Impact of Corporate Governance and Ethics on Firms Financial Performance - Research Paper Example

Impact of Corporate Governance and Ethics on Firm’s Financial Performance Introduction The concern of corporate governance and ethics has increased exponentially among researchers in the past decade. More than fifty percent of companies included in Fortune 1000 publish corporate social responsibility reports. Nowadays, most of the companies are engaged in efforts to integrate CSR into all their areas of business. Upsurge in the number of analysts, shareholders, regulators, labor unions, activities, community organizations, news media, and employees are probing companies to be accountable for CSR issues. Demand for transparency has increased and expectations are rising for companies to evaluate report and improve their environmental, social, and economic performance. Corporate Social Responsibility (CSR) does not have intricate definition. According to McWilliams and Siegel (2001) “actions that appear to further some social good, beyond the interest of the firm and that which is required by law” (McWilliams and Siegel, 2001, p. 117). CSR is more than compliance with the law. Frooman (1997) exemplifies CSR as “An action by a firm, which the firm chooses to take, that substantially affects an identifiable social stakeholder’s welfare” (Frooman, 1997 p.227). In the light of these definitions, CSR can be viewed as a comprehensive set of rules, practices, programs, and policies that are incorporated into supply chain, business operations, and decision-making processes of the company. CSR usually include community investment, business ethics, governance, environmental concerns, human rights, workplace, as well as the market place. When it comes to Business performance, this is an area where companies pay great deal of attention since it provides integral information about the success and position of the company as well as development and future standpoint. All business operations, in one way or other, revolve around the targeted goal of an organization that is contributing to the success of the business. Business performance provides a neutral description of the efficiency and effectiveness of the company’s action. It can be characterized with attributes such as poor or well. Business performance is considered as vital area of interest for the top management of firm. Several elements contribute to the success or failure of the company. CSR is one such variable that contributes to the well-being, reputation, and financial performance of the company. This paper seeks to investigate the impact of CSR practices on firm’s performance. A critical analysis of prior literature conducted in the same field will be provided in order to evaluate the causal relationship between the two variables. Impact of Corporate Social Responsibility (CSR) on Financial Performance Ways in which companies implement practices of corporate social responsibility differs from one another. These differences are based on factors such as respective industry involved, size of company, demands of stakeholders, business culture of the firm, and historical progress of company while dealing with CSR. Numbers of studies have been conducted in order to test the relationship between ethical and social performance of corporation and its impact on financial performance. Erhemjamts, Li, and Venkateswaran, (2012) conducted a study to investigate the determinants of CSR and its implications on the organizational strategy, investment policy, and performance of the business. Erhemjamts, Li, and Venkateswaran, (2012) found that firms having higher R&D intensity, better performance and financial health are more likely to engage in Corporate Social Responsibilities (CSR) activities, whereas riskers firms are less likely to involve in such activities (Erhemjamts, Li, and Venkateswaran, 2012). Stanwick, and Stanwick, (1998) conducted a study to investigate the relationship between corporate social responsibility of a business with financial performance and two more variables including environmental performance of business and size of organization. After conducting empirical testing of data taken for the period of 1987-1993, it was found the corporate social responsibility performance of an organization is affected by the size of the organization as well as the profitability level of the company. All three variables showed positive relationship with corporate social performance of the company (Stanwick, and Stanwick, 1998). Numbers of other studies have tested the linkage between corporation’s ethical and social performance of the company and its financial performance. Study of Verschoor, (1998) demonstrated a relationship between financial performance of the overall organization and its impact on ethics and corporate governance aspects of the company. The results of the study revealed that 26.8% of the 500 largest public corporations in U.S., in their annual report, emphasize on complying with their ethical code of conduct or commit to comply with ethical behavior towards all of their stakeholders. The financial performance of these firms remained higher than those who do not do. Verschoor, (1998) concluded that these findings should encourage companies to utilize the rules and regulations of Social and Ethical Accounting, Auditing and Reporting (SEAAR) (Verschoor, 1998). Corporate governance and corporate social responsibility has deep linkages with employees as well. Too often, employees evaluate the CSR performance of the company to determine of their personal values contradicts with that of company were they work. There are many instances where employees were pressurized by their supervisors to overlook the moral or written laws in order to attain greater amounts of profits. These malpractices at workplace create a culture of fear and hurt the loyalty, trust, and commitment of employees to the company. Companies that work on improving labor practices and working conditions also undergo reduced error rates and increased productivity. Regular surveillance in the production facilities throughout the world ensures better working conditions for employees as well as earnings. These practices might be costly but improved quality of products and improved workers’ productivity leads to positive cash flows that can cover the related costs. Therefore, in essence, companies may actually be benefited by the implementation of corporate social responsibility in regards to productivity and employee morale. Critical Analysis Prior mentioned discussion reveals that though it is relatively straightforward to label the above-mentioned benefits as socially responsible for companies, the biggest obstacle it that it is a difficult task to measure and quantify these benefits. Since CSR is incorporated into the practices of business processes, by definition it is quite complex to measure the effectiveness individually. Ideally, it would be feasible to keep all other factors constant and measure the volatility of cash flows and financial performance of the company before and after employing the principles of CSR. By and large, empirical techniques are utilized to determine the relationship between company’s financial performance and socially responsible conduct. The study of Erhemjamts, Li, and Venkateswaran, (2012) mentioned above stated that majority of those companies employ CSR practices who enjoy rich revenue streams while firms having negative cash flows remain reluctant in investing in CSR policies. This study draws a line between good performing firms and bad performing firms with respect to CSR. The reason is the underlying factor of marketing tactic. Bilson, (2013) stated that CSR is widely used as a Marketing Ploy. Firms, which are already in adverse position, cannot be able to invest in marketing whereas this opportunity can be exploited by firms yielding higher returns. Investing more in marketing tactic such as CSR allows such firms to get more streams of revenues. If CSR would be impartial for both, good performing firms and bad performing firms, then the practices of implementing CSR would be same in all firms. Companies engaged in socially irresponsible acts are given out CSR awards and socially irresponsible behavior significantly engulfs few socially responsible acts. The case of British American Tobacco was attacked by critics after its annual social report won United Nations Environment Program award. Winning such award might be a tool to repel criticism against socially irresponsible viewpoint of selling such products that cause too much damage to human health (Bilson, 2013). Study of Stanwick, and Stanwick, (1998) is also substantiated by similar agenda. It is an exasperating fact that despite of being impartial and unbiased element, CSR is being successfully applied only in profitable firms. This phenomenon validates that CSR has deep linkages with financial profitability of the firm. Again, the study of Verschoor, (1998) conforms that 26% of high performing firms assert complying with CSR policies. This agenda calls for future research within this area in order to identify whether the financial performance is actually being improved by applying CSR or firms are using CSR as a marketing ploy in order to generate higher returns on shareholding. Either of the two statements can be correct, therefore, profound study is required within this realm. A hint of such situation had been given by Friedman in 1970. Friedman, (1970) wrote in his article, which was published in New York Times Magazine that, “the one and only social responsibility of business, is to increase profits for shareholders.” The fundamental goal of management is to seek value for its shareholders. It then calls for a question, that purpose does CSR serve in today’s world. There are some criticisms thrown at CSR, which include misleading as marketing ploy, lack of regulation and abuse of power by companies. Profitability of companies and cost of implementing CSR activities is another point that comes into mind after reviewing the prior mentioned studies. When companies intend to conduct a CSR campaign, a proportion of shareholder’s money is used in giving away the charity or meeting the costs of CSR campaign. It is only possible if the company sees potential profits in it. The objective of companies is usually to improve their reputation by associating themselves with a cause. It may be in the form of countering the claims of pressure groups, or exploiting frugal vehicles for advertisement, but there always remain a financial motive due to which, the company benefits more than the charity. Another area resulting in criticism of CSR is PR department of companies. PR departments of any company are considered as a surveillance team. It monitors the relationships of the corporation with its external and internal environment. It foresees difficult issues and contributes to policies for addressing the problematic issue before they come to damage the company. CSR is considered as a tool to make better public relations with the outside world. Better CSR means better reputation and better reputation means more customers thereby, more profits. When it comes to employees, CSR has substantial impact on the morale of employees. As mentioned above, if supervisors aim to enhance profits no matter what it takes, then it reduces employees’ morale and productivity. Employees fell that if the malpractice can be conducted as opposed to external stakeholders (community, environment, customers etc.) then it can also be conducted against internal stakeholders (employees), due to which a sense of exasperation might arise among employees. Conclusion There are number of practices that can be used either ways, to provide benefits to organization, to community, or to both. Firms never compromise on any benefit. Since the primary objective of the business is to seek profit maximization therefore, they see every potential opportunity from the spectacles of profit maximization and own benefits. CSR is one such practice. This paper attempted to find whether CSR helps firms in increasing the profitability or not. After reviewing relevant literature and research in this regard, it can be concluded that certainly, CSR is used as a ‘tool’ for increasing the profitability of business. If the core purpose of business is to contribute to environment, then it would not be called as a business, it will then become non-profit organization. For corporations, the primary purpose of developing CSR campaigns and implementing CSR practices is to increase profitability and brand reputation. It is substantiated by studies mentioned in this paper. Majority of the studies revealed that CSR helps in improving the profitability of companies. However, further research is required in order to reduce the gap between whether CSR impartially improves business performance or it is meant to implement in a way that it will surely lead to enhancement of rich cash flows. Future research is required to highlight that if CSR literally improves business performance then why only large multinational seem to be engaged in CSR practices and not SMEs. These questions need to be brought under limelight by future research in order to provide an impartial and unbiased view of CSR. Works Cited Bilson, Jo. “Criticisms of Corporate Social Responsibility”. 18 November 2013. Web. 21 November 2013. Curtis C. Verschoor. “A Study of The Link Between a Corporation's Financial Performance and Its Commitment to Ethics” Journal of Business Ethics, 17.13 (1998): 1509-1516. Print. Donald Lange and Nathan T. Washburn. “Understanding Attributions of Corporate Social Irresponsibility” ACAD MANAGE REV, 37.2(2012): 300-326. Friedman, M. “The social responsibility of business is to increase its profits.” New York Times Magazine, (1970): 32-33, 122, 124, 126. Print. Frooman, Jeff. “Socially Irresponsible and Illegal Behavior and Shareholder Wealth: A Meta-Analysis of Event Studies” Business Society, 36 .3(1997): 221-249. Print. McWilliams, A., and D. Siegel. “Corporate social responsibility and financial performance: Correlation or misspecification?” Strategic Management Journal, 21.5(2000): 603-609. Print. Peter A. Stanwick, and Sarah D. Stanwick. “The Relationship Between Corporate Social Performance, and Organizational Size, Financial Performance, and Environmental Performance: An Empirical Examination” Journal of Business Ethics, 17.2,( 1998): 195-204. Print. Otgontsetseg Erhemjamts, Qian Li, Anand Venkateswaran. “Corporate Social Responsibility and Its Impact on Firms’ Investment Policy, Organizational Strategy, and Performance” Journal of Business Ethics, (2008). Web. 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