Master Thesis
THE EFFECT OF INDIVIDUAL SUSTAINABILITY DIMENSIONS ON CORPORATE PERFORMANCE AND THE MODERATING ROLE OF INNOVATIVENESS
MSc International Business and Management 2018/2019 University of Groningen. Faculty of Economics and Business
21-01-2019
Author:
Mats T. Knuif S2316781
m.t.knuif@student.rug.nl
Supervisor:
Dr. O. Lindahl
Co-assessor:
Dr. R. W. De Vries
2 Abstract
Firms are expected to become increasingly sustainable. Although the benefits to the environment and society might be clear, ambiguity arises in the literature on the effects of corporate sustainability on firm performance. Most studies show inconsistent findings, indicating the complexity of corporate sustainability and the existence of conceptualization issues. This paper addresses these conceptual issues by dissecting the corporate sustainability concept in three dimensions, environmental, social, and corporate governance (ESG).
Furthermore, firm innovativeness is regarded as a possible moderator in the corporate sustainability-performance link. The individual effects of each dimension on firm
performance and the moderation effect of innovativeness is modeled and tested using a large sample with global coverage of publicly listed firms. The main results of the analyses show that each ESG dimension affects firm performance differently. Additionally, the moderation effect of innovativeness is found among two of the three dimensions. Support for a direct effect of innovativeness is absent, revealing the presence of indirect influence. Concludingly, theoretical and managerial implications are presented.
Keywords: Corporate sustainability, environmental, social, corporate governance. firm performance, innovativeness
Word count: 14632
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1. INTRODUCTION... 5
2. THEORETICAL FRAMEWORK ... 8
2.1. Literature Review ... 8
2.1.1. Corporate Sustainability ... 8
2.1.1.1. Development of the corporate sustainability concept ... 8
2.1.1.2. Corporate sustainability in context ... 10
2.1.1.3. CSR and corporate sustainability ... 11
2.1.2. Innovativeness ... 12
2.1.3 Corporate performance ... 14
2.2. Hypothesis Development ... 15
2.2.1. Corporate Sustainability and Financial Performance ... 15
2.2.1.1. Environment-Based Sustainability and Financial Performance ... 16
2.2.1.2. Social-based sustainability and corporate financial performance ... 18
2.2.1.3. Governance-based sustainability and corporate financial performance ... 19
2.2.2. The moderating role of innovativeness ... 20
2.3. Theoretical Model ... 23
3. METHODS ... 24
3.1. Sample ... 24
3.2. Data Collection and Measures... 25
3.2.1. Dependent Variable ... 25
3.2.2. Independent Variable ... 26
3.2.3. Moderating Variable ... 27
3.2.4. Control Variables ... 28
3.3. Data Analysis ... 28
4. RESULTS ... 31
4.1. Descriptive Data and Correlations ... 31
4.2. Results and Hypotheses Testing ... 32
4.3. Robustness Test ... 34
5. DISCUSSION ... 37
5.1. Theoretical Implications ... 39
5.2. Managerial Implications ... 41
5.3. Limitations and Future Research... 42
6. CONCLUSION ... 45
7. REFLECTION ... 46
8. ACKNOWLEDGMENTS ... 49
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9. REFERENCES ... 50
10. APPENDICES ... 63
10.1. Appendix 1: VIF test for multicollinearity ... 63
10.2. Appendix 2: Normal P-P plot of regression standardized residuals ... 63
10.3. Appendix 3: Breusch-Pagan and Koenker tests for heteroskedasticity... 64
5 1. INTRODUCTION
Accompanying the rise in problems resulting from global warming and the increase in awareness of social issues amongst societies, corporations are increasingly redirecting their resources towards sustainable activities (Aras & Crowther, 2008). Those who adopt the neo- classical view of the firm view identify the provision of employment and the payment of taxes as the sole responsibilities of business. However, this viewpoint is increasingly losing popularity.
Overall, awareness of the urgency of sustainability in the corporate setting led to an increase in sustainable practices. Over the years, several organizational guidelines and indices were developed, although significant differences exist between these. For example, the
Global Reporting Initiative (GRI) sustainability reporting guidelines were developed to provide firms with incentives to be more transparent on sustainability practices, and thus increasing sustainable behavior of firms (Hussey, Kirsop, & Meissen, 2001). Nevertheless, the effectiveness of these initiatives has been questioned repeatedly, indicating that the concept of sustainability is far more complex than researchers thought (Milne & Gray, 2013).
The abovementioned indicates the necessity of a better understanding of the concept of corporate sustainability. Resultingly, scholars have studied sustainability as a corporate strategy extensively in the last decade (Aras & Crowther, 2008). This surge in academic interest led to scholars increasingly acknowledging corporations’ impact on the social and environmental dimensions, which resulted in a discussion on the accountability of firms on the matter. Consequently, the view that firms should be held accountable for the
consequences of their actions on the abovementioned dimensions is increasingly receiving support (Kolk, 2008). Even firms, in general, seem to increasingly view corporate
sustainability as common practice, instead of exception (Eccles, Ioannou, & Serafeim, 2014).
Tis surge in attention to sustainability raised the need for a more complete understanding of the concept. Resultingly, the continuing confusion around sustainability became apparent.
This dissertation is aimed at amending theoretical inconsistencies and uncertainties, to clarify some complex mechanisms of the corporate sustainability concept. Although
corporate sustainability has been studied extensively, many studies report inconsistent
findings. Earlier studies on the relationship between sustainable activities and firm
performance sketched a rather bleak scenario. It was long believed that there existed a
substitution effect between sustainability and other, more profitable opportunities. Among
others, sustainable activities possibly bring significant costs, which includes the direct cost of
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the activities, the cost of future compliance to sustainability norms, and the foregone costs of other, more lucrative activities (Epstein & Roy, 2001). Moreover, pursuing sustainable strategies often requires organizational overhaul and a change in corporate culture, creating a significant barrier for corporations (Linnenluecke & Griffiths, 2010). Nevertheless, many studies have found that sustainable activities provide corporations with opportunities, indicating that beyond societal benefits, sustainability yields direct and indirect financial benefits. Scholars have found that sustainable corporations maintain improved relationships with stakeholders, have better access to capital, and possibly enjoy reduced long-term costs stemming directly from sustainable activities (Epstein & Roy, 2001). Even more, corporate sustainability is found to affect future performance as well, suggesting that the ability of firms to perform well in the area of sustainability relates to their managerial performance (Waddock & Graves, 1997). Moreover, studies found that firms which emphasize sustainable practices enjoy a higher financial performance, and those positive effects are sustained and increased over time periods, indicating long-term reinforcing positive effects (Ameer &
Othman, 2012; Eccles et al., 2014).
The findings outlined above portray the difficulty in studying corporate sustainability, which has been confirmed by scholars, as establishing a strong causal relationship remains difficult (Ameer & Othman, 2012). A major cause could be that sustainability is found to be highly multifaceted. Differences between the dimensions of sustainability are often
overlooked, as researchers oftentimes assess sustainability using a single measurement, while research has pointed out that producing one single, aggregated measure for corporate
sustainability is insufficient (e.g. Friede, Busch, & Bassen, 2015). Moreover, corporate sustainability is mainly studied in direct relationship with firm performance, while important possible confounders are seldom included. Consequently, on the practical side, integrating social and environmental issues in their business models remains a difficult endeavor for firms, simply because the mechanisms of corporate sustainability require better
understanding (Eccles et al., 2014). These arguments all build towards the importance of closing this research gap. Thus, the importance of a better understanding of the corporate sustainability concept and the differentiation of its dimensions is paramount.
Therefore, this study proposes firm innovativeness as a moderator in the relationship
between corporate sustainability and firm performance. The intensity of investments required
by firms to incorporate these sustainability issues in their strategy remains mostly unknown
and is to date heavily understudied. In the relationship between corporate sustainability and
performance, the innovativeness of corporations is often excluded from the equation and
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furthering the understanding of corporate sustainability requires knowledge of these mechanisms, as sustainability initiatives are basically investments, which are believed to benefit from innovativeness. Scholars have not yet been able to specify the explicit effect of firms’ innovativeness on the relationship between the individual corporate sustainability domains and performance. Studies, however, have been able to address innovativeness in relation to the triple-bottom line (TBL), where innovation efforts of firms increase overall performance (Kostopoulos, Papalexandris, Papachroni, & Ioannou, 2011). Additionally, social and environmental innovation can be a source of competitiveness to firms (Boons, Montalvo, Quist, & Wagner, 2013). Consequently, the identification of the abovementioned research gap led to the following research question, which this study addresses:
How do environmental-, social-, and corporate governance-based corporate sustainability affect firm performance, and how is this relationship influenced by a firm’s innovative capabilities?
This study will answer this question by using a dataset with global firm coverage. The three sustainability dimensions, firm performance, and innovativeness are operationalized, and proposed relationships will be tested according to the Theoretical Model, which will be presented later in this paper.
The main contribution of the present study will be the development of an improved understanding of the influence of innovation on the relationship between corporate
sustainability and performance, by studying ESG dimensions separately. The importance of the dissection of the sustainability domains is explicitly highlighted, as this practice is still uncommon in sustainability research. Ultimately, our understanding of the sustainability concept will be improved. On the practical side, the importance of proper integration of corporate sustainability is emphasized.
The present paper is structured in the following manner. First, the theoretical framework will be presented, which build towards the hypotheses that will test the
Theoretical Model. Thereafter, the research method will be introduced. The results section,
which will report the process in depth and present the hypotheses testing, follows. The final
part of the paper will facilitate the discussion. First, a short summary of the findings is
presented, which will be interpreted. Then, the implications, limitations, and directions for
future research will be discussed.
8 2. THEORETICAL FRAMEWORK
In the following section, the Theoretical Model that will be presented is specified and substantiated with an overview of the literature in the field of corporate sustainability, (financial) performance and innovativeness. Moreover, various key concepts are defined, the historical evolution of these concepts is given, and the current state of the literature regarding these concepts are presented. In particular, the conceptualizations of corporate sustainability and CSR are highlighted, to show that these concepts are very similar, however, not identical.
In addition, a justification is presented for the specific decisions regarding the adopted conceptualizations.
2.1. Literature Review
2.1.1. Corporate Sustainability
2.1.1.1. Development of the corporate sustainability concept
The topic of corporate sustainability is characterized by controversy, as many interpretations exist, and more importantly, each firm should devise its own definition to suit its purpose and objectives (van Marrewijk & Werre, 2003). Throughout the decades the concept of corporate sustainability underwent significant changes (Montiel, 2008; European Commission, 2011).
Even nowadays, a universally accepted definition remains absent, and a plethora of
definitions have been published in the last decades, of which the definition in the publication
of the World Commission on Environment and Development (WCED, 1987, p. 8) arguably
became the most widely adopted interpretation. In this publication, the concept of sustainable
development was coined, which was described as “development that meets the needs of the
present without compromising the ability of future generations to meet their own needs”. In
more detail, the concept outlines that the needs of the worlds poor should be prioritized and
that the state of technology and social organization impose limitations on the environment’s
ability to meet present and future needs. The WCED publication is also believed to usher the
corporate sustainability concept in business research, as the rise in popularity spurring from
this publication is easily distinguished. In line with the definition of the WCED, Kuhlman
and Farrington (2010) believe that corporate sustainability is concerned with the well-being
of future generations and natural depletable resources, as opposed to the gratification of the
present well-being. Essentially, corporate sustainability involves a balance between future
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and present needs. Generally, most definitions seem to rely on the notion of present and future needs.
As such, this paper argues that corporate sustainability is best defined along the lines of the definition of the WCED. Consequently, in business research, corporate sustainability, according to the popular WCED definition, is viewed as “meeting the needs of a firm’s direct and indirect stakeholders, without compromising its ability to meet the needs of future
stakeholders as well” (Dyllick & Hockerts, 2002, p. 131). Specifically, firms are required to function in the environmental, social, and economic dimension, in order to be profitable.
Note that the focus is shifted from ‘generations’ in general towards ‘stakeholders’, which expresses the ultimate focus of most firms. According to stakeholder theory in management literature, all persons or groups with legitimate interest and participating in an enterprise do so on the sole basis of reaping benefits, where there is no set of interest that is more important than others. In essence, the firm influences the stakeholders, and vice versa (Donaldson &
Preston, 1995). Their viewpoint still holds today and might explain why corporations exert increasing effort on non-financial activities.
Corporate sustainability became increasingly strongly associated with the Triple- Bottom-Line theory (TBL) (Milne & Gray, 2013). TBL refers to the three relevant dimensions that the success of businesses is based on, namely economic, social, and environmental (Elkington, 1997). In essence, for a business to be so successful, it must perform on all three dimensions. Lacking performance in one dimension greatly deteriorates success chances in other dimensions. The idea of the TBL is portrayed in the definition of the World Business Council for Sustainable Development (WBCSD, 1999), where sustainable development is regarded as the integration of social, environmental, and economic
considerations. The rise in popularity of the TBL concept in the twenty-first century foresaw the crumbling of the barrier between financial and environmental performance. As non- financial indicators are more frequently used by investors to assess the performance of companies. Resultingly, the concept of Environmental, Social, and (corporate) Governance (ESG) measurement gained traction at the same time. Academic work confirmed the
suitability of the ESG concept in measuring sustainable intent of companies (Escrig-Olmeda, Munoz-Torres, & Fernandez-Izquierdo, 2010; Ng & Rezaee, 2015). Moreover, ESG data is prominently used as a sustainability indicator for companies (e.g. Bassen & Kovacs, 2008).
Even before the WCED report, sustainability was a familiar concept, with its roots
tracing all the way back to forestry (Wiersum, 1995). Corporate sustainability began to gain
popularity in the last decades of the twentieth century (Montiel, 2008). Back then,
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sustainability was mostly associated with ecological activities (Shrivastava, 1995; Starik &
Rands, 1995). In summary, ecological sustainability is concerned with the prolonged
preservation of the environment and ecological systems. Environmental impacts of firms are caused by resource use, emissions into the air, water and ground, and (hazardous) waste (Baumgartner & Ebner, 2010). Firms engaging in ecological sustainability attempt to reduce their ecological footprint by diminishing their impact on the environment.
On the other hand, some scholars seem to accentuate the social role of firms in their environments, as they view corporate sustainability as a social responsibility of firms
(Carroll, 1999). Firms have an inherited social obligation to provide societies with the means to improve. Within the social domain, firms primarily deal with constituents in the form of customers, the government, and employees, which are in power to influence the operations of firms extensively (Ehrgott, Reimann, Kaufmann, & Carter, 2011).
A new dimension in corporate sustainability is corporate governance. The key terms defining good corporate governance are transparency, responsibility, and accountability (Tuan, 2014). Here, the belief is that governance practices, such as board dynamics and sustainability strategies, influence the continuing operation of any corporation (Aras &
Crowther, 2008). Transparency, as part of the corporate governance package, is the disclosure of information, which firms have attempted through sustainability reporting (Kolk, 2008).
Increasingly available evidence seems to prove that firms’ efforts toward corporate governance and sustainability are merging. Disclosure of firms on the links between corporate governance and sustainability is becoming more common.
2.1.1.2. Corporate sustainability in context
Scholars have made efforts to define the antecedents of corporate sustainability. For example, within organizational culture research, stability and control focused firms tend to conform to formal institutions, and prioritize economic performance, thus restricting the enactment of sustainability, whereas firms characterized flexibility place greater emphasis on innovation for achieving corporate sustainability (Campbell, 2007). Furthermore, financial performance and the economic environment influence firms’ capabilities to enact corporate sustainability.
As mentioned earlier, access to resources, which is enabled by financial performance, enhances the ability of firms to invest in sustainable activities (Waddock & Graves, 1997;
Campbell, 2007). Other firm-level determinants of corporate sustainability are firm size,
growth rate, and higher returns (Artiach, Lee, Nelson, & Walker, 2010). Additionally,
country-level determinants include unhealthy economic environments, which hampers the
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inclination of firms to be sustainable (Chih, Chih, & Chen, 2010). Besides, investor protection and law enforcement influence the possibilities for corporate sustainability (Lourenco & Branco, 2013).
In terms of the benefits of corporate sustainability, extant research on corporate sustainability follows a win-win paradigm, where the environmental, social, and economic aspects of corporate sustainability are (partly) in harmony with each other (Hahn, Figge, Pinske, & Preuss, 2010). Consequently, managers aim to identify opportunities that enhance all three aspects simultaneously. In other words, most corporate sustainability activities are based on the assumption that there is at least some financial pay off (Dyllick & Hockerts, 2002). Moreover, consumer preference is inclined towards sustainable firms, where
environment-based sustainability has the largest effect on consumer responses. Consumers seem to be willing to pay a price premium for products from sustainable firms as well (Jones, Frost, Loftus, & van der Laan, 2005). Additionally, a major stream of research identified the benefits of firms’ disclosure of their sustainability activities. Depending on the firm,
sustainability reporting can either be mandatory or voluntary. Sustainability reporting that is driven by regulation increases firm’s valuation, however, recent research found that even in the absence of regulatory institutions, firms seek to disclose sustainability, as it serves as comparison and credibility tool (Ioannou & Serafeim, 2017).
2.1.1.3. CSR and corporate sustainability
A stream of sustainability literature emphasizes the social responsibility role of firms, which is knowns as corporate social responsibility (CSR). CSR expresses the citizenship role of firms. Firms enjoy the benefits of using society’s resources, and must, in turn, give back to society (Montiel, 2008). Essentially, firms must address the societal expectations of its operations. As Carroll (1979, p. 500) argues, CSR is the “social responsibility of businesses that encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time”. A meta-analysis conducted by Dahlsrud (2008), resulted in the distinction of five main dimensions extracted from a large amount of CSR literature: social, environmental, economic, stakeholder, and voluntary.
An early stream of CSR viewed the concept as corporate philanthropy, which states that CSR activities are on a voluntary basis. Nobel-prize winning economist Milton Friedman argued, however, that corporate philanthropy was not to be desired by firms, as CSR
adversely affects the economic interest of firms (Friedman & Friedman, 1980). Other
scholars adopt the stakeholder view, arguing that CSR activities should be aimed at all
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grouping affected by the operations of firms (Buysse & Verbeke, 2003). Lastly, the broad view of CSR links the social responsibilities of firms to the TBL, where firms’ focus lies on the environmental, social, and economic dimension (Baumgartner, 2014). Arguments could be made for the resemblance among CSR and corporate sustainability, regardless of the preferred conceptualization of both terms. Indeed, scholars have been using the terms
interchangeably throughout their manuscripts recently (Perez-Batres, Miller, & Pisani, 2010;
Montiel, 2008). In this paper, the argument is made that CSR is basically the action of (trying to) achieve sustainability since CSR is mainly action-oriented. As such, the ultimate goal of engaging in CSR activities is to achieve corporate sustainability.
2.1.2. Innovativeness
As an old area of study, corporate innovation has received plenty of attention from scholars.
The consensus is that for firms, innovation can be a powerful tool to distinguish themselves from similar firms. As argued by Schumpeter (1942), firms gain a temporary quasi-monopoly position that allows them to extract rents. Through these rents, firms can profit from
innovation, and thus, innovativeness is oftentimes a sought-after strategy. Nowadays, innovation is generally seen as the generation, development, and implementation of new ideas and behaviors, and can take the form of a new product or service, a new (production) process, a new structure or system, or a new plan or program (Damanpour, 1991). The keyword in innovation literature is ‘new’, as a fundamental characteristic of innovation is the notion of newness. Inspired by the expressed importance of innovation and entrepreneurship by Schumpeter, Drucker (1954) published the book ‘The Practice of Management’, which would lay the foundation for the development of the innovation field of study. In larger firms, innovation has been established as an important source of competitiveness, and these firms have a proportionally higher share of their resources dedicated to innovation (Nieto &
Santamaria, 2010). Additionally, industries with large constituents are characterized by higher resource allocation towards innovation (Acs & Audretsch, 1988). Innovation is believed to be an important driving force for new businesses, especially for SMEs. In their meta-analysis, Rosenbusch, Brinckmann, & Bausch (2011) argue that entrepreneurs and small managers view innovation as a positive driving force, regardless of the circumstances.
They also found that SMEs can indeed profit from innovation, even though the risks are
greater. It is also a general belief that firms who invest heavily in innovation have a greater
promise at success (Lee & Chen, 2009).
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However, most of research on innovation is focused on larger firms. As argued by Van de Ven (1986), innovation requires a substantial amount of resources, which may be unavailable for smaller firms, or force them to overstrain their possibilities. Several factors seem to support the notion that the benefits from innovation primarily apply to the larger firms, as these firms are likely to absorb the risk of failure and have experimented with innovation more often (Rosenbusch et al., 2011).
In innovation theory, the distinction can be made between exploratory and
exploitative innovation. The former mainly involves the challenging of existing approaches, while the latter builds on improving and fine-tuning current skills and processes. Therefore, exploratory innovation is oftentimes associated with radical innovation, whereas exploitative innovation tends to be more incremental (Mueller, Rosenbusch, & Bausch, 2013). It must be noted that both approaches to innovation have differentiated effects on the success factor.
Organizational characteristics play an important role in selecting the preferred innovation approach and its effectiveness. Jansen, Van den Bosch, and Volberda (2006) found that exploratory innovation flourishes under a flexible organizational regime and the exploitative approach thrives under a centralized, formal structure. Moreover, in dynamic environments, the exploratory approach seems better suited. However, if the firm operates in a highly competitive environment, exploitation is more sought after.
The innovative ability of firms is becoming increasingly important, as markets are becoming highly competitive. However, as innovation used to be solely beneficial to firms, recent research suggests that successful innovation depends on contingency factors, such as innovative capabilities and market characteristics (Mueller et al., 2013). Disregarding the conditionality of innovative success, several linkages of innovation have been established. It has been found that innovation is the driving force behind organizational renewal (Floyd &
Lane, 2000). Organizational renewal involves building and expanding organizational competencies over a time span, often leading to changes in the organization’s product domain. Additionally, they argue that organizational renewal is paramount in exploiting existing competencies and exploring new ones. An important factor influencing a
corporation’s ability to innovate is its market orientation, which firms can foster through the organization-wide collection of market information, dissemination of the information among functions, and organizational responsiveness to such information (Atuahene-Gima, 1996).
Furthermore, firm size is correlated to firm innovativeness, as larger firms are more
innovative (Danneels, 2002). This observation seems to hold for SMEs as well (Camison-
Zornoza, Lapiedra-Alcami, Segarra-Cipres, & Boronat-Navarro, 2004).
14 2.1.3 Corporate performance
Understandably, corporate performance is the most studied phenomenon in corporate
literature, as it is the central point to the existence of firms. Basically, corporate performance captures how well the firm has been doing in its environment and is oftentimes used as a predictor of future performance (Hax, 2003). However, the concept of corporate performance has been extended tremendously over time. For instance, corporate performance takes
different forms in the literature, where the most common measures are financial performance and accounting performance (Daniel, Lohrke, Fornaciari & Turner, 2004). These measures are often operationalized as returns on assets or equity, market value, or accounting profits and seem to have an inherent focus on short-term performance. Even though these measures seem to provide exact measures, the concept of corporate performance remains, too an extent, abstract (Hax, 2003). Nowadays, non-financial or non-accounting measures are more
frequently employed. Measures include consumer satisfaction and brand loyalty, which seem to imply how well a firm addresses consumer needs, and as a result can expect returning sales (Bloemer & Kasper, 1995). Another recurring measure, brand awareness, indicates how well a corporation profiles itself to the world, and as such, is sometimes operationalized as a proxy for performance. Studies showed that there is indeed a positive link between brand awareness and financial performance (Homburg, Klarmann, & Schmitt, 2010).
Obviously, countless determinants of corporate performance exist, of which a distinction can be made between internal and external determinants. Firstly, internal determinants deal with the factors or characteristics within firms that drive or hamper performance. It is believed that firms have control over these factors, and as such are well studied. As explained before, innovation is identified as a major driving force, as it provides firms with the means to differentiate from competitors. Moreover, technological capabilities, which indicate a firm’s ability to create technology and adopt it in their activities, together with a firm’s access to financial resources are found to be related to higher firm performance (Lee, Lee, & Pennings, 2001; Calantone, Cavusgil, & Zhao, 2002). Additionally, marketing effort is a strong predictor of firm performance and is sometimes found to impact
performance more strongly than innovation (Krasnikov & Jayachandran, 2008; Morgan, Vorhies, & Mason, 2009).
External factors deal with forces often out of reach from the sphere of influence of firms. In general, these environmental forces have been established properly in the literature.
However, the effects of environmental factors seem to be largely interdependent. The
contribution of Porter (1979) with his ‘Five Forces Model’ made significant progress on the
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industry level. Oftentimes, in firm-level research, industry effects play a significant role (Hansen & Wernerfelt, 1989). Industry-specific effects seem to partly drive the activities of firms (Stam, Arzalian, & Elfring, 2014). Moreover, the institutional environment provides firms with the rules of the game, where the quality of institutions plays the most prominent role in determining firm performance (Rodrik, Subramanian, & Trebbi, 2004). How firms respond to these external forces proves to be a major source of competitiveness and is a central focal point within this dissertation.
2.2. Hypothesis Development
2.2.1. Corporate Sustainability and Financial Performance
The theoretical foundations for the relationship between corporate sustainability and firm financial performance dictate that the linkages might be conditional. Hypothetically, the main purpose of a firm remains the maximization of shareholder value and any deviation from that course generally hinders firms’ ability to do so (Margolis et al., 2009). Moreover, Ameer and Othman (2012) reason that industries with a high environmental and social impact have an inherited disposition towards corporate financial performance in industries characterized by strong institutions. Following this line of reasoning leaves little hope for a positive link between corporate sustainability and firm (financial) performance.
However, some scholars argue that firms might be able to be sustainable reap economic benefits simultaneously. According to the stakeholder theory, the satisfaction of various stakeholders is instrumental for corporate financial performance (Orlitzky, Schmidt,
& Rynes, 2003). Sustainable firms can invest more extensively in the bilateral relationships
and contracts between stakeholders and the firm. Moreover, by listening to and acting
towards stakeholder demands a balance can be crafted, which increases the efficiency of a
firm’s organization towards the adaptation of external demands. Schaltegger and Synnestvedt
(2002) argue that the explicit costs of social responsibility are minimal and thus, room for
profits in these fields is found. Moreover, they argue that if firms can facilitate cost savings
on the marginal level, while using environmentally friendly technologies, a positive link
between sustainability and corporate performance is possible. This conditional relationship
translates into the question ‘When does it pay to be green?’ and is contingent on internal and
external factors alike. Another possible source of profitability is the mitigation of pressures
by social groups and governments, and a more valuable appearance towards investors, as the
result of consistent sustainability reporting (Ioannou & Serafeim, 2017). In recent years,
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expectations of parties towards corporate sustainability have increased, and firms’ disclosure of sustainability information could indicate proper sustainability management. This signaling is believed to be effective in matching investor demands, as they began to integrate ESG data in valuation models (Ioannou & Serafeim, 2017).
There has been ample research on the empirical relationship between corporate sustainability and performance. Most of the literature seems to report positive associations between corporate sustainability and performance (Eccles et al., 2014; Waddock & Graves, 1997; Ameer & Othman, 2012; Kiessling, Isaksson, & Yasar, 2015; Margolis, Elfenbein, &
Walsh, 2009). However, negative (Lopez, Garcia, & Rodriguez, 2007) and weak or insignificant relationships (Van de Velde, Vermeir, & Corten, 2005; Buys, Oberholzer, &
Adrikopoulos, 2011; Cochran & Wood, 1984; Surroca, Tribo, & Waddock, 2010) are common as well. Some researchers acknowledge that difficulties in investigating the relationship between corporate sustainability and performance lie in the multidimensional concept of corporate sustainability, which results from the lack of an unambiguous
conceptualization, as stressed earlier in this paper. More importantly, the operationalization of the sustainability concept proves to be challenging (Margolis et al., 2009). Also, the results are hardly conclusive along the time spectrum, as for example Lopez et al. (2007) report that a long-term negative effect of corporate sustainability on performance could not be produced.
Despite the variety among results, certain observations in the literature can be made. First, the main benefits seemingly stemming from responsible and sustainable initiatives revolve around long-term engagement of important stakeholders, whether these may be communities, suppliers, governments, or other stakeholders (Eccles et al., 2014; Epstein & Roy, 2001).
Greater involvement between these stakeholders and firms result in unique opportunities, which might even prove to be a source of competitiveness. Such intangible sources of competitiveness are, per definition, harder for firms to imitate. Furthermore, the
consequences of neglecting sustainability have been studied to some extent. Margolis et al.
(2009) found that corporate misdeeds are particularly costly to corporations. Their research reinforced the meta-analytical findings by Frooman (1997), which concluded that the financial impact of wrongdoings can be severe.
As outlined in the literature review of this paper, corporate sustainability is dissected into its three dimensions according to ESG theory, namely environmental, social, and corporate governance. Below, each dimension is considered individually.
2.2.1.1. Environment-Based Sustainability and Financial Performance
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The relationship between environmental performance and financial performance underwent significant changes in the past decades (Nakao, Amano, Matsumura, Genba, & Nakano, 2007). This change resonates in recent literature, where the establishment of a universally accepted relationship is yet to be achieved. In their meta-analysis, Orlitzky et al. (2003) found there are differences between the dimensions of corporate social performance and financial performance. The relationship between CSP and performance is stronger for the social dimension than for the environmental dimension. The reported link between environmental sustainability and corporate performance, albeit positive, is viewed as weak. Moreover, there is reason to assume that environmental initiatives do not contribute to or even harm the financial performance of firms in some cases (Horvathova, 2010). In this meta-analysis differences between types of studies became apparent. Most studies reported a positive relationship between environmental and financial performance, although the number of studies reporting a negative or insignificant relationship almost equals the positive studies.
They argued that the country of analysis proved to be an important factor since positive links between sustainability and performance are more likely to be found in common law
countries, as opposed to civil law countries. It must be noted that most of the negative results were found in studies using correlation coefficients and portfolio studies, thus methodological challenges seem to be present as well. However, recent work in the field showed that there are indeed positive linkages and evidence seems to support both the ‘when does it pay to be green?’ theory and the win-win paradigm (Albertini, 2013). Green initiatives have the propensity to be beneficial to firms, if only they are conducted correctly. Russo and Fouts (1997) concluded in their paper that there is indeed evidence for the hypothesis that it pays to be green. On a side note, scholars found that smaller firms can profit at least as much as their larger counterparts from environmental sustainability (Dixon-Fowler, Slater, Johnson, Ellstrand, & Romi, 2013).
There is some evidence that points towards lack of consensus in the literate, which raises controversy about the expected relationship between environment-based sustainability and corporate financial performance. Nevertheless, the findings of the studies above predict a larger likelihood of finding a positive relationship between environmental and financial performance. Moreover, the studies that did report a positive relationship tend to be more empirically advanced, raising the argument that finding a non-significant or negative
relationship between environment-based sustainability and firm performance might be due to
methodological errors. Along with theoretical lines, environmental initiatives are predicted to
be beneficial to firms as well, and these theories have largely been backed by empirical
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evidence. Based on this surplus of empirical evidence of a positive link between environmental sustainability and firm performance, Hypothesis 1 states that:
H1: Environment-based sustainability is positively related to corporate financial performance.
2.2.1.2. Social-based sustainability and corporate financial performance
The social aspect of sustainability is mainly concerned with the various stakeholders of the firm. The social stakeholders are often grouped in two domains, namely internal, such as employees and firm governance, and external, such as communities and public instances (Tang, Hull, & Rothenberg, 2012; Basu & Palazzo, 2008). Theory suggests that accounting for external stakeholders in order to increase revenues is more difficult than internal
stakeholders since external stakeholders are typically farther away from the firm. In their paper, Basu and Palazzo (2008) argue that internal issues are more easily handled, as the firm has more control of these issues, and failure of successfully resolving internal issues incur relatively lower costs. On the other hand, successful community-based initiatives are highly likely to contribute to the performance of firms. As Waddock and Graves (1997) stated along the lines of good management theory, positive customer perceptions about the efforts directed at external affairs are becoming bases of competition. Indeed, theorists argue that
corporations known for their activities in the social domain of sustainability should expect easier employee attraction and attainment, higher employee satisfaction, and, through building goodwill and trust with key stakeholders, lower transaction costs (Qiu, Shaukat, &
Tharyan, 2016).
Overall, social issues are found to be an important source of challenges for firms and is becoming an increasingly important area of focus. Several meta-analyses concluded that successful mitigation by incorporating these social issues in corporate activities or even creating new profit opportunities out of social initiatives, does increase firm performance (Margolis & Walsh, 2003; Yawar & Seuring, 2015). Oftentimes, a major share of aggregated research reports a significant positive effect of social sustainability on firm performance.
Moreover, extensive social sustainability disclosure has been linked to higher market
valuation and profits as well, indicating social sustainability especially benefits firms that
actively seek to publish their good-doings (Gray, 2001; Milne & Gray, 2007; Qiu et al.,
2016). However, firms seem to mainly focus on the issues that directly influence their profit,
thus the effect of activities not relating directly to performance is not known. In the field of
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employee-based sustainability, human capital initiatives are found to be strongly related to firm performance (Rosenbusch et al. 2011), especially when the human capital is firm- specific (Crook, Combs, Todd, Woehr, & Ketchen, 2011).
Empirical work obviously favors a positive relationship between social sustainability and firm performance. Moreover, social sustainability reporting is found to be a positive influence in this relationship as well. Theoretical foundations for this relationship are solid as well, as firms that engage in social sustainability do so based on expected returns. Firms actively publish and promote their good-doings, in order to increase positive customer perceptions. Oftentimes, firms can charge customers a price premium for sustainable
products. Given the evidence, a positive relationship between social-based sustainability and corporate financial performance is predicted. Therefore, Hypothesis 2 states that:
H2: Social-based sustainability is positively related to corporate financial performance.
2.2.1.3. Governance-based sustainability and corporate financial performance
The inclusion of corporate governance in corporate sustainability literature is, as pointed out above, new, while corporate governance on itself received plenty of attention. Overall, the impact of proper management regarding sustainability has been proven (Epstein, 2018).
Findings in the literature show that if firms engage in good governance, their performance is enhanced, through the effects of greater transparency, accountability, and responsibility (Tuan, 2014). However, there seems to be a general controversy in the corporate governance literature, as corporate governance studies suffer from statistical problems when relating the concept to firm performance, such as endogeneity (Love, 2010). For instance, in a study on the chemical and pharmaceutical sector, Ibrahim, Rehman, and Raoof (2010) find that corporate governance moderately positively relates to return on equity (ROE), while this effect cannot be replicated for return on assets (ROA) as a firm performance measure.
Nevertheless, studies mainly report positive relationships (Love, 2010; Gillan & Starks, 2007). Moreover, a plethora of studies on sustainability reporting reveals that it can be a source of competitiveness (e.g. Waddock & Graves, 1997; Ioannou & Serafeim, 2017).
Disclosure has even been proven to positively moderate the general relationship between corporate sustainability practices and firm performance (Fatemi, Glaum, & Kaiser, 2017).
Additionally, individual board characteristics, such as the inclusion of community influentials
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on the board and the presence of a sustainability committee, have been found to affect the level of disclosure, and thereby performance (Michelon & Parbonetti, 2012).
The various effects that are found within the corporate governance realm with respect to firm performance are generally positive. The theory seems to favor a positive effect of sustainable corporate governance along the lines of increased transparency, accountability, and responsibility. When looking at empirical evidence for sustainable corporate governance practices, a lot is still unknown. No study has been devoted to the investigation of the explicit link between general sustainable corporate governance and firm performance. One aspect within the area of corporate governance-based sustainability, sustainability reporting, is empirically founded, as research showed unambiguous benefits to firm performance.
Therefore, it is expected that corporate governance-based sustainability in general benefits firm performance as well. Thus, with respect to the available empirical evidence on this topic, Hypothesis 3 states:
H3: Governance-based sustainability is positively related to corporate financial performance.
2.2.2. The moderating role of innovativeness
The theoretical foundations beneath the linkages between firm innovativeness and firm performance have been thoroughly studied. Overall, innovativeness is believed to be an important antecedent of firm performance, yet evidence for mediating and moderating roles of innovativeness is presented as well (Hult, Hurley, & Knight, 2004; Cho & Pucik, 2005).
Moreover, some scholars argue that firm innovativeness is the number one determinant of firm performance (Calantone et al., 2002). The meta-analysis of Rubera and Kirca (2012), which covered 153 studies, found positive direct effects between firm innovativeness and firm value, and market and financial position. Additionally, innovativeness was found to indirectly affect firm value through firms’ market and financial positions. The meta-analysis shows that innovativeness creates value for firms in various ways. Moreover, evidence for a bilateral relationship is found, implicating that innovativeness may have a reinforcing effect as well.
Regarding sustainability, innovation is a much lesser studied subject. Firms with better innovative capabilities are expected to be more proficient in their sustainable
initiatives. Compared to non-sustainable innovativeness, firms are not expected to profit more
from sustainable initiatives. However, disregarding non-sustainable innovations, a positive
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relation is found between the intensity of sustainable innovation and firm profitability
(Aguilera-Caracuel & Ortiz-de-Mandojana, 2013). It is found that innovation is an important factor to account for in investigating the relationship between sustainability and firm
performance, as modeling this link without the inclusion of innovation produces upwardly biased estimators of the financial impact of sustainability (McWilliams & Siegel, 2000). On the other hand, Wagner (2010) found that innovativeness is not interacting with corporate sustainability. Innovation does not per se improve the effect of corporate sustainability on performance. Thus, the effect of innovation on specified relationships above needs to be examined further.
Some scholars argue that firms, regardless of the institutional environment, invest heavily in green products or processes. These activities seem to enable firms to preserve revenues and reputation, and even create new businesses (Dangelico & Pujari, 2010). Also, the argument can be made that larger innovation expenditures on environmental sustainability result in long-term benefits, as eco-innovation is the key to realizing growth (OECD,
2009a/2009b). Also, empirical studies seem to provide evidence for these arguments. For example, Doran and Ryan (2012) found that eco-innovation is found to be a more important determinant for firm performance than non-eco-innovation. On the supply side it is found that internal R&D expenditures are likely to induce eco-innovation, whereas, on the demand side, a significant increase in the demand for eco-friendly products and services is found. Indeed, innovativeness can be a powerful source of influence. According to the Porter hypothesis, environmental regulation in combination with innovation initiatives lead to higher
performance (Porter, 1991). More specifically, three distinct variants of the Porter hypothesis expand on the role of regulations. Either, environmental regulation will stimulate eco-
innovation, flexible policy regimes provide firms with greater incentives to innovate, or properly designed institutions may induce cost-saving innovations that more than
compensates for the cost of compliance (Jaffe & Palmer, 1997). All in all, evidence points towards the existence of a moderating role of innovativeness on the relationship between environmental sustainability and firm performance.
Based on the literature, greater innovativeness is expected to positively moderate the
relationship between environmental-based sustainability and performance, as the demand for
eco-friendly products and services is increasing. Moreover, as spelled out by the Porter
Hypothesis, innovation plays an influential role in the link between environmental
sustainability and firm performance. Therefore, Hypothesis 4a states that:
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H4a: Greater innovativeness positively moderates the positive relationship between environment-based sustainability and performance.
In comparison to the economic or private returns to sustainability, the social returns to sustainability are possibly even greater (McWilliams, Siegel, & Wright, 2006). This implies that there are tremendous gains to be collected in the social field of innovation. Prominent examples of great solutions to social problems that are at least partly organizational driven are fair trade, human rights, and unions (Mulgan, Tucker, Ali, & Sanders, 2007).
Interestingly, these assumptions remain largely untested. However, a study on the moderation effect of innovation on the corporate social performance–firm performance link found a negative moderating effect, indicating that the effect of corporate social performance is expected to be higher in firms characterized by lower levels of innovation (Hull &
Rothenberg, 2008). They argue that social sustainability substitutes the need for innovation in order to differentiate from the competition, and as such, the latter hinders the former.
Obviously, the sparsity of research on the moderating effect of innovativeness on the social sustainability-firm performance link expresses the importance of additional research.
The available research, however, suggests that the moderating effect is negative. In the absence of further evidence for a different moderating effect, and in agreement with the findings in Hull & Rothenberg (2008) Hypothesis 4b states:
H4b: Greater innovativeness negatively moderates the positive relationship between social-based sustainability and performance.
In corporate governance research, scholars have found that there exists a link between corporate governance and innovativeness and that this link influences firm performance (Sheng, Zhou, & Li, 2011). However, causality and the direction of this link remain largely understudied. There is some evidence for a causal positive link though, as corporate
governance seems to benefit from larger amounts of innovativeness, as firms can move towards more efficient business models (Morioka, Evans, & Monteiro de Carvalho, 2016).
On the individual level, managerial latitude for innovation is found to be positively related to
firm performance, hinting at a moderation effect of innovativeness on the individual level as
well (Ongore & K’Obonyo, 2011). Here, higher managerial innovativeness positively
influences the link between board characteristics and firm performance.
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Aggregating the above leads to the assumption that good governance and innovation are possibly reinforcing each other. Even in the absence of a solid amount of evidence, empirical findings seem to suggest that innovativeness reinforces the relationship between corporate governance-based sustainability and firm performance. Therefore, Hypothesis 4c predicts that:
H4c: Greater innovativeness positively moderates the positive relationship between corporate governance-based sustainability and performance.
2.3. Theoretical Model
The expected hypothetical relationships outlined in the previous section are visually aggregated in the model in Figure 1. This Theoretical Model will serve as the basis for the statistical analysis that will be described and conducted in the next sections.
Figure 1: The Theoretical Model
Corporate Sustainability
H4c
+ H4b
−
H4a +
H3 + H2 + H1 +
Innovativeness
Social Environment
Corporate Governance
Financial
Performance
24 3. METHODS
In this section, an overview of and justification for the preferred research method will be presented, discussing the selected sample, the data collection and measures, and statistical procedures.
3.1. Sample
The present study is based on a cross-sectional dataset originally consisting of 4449 publicly traded firms, originating from 62 countries, for the year 2012. Due to missing data the sample size is decreased, such that for the regression analyses the sample size is 1051. The selection of these firms is primarily based on the availability of data in the Thomson Reuters ASSET4 database. This database provides data on many firms from various countries, including data on firm financials and scores on the ESG sustainability domains. The ESG scores are aggregated and standardized based on more than 400 measures, originating from firms’
annual reports, websites of the firm and NGO’s, stock exchange filings, CSR reports, and news sources (Thomson Reuters, 2018). An overview of the distribution of firms in the industry and geographical region dimensions is found respectively in Table 1 and Table 2.
Noteworthy, the regions Asia & Pacific, Europe, and North America have a similar high frequency, while the other regions have a very low frequency. The main reasons for this are that Thomson Reuters is an American firm, and data on western firms are in abundance. It has been proven that ESG reporting is less common in developing countries, as the public pressure for firms to disclose sustainability information is lower (Ali, Frynas, & Mahmood, 2017). This reflects in the distribution of firms since Africa, the Arab States, and South America are generally viewed as developing regions. Moreover, the institutional
environment is weaker in developing countries, generally speaking (Khan & Gray, 2006).
Resultingly, firms are less pressured by governments to disclose business data, which results in lower disclosure of ESG data. Thus, the sample is skewed towards firms located in
countries with a better institutional environment. This problem is common for nearly all
databases in sustainability. The distribution of firms among industries is more balanced since
the largest industry group has just over a quarter of the observations.
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Table 1: Frequencies Companies by RegionRegion Region Code N % Cumulative %
Africa AF 17 1.6 1.6
Arab States AS 8 .8 2.4
Asia & Pacific AP 333 31.7 34.1
Europe EU 246 23.4 57.5
North America NA 419 39.9 97.3
South America SA 28 2.7 100.0
Total 1051 100.0
Table 2: Frequencies Companies by Industry
