Master Thesis 2016-2017

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Thesis 20 August 2017

Being Corporate Social Responsible has an effect on

firm value, or does it? Moderated by the society’s level

of inequality

Student number: s1797786

Name: Karst Bron

Study Programme: MSc IFM

Supervisor: dr. H. Gonenc

Msc Thesis IFM

Words: 7523

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Abstract

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Foreword

In the summer of 2014 I participated in the Summer school with the higher school of economics Moscow. There I came in contact with a new phenomenon, (un)ethical behaviour. The idea that profits however attained are profits, how the environments reacts or suffers because it does not matter. The welfare state, or the lack of it, showed the enormous gap it left behind. This has greatly inspired me, and changed my deeper beliefs.My master thesis on the subject “Corporate Social Responsibility and what are the further implications for companies”has allowed me to put together my previous interests in the financial world and combining it with the relevant questions raised on Corporate Social Responsibly. Diving deep into the topics and making me familiar with the current developments and what are the current trends of western companies, which I thought was very interesting as I now have a better understanding and will be more willing in the future to allow for projects to have a more societal beneficial side.

Next, I want to thank my current supervisor dr. H. Gonenc who has been very patient with me, giving me tips and support during the few meetings we had. It’s been nothing but excellent guidance. Moreover I would like to thank you for allowing me to do this thesis.

Furthermore, a rare special thank you for G Wiegers and M Bron; the situation has been a rough one for all of us. I want to thank the both of you, especially you dad. Even when you were in such a “fragile” state, you still had to energy to be there.

Then, now this ride has been one long overdue, but I can say that hopefully after reading my master thesis. This journey will come to an end, and there rests only one more thing to do; graduate from the RUG.

I hope you enjoy your reading. Karst Bron

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1. Introduction

What has globalising brought the world? In what way has globalising giving the companies of the day, benefits or disadvantages? Every company has come to face the ever increasingly more competitive becoming markets. However what can be done in order to survive as a company. The solution has been found in an odd place. In the past, in the years of Ford, companies were considered to only care for their shareholders, providing maximum profits.

A new way of thinking has emerged, over the last couple of decades companies have become increasingly aware of the role that Corporate Social Responsibility (CRS) has on firm value. According to Van Marrewijk (2003) CSR can be referred to as the “company’s activities - voluntary by definition - demonstrating the inclusion of social and environmental concerns in business operations and in interactions with stakeholders”. Meaning that aside from the company’s interests, the company voluntarily invests in the communions and environment that would otherwise in the classical way of thinking would not have happened, as such involvement is not required by law. Moreover, according to the European Commission (2014), CSR is “the responsibility of enterprises for their impact on society. CSR should be company led. Public authorities can play a supporting role through a smart mix of voluntary policy measures and, where necessary, complementary regulation. Companies can become socially responsible by: following the law; integrating social, environmental, ethical, consumer, and human rights concerns into their business strategy and operations.” In short it means that companies take responsibility for enhancing their impact on external stakeholders. Therefore Van Marrewijk (2003) and the European Commission (2014) believe that CSR allows for an increase in competitiveness, which would in normal markets mean an increase in profitability. Hence, a firm is more valuable, than without having a CSR policy.

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6 market value of assets divided by the replacement costs of assets. Or differently by the market capitalization plus the total liabilities divided by the Common stock price plus the total liabilities. The information on these companies is acquired through the Datastream databases, giving all the financial information in the form of Tobin’s Q. Thus for the CSR, is substituted for the ESG score. The database used to gather the information on the softer side of companies, is the ASSET4 ESG dataset of Thomson Reuters (2013). It contains annual scores on Environment, Economic Performance, Social and Corporate Governance. And these indicator scores are available on country and company level.

Further study should be conducted on other dimensions of Hofstede. This is for example, by instead of picking only one dimension; try to find a way to combine all dimensions to see with overall moderating effect. But next also see the distinguishing factors, and which dimension plays a larger role in the whole cultural difference that countries or country blocks have. Moreover, more research should be done on other moderators. Thus, by narrowing down the specific key factors that are needed, to be taking into consideration, when making a business decision when it comes to CSR and implementing it in such a way that it will enhance financial performance. Thus making it a more an attractive proposition for the future.

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7 2. Literature review

Background studies on the older theorem that provides insights in the relationship between CSR and firm value. Moreover, to contracting findings older studies have found. Therefore this part explains the theoretical background on the subjects. Consequently draws up the hypotheses.

2.1.Theoretical Framework

The main normative theories of corporate social responsibility can be split into shareholder or stakeholder theory. Whereas in the case of shareholder theory by Friedman (1962), one believes that firms do not have the moral obligation to show remorse of being social responsible, other than to maximize their own profits. The opposing view is called the stakeholder theory. Hence, instead of focusing on maximizing profits, companies have the obligation to take their surroundings in consideration (Freeman, Jennings, 2012).

Corporate social responsibility and financial performance, there has been previous studies that examined the role CSR has on financial performance. However, over the years the precise effects have not been linked to ethical behaviour in a matter of looking at the social implications CSR has on ethics and in the end on firm value. Cochran and Wood (1984) have found two methods of measuring CSR, either by a reputation index or content analysis. As they also found, that both these measure for CSR are inadequate, the findings in ASSET4 should provide a more creditable solution. Firm value according to Maury and Pajuste (2005) can be best defined as the market value of assets divided by the replacement costs of assets (Tobin’s Q).

Positive effect; CSR related to firm value

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8 Negative effect; CSR related to firm value

Due to limited resources, according to literature one can find that investors will be put off if managers spend too much of their money into non -core initiatives. Whereas branching of from the main activities of the firm, creating value for the investors/owners for a sustainable period of time. The agency costs related to the managers wanting to stray from the main objective can be put under this (Jensen, 1976). This might in turn lower the overall firm value, as investors can be put off for making future investments.

The moderator Culture

International managers always face a dilemma when it comes to working in multiple countries, the culture tends to differ. The way things are done, even when the countries reside within the culture bloc, are different. Thus it is quite right that managers should carefully consider what to do when it comes to the overall strategy. The past has shown that not every multinational firm has considered fully that some form of doing business will not work. Examples, such as choosing the wrong brand name, this has lead to many customers avoiding the brand all together. Griffith, et. al (2014) found the same to be true when it comes to releasing a new product and what to consider from the influence the national culture has on the acceptance. They discovered that there is a significant influence that national culture has on how a product will be received on a country-level. Hence, a closer look at the relationship that culture has on the interaction between CSR and firm value is needed.

Whilst looking at Culture, the main two branches of determining the influence difference of a national culture compared to another are the six dimensions of Hofstede’s Cultural Dimensions and the nine competencies of the GLOBE cultural competencies.

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9 Power distance index focuses on the inequality in society. Hofstede (2017) states that the dimension power distance is best defined as follows; “This dimension expresses the degree to which the less powerful members of a society accept and expect that power is distributed unequally. The fundamental issue here is how a society handles inequalities among people. People in societies exhibiting a large degree of Power Distance accept a hierarchical order in which everybody has a place and which needs no further justification. In societies with low Power Distance, people strive to equalise the distribution of power and demand justification for inequalities of power.”Hence can be said that companies in a country with a higher score on the power distance index chart, shows that in said country CSR might be less effective as society accepts that there is a difference between the less and more fortunate.

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10 2.2.Hypotheses

Hence, the proposed research objectives for this study discover the relationship between CSR and firm value (as in the form of financial performance, through a proxy of Tobin’s Q). Therefore, showing insights based on certain social responsible ways of structuring and doing business. Whereas once firms were not stimulated to differ any capital in such a matter that does not maximize shareholder wealth. In the current global market, more and more firms are performing acts of generosity and are requiring their employees to act and behave within a stricter set of morals and display a higher level of social responsibility.

Consequently, the Research Question sounds as followed:

Is having a CSR policy lead to an increase in firm value. Hence, enhancing financial performance overall.

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11 relationship between CSR and financial performance of a firm should be proven to exist and is indeed positive.

Hypothesis 1: The relationship between having a CSR policy and Financial Performance is positive.

As each country has their own set of ideas and culture, this can become an important factor in to the perceived and given CSR and to what extent unethical behaviour is punished by society. Therefore, this study looks at the effects culture has on the relationship between CSR and Financial Performance and Financial Performance. Previous studies suggest that national Culture has a strong affect on CSR (Ringov and Zollo, 2007), whereas other authors confirm that a country’s culture has a certain degree of influence over the CSR custom (Fernandez and Luna, 2007). The literature found that by using the dimensions of Hofstede in combination with the GLOBE dimensions, national culture has an effect on CSR per level of dimension (Waldman and Konrad, 2006). In the case of Ethics (ethical behaviour) one study has found that certain dimensions of GLOBE do have a moderating impact on the relation Ethics and Financial performance (Karaibrahimoglu and Cangarli, 2015). Leads to hypothesis 2;

Hypothesis 2: The positive relationship between CSR and Financial Performance is moderated by national Culture.

2.3.Contribution to the literature

The previous mentioned theories have found that there are relationships between the CSR and financial performance. However the current literature is not very conclusive when it comes towards this relationship. As some authors say that there is a positive relation, others found a clear negative relation.

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12 environment or institutional situation effects and leads to a better firm performance and thus firm value.

Thus, aside from revaluating the current relationship, also a closer look at the moderating implications. As culture tends to vary amongst countries, it would be interesting to see how the culture of a country enables a distinct differentiation amongst others. Therefore by using the Hofstede’s dimensions index in combination with the ESG database provided by ASSET4 from the Thomson Reuters (2013) to clearly show the effect of the different country characteristics on the Power distance index and the CSR based scores from the ESG database. This particular area, according to my research, has not been fully researched in this sort of setting. Hence, providing the insights that future research should test.

3. Methodology & Data section

This section gives an overview of the methods used for this research. Firstly, the dataset and sources are provided. Then the variables are defined and which methodological technique is used and what kind issues are known according to previous literature.

3.1.Dataset

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13 3.2.Variables

3.2.1. Dependent Variable

Tobin’s Q is used in by previous authors as the ratio in other to stand in for the company’s value. Making Tobin’s Q the indicator if an investment in a company pays off, or leads to firm value increase. This will be the main factor in order to determine, if having CSR increases or decreases the overall firm value.

Tobin’s Q = 𝑀𝑎𝑟𝑘𝑒𝑡𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛+𝑡𝑜𝑡𝑎𝑙𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝐶𝑜𝑚𝑚𝑜𝑛𝑠𝑡𝑜𝑐𝑘+𝑡𝑜𝑡𝑎𝑙𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (1)

3.2.2. Independent Variable

CSR score attracted from the ASSET 4 ESG database, provide an insight on three pillars; Environmental, Social and Governance. This weighted score determines the CSR score and thus the impact on the Tobin’s Q (company value).

3.2.3. Moderator Variable

Hofstede’s Culture dimensions score is used to determine the differences between countries to see if national culture enhances the relationship between CSR and company value. The score that portraits the culture scores, is the power distance index. Whereas, instead of making an average of the six scores or using them individually, focusing on the one dimension called the Power distance Index.

3.2.4. Control

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14 better image of having CSR. Hence, increasing ones’ standing overall, gaining more sales, leading to more willingness to invest into the company. Thus lowering the Cost of Capital, and give more room for R&D invests.

Firm age, older firms may feel more obliged to support their environment as older firms have been around longer. The newer firms might feel less of a connection with their environment as this bond grows over time. Meaning that older companies might have received the fruits from the society and are now more willing to give some of these benefits back. However firm age as a way to distinguished firms will not be used, as such a control variable would provide no clear insight into how it would affect the IV, DV and moderator. Therefore age is excluded from this study.

Firm size, is used as there might be a economies of scale effect between larger and smaller firms. The smaller firms have less of a total amount of recourses available to them, in comparison to the larger firms. Larger firms might have an easier time at allocating resources towards certain CSR projects, as it will relatively take up less resources. Moreover, there might be a relationship between size and firm value. The literature would suggest that firm value as the proxied by Tobin’s Q, would love the overall outcome.

Risk is used in order to access the amount of risk a firm is willing to take on and to what extend that affects the CSR policies. Hence, the managers within the firm decide to what extent they are willing to take on risk, and therefore decide to what extend their perceived level of risk is worth the benefits that might be gained for the investments in CSR. This has to do with the debt to asset ratio, seeing if more debt (ergo more risk) leads to more CSR and thus has to potential of having a higher firm value.

3.3. Measurements validities

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15 Table 1: Conceptual Model, depicting the relationship between CSR and Firm value. Whereas, Culture shows

the moderating affect it has on the relationship. Either enhancing the effect having CSR on the overall company value and to what extend this leads to differences amongst countries. Culture is in this case defined as the hofstede’s dimension; Power distance Index, society’s inequality. The *;**;*** indicate the significance level at the p<0.10, p<0.05 p<0.01.

3.4. Hypotheses 1 & 2

The most common way to analyze the hypotheses is by using OLS regression model, thus leading to the following formula;

𝐹𝑖𝑟𝑚𝑣𝑎𝑙𝑢𝑒𝑖𝑡 = 𝛼𝑖+ 𝛽1𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒𝐺𝑜𝑣𝑒𝑟𝑎𝑛𝑐𝑒(𝑖𝑡) + 𝛽2𝐹𝑖𝑟𝑚𝑅𝐷(𝑖𝑡) + 𝛽3𝐹𝑖𝑟𝑚𝑠𝑖𝑧𝑒(𝑖𝑡) +

𝛽4𝐿𝑒𝑣𝑒𝑙𝑜𝑓𝑅𝑖𝑠𝑘(𝑖𝑡) + 𝜀𝑖 (1)

Whereas the firm value in form of Tobin’s Q can be seen as firm i in Time t (Firm value(it)) for the function of CSR, CSR score, Firm R&D, Firm size and the level of Risk; plus the error term. For the second hypothesis, the PDI will be added as an extra variable to see to what extend it effects to outcome and to what extend it effects to relationship between firm value and corporate governance (CSR).

4. Results

According to previous research, the relationship between having positive CSR policies should lead to an increase in the firm’s ability to position them in a better competitive place. Hence, having a slightly bigger advantage over non CSR companies or companies that use other forms of being CSR that are less effective. However, these results will not hold for industries that are known for being ridded and conservative in their way of handling things (e.g. Steel, Chemistry).

Table 1Conceptual model depicting the relationship between CSR and Firm Value, and showing the moderator effects on the relationship between the IV and DV

CSR

Independent Variable Company value _Dependent variable Culture

Moderator variable

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16 4.4. Summary

Panel A of Table 2, Summary Statistics, shows the information on the main variables that are related to this research. The Dataset has been formed around five countries; three European countries and one North American country and one Asian country. The average Tobin’s Q of the firms is 1.35, a Corporate Governance Score of 66.03 and all the ESG scores from the ASSET4ESG database led to an average of 36.67. The firm’s risk taking level is measured by taking the average debt over the years 2010-2013 and dividing that by the average assets of the years 2010-2013. Giving an average Risk level of... The average size of the firms is 14678.56 and the respective investiture on R&D is 19%. Furthermore, from all the firms on average 86% is making a profit and the average culture dimension of the Power distance Index shows 42.20, with 40 being the United States.

Panel B of Table 2, Correlation Matrix, contains the correlations between the main variables. The correlation between corporate governance (CSR) and culture (PDI) is strongly negative and significant. The same holds for Culture (DPI) and Tobin’s Q, this will be further discussed if these correlations do indeed mean to influence the outcomes towards to presumed relationship. Whereas the correlation between Tobin’s Q and corporate governance is insignificant, the opposite of what the hypotheses expect. Moreover, as expected that there is a correlation between the overall ESG score and the corporate governance score, slightly correlated but still significant. Contrary to the previous literature the CSR variable does not seem to be correlated to any of the control variables.

Table 2. Summary Statistics

Panel A: Descriptive Statistics Mean Median SD Minimum Maximum

Tobin’s Q 1.35 1.03 1.29 -.83 21.86 Culture (PDI) 42.20 40 9.48 35 80 Risk (%) .25 .22 .21 .00 3.12 Size 14678.56 14606.75 1855.89 5591.50 21622.00 R&D (%) .19 .19 .93 .00 33.53 ESG 36.67 27.82 44.84 1.29 740.99 Corporate Governance (CSR) 66.03 71.03 21.45 2.05 96.07

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Panel B: Correlation Matrix (1) (2) (3) (4) (5) (6) (7)

Tobin’s Q 1 Culture (PDI) -.080*** (.001) 1 Risk .004 (.856) .006 (.800) 1 Size -.264*** (.000) .340*** (.000) .051** (.032) 1 R&D .045* (.068) -.013 (.589) -.039 (.104) -.195*** (.000) 1 ESG .125*** (.000) -.139*** (.000) -.017 (.488) .085*** (.001) -.027 (.272) 1 Corporate Governance (CSR) .032 (.299) -.484*** (.000) .000 (.998) .007 (.830) -.010 (.736) .068** (.027) 1

Table 2: Depicts the panel set of the variables shown in the descriptive statistics. The sample size is N = 1780 firms between the years 2010-2013. Whereas ***, **, *. Correlation is significant at the .01, .05, .10 levels.

4.5. CSR policies and Tobin’s Q

In order to find evidence for the first hypothesis, an OLS regression on the Corporate Governance as main variable on the dependent variable Tobin’s Q. The weak positive significantly coefficient on corporate governance, seen in Table 3, shows that corporate governance in the form of CSR has a positive effect on Tobin’s Q. The other control variables (except size) are found to be insignificant, this contradicts the literature. However the size coefficient is zero.

Table 3. OLS Regression (without PDI)

Variables Tobin’s Q

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18 (.022) Risk .000 (.956) Size .000*** (.000) R&D .153 (.658) ESG .000 (.894) Constant 4.206 (.000) Number of Firms 1780 R-squared .068

Table 3, shows an OLS regression between Corporate Governance (as a CSR) and Tobin’s Q. Whereas ***,**, *. Correlation is significant at the .01, .05, .10 levels.

4.6. CSR policies and Tobin’s Q, the moderating effects of Cultural Power Distance

For the second hypothesis, the same OLS regression test will be preformed. Only this time three times, once with all the five countries, once with the low PDI countries (Netherlands, Germany, United States) and lastly with high PDI countries (Belgium and China). In the table can be found that the coefficients of the (1) and (3) are more or less the same. Surprisingly, however for the low PDI countries, the coefficient has switched around. Thus making the relationship between CSR and the firm value a negative relation; nonetheless none of these coefficients are found to be significant. Only the R-square results differ quite a bit, varying from 5% to almost 20%.

Table 4. OLS Regression (Moderating effect of PDI)

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19 (.399) (.351) (.236) Risk .000 (.861) .000 (.966) .002 (.406) Size .000*** (.000) .000*** (.000) .000*** (.000) R&D .244 (.481) .088 (.815) .040 (.943) ESG .000 (.972) .000 (.861) .006 (.115) Constant 4.288 (.000) .248 (.864) -.005** (.996)

Power Distance Index -.009**

(.022) .100*** (.004) .035** (.018) Number of Firms 1780 1780 1780 R-squared .072 .050 .195

Table 4, shows an OLS regression between Corporate Governance (as a CSR) and Tobin’s Q, moderated for with the cultural Power Distance Index dimension. (1) Tobin’s Q (PDI) is where the PDI’s of the five countries is used. (2) Tobin’s Q (low PDI) is using the countries; Netherlands, Germany and the United States. The other two countries; Belgium and China are used for the high PDI (3). Whereas ***,**, *. Correlation is significant at the .01, .05, .10 levels.

5. Discussion

In the discussion the emphases will lie on examining the methods and then followed by the results of the study and how to interpreter them.

5.4. Methodology Analysis

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5.4.1. Hypothesis 1 OLS regression

The effect found in the results, shown in table 3, states a very weak positive relationship between the CSR (in this study substituted for the corporate governance score, by taking the questions related to the CSR policies of the ASSET4ESG) and the firm value (Tobin’s Q). Which might suggest that even though the R squared is also quite low, meaning that the included variables do not attribute strongly towards the outcome of the Tobin’s Q. According to Salzman et al., (2005) and other authors, this seems to be the case that there are a lot of other variables effect the firm’s aspects when it comes to the CSR firm value interplay. However, when reversing the variables, Tobin’s Q for Corporate Governance (CSR), the results suggest that the Tobin’s Q is positive significantly related to the Corporate Governance (CSR). Hence, meaning that there is a case of positive reverse causality relationship between the facts that CSR increase the firm’s value, or that higher Tobin’s Q leads to more investments into the CSR of a firm. This could mean that firms investment in times of prosper more strongly in the concept of being aware of CSR, as this could be more encouraged by their owners/investors (Stonski et al., 2014). Whereas vice versa shows no such strong relationship.

5.4.2. Hypothesis 2 OLS regression PDI moderator

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21 The findings of the hypotheses can both be accepted; however the implications following from these results might be providing less of a strong impact. The literature already stated that the relationship between CSR and firm value is either positive or negative or reversed, meaning that an overall weak positive effect does not mean that it could help firms predict their firm value. And use these results as a way of validating their investments into CSR. The second hypothesis does reaffirm that culture is an element that firms ought to consider. According to the results, the part of culture playing a stronger role is in the countries with a higher level of PDI. Hence, this might mean that countries where strong enforcement lies upon entrenched cultural value or ways of doing things that are deeply engraved, play a stronger part. The effects of CSR seem to be stronger received, due to the more top down society.

6. Conclusions

Returning to the research question, and seeing to what effect having a CSR policy does lead to the expected increase in firm value (performance).

Is having a CSR policy lead to an increase in firm value. Hence, enhancing financial performance overall.

The results show that the moderator as such, suggests that firms should consider the small cultural differences. Consequently, meaning that just any type of acting social responsible is no longer enough. Firms should consider the different impacts one particular policy has in different countries. Due to the fact that some countries already have a higher standard of what is accepted as the norm, whereas countries with a lower standard and with fewer institutions that already provide what in Europe is called the basics. There the effect would be seen as more influential and more generously received.

6.4. Limitations

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22 just one dimension, it can mean the intractably also the other dimensions will have a certain effect, even when that had not been studied here. Making a clear distinction between the dimensions as such would provide a better insight, on setting out a path for future research.

6.5. Managerial Implications

This study shows that having a CSR policy could lead to an increase in the overalls firm performance, which leads to the increase of real firm value. However, it is interesting for managers to know that if the company they are leading is active in a certain industry this is effect is either null or negative. Similarly if the managers realize that they are in a highly sensitive market they would be wise to implement several CSR policies. In addition to providing a service to the society and increasing one’s image. It could provide that one edge over the competitors to drive costumers towards their business instead of the others. Nonetheless, it is not quite clear when the results of having implemented a CSR will give the expected benefits. The short or medium term would not be one of them, as image and actualization of a CSR takes time, a future lagged study on the effects would be required. Moreover, the effects could also come in the form of not only competitive advantage but in fulfilling the newly required demand from the market or government.

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