The Multidimensionality of CSR: The Effect on Short-term Financial Performance

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The Multidimensionality of CSR: The

Effect on Short-term Financial

Performance

By Frank B. Korf

Thesis Coordinator: Prof. dr. H. Van Ees

Rijksuniversiteit Groningen

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Preface

Completing this thesis will result in obtaining my Doctorandus in International Economics and Business at the Rijksuniversiteit Groningen (RUG). This however will not be the end of my career as student at the RUG. The coming year, I will pursue a MSc in Business Administration. However, graduating in International Economics and Business does represent the end of a very inspiring period in my life.

I would like to express my gratitude to the following people. Firstly, I would like to thank Prof. dr. Hans van Ees for his guidance and instructions during the writing of this thesis. When often I felt lost in all the theory and empirics, his views, insights and comments set out a clear and structured approach. Furthermore, I would like to thank my family, in particular my parents, who have supported me throughout my studies in more ways they probably are aware of. Last but not least, I would like to thank the entire teaching staff of the Economic faculty and my fellow students for enabling me to develop myself intellectually, socially and personally over the past six years.

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Management Summary

The aim of this thesis focused on the identification of the dimensions of CST which have an effect on short-term financial performance, measured as sales. After reviewing the theory, a pattern between the different dimensions and sales is investigated.

Seven dimensions where applied in this research; Community, Corporate Governance, Diversity, Employee relations, Environment, Human Rights and Product. Analysis pointed out that these dimensions are not all separate and independent from each other. The seven dimensions can be distributed over three underlying CSR constructs; Internal Operations CSR, External CSR and Human Capital CSR.

From these three constructs, two were found to have a significant effect on sales. First of all, Human Capital CSR has a positive effect on sales. Higher employee satisfaction and diversity caused by the CSR activities in this construct are given as the explanation. Secondly, Internal Operations CSR also has a significant effect on sales. However, this effect is negative. Internal Operations CSR can be said to be a cost on the short-term. External CSR did not have a significant effect on sales. It was however expected to have both negative and positive effects on sales. The contradicting effects may cancel each other out, causing no significant effect on sales.

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1. Introduction

Corporate Social Responsibility (CSR) has become a much debated topic over the last decades. Traditionally, there are two main perspectives on CSR; the Economic perspective and the Ethical perspective. Economists have been divided over these perspectives, with strong arguments supporting both sides.

The Economic perspective is based on the traditional laws of economics. Friedman is one of the most important scholars advocating the Economic perspective. He states that the only social responsibility a corporation has is to create value and increase its profits. This view can be traced back to Adam Smith’s invisible hand theory. The Ethical view states that a corporation should take into account not just the shareholders but others influenced by the action of the corporation (employees, environment, etc) as well. According to the Ethical view corporations are to do business in such a way that the total benefit for all the stakeholders is at its maximum; indicating that a corporation also has social, often non-financial, responsibilities. Thus where the Economic perspective advocates minimalist public police, the Ethical view expects high performance in the field of CSR.

Recent years have shown that these perspectives might not be as contradictory as they seemed. Where they were believed to be total opposites, recent empirical research tends to conclude other wise. Numerous scholars (e.g. Cochran and Wood, 1984; Hansen and Wernerfelt, 1989; Ingram, 1978; Levy and Shatto, 1980; Spicer, 1978) have shown a positive relationship between performance in CSR and financial performance. The research reveals empirical evidence stating that yielding a high performance in CSR can positively affect the financial performance. According to this research, the Economic view of maximizing the financial returns to the owners requires companies to undertake action to attain high performance in CSR. Thus with high performance in CSR as one of the drivers to profit, in the Economic view, one can conclude these perspectives have come together and now both advocate high performance in CSR.

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the relationship on the short- and long-term. They found that the relationship exists both in the long-term and the short-term. However, no explanation is given for the separate effects (i.e. as to what causes the short-term and what causes the long-term effect). Pirsch et al (2007) suggest that explanation can lie in the different CSR initiatives applied. More specifically, they state that a company can actively pursue short-term results by selecting certain CSR initiatives. Other research (Zarha & LaTour, 1987) already shows that different dimensions of CSR can affect the performance of a company in different ways.

In this thesis, seven dimension of CSR will be used to represent CSR. These are; Community, Corporate Governance, Diversity, Employee relations, Environment, Human Rights, and Product. These seven dimensions are not all independent and can be grouped in three underlying constructs; External CSR, Human Capital CSR and Internal Operations CSR.

This thesis will focus on identifying the constructs which have a short-term effect on financial performance. More abstractly, it will investigate which of the three CSR constructs have an effect on the sales of a company.

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2. Theoretical Framework

Corporate Social Responsibility (CSR)

Emergence of CSR

The concept of CSR can be traced back decades. The business community’s concerns for society have existed far before the theory of CSR has been discussed and defined. One might argue Corporate Social Responsibility has its roots in the late 19th century. In 1882 John D. Rockefeller and companions formed a partnership known as Standard Oil Trust. Driving competition out of business, by 1890 Standard Oil controlled an approximate 88% of all the refined oil flows in the United States.

Also in 1890, the Sherman Anti-trust Act was passed by the Congress. This Act is the source of all anti-monopoly laws in America and states: “"Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal" (Antitrust Division Manual Sherman Antitrust Act, 15 U.S.C. §§ 1-7(1890)). The rationale behind passing the Act was the fact that “the new industrial trusts and corporations had become too powerful, wasted resources, were politically dangerous and socially irresponsible” (McEwan, 2001).The passing of this Act was the beginning of the end for the Standard Oil Trust.

When in 1904 Ida M. Tarbell published her book “The History of the Standard Oil Company” in which she fiercely criticizes Rockefeller’s monopolistic practices, public resistance forced governments to take action.

In 1909 the U.S. Department of Justice filed suit in federal court and forced the Standard Oil Trust to disseminate into thirty-four independent companies.

The dissemination of Standard Oil Trust can be seen as the birth of Corporate Social Responsibility. Due to pressure from the society the government intervened and forced the Trust to operate in a more socially acceptable manner. The passing of the Sherman Anti-trust Act can be seen as the first action in the area of CSR.

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Are businessmen, by virtue of their strategic position and their considerable decision-making power, obligated to consider social consequences when making their private decisions? If so, do they have social responsibilities that transcend obligations to owners or stockholders? The answer to both of these questions is clearly yes. (p4)

His definition of the social responsibility is highly focused on the personal responsibilities of the individual businessman and is formulated as follows;

(...) obligations of businessmen to pursue those policies, to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society. (p6)

In the 1960s the concept of CSR developed into stating that a corporation;

(…) has not only economic and legal obligations but also certain responsibilities to society which extend beyond these obligations. (McGuire, 1963)

Furthermore, McGuire argues a business, and not just a manager, must act “justly” as a proper citizen should (p144).

Definition of CSR

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Though the concept of corporate social responsibility may from time to time be supplanted by various other focuses such as social responsiveness, social performance, public policy, ethics, or stakeholder management, an underlying challenge for all is to define the kinds of responsibilities management and businesses have… (1991)

Carroll splits CSR up in four parts and identifies the following social responsibilities; economic, legal, ethical and philanthropic. To illustrate the hierarchy of these different responsibilities they can be depicted as a pyramid.

Fig 1: The pyramid of CSR (Carroll, 1991)

The Economic responsibilities are depicted as the bottom layer, and the foundation of the other responsibilities. The rationale is that historically the principal role of a business is to create value. Though the Legal responsibilities are depicted as the next layer in the pyramid it is part of the fundaments. Firms are expected to obey the law. The legal responsibilities enforce the ethical norms about justice and fairness.

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employees, shareholders, and the community regard as fair, just, or in keeping with the respect or protection of stakeholders’ moral rights. To be ethical, companies have to go further than as required by law.

The fourth separate responsibility, Philanthropic responsibilities, can be defined as going beyond expectations society has on an ethical basis. For example, a contribution of financial means by a company to a humanitarian program (e.g. Abbott’s AIDS/HIV program in South Africa) is desired by the community but not expected. If the firm would decide not to support the program, it would not be seen as unethical. On the other hand, when the firm decides to contribute it will be viewed as a good corporate citizen.

Summarizing, the definition of CSR used in this thesis is the one proposed by Carroll. He states that:

(…) four kinds of social responsibilities constitute total CSR: economic, legal, ethical and philanthropic. (Carroll, 1991)

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Perspectives on Corporate Social Responsibility

Naturally, a concept which has no clear, general definition will be viewed upon differently by different people. However, taking Carroll’s definition, the perspectives can be split up between the four responsibilities. The main difference between the various perspectives is the emphasis the perspective puts on the separate responsibilities. Using this definition provides two main perspectives on CSR; the Economic perspective, which discards the ethical and philanthropic responsibilities, and the Ethical perspective, which embraces all four responsibilities.

The Economic perspective

According to the Economic perspective, the only social responsibilities a company has are the economic and legal responsibilities. The Economic perspective flows from the Shareholder Theory; managers primarily have a duty to maximize shareholders returns. Nobel Prize-winning Milton Friedman’s publications are seen as the principal documents in the Shareholder Theory. Friedman stresses responsibility to the shareholders;

(…) the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them. (1970)

The argument for the Economic perspective can be traced back to Adam Smith’s mechanism of the invisible hand. Smith argues that better economic performance occurs where capital allocation for production and distribution of wealth operates under conditions of relatively free and competitive markets within minimalist public policy. In essence applying CSR entails a company will distribute (part of) the wealth created, which is seen as suboptimal. Concerning the distribution of wealth, Smith claims the following:

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carried on it as nearly as possible in the proportion which is most agreeable to the interest of the whole society. (1776)

This puts the company out of the equation concerning social responsibilities, since value created will be distributed in the best interest of society without intervention of the company. The next passage out of Friedman’s book Capitalism and Freedom is the essence of the Economic perspective on CSR

(...) there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud. (1962)

The above statement contains both components of the Economic perspective and excludes the rest. It excludes the ethical and philanthropic responsibilities and stresses the economics responsibilities by stating the only responsibility a company has, is to increase its profits. It does put legal responsibilities on the company since the company is expected to abide the law.

The Ethical perspective

The Ethical perspective on CSR implies a company must submit to all four responsibilities, the economic, legal, ethical and philanthropic. In contrary to the Economic perspective, companies are believed to not only have responsibilities towards the shareholders but also towards other stakeholders (such as the community, the environment etc). The Ethical perspective has close ties with the Stakeholder Theory. One of the most thorough explanations of Stakeholder Theory is given by Thomas Donaldson and Lee E. Preston (1995). They present the Stakeholder Theory from 3 approaches; descriptive/empirical, instrumental, and normative.

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… (a) the nature of the firm (Brenner & Cochran, 1991), (b) the way managers think about managing (Brenner & Molander, 1997), (c) how board members think about the interests of corporate constituencies (Wang & Dewhirst, 1992), and (d) how some corporations are actually managed (Clarkson, 1991; Halal, 1990; Kreiner & Bhambri, 1991). (Donaldson & Preston, 1995)

An instrumental approach is hypothetical in essence; it says “to achieve result Y, adopt practices X”. The instrumental approach on Stakeholder Theory focuses on the identification of connections between stakeholder management and the achievement of traditional objectives, such as profit and growth.

The normative approach is categorical, it says; “Do this for it is the right thing to do based on moral and/or ethical grounds”. The normative approach is based on two principles concerning stakeholders:

… (a) Stakeholders are persons or groups with legitimate interest in procedural and/or substantive aspects of corporate activity. Stakeholders are identified by their interest in the corporation, whether the corporation has any corresponding functional interest in them.

(b) The interests of all stakeholders are of intrinsic value. That is, each group of stakeholders merits consideration for its own sake and not merely because of its ability to further the interests of some other group, such as the shareowners. (Donaldson & Preston, 1995)

The normative approach is the more general grounds of the Stakeholder theory. Donaldson and Preston state;

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CSR – Financial Performance (FP) Relationship

Perspectives on CSR and the CSR-FP relationship

The classical ideas on this relationship assume a negative relationship between CSR and financial performance. Economists adhering to the Economic perspective on CSR often see this as an argument for the Economic perspective. According to the classical ideas on the relationship a manager is “spending someone else’s money for general social interests” (Friedman, 1970). An even stronger opinion stems from Theodore Levitt, a Harvard Business Review editor, who argues that the absence of social responsibilities - ethical and philanthropic - is economically beneficial. He states:

With none of the corrosive distractions and costly bureaucracies that now serve the pious cause of welfare, politics, society, and putting up a pleasant front, with none of this draining its vitality, management can shoot for the economic moon. (Levitt, 1958)

Thus, the Economic perspective predicts CSR to have a negative impact on the financial performance of corporations. It sees the ethical and philanthropic responsibilities as draining energy and profits from the corporation’s resources.

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The empirics of the CSR-FP relationship: Both perspectives get what they want? Motivated by the theoretical predictions concerning the relationship between CSR and financial performance, many scholars empirically investigated this relationship (e.g. Abbott & Monson, 1979; Dooley & Lerner, 1994; Greening, 1995; Herremans et al., 1993). The results were mixed at best, some scholars found a negative relationship, others concluded a neutral relationship exists, and some find proof for a positive relationship between CSR and financial performance. To get a clear idea of what the bulk of the research states about the relationship Orlitzky et al (2003) conducted a meta-analysis of 52 different studies on this relationship. The total sample size adds up to 33,878 observations. The main hypothesis formulated by Orlitzky et al is:

H1: Corporate social performance and financial performance are generally positively related across a wide variety of industry and study contexts. (2003)

The meta-analytic findings support this hypothesis. The mainstream of the research articles investigated show a positive relationship between CSR and financial performance. The outcome has two main implications. Firstly, market forces generally do not penalize firms with high performance in CSR. Therefore, managers can afford to be socially responsible. Secondly, CSR can be used strategically to attain a high financial performance.

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The Ethical perspective itself is not so much affected by the empirics. However, the supporters of the Ethical perspective can use the empirics as ammunition in their efforts to put ethical and philanthropic responsibilities on the corporate agenda.

All in all, one might say that the empirical evidence causes the perspectives on CSR to argue the same concerning CSR. With these facts uncovered, now both perspectives must advocate high performance in CSR; the Economic perspective based on profit maximization and the Ethical perspective on moral grounds. Even though both perspectives advocate different objectives, high performance in CSR can cause both of the objectives to be attained simultaneously.

Explaining the CSR-FP Relationship: Stakeholder theory

The positive relationship that exists between CSR and FP can be explained by the instrumental approach to the Stakeholder Theory. Donaldson and Preston (1995) state:

Instrumental uses of stakeholder theory make a connection between stakeholder approaches and commonly desired objectives such as profitability. (Donaldson & Preston, 1995)

Explaining the relationship between CSR and FP through the Stakeholder theory, entails adding the stakeholders as a mechanism. Firstly, one must define how CSR affects stakeholders. Secondly, the effect stakeholders (can) have on FP must be revealed. This will be done by applying the stakeholder role in the business environment as proposed by Wood and Jones (1995) and the Resource dependency theory (Pfeffer & Salancik, 1978).

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(1) set expectations; (2) experience effects; (3) evaluate outcomes; and

(4) act on these evaluations (Wood & Jones, 1995)

The role of the stakeholders proposed by Wood and Jones (1995) show that stakeholders develop expectations and evaluate to what extent the corporation has met the expectations set by the stakeholders. Every stakeholder may have several expectations and the expectations differ for the various stakeholders. For example, employees will expect good working conditions, where society expects the company to be environmentally friendly. The resource allocation decision of stakeholders is influenced by how the company meets their expectations. This entails that a corporation needs to convince the stakeholders of their ability to meet these expectations and leave a positive image in the minds of the stakeholder if they want to continue to benefit from the resources provided by the stakeholder. This is where the activities in CSR come in to play. Taking the Ethical perspective, the core of CSR is to positively impact all stakeholders, which in effect will influence them to make their resources available to a company.

The Resource dependence theory (Pfeffer & Salancik, 1978) is the basis to explain the influence of the stakeholders on the financial performance. Pfeffer and Salancik (1978) state:

Because organizations are not self-contained or self-sufficient, the environment must be relied upon to provide support. For continuing to provide what the organization needs, the external groups or organizations may demand certain actions from the firm in return.

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depends. Therefore, the stakeholders can be identified as agents that influence the financial performance of the corporation.

Thus CSR can influence a stakeholder’s decision to make the resources, upon which a company is dependent, available and thus influence the financial performance of a corporation.

CSR-FP: The short-term effect

Based on Orlitzky’s meta-analysis it can be stated that the empirics generally show a positive link between CSR and FP. McWilliams and Siegel (2000), claim that most research on the CSR and FP relationship can be categorized in two types of studies, short-term and long-term. They state:

One set of studies uses the event study methodology to asses short-run financial impact (abnormal returns) when firms engage in socially responsible or irresponsible acts (…) A second set of studies examines the nature of the relationship between some measure of corporate social performance, CSP (a measure of CSR), and measures of long-term firm performance, using accounting or financial measures of profitability. (McWilliams & Siegel, 2000)

Much of prior research has either searched for short- or long-term effects, very few have, consciously, done both. Ruf et al (2001) have taken a dual approach, both investigating short- and long-term effects of performance in CSR and FP. The aim of their research is as follows:

(…) the study investigates the relationship between changes in CSP (Corporate Social Performance) and concurrent and subsequent changes in financial performance. (Ruf et al, 2001)

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Pirsch et al (2007) suggest that the explanation can lie in the selection of the CSR initiatives applied by the company. For short-term results they state that companies can apply Promotional CSR programs which

(…) are defined as focusing on using CSR initiatives primarily as a tool to drive product sales (through such programs as cause-related marketing, for example). (…) are primarily designed to capture attention at point of purchase and generate product trial, focusing more on driving sales through positive purchase intention (…).(Pirsch et al, 2007)

Thus according to Pirsch et al (2007), a company can apply a CSR program in such a way that it will be focused on short-term performance by selecting certain CSR initiatives. Ruf et al (2001) do indeed find short-term results, but due to the use a composite measure of CSR, combining several dimensions of the KLD Socrates database, they cannot identify whether there are certain dimensions that cause this effect

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CSR Dimensions and Short-term Financial Performance

Multidimensionality of CSR

CSR has consistently been treated as a multidimensional construct, but in different manners. Carroll (1991) addresses the multidimensionality by composing CSR out of four different social responsibilities; Economic, Legal, Ethical and Philanthropic responsibilities. Clarkson (1995) constructs the dimensions of CSR based on the different stakeholder groups surrounding the company. Others (Abbot & Monsen, 1979; Zahra & LaTour, 1987) base their dimensions on social areas of interest such as environment, personnel, community involvement etc.

In research, the multidimensionality has given rise to different research designs concerning the measurement of the performance in CSR. The importance of identifying the various dimensions of CSR in the measurement of the performance in CSR is addressed by Ruf et al (1998). They state:

A measure of CSP should: (1) be responsive to a variety of factors that constitute social responsibility, (2) be independent of the characteristics of the organization (…). To satisfy the first two requirements, it is necessary to select the CSP dimensions which reflect the individual constructs of social performance. The selection of these dimensions should not be influenced by the specific entities being evaluated, rather they should accurately portray the prevailing societal norms. (Ruf et al, 1998)

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(…) these studies do not capture firms’ social performance as they “inadequately reflect the breadth of the construct” (Griffon & Mahon, 1997, p25) and thus lack an appropriate level of validity. (Rowley & Burman, 2000)

Their criticism on the aggregate measure is formulated as follows:

(…) by aggregating multiple dimensions into a composite measure, much of the meaning and richness in the data is lost. (Rowley & Burman, 2000)

A common problem presented by Rowley and Burman (2000) for the two measures entails difficulties in comparing research. Single-dimension research, which base total CSR performance on different dimensions, are not comparable. Neither is aggregate measure research, since often the aggregate is based on different dimensions. Rowley and Burman (2000) warn for the loss of meaning due to aggregation of the dimensions in a composite measure.

Zarha and LaTour (1987) acknowledge the multidimensionality of CSR and the potential difference in effects these dimensions may have on a company’s performance. One of their main objectives is:

(…) to test the proposition that specific aspects of CSR impact certain OE (Organizational Excellence) dimensions while not affecting others. (Zarha & LaTour, 1987)

They identified eight dimensions of CSR and three for OE. Using canonical analysis of survey data collected from university graduate students, they came to the following conclusion;

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misleading. Instead, the task for scholars is to pinpoint CSR areas which lead to significant improvements in the performance of a given OE dimension. (Zarha & LaTour, 1987)

Zarha and LaTour (1987) use three dimensions to encompass OE. These are Entrepreneurial viability, Satisfying needs of the public, and Profitability and Growth. They found that only three out of the 8 dimensions used to encompass CSR had a significant effect on the financial dimension of OE, Profitability and growth. These were Government regulations, philanthropy and religious awareness.

The results from Zahra and LaTour (1987) entail that different dimensions of CSR can have different effects on the performance of a company. This strengthens the statement from Rowley and Burman (2000) that by aggregating the dimensions into one composite measure will lead to the loss of valuable information.

In this thesis, seven dimensions will be used to encompass total CSR. Following the KLD Socrates database the following dimensions are selected:

• Community (e.g. charitable giving, volunteer programs)

• Corporate Governance (e.g. limited compensation for top management)

• Diversity (e.g. promotion of women and minorities, employment of the disabled)

• Employee relations (e.g. profit sharing, retirement benefits) • Environment (e.g. pollution prevention, recycling)

• Human Rights (e.g. labor rights)

• Product (e.g. innovative leader, quality control)

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control of and restraint in the production process and the management of the company. The remaining three dimensions, Community, Environment and Human rights, are aimed externally. Generally, these dimensions can be said to respect cultures, the well-being of the planet and all its inhabitants.

This intuitive categorization will be statistically tested as well. It will be investigated whether all dimensions are independent or whether some can be grouped to explain an underlying construct.

Short- term Financial Performance

The Stakeholder theory has been applied before to explain the positive relationship between CSR and FP. It is stated that stakeholders decide to make resources, upon which a company is dependent, available and therefore influence the financial performance of a company. It is also said that, through CSR, companies can influence this decision made by stakeholder. This entails that central to the relationship is the stakeholder response to the CSR efforts of a company and this response results in higher financial gains. Therefore, the stakeholders’ responses will be representing Financial Performance in this paper. More specifically, the response by the consumer stakeholder group will be the indicator for Financial Performance. The reasoning behind this is provided by Pirsch et al (2007) state that even when the CSR programs are targeted at non-consumer stakeholders the consumer will evaluate the company on those programs as well.

For example, while employee diversity may not directly affect the consumer of a company’s product, the presence of this policy is likely to be regarded as a positive in the consumer stakeholders’ eyes. (Pirsch et al, 2007)

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(…) purchase intentions are often used as a predictive measure of subsequent purchase behavior. (1992)

This thesis will take the actual behavior of the consumer, measured by sales, as the short-term financial measure.

The CSR Dimensions and Sales

The effects of the dimensions on sales will differ. Branco and Rodrigues (2006) propose that CSR has two types of benefits, external benefits and internal benefits. Firstly, concerning the external benefits of CSR, Branco and Rodrigues suggest the following:

The external benefits of CSR are related to its effect on corporate reputation. Firms with good social responsibility reputation may improve relationship with external actors such as customers, investors, bankers, suppliers and competitors. (2006)

Brown and Dacin (1997) find a similar external effect by arguing that the consumers’ evaluation of a company’s products is influenced by CSR as a whole. They state:

(…) the primary influence of CSR associations comes through their influence on the corporate evaluation. (Brown & Dacin, 1997).

The effect on sales, through reputation, is however more probable on the long-term than on the short-term. According to Fombrun reputation is:

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From this one can deduct that the reputational effect of current activities will take place on the long term, since it is based on “a company’s past actions”. Moreover, concerning reputation and the effect on financial performance, Wilson states:

(…) reputations are assets in which individuals and firms invest, requiring to trade short-term pay-offs for long-term benefits. (1985)

It is therefore, that the external benefits of CSR as proposed by Branco and Rodrigues (2006) are not expected to have an influence on the short-term and therefore will not positively affect current year sales. On the contrary, it is expected that dimensions which only exert these external benefits will have a negative influence on sales. Levitt states that CSR activities are ‘corrosive distractions and costly bureaucracies’ (1958), and applying these will use valuable resources from the company. These resources are then not available for sales-generating activities.

Secondly, Branco and Rodrigues state that there are internal benefits of CSR, which are the following:

Investments in socially responsible activities may have internal benefits by helping firms to develop new resources and capabilities that are related to know-how and corporate culture. (Branco & Rodrigues, 2006)

They find that human resource activities are strong in internal benefits, viewing the employees as a valuable resource.

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The two dimensions, Diversity and Employee relations, with the focus on the human capital in the company, can be said to both have internal and external benefits. The two dimensions consist of CSR activities improving employee relations and workforce diversity. Examples for employee relations activities are cash profit-sharing programs and employee involvement policies. As for diversity, activities include promotions of women and minorities and employment of the disabled.

Branco and Rodrigues (2006) also suggest that human resource activities have strong internal benefits. The employees are a valuable resource and through human resource activities can be made into more motivated and diverse workforce.

Since ‘a company depends on its employees (…) relationships with other stakeholders to create and deliver value’ (Focus Report in Business and the Environment, 2004), it depends on its employees to sell their products to consumer and to provide customer support. The employee relations activities are aimed at increasing employee satisfaction. Activities to ensure employee satisfaction can be useful to ‘attract and retain highly skilled employees’ (Johnson, 2003). Furthermore, it can ‘increase current employees’ motivation, morale, commitment and loyalty to the firm’ (Branco & Rodriguez, 2006). Thus these activities can help build a highly skilled and motivated labor force. This can lead to superior customer service and superior selling-efforts, in turn leading to higher levels of sales.

Through activities that promote diversity in the labor force, a company can also gain a competitive advantage. Cox states:

Organizations may increase their number of women and racioethnic minorities to better match the demographic characteristics of their significant customers in order to achieve a competitive edge in the market. (1994)

Also a similar argument as for employee relations applies for the diversity activities;

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Diversity activities may thus have an effect on sales through a better match between employees and consumers and through employing highly skilled people from all races, ethnicity and gender.

In line with the discussion of the two dimensions of CSR focused on human capital and their potential effect on sales, the following proposition is formed:

Proposition 1

The dimensions focused on human capital (Diversity and Employee relations) will have a positive influence on sales.

The next group of dimensions that will be discussed are the dimension with the internal focus on operations; Corporate governance and Product. These dimensions are expected to only exert external benefits, meaning that there will be a reputational effect. These CSR dimensions are aimed at the internal fairness and justness of the company. They ensure that the management of the company is done right and that the production process is controlled. This may influence the consumers’ evaluation of a company, thus leading to a better reputation of the company. Or, the effects of not assuring good corporate governance can have a severe detrimental effect on reputation, consider for example the Enron scandal which severely harmed their corporate reputation.

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Proposition 2

The dimensions aimed at the operations of a company, Corporate governance and Product, will have a negative influence on sales

The third and final group of dimensions, Community, Environment and Human rights, with the external focus are expected to have the same benefits as the internal operations focused dimensions. Thus, the expected benefits are external, reputational benefits which will pay off in the long run. It is therefore that the expected effect on sales will also be negative. However, these dimensions with the outward focus can have better visibility for the consumers. Often, a number of activities within the above mentioned dimensions are used as marketing and advertising tools. Cause-related marketing (CRM) is just one of the examples. CRM is used when a firm communicates their affiliation or work with non-profit organisations or support for charities. CRM is often used to “enhance image” (Brønn & Vrioni, 2001) but it is also said to “most directly enhances financial performance” (Mullen, 1997). Another example is environmental advertising where the company expresses their concern for the environment and the activities it has undertaken to demonstrate this concern (Davis, 1994). Companies such as BP, Ford and General Motors apply such advertising. This makes these activities more visible and possibly shortening the time it takes to accrue some benefits from these specific activities. The above entails that generally the dimensions are expected to have a negative effect, but some activities may have some influence on the short term through advertising. From this the following proposition is formed:

Proposition 3a

The dimension with an external focus, Community, Environment and Human rights, will have a negative effect on sales

Proposition 3b

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3. Research Objectives

This thesis is aimed at exploring the dimensions of CSR and their effect on short-term financial performance, measured as sales. The dimensions have been intuitively categorized based on the focus of the dimensions. To investigate whether the dimensions can be grouped to represent underlying constructs a factor analysis will be applied. Concerning the effect of the groups of dimensions on sales the following propositions will be explored:

Proposition 1

Proposition 2

Proposition 3a

Proposition 3b

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4. Methodology

According to Collis and Hussey (2003) there are four types of research; exploratory, descriptive, analytical and predictive research. They state that exploratory research is applicable when:

(…) there are very few or no earlier studies to which we can refer for information about the issue problem. The aim of this type of study is to look for patterns, ideas or hypotheses, rather than testing or conforming a hypothesis. (Collis and Hussey, 2003)

Up to this point, there is no prior research to which can be referred and/or be used to construct hypotheses concerning the different dimensions and their potential short or long-term effect on financial performance. Therefore, investigating the different effects of different CSR dimensions on the timeline of the CSR-FP relationship will be exploratory.

Sample

The sample used in this study consists of 195 companies from the manufacturing industry. All companies in the sample operate in the United States market. The data gathered from this sample is from the year 2000. The sample size has been determined by taking all matching companies from DataStream and the KLD Socrates database. With the manufacturing industry and the United States as market of operations as selection criteria, 195 companies remained after cross-referencing between the two databases.

Variables

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Corporate Social Responsibility Dimensions

Seven broad dimensions will be used to construct the general CSR policy. These are the following;

• Community (variable name: COM-score)

• Corporate Governance (variable name: CGOV-score) • Diversity (variable name: DIV-score)

• Employee relations (variable name: EMP-score) • Environment (variable name: ENV-score) • Human Rights (variable name: HUM-score) • Product (variable name: PRO-score)

The seven dimensions will be measured based on the Socrates Database which is constructed by KLD Research & Analytics.

The Socrates Database is often used as a measure of CSR (e.g., Agle et al., 1999; Berman, Wicks, Kotha, & Jones, 1999; Hillman & Keim, 2001; Waddock & Graves, 1997) and has been tested on validity (Sharfman, 1996). Concluding the validity testing, Sharfman states:

(…) researchers interested in studying corporate social performance now can have confidence in the KLD measures and feel secure in the idea that this new data does tap into the core of the social performance construct. (1996)

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assigned. This entails that companies are scored separately for each dimensions of CSR, thus keeping the information that may be lost when aggregating these into one aggregate score (Rowley & Burman, 2000).

As stated before, these dimensions can be grouped according to their focus of their efforts. Therefore, it will be investigated whether the dimension can be grouped to reveal underlying constructs or that they are separate, independent constructs on their own.

Firstly, the correlations among the seven dimensions are investigated. Table 1 depicts the correlations found among the CSR dimensions.

1 2 3 4 5 6 7 1. COM-score 1,0000 2. CGOV-score 0,0130 1,0000 3. DIV-score 0,2200 -0,2170 1,0000 4. EMP-score 0,0630 -0,1370 0,2120 1,0000 5. ENV-score 0,2730 0,3580 -0,1040 -0,0190 1,0000 6. HUM-score 0,2640 0,1900 0,0050 -0,0670 0,3360 1,0000 7. PRO-score 0,0910 0,2350 -0,2530 0,0830 0,4640 0,0760 1,0000

Note: Bolded values indicate correlations significant at the .01 significance level

Table 1: Pearson Correlation analysis

The above table shows that there are many significant correlations between the CSR dimensions. Even though, the correlations do not show extremely strong relations, it does justify investigating the independency of the dimensions further.

Based on the correlations found, the second step of investigating the dimensions will be investigating the possibility to combine the seven dimensions into fewer, more general dimensions. Therefore, it will be tested whether the data is suitable for factor analysis, since factor analysis;

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To test whether factor analysis is appropriate, two tests will be applied. Firstly, the Kaiser-Meyer-Olkin measure of sampling adequacy will be determined. The KMO-measure indicates the proportion of variance in the variable which is common variance, i.e. which might be caused by underlying factors. The value of the KMO-measure should be at least above 0.50 (Hair et al, 2006). The second test is the Bartlett’s test of sphericity, which examines the entire correlation matrix. It provides the statistical significance that the correlation matrix has significant correlations among at least some of the variables. More strictly, it tests whether the correlation matrix is an identity matrix. The table below shows the results of the two above mentioned tests.

Kaiser-Meyer-Olkin Measure

of Sampling Adequacy 0,606 Bartlett's Test of Sphericity 0,000 -Sig.

Table 2: Testing suitability for Factor analysis

There are two main methods for factor analysis, the Principal Components Analysis and Principal Axis factoring, or Common Factor Analysis. The choice of methods depends on the goal of the factor analysis.

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among observed variables then reflect the influence of latent variables. (Widaman, 1993)

Obviously, the goal of the factor analysis in this paper is to discover underlying constructs, or latent variables. Therefore, Principal Axis Factoring or Common Factor Analysis will be applied.

Establishing the number of factors to be extracted will be the first step in the factor analysis. There is no one rule to make the decision how many factors should be extracted. However, several rules of thumb can be employed determine this number. This paper will use two of these rules of thumb; extract factors with eigenvalues above 1, and accumulated total variance explained must be above 60%. Table 3 shows the results for the data used.

Factor Total % of Variance Cumulative %

1 2,023 28,9% 28,9% 2 1,441 20,6% 49,5% 3 1,088 15,5% 65,0% 4 0,749 10,7% 75,7% 5 0,699 10,0% 85,7% 6 0,573 8,2% 93,9% 7 0,427 6,1% 100,0% Initial Eigenvalues

Table 3: Eigenvalues and Variance Explained

Applying, the rules of thumb would imply extracting 3 factors.

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1 2 3 COM-score 0,03 0,52 0,22 DIV-score -0,34 0,22 0,52 EMP-score 0,09 -0,03 0,45 ENV-score 0,54 0,56 -0,12 HUM-score 0,06 0,53 -0,14 CGOV-score 0,30 0,23 -0,35 PRO-scrore 0,80 0,07 0,03 Factor

Table 4: Rotated Factor Matrix

The bolded values are the highest factor loading for each variable. A bolded value thus means that the variable is most represented in this factor. From table 4 we can read how the variables are assigned to the different factor.

Factor 1 contains: • Corporate Governance • Product Factor 2 contains: • Community • Environment • Human Rights Factor 3 contains: • Diversity • Employee relations

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The factor analysis has two important implications. Firstly, it shows that the seven dimensions cannot be combined into one factor/variable, meaning that the dimensions really do address different areas of CSR. This strengthens the expectation that multidimensionality can be an explanation of different effects on FP on the short and long-term. Secondly, the seven dimensions are not all unrelated. From the seven variables, three factors can be constructed. This entails that not all dimensions must be seen as separate, but some must be combined since the (mostly) measure the same concept. The three constructs that were revealed through this analysis confirm and justify the prior intuitive grouping of the dimensions.

Therefore, for the remainder of the research the seven dimensions of CSR will be replaced by the three underlying constructs (Internal Operations CSR, External CSR, and Human Capital CSR) discovered through the factor analysis. To enable this, factor scores were calculated using the regression method.

Short-term Financial Performance

As stated before, short-term financial performance will be measured by sales. The data will de extracted from DataStream

Control Variable

In general CSR-FP relationship research there are three main control variables mentioned, size, risk and industry (e.g. Ullman, 1985; Waddocks & Graves, 1997). However, the only relevant control variable for this research is company size. The size of a company can be expected to have a large influence on the sales of a company. The industry control variable is not applicable due to the fact that all firms in the sample belong to the same industry (manufacturing). The risk control variable is not so much relevant due to the fact that the risk control variable is more directed at the potential influence of shareholders and cannot be expected to have an influence on the purchasing behavior of consumers.

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5. Analysis

Regression equation

A linear regression model, based on OLS, will be estimated to unveil the potential effect of different CSR constructs on the short-term financial performance measure, Sales. The following regression equation will be estimated:

SIZE

HCC

EC

IOC

SLS

=

β

₀

+

β

₁

+

β

₂

+

β

₃

+

β

₄ = SLS Sales

IOC = Internal Operations CSR EC = External CSR

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Outlier detection and deletion

Before commencing with the regression analysis, the dependent variable will be investigated for outliers. A boxplot will be used to check whether outliers are present in the data. Sales 2000 2,5E8 2E8 1,5E8 1E8 5E7 0E0 73 84 76 82 62 111 92

Figure 1: Boxplot dependent variable sales

From the boxplot it can be concluded that there are many outliers present. In total 20 cases are identified as an outlier, using the following formula:

IQR

Q

SLS

Obs

(

)

>

₃

+

1 .

5

Where Q3 is the third quartile and IQR is the interquartile range, equalling Q3 - Q1.

Q1 1491190

Q2 4286000

Q3 9564412

IQR _8073222

Table 5 Quartiles and the Interquartile range

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Correlations and Regression

With the outliers deleted, now the correlations among the variables are calculated. Checking the correlations will help to determine whether there is a possible relationship between the dependent and independent variables.

1 2 3 4 5 1. SLS 1,000 2. SIZE 0,771 1,000 3. IOC -0,293 -0,319 1,000 4. EC -0,048 -0,110 -0,008 1,000 5. HCC 0,309 0,170 0,063 0,224 1,000

Note: Bolded values indicate correlations significant at the .01 significance level

Table 6: Pearson Correlation analysis

This table (i.e. the bolded values) shows that there is reason to expect a relationship between the dependent variable (SLS) and the independent variables. Furthermore, it can be concluded form the above table that multicollinearity is not an issue in this dataset. All correlations between the dependent variables do not exceed the 0.700 mark (Tabachnick & Fidel, 1996), which entails multicollinearity is not present.

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- 4 2 -Regression Analysis Independent variable: SLS Model Summary R 0,743 R Square 0,552 Adjusted R Square 0,542

ANOVA- significance testing of the model

Sum of Squares df Mean square F Sig.

Regression 2,10756E+15 4 5,2689E+14 52,38781 0,000

Residual 1,70977E+15 170 1,00575E+13

Total 3,81733E+15 174

Coefficients

Standardized Coefficients

B Std. Error Beta t Sig.

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To asses the goodness of fit of the model to the data, two figures are important. Firstly, the Adjusted R square, which reflects the proportion of variation in the dependent variable explained by the estimated model. For this model the Adjusted R square is equal to 0.542, which especially for exploratory research, is a sign that the model fits fairly well. The second important figure is significance value of the F-statistic from the ANOVA test. The value is smaller than 0.05, which means that the independent variables do explain (part of) the variation in the dependent variable. All in all, the two figures show a fairly high goodness of fit.

The regression equations can be constructed using the coefficients outcomes presented in table 7. Due to the exploratory nature of this research, variables with a significance value smaller than 0.10 will be included in the model. This entails that three independent variables will be included in the equation; SIZE (p<0.01), HCC (p<0.01) and IOC (p<0.10). The fourth variable EC (p>0.10) will be excluded from the equation. Furthermore, the regression equation will be constructed using the standardized coefficients, to facilitate the interpretation of the formula. This means that the constant will be equal to 0 and the absolute influence of the independent variables will be lost. Since the objective of the research is to identify patterns, the standardized coefficients will suffice in determining in what manner the dependent variable is influenced by the independent variables. Following the above mentioned, the regression equation is as follows

IOC

HCC

SIZE

SLS

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6. Discussion

Two different analyses were performed in this thesis. Instead of straightforwardly accepting and applying the seven KLD dimensions of CSR, a factor analysis was performed in search of underlying constructs. This revealed that the seven different dimensions can be divided into three underlying constructs; Internal Operations CSR, External CSR and Human Capital CSR. A regression analysis was then performed to determine how and if these constructs have an effect on the short-term financial performance. The results will be discussed by the propositions.

Proposition 1

The regression analysis shows the Human Capital CSR construct to have a positive effect on a company’s sales (standardized coefficient 0.212), thus Proposition 1 is confirmed. Human Capital CSR was also the construct with the most significant effect (t=3.911). The positive effect is expected to be derived from the internal benefits which human resource activities give rise to. By applying the Human Capital CSR, the company can construct a highly skilled and motivated labor force, and better match its demographics to their target consumers.

Proposition 2

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costly bureaucracies’ (1958), and applying these will use valuable resources from the company. From the results of this analysis it seems that, in the short-term, Levitt could be right.

Proposition 3a

Proposition 3b

The negative effect of the external focussed dimension will be smaller than the negative effect of the internal operations focussed dimensions.

The analysis cannot confirm Proposition 3a; the External CSR construct does not have a significant effect on a company’s sales numbers. As for Proposition 3b, it can be argued to be confirmed. It also expected a negative effect for External CSR, but the effect is expected to be smaller than the negative effect of Internal CSR. The analysis shows that External CSR does not have an effect at all, thus it has no negative effect on sales where Internal CSR does. Therefore, the results are in line with Proposition 3b.

The reason there is no effect could be that the positive and negative effects of External CSR, as explained before, cancel each other out. It was stated that the general effect on sales would be negative due to the external, reputational benefits, but some activities (CRM and environmental advertising) could cause a positive effect. However, based on these results this remains speculation.

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7. Conclusion and Implications

Over the years, many scholars have investigated the relationship between CSR and FP. Overall, a positive relationship between CSR and FP has been established (Orlitzky, 2003). Both in the short and long run, the relationship held up, making CSR a strategic weapon to increase the financial performance in the business society. However, little was known how CSR affects financial performance, especially how CSR in some cases has an effect on short-term financial performance and in others on long-term financial performance.

This aim of this thesis was to investigate which CSR dimensions will produce short-term financial results. It attempted to look for a pattern between different dimensions and their effect on short-term financial performance. Seven dimensions were employed to cover CSR; Community, Corporate Governance, Diversity, Employee relations, Environment, Human Rights and Product. A factor analysis (Principal Axis Factoring) revealed that these seven dimensions were to be distributed among three underlying CSR constructs; Internal Operations CSR, External CSR and Human Capital CSR. From these three constructs, only two were found to have a significant effect on a company’s sales.

Human Capital CSR was the only CSR construct to have a positive effect on sales. It can be concluded that the CSR activities aimed at human capital will cause a rise in the sales of a company. The reasoning behind this stem from higher employee satisfaction and diversity. The CSR activities enable a firm to develop a highly skilled and motivated labor force. Additionally, through advocating diversity in the labor force, a better match with the consumer demographics can be attained.

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reputational benefits assigned to this construct, these costs could be justified through effects financial performance on the long run. Therefore, it cannot be concluded that Internal Operations CSR is per definition a cost, but it is a cost in the short run.

As for the External CSR construct, no significant effect could be revealed. As stated before, it could be the case that potential positive effects caused by CRM and environmental advertising are offset by the same negative effect as is the case for Internal Operations CSR.

This research confirms the expectation that there does exist a pattern between different dimensions of CSR on short-term financial performance. The different CSR construct all have a different effect on the sales of a firm. One has a positive effect, the other a negative, and the third has no effect.

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8 Limitations and Future Research

There are several limitations to the research conducted in this paper. First of all, short-term financial performance is reflected by sales. This entails that only the reaction of once stakeholder, the consumer, on CSR is measured. Taking the response of only one stakeholder group (consumers) may not fully grasp the effect the CSR constructs have on financial performance. Subsequent research should be focused on other stakeholder responses on CSR.

Secondly, this research has focused only on the short-term financial results. No conclusion can be drawn on the potential long-term effect the CSR constructs may have. For example, the negative influence of Internal Operations CSR on the short-term does not entail that Internal Operations CSR has a negative effect overall. The detrimental effect it may have on current year sales may well be made up for by sales in subsequent years. Potentially, it has an effect on customer loyalty, generating sales over a longer stretched period of time. Future research should focus on also trying to establish the long-term effects of the three CSR constructs on the financial performance of a firm. This would help identifying constructs with a stronger short-term effect and the ones with a stronger long-short-term effect.

A third limitation concerns the industry from which the sample is drawn. The companies from the sample all operate in the same industry. This makes the results hard to generalize. Based on this research the conclusion drawn can only be applied in the Manufacturing industry. Future research can be directed to asses the relationship between the CSR constructs and financial performance in other industries.

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The Multidimensionality of CSR: The Effect on Short-term Financial Performance