THE IMPACT OF COMMUNITY INVOLVEMENT AND DEVELOPMENT (CID) ENGAGEMENT ON FIRMS’ FINANCIAL PERFORMANCE

THE IMPACT OF COMMUNITY INVOLVEMENT AND DEVELOPMENT

(CID) ENGAGEMENT ON FIRMS’ FINANCIAL PERFORMANCE

University of Groningen Supply Chain Management

Master Thesis

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st

_{Supervisor: Dr. X. (Bruce) Tong}

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nd

Supervisor: Prof. Dr. K.J. (Kees Jan) Roodbergen

February 2020

Baris Demir S3792994

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Acknowledgments

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List of Figures

Figure 1: Conceptual Model ... 16 Figure 2: Illustration of the Time Horizon ... 22

List of Tables

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Content

1 Introduction ...4

2 Literature Review ...7

2.1 CID under Corporate Social Responsibility ...8

2.2 The Relationship between CSR and CFP ...9

2.3 Firm Reputation under CSR ... 10

2.4 Type of CID Investments ... 11

3 Theory and Hypotheses Development ... 12

3.1 CID and Firm Market Value ... 12

3.2 CID and Labor Productivity ... 13

3.3 The Influence of Firm Reputation on the Relationship between CID and CFP ... 14

3.4 The Influence of Social Investment in Education on the Relationship between CID and CFP 15 4 Data Description ... 16

5 Methodology ... 18

6 Empirical Results ... 22

6.1 Analysis of the Impact on the Market Value – Hypothesis 1 ... 22

6.2 Analysis of the Impact on Labor Productivity – Hypothesis 2 ... 23

6.3 Analysis of the Influencing Effect of Firm Reputation – Hypothesis 3 ... 24

6.4 Analysis of the Impact of Social Investment in Education – Hypothesis 4 ... 26

7 Discussion ... 29

8 Conclusion and Future Research ... 32

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Abstract

This research aims to investigate the relationship between engagements in Community Involvement and Development (CID) initiatives and Corporate Financial Performance (CFP). In this research, the CFP of US firms is measured at the market-based and the accounting-based level. The two influencing effects of firm reputation and social investment in education with a direct impact on a firm’s financial performance are examined afterwards. This research is conducted by a short-term event study to identify an immediate stock market reaction, and a long-term event study to investigate the impact of CID on a firm’s labor productivity. Using data derived from 100 CID initiatives announcements between 2009 and 2017, the findings suggest that CID initiatives are associated with statistically significant negative Abnormal Returns (ARs) at the US stock market, while the long-term event study indicates statistically significant positive Abnormal Performances (APs). The stock market reaction, however, is negatively influenced by a higher firm reputation, which is assessed by the Fortune Most Admired Companies (FMAC) survey. Moreover, this research demonstrates that shareholders systematically depreciate CID initiatives, regardless of the type of investment.

Keywords: corporate social responsibility; shareholders; abnormal returns; abnormal performance;

firms’ market value; firm’s labor productivity.

1 Introduction

5 Responsibility (2006), which not only addresses the importance of responding to stakeholders’ demands but also integrates business principles with moral objectives. CSR is defined as “achieving commercial success in ways that honor ethical values and respect people, communities and the natural environment” (White, 2006, p. 6). ISO 26000, the international standard, provides a compelling direction for firms to assess and improve social responsibilities and determines Community Involvement and Development (CID) as one core subject of CSR (Schmidt et al., 2016).

The following research uses CID initiatives to shed light on the specific dimension of broad CSR practices. CID categorizes actions that benefit communities, among job creation, skill development, and the provision of health, welfare, and other services that should be integrated into business models of firms (Schmidt et al., 2016). For example, the pharmaceutical company Abbott Laboratories has engaged a CID initiative fighting malnutrition in Haiti by providing voluntary capabilities, technical advice, and US$10 million in funding to support nutrition factories (Abbott, 2018). The initiative also supported the local economic development by providing new skills and expertise in farming to improve the product quality that positively affects the incomes of local farmers (Abbott, 2018). However, the ambition of compensation rewards has expanded during a shift from corporate philanthropy based on altruism to a more intimate relationship between firms and the provided community in the last decades (Austin, 2000). Engaging firms are expecting public recognition and economic reward benefits throughout the engagement (Seitanidi & Ryan, 2007), which turned CID initiatives into a business strategy to achieve competitive advantage on different levels by taking the interests of various stakeholders into account. The Instrumental Stakeholder Theory (IST) suggests that CID initiatives help firms to establish a competitive advantage through trustworthy stakeholder relationships (Barnett, 2007; Jones et al., 2018). Trust reflects partner reliability and faithfulness, so viewed as the generic opportunism-deterring mechanism (Larson, 1992; Moran, 2005 in Y. Kim & Choi, 2015). Thus, CID initiatives may influence stakeholder expectations by transmitting trustworthiness that eventually drives a firm’s market value and operational performance (Vlachos et al., 2013). Thereby, it is necessary to categorize the stakeholders into the primary (i.e., shareholders, suppliers, employees) and the secondary stakeholders (i.e., government and communities). Although the secondary stakeholders are not directly affiliated in a transaction with firms, their interest should be equally considered with those of the primary because both groups are influencing the central issue of a firm’s success (Clarkson, 1995).

6 CSR programs (Waddock & Graves, 1997; Fisman et al., 2005). Other studies, on the contrary, have reported a lack or even a negative association between CSR programs and stock market returns (Berman et al., 1999; Bernon et al., 2018), which indicates overall an inconsistency in the findings. According to the limitation of studies focusing on the CID sub-dimension, this research aims to provide conformity in the direction of community-related engagements on the market value. CID initiatives might influence not only the market performance but also a firm’s operational efficiency, as prior studies have shown a positive effect on labor productivity (Brammer et al., 2007; Lo et al., 2014). Labor productivity is concerned with the volume of output obtained from each employee that determines organizational and efficiency changes (OECD, 2001) through increased organizational commitment, a tighter cultural fit in employment, and intensified job satisfaction (H. R. Kim et al., 2010; Stuebs & Sun, 2010; Vlachos et al., 2013).

A firm’s reputation management can be critical for the ambition of positive economic reward through CID initiatives since the engagement needs to deal with the interests of the secondary stakeholders that takes a firm or initiative for granted. Firms require a certain degree of legitimacy to perform efficiently and gain a competitive advantage, which leads to the development of capabilities and the ability to persistently create more economic value than the competitor in its product market (Jones et al., 2018). Reputation is part of a firm’s social responsibility as an element of trust in the relationship among businesses and its social environment due to institutional pressure (Carroll, 1998; Zadek, 2004 in Nijhof et al., 2008). Marketing programs related to CID initiatives, such as Corporate Societal Marketing (CSM), may uplift a firm’s reputation through an enhanced brand image (Hoeffler & Keller, 2002). Furthermore, the type of CID investment, particularly social investments in education, might become crucial in achieving an expected reimbursement due to the creation of shared value (Porter et al., 2013). Social investments in education intend to deliver improvement on different education levels, as well as a return on a firm’s initial CID spending throughout enhancements of human capital and labor market participation support (Ahn & Kim, 2015). Education programs are essential in the development of human capital, which defines the knowledge and skills that individuals create, maintain, and use (Armstrong, 2006). In present times, a well-educated workforce is more likely to have fewer difficulties coping with the emerging Information and Communication Technology (ICT), which is the key technology that has improved most industries and society sectors (Cruz-Jesus et al., 2016). Therefore, revised education programs may create opportunities for talents in disadvantaged communities and increase the probability of improving the quality of life that prospectively benefits firms.

7 a need to investigate CID from a practical standpoint and explore how it can influence a firm as an economic existence. Therefore, this research aims to examine the causal relationship between CID and CFP with the influence of a firm’s reputation as well as social investments in education, which may be critical for a business's sustainable success.

In light of the above discussion, the research questions asked in this thesis are as follows:

1. What is the relationship between Community Involvement and Development (CID) and firms’ financial performance?

2. Do a higher firm reputation and social investment in education influence the relationship between CID and firms’ financial performance?

Notably, this research follows the suggestion of Gentry and Shen (2010) to distinguish accounting profitability (labor productivity) and market performance (market value), since their results represent little empirical overlap to explain the variation adequately in both performances (Gentry & Shen, 2010). The contribution relative to the antecedent literature is a quantitative analysis of the relationship between CID initiatives and CFP to clarify the expectation of economic reward in the short and long run. This research analyzes a data set of 100CID-related news announcements from US firms by conducting two distinctive event studies to identify abnormal returns/performances to examine the proposed research question. Moreover, data will be acquired from Fortune’s Most Admired Companies (FMAC) survey to investigate the impact of a firm’s reputation on CFP. In addition, a separation between social investments in education and compensatory CID investment will be prepared to analyze the stock market reaction on both samples. Contrastingly to a firm’s benefit intentions through social investments in education, compensatory CID investments target social risks, such as healthcare-related initiatives and social assistant that aims to support social policies without the purpose of an economic reward (De Deken, 2013).

The rest of the thesis is arranged across seven sections. A literature review is presented to provide background information on the topic of the study in the first section, followed by the hypotheses development in the third section. In the fourth section, the steps of data collection will be explained in detail, and the methodology of the two event studies used in this thesis will be introduced. Finally, the results will be presented in the fifth section, and the final two sections will discuss the results, and a conclusion will be reached.

2 Literature Review

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2.1 CID under Corporate Social Responsibility

CID is a significant concept of CSR and describes actions that benefit communities either through philanthropy or through a cooperative relationship (Schmidt et al., 2016). Corporate philanthropy is associated with charitable donations and material contributions from businesses to non-profit organizations (NPO) (Cullip et al., 1994). Seitanidi and Ryan (2007) have described the usual relationship between donors and NPOs as asymmetrical based on altruism: One-way giving without a direct economic reward, as companies uncommonly expecting public recognition in the sense of compensation rewards (Seitanidi & Ryan, 2007). However, CID initiatives have transformed into a multidimensional concept, including more than charitable donations by addressing active sustainable ventures in social, ecological, human, and political dimensions of business and society synergies to respond to a wide variety of problems (Muthuri et al., 2012). Improvements are achieved through obligation in activities to set up the human capital (e.g., social investment in healthcare provision and the promotion of education and culture) and economic capital (e.g., employment creation) (ISO Focus+, 2011).

In contrary to broad CSR studies, antecedent CID research mainly conducted qualitative methods to explain the practice of CID engagement. For example, Joseph Galaskiewicz (1997) has studied and compared the long-term relevance of CID engagement between the years 1979-81 and 1987-89 in Minneapolis-St. Paul, Minnesota (Galaskiewicz, 1997). Guthrie and Mcquarrie (2004) have used a multiple case study in three cities based on a representative data sample of 2776 corporations to examine corporate-community relations (Guthrie & Mcquarrie, 2004). Both studies have indicated a tendency towards a closer relationship between firms and communities during the examination years but have not explored CFP throughout the CID initiatives. Hedin and Ranängen (2017) have collected data from interviewees for an improved understanding of the community’s expectation in their recent case study of the Swedish mining and metal company Boliden AB (Hedin & Ranängen, 2017). The findings have suggested that Boliden's motives for CID engagement consider risk minimization by identifying and focusing on the social and environmental risks that could potentially damage the company’s reputation and thereby lead to problems with employee recruitment (Hedin & Ranängen, 2017). Moreover, the research has stated that CID creates higher value for the stakeholders and lifts Boliden’s so-called “social license” to operate in the local area (Hedin & Ranängen, 2017).

9 literature did not explicitly mention the relationship between CID initiatives and CFP with the direct influence of a firm’s reputation. As a result, this research will aim to fill this gap.

2.2 The Relationship between CSR and CFP

10 and firm turnover by using labor productivity as a proxy for a firm’s performance measurement (Lo et al., 2014).

The majority of the studies that have analyzed the relationship between CSR and CFP have the commonality that social and financial performance are determined by the stakeholder theory which suggests that managers should “address and balance the claims of multiple stakeholders” (Orlitzky et al., 2003, p. 405) to establish the organization's survival (Freeman, 1984). Stakeholders are defined as “any group or individual who can affect or is affected by the achievement of the organization’s objectives” (Freeman, 1984, p. 46). This thesis will follow the line and regards the stakeholder theory as the foundation of the relationship between CID and CFP.

2.3 Firm Reputation under CSR

According to the literature available, the effect of firm reputation on CFP under the subject of CID has not been answered yet. Therefore, this section outlines the function of reputation on the broad CSR dimension. Firm reputation appears as an essential role influencing the impact of CSR programs on CFP and acts as one of the main factors for the conflicting findings in the literature (Orlitzky et al., 2003; Allouche & Laroche, 2005). Reputation is described as “the evaluation of a company over time, based on the stakeholder’s direct experiences that provides information about the firm's actions and/or a comparison with the actions of other leading rivals”(Gotsi & Wilson, 2001, p. 29). Scholars of the legitimacy theory asses firm reputation as an essential variable mediating the relation between CSR programs and CFP, believing that socially responsible engagement and firm profitability are not mutually exclusive (Czinkota et al., 2014; Flammer, 2013). Shenkar and Yuchtman-Yaar (1997) have associated reputation with image, esteem, prestige, and goodwill in developing an interdisciplinary theory of organizational standing (Shenkar & Yuchtman-Yaar, 1997). Their research has categorized reputation as a corporate asset that is exchangeable into a financial resource (Shenkar & Yuchtman-Yaar, 1997).

11 a firm’s reputation concerning its financial constructs (Fryxell & Wang, 1994). Antunovich and Laster (1998) have argued that the FMAC survey is appropriate to measure a firm’s reputation because it provides comparable data over an extended period, the number of respondents is superior to those of other ratings, and respondents rate only firms in an industry with which they are familiar (Antunovich & Laster, 1998). Furthermore, a social performance dimension exists in the FMAC rating, and since the topic of CID has become increasingly important, one may expect that a firm’s social investments influence its reputation.

However, it is essential to notice that reputation and legitimacy have similarities and overlapping explanations since this research elaborates on both concepts. Legitimacy and reputation represent the assessments of a firm by its social system that result from similar social construction processes, such as the evaluation of firm size, charitable giving, strategic alliances, and regulatory compliance (Oliver, 1990; Stuart, 2000; Ashforth & Gibbs, 1990 in Deephouse & Carter, 2005). Deephouse and Carter (2005) have described legitimacy as “the social acceptance resulting from adherence to regulative, normative or cognitive norms and expectations” and viewed reputation as “a social comparison among organizations on a variety of attributes, which could include these same regulative, normative or cognitive dimensions” (Deephouse & Carter, 2005, p. 332). Thus, reputation can be interpreted as a social competition between firms on the level of legitimacy.

2.4 Type of CID Investments

This section focuses on the benefits firms gain from playing a more active role in treating human capital like other capital. Social investments can be categorized as a process of CID initiatives that seeks to consider both financial return and social/environmental good to bring about social change (Heitzmann & Wukovitsch, 2015). Social Investments are investment strategies that imply a form of welfare that stresses economic performance and defines spending’s that seek to solve social issues (Lundvall & Lorenz, 2012 in Ahn & Kim, 2015), which are increasingly promoted among industry, media, and civil society as a co-operative investment (Heitzmann & Wukovitsch, 2015). Nikolai (2012) has distinguished socially from compensatory welfare investments, which are mainly designed as financial aid to secure social risks such as healthcare-related issues and unemployment (Nikolai, 2012). Social investments, on the contrary, are strongly oriented towards provision for the future and the needs of the younger generation, such as active labor market policy, education, and training (Nikolai, 2012). Building upon Nikolai’s argumentation, this thesis separates social investments from compensatory CID investments by aiming the attention on the particular type of social investment in education. The research assumes that education-related CID announcements have a greater impact on the stock market.

12 human capital investments include training and education that enhances capabilities in performing activities, as well as personal and social perspectives (Marimuthu et al., 2009). Blundell et al. (2005) have examined the impact of educational training of employees on a firm's productivity and concluded difficulties in measuring an explicit correlation between those two variables (Blundell et al., 2005). The empirical research on UK manufacturing firms, although, has indicated a positive relationship between a well-educated workforce (high average levels of skills and knowledge) and higher labor productivity in comparison to industry-specific control firms (Blundell et al., 2005).

OSCM is affected by automation, digital platforms, and other technological innovations that are changing the fundamental nature of work (Koh et al., 2019). Understanding the shifts can help a firm to initiate a strategical CID initiative in the preparation of the future workforce that can benefit both entities. Porter et al. (2013) have described that the active roles of firms by partnering with schools, nonprofits, and governments grow educational outcomes and creates shared value (Porter et al., 2013). Shared value is a business approach that unlocks opportunities for companies to increase profitability and strengthen long-term competitiveness (Porter et al., 2013). Culp et al. (2005) have addressed the challenges and opportunities in integrating technology into the education system, which acts as an agent that catalyzes the quality of teaching and learning processes (Culp et al., 2005). The integration refers to the economic and social shift as a central force in economic competitiveness that has made technology skills critical to the future employment of today’s students (Culp et al., 2005). A survey by McKinsey has indicated a lack of technical expertise in Science, Technology, Engineering, and Mathematics (STEM) as the main reason for entry-level job vacancies (Mourshed et al., 2013).

3 Theory and Hypotheses Development

The literature review provides a slightly positive tendency on the relationship between CSR initiatives and CFP. This section builds on the prior findings and transfers the results on the CSR sub-dimension CID, taking the stakeholder and legitimacy theory into account.

3.1 CID and Firm Market Value

13 firms can sustain stable operations if they pursue responsible decision-making in communities and are likely in reverse to receive beneficial responses from shareholders. Exchanging corporate information and recognizing the interest of the secondary stakeholder, i.e., local authorities and NGOs, fortifies the level of trust and supports a collaborative strategy for a CID initiative. Thus, firms with more and higher quality-partnerships receive higher market valuations (Powell, 1996 in Dyer & Singh, 1998). Moreover, the increasing attention of investors for CID initiatives over the past decades can attract institutional investments that purchase a firm’s stock as a long-term investment (Sparkes & Cowton, 2004). For instance, pension and insurance funds tilt their portfolios towards firms with superior socially responsible performance (Hoepner & Schopohl, 2019). This may have a significant impact on a firm’s stock since the funds allocate large investment capitals.

The market value of a firm's equity is the total value given by the investment community to a business (Lasher, 1996). In the context of CID, an improved relationship with the provided communities transmits trust and enables financial rewards by shareholders that benefit a firm’s market value. Therefore, this discussion is translated into hypothesis 1:

H1: CID initiatives are positively related to a firm’s market value

3.2 CID and Labor Productivity

In this framework, CID initiatives affect a firm’s employee relationship and influence labor productivity positively, which is triggered by higher organizational commitment. In times of expectation to do more with fewer resources, i.e., a lower workforce, it is crucial for a firm’s success to retain highly productive employees. The management approval of active employee participation in CID initiatives may be a vital factor to raise job satisfaction, which has a constructive causal relationship with a firm’s turnover (Hom et al., 2017). Job satisfaction is the degree to which employees appreciate their job and theoretical and empirical work suggest that a higher level of satisfaction is associated with a higher level of organization commitment (Spector, 1987; Bateman and Strasser, 1984; Currivan, 1999; Curry et al., 1986 in Brammer et al., 2007). From the employee's perspective, involvement in CID initiatives contribute to a definite perceived link and strengthens the identification of its company culture (H. R. Kim et al., 2010). Hence, increased organizational commitment, which defines the level of enthusiasm towards the workplace (McIntire, 2011), is also established through the physical interaction of employees with a provided community. Thus, a firm’s engagement in CID encourages the level of organizational commitment that delivers an increase in performance, reduction of error rates and improvements in corporate working culture with higher rates of trust and loyalty (Tsoutsoura, 2004). Therefore the thesis posits the hypothesis:

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3.3 The Influence of Firm Reputation on the Relationship between CID and CFP

This study proposes that a high firm reputation positively influences the impact of CID initiatives on a firm’s financial performance. A high firm reputation is a valuable asset that can be traded for sustainable business performance, trust, and the legitimization of a position that becomes advantageous in a contest with other firms on the CID level (Shenkar & Yuchtman-Yaar, 1997; Jones et al., 2018). Isomorphism explains the general motivation laid in the plain sight of CID initiatives and contributes to the higher relevance of CSR programs (Johansen & Nielsen, 2012), which is defined in this context as “the resemblance of a focal corporation’s social practices to those of other corporations within its geographic community” (Marquis et al., 2007, p. 926). Moreover, isomorphism influences legitimacy as a key organizational concern since a firm seeks out to be labeled as credible by the society in which they operate in matching the expectations, norms, and values by acting responsibly (Suchman, 1995). Whereby a superior firm reputation may integrate a higher stakeholder’s appreciation in the social comparison among other organizations that are taken for granted (Deephouse & Carter, 2005). In this sense, not only the price of goods and services but also legitimacy and reputation become supportive of acquiring a competitive advantage.

Primary and secondary stakeholders seize the knowledge of firms by utilizing transmitted information signals in the stock market, newspapers, or social media to evaluate a firm’s reputation (Chiu & Sharfman, 2011). Notably, different stakeholder groups are expected to have different preferences over firms' actions, processes, and outcomes. Not only trust, as mentioned in the previous section, but also the level of perceived risk affects the stock market decision process of shareholders (Ryan & Buchholtz, 2001). This leads to greater stakeholder scrutiny for socially responsible activities and increased awareness of firm reputation that might force a company to implement marketing strategies to achieve competitive differentiation. For example, Corporate Societal Marketing (CSM), which are marketing initiatives related to social welfare engagements, enhance brand criteria, such as brand image and brand engagement (Hoeffler & Keller, 2002). CSM supports CID initiatives in attracting more considerable attention from potential shareholders by greater media exposure, which may reinforce positive stock market reactions and, simultaneously, a firm’s market value.

Furthermore, a high firm reputation supports the creation or maintenance of labor resource efficiency advantages (Fombrun & Shanley, 1990) and becomes a critical factor for labor productivity. Firms with a high reputation attract employees resulting in a more abundant labor supply competing for jobs in high-reputation firms (Stuebs & Sun, 2010). In this way, highly skilled employees could be acquired and retained, who can involve themselves voluntarily in socially responsible programs.

15 external representation at the stock market competition and the internal employee efficiency that affects labor productivity - hence, the theoretical discussion leads to the hypothesis:

H3: The relationship suggested in H1 and H2 is positively influenced by a higher firm

reputation

3.4 The Influence of Social Investment in Education on the Relationship between CID

and CFP

This research proposes that CID engagement, particularly social investments in education programs, creates a win-win situation for society and businesses. The literature review indicates a demand for a technically skilled workforce and better provision of education that could close barriers in accomplishments and embellish talent recruitment. CID investments in education improve the accessibility and integration of technology, which is the central force in economic competitiveness and essential for future employment. In the context of digitalization, a lack of technological integration and impeded accessibility poses a significant threat to fulfill sustainable improvements. Research has shown that digital divides, which describes the unequal access to Information and Communication Technology (ICT) (OECD, 2018), are formed by socio-economic inequalities among countries and individuals. A charitable contribution to improve ICT access enhances growth possibilities for all students to be prospectively successful in a global workforce and creates more significant opportunities for high-quality education (King et al., 2017). Throughout social investments in education, firms can benefit from playing a more active role in trying to close the gap between job requirements and unrecognized talents. Consequently, CID initiatives unlock shared value that delivers business returns (Ennes, 2015) by partnering with schools, nonprofits, and governments.

A greater focus of firms on social issues, i.e., fixing barriers in different education levels, may attract the attention of shareholders based on the IST (Jones et al., 2018). However, the argumentation is in contrast to Milton Friedman’s conclusion that “the only responsibility of corporations is to make profits” (Friedman, 1970, p. 6), but consistent with stakeholders' demand for more sustainable business behavior, which should bring about positive stock market reactions. Thus, the discussion leads to the hypothesis:

16 Figure 1 displays the relationship based on the four hypotheses.

Figure 1: Conceptual Model

4 Data Description

17 previous studies that have employed the collection of news announcements (Hendricks & Singhal, 2009; Pérez et al., 2019).

The next step considered the validity check of the CID announcements since some publications required to be excluded from the final sample. Firstly, the announcement sample has been reviewed to detect multiple announcements on different newswires for the same CID initiative that has been launched by the same firm. The announcement with the earliest event date remained in the sample to evade duplicates. Secondly, announcements from a government department or private firms were excluded to ensure a precise examination of abnormal returns/performances based on available financial data, as those shares are not traded on the stock exchange. To check whether an announcing firm is publicly-traded, the Nexis Uni option “company dossier” was used for clarification. The chosen announcements reflected a broad scope of community, as companies are not limited to its operating community and can implement CID initiatives in remote communities. Hence, Table 1 displays the batch of utilized phrases, initial keywords (bold fonts), and further keywords to search for full-text documents from the newswires Business Wire, P.R. Newswire, and Dow Jones News Service.

Table 1: Possible Phrases and Keywords for Nexis Uni

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Table 2: Example of a Data Sample

Based on the utilized keywords and the requirement that the CID initiating firms meet the criteria of being publicly traded in the US with adequate financial information, the final sample consists of 100 announcements between 2009-2017. The “timeline” has been chosen due to the increasing attention for CID initiatives in the past decades (ISO Focus+, 2011) and the contemporary of this research. CID initiatives from earlier decades would not ensure the research propositions made in the previous sections regarding, i.e., ICT or present OSCM turbulences. The sample entails 64 firms from 34 different industries listed in the US stock market that announced one or more CID initiatives.

The data on firm reputation was acquired from the online database of Fortune’s Most Admired Companies, who carry out the survey annually. In 2019, the reputation assessment encompassed 680 companies from 52 different industries ranked by revenue, that have been picked out from an assortment of the 1500 largest US and non-US companies (Fortune, 2019). 3,750 executives, directors, and securities analysts have responded to the survey and voted on nine attributes from zero (poor) to ten (excellent) (Fortune, 2019). As mentioned in the literature review section, the participants for the survey also work for the companies that have been picked out for the assessment. The overall firm reputation score is an average of the following individual attribute scores:

1. Ability to attract and retain talented people 2. Quality of management

3. Social responsibility to the community and the environment 4. Innovativeness

5. Quality of products or services 6. The wise use of corporate assets 7. Financial soundness

8. Long-term investment value

9. Effectiveness in doing business globally

5 Methodology

19 method to identify the effect of news announcements on a short-term event horizon, such as stock market reactions, as well as for a long-term event horizon, i.e., a firm’s operating performance. Conducting a short-term event study to examine the market reaction is appropriate, given that this method is a widely adopted practice in OSCM and increasingly used for assessing the impact of managerial decision making (McWilliams & Siegel, 1996; Hendricks & Singhal, 1996; Klassen & McLaughlin, 1996 in Ding et al., 2018). As the previous sections already discussed the event of interest (CID announcements of US firms), the basic steps for conducting a short-term event study in this research are as following:

(1) The definition of the event window and the justification of the choice of the window length; (2) The prediction of normal returns with an estimation model;

(3) The calculation of abnormal returns, aggregating them over the event windows and test their significance (MacKinlay, 1997 in Ding et al., 2018)

First of all, the common practice is to define the event date as the day an announcement is published (i.e., Day 0). One disadvantage of the setting is the “event uncertainty,” which describes the conflict of the news announcement and the actual event date (Flammer, 2013). CID announcements may have been published right before the stock market exchange closing, and potential market reaction could be neglected as a consequence. Therefore, this research will expand the event window to two days:

[t=-1;t=0] for the day of the announcement and [t=0;t=1] for the potential market reaction to respond

to the “event uncertainty” (Flammer, 2013). Secondly, an estimation window of 200 days is set to predict the regular returns prior to the event windows. In addition, a trading day gap of 50 days is inserted between the estimation window and the event window to oppose possible information leakage from insiders to partners preceding the official CID announcement (Elad & Bongbee, 2017). The Estimated Returns E(R) includes the Ordinary Least Square (OLS) parameters αi and βi, which

represent the estimation window for a firm's stock return i, and the Estimated Return to the Market Portfolio m on day t (E(Rm,t)). This method is used to control the relation between expected stock

returns and expected market returns by allowing risk adjustment associated with a firm's stock return

i by setting the OLS parameters (estimation window) (Salinger, 1992). In other words, risk adjustment

can become trivial for the ARs by causing a possible error if an estimation window longer than one year for a small event window would be chosen (Salinger, 1992). E(Rm,t) represents the market as a whole

by its expected return (Garcia & Ferruz, 2015). In this case, the Center for Research in Security Prices value-weighted index (CRSP) is used as the benchmark market portfolio m on day t (Wharton, 2019) that determines E(Ri,t). Thus, E(R) considers a specific stock’s performance and its sensitivity to general

20

(1) E(Ri,t) = αi + βi * E(Rm,t)

Finally, this research uses the “market-model” to predict the return on the stock in normal conditions, which is calculated automatically by WRDS. Researchers have typically used the market model to estimate the expected stock return in a single country (Madsen & Rodgers, 2014; Park, 2004). The market model determines the Abnormal Return (AR) for each firm i on the event day t by the difference between actual Returns (R) (ex-post return after the event took place) and E(R) for each firm i at each point in time during the event day t, as shown in equation (2):

(2) ARi,t = Ri,t – E(Ri,t)

However, the empirical analysis not only considers the ARs on the single event days (t=-1, t=0, and t=1) but also recognizes the Cumulative Abnormal Return (CAR) of the two days event window. The CARs for the two days event window [t=-1;t=0] and [t=0;t=1] can be determined by summing up the daily

ARs, which is useful for the statistical analysis to get a sense of the aggregate effect (Elad & Bongbee,

2017).

The result of the event study is empirically validated by using significance tests. According to most event study literature, the statistical analysis adapts a parametric (t-test) and two non-parametric tests (Wilcoxon signed-rank and binomial sign test) to assess the significance concerning the ARs and CARs in the stock market (Barber & Lyon, 1996; Ding et al., 2018; Hendricks et al., 2009; Lam et al., 2019; Lie, 2001). Thus, a paired t-test will be applied to determine a statistically significant difference between the mean ARs (CARs) and zero. The binomial sign test determines the statistically significant percentage of positive ARs (CARs) different from the boundary of 50%, which is represented by the median ARs (CARs). Besides, the Wilcoxon-signed-rank test incorporates more information than the binomial sign test, in order to guarantee a more critical observation of the media ARs (CARs). The test considers not only the sign but also a ranking of the absolute differences between the ARs (CARs) and the median. Similar to the binomial sign test, the statistically significant percentage of positive ARs (CARs) different from the boundary of 50% will be reconsidered after the rank determination (Taheri & Hesamian, 2013). Notably, non-parametric tests allow statistical inference without assuming that a sample has been taken from a particular distribution (e.g., normal) (Sitthipongpanich, 2011). The parametric counterpart, however, is more reliable on a normally distributed sample, which is the prerequisite for the t-test under certain circumstances. Therefore, this research added the Kolmogorov-Smirnov test for each sample ARs (CARs) to identify the distribution and figure out whether to rely on the mean or median ARs (CARs) for the statistical analysis.

21 regression test considers firms that received a reputation rating by FMAC, and the second regression test uses the actual reputation of firms (1 “poor” to 10 “excellent”) to analyze a more detailed examination of the rating effect. Furthermore, the data sample will separate social investments in education from compensatory CID investment to compare the results and investigate hypothesis 4. This research comes up with two control variables that may affect a firm’s financial performance, which is the firm size and industry type. The natural logarithm of the total asset of the company in the fiscal year ending before the announcement year will be applied (Dang & Li, 2013). Firms get classified by their SIC-Code in different industry types, which may be a factor that influences the stock market reactions, e.g., shareholder reaction to damaging environmental industries.

The impact of CID initiatives on labor productivity will be estimated by a long-horizon event study, which sets the year of the announcement as a base year. A firm’s productivity, in general, corresponds to all outputs an organization produces, divided by the provided added value (OECD, 2001). In order to determine labor productivity, the revenue per employee as an economic performance indicator, the ratio of operating income before depreciation to the number of employees will be applied (Lo et al., 2014). Operating income incorporates “sales less cost of goods sold, selling, general and administrative expenses that exclude interest expense, special items, income taxes, and minority interest” (Barber & Lyon, 1996, p. 361). The operating income is chosen because it conceals special items, tax considerations, or accounting interests to ensure a more explicit measurement. To asses whether a firm is performing unusually well or poorly, the expected performance in the absence of an event needs to be specified, which is a benchmark against control firms. Each CID engaging sample firm will be matched with comparable control firms that have total assets within 50-200 %, and pre-performance within 90-110% to the sample firm (Lo et al., 2014). The formula used for the calculation of the Expected Performance (E(P)) is seen in equation 3:

(3) E(Pi,t=+1) = Pi,t + (PCi,t=+1– PCi,t)

E(P) for a sample firm i of the year of the announcement t=+1 is the addition of the preceding

Performance (P) for a sample firm i prior the year of the announcement t and the median Performance Changes (PC) of the control firm(s) i in year t=+1 and t. The Abnormal Performance (AP) will be measured over two years with the calculation seen in equation 4:

(4) APi,t=+1 = Pi,t=+1 – E(Pi,t=+1) (Barber & Lyon, 1996)

AP for a sample firm i of the year of the announcement t=+1 is the difference between P, the actual

22 The statistical analysis for the single APs (t=+1, and t=+2) conducts the same steps as for short-term event study and includes (CAP) for the two-year event window [t=+1;t=+2]. Figure 2 illustrates the time horizons for the short- and long-term event studies.

Figure 2: Illustration of the Time Horizon

6 Empirical Results

6.1 Analysis of the Impact on the Market Value – Hypothesis 1

23 Kolmogorov-Smirnov Test Statistic (KSS) shows that the ARs on Day -1 are normally distributed, while any other ARs and CARs do not follow a specific distribution. Since the potential market reactions on the daily ARs could be diminished due to the event uncertainty, this research is interested in the event window’s CARs. The analysis relies on the Z-statistic significance for the median [Day -1; Day 0], while on the significant t-statistic (mean) for the event window [Day 0; Day 1], since a statistical significance for the non-parametric tests do not appear. Parametric analyses can produce reliable results when a requirement for a minimum of 15 observations is fulfilled even when the distribution of APs (CAPs) is skewed (Minitap, 2015).

In this respect, the results do not support hypothesis 1, since this analysis indicates a negative contribution of CID engagement on a firm’s market value.

Table 3: Abnormal Returns and Cumulative Abnormal Returns for 100 CID Announcements

6.2 Analysis of the Impact on Labor Productivity – Hypothesis 2

24 2]. Table 4 displays a positive mean APs for Year 1 but a negative mean APs for Year 2, whereby the t-statistic shows no t-statistical significance for both APs. However, the mean CAPs on the event window [Year 1; Year 2] is positive and statistically significant, with 8.8870 at the 1% level. The consistency among the results of the median and the percentage of positive APs been investigated as well. The median APs for Year 1 and 2, as well as the median CAPs for the event window [Year 1; Year 2] are positive. The Z-statistic reveals a negative value for Year 1 but positive values on Year 2 and the event window [Year 1; Year 2], which are all statistical non-significance. The percentage of positive APs above the boundary of 50% is only reached on Year 2, while the APs on Year 1 and the CARs for the event window [Year 1; Year 2] are slightly below, but the Z-statistic2 indicates no statistical significance. The KKS shows a non-existent specific distribution for any APs and CAPs. The results are usually more reliable on the non-parametric tests. However, the analysis can rely on the significant t-statistic by the number of observations since a statistical significance for the non-parametric tests does not appear. In this sense, the results support hypothesis 2 and indicate a positive contribution of CID engagement on a firm’s labor productivity.

Table 4: Abnormal Performance and Cumulative Abnormal Performance for 65 CID Announcements

6.3 Analysis of the Influencing Effect of Firm Reputation – Hypothesis 3

To test the influencing effect of firm reputation on the mentioned relationship in hypothesis 1, the thesis uses the first linear regression model for the general effect of a Fortune Most Admired Company (FMAC) rating:

25 And the second linear regression model for the actual reputation of firms (1 “poor” to 10 “excellent”) ranked by FMAC to analyze a more detailed effect.

CARi=α + β

1

IndType + β

2

FirmSize + β

3

FMAClowRating + β

4

FMACfairRating + β

5

FMACgoodRating + ɛi

CARi represents the cumulative abnormal return for the event window [Day 0; Day 1]; IndType and FirmSize the control variables defined in the methodology section; and

ɛ

i the error term. In the event study, the influencer, firm reputation, can be used as the independent variable in the regression model, which in this thesis is the FMAC rating. Out of the sample of 100 firm announcements, 73 are accompanied by a rating (FMACRating), whereby 3 of them have a low ranking in their reputation between 3,0 and 4,49 (FMAClowRating). 51 announcements received a fair reputation ranking between 4,5 and 6,99 (FMACfairRating), while 19 announcements are declared to have a good reputation between 7,0 and 8,49 (FMACgoodRating). I refer to the thresholds in the reputation ranking because the Fortune database only provides the information that 1 is declared as “poor” and 10 as “excellent.” Table 5 presents the linear regression results, representing the regression coefficients within the quote marks and the t-value in the brackets. Model 1 contains the general effect of the FMAC rating and both control variables, while Model 2 contains the actual rating and both control variables. According to the results, the coefficient FMACRATING is negative (-0.034) for Model 1 at a 5% level, also FMACfairRating (-0.037) and FMACgoodRating (-0.047) are negative for Model 2 at a 5% level. Notably, both models are statistically significant at a 5% level (5.24 and 3.865). The results indicate that the FMAC rating negatively influences the relationship in hypothesis 1.

26 The same process is applied to test the influencing effect of a firm reputation on the discussed relationship in hypothesis 2. The thesis uses the following first linear regression model for the general effect of the Fortune rating:

CAPi=α + β

1

IndType + β

2

FirmSize + β

3

FMACRating + ɛ

i

And the second linear regression model for the actual reputation of firms (1 “poor” to 10 “excellent”) ranked by FMAC to analyze a more detailed effect.

CAPi=α + β

1

IndType + β

2

FirmSize + β

3

FMAClowRating + β

4

FMACfairRating + β

5

FMACgoodRating + ɛi

Where CAPi is the is the cumulative abnormal performance for the event window [Year 1; Year 2];

IndType and FirmSize the control variables defined in the methodology section and

ɛ

i the error term.

The sample consists of 65 firm announcements, whereby 48 announcements received a rating (FMACRating). 2 of them have a low (FMAClowRating), 35 are fair (FMACfairRating), and 11 a good rating (FMACgoodRating) according to the thresholds mentioned above. Table 6 displays the linear regression results, but only Model 2 shows a statistical significance at a 5% level (3.216). The FMAC ratings indicate a negative effect but no significance for both models predominantly. The control variable industry type (IndType) is positive for both models at a 5% level. In this sense, the results imply that the FMAC rating has no influencing effect on the relationship suggested in hypothesis 2.

Table 6: Regression Analysis based on 65 Announcements

6.4 Analysis of the Impact of Social Investment in Education – Hypothesis 4

27 1, and the CARs for two-days event windows ([Day -1; Day 0]) and ([Day 0; Day 1]). Table 7 and 8 shows the stock market reaction for both samples. Table 7 presents the information on the daily and cumulative abnormal returns based on education-related CID investments. Whereby Table 8 derived the information on the daily and cumulative abnormal returns from samples related to compensatory CID investments. As seen in both tables, the mean ARs and CARs are predominantly negative for both samples and defines a positive return for the days prior and after the announcement (Day -1 and Day 1). Table 7 indicates negative statistically significant CARs on both selected event windows [Day -1; Day 0] and [Day 0; Day 1] with -4.7860 at the 1% and -2.4080 at the 5% level, respectively. In comparison, Table 8 also indicates negative statistically significant CARs on both selected event windows [Day -1; Day 0] with -5.7190 and [Day 0; Day 1] with -2,9120, but at a 1% level. The median for each ARs and CARs in Table 7 are negative, while only the median for both event windows ([Day -1; Day 0]) and ([Day 0; Day 1]) in Table 8 are negative. The Z-statistic in Table 8 shows significantly negative CARs at the event window [Day -1; Day 0], reaching 10% (-1.743) for the compensatory CID investments, while the Z-statistic in Table 7 indicates no significance. On both tables, the percentage of positive ARs and CARs are predominantly but slightly below the 50% boundary without indicating statistical significance. The KSS in Table 7 reveals that the ARs on Day -1 and the CARs for the event window [Day 0; Day 1] are normally distributed. In comparison, only the ARs on Day -1 are normally distributed in Table 8, while any other ARs and CARs on both tables are skewed. In Table 7, the analysis relies on the negative mean CARs (t-statistic) for the event window [Day 0; Day 1], while the median CARs for Table 8 event window [Day -1; Day 0] is more reliable.

28

Table 7: Abnormal Returns and Cumulative Abnormal Returns for 49 Social Investments in Education

Table 8: Abnormal Returns and Cumulative Abnormal Returns for 51 Compensatory CID Investments

All in all, the results support hypothesis 2 but fail to uphold the other three hypotheses, as summarized in Table 9.

29

7 Discussion

This research has aimed to find a positive relationship between CID initiatives and a firms’ financial performance by investigating two effects, which are firm reputation and social investment in education. On a broad CSR dimension, prior studies have shown inconsistency in the results regarding a direct relationship on CFP. However, a slightly positive impact between these two measures has been found (Allouche & Laroche, 2005; Margolis & Elfenbein, 2007). Building upon this assumption, the research proposed four hypotheses to prove for the CID sub-dimension that a firm’s social engagement achieves a consistently positive compensation reward in labor productivity and market value.

To begin with an excursus about the test reliability carried out in the research analysis. Under the keyword development approach in section 4, the sample data is representative since it correspondence particular CID announcements and excluded duplicates and outliers to ensure a conclusive event study. However, the final sample was relatively small due to the timeline setting between 2009-2017 and the requirement of necessary firm information for the calculations. The occurrence of a relatively small sample size may have affected the power of the event study. To be more specific, the probabilities of detecting ARs of 0.5%, 1.0%, and 2.0% for a two days event window with a sample size of 50 are 14%, 42% and 94%, respectively (MacKinlay, 1997). The probability increases with a greater sample size. For instance, the probabilities of detecting ARs of 0.5%, 1.0%, and 2.0% for a two days event window with a sample size of 100 are 24%, 71% and 100%, respectively (MacKinlay, 1997). Moreover, the research was able to ascertain the data distribution, which indicated most ARs (APs) and CARs (CAPs) do not follow a specific distribution (e.g., normal). As a consequence, the analysis should have relied on significant non-parametric test results that could not be confirmed in some cases. In general, non-parametric tests are less powerful than their parametric counterpart and become less effective if a small sample size comes on top (Sullivan, 2017). As a result, an observation bias may appear that is stronger for skewed samples of smaller size.

30 the expected economic reward falls short of the costs (Krüger, 2014). Firms with better stakeholder relations are likely to have higher general and administrative expenses (Di Giuli & Kostovetsky, 2014). Hence, shareholders could perceive CID announcements as adverse cash flow shocks, which should, in turn, lead to a decline in stock prices in the short-run (Mackey et al., 2007).

This thesis furthermore proposed a positive market reaction for social investments in education, due to close partnerships with schools and nonprofits that facilitate technology skills to (underdeveloped) communities which unlock shared value (Culp et al., 2005; Ennes, 2015; Porter et al., 2013). In the same line, the above discussion upholds the negative results in analyzing the impact of social investments in education since it seems that shareholders are systematically depreciating CID investments, regardless of the type of social investments. The risk of a more significant observation bias through the separation of the sample increased by its smaller size for the hypothesis 4 analysis. However, the risk has been shared since the sample is basically disconnected in halve. The findings do not indicate critical differences for the event windows, apart from the reliability of the (non-) parametric test significances. In sum, CID initiatives that aim at voluntarily increasing the welfare of communities can be declared as wasteful wealth transfers from shareholders to communities (Krüger, 2014).

31 (Chen & Hung-Baesecke, 2014). Moreover, a firm’s leadership participation and facilitation for community programs counter critiques of window dressing via CID and increases employee’s ability to cooperate (Chen & Hung-Baesecke, 2014).

32 Philanthropic Trust, 2019). The CID announcements used in the thesis show in their title that the majority of the engaging firms set up corporate foundations instead of contributing directly from their business accounts. Despite the fact, it is out of the scope of this research to indicate what type of corporate foundations has been established to confirm if and which tax loopholes had been utilized. However, a closer investigation into the corporate tax rates indicates a decline since the 1980s; meanwhile, firm profits have increased (Hungerford, 2013). Thus, one may imply that competitive advantage throughout CID initiatives does not consider the communities' demands but rather the contest of tax savings and the purpose of window dressing for reputation cleansing. However, some initiatives are credible, helpful and necessary, revising the example of Abbott Laboratories in the first section, because some communities do not at their level of development, have the capacity publicly to solve those problems themselves.

8 Conclusion and Future Research

33 was relatively small, an extension by non-US firms at different stock markets can be applied to identify a more reliable analysis of the impact on a firm’s CFP. The final recommendation relates to the evaluation of firm reputation by the Fortune Most Admired Company (FMAC) survey. A firm’s reputation is assessed by firm managers and directors, as well as from market analysts. These are essential stakeholder groups, whose assessments are important in an analysis that focuses on the financial performance of firms within competitive markets. However, there are other groups of stakeholders, such as employees, customers, and suppliers, whose evaluations of a firm are also likely to have ramifications for financial performance dynamics. Future research could assess a firm reputation by analyzing responses on social media. Abundant information is available at all times and spreads very fast, as firms cannot hope for unnoticed irresponsible social behavior. For instance, tweets on Twitter can be examined to assess the recognition of a firm’s CID initiative by the general public.

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