Corporate Social Responsibility as a Strategy Tool to Increase Shareholder Value - Research Paper Example

A critical analysis of Corporate Social Responsibility as a strategy tool to increase shareholder value Introduction The Corporate social responsibility (CSR) grew exponentially over the last decades in importance and significance. Its idea is that business enterprises owe the society some responsibilities besides that of maximizing their shareholders’ value. An increasing number of shareholders, regulators, analysts, labour unions, activists, community organisations, news media and employees are asking business enterprises to be accountable to an ever-dynamic set of CSR issues1The demand for transparency and growing expectations have increased the need for companies to measure, report and continuously enhance their social, environmental and economic performance. The CSR is defined as actions that corporations engage in to further some social good, and which are beyond the firms’ interest and are legally required. It is also viewed as achieving commercial success through means that honour ethical values and people, communities, as well as the natural environment. In broader terms, the CSR denotes a comprehensive set of policies, programs and practices that are integrated into the business strategies and decision making processes and include issues related to governance, human rights, environmental concerns, community investment, business ethics, the marketplace and the workplace2. This concept receives different views from its supporters and detractors. Broadly, those against it, use the classical economic arguments as put by Milton Friedman; that the management should serve to maximise the shareholders profits. This is different from the CSR practices that serve many stakeholders. The second objection is that business managers are not meant to handle social activities as they lack social skills and should handle financial and operational matters. The third objection is that the engagement in social activities dilutes the business’s primary purpose. On the other hand, the proponents of CSR argue that CSR practices are useful for a business that would want to function in the future since it makes it create a healthy climate. The next support for CSR is that the government regulation is reduced, and the companies have the necessary and adequate resources to fulfil society’s expectations of it. Another argument for CSR is that being proactive is better than being reactive because being proactive helps an organisation to plan and is less costly than reacting to social problems after they have occurred. Case for Corporate Social responsibility and shareholders' value creation The concept of social responsibility and sustainability have become of great interest to businesses and investors. However, despite this increase, 3states that there are still a number of companies that are yet to integrate this concept into their business models, core mission, strategy, and products or services because they experience challenges on how to communicate the nature of CSR initiatives and their impact on the concerned stakeholders, including the sceptical customers, employees, investors and environmental activists. At the centre of this matter, there exists a conflict between the CSR initiatives and the management because of the shareholders’ value. Therefore, to understand the conflict between the CSR activities and the shareholders’ value, one need to look at the executives involved in terms of gender, education level and the study area. The CEOs and the CFOs are always held accountable for the shareholder wealth creation. According to4, the leadership of TD Direct Investing (Europe) Limited has used the CSR to strengthen itself, leading to enhanced shareholders’ value over the long run. Its leadership makes cautious decisions based on the feedback from its research on the locals on how best to give back to them. The other challenge is in the measurement and reporting due to differing interpretation of terms, cultural impacts, varying needs and organizational imperatives. Whereas shareholders’ value is measured in terms of dollars, the social capital and environmental health has no unit of measure. The accounting rules and standards have, however, simplified the matter because they have prescribed the nature of the financial information that companies must disclose, as well as how to disclose it and with some comparable requirements. The measurement of the market capitalization, revenue and profits are universally understood and clear. From a recent study5, there exists no goal comparable to increasing the value of shareholders because CSR comprises of a full gamut of corporate decisions and activities. In essence, CSR involves producing quality products, paying a living wage and not market wages, corporate philanthropy, obeying environmental laws, campaigns to reduce employee obesity, not operating in economies with poor records of human rights, reducing carbon footprint, and funding advertising campaigns to end racism among others. Another challenge in the measurement of CSR and sustainability is the lack of consistency in its reporting requirement. These scenarios make reconciliation of shareholders’ value and the CSR activities to be difficult. If well and apparently connected to the financial performance, the CSR activities will significantly enhance the shareholder value creation and maintenance. The value of the shareholders can be viewed from the share price of a company, which in the basic finance theory, represents the present value of future cash flows.6 If CSR practices will lead to increased future cash flows or assist in reducing their risks, then shareholders’ value will have been created. Therefore, through the reduction of risks, costs and an increase in revenues, CSR activities lead to improved financial performance. In the case of cost reduction, profits are increased. Companies engaging in the CSR gain this by prioritising to purchase raw material and goods from the local producers as opposed to buying from other distributors. Through local purchases, businesses can acquire goods at cheaper prices. Also, an entity can reduce its costs by engaging in CSR such as using cheaper and cleaner alternative energy sources like the wind energy. Another way that companies reduce costs in a way that is environmentally friendly is through packaging, where its design should not use more materials. This would in turn cut on the shipping and warehousing costs. Companies with strong CSR commitment can attract and retain the right fit that will work towards the realisation of its objective and lead to the realisation of returns, thereby add to shareholders value. In addition, these employees would feel satisfied, leading to reduced turnover and savings on recruitment and training costs. In regard to the revenue growth, CSR is a good driver. Since revenues are grown by charging higher prices or selling more products, an organisation will realise this since consumers will not hesitate to pay a premium for socially cautious products. For instance, organic products justify their higher prices. More products can be sold if they are sourced in an environmental friendly way or where they offer environmental benefits in use. Therefore, shareholders’ value is created by ensuring that the premium charged is reasonable to cover all costs involved in the CSR, thereby maintaining profitability. A socially responsible company can avoid negative social and environmental externalities. The CSR activities are believed to help an entity in reducing risks such as the corporate governance issues, social issues and environmental issues even where new investment is required. An entity can avoid some regulations, fines and taxes, which when imposed, would lead to reduced cash flows and consequently reduced shareholders’ value. Where an entity’s principle in its CSR activities is more transparent, bribery and corruption risks are minimal. In addition, it may develop stringent and costly quality and environmental controls, but which save it the risks of having to recall defective products, thereby tarnishing its reputation and affecting customers’ loyalty negatively. The trick environmental controls make it avoid heavy fines for excessive pollution. By saving these cash outflows through CSR practices, the shareholders’ value is maximised. Another approach through which a company uses CSR activities to reduce risk is by engaging in activities that promote and support the community and its reputation, thereby preventing it from reputation related risks.7 Socially responsible companies usually develop an enhanced brand image and reputation, which will always draw customers to purchase, leading to increased sales revenues. Related to cost saving, an entity will be saved the advertisement costs, leading to increased profits for shareholders. In his article, 8 states that the voluntary CSR disclosures add to shareholders’ value. The movement towards making the nexus between increased shareholder value and good corporate citizenship has been enhanced by information availability and its intensity. When companies reduce the information asymmetry concerning the voluntary disclosure of CSR activities, its cost of capital is lowered, which directly affect and impact shareholders' value. Customers frequently require the social responsibilities, while employees desire it since a company practising it shows that it is committed to extemporary corporate citizenship9. This has been evidenced by employees of the TD Direct Investing (Europe) Limited, who have demonstrated higher employee engagement as well as performance, which ultimately benefit shareholders. Companies that improve labour practices and working conditions experience increased productivity and reduced errors. According to10, even though the improved working conditions might be costly, there is value creation from the increased productivity and product quality, which generate positive cash flows. This point shows that entities that engage into CSR through their employees, also create value for their shareholders through improved productivity. Through voluntary disclosure about the CSR, an entity can address issues relating to the off-balance sheet liabilities and assets. Through these disclosures, companies reduce the off-balance sheet liabilities like the future climate change costs, which flow right into the equity. In addition, when the off-balance sheet assets are increased like the brand intangibles, they also flow into equity. Therefore, through these disclosures, the CSR adds to the shareholder value. Another way through which the voluntary disclosure of the CSR activities creates value for the shareholders lies with the fact that the management only disclose information that carry more benefits than costs. When the financial statement information users read them, they interpret them in the proper way. However, a risk may arise where an appropriate decision is not made on exactly what to disclose. Additionally, the frequency with which a company makes a voluntary disclosure about its CSR affects its value. Through more CSR and environmental disclosures, the value of the stock improves. Conflict between the CSR and shareholder value creation The opposers of companies’ participation in corporate social responsibility practice, base their argument against Freeman (1984)’s word of stakeholders. This term refers to groups, which include employees, government, shareholders and investors, suppliers, customers, publics and management, all which can either make an entity to succeed or fail, based on their stake in the decision making. Therefore, even though the CSR may add value to stakeholders, it might not necessarily be to shareholders. In essence, the managers’ job is to serve their principal shareholders. They will achieve this by maximizing shareholder wealth through increased share price and dividend distribution, and increasing profits. Therefore, their enormous expenditures in social activities reduce the profits that should have been distributed to shareholders as dividends. In itself, this move leads to a decrease in shareholders' value. The detractors of CSR also argue that increased expenditure could be consistent with the firm's value maximization goal to the extent that it changes shareholders' preferences. However, a conflict of interest arises where managers seek to over-invest in CSR in order to benefit themselves by improving their reputations as good global citizens. Such activities are at the expense of shareholders and the corporation in general. Therefore, socially responsible actions that managers take harm shareholders value. According to 11, the environmental CSR may have adverse effects on the shareholders’ value through a drastic decrease in the stock price. For instance, in 2010, the shareholders of British Petroleum had their value lost due to the fall in their stock prices. The fall in price was $28.9 from $59.5 as a result of an oil spill incident that contaminated a large marine environment area. Being socially responsible, the British Petroleum set aside $20 billion for CSR activities in the form of economic claims, as well as restoration work. The oil spill also made the company suffer a loss of approximately 4.9 million barrels. The British Petroleum further suffered a financial loss of up to $14 billion in its bid to clean up. Another similar incident, though not very severe was the Exxon Valdez spill, which led to the death of around 35,000 seabirds. In addition, native wildlife, as well as the natural environment is yet to recover since there are instances when the oil pool directly below the shoreline's surface. This spill also led to a loss of shareholder value when the stock's price fell from $44.5 to $41.75. The shareholders’ value is also lost where the environmental CSR comes from outside the firm such as the pressure from environmental regulation, customers’ sensitivity to environment-related issues or media attention to the environment to becoming green12. The more becoming green is institutionalised to be a norm; any negative news will negatively affect the stock’s value and thereby destroy shareholder wealth. Similarly, shareholders might ignore the announcement of eco-friendly initiatives of going green where it is a norm. Findings by 13, determined that companies that continued to undertake eco-friendly initiatives had their stock prices decrease over time. This could be based on the marginal returns concept. On the other hand, the firms, which had eco-harmful behaviour had their stock prices become more negative. Conclusion In the contemporary business arena, companies in need of surviving cannot afford to ignore the concept of CSR. Other than serving just shareholders, managers have integrated other stakeholders through social and environmental concerns. This paper sought to establish the extent to which CSR affects the shareholders’ value. The findings I this paper have shown that CSR leads to value creation, as well as destruction. CSR creates value through its voluntary disclosure by entities, enhancing cost reduction, improving revenues, and reducing risks. On the other hand, shareholder value is destroyed when the prophets meant for them are channelled to the CSR activities, and where there is an external pressure on the firm in regard to environmental issues. Bibliography Bliss, Richard T. Shareholder Value and CSR: Friends or Foes? February 9, 2015. http://ww2.cfo.com/risk-management/2015/02/shareholder-value-csr-friends-foes/ (accessed April 5, 2015). Flammer, Caroline. Corporate Social Responsibility and Stock Prices:The Environmental Awareness of Shareholders. Research paper, Cambridge: MIT Sloan School of Management, 2012. Griffin, Paul. The Role of Voluntary Corporate Social Responsibility Disclosures in Increasing Shareholder Value. May 1, 2013. http://gsm.ucdavis.edu/blog-feature/role-voluntary-corporate-social-responsibility-disclosures-increasing-shareholder-value (accessed May 5, 2015). Matten, Dirk, and Jeremy Moon. " ‘Implicit’ and ‘Explicit’ CSR: A Conceptual Framework for a Comparative Understanding of Corporate Social Responsibility." Academy of Management Review, 33 (2), 2008: 404-424. Nolop, Bruce. "Four Ways Corporate Social Responsibility Helps Shareholders." The Wall Street Journal, October 2014: http://blogs.wsj.com/experts/2014/10/22/four-ways-corporate-social-responsibility-helps-shareholders/. Reich, Robert B. The Case against Corporate Social Responsibility. Working Paper, No. GSPP08-003, Berkeley, California: Goldman School of Public Policy, 2008. TD Direct Investing (Europe) Limited. How Corporate Social Responsibility enhances Shareholders value. 2015. https://www.tddirectinvesting.co.uk/about-us/corporate-social-responsibility/how-our-csr-enhances-shareholder-value/ (accessed May 5, 2015). Tsoutsoura, Margarita. Corporate Social Responsibility and Financial Performance. Research paper, Berkeley, California: the University of California at Berkeley, 2004. Read More