Cost of equity of Dutch for-profit social ventures

Hele tekst

(1)Cost of equity of Dutch for-profit social ventures. Master Thesis MSc Business Administration Specialization: Finance. University of Groningen Faculty of Economics and Business. Author: Jurjen IJska Student Number: S1534238 First Supervisor University of Groningen: Prof. Dr. L.J.R. Scholtens Second Supervisor University of Groningen: Prof. Dr. B.P. de Bruin April 2012.

(2) Cost of equity of Dutch for-profit social ventures Jurjen IJska1. ABSTRACT. This study focuses on the cost of equity of Dutch for-profit social ventures, thereby making use of two methods. The first method is based on data provided by a Dutch investment organization and the second method is based on a survey done by the University of Groningen. The conclusion is that there is statistically significant evidence for a decrease in cost of equity based on the social and environmental performance of for-profit social ventures.. 1. University of Groningen, Faculty of Economics and Business, MSc Business Administration, S1534238. 2.

(3) 1. Introduction This thesis examines the cost of equity of Dutch for-profit social ventures in order to determine their value. A for-profit social venture is a venture that has as main goal the creation of social value; however, it also wants to create economic value. The relevance of the topic lies in the fact that current investors in for-profit social ventures are having trouble to determine the value of such a venture. Knowing the cost of equity would make it possible to value a for-profit social venture using a Discounted Cash Flow (DCF) approach, the cost of debt comes from the debt contracts a for-profit social venture goes into. Furthermore, for-profit social ventures are mostly young firms (Dees and Anderson, 2003) and for young firms it is difficult to attract debt (Gompers, 1995). Therefore, it is unlikely that for-profit social ventures are heavily financed with debt, thereby making equity the primary source of capital. Currently one of the methods used by a Dutch investment organization to value a for-profit social venture is a 25% write off on the invested capital. This 25% write off is made in order to put the for-profit social venture on the balance sheet of the Dutch investment organization. The 25% write off is based on the guidelines for venture capital, the CVCA/EVCA standards for venture capital, which state that write offs should be done in tranches of 25%. One of the reasons why this 25% write off is done is that social ventures most often generate less income than their commercial counterparts (Austin, Stevenson & Wei-Skillern, 2006) and in some cases this can mean that a for-profit social venture is not economically viable using a cost of equity used for ‘normal’ ventures (Austin, Stevenson & Wei-Skillern, 2006). However, when there would be a lower cost of equity for for-profit social ventures, these ventures could become economically viable. Therefore the first question addressed in this thesis is; what is the current cost of equity for a for-profit social venture? This question is addressed by using data provided by a Dutch investment organization in for-profit social ventures that likes to stay anonymous. The second question addressed in this article is; what would happen to the cost of equity for forprofit social ventures when individual investors would invest in for-profit social ventures? One way for individual investors to invest in a company is when the company is listed on a stock. 3.

(4) exchange. In Brazil there is a social stock exchange, the BVS&A2. On the BVS&A there is however, no possibility of trading the shares, therefore it is not a real stock exchange and the investments are more in the form of donations. There are however, other initiatives for opening stock exchanges especially designed for for-profit social ventures. In 2012, for example, the Impact Investing Asia Exchange3 will open a platform to purchase and trade shares in social ventures. Furthermore, in Germany there are also plans to open a social stock exchange4. A generally accepted theory about stocks is that the price of a share is based upon the expectations of all investors about the company. Therefore, a survey is used to find out what the cost of equity would be for a for-profit social venture5. The survey will be further discussed in the methodology section. There are indications that the cost of equity of a for-profit social venture would be lower than the cost of equity of ‘normal’ ventures. For example, the article by Epstein and Pava (1992) shows that shareholders do not always want to maximize financial return; they also want to invest in product safety and environmental performance. Epstein and Pava (1992) conclude that shareholders gain utility from alternative sources, this conclusion could mean that social and environmental return could lower the cost of equity of a for-profit social venture. The outline of this thesis is as follows; in section two a background is given. The background starts with the concept of value and is followed by the definition and a brief history of social ventures. Furthermore, the findings in articles about financial performance in relationship with social goals of a company are discussed. To conclude this section venture capital is briefly discussed and the hypotheses that are researched in this thesis are given. The thesis continues with section three, where the used methodology is discussed. In section four an overview of the data collected to conduct the research is presented and section five elaborates on the research results. Finally, in section six the conclusions and the limitations of this research are discussed and suggestions for further research are provided.. 2. Connected to the São Paulo Stock Exchange. 3. http://www.asiaiix.com. 4. http://www.nextsse.com. 5. The expected rate of return is the same as the cost of equity in this case. 4.

(5) 2. Background This section gives a background, starting with the definition of value. Section 2.2 gives a definition and brief history of for-profit social ventures. Section 2.3 is about the relation between social goals of a company and the financial performance. In section 2.4 venture capital is discussed and section 2.5 gives the research hypotheses.. 2.1 The concept of value The first part of this section discusses the Discounted Cash Flow (DCF) approach and later a broader view on the concept of value is given. Companies are given a certain value (e.g. share price), based upon the expectations of all investors about that company. One of the most common ways in finance to determine the value of a company is to use the Discounted Cash Flow (DCF) approach. For the DCF approach, the expectations of the future free cash flows are separated in the present value of the future free cash flow during the explicit forecast period. And in the present value of the future free cash flows after the explicit forecast period, also known as the continuing value (Koller et al., 2005)..

(6) . . ! "##$. (1). Where NOPLATt+1 is the normalized level of Net Operating Profits Less Adjusted Taxes in the first year after the explicit forecast period, g is the expected growth rate in NOPLAT in perpetuity. Next, RONIC is the expected rate of return on new invested Capital and the WACC is the weighted average cost of capital, as described in formula 2.. %& Where. '. '(). '. '(). *+ ,1 . /0 1 2. ). '(). *3 (2). is the target level of debt using market-based values and. ). '(). is the target level of. equity using market-based values. The cost of debt is *+ and /0 is the company’s marginal. income tax rate. The cost of equity is *3 and is calculated using formula 3. 5.

(7) 4 5

(8) 67 89 2 : ∗ ,80 . 89 1. (3). Where 89 is the risk-free rate and 80 is the market return and : is a proxy for the riskiness of. the company to a diversified investor. 80 . 89 is called the risk premium. Formula 3 is better. known as the CAPM.. Formula 1 shows that an important part of determining the continuing value of a company is the WACC, also known as the discount rate; a higher WACC means a lower value for the company. As can be seen in formula 2 the WACC is based upon the cost of debt and the cost of equity. The cost of equity for the company is the percentage of return an investor wants to make ex ante; i.e. the expected rate of return of the investor. In this thesis value in a broader sense refers to the article by Emerson (2003). In that article he introduces the blended value proposition, arguing that value is more than financial return it also needs to include social and environmental return. Furthermore, he argues that there is no inverse relationship between these returns. However, they are all present in every activity and investment in the market. Social and environmental return creates utility, so the blended value proposition is based upon the value of the utility created by a company. This is in line with the theory in micro economics that individuals want to maximize utility; hence the highest value should create the most utility. In the case of shareholders it means that shareholders want to maximize utility by investing in a company. Because the blended value proposition takes into account the social and environmental performance it would be a better way to determine the value of a for-profit social venture, because a for-profit social venture is expected to create utility by their social and environmental performance. One of the biggest problems of this proposition is that it is really hard to accurately measure and quantify social and environmental return (Emerson, 2003). For example, one way to measure social and environmental return is using the social return on investment (SROI) analysis as discussed by Lingane and Olsen (2004). The advantage of using SROI compared to, for example, a cost benefit analysis, is that SROI is a practical management tool, enabling informed decision making on a regular basis. A second advantage is that SROI enables managers to maximize social, environmental and financial benefits. In contrast, cost-benefit analysis typically frames benefits and costs as trade-offs and does not facilitate planning or prioritizing that optimizes 6.

(9) financial, environmental and social value creation (Lingane and Olsen, 2004). Lingane and Olsen (2004) have developed the standard for social return on investment (SSROI) analysis. This standard consists of ten guidelines to help accurately measure and quantify SROI. One of these guidelines consists of using the correct discount rate for discounting the social and environmental outcome another; is about how to monetize the social and environmental performance. However, despite using these guidelines, Linagane and Olsen (2004) state it remains difficult to correctly measure and quantify the social and environmental performance of a company. Therefore, using the blended value proposition of Emerson (2003) to value a company by calculating a separate financial, environmental and social value, leads to problems in terms of correctly valuing the environmental and social value. To overcome this problem, this thesis uses an adjustment on the cost of equity, which results in an adjustment of the WACC. The adjustment made in the WACC will give an indication of the value of the environmental and social performance. A comparison can be made between this adjustment of the WACC and the adjustment made on the WACC in the form of the tax shield on the debt, represented in formula 2. The tax shield can also be calculated separately and added to the value of the company. However, a common way is adjusting the cost of debt and thereby adjusting the WACC. The biggest difference, however, is that the tax shield can be calculated precisely. By adjusting the cost of equity for the social and environmental performance of the company, these performances are incorporated in the DCF analysis. This will be further discussed in the methodology section.. 2.2 For-Profit Social Venture Definition In recent years there has been increased attention for the subject of social ventures. For example, in 2010 the Journal of Social Entrepreneurship was founded. However, social ventures are not a new phenomenon. In 1972 Banks already introduced the term social entrepreneur (Nicholls, 2006), who is most often the founder of a social venture. In this thesis, the focus is on for-profit social ventures, because they are entitled to distribute their retained earnings to their owners (Dees and Anderson, 2003) thereby making it possible for shareholders to get a financial return. Therefore, first a definition of for-profit social ventures will be given and after this definition the social entrepreneur will be further discussed. After that, the context in which social ventures 7.

(10) originate will be addressed to get a better understanding for the increase in the number of social ventures. For-profit social ventures are defined by Dees and Anderson (2003) as entrepreneurial organizations that are: 1. Legally incorporated as for-profit entities, with one or more owners who have a formal right to control the firm and who are entitled to its residual earnings and net assets. Forprofit forms include proprietorships, partnerships, corporations, limited liability companies, and cooperatives.. 2. Explicitly designed to serve a social purpose while making a profit. Having a social purpose involves a commitment to creating value for a community or society rather than just wealth for the owners or personal satisfaction for customers.. Because for-profit social ventures have two objectives - social value and financial performance, in which the creation of social value is the most important - the success of a for-profit social venture is measured in terms of the creation of social value (Dees and Anderson, 2003). Forprofit social entrepreneurs have dual social and financial objectives that influence their managerial decision-making (Dees and Anderson, 2003). For financial performance there are several performance measures for example profit, return on assets and sales. Social performance on the other hand is much harder to define (Dees and Anderson, 2003) thereby making the decision-making process more complex for the social entrepreneur compared to the commercial entrepreneur. Also for investors it makes it harder to monitor the total performance of a for-profit social venture. As mentioned earlier in section 2.1, the social performance of a company is hard to measure even if a method like the SSROI is used. To get a better understanding about the for-profit social entrepreneur this article will now shortly examine social entrepreneurship. The for-profit social entrepreneur differs from the social entrepreneur in the sense that the venture of the for-profit social entrepreneur is legally incorporated as a for-profit entity, whereas a social venture is not legally incorporated as a forprofit entity. Social entrepreneurship refers to innovative activity with a social objective in either 8.

(11) the for-profit sector, such as in social-purpose commercial ventures (e.g., Dees & Anderson, 2003; Emerson & Twersky, 1996) or in corporate social entrepreneurship (e.g., Austin , Leonard, Reficco, & Wei-Skillern, 2004); or in the nonprofit sector, or across, such as hybrid structural forms which mix for-profit and nonprofit approaches (Dees, 1998). Austin, Stevenson & Wei-Skillern (2006) define social entrepreneurship as innovative, social value creating activity that can occur within or across the nonprofit, business, or government sectors. Key in these definitions of social entrepreneurship is that it differs from commercial entrepreneurship in the fact that, a commercial entrepreneur aims at creating profitable operations resulting in private gain and a social entrepreneur wants to create social value (Austin, Stevenson & Wei-Skillern, 2006). Social entrepreneurship in the Netherlands is examined in a study by Witkamp, Royakkers & Raven (2011). They found in their survey that the average age of social ventures in the Netherlands is 4.7 years, with an average of 5.4 employees and 89% of these social ventures are located in the ‘Randstad’. So you could state that social ventures in the Netherlands are on average young and small companies that are located in an urbanized area. Important partners for these social ventures are the Chamber of Commerce and several networking organizations especially designed to help social ventures. Furthermore, important partners for the funding of these social ventures are some wealthy ex-entrepreneurs who understand the power of the business model that social ventures use to solve social problems (Witkamp, Royakkers & Raven, 2011) Figure 1 gives an overview of different kinds of organizations in a spectrum from impact only to finance only, in which on the left hand side the charities are placed. Their primary focus is the creation of social value. On the right hand side the mainstream companies are placed and their primary focus is the creation of financial value. As can be seen in figure 1, social entrepreneurship is placed in the middle of this spectrum. Social entrepreneurs focus on social return however. they are not only relying on grants for financing like charities do. For-profit social ventures are placed in the profitable surplus reinvested and the profit distributing socially driven, because they are designed to make a financial return besides the creation of social value.. 9.

(12) As mentioned earlier there is an increasing attention for social ventures. This can be partly explained by the fact that there is an increase of social ventures (Hoogendoorn et al., 2010). Hoogendoorn et al. (2010) distinguish several mutual reinforcing factors explaining the increase in social ventures. Thereby they use two sides, as they call it the demand side and the supply side. First the demand side will be discussed, which will be followed by the supply side. Figure 1: Impact only – Financial only. Based upon John Kingston, Venturesome - © Shaerpa. On the demand side, Hoogendoorn et al. (2010) argue that the awareness of the ever-growing inequality in wealth (Worldbank, 2007) and concern for the environment are two important drivers for the increase in social ventures. Furthermore, governments worldwide emphasize a market approach, so funds for non-profit organizations are shrinking. Also the number of nonprofit organizations has grown exponentially thereby creating more competition for funding (Johnson 2000; Salamon, Sokolowski, & List, 2003). Because of this competition for funding a lot of non-profit organizations are trying to generate earned income and shift to the right in figure 1. By generating earned income they are less depending on funding in the form of gifts (Hoogendoorn et al., 2010).. 10.

(13) However, there is also a downside in generating earned income for a social goal. Foster and Bradach (2005) found that in most of the cases these non-profit organizations failed to earn income, they only generated losses that they had to offset by using gifts. This in return made the organizations less effective in achieving their social goal. So for non-profit organizations, becoming a social venture is not always the way to go in achieving funding for their social goals. On the supply side Hoogendoorn et al. (2010) argue that the increased concentration of wealth in the private sector is promoting calls for increased corporate social responsibility and more proactive responses to complex social problems (Zahra et al. 2008). There is a strong corporate social responsibility movement, reconsidering the assumption that doing social good and making a profit is mutually exclusive (Zahra et al., 2008). Furthermore, some people are earning fortunes at younger ages than the previous generation. Therefore, they can devote their time and resources to social goals earlier in life (Reis & Clohesy, 2001). Using the above information and taking a closer look at figure 1, it is clear that from the left hand side some of the non-profit organizations are becoming a social venture, with as mean reason trying to become less dependent from gifts. From the right hand side successful people from commercial ventures are devoting their time to social goals, for example, Bill Gates who has created the Bill Gates Foundation. The Bill Gates Foundation supports organizations that have a social goal. Furthermore, more and more commercial ventures are becoming socially responsible (Hoogendoorn et al., 2010). The performance of these socially responsible companies is further discussed in section 2.3.. 2.3 Financial performance and social goals of a company As mentioned in section 2.2, an increasing amount of mainstream companies becomes socially responsible (Hoogendoorn et al., 2010). Some companies are shifting from the right hand side of figure 1 towards the middle. There have been multiple studies about the financial performance of companies that become socially responsible. For example, Lo and Sheu (2007) found that there is a positive relationship between corporate sustainability and market value. Consolandi et al. (2009) have looked at the Dow Jones Sustainability Index (DJSSI). They observed that when a company gets included in the DJSSI there are positive abnormal returns and when it gets. 11.

(14) excluded there are negative abnormal returns. They suggest this is due to socially responsible investing (SRI) investors. Because SRI investors only invest in social responsible companies the demand on the stock exchange for a company gets higher when it gets included in the DJSSI. A higher demand means an increase in the share price, which explains the abnormal return. The effect of the higher share price is that the expected return decreases, because there is no evidence that the expected cash flows increase. A lower expected return equals a lower cost of equity. In a DCF analysis this lower cost of equity would result in a higher value. However, because SRI investors are a small percentage of the market these effects are quite small (Consolandi et al., 2009). The study by Pava and Krausz (1996), which is based upon 21 empirical studies, has found what they call “the paradox of social costs”. With this phrase they mean that social activities are costly to a firm, so you would expect a negative relationship between social performance and financial performance. However, they find that firms that have met social responsibility criteria have either outperformed or performed as well as other firms, which are not (necessarily) sociallyresponsible. This study shows that there is some evidence for a positive relationship between social responsibility and financial performance. Also the study by Schueth (2003) shows that there is no need to sacrifice financial returns in order to invest in a social responsible matter. Furthermore, this study shows that the market for social responsible investing is growing. The total amount invested in a socially responsible way in the USA has grown form 695 billion dollar in 1995 to 2,159 billion dollar in 2003. The study by Hamilton, Jo and Statman (1993) shows that social responsible mutual funds have no significant different financial return compared to normal mutual funds. Also companies that focus on their environmental performance can increase their value. For example, Derwall et al. (2005) show that environmentally responsible companies in the long run outperformed their competitors; they proofed this using portfolios based on Innovest ratings. Heinkel, Kraus and Zechner (2001) show that the presence of green investors can change firms from a polluting to a cleaner technology. The more green investors the more firms change from a polluting to a cleaner technology. Edmans (2011) on the other hand shows that companies that have a high employee satisfaction, in the long run outperform their competitors.. 12.

(15) So the conclusion may be that there is no evidence that social responsibility would lower financial performance. However, there is evidence that social responsibility increases financial performance. Using the blended value proposition of Emerson (2003) one might come to the conclusion that a company that is socially responsible would have a higher blended value, given a similar financial performance because of the higher social/environmental performance. So when the financial performance of socially responsible companies is even better the blended value should even further increase.. 2.4 Investments in Venture Capital In most articles about for-profit social ventures, these for-profit social ventures are young and risky ventures. Other young and risky ventures are the firms venture capital invests in, from this point on in this thesis called capital ventures. The benefit of using venture capital to describe the investment process in young and risky ventures is that there is much literature about venture capital. One of the reasons for that is that the first true venture capital firm was already established in 1946 by MIT President Karl Compton and General Georges F. Doriot, who was a professor at Harvard Business School, and local business leaders and was named American Research and Development (ARD) (Gompers and Lerner, 2001). Since then a lot of research had been done about venture capital and the amount of money invested in venture capital in the Europe has risen to €42.6 billion in 20106. Venture capital has had several success stories in which investors gained massive returns, for example Apple Computer, Intel, Federal Express and Microsoft (Sahlman, 1990). On the other hand there are also stories about investors losing their entire investment, for example Ovation Technologies and Osborne Computer (Sahlman, 1990). Therefore, there is a need for investors to select the successful ventures to invest in. The difficulty for investors to select these ventures lies in the fact that a lot of investors have limited project-specific expertise (Campello and Matta, 2010). Therefore, those investors hire agents with project-specific expertise, known as venture capitalists. Part of the research about venture capital has focused on the agency problems that occur with venture capital. Agency problems arise when ownership and control of an organization are separated. Investors receive ownership in the form of equity in return for providing capital. And 6. www.evca.eu. 13.

(16) the management does not own the company but is responsible for controlling the company (Fama & Jensen, 1983). The characteristics of venture capital create a double agency problem, because the investors invests in a venture capital fund managed by the venture capitalist and the venture capitalist invests the money from the venture capital fund in a venture under management of the entrepreneur. The agency costs between the investors and the venture capitalist lie in the fact that the venture capitalist has many oppurtunities to take advantage of the investors. Therefore, the contracts between the investors and the venture capitalist are designed in such a way that the risk of these agency costs occuring are minimized. In Sahlman (1990) five meauseres are mentioned to minimize these agency costs. To overcome the agency problems between the venture capitalist and the entrepreneur, the venture capitalists have developed four instuments (Sahlman, 1990), which minimize agency costs between the venture capitalist and the entrepreneur. Another part of research on capital venture has focused on the return capital venture funds are making. Several papers estimate the annual rate of return venture capital funds are making, these returns vary from 20% to 22% annually (Campello and Matta, 2010; Kaplan and Schoar, 2005; Sahlman, 1990). In this thesis the annual rate of return is set in the middle of this range at 21%. The standard deviation on the return found by Kaplan and Schoar (2005) was 40%, this is a high standard deviation which can be partly explained by the fact that some ventures create massive returns and other ventures go bankrupt. Plummer (1987) has described the discount rates used by venture capitalists to determine the terminal value of a venture varying from 50% to 70% during the startup phase of the venture, to 25% to 30% when the venture goes public. These discount rates seem quite high compared to other rates of return however, the high discount rates reflects the fact that entrepreneurs are most of the time too optimistic about the future performance of their venture. So in fact, the high discount rates are based upon two components, a correction on the too optimistic financial information from the entrepreneur and a discount rate. Therefore, in this thesis the cost of equity for a capital venture is set to be the same as the historical annual rate of return of venture capital funds of 21%.. 14.

(17) 2.5 Research hypotheses The analysis in this article is based upon two steps. First an analysis is done about the expected return of a Dutch for-profit social venture, based upon data provided by a Dutch investment organization in for-profit social ventures. For this first part of the analysis this expected return is compared with the cost of equity of a capital venture, which is stated in section 2.4 to be 21%. The reason for this comparison is that capital ventures are also young and risky firms, however as mentioned earlier, there are also differences between a for-profit social venture and a capital venture. The most important difference is that for-profit social ventures have social value as their main goal instead of financial performance, thereby increasing the risk of the financial performance (Dees and Anderson, 2003). Because for-profit social ventures do not fully focus on financial performance they often generate less income than capital ventures (Austin, Stevenson & Wei-Skillern, 2006). For-profit social ventures are still financed, therefore a lower cost of capital would be expected and as mentioned earlier the main source of financing of for-profit social ventures is equity. Therefore a lower cost of equity would be expected, hence the first hypothesis.. Hypothesis 1: For-profit social ventures have a lower expected return (cost of equity) compared to capital ventures.. The second part of the analysis focuses on the expectations of possible future investors in forprofits social ventures. The expectations are in the form of expected returns that are derived from a survey. This is done to come up with the expected rate of return for which future investors want to invest in a for-profit social venture. This expected rate of return is then compared with the expected rate of return of for-profit social ventures from the H1 and the cost of equity of capital ventures. Because H1 is based upon data from a Dutch organization investing in for-profit social ventures, the mission of the Dutch investment organization is “solving social problems by supplying capital to organizations, who on an entrepreneurial basis maximize social value” the expectation is that the expected rate of return from H1 is lower compared to the expected rate of return from the survey.. 15.

(18) For-profit social ventures should create social/environmental performance which increases the blended value of a venture and as mentioned in section 2.3 there is some evidence that companies that act socially responsible have a lower cost of equity. Therefore the expectation in this article is that the expected rate of return from the survey is lower than the cost of equity of a capital venture. Therefore, the second and third hypotheses are.. Hypothesis 2: The expected rate of return the Dutch investment organization is willing to accept is lower than the expected annual rate of return individual investors are expecting to invest in a for-profit social venture.. Hypothesis 3: The expected annual rate of return individual investors are expecting to invest in a for-profit social venture is lower than the historical cost of equity of capital ventures.. H4 and H5 refer to the characteristics of the participants of the survey. One of the reasons for individuals to invest in the stock market is to make a financial return higher than the return on a savings account. Therefore, you could state that people who invest in the stock market are interested in making financial return. Consequently, the expectation in this article is that people who have experience with investing in the stock market are more interested in making financial return than that they are interested in social/environmental return, which would lead to a higher expected rate of return for this group. Furthermore, based on the utility theory, which states that people want to maximize their utility, the reason for people to give money to charity should be that it increases their utility. A possible explanation for the increase in utility is that the social/environmental value created by charities creates utility for these people. Therefore, the expectation in this thesis is that people who have experience with giving money to charity gain more utility by the social and environmental performance of the for-profit social venture. Thereby lowering the expected annual return they request of a for-profit social venture. Therefore, the fourth and fifth hypotheses are the following.. Hypothesis 4: Individuals who have experience with investing in the stock market request a higher expected annual rate of return from for-profit social ventures compared to individuals who have no experience with investing in the stock market. 16.

(19) Hypothesis 5: Individuals who have experience with giving money to charity accept a lower expected annual rate of return from for-profit social venture compared to individuals who have no experience with giving money to charity.. 3. Methodology This section describes the methodology that is used to conduct the survey and to test the hypotheses from section 2.5. To test H1 historical data and a projection for future cash flows from a for-profit social venture, provided by a Dutch organization investing in for-profit social ventures, is used. These data includes a forecast until 2016 of two scenarios, a high growth and a moderate growth scenario, about the operational cash flow and the financing and investing cash flow. Furthermore, it includes a balance sheet per January 1, 2011. Using this data a discounted cash flow analysis (DCF) is done, the present value of the continuing value is calculated using formula 4 (Koller et al., 2005). >#> ,($1. < =

(20) ,(? 1 @. ,?@ $1. (4). Where AA is the free cash flow in year t, which is the final year of cash flow projections and g. is projected constant growth rate into perpetuity, B+ is the appropriate discount rate, which equals. the WACC.. Formula 4 is used instead of formula 1 because there are no projections about future NOPLAT, there are only projections about future cash flows. After calculating the present value of the future free cash flows of the explicit forecast period and the present value of the continuing value, those two are added. This value is then corrected with the mid-year adjustment factor, which is stated in formula 5 (Koller et al., 2005). This value is then set equal to the present value of the equity from the moment of investing and the book value of the debt, using the cost of equity as the changing parameter. Thereby calculating the cost of equity of the for-profit social venture, for which the invested capital is equal to the future free cash flows. CD . 7

(21) B DE4F

(22) 5 GB ,1 2 %&1/2 (5) 17.

(23) As already mentioned in the introduction the Dutch organization that provided the data invests in for-profit social ventures and is using a 25% write off on the equity to put it on their balance sheet. The 75% remaining equity value can be seen as the market value of the equity, because investments in equity should be valued at market value on your balance sheet (Koller et al., 2005). Therefore, a new DCF is done, in which the value from the DCF is set equal to 75% of the present value of the equity from the moment of investing and the book value of the debt, using the cost of equity as the changing parameter. Thereby, calculating the expected return on the market value of the equity. This is done to come up with the appropriate expected market return given the risk of the for-profit social venture. Because the Dutch investment organization is able to put the investment on their balance sheet, this expected return should be equal to the cost of equity of a normal venture with a similar risk, assuming that CAPM holds. To test H2, H3, H4 and H5 a survey (Appendix A) is used. In this survey participants are asked to give an expected return for which they want to invest in the for-profit social venture, given a certain beta. This beta is from the Capital Asset Pricing Model (CAPM), formula 3, and can be seen as a proxy for the riskiness of a company. In the survey there is a normal market return given for every beta, the security market line, this return is based upon a risk-free rate of 2.5% and a market risk premium of 5% as suggested by Koller et al. (2005). The survey is created by using the guidelines as suggested by Dillman (2000). The reason for using the survey is that there are signals that the way in which for-profit social ventures are financed will change, e.g. the opening of a social stock exchange in Asia and Germany. The assumption in this thesis is that this will lead to a more liquid market in which individual investors can invest in a for-profit social venture. Therefore it is interesting to know the opinion of those individual investors, because the price of a stock is based upon the expectations of all investors. Because it is near to impossible to survey all possible investors, the choice in this thesis is made to survey students at the University of Groningen. Students form a good sample for this study, because most of the students of the sample are students of the faculty of Economics and Business and therefore you could expect them to have an above average knowledge of investing.. 18.

(24) The survey is done online and on paper, the paper survey is done in the library of the Faculty of Economics and Business of the University of Groningen. A total of 105 students have filled in the survey, further characteristics of the respondents of the survey are discussed in section 4. Firstly the data from the survey is tested for normality (Appendix C) using Jarque-Bera. Subsequently the hypotheses are tested. H2 and H3 are tested using a one sided Students T-test, formula 6, and using the non-parametric Wilcoxon signed rank test. The one sided Students Ttest is chosen because both the hypotheses are based upon the assumption that one of the returns is lower than the other return; therefore they are tested using a one-sided Students T-test.. . JK LM N,JK 1. (6). Where for every beta, P X is the average return from the survey and QR is the return from the. CAPM. S ,T 1 is the standard deviation based upon the variance of the returns from the survey. calculated for every beta separately.. To test H4 and H5 the formulas 7, 8, 9 and 10 are used, these formulas are based upon Newbold et al. (2003). H4 and H5 are tested by dividing the sample into two groups, in the case of H4 in individuals that have experience with investing and those who do not, in case of H5 in individuals that have experience with giving money to charity and those who do not. The differences in average returns are tested using formula 7 or 9; both formulas presume that the variances of the population are unknown as is so in this case. Formula 7 is used when the variances of both populations are equal and formula 9 when they are unequal. The equality of the variances is tested using Levene’s F-Test for equality of Variances (Appendix B.1). The outcome of this test is presented in Appendix B.2.. . JK UK WY X. WY V ( X Z[ Z\. (7). Where TK is the average return per beta for those who have experience and ]K for those who do not have experience, ^ and _ are the number of respondents. 4à is the pooled variance estimator, described hereafter in formula 8.. 19.

(25) bà . ,c[ 1d[Y (, c\ 1d\Y ,c[ (c\ a1. (8). Where 4â and 4_a are the sample variances and ^ and _ are the number of respondents.. . JK UK. Y WY W V [( \ Z[ Z\. (9). Where TK is the average return per beta for those who have experience and ]K for those who do not have experience, ^ and _ are the number of respondents. 4â and 4_a are the sample variances, the degrees of freedom, v, for the students t statistic is given by using formula 10.. =. Y. Y. W\ W ef [ g(,h ijY Z[. Z\. Y Y WY WY \ [ f g /,c[ 1 (h i /,c\ 1 Z[ Z\. (10). In which v is the degree of freedom, 4â and 4_a are the sample variances ^ and _ are the numbers of respondents.. 20.

(26) 4. Data description This section describes the data that is used to conduct the analysis from section 3. The section is divided in two parts, the first part focuses on the data provided by the Dutch investment organization and the second part focuses on the data from the survey.. 4.1 Data provided by the Dutch investment organization The data is provided by a Dutch organization that invests in for-profit social ventures; unfortunately this data is confidential and is therefore not included in this article. The data that is provided consist of an outlook on the cash flows until 2016 and furthermore, a balance sheet and profit and loss account for 2009 and 2010. Because there is insufficient data to accurately predict the NOPLAT for 2016, formula 4 is used instead to calculate the continuing value. The cash flow from operations is growing rapidly from a negative in 2012 to a high positive number in 2016; this can be explained by the fact that the for-profit social venture is a young company and growing rapidly.. 4.2 Data Survey A total of 105 respondents have filled in the survey. Four outliers, the top two and the bottom two, are removed, thereby reducing the data to 101 respondents. The data from the 101 respondents is distributed normally (Appendix C). From this group of 101 respondents a total of 8 have filled in the survey with above market costs of equity for the for-profit social venture. This could be a miss interpretation by the respondents of the survey and therefore a second analysis is done in which this data is excluded (Appendix D). The survey is partially done online, however, it was really hard to get enough responses online, and therefore the survey is also done in hard copy on the faculty of Economics and Business. From all the respondents a total of 20 have filled in the survey online and 81 have filled in the hard copy version. The characteristics of the respondents of the survey are presented in table 1. Approximately 92 percent of the respondents are a student of the faculty of economics and business (FEB) and the average age is 22.5. So a big part of the respondents is senior student at the FEB, thereby creating the expectation that they have above average knowledge about financial markets. The risk profile of. 21.

(27) the respondents is determined by using the results of question 10 of the survey (Appendix A). In this question the net present value of the lottery ticket is 10 euro. So when a respondent would be willing to buy this ticket for a price of above 10 euro this respondent would be considered risk loving. When the respondent would answer 10 euro this respondent would be considered risk neutral and when the respondent would only be interested in buying the ticket for a price below 10 euro this respondent would be considered risk averse. Table 1: Characteristics from the respondents of the survey. Total number of respondents. 105 Risk Loving Risk Neutral Risk Averse Male Female. Risk profile Gender Average age Student of the faculty of Economics & Business Currently investing in stocks Invested in stocks in the past Currently giving money to charity Given money to charity in the past. Yes No Yes No Yes No Yes No Yes No. 13.9% 22.8% 63.4% 83.2% 16.8% 22.5 92.1% 7.9% 22.8% 77.2% 38.6% 61.4% 39.6% 60.4% 72.3% 27.7%. The relative large percentage of males can be partly explained by the fact that there are more males on the faculty of Economics and Business, 68% is male7. When the people who have ever dealt with investing in stocks are combined a total of 41% comes up, so 59% has no experience with investing in stocks. When a similar approach is taken for giving money to charity a total of 26% has never given money to charity and the other 74% has given money to charity.. 7. www.rug.nl. 22.

(28) The average beta as reported by the respondents is 3.61 for a for-profit social venture, which is not higher than the beta of a capital venture, this is in contrast with existing literature that suggests that for-profit social venture should have a higher risk compared to companies that focus on financial return (Dees and Anderson, 2003.. 5. Results and Discussion In this section the results from the data provided by the Dutch investment organization and the results from the survey are discussed.. 5.1 Results of the case study As can be seen in table 2 the results of the data provided by the Dutch investment organization show that the cost of equity for the for-profit social venture is between 15.8% and 16.9%, given the two different scenarios of moderate and high growth. From here on these returns are mentioned as the social cost of equity. The expected rate of return on the 75% of the invested capital in equity that stands on the balance sheet of the investor is between 16.6% and 17.6%. This can be seen as the normal expected market return; because you have to value the company at market value to put it on your balance sheet. So the effect of writing off 25% on the invested capital is between a 0.7 and a 0.8 percent point increase in expected return in this case.. Table 2: Returns from the data provided by the Dutch investment organization Cost of equity of the for-profit social venture (the social cost of equity). And the expected rate of return on 75% of the invested capital (market cost of equity).. Moderate Growth. High Growth. Social cost of equity. 15.80%. 16.90%. Market cost of equity. 16.60%. 17.60%. 23.

(29) The difference of these 0.7-0.8 percent points can be seen as the utility gained by the social and environmental return, expressed in financial return. Because the investor writes off the 25% immediately after doing the investment, therefore the investor already knows before doing the investment he is going to write off the 25% of its value and is still making the investment. In H1 it is stated that the historical cost of equity of for-profit social ventures is lower compared to that of capital ventures. The historical cost of equity of capital ventures as discussed in section 2.4 is set at 21%, which is based upon the articles of Campello and Matta (2010), Kaplan and Schoar (2005) and Sahlman (1990). It is easy to see that in this case the return, which is presented in table 2, as calculated on basis of data provided by the Dutch for-profit social venture is lower. It is lower because of two effects. First the beta (risk) of the company on which the Dutch investment organization provided the data is lower. The evidence for the lower beta lies in the fact that the 75% of the equity which is placed on the balance sheet is seen as the market value, therefore the return on this part can be seen as the marketl return without the social component, so this should follow CAPM. This normal return lies between 16.6% and 17.6% which is lower than the 21% cost of equity of capital ventures. The second effect is the social effect which is in this case lowers the cost of equity of the for-profit social venture by 0.7-0.8 percentage point. Therefore based on this data the statement in H1 is accepted, even when the beta of the for-profit social venture and the capital venture are similar, the social effect still lowers the cost of equity of the for-profit social venture. Of course based on just one for-profit social venture there is no basis to say if this difference between the historical cost of equity between the for-profit social venture and the capital venture is significant. However, this example gives a clear picture that there is a social component that lowers the cost of equity of for-profit social ventures, which effect is an increase in the value of for-profit social ventures.. 5.2 Results from the survey In figure 2 the average of the survey per beta is plotted against the CAPM, as can be seen the average of the survey is lower than the CAPM. The absolute difference between the two lines is also increasing; this is in line with the theory that the people are willing to give up financial return for social return. However, as can be seen in table 3 these differences are not statistically significant and therefore no absolute conclusions can be drawn on these differences. As 24.

(30) mentioned in section 4.2 also a second dataset is created without the above CAPM returns for the for-profit social venture, a similar analysis is done as in table 3 (Appendix D). However, the differences remain statistically insignificant. Furthermore, a Wilcoxon signed rank test is performed to test if the median of the survey is lower than the CAPM. The results in table 4 show that the median of the survey is indeed lower. So the differences are not statistically significant however, the Wilcoxon signed rank test shows that the median return from the survey is significantly lower at a 1% level. The results from table 4 show that there is a difference between the CAPM and the cost of equity of for-profit social ventures, the cost of equity of forprofit social ventures is lower than that would be expected following the CAPM. Figure 2: Expected rate of returns from the survey This figure shows the expected rate of returns from the survey based on 101 respondents given a certain beta. The xaxis is the beta the y-axis is the expected rate of return. CAPM is based on a risk-free rate of 2.5% and a market risk premium of 5%. 45.00% 40.00% 35.00% 30.00% 25.00% CAPM 20.00%. Average Survey. 15.00% 10.00% 5.00% 0.00% 1. 2. 3. 4. 5. 6. 25. 7. 8.

(31) Table 3: Results Survey, one sided Students T-test Table 3 shows the differences between the expected return based on the CAPM and those found in the survey based on 101 respondents. The first column shows the beta, the second column the corresponding return from the CAPM, the third column shows the average return from the survey, the fourth column the difference between the second and the third column. The fifth column shows the standard deviation from the returns of the survey and the last column shows the probability for difference shown in column four. The probability is based on a one sided t-test.. Beta. CAPM return. 1 2 3 4 5 6 7 8. 0.0750 0.1250 0.1750 0.2250 0.2750 0.3250 0.3750 0.4250. Average return survey 0.0609 0.1036 0.1442 0.1876 0.2318 0.2766 0.3179 0.3627. Difference -0.0141 -0.0214 -0.0308 -0.0374 -0.0432 -0.0484 -0.0571 -0.0623. Standard deviation 0.0137 0.0213 0.0311 0.0384 0.0485 0.0527 0.0630 0.0734. Probability 0.1529 0.1574 0.1611 0.1647 0.1866 0.1796 0.1825 0.1979. Table 4: Results Survey, Wilcoxon signed rank test Table 4 shows the results of the median of the survey, based on 101 respondents, tested against the median of the CAPM. Column one shows the beta, column two the median of the CAPM, column three the median of the survey. The fourth column shows the difference between the two, column five shows the test statistic for the Wilcoxon signed rank test and column six the probability. *** indicates significance at the 1% level.. Beta. Median CAPM. Median survey. Difference. test statistic. Probability. 1 2 3 4 5 6 7 8. 0.0750 0.1250 0.1750 0.2250 0.2750 0.3250 0.3750 0.4250. 0.0600 0.1000 0.1500 0.2000 0.2400 0.2800 0.3300 0.3800. 0.0150 0.0250 0.0250 0.0250 0.0350 0.0450 0.0450 0.0450. 7.3917 7.4511 7.3345 7.1879 7.0751 7.3558 7.2070 6.7597. 0.0000*** 0.0000*** 0.0000*** 0.0000*** 0.0000*** 0.0000*** 0.0000*** 0.0000***. 26.

(32) In H2 the expectation was that the cost of equity based on the data provided by the Dutch investment organization would be lower than the cost of equity from the survey. As already mentioned in section 5.1, the market cost of equity of for-profit social ventures is between 16.6% and 17.6%. When we plot this in figure 2 as being CAPM to calculate the beta and subsequently use this beta to calculate the corresponding average return for the survey; this is between 13.69% and 14.50%, as can be seen in table 5. As can be seen in table 2, the social cost of equity based on the data provided by the Dutch investment organization is between 15.8% and 16.9%. So it is easy to see that H2 is rejected. Because instead of the cost of equity based on the data provided by the Dutch investment organization is lower than the cost of equity based on the survey, the opposite is true. A possible explanation for this surprising result could be that students gain a higher utility by the social and environmental performance of a social venture compared to the Dutch investment organization and are therefore willing to accept a lower financial return. In H3 the expectation was that the cost of equity derived from the survey would be lower than the historical cost of equity from capital ventures. When we plot the historical cost of equity of capital ventures of 21% in figure 2 at the CAPM line, the assumption is that CAPM holds so this 21% should lie on the CAPM line, a return of 17.46% comes out as being the return from the survey. This 17.46% return is lower than the historical cost of equity of capital ventures; however this return is not significant with a probability of 0.1906, as can be seen in table 5. When however the betas are used that are calculated on basis of the data provided by the Dutch investment organization, so presuming the beta of for-profit social ventures is lower than capital ventures even though theory suggests that the risk of for-profit social ventures is higher (Dees and Anderson, 2003). The return from the survey lowers to between 13.69% and 14.50% as mentioned earlier in discussing H2. The corresponding probabilities to the differences between the cost of equity of capital venture and the returns from the survey can be found in table 5. As can be seen in table 5, the difference between the lower bound of the survey, the 13.69% return, and the 21% cost of equity of capital venture is significant at a 5% level. The difference between the upper bound of the survey, the 14.50% return, and the 21% cost of equity of capital venture is also significant at the 5% level. So the conclusion is that H3 is accepted when the beta of forprofit social ventures is substantially lower than the beta of capital ventures. This is contrary to what theory suggests, because the risk of for-profit social ventures should be higher than that of 27.

(33) capital ventures. When the risk between capital ventures and for-profit social ventures is equal, than H3 is rejected because the difference between the 21% cost of equity of capital venture and the 17.3% return of the survey is not significant at a 10% level.. Table 5: Cost of equity capital venture versus results survey Table 4 shows the differences between the cost of equity of capital venture (.2100) and those found in the survey, based on 101 respondents. The first column shows beta, the second column the return from the survey based on different betas, the third shows column the difference between the cost of equity of capital venture and the return from the survey. The fourth column shows the standard deviation from the returns of the survey and the last column shows the probability for difference shown in column three. The probability is based on a one sided t-test, ** indicates significance at a 5% level.. Beta. Return survey. Difference. 2.82 3.02 3.70. 0.1369 0.1450 0.1746. -0.0731 -0.0650 -0.0354. Standard deviation 0.0319 0.0340 0.0405. Probability 0.0109** 0.0279** 0.1906. Table 6: Returns Investors versus Non-investors Table 6 shows the differences in expected returns for different levels of beta when the 101 respondents are separated into two groups, people who have experience with investing and those who do not. The first column shows the beta, the second shows the return for those who have experience with investing, the third shows the return for people who do not have experience with investing, column four shows the difference between column two and three. Column five shows the test statistic based on formula 9 and column six shows the probability corresponding to the test statistic. ** Indicates significance at a 5% level, * indicates significance at a 10% level.. Beta. Investors. 1 2 3 4 5 6 7 8. 0.0641 0.1075 0.1501 0.1908 0.2341 0.2778 0.3174 0.3594. NonDifference investors 0.0590 0.0052 0.1018 0.0057 0.1418 0.0083 0.1878 0.0030 0.2333 0.0009 0.2797 -0.0019 0.3228 -0.0054 0.3702 -0.0108. 28. Value. Probability. 1.8572 1.3442 1.3699 0.4068 0.0944 -0.1954 -0.4582 -0.7909. 0.0316** 0.0894* 0.0854* 0.3421 0.4624 0.4225 0.3234 0.2145.

(34) H4 which states that, individuals that have experience with investing would demand a higher expected return from a for-profit social venture compared to their counterparts who do not have experience with investing is partly accepted on basis of table 6. This conclusion is made because H4 is statistically significant at a 5% level for a beta of one. For a beta of 2 and 3 the difference has the expected sign and is statistically significant at a 10% level. For a beta of 4 and 5 the difference has the expected sign and is statistically insignificant at a 10% level. However, for a beta of 6, 7 and 8 the sign of the differences changes and the differences are statistically insignificant. Based upon the results from table 6 the conclusion is that for the betas 1, 2 and 3 H4 is accepted and for the higher betas H4 is rejected. A possible explanation could be that on a stock exchange a beta of 3 is seen as a very high beta, so the investors in this sample probably only have experience with investing in stocks with betas below 3. Therefore these investors also have a clearer picture about the return they request on investments with a beta below 3. For higher betas they lack this experience and are therefore accepting similar returns compared to non-investors. The implication of this result is that it would be beneficial for for-profit social ventures to focus on people who have no experience with investing to gain access to cheaper equity capital. The differences are within the 1 percentage point and therefore in practice the cost of focusing on this group can outweigh the benefits of a less than 1 percentage point decrease in cost of equity. When we look at the results in table 7 and test H5 which states that individuals who have experience with giving money to charity expect a lower expected return compared to individuals who do not have that experience, it is easy to see that H5 is rejected. The differences in returns between the two groups do not have the expected sign and furthermore, the probability corresponding with the test statistic shows that the returns are not statistically different. The conclusion on basis of these results is that whether or not someone has experience with giving money to charity this has no effect on the expected return someone wants to receive from a forprofit social venture. The implication of this result is that it would be of no help for for-profit social ventures to focus on people who give money to charity to gain access to cheaper equity capital.. 29.

(35) Table 7: Returns giving to charity versus not giving to charity Table 7 shows the differences in expected returns for different levels of beta when the 101 respondents are separated into two groups, people who have experience with giving money to charity and those who do not. The first column shows the beta, the second shows the return for those who have experience with giving money to charity, the third shows the return for people who do not have experience with giving to charity, column four shows the difference between column two and three. Column five shows the test statistic based on formula 9 and column six shows the probability corresponding to the test statistic.. Beta 1 2 3 4 5 6 7 8. Charity 0.0615 0.1050 0.1469 0.1895 0.2344 0.2799 0.3219 0.3662. No Charity 0.0596 0.1015 0.1402 0.1873 0.2313 0.2762 0.3169 0.3648. Difference -0.0019 -0.0035 -0.0067 -0.0022 -0.0030 -0.0037 -0.0050 -0.0014. 30. Value -0.6068 -0.7305 -0.9865 -0.2693 -0.2943 -0.3389 -0.3791 -0.0948. Probability 0.2720 0.2325 0.1619 0.3938 0.3843 0.3674 0.3523 0.4622.

(36) 6. Conclusion This study focuses on the cost of equity of for-profit social ventures in order to determine the value of a for-profit social venture. Value in this case is referring to the blended value as mentioned by Emerson (2003) in his blended value proposition. Blended value is the sum of financial, environmental and social value. As mentioned by Linagane and Olsen (2004) it is really hard to accurately measure and quantify social and environmental return. Therefore the approach taken in this thesis is to make an adjustment on the cost of equity to incorporate the social and environmental return. The expectation was that this adjustment would lower the cost of equity of for-profit social ventures thereby increasing their value. The conclusion of this thesis on basis of the Wilcoxon signed rank test (table 4) is that the cost of equity of for-profit social ventures is lower than the cost of equity of other companies. This result is in line with existing literature that shows that socially responsible companies outperformed competitors (e.g. Derwall et al., 2005, Consolandi et al., 2009). This thesis did, however, not succeed in quantifying this difference. The implication of a lower cost of equity of for-profit social ventures is that the value of a for-profit social venture is higher than that of other companies with comparable cash flows. Furthermore a lower cost of equity of for-profit social ventures means that more for-profit social ventures are economically viable, thereby creating the opportunity for more for-profit social ventures to start up. Furthermore, this thesis has opened the debate about the risk of for-profit social ventures; the data provided by the Dutch investment organization suggest that the beta of for-profit social ventures is lower than that of venture capital. This is contrary to existing literature that suggest that the risk of for-profit social ventures is higher because of the dual objective of for-profit social ventures (Dees and Anderson, 2003).Also the respondents of the survey suggest that the beta of a for-profit social venture is not higher than that of venture capital, thereby further opening the debate whether or not the risk of for-profit social ventures is indeed higher than that of companies that focus on financial return. The risk of for-profit social ventures can perhaps be even further reduced using the control instruments that Sahlman (1990) developed for venture capital.. 31.

(37) A further conclusion of this thesis is that when people have no experience with investing they are prepared to accept lower returns from for-profit social ventures than people who have experience with investing, for betas varying from 1 to 3. This could help for-profit social ventures to gain access to cheaper equity capital. The difference is however, smaller than 1 percentage point therefore in practice the cost of focusing on this group could be higher than the benefits. Whether people have experience with giving money to charity does not influence the returns they want to receive from for-profit social ventures. This research comes with some limitations. First of all the data provided by the Dutch investment organization is limited to just one for-profit social venture because of the high degree of confidentiality of the data. This could lead to a potential misjudgment of the current cost of equity of for-profit social ventures. However, this is partly covered by the fact that the organization has a good reputation in investing in for-profit social ventures. Secondly, the survey has the limitation that it only records what people say and it does not record their actions, therefore there is always the potential effect that people give socially preferable answers thereby reducing the cost of equity. A safeguard used in this thesis to prevent that people give socially preferable answers is that the survey was anonymous. Furthermore, the survey is created using the guidelines as suggested by Dillman (2000). Thirdly the assumption in this article is that CAPM holds. Overall, this article concludes that the cost of equity of for-profit social ventures is lower than that of companies that focus on financial return; there is statically significant evidence that the social and environmental return lower the cost of equity. Furthermore, it is possible that the risk of for-profit social ventures is overestimated, though further research is needed to proof that. Another possibility of further research would be using stock market data from the new to be founded social stock exchanges in Asia and Germany to calculate the cost of equity of for-profit social ventures.. 32.

(38) References Austin, J., H. Leonard, E. Reficco, and J. Wei-Skillern, 2004, Corporate social entrepreneurship: A new vision of CSR, Harvard Business School Working Paper No. 05-021. Boston: Harvard Business School. Austin, J., H. Stevenson, and J. Wei-Skillern, 2006, Social and Commercial Entrepreneurship: Same, Different, or Both?, Entrepreneurship Theory and Practice 30(1), 1-22 Campello, M., and R. A. da Matta, 2010, How Are Venture Capitalists Rewarded? The Economics of Venture Capital Partnerships, Working Paper Electronic copy available at: http://ssrn.com/abstract=1571663 Consolandi, C., A. Jaiswal-Dale, E. Poggiani, and A. Vercelli, 2009, Global Standards and Ethical Stock Indexes: The Case of the Dow Jones Sustainability Stock Index, Journal of Business Ethics 87, 185-197. Dees, J.G., 1998, The meaning of “social entrepreneurship.”, Center for the Advancement of Social Entrepreneurship, Fuqua School of Business, Duke University. Dees, J.G., and B.B. Anderson, 2003, For-profit Social Ventures, International Journal of Entrepreneurship Education 21, 1-26. Derwall, J., N. Günster, R. Bauer, and K. Koedijk, 2005, The Eco-efficiency Premium Puzzle, Financial Analyst Journal 61(2), 51-63. Dillman, D. A., 2000, Mail and Internet Surveys, The Tailored Design Method, John Wiley & Sons, New York Edmans, A., 2011, Does the stock market fully value intangibles? Employee satisfaction and equity prices, Journal of Financial Economics 101, 621-640 Emerson, J., and F. Twersky, 1996, New social entrepreneurs: The success, challenge, and lessons of nonprofit enterprise creation, San Francisco: Roberts Foundation, Homeless Economic Development Fund. Emerson, J., 2003, The Blended Value Proposition: Integrating Social and Financial Returns, California Management Review, 45(4), 35-51 Epstein, M.J., and M. L. Pava, 1992, Corporations and the environment: Shareholders demand accountability, USA Today Magazine 121, 32-33.. 33.

(39) Fama, E.F., and M.C. Jensen, 1983, Separation of Ownership and Control, Journal of Law and Economics 26, 301-325 Foster, W., and J. Bradach, 2005, Should Nonprofits Seek Profits?, Harvard Business Review 2, 1-9. Gompers, P., 1995, Optimal Investment, Monitoring, and the Staging of Venture Capital, The Journal of Finance 42, 133-156 Gompers, P., and J. Lerner, 2001, The Venture Capital Revolution, The Journal of Economic Perspectives 15(2), 145-168 Hamilton, S., H. Jo, and M. Statman, 1993, Doing Well while Doing Good? The Investment Performance of Socially Responsible Mutual Funds, Financial Analyst Journal 49(6), 62-66 Heinkel, R., A. Kraus, and J. Zechner, 2001, The Effect of Green Investment on Corporate Behavior, The Journal of Financial and Quantitative Analysis 36 (4), 431-449 Hoogendoorn, B., E. Pennings, and R. Thurik, 2010, What do we know about social entrepreneurship; an analysis of empirical research, International Review Entrepreneurship 8(2), 71-112. Johnson, S., 2000, Literature Review on Social Entrepreneurship, Working Paper, Canadian Center for Social Entrepreneurship, 1-16. Kaplan, S.N., A. Schoar, 2005, Private Equity Performance: Returns, Persistence, and Capital Flows, The Journal of Finance 60(4), 1791-1823 Koller, T., M. Goedhart, and D. Wessels, 2005, Valuation Measuring and Managing the Value of Companies, John Wiley & Sons, New York Levene, H., 1960, Robust tests for equality of variances, Contributions to Probability and Statistics, Stanford University Press, Palo Alto, California, USA.. Lingane, A., and S. Olsen, 2004, Guidelines for Social Return on Investment, California Management Review (46) 3, 116-135 Lo, S.-F., and H.-J. Sheu, 2007, Is Corporate Sustainability a Value-Increasing Strategy for Business?, Corporate Governance: an International Review 15(2), 345-358.. 34.

(40) Newbold, P., W.L. Carlson and B.M. Thorne, 2003, Statistics for Business and Economics, Pearson Education, New Jersey Nicholls, A., 2006, Social Entrepreneurship: New Models of Sustainable Change, USA: Oxford University Press. Pava, M.L., and J. Krausz, 1996, The association between corporate social-responsibility and financial performance: The paradox of social cost., Journal of Business Ethics 15, 321-357. Plummer, J.L., 1987, QED report on venture capital financial analysis (QED Reseach, Inc., Palo Alto, CA) Reis, T. K., and S. J. Clohesy, 2001, Unleashing new resources and entrepreneurship for the common good: A philanthropic renaissance, New Directions of Philanthropic Fundraising 32, 109-144. Sahlman, W.A., 1990, The Structure and Governance of Venture Capital Organizations, Journal of Financial Economics 27, 473-524 Salamon, L., S.W. Sokolowski, and R. List, 2003, Global Civil Society: An Overview, The Johns Hopkins Comparative Nonprofit Sector Project, Baltimore: Johns Hopkins University. Schueth, S., 2003, Socially Responsible Investing in the United States, Journal of Business Ethics 43, 189-194 Witkamp, M.J., L.M.M. Royakkers, and R.P.J.M. Raven, 2011, From Cowboys to Diplomats: Challenges for Social Entrepreneurship in the Netherlands, Voluntas 22, 283-310 Worldbank, 2007, 2007 World Development Indicators, New York: Worldbank. Zahra, S.A., H.N. Rawhouser, N. Bhawe, D.O. Neubaum, and J.C. Hayton, 2008, Globalization of social entrepreneurship opportunities, Strategic Entrepreneurship Journal 2(2), 117-131.. 35.

(41) Appendix A: The Survey Thank you for participating in this survey, the survey will take approximately 5 minutes. The survey is about the expected return of for-profit social ventures. A for-profit social venture is defined as an entrepreneurial organization that is: 1. Legally incorporated as for-profit entities, with one or more owners who have a formal right to control the firm and who are entitled to its residual earnings and net assets. and 2. Explicitly designed to serve a social purpose while making a profit. Having a social purpose involves a commitment to creating value for a community or society rather than just wealth for the owners or personal satisfaction for customers. So the main difference between a normal venture and a for-profit social venture is that a for-profit social venture wants to create social value. Questions 1 -9 use the beta from the Capital Asset Pricing Model (CAPM) as a proxy for the risk a company is taking. In the CAPM the expected return of a company is based upon the risk-free rate plus beta times the market risk premium. In this survey the risk-free rate is set equal to 2.5% and the market risk premium is set at 5%. So the expected return for a normal company with a beta of 1 is 7.5% = 2.5%+1*5%. In the questions 1-8 you are asked to give an expected return for which you want to invest in a for-profit social venture. A lower expected return than the expected return for a normal company that is presented in each question, means that you are willing to give up return for the social value created by the for-profit social venture. The lower the expected return you want to get the more social value can be created by the for-profit social venture. Q1. Given a for-profit social venture with a beta of 1, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 1 is 7.5%)…………….. Q2. Given a for-profit social venture with a beta of 2, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 2 is 12.5%)…………….. Q3. Given a for-profit social venture with a beta of 3, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 3 is 17.5%)……………… Q4. Given a for-profit social venture with a beta of 4, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 4 is 22.5%)……………... 36.

(42) Q5. Given a for-profit social venture with a beta of 5, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 5 is 27.5%)…………….. Q6. Given a for-profit social venture with a beta of 6, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 6 is 32.5%)…………….. Q7. Given a for-profit social venture with a beta of 7, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 7 is 37.5%)…………….. Q8. Given a for-profit social venture with a beta of 8, which expected return do you think is reasonable to invest in this for-profit social venture? (The expected return of a normal company with a beta of 8 is 42.5%)…………….. A for-profit social venture is in many ways similar to a normal capital venture; they are both young entrepreneurial companies. However, the for-profit social venture has to focus on two objectives namely the social return and the financial return, whereas the normal capital venture only has to focus on the financial return. Q9. Given a beta (risk) of approximately 1.0 for Shell and approximately 4.0 for venture capital what is your estimation of the beta of a for-profit social venture? (The higher the beta the riskier the company is) …………….. Q10. Given a lottery with a 50% chance of winning 20 euro, when would you buy a ticket? (Select the highest price) A When the ticket price is 10.05 euro B When the ticket price is 10 euro C When the ticket price is less than 10 euro Q11. What is your gender? …………….. Q12. What is your age? …………….. Q13. Are you a student of the faculty of Economics and Business (FEB)? …………….. Q14. Are you currently investing in the stock market? …………….. Q15. Did you invest in the stock market in the past? …………….. Q16. Do you currently give money to charity? …………….. Q17. Did you give money to charity in the past? ……………... Thank you for your participation. 37.

No results found