suggests a negative relationship between CSP and CFP, with the reason that social responsibility is likely to increase costs which could worsen firms’ competitiveness and reduce profits. Also, Preston and O'Bannon (1997) argue that an increase of funds to invest in social performance can lead to poorer financial performance because of negative synergy.
In addition to above researches, some scholars find there is no linear relationship between them. Bowman and Haire (1975) find that the firms with middle rating level of corporate social responsibility performed best in term of financial performance, suggesting a relatively reverse U-shaped relationship between CSR and CFP. Also, Aupperle, Carroll, and Hatfield (1985) also fail to find any relationship between social responsibility and profitability by using elaborate forced-choice instrument administered by corporate CEOs.
2.4 The relationship between the Environmental CSR and CFP
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performance can also be classified into three types, positive, negative and reverse U-shaped relationship. According to the neoclassical theory (individuals maximize utility and firms maximize profits), some scholars (Palmer et al., 1995; Walley and Whitehead, 1994) put forward that improved environmental performance leads to an additional costs, since these environmental efforts decrease the marginal profits of a firm. Similar conclusions can be found in Bird et al.’s (2007) paper, which uncovered a negative relationship between firms' excess return and one year lagged environmental corporate social responsibility activity. Besides, Lioui and Sharma (2012) also find ECSR strengths and concerns have a negative relationship with CFP. Filbeck and Gorman (2004) find that there is no positive relationship between holding period returns and a measure of environmental performance, instead, the negative correlation is found.
On the other hand, other scholars agree that it pays to green and leads to a win-win situation in which both social welfare and financial performance gain benefits. For example, Russo and Fouts (1997) find a significant positive correlation between various financial returns and indexes of environmental performance. Hart and Ahuja (1996) consider the timing effect on CFP by measuring a sample of 500 firms from manufacturing, mining and production industry and firms with emission reduction policy in time period t. They find a positive relationship in the model with the lagged environmental variables (one or two years after initiation) which enhances the operating and financial performance after one or two year. Similarly, King and Lenox (2001) confirm the hypothesis “pays to be green” by analyzing 652 U.S. manufacturing firms over the time period 1987–1996. In addition, there is a third correlation between ECSR and CFP, Lankoski (2000) proposed a reverse U-shape relationship. This view indicates that there is a positive correlation until the economic performance reaches at a maximum, after that peak increasing environmental performance will trigger a decrease of financial performance reversely.
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(multiple regression and panel data). This may be due to possible omitted variable bias in these studies. For example, possible factor (e.g. the size of the company or industry sector may be omitted). The results also show that the portfolio studies tend to report a negative link between environmental and financial performance, and confirm the importance of appropriate time coverage to a positive link between environmental and financial performance.
Table 1: A list of “pays to green” empirical literatures
Examples Findings
Spicer (1978)
Firms in terms of pulp and paper industry with better pollution-control records tend to have higher profitability, larger size, lower total risk, lower systematic risk and higher price/earnings ratios than firms with poorer pollution-control records.
Hamilton (1995)
The higher pollution of a firm reported in Toxic Release Inventory (TRI), the more likely the shareholders will experience the negative, statistically significant abnormal returns upon the first release of the information.
Hart (1996)
a positive relationship in the model with the lagged environmental variable (one or two years after initiation) by measuring a sample of S&P 500 firms. Firms with emission reduction policy in time period t enhance the operating and financial performance after one or two year
King and Lenox (2001) provide additional support for “pays to green” and illustrate that the timing of “pays to green” is more important
Al-Tuwaijri (2004)
“good’’ environmental performance is significantly associated with ‘‘good’’ economic performance, and more extensive quantifiable environmental disclosures of specific pollution measures and occurrences is positively associated with ‘‘good’’ economic performance.
Derwall, Guenster, Bauer, and Koedijk (2005)
The high-ranked portfolio of economic efficiency score gained higher average profits return than its counterparty over the 1995-2003 period.
Elsayed and Paton (2005)
Significant impact of lagged environmental performance on Tobin’q and return on sales and a negative impact that is only weakly significant on the third measure (return on assets). Panel data estimates reveal weak evidence that environmental performance affects financial performance by measuring UK firms
Filbeck and Gorman (2004)
There is no positive relationship between holding period returns and an industry-adjusted measure of environmental performance nor do they find that regulatory climate appears to explain returns.
Nakao et al. (2007)
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2.5 Methodologies
One important thing to study the relationship between the CSR and CFP is to figure out the approaches to measure the indicators of CSR. Basically, approaches can be divided into content analysis and indicator evaluation.
Content analysis refers to the annual or other reports of a company, which contain score of specific dimensions of CSR from both quality and quantitative perspectives. However, this approach has several disadvantages. For instance, the criteria to select suitable CSR indicators in CSR annual report might be biased and writers of the annual reports are subjective. For firms in heavy industry, they may select less environmental indicators. What is more, firms can also easily cheat in the disclosure of CSR report (e.g. Enron corporation auditing scandal). What they claimed that they have done for CSR actually may be not what they really did.
Indicator evaluation is that some rating agencies give a ranking of firms according to their performance from some aspects of CSR. One example is that in 1980s, many scholars started to apply Fortune magazine’s Annual Survey of Corporation Social Responsibility to study on CSR related topics. Besides, some environmental indicators and polluting emissions can be drawn from toxic release inventory (TRI), an annual report of releases of over 300 chemicals required for manufacturing facilities in US (Hart and Ahuja, 1996). Compared with content analysis, indicator evaluation is more objective and thus it is used in this study to measure the CSR.
With regard to indicator evaluation of CSR, Thomson Reuters Datastream ASSET4 is a CSR rating, which provides in-depth, objective and comparable ESG (environmental, social and governance) data on over 3,500 firms worldwide. It collects information from publicly available sources (e.g. annual reports, CSR reports, and NGO websites) with no subjective inputs from analysts in the formulation of its ESG ratings and provides a good overview of the capital market expectation associated with socially responsible portfolio. It is widely used by institutional investors (e.g., NYSE has used Asset4 to list firms to benchmark their corporate social performance).
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regular MSCI Semi-Annual and Quarterly Index Review schedule. However, Entine (2003) criticized measurements of CSR and of the rating MSCI in particular. He explains the drawbacks of social performance ratings and illustrates these drawbacks with KLD. He argues that the ratings of KLD are tainted by anachronistic, contradictory, idiosyncratic, and ideologically constructed notions of corporate social responsibility. The first argument is that the data of social responsibility lacks reliability since there may be some undertrained junior staffers who select data which is relevant based on their own view. The next argument is that social responsibility measures use arbitrary and subjective standards. One example is that MSCI excludes firms that derive revenue of more than a specific percentage from activities concerning alcohol, gambling, tobacco, etc. (KLD Research & Analytics, Inc., 2006). Entine (2003) highlights that these percentages are arbitrary and that it is not motivated by KLD explicitly how they estimate these numbers. Finally, Entine (2003) argued that the data collection and the transformation of the data into ratings of MSCI ESG Indexes are subjective and unreliable procedures. Simply stated, the main conclusion is that MSCI ESG Indexes offers too little explanation and substantiation for their methodology, data collection and indicator criteria. Hence, this is also why this paper chooses the former CSR rating, Thomson Reuters Datastream ASSET4, instead of this one.
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- Multiple regression study - Event study
- Portfolio study comparing
First, multiple regression is used widely through considerable existing literatures. Hart and Ahuja (1996) apply the multiple regression analysis to test hypotheses regarding whether it pays to green in terms of ROA, ROE and ROS. King and Lenox (2001) use least-squares regression analysis to find a linear relationship between our independent variables and the firm’s future Tobin’s Q. Chad Nehrt (1996) tests the investment timing and intensity conditions under which advantages may exist for first movers in environmental investments by using multiple regression analysis.
Second, an event study is a statistical method to assess the impact of an event on the value of a firm, which is used to investigate the stock market responses to corporate events, such as mergers and acquisitions, earnings announcements, debt or equity issues, investment decisions and corporate social responsibility. One example is that Becchetti et al (2012) employ an event study analysis during 1990–2004 to measure the market reaction of CSR index entry and exist. They find a significant negative effect on abnormal returns after exit announcements from the Domini index. The impact continues even after controlling for concurring financial distress shocks and stock market seasonality. In addition, Curran and Moran (2007) also measure whether corporate financial performance is affected by public endorsement of environmental and social performance based on event study methodology’s notion of market efficiency. Nevertheless, McWilliams et al (1999) provide a critical analysis of the use of event study methodology on corporate social responsibility. In their paper, they claim that the disadvantages of event study, in terms of corporate social responsibility, are first event studies, which merely provide estimates of short run impact on shareholders but not on other stakeholders. And then event study results are sensitive to small changes in research design.
With regard to the portfolio analysis, it compares the performance of established portfolio of models with a uniform benchmark index. However, Salzmann, et al. (2005) claim that this methodology contains drawbacks that the results of portfolio analysis are ambiguous and contingent upon diverse factors such as risk adjustments, time coverage and the re-weighting of portfolio.
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regression methodology usually measures long-term (in months or years) correlation, while event study emphasizes on much short term period which is usually measured in days (Horváthová 2010). In this paper, year-based data is used, which is not applicable in very short (day-based) period methodology (event study). Hence, multiple regression methodology is more suitable.
3. Hypothesis Development
As externalities, the beneficial effect of pollution and degradation are not immediately reflected in measurements of firms’ financial performance. Instead, the negative effect on financial performance appears more quickly since it requires significant resources and managerial effort to cope with pollution if it is beyond existing government environmental regulation (Clarkson, Li, Richardson, and Vasvari, 2011). Aupperle et al. (1985) show that, if only think about the short-term effect, firms being socially responsible are forced into an unfavorable financial situation compared with those refuse to do it. Furthermore, environmental enhancement (e.g. pollution prevention, emission reduction, etc.) requires other relevant cost in training professionals, purchasing corresponding equipment, and spending extra time on relevant work (e.g. making renegotiation of supply and discussing waste disposal contracts) (Hart and Ahuja, 1996). Hence, these costs of environmental strategies, from a short term perspective, are more likely to make firms face a competitive disadvantage and the first hypothesis follows:
Hypothesis H1: From a short-term perspective, implementing environmental strategies tends
to exert a negative impact on corporate financial performance.
However, Hart and Ahuja (1996) researched the ECSR-CFP nexus by considering the timing effect of financial performance. They find that, in the short term (within one or two years after initiation), efforts to prevent environmental pollution and reduce emissions seems to bring few benefits but costs, while in the long run (one or two years after the initiation of environmental policy), undertaking environmental corporate social responsibility will improve the financial performance. Horváthová (2010) also shows that appropriate time coverage is important in order to establish a positive link between environmental performance and financial performance.
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propose that poor environmental performance always result from unqualified management. Porter and Esty (1998) also point out that the pressure resulted from environmental CSR is well associated with better R&D investment and better innovation capability. They advocate that high environmental cost pressure stimulates firms to improve management capability and develop new technologies to reduce the environmental cost, which eventually improves financial performance. From the perspective of government’s environmental regulation, the best strategy to cope with increasingly stricter environmental regulation is to develop new technologies and efficient management in advance. This can be illustrated by “first mover advantage”: those firms which firstly obtain advanced technologies gain competitive advantages not only by reducing product cost, but also by selling innovations and technical solutions to other firms. To some degree, as the idea Porter et al. (1995) point out, the ability to innovate and develop new technologies plays a more important role in firms’ competitive advantages than traditional factors in firms’ profitability.
To sum up, although implementing environmental strategies is costly, it eventually reaps a good payoff in the long run. To be specific, the adoption of environmental strategies exerts firms with economic pressure, which stimulates them to acquire innovation in production or develop new technologies. These innovations and technologies could lead firms to obtain more efficient processes, less cost in compliance, improvement in productivity and eventually better financial performance. Hence, the second hypothesis follows:
Hypothesis H2: Although implementing environmental strategies seems to pose a negative
impact on corporate financial performance in the initial period, it will eventually turn into positive factor in the long run.
4. Empirical approach
4.1 Data
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worldwide sample of electrical firms from Datastream to discuss the link between the environmental performance and electrical firms’ financial performance.
Moreover, this paper chooses US firms for analysis. It is mainly motivated by the fact that the data of US firms is most complete in database, and many existing literatures regarding the link between environmental performance and firm performance are aiming to study US firms, which could provide me with enough references. Also, it is also found that literatures studying the latest year’s United States firms’ data are few. Hence, I choose the data of US firms during latest years.
Two strategies are adopted to screen out the target firm data. On one hand, only those firms in which emissions reduction is salient are selected. With the help of SIC codes, we choose firms in manufacturing industries. On the other hand, to ensure stability and reliability, firms with too many missing values (over 30%) are omitted. After applying these two screens to the data, it ultimately ends up with 362 firms in the study.
4.2 Measures
4.2.1 Financial Performance Measures
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4.2.2 Environmental Performance Measures
As shown in the Table 2, one of the widely used measures of environmental performance is polluting emission, which is proven to be applicable (Spicer, 1978; Hart, 1996; King and Lenox, 2001; Lioui and Sharma, 2012). Here, we choose five variables regarding emissions reduction as environmental performance measures: 1) Emissions Reduction Policy (ERP, dummy variable, equal to one if the firm adopts emission reduction policy); 2) CO2 Reduction Policy (CRP, dummy variable, equal to one if the firm adopts CO2 reduction policy); 3) Ozone-Depleting Substances Reduction Policy (ODSRP, dummy variable, equal to one if the firm adopts ozone-depleting substance reduction policy); 4) Toxic Chemical Reduction Policy (TCRP, dummy variable, equal to one if the firm adopts toxic chemical reduction policy); 5) Log of CO2 Equivalents Emission Total (LCEET, measured in tonnes, log of the amount of CO2 that company releases). We use the Log of CO2 equivalents emission total instead of its original value because the original value is too large when compared with other variables’ value. These five aspects are related to emissions reduction, which measures a company's management commitment and effectiveness towards reducing environmental emission in the production and operating process. It reflects a company’s capacity to reduce the detrimental environmental impact in the local or broader community.
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Table 2: Measures of corporate environment performance in “pays to green” literatures
Examples Measures
Spicer (1978) Nehrt (1996)
Capital expenditures on pollution control technology
Hamilton (1995) Hart (1996)
Emissions of toxic chemicals (typical source: TRI)
King and Lenox (2001) Total emissions, relative emissions, industry emissions, source: TRI Filbeck and Gorman (2004) The Investor Responsibility Research Centre Compliance Index
Al-Tuwaijri et al. (2004)
Ratio of toxic waste recycled to total toxic emission generated (source: Council on Economic Priorities’ (CEP) company rating charts)
Khaled Elsayed, David Paton (2005)
Management Today Survey of Britain's Most Admired Companies evaluation criteria; Data stream and Financial Analysis
Derwall et al. (2005) Economic efficiency scores
Nakao et al. (2007) Environmental index
Lioui and Sharma (2012) Environmental strengths, environmental concerns (source: KLD STATS Inc.)
With respect to production innovation, there is also only one variable: 7) Energy Footprint Reduction Policy (EFRP, dummy variable, equal to one if the company adopts energy footprint reduction policy). It is reasonable that if firms develop new technologies to efficiently reduce pollution emissions, the cost of environmental control will be reduced and therefore their competitiveness will be enhanced. The Energy Footprint Reduction policy is related to product innovation, which measures a company’s management commitment and effectiveness towards supporting the research and development of economic efficient products or services. It reflects a company’s capacity to reduce the environmental costs and burdens for its customers, and thereby creating new market opportunities through new environmental technologies and processes or eco-designed products with extended durability.
4.2.3 Controls
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we focus are in manufacturing category which is labor intensive; Better R&D and better innovation always go with undertaking environmental CSR (Porter and van der Linde, 1995). Chauvin et al. (1993) and Lioui et al. (2012) show that there exists a large positive relationship between R&D expenditure and firms’ financial performance. Hence, it is natural to get another control: 2) the R&D intensity (R&D Intensity), is calculated as dividing R&D expenditure by operating revenue. To sum up, the definition of variables are shown in Table 3.
Table 3: Definition of measures
Measures Definition
Financial Performance Measure
Return on Equity (ROE) The ratio of net income to firm equity Emission Reduction Related Measures
Emissions Reduction Policy (ERP) Does the company have a policy to reduce emissions?
CO2 Reduction Policy (CRP)
Does the company show an initiative to reduce, reuse, recycle, substitute, phased out or compensate CO2 equivalents in the production process?
Ozone-Depleting Substances Reduction Policy (ODSRP)
Does the company report on initiatives to recycle, reduce, reuse or substitute ozone-depleting (CFC-11 equivalents, chlorofluorocarbon) substances?
Toxic Chemicals Reduction Policy (TCRP)
Does the company report on initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances?
Log of CO2 Equivalents Emission
Total (LCEET) Log of total CO2 and CO2 equivalents emission in tonnes.
Energy Efficiency and Product Innovation Measures
Energy Efficiency Policy (EEP) Does the company have a policy to improve its energy efficiency? Energy Footprint Reduction Policy
(EFRP)
Does the company describe initiatives in place to reduce the energy footprint of its products during their use?
Controls
Firm Size (FS) The log of number of employees.
R&D Intensity (RDI) The ratio of R&D expenditure to operating revenue.
4.3 Methodology
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factor into account, in this study to analyze the relationship between CSR and CFP. The model is shown as followed:
ROEi,t = + β1EPRi,t-k + β2CPRi,t-k + β3ODSRP i,t-k + β4TCRPi,t-k + β5LCEETi,t-k + β6EEPi,t-k + β7EFRPi,t-k + β7FSi,t-k +β7RDIi,t-k + ε (1) Where k represents lags of years and definitions of variables are shown in the Table 3.
This model is used to test whether the previous environmental strategies will pose positive or negative effect on firm’s financial performance (ROE). With regard to k, it is used to represent the timing factor. For example, lags of one or two years will be represented as k = 1 or k = 2. In section 5, results of four models (no lag, k=0; lag of one year, k=1; lag of two years, k=2; lag of three years, k=3) will be shown and discussed.
4.4 Descriptive statistics of sample data
Table 4: Descriptive statistics of independent, dependent and control variables
Variables Mean Median Maximum Minimum Std dev
Financial Performance Measure
Return on Equity 0.24 0.21 1.10 -0.11 0.16
Emission Reduction Related Measures
Emissions Reduction Policy 0.66 1.00 1.00 0.00 0.48
CO2 Reduction Policy 0.27 0.00 1.00 0.00 0.44
Ozone-Depleting Substances Reduction Policy 0.12 0.00 1.00 0.00 0.33
Toxic Chemicals Reduction Policy 0.19 0.00 1.00 0.00 0.39
Log of CO2 Equivalents Emission Total 13.75 13.63 18.93 5.13 2.29
Energy Efficiency and Product Innovation Measures
Energy Efficiency Policy 0.67 1.00 1.00 0.00 0.45
Energy Footprint Reduction Policy 0.18 0.00 1.00 0.00 0.39
Controls
Firm Size 9.95 9.90 14.60 4.39 1.42
R&D Intensity 0.07 0.03 0.43 0.01 0.07
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profitable, but most of firms also centralize in a certain range (the standard deviation is relatively small). Firms that adopt emission reduction policy cover 66% of firms. It is possible that government regulations require them to do or they realize that emission reduction policy leads to a more profitable result. Due to the limitation of resource, here we cannot give a decided explanation. Different from emission reduction policy, much less firms adopt CO2 reduction policy (27%), ozone-depleting substance reduction policy (12%), and toxic chemicals reduction policy (19%), especially the last two policies. However, energy efficiency policy is very similar to emission reduction policy that the average coverage is 67% and the standard deviation is 0.45. Firm size is calculated as the log of the number of employees, since manufacturing industries are labor intensive. Most of firms concentrated in the medium size (the first quarter is 8.85, the third quarter is 10.84, and the standard deviation is 1.42). Averagely, firms invest 7% revenue in R&D. But the maximum investment ratio is 43%, which could be a rapidly developing company.
4.5 Correlation analysis
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Table 5: correlation between variables
ROE ERP CRP ODSRP TCRP LCEET EEP EFRP FS
ROE 1 ERP 0.037* 1 CRP 0.026 0.389*** 1 ODSRP 0.095*** 0.206*** 0.265*** 1 TCRP 0.035* 0.286*** 0.268*** 0.291*** 1 LCEET -0.060** 0.239*** 0.334*** 0.101*** 0.014 1 EEP 0.033 0.454*** 0.324*** 0.214*** 0.279*** 0.108*** 1 EFRP 0.046** 0.258*** 0.181*** 0.244*** 0.294*** -0.029** 0.244*** 1 FS 0.164*** 0.140*** 0.020 0.147*** 0.115*** 0.154*** 0.198*** 0.142*** 1 RDI -0.026** -0.073** -0.044 0.021 0.116*** -0.435*** -0.041 0.042 -0.235***
T-statistics are reported in brackets: ***, **, and * respectively stand for p < 0.001, p < 0.01, and p < 0.10.
Variable definition: ROE, return on equity, the ratio of income to firm equity (financial performance measure); ERP, Emissions Reduction Policy (dummy variable): if the company have a policy to reduce emissions; CRP, CO2 Reduction Policy (dummy
variable): if the company show an initiative to reduce, reuse, recycle, substitute, phased out or compensate CO2 equivalents in the
production process; ODSRP, Ozone-Depleting Substances Reduction Policy (dummy variable), if the company report on initiatives to recycle, reduce, reuse or substitute ozone-depleting (CFC-11 equivalents, chlorofluorocarbon) substances; TCRP, Toxic Chemicals Reduction Policy (dummy variable), if the company report on initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances; LCEET, Log of CO2 Equivalents Emission Total, log of total CO2 and CO2 equivalents emission in tonnes;
EEP, Energy Efficiency Policy (dummy variable), if the company have a policy to improve its energy efficiency; EFRP, Energy Footprint Reduction Policy (dummy variable), if the company describe initiatives in place to reduce the energy footprint of its products during their use; FS, Firm Size, the log of the number of employees; RDI, R&D intensity, the ratio of R&D expenditure to operating revenue.
5. Empirical results and discussion
In this section, results of empirical studies are shown orderly. Multiple linear regression is applied to test two hypotheses. In the Section 5.1, the result of short term (within one year) CSR-CFP relationship is shown, which is analyzed to test the hypothesis H1. Similarly, results of long term CSR-CFP relationship is discussed in section 5.2 to verify the hypothesis H2.
5.1 Estimate of short-term (one year) financial performance
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financial performance within a year (k=0). After adjustments, there are 2723 observations to test the correlation. The result shows that emission reduction policy, CO2 reduction policy, and ozone-depleting substances reduction policy all exert negative effect on the financial performance, but only the result of CO2 reduction policy is of significance. Also, considering that the coefficient for “CO2 equivalents emission total” is positive (but it lacks significance), it could imply that firms with higher emission of CO2 tends to experience higher financial performance in short-term period.
Table 6: Estimate of financial performance
Measures Predicted Sign Coefficient
(k=0, within a year)
Intercept + 0.165*
Emission Reduction Related Measures
Emissions Reduction Policy - 0.009*
CO2 Reduction Policy - 0.034**
Ozone-Depleting Substances Reduction Policy - 0.011*
Toxic Chemicals Reduction Policy + 0.004
Log of CO2 Equivalents Emission Total + 0.003
Energy Efficiency and Product Innovation Measures
Energy Efficiency Policy + 0.017*
Energy Footprint Reduction Policy - 0.004
Controls Firm Size + 0.022*** R&D Intensity - 0.003** F-value 4.248 *** R square 0.046 Adjusted R square 0.035 Number of Obs. 2723
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Another noticeable measure is energy efficiency policy which is with significance and positive coefficient. The reason for this result could be that the effect of energy efficiency policy comes out more quickly in production processes and therefore production cost is reduced. As for the product innovation (energy footprint reduction policy), the coefficient is -0.004, but it is insignificant. The R&D activity tends to exert negative effect on financial performance in this model (coefficient equals -0.003 and p<0.01). It is not difficult to understand that research and development investment needs time to gain returns that one year usually is not enough. In other words, during short-term period, R&D investment could pose a negative effect on CFP. Also, since the sample of data is come from manufacturing industry, which is labor intensive, the number of employees is supposed to be an important factor. This is indicated by the measure firm size (firm size is measured through the number of employees), which is shown to be positive and significant.
So in conclusion, the result shown in Table 6 supports the hypothesis 1 that, in short time period, implementing environmental strategies tends to have negative effect on CFP. Apart from energy efficient policy (significant) and toxic chemicals reduction policy (insignificant), all other environmental protection related policy, especially CO2 reduction policy, are negative toward CFP. In addition, investment on research and development (measure RDI) in this period also tends to be negative toward CFP, while the firm size has positive effect.
5.2 Estimate of future (within three years) financial performance
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ERP does not have any positive result. It is likely that we may fail to consider some important emission reduction related policies, since the measure ERP, the overall measure which indicates if firms adopt emission reduction policies, shows an opposite result compared with existing specific emission reduction related measures (CRP, ODSRP, and TCRP). But we cannot make a decided conclusion due to the limitation of available information. In summary, the measure ERP is inclined to have negative effect, while the results of other specific emission reduction related measures are shown to be positive. As majority of emission reduction related measures are positive, it seems more reasonable to conclude that their effects are positive toward financial performance.
Table 7: Estimate of future financial performance
Measures
k=1, one year later k=2, two years later k=3, three years later
sign coefficient sign coefficient sign coefficient
Intercept + 0.173* + 0.165** + 0.177**
Emission Reduction Related Measures
ERP - 0.009 - 0.011 - 0.006*
CRP - 0.004 - 0.002 + 0.011*
ODSRP + 0.019** + 0.020* + 0.014
TCRP + 0.004 + 0.007 + 0.004
LCEET + 0.001 + 0.001 - 0.002
Energy Efficiency and Product Innovation Measures
EEP + 0.011** + 0.005* + 0.010* EFRP - 0.012* - 0.007* - 0.001* Controls FS + 0.002 + 0.007* + 0.006** RDI - 0.001** + 0.012** + 0.013** F-value 2.394** 2.466** 3.246*** R square 0.034 0.037 0.042 Adjusted R square 0.020 0.022 0.026 Num. of Obs. 2441 2135 1727
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On the other hand, with regard to resource reduction related measure EEP, all three coefficients are positive and significant, which further supports the result in Table 6. Similarly, results of measure, firm size, is also consistent with the result in Table 6, which further reveals the importance of labor in manufacturing industries. For product innovation related measure, energy footprint reduction policy, EFRP, is shown to be negative in all three models, but the value of coefficient (and they are all significant) gradually decrease along with time. To some degree, it indicates that returns on the EFRP gradually increase and thus the negative effect is reduced. Another innovation related measure, R&D Intensity (RDI), also has a same tendency, but the change of coefficient value is more evident than EFRP. Consider the result in Table 6 together, it shows that the effect of RDI changes from -0.003 (k=0), to -0.001 (k=1), to 0.012 (k=2), and to 0.013 (k=3), and all coefficients are significant. The results reveal that RDI eventually exerts positive effect on CFP even if negative in first two years.
To summarize, as taking time factor into consideration, measures especially innovation associated variables (RDI and EFRP), which initially are negative toward CFP, gradually transforms into (or in a strong tendency to be) advantageous factors. Also, majority of emission reduction related measures gradually turn into positive factors toward financial performance. As for hypothesis h2, these results support that, in the long run, implementing environmental strategies bring economic benefits and also promotes the development of innovation and technologies which are shown to exert positive effect on CFP.
6. Conclusion
The results in this study show that even if choosing to improve environmental performance is inclined to exert negative effect on financial performance in the short run, firms tend to obtain better economic performance in future.
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be positive since the majority are positive. However, limited by the sample of data, this conclusion is not decided enough. More efforts will be paid on this problem in future work.
Furthermore, the measure energy efficiency policy (EEP) shows a strongly positive effect on firms’ financial performance, since all its results are shown to be positive and significant. This finding provides valuable information for decision makers in manufacturing industries: adopting energy efficiency policy is a good choice for firms to improve financial performance. Another important finding is associated with innovation. The results of measures, RDI and EFRP, both reveal similar tendency, which is from negative to positive. This strongly indicates the importance of timing factor in mediating their relationship with financial performance. As for decision makers, this finding suggests that sustained effort in R&D and innovative activities is required and it will pay back with better prospects for the firm. The last finding is apparent that the measure firm size, which is calculated by log of the number of employees, shows a significant and positive relationship with financial performance. It is not difficult to understand since our sample of data is based on manufacturing firms, which are labor intensive.
One thing to note here is that our results are based on the 362 United States manufacturing firms’ data which cannot represent all firms’ situation. In other words, the findings could be valuable for manufacturing industries, but may not be suitable to generalize into other industries.
Acknowledgement
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