Master Thesis
A FIRM PERSPECTIVE ON THE RELATIONSHIP BETWEEN THE OWNERSHIP STRUCTURE AND CORPORATE CREDIT RATINGS:
Investigating the mediation role of Corporate Social Responsibility
MSc International Business and Management 2016 - 2017 University of Groningen, Faculty of Business and Economics
Filippo Milano S3172589
E-mail: filippomilano92@gmail.com Tel. (+39) 333 2305368
Supervisor: Drs. A. Visscher Co-assessor: Dr. M.M. Wilhelm
Word count: 14.800
Abstract
In the growing study of Corporate Governance as predictor of corporate dynamics, this paper examines how the presence of certain types of shareholders affects corporate credit ratings - by injecting their preferences into the decision making - and whether the implementation of CSR practices mediates this relationship.
The study is focused on a firm level method of analysis to verify the hypotheses, taking into consideration companies included in the S&P 500 index at the end of 2016.
Furthermore, the analysis is employed by making use of the framework on the mediation provided by Baron and Kenny (1986).
Results show that Institutional shareholders, both with long and short-term orientations and significant percentage of the stock to influence the decision making (>10%), affect directly and negatively corporate credit ratings, while no evidence is found for managerial and foreign ownerships. Furthermore, Corporate Social Responsibility acts as mediator in presence of Institutional investors with short-term orientations, which exercise a double effect on corporate credit ratings.
This research provides insight for future research and might make managers and shareholders more concerned about the effects their actions produce.
Key words: Corporate Social Responsibility (CSR), ownership structure, credit ratings, Institutional, foreign, managerial
TABLE OF CONTENTS
1.INTRODUCTION 5
2. LITERATURE REVIEW 9
2.1 The ownership structure 9
2.2 Corporate Social Responsibility 12
2.3 Corporate Credit ratings 16
3. HYPOTHESES DEVELOPMENT 17
3.1 The relationship between the ownership structure and corporate credit ratings 17 3.2 The ownership structure and the implementation of CSR practices 19 3.3 Corporate Social Responsibility influences corporate credit ratings 23 3.4 The mediation role of Corporate Social Responsibility 25
4. RESEARCH METHODOLOGY 28
4.1 Sample and Data Collection 28
4.2 Variables Description 29
4.2.1 The Ownership structure 29
4.2.2 Corporate Social Responsibility 30
4.2.3 Corporate Credit Ratings 31
4.2.4 Control variables 32
4.3 The regression model 35
4.4 Preliminary analysis 35
5. RESULTS 37
5.1 Descriptive Statistics 37
5.2 Regressions results 38
5.3 Robustness Check 43
6. DISCUSSION 44
6.1 Theoretical implications and recommendations 48
6.2 Limitations and suggestions for further research 49
7. CONCLUSION 51
ACKNOWLEDGEMENTS 52
REFERENCES 53
APPENDIX 60
1.INTRODUCTION
In recent years, issues related to corporate governance of firms have drawn more attention and it has became one of the most discussed topics of the new century. This happened because the scandals at the beginning of 2000s led the authorities to develop the implementation of codes of governance, which could provide rules and guideline to follow in order to avoid new cases of fraud. Furthermore, the most recent recent financial crisis has made people concerned about the importance of investing money in companies which show high probabilities to generate future cash flows and, consequently, has put importance on potential factors of the firm's creditworthiness. The latter is reflected in credit ratings, which are scores assigned by specialized credit agencies on the basis of the firm's capability to repay its financial obligations.
Corporate Social Responsibility (CSR) has assumed a critical and important role in the recent literature, turning into one the most discussed issues of the 20th century.
Indeed the growing awareness about problems related to the sustainability and the respect of the environment has driven the development of policies directed to promote the social welfare. Recently this concept has been embedded within companies' cultures and included in corporate strategies, allowing, among others, to establish strong relationships with external stakeholders, which strengthen the firm's reputation (Gazzola, 2014).
A question that receives particular importance takes into consideration factors that put firms in conditions of promoting certain positive values - such as transparency and social welfare - which influence the idea people have about companies' sustainability and profitability.
Credit ratings are concerned about the governance structure, since it might affect negatively the use of financial resources and, thus, make the company unable to satisfy liabilities towards bondholders. In fact the presence of certain types of shareholders with the power to exercise their influence on the corporate decision making, due to the high number of shares owned (Nesbitt, 1994), might incentivize the implementation of strategies to favor their interests at the expense of bondholders' ones.
Furthermore shareholders might exercise their power by incentivising the integration of CSR practices into corporate strategies in order to develop long-term sustainable plans which benefit both the business and the environment. The extent to which shareholders favor the implementation of these activities depends on their capacity to influence the corporate decision making and on their preferences. In fact, shareholders with short-term orientation will prefer to obtain high performances quickly, not promoting CSR activities, which could take time before to be profitable (Abowd and Kaplan, 1999) and be harmful for short - term performance (Flammer, 2013).
These activities take into consideration, among others, the launch of products built with sustainable materials which not harm the environment (Luo and Du, 2015), the entrance in new markets as a consequence of the high reputation they have among customers (Shenkar, 2001), the promotion of values - like transparency - which allow firms to be perceived as safe and, consequently, more likely to generate future cash flows. Thus, the implementation of these activities might be an important driver which lead companies to increase their performance and, consequently, their value.
Furthermore, credit agencies have started to include CSR into their criteria to rate companies. In particular, they take into consideration a set of practices adopted by firms to provide more transparent and accurate information finalized to reduce the perceived risk of financial distress. Moreover, the promotion of sustainable long-term strategies based, among others, on intense relationship with stakeholders, on the efficient use of internal resources and on the reduction of transaction costs related to socially irresponsible behaviours help firms to enhance the likelihood to generate future cash flows, reflected in credit ratings.
This analysis is aimed to cover some gaps in the literature. It would provide insight which might help shareholders to understand the effects that their actions might have both on the reputation the firm have among external stakeholders and on the perceived riskiness. Indeed, the implementation of aggressive short-term strategies focused only on results might be harmful in the long period, since people are more willing to buy products from companies which pay attention to benefit the environment (Gazzola, 2014).
Furthermore, the promotion of high - dividend policies and strategies aimed to harm bondholders increase the perceived likelihood of financial distress and, consequently, reduce the quality of debt issued, expressed by credit ratings. In the long run it might be harmful for companies; in fact if they are considered risky and unable to generate cash flows, less investors will be attracted by their debt and they will face problems to collect funds to finance their operations.
The framework of this research is aimed to provide insight about the impact that certain types of shareholders - Institutional, foreign and managerial - have on corporate credit ratings, since their actions might impact negatively bondholders' interests and, consequently, increase the perceived financial riskiness of the firm.
Furthermore, I argue that this relationship is also mediated by the implementation of CSR practices. Indeed, previous studies have shown that certain types shareholders could inject their preferences into the corporate decision making, by favoring the development of long - term sustainable strategies rather than short - term ones (Baysinger et al. 1991;
Kochhar & David 1996), and that the adoption of CSR activities is a mean to reduce the firm's perceived riskiness.
Thus, this paper aims to examine both the direct effect that certain types of shareholders have on corporate credit ratings and the indirect one, through the influence they exercise in implementing CSR activities.
Therefore, the research questions behind this research are: Does the presence of certain types of shareholders influence corporate credit ratings? Is this relationship mediated by Corporate Social Responsibility?
The study tries to give insight on the effects exercised by the ownership structure on corporate credit ratings and on the mediation role that Corporate Social Responsibility takes on this relationship.
The analysis is conducted on companies included in the S&P 500 index, which takes into consideration 500 big companies listed on the NYSE or NASDAQ. Data are gathered from different sources. In particular, Orbis is used to take information about the presence of the analyzed shareholders; data about credit ratings assigned by the credit
agency Standard and Poor's are gathered from Compustat North America. Finally, scores about the implementation of CSR practices come from ASSET4 (Thomson Reuters). This dataset includes more than 250 key performance indicators, grouped into four main dimensions: social, environmental, economic and corporate governance.
The paper is structured as follows. First, an overview on prior literature about the ownership structure, the Corporate Social Responsibility and credit ratings is discussed in order to provide a deep knowledge about concepts analyzed in the research. Second, the hypothesis are presented and the relationships are discussed by following the structure of the mediation model. Third, the research setting - including the sample, the variables description and the methodology - is introduced. Fourth, results are analyzed and discussed. Fifth, limitations, suggestion for future research and conclusion are presented.
2. LITERATURE REVIEW 2.1 The ownership structure
The capacity of managers to influence the process of corporate decision making could be a potential problem for shareholders since executives might pursue their own interests by putting their characteristics to shape corporate actions and strategies. Several studies try to explain the extent to which executives are able to inject their preferences into strategies at the expense of shareholders. However past literature provides opposing views about the problem. According to neoclassical economics (Teece and Winter, 1984;
Augier and Teece, 2009) corporate decisions are aligned with some contextual characteristics - such as the market and the competition - and not with managers ones.
Similarly, the New Institutional theory (Di Maggio and Powell, 1983) argues that managers preferences have little influence on corporate strategies since isomorphic and inertial forces constrain companies to align to the environment in which they operate. In contrast, the agency theory (Eisenhardt 1989; Jensen and Meckling 1976) argues that managers are affected by universal preferences - such as risk-aversion, empire-building and shirking - which drive them to pursue their own and not shareholders’ interests. A similar perspective, known as Upper Echelons Theory (Hambrick and Mason, 1984;
Hambrick, 2007), states that managers influence firms' strategies in different ways, according to their personal preferences. Indeed the corporate decision making is seen as an interpretative endeavor since experiences, personalities and values contribute to form personal lenses through which executives perceive and judge events and situations. In alternative to agency theory, thus, upper echelons theory argues that differences in firms' outcomes are due to distinct characteristics of actors.
Shareholders, thus, face an important challenge since they have the duty and the need to ameliorate these problems by implementing opportune actions in order to prevent opportunistic behaviours of executives. However, in situation of dispersion of ownership, in which none of the shareholders hold enough shares such that they can have incentives to control, monitor and evaluate the corporate decision making, the management will
likely be free to operate without interferences (Fama and Jensen, 1983). In fact, minority shareholders have no motivation to spend their time to oversee the work of executives, since they are not able to influence strategies due to the lack of voting power.
The pattern is different in presence of shareholders with significant percentage of the stock, since the greater power will incentivise them to participate actively in the corporate decision making (Admati et al. 1994; Lee and Lounsbury 2011; Smith 1996) by naming members of the Board of Directors (Boyd, 1994) and installing appropriate systems of control and incentives. Previous empirical studies show the positive relationship between the ownership concentration and the process of decision making (Baysinger et al. 1991;
Kochhar & David 1996).
Furthermore Nesbitt (1994) states that a major concentration of ownership allows to influence and control management better and, consequently, it leads to less managerial opportunistic behaviours. This exercise of power will not secure benefits only to the shareholders of the company but also to other providers of funds, such as bondholders. In contrast Bhojraj and Sengupta (2003) argue that shareholders preferences might hurt bondholders, since they can force executives to take on risky strategies to benefit profits, even if the risk of failure is shared with other stakeholders.
According to La Porta et al. (1999), the minimum percentage of votes needed in order to have the power of injecting their preferences and, consequently, influencing the corporate decision making, is 10 percent.
In addition different types of shareholders have different perspectives about investments. These differences will be injected into the organization’s decisions, since companies’ strategies reflect their shareholders’ preferences, assuming they own a significant part.
Shleifer and Vishny (1997) report that Institutional shareholders influence the decision making and exercise their power since they often hold significant shares of the firm’s stock which cannot easily be sold, have asymmetric information advantages over the other shareholders (Schnatterly et al. 2008) and a long-term orientation (Sethi, 2005).
Jensen (1993) and Shleifer and Vishny (1997) argue that Institutional investors that own
significant part of stock or debt are important actors in guaranteeing well structured systems of corporate governance. Indeed they have the power to force managers to change their behaviours, if they are not aligned with shareholders' interests, and are able to analyze and judge firm executives and policies in their objective way, given the long-term nature of their interest. However, according to the analysis conducted by Fortune (1993) Institutional investors have different perspectives about investments since some focus on long-term performances while others on short-term ones. In particular mutual and public pension funds tend to have long-term perspectives, given the long-time horizons and the transparent nature of their investments. On the other hand investment banks, security firms and insurance companies are characterized by compensation policies based on short-term performances (e.g. Johnson and Greening, 1999) and high turnover rates (Bushee, 1998).
Previous studies report that foreign investors are more willing to control, monitor and influence the corporate decision making in order to prevent opportunistic behaviors (De Jong and al., 2014). Both managers and local shareholders have an information advantage over foreign investors, especially if the characteristics of the home and foreign environment are substantially different (Vachani, 1999). Indeed, with increased distance, obtaining accurate and complete data about the company becomes more difficult and costly (Roth & O'Donnell, 1996). Then foreign investors tend to oversee more on strategical decisions taken by the management to preserve their interests. Given the highly expensive nature of the investment in terms of time and money, foreign investors are generally constituted by large companies or Institutional institutes. In fact, they are more willing to explore new markets or to diversify their portfolios by expanding abroad through huge long-term strategies. However, foreign investors could face problems related to the liability of foreignness, considered as the cost to invest abroad due to differences in culture and institution (Hymer, 1976; Kindleberger, 1969). According to these assumptions foreign shareholders might not be able to influence the corporate decision making since they could not have enough knowledge about the cultural and institutional environment of the foreign country.
In a similar vein, Zahra (1996) argues that the executive stock ownership is positively correlated to the process of corporate entrepreneurship, since it mitigates the risk that managers could maximize their return at the expense of the firm's one. According to the agency theory (Eisenhardt, 1989; Jensen and Meckling, 1976), managers are able to obtain the support of different stakeholders by allocating resources in a way to benefit them. These behaviours allow managers to have more power than shareholders and, consequently, to manage the company by injecting their personal preferences. Providing shares to managers is a strategy to align their interests to those of the shareholders and mitigate agency conflicts. Indeed, if executives hold significant part of the equity they are more willing to maximize the shareholders' value (McConnell and Servaes, 1990).
2.2 Corporate Social Responsibility
The concept of Corporate Social Responsibility was introduced in 1950s years by many scholars including Bowen, who was the first to give an important contribution to this notion in 1953. He argued that managers' actions also have to pursue the increase of the society's welfare by taking socially responsible behaviours, considered a duty of all businessmen.
During the 1960s the doctrine of Corporate Social Responsibility was further defined and studied. Davis (1960) introduced the notion of CSR as "decisions and actions taken for reasons at least partially beyond the firm's direct economic or technical interest" 1 (pag. 70).
Furthermore, in his work Strategic Management: A Stakeholder Approach, Freeman (1984) was the first to describe the stakeholder theory. He stated that companies have duties and responsibilities toward stakeholders they interact with, such as society, workers, suppliers and consumers.
Cochran and Wood (1984) were the first to introduce CSR as an activity that helps companies to become more profitable. The goal of their study was to understand if socially responsible behaviours had a positive impact on firms' performance.
1 Davis, K. (1960). Can business afford to ignore social responsibilities? California Management Review, 2(3),
Two main perspectives on CSR arise from past studies. First, investments are viewed as a mean to increase firms' performance. According to Freeman (1984), managers have the duty to benefit stakeholders - such as communities, governments and NGOs -, considered critical resources to increase the firm's value. A concrete example of this view is reflected in the Caux Principles, a set of purposes established by a group of influential managers. This set of proposed behaviours is based on two principles: human dignity and kyosei - a japanese term commonly meant as "living and working together for the common good" . On the contrary, Friedman (1970) argues that executives have the goal2 to maximize the shareholders' return in order to mitigate agency conflicts. In fact, they should be able to recognize and exploit all profit drivers, included goodwill and reputation. Both the theories emphasize the need to engage CSR practices but with different perspectives. While Freeman states that CSR - meant as all actions taken to benefit stakeholders - is the basis on which managers build strategies, Friedman argues that CSR is a mean to reach the goal, maximizing the shareholders' return. Thus, CSR practices are seen as resources that could be invested differently to enhance the firm's value chain.
During the 1990s, the concept of CSR was further developed. In fact, many scholars started to study it as part of firms' strategy to increase profits and the market share (Barnett, 2016).
The promotion of socially responsible practices practices allow companies to build solid and long-term relationship with society and, more in general, with all stakeholders.
However CSR should not be considered as an opportunistic action firms adopt to enhance their reputation among stakeholders and, even if it is the consequence of their behaviours.
Companies can implement successful CSR strategies in several ways. First of all, an active and constant collaboration with stakeholders is required in order to understand which themes need an intervention. Then, activities should be splitted into divisions, according to different critical areas on which investing.
2Melé, D. (2009). Integrating personalism into virtue-based business ethics: The personalist and the common good principles. Journal of Business Ethics, 88(1), 227-244
Why do companies invest in CSR?. Firms can implement CSR strategies in different ways to benefit of improvements and opportunities derive from them. Previous studies (Luo and Du, 2015) have shown that companies pay particular attention to CSR practices when they are trying to launch a new product, to enter a new market, to increase the reputation among customers and to improve the satisfaction of workers.
First, companies can use CSR practices strategically to introduce a new product in the market. In fact, firms are incentivized to work on the launch of goods that support both the business and the environment through investments in Research and Development.
According to Luo and Du (2015) companies that focus on CSR as a pivotal activity to improve their growth and innovativeness have a consistent advantage in the development of new products. Indeed, socially responsible firms are more able to capture information on market trends and evolution, since they build strong relationships with stakeholders, and to set up opportune R&D strategies.
Second, sustainable practices are engaged to enter new markets since socially responsible behaviours help companies to improve their knowledge about new environments. The rapid globalization faced in recent years has been highly challenging for companies, since they have been forced to work with people from different countries and to look for new markets.
Third, CSR is also considered a good mean that help companies to enhance their reputation among customers and, consequently, their market shares. People pay attention to environmental sustainability and are more willing to buy products and services from socially responsible firms. Investing in activities aimed to enhance the social corporate image is considered a good practice to create a loyal clientele and to increase the firm's value (Gazzola, 2014). Moreover companies pay more attention to not damage their reputation with unethical behaviours, since many credit agencies have included social activities in the criteria to value firms.
Fourth, employees are more satisfied to work in companies that benefit the social welfare and, consequently, they will perform better. According to the results of a study made by the Center for Talent Innovation, workers would be willing to leave their
positions if their firms do not respect the environment in which they operate. Moreover, the social identity theory (Ashforth & Mael, 1989; Pratt, 1998) argues that people tend to identify themselves with organizations when their values overlap the organizational ones.
In situation of organizational identification, employees are more likely to work hard.
Indeed, they feel proud to work for a company that benefits society and has a strong reputation in the community. Thus, the goal for firms is creating an organizational culture based on norms and values - such as responsibility and respect - shared by employees.
Furthermore, the sense of gratitude and, consequently, of obligation toward the company that operates in favor of the environment leads employees, that are part of the society, to react with an exchange of gratifications to help who has helped them (Gouldner, 1960).
Factors that influence the engagement of CSR practices. Previous studies have inquired on which factors could encourage and allow companies to engage CSR activities.
The first is the Performance.According to the positive approach to CSR, the extent to which companies invest in social responsible practices depends on performances.
Individuals have the tendency to develop their "critical sense" only in situations of welfare (Poddi and Vergalli, 2009). Thus, firms with high performances will be more willing to invest in research and development and in practices that benefit the environment. Moreover, bigger firms also engage socially responsible behaviours since they are more exposed to the pressure and the attention of media.
The industry is another aspect that can drive firms to invest in CSR. Each company interacts with a different number and typology of stakeholders - defined by Freeman (1984) as "any group or individual who can affect or is affected by the achievement of a corporation’s purpose" - according to their operations and environments in which they3 operate. Thus, industries determine the cluster of stakeholders firms interact with (Simpson and Kohers, 2002) and the extent to which they engage social practices (Sacaris, 2004).
3Freeman, R. Edward. (1984). Strategic Management: a Stakeholder Approach. Boston: Pitman Publishing Inc.
Reprinted in 2010 by Cambridge University Press
The CEOs' Political Ideologyproduces effects on firms' level of investments in CSR.
According to the Upper Echelons Theory (Hambrick and Mason, 1984; Hambrick, 2007) CEOs take decisions, including those about CSR, on the basis of their personal set of values, personalities and experiences. In particular, liberal people have the tendency to pay more attention to social problems than conservatives (Schwartz, 1996), which are more concerned with status quo, order, business needs and stability (Jost and al., 2003).
Thus, liberal CEOs engage CSR activities more, since they strongly believe that socially responsible behaviours are profitable and desirable for shareholders (Chin, Hambrick and Trevino, 2013).
The last factor that could influence the extent to which companies invest in CSR is the Risk. Previous studies have analyzed whether a relationship between market risk and CSR practices exists. Trotman and Bradley (1981) state that firms with a higher systematic risk - meant as the one which could not be diversified since it is inherent to the business - are more concerned to provide social responsibility disclosure in order to strengthen their reputation and reduce cost of capital and asymmetric information.
2.3 Corporate Credit ratings
Rating agencies - such as Standard & Poor's, Moody's and Fitch Ratings - determine corporate credit ratings (on the basis of letter designations) according to the probability bondholders have to be payed, which depends on the firm's cash flows. Indeed, a firm's creditworthiness is established on the capability to generate enough cash flows to cover principal expenses and debt service costs. As a consequence, credit ratings are expected to follow the trend of cash flows. If the latter increase the likelihood of default decreases and, thus, the firm's credit rating will be expected to be higher.
Credit ratings are established with letter designations through a process that develops as follow: the team of analysts collect data and study them in order to understand the financial situation of the company; then, a committee analyze the material collected by the analysts and value it by assigning a score; finally, the rating is communicated to the company that can decide to publish or not. However this process can create situations of
insider trading due to the lack of communication to the market of information that affect the stock price. In fact it leaves space for speculation, since the client company may use information received from the credit agency to sell its shares before the stock prices falls.
Over the years credit agencies have received several critics regarding potential conflict of interests. First, some agencies can use the double role of credit agency and Investment banking to manipulate market prices by assigning overrated or underrated scores to companies to speculate about fluctuation of stock prices. Second, rating agencies are payed to provide ratings; thus, they can assign scores that do not reflect the real situation of a firm to not lose a client, especially if it also commit consultancy or banks services.
After the scandals of the first decade of 2000s - such as Enron, Parmalat, Cirio and the most recent Lehman Brothers - in which credit agencies were accused to have assigned overrated scores, the Securities Exchange Commission has implemented new rules, in order to enhance controls and to introduce new standards of experience, training and competence, and has increased punishments. Furthermore most of the credit agencies have reinforced their internal procedures to appear more transparent, reliable and compliant.
Finally, credit ratings cannot be used as official documents for all activities; National authorities have the duty to determine when companies are allowed to use them officially.
3. HYPOTHESES DEVELOPMENT
3.1 The relationship between the ownership structure and corporate credit ratings In accordance with the agency theory framework provided by Jensen and Meckling (1976), companies face three types of problems that can affect the probability of default and, consequently, the firm's value. First, both shareholders and bondholders' interests could enter in conflict with the managements' ones. In firms with widely dispersed ownership, characterized by separation of control, information asymmetry problems are more likely to arise. The lack of control leads managers to pursue their own interests at the expense of shareholders, since their behaviours could affect expected cash flows. As
described above, a decrease of cash flows exposes the company to a major risk to not cover all commitments; thus, the probability of default increases, while credit ratings are lower. Agency conflict problems can be mitigated through governance mechanisms, aimed to promote norms and values and to control and to limit opportunistic managerial behaviours that could affect the firm's cash flows and value. In fact when corporate governance is weak, companies face a major probability of default and, consequently, lower credit ratings, since managers are free to pursue their own interests at the expense of all stakeholders (Kisgen, 2006). The variance of expected cash flows will increase, since it is difficult to make predictions in situation of uncertainty; consequently the likelihood of default increase and the firm's credit rating will be lower, as consequence of the major riskiness.
Previous studies have shown that the presence of certain types of shareholders can reduce agency conflicts. Infact Institutional and foreign shareholders are more willing to control and monitor managers' actions and to favor the development of sustainable behaviours by injecting their preferences into the corporate decision making. Moreover, providing shares to top management is a strategy to align their interests to those of shareholders and to mitigate the agency problem. Thus, certain ownership structures can benefit the firm's perceived risk and the variance of the expected future cash flows through the mitigation of agency conflicts.
However, bondholders could face agency problems (type 3) also with shareholders, since the latter are incentivized to maximize their wealth. In fact, they can undertake strategies to move money from bondholders to themselves, influencing the variance and the mean of expected future cash flows. For instance, if shareholders make a request of direct payouts they will take money which managers can use to invest in activities with positive net present value and to generate higher cash flows, that will decrease in this pattern. Similarly, shareholders can make pressure on managers to take risky projects that increment the variance of future cash flows. Thus, bondholders face the risk that their fixed amount won't be payed while shareholders increase their potential profits.
Furthermore shareholders, especially those who are able to influence the corporate
decision making, could ask for higher dividends that reduce the financial availability and, consequently, increase the financial exposure of the company.
Shareholders with enough power to exercise control over management might try to favor their personal interests at the expenses of bondholders' ones (Shleifer and Vishny, 1997), by forcing executives to take actions like greenmail and targeted share repurchases (Dann and DeAngelo, 1983).
According to the assumptions stated above and to the framework provided by Baron and Kenny (1986) on the mediation effect, I argue that a high degree of Institutional, both with long and short-term orientations, foreign ownership or the presence of shareholders that are also managers companies influence negatively firms’ credit ratings in order to verify whether there is an effect that could be mediated.
H1a: A high degree (at least 10%) of Institutional ownership with long - term orientations is negatively correlated to credit ratings.
H1b: A high degree (at least 10%) of Institutional ownership with short - term orientations is negatively correlated to credit ratings.
H1c: A high degree (at least 10%) of foreign ownership is negatively correlated to credit ratings.
H1d: The presence of managerial shareholders is negatively correlated to credit ratings.
3.2 The ownership structure and the implementation of CSR practices
Socially responsible investments should benefit shareholders; however, as part of long-term sustainable strategies, they do not produce effects in the short them and, thus, corporate decisions regarding CSR are influenced by the presence of specific types of shareholders since their investments are led by different interests. CSR activities help companies to strengthen their position in the market. In fact, CSR practices allow to build stronger and deeper interactions with stakeholders, favoriting the exchange and the sharing of external knowledge which complements the internal one and facilitates the
process of innovation. Thus, socially responsible firms have more resources - meant as the set of internal and external ones - to invest in Research and Development and to develop products that benefit both their business and the environment in which they operate (Luo and Du, 2015). Secondly, firms that consider CSR as a pivotal activity show a major capacity to protect their market shares or to enter new markets due to the higher reputation they have among clients (Shenkar, 2001). In fact customers are sensitive to environment conditions and show the tendency to spend their money for goods and services offered by companies that pay attention to social welfare and make investments in sustainable activities.
Firms are incentivized to invest in CSR activities because they are positively associated with the performance in the long run (Orlitzky et al. 2003), help companies to improve their relationships with stakeholders, according to the good management theory (Waddock and Graves, 1997), and are a key driver to create valuable intangible assets, such as customer loyalty or retain high-quality employees (Turban and Greening, 2000).
Then, in accordance with the resource-based view (Barney, 1991), companies that use internal assets to finance their investments in CSR are likely to reduce the perceived probability to incur in the risk of financial distress since they show capacity and availability to allocate their resources efficiently. Socially-oriented firms are perceived as
“safer”; the orientation influences the public perception about a firm’s compliance and, consequently, about its inclination to meet shareholders’ expectations (Shane and Spicer, 1983). Previous studies have shown how potential investors judge socially irresponsible companies as having more idiosyncratic risk (Lee and Faff, 2009).
Furthermore, many scholars suggest that the type of ownership affect firms’
strategies, since the interests of shareholders are different. Siegel and Vitaliano (2007) argued that Institutional shareholders, such as pension funds, banks, insurance agencies and securities firms, invest in socially responsible companies to show to their potential clients the responsibility and the affordability of the Institute. Institutional shareholders tend to make huge investments in order to exercise substantial voting power (Shleifer and Vishny, 1997) and to use the potential asymmetric information advantage over other
shareholders (Schnatterly et al., 2008). Furthermore, according to the good management theory (Graves and Waddock, 1994), Institutional shareholders are more willing to support CSR practices since they enhance the firm's long term performance. However a study conducted by Fortune (1993) stated that Institutional investors have different perspectives about investments and, consequently, different propensity to support the implementation of CSR practices, more focused on the long - term period.
Another line of argument focuses on the idea that CSR practices may help foreign investors to reduce the uncertainty. Indeed, as stated above, social investments may represent a signal of trustworthiness companies want to send to potential investors (Siegel and Vitaliano, 2007). Investing abroad could be risky due to information asymmetry problems caused by environmental and cultural differences (Gehrig, 1993); indeed foreign investors might face issues related to the liability of foreignness (Hymer, 1976;
Kindleberger, 1969), which could not make them able to collect and decodify enough information to exercise their power. Thus, investing in socially responsible companies - which promote values of transparency and compliance - could be a way to mitigate the risk of going abroad.
Furthermore, the risk should be also mitigated by taking actively part to the corporate decision making in order to pressure managers to make socially responsible behaviors and avoid to lose their money due to bankruptcy or legal sanctions (Gehrig, 1993).
However, previous studies have shown that foreign investors - which come from countries with high levels of corruption and antisocial behaviours - could try to inject their personal preferences in the corporate decision making and, consequently, support socially irresponsible strategies (Davis and Kim, 2007).
Then, providing stock to managers is a strategy to reduce the risk to incur in agency problems. If they hold a significant part of the stock, they are more likely to make strategies focused on the maximization of shareholders’ interests. Previous studies have shown that CSR practices are positively correlated to the firm's performance (Orlitzky et al., 2003); thus, managers might be willing to include the implementation of CSR
practices in the corporate strategy as a mean to increase the firm's value and, consequently, their return.
Moreover, the environmental context may influence the extent to which managers take socially responsible behaviours. Developed countries put more pressure on management to invest in CSR practices (Campbell, 2007). In fact, the Institutional environment encourage transparency by forcing companies to provide more disclosure about investments and critical information. In this pattern, managers are less free to pursue their own interests by taking actions that may affect negatively the firm's sustainability.
However, being CSR investments associated to long-term orientations, since the implementation of practices that benefit both businesses and the environment could require time before to be profitable (Abowd and Kaplan, 1999), managers might pursue strategies in order to increase the price of shares and the firm's performance in the short-term (e.g. favoriting the divestiture and the selling of business units). Indeed, they are judged on results and, thus, the presence of shareholders that do not support the implementation of long-term sustainable practices could lead management to take actions finalized to obtain profits quickly.
This line of argument fits best with the current economical situation, characterized by a strong competition; managers, afraid about the possibility to be replaced, tend to be more focused on short-term results in order to keep their position safe.
Companies in which shareholders own a significant part of the stock face less agency problems. Indeed, previous studies have shown that shareholders with a relevant percentage of shares are more willing to monitor and control the actions of managers and influence the corporate decision making, since they are able to exercise their power (Kochhar and David, 1996).
Thus, I hypothesize that a high degree both of Institutional shareholders with long - term orientations and of foreign ones affects positively the extent to which companies invest in CSR practices, since they have the power to influence the corporate decision making on the basis of their preferences, which are focused on the implementation of
long-term strategies. Furthermore, the presence of managerial ownership or of Institutional investors with short-term orientation shareholders is hypothesized to be negatively correlated to CSR since they are incentivized to promote and pursue strategies which increase the company's value in the short period.
H2a: A high degree of Institutional ownership with long - term orientations positively affects the implementation of CSR practices.
H2b: A high degree of Institutional ownership with short - term orientations negatively affects the implementation of CSR practices.
H2c: A high degree of foreign ownership positively affects the implementation of CSR practices.
H2d: The presence of managerial shareholders negatively affects the implementation of CSR practices.
3.3 Corporate Social Responsibility influences corporate credit ratings
Recently companies are facing more external pressures and credit agencies have started to include social activities of firms into their rating assessments. Standard and Poor’s, one of the most accredited credit rating agencies, made a review of the corporate ratings criteria guidebook in 2008. It refers to two categories of risk in assigning scores to companies, business and financial risk. The agency does not explicitly use the category
“Corporate Social Responsibility”, but it introduced a set of CSR - related activities in order to measure the extent to which companies operate in the respect of investors and stakeholders’ interests. This set refers to all procedures, policies and practices implemented by companies to provide clear and transparent information and to reduce the perceived risk. For instance the S&P guidebook states that "covers a broad array of topics relating to how a company is managed; its relationship with shareholders, creditors, and others, and how its internal procedures, policies, and practices can create or mitigate risk"
(p.34) and that "how management handles unions and employees can determine a company’s fate in cases where a strike could be fatal to operations" (p. 33). Furthermore,
the Dallas' guideline (2004) on the corporate governance takes into consideration the importance of relationships between the company and its external stakeholders. In particular it emphasizes that a good firm "maintains good public reporting on key areas of employee, community, and environmental activities that address concerns of non-financial stakeholders and maintain an active policy of engagement with diverse investor and stakeholder interests" (p. 82).
CSR practices can be a determinant factors to improve the firm's reputation and, consequently, its credit rating. Indeed they contribute to reduce the company's risk of financial distress; in particular they affect the perception of corporate riskiness since their implementation favors long-term sustainability by enhancing relationships with stakeholders, by using internal resources efficiently and by decreasing transaction costs related to socially irresponsible behaviours.
First, according to the good management theory (Waddock and Graves, 1997) CSR practices benefit relations with stakeholders - such as authorities, workers, customers, and suppliers- helping companies to increase their reputation in the environments in which they operate, to create valuable intangible assets (Turban and Greening, 1997) and to improve their market shares and competitive positions (Whitehouse, 2006).
Second, firms can reduce their financial exposure by meeting stakeholders expectations through the use of internal resources. According to the resource-based view (Barney, 1991) the way in which strategic resources are used and combined within companies determine the capacity to generate sustained competitive advantages. In particular, firms that use their resources efficiently are more likely to create value, rareness, inimitability and substitutability. The latter refers, among others, to the ability to finance investments with internal resources instead of recurring to external funds. Thus, the capacity to allocate internal resources efficiently is seen as a signal of profitability and stability that can decrease the financial exposure of the firm and, consequently, the perceived risk of financial distress.
Third, companies that provide more disclosure about their socially-oriented activities are perceived as more compliant and, consequently, as more likely to distribute cash
flows in the future (Shane and Spicer, 1983). Thus, firms that have the tendency to not give much information may face an increase in the idiosyncratic risk (El Ghoul et al., 2011), since they are perceived as socially irresponsible by investors because of the lack of transparency. This is reflected in lower credit ratings and in an increase of transaction costs companies face to be considered ethical and compliant.
Furthermore, since both CSR practices and credit ratings are affected by the ownership structure of the company, a correlation may exists because they are caused by the same variable. For this reason, the relationship is controlled by the ownership structure.
I hypothesize that investing in CSR practices lead to higher credit ratings, since they help companies to be perceived as reliable, transparent, compliant and, consequently, less risky.
H3: Investments in Corporate Social Responsibility are positively correlated to corporate credit ratings, by controlling for the ownership structure of the company.
3.4 The mediation role of Corporate Social Responsibility
In recent years, potential investors have lost trust in companies due to the fear to not have their money back. In conditions of uncertainty, credit ratings are of crucial importance for firms, since they represent signals of reliability, efficiency and transparency.
Previous studies have shown how certain types of shareholders can favor the extent to which companies implement CSR practices because of the nature of their investments. As argued by Friedman (1970) investments in socially responsible activities affect positively profits of companies. In fact, considering CSR as part of the corporate strategy allows firms to benefit the way in which they are used to do business. Since companies are involved in a lot of exchanges with many external actors, that are part of the environment, sustainable behaviors improve relationships with stakeholders and, consequently, favor the reduction of transaction costs and the increase of the corporate reputation.
Firms which take care about stakeholders’ interests by promoting and sharing values of transparency and trustworthiness are more likely to receive high scores. They are considered less risky and, consequently, good investments for potential investors.
Furthermore, according to the model on the mediation provided by Baron and Kenny (1986), verifying the relationship between independent and dependent variable by controlling for the mediator, help to understand whether the ownership structure produces effects on corporate credit ratings only through the mediation of CSR (full mediation) or there is also a direct relation between the two variables (partial mediation).
Thus, I argue that investments in Corporate Social Responsibility mediates positively the extent to which Institutional shareholders with long-term orientations or foreign shareholders - with a sufficient percentage of votes to influence the corporate decision making - influence corporate credit ratings. In fact, favoring the implementation of CSR activities might bring to higher corporate credit ratings, since socially responsible companies are perceived as less risky. On the other hand, CSR negatively mediates the relationship between Institutional shareholders with short-term orientations or managerial shareholders and corporate credit ratings; indeed these types of investors, not incentivising the implementation of long-term sustainable strategies, could expose companies to be perceived as unlikely to generate future cash flows.
H4a: Corporate Social Responsibility positively mediates the relationship between a high degree of Institutional ownership with long-term orientations and corporate credit ratings.
H4b: Corporate Social Responsibility negatively mediates the relationship between a high degree of Institutional ownership with short-term orientations and corporate credit ratings.
H4c: Corporate Social Responsibility positively mediates the relationship between a high degree of foreign ownership and corporate credit ratings.
H4d: Corporate Social Responsibility negatively mediates the relationship between the presence of managerial shareholders and corporate credit ratings.
4. RESEARCH METHODOLOGY 4.1 Sample and Data Collection
Data are collected using three different sources. First, information about the ownership structure and the control variables (average ROA, average Solvency ratio, average Coverage ratio, industry and profit and loss) - based on previous studies on CSR (Sacaris, 1994; Waddock and Graves, 1997) and credit ratings (Blume et al., 1998;
Bhojraj and Sengupta,2003; Mansi et al., 2004; Ashbaugh-Skaife et al., 2006) in order to not incur in endogeneity problems - are gathered from Orbis. It is "Bureau van Dijk's flagship database of private and listed company information from around the world" , 4 which provides numerous report about firms by combining data from different sources (e.g. financial, statements, merger and acquisitions, ownership structure, directorship).
Second, I make use of the Thomson Reuters ASSET4 dataset to collect secondary data about Corporate Social Responsibility.
Finally, credit ratings scores are obtained from Compustat North America, which is
"a database of financial, statistical and market information on active and inactive global companies throughout the world" . 5
The research involves companies present in the S&P 500 index at the end of 2016.
The index is based on the market capitalization of the largest and most established U.S.
firms listed on the NYSE or NASDAQ. These firms are considered appropriate domains of study. Indeed according to the framework provided by Matten and Moon (2008) U.S.
firms tend to be more involved in CSR practices due to the characteristics of the social, cultural and political environment in which they operate and the coercive pressures they receive from it. The authors inquired why there are different forms of Corporate Social Responsibility across countries and they found that U.S. companies tend to enact programs, policies and practices linked to CSR more explicitly. In fact in U.S. the
4Orbis. (2017). Company information worldwide. Retrieved from
https://www.bvdinfo.com/en-us/our-products/company-information/international-products/orbis
5Wikipedia. (2017). Compustat. Retrieved from https://en.wikipedia.org/wiki/Compustat
government does not provide an extended regulation about labor, education and environmental protection; thus companies are encouraged to engage explicit CSR practices in order to address issues, such as workers' rights (e.g. redundancy, fair wages, health care, working conditions and time) or social inequality (e.g. financing local schools, providing scholarships), not regulated by law. On the contrary, European companies incur in implicit CSR, meant as the compliance to rules enacted by governments.
Moreover small firms tend to reduce investments in CSR due to the lack of resources while large companies are more involved in sustainable concerns since they face a greater exposition to public opinion pressures because of a major financial availability (Yelkikalan & Köse, 2012). Thus, I decide to take into consideration firms included in the S&P 500 - the largest in U.S. ranked on the basis of their revenues - in order to isolate them from small and medium companies that might not have enough resources to engage complete CSR plans, aimed to benefit both the business and the environment.
I exclude from the sample companies for which not all data are available; thus, the number of companies analyzed is 334.
4.2 Variables Description 4.2.1 The Ownership structure
In order to measure the Independent variable, I categorize ownership structure into institutional ownership, foreign ownership and managerial ownership.
Previous studies have argued that Institutional investors have different perspectives about investments due to the characteristics of their investors and holdings (Fortune, 1993); Thus, I consider this difference by splitting Institutional investors into two variables, according to the time horizon of their investments. In particular, mutual and pension funds are grouped as Institutional Shareholders with long-term orientations, while investment banks, security firms and insurance companies as Institutional Shareholders with short-term orientations.
Foreign ownership refers to investors from foreign countries which hold shares of companies included in the sample of study. Due to the size of the investment, the complexity to deal with a foreign environment and the difficult to gather information about foreign companies, foreign investors are often represented by Institutional organizations. Thus, in case of an investor is both foreign and Institutional I will take it once and, in particular, it will be considered an Institutional shareholder.
Furthermore, I take into consideration only Institutional or foreign shareholders with at least 10 percent of votes, so that they could be able to influence the corporate decision making.
Managerial ownership refers to companies in which members of the Top Management Team own shares of the stock.
The four categories that form the Independent variable are considered separately and are measured through a Dummy that assumes the value of 1 if a company has Institutional with long-term orientations (Dummy_INST_LONG), Institutional with short-term orientations (Dummy_INST_SHORT), Foreign (Dummy_FOR) or Managerial (Dummy_MAN) shareholders, and the value of 0 otherwise.
4.2.2 Corporate Social Responsibility
Corporate Social Responsibility has become source of discussion among researchers not only because there is not a commonly accepted concept of what CSR refers to (Gond
& Crane, 2008), but also because it has been measured using different approaches (Wood, 2010), all characterized by the utilization of different indicators rather than a unique measure (GRI, 2006). In order to calculate the effort firms put into investments in CSR, previous studies used an expenditure-related measure which calculated the monetary amount allocated to engage sustainable activities (Wood, 2010).
On the other hand, since CSR include numerous dimensions that are related each others there is the “need for a multidimensional measure applied across a wide range of
industries and larger samples of companies” (p.304), as stated by Waddock and Graves 6 (1997).
Some scholars have used the database ASSET4 to measure the level of companies' investments in CSR practices (Cheng, Ioannou, & Serafeim, 2014; Ioannou & Serafeim, 2012), since it identifies the extent to which firms integrate their operational frameworks with sustainable policies (Cheng et al., 2014; Mackenzie, Rees, & Rodionova, 2013). For this reasor I gather data to measure CSR from the database ASSET4. It measures CSR by summing such indicators which are expression of a firm's effectiveness, involvement and commitment towards socially responsible activities and its capacity to set up day-to-day processes. In particular it takes into consideration 250 key performance indicators which are grouped into 18 different categories within four pillars (social, economic, environmental and governance) to provide information about transparency and objectivity (Schäfer, Beer, Zenker, & Fernandes, 2006) and guarantee high standards of accuracy, quality and timeliness. A z-score - which measures a firm's performance on the basis of equally-weighted calculations of categories and pillars - is assigned to each company; then it is compared to those attributed to other firms. As stated by Shaukat et al. (2016) the attribution of scores provided by ASSET4 is more comprehensive and less biased than the MSCI ESG STATS (formerly known as KLD STATS).
4.2.3 Corporate Credit Ratings
Credit ratings are measured by specialized agencies on the basis of bonds issued by each company in order to establish the probability of default.
I take into consideration the long-term credit ratings assigned by the U.S. agency Standard and Poor's and provided by Compustat North America. Ratings vary from the highest score of AAA to the lowest D, and reflect the firm's ability to meet senior debt obligations. Scores are transformed into an ordinary scale. It is in accordance with previous studies (Blume et al. 1998; Bhojraj and Sengupta 2003; Mansi et al. 2004;
6Waddock, S. A., & Graves, S. B. (1997). The corporate social performance—financial performance link. Strategic Management Journal, 18, 303–319
Ashbaugh-Skaife et al. 2006, among others), which turned scores assigned by credit agencies into ordinary numbers to analyze them.
Accordingly, a score of 8 is given if the firms obtained a S&P rating of AAA, 7 if AA, 6 if A, 5 if BBB, 4 if BB, 3 if B, 2 if CCC, and 1 if CC.
4.2.4 Control variables
In order to isolate the effects of the independent variables I introduce some variables used in previous studies on credit ratings (e.g., Blume et al. 1998; Bhojraj and Sengupta 2003; Mansi et al. 2004; Ashbaugh-Skaife et al. 2006). Thus, H1, H3 - in which corporate credit ratings form the outcome variable - are controlled for the Coverage ratio, the Profit Margin and Losses. The first - defined as the "measure of a company's ability to meet its financial obligations" is directly connected to credit ratings since it determines to what7 extent companies are able to generate enough cash flows to pay creditors. The second - calculated as net profits on sales - is used to determine the impact that a major ability to generate profits from sales has on corporate credit ratings. The third variable - a dummy that assumes value of 1 if the company had a negative net income before extraordinary items either in the current or in the previous year, and 0 otherwise - is introduced to verify whether the perceived ability of companies to meet creditors' expectations is directly connected to profits.
Then, I control for industry effects in H1, H2 and H3 since the industry may alter both the extent to which companies invest in Corporate Social Responsibility (Sacaris, 2004) and the default risk. In order to verify if there are any potential industry effects, I make use of several dummies, which assumes the value of 1 if a company belongs to that industry, and 0 otherwise. In particular I group companies according to the North American Industry Classification System (NAICS) - used in U.S.A., Canada and Mexico - which classifies company on the basis of their economic activities. Industry sectors for which there are less than 10 companies related to are grouped into the category "Others"
7 Investopedia. (2015). What are financial risk ratios and how are they used to measure risk?. Retrieved from http://www.investopedia.com/ask/answers/062215/what-are-financial-risk-ratios-and-how-are-they-used-measure-ris
(see Table 2 in the Appendix). Thus, I create 9 dummies by taking the category "Others"
as reference industry.
Moreover Hypothesis 2 - in which Corporate Social Responsibility is the outcome variable - is controlled for measures of company characteristics through the use of indicators of financial performance. I control for the average of firms' past performances in order to mitigate the risk that companies invest more in CSR as a consequence of the major profitability they have, as stated by the slack-resources theory (Waddock and Graves, 1997). Thus, I make use of the Return on asset (ROA) and of the leverage - calculated through the debt-ratio - to measure the profitability of firms.
All the variables mentioned above, except dummies, are calculated as the average of the previous 3 years (2013, 2014 and 2015) in order to create a time lag and to mitigate effects of potential extraordinary events.
Table 3. Variables, measures and sources of data
Variable Measure Source
Dependent Variable Corporate Credit ratings S&P long-term issuer credit ratings
Compustat North America
Independent Variable
Ownership structure 1.Dummy indicator that assumes value of 1 if there are certain types of shareholders and the value of 0 otherwise
ORBIS
Mediator Variable Corporate Social Responsibility ASSET4 index - Thomson Reuters
Datastream
Control Variables Industry 9 Dummy indicators (see Appendix 1).
An indicator takes the value of 1 when the company analyzed belongs to that specific industry, while the others takes the value of 0.
ORBIS
Performance 1.Coverage, calculated dividing the EBIT over the financial expenses.
2.Profit margin, calculated dividing the net income over net sales.
3.ROA, calculated dividing the company's net income over total assets.
4.Solvency, calculated dividing the EBITDA over total liabilities
All the indicators are expressed by averaging values of the last 3 years
ORBIS
Profit and Loss Dummy that assumes
value of 1 if the company had a negative net income before extraordinary items either in the current or in the previous year,
ORBIS
4.3 The regression model
The hypotheses are verified through multiple ordinary least squares (OLS) regression analysis, using the software SPSS. The OLS method is used to estimate "the unknown parameters in a linear regression model, with the goal of minimizing the sum of the squares of the differences between the observed responses (values of the variable being predicted) in the given dataset and those predicted by a linear function of a set of explanatory variables" . It is considered the best estimation method in case of exogenous8 regressors and homoscedastic and uncorrelated errors; indeed, under these assumptions, the OLS is the method with the minimum-variance mean-unbiased estimation.
The model used in this study implies the presence of a mediator that affects the relationship between the independent and the dependent variables.
Baron and Kenny (1986) established four steps to measure the effect of mediation.
First a relation between the independent variable and the dependent one has to occur, in order to establish that there is an effect that could be mediated (path c). Second, the independent variable has to be correlated to the mediator, considering it as an outcome (path a). The third step involved is to verify if a correlation between the mediator, treated as an independent variable, and the outcome variable exists. Since they may be correlated because caused by the same variable, it is necessary to control for the independent variable (path b). The fourth step is finalized to establish the kind of mediation, full or partial. If the effect of the independent variable over the dependent one while controlling for the mediator is zero the mediation is full, otherwise partial (path c').
4.4 Preliminary analysis
Before to test the hypotheses through the use of regressions, some assumptions have to be tested in order to not incur in errors. In particular the procedures to be tested are linearity, normality, multicollinearity and homoscedasticity.
8 Wikipedia. (2017). Ordinary least squares. Retrieved from https://en.wikipedia.org/wiki/Ordinary_least_squares
