Corporate Social Responsibility and Stock Market Performance - Essay Example

Corporate social responsibility as an area of scientific inquiry has received little attention in the popular and academic press during the last decade. Efforts to investigate social responsibility and its relationship to corporate performance have been frustrated by a lack of adequate operationalizations and measures of social responsibility. Regardless of the reasons for this inattention to the issues of corporate responsibility, the tide appears to be turning. Recently, TIAA-CREF, the largest institutional trader in the country, initiated an optional fund which invests exclusively in firms that are deemed socially responsible. Such actions suggest that corporations will increasingly be held accountable for activity of concern to multiple stakeholder groups. As a result there will likely be a renewed interest in identifying the dimensions and consequences of corporate social responsibilities. Cameron has suggested that multiple perspectives of organizational effectiveness exist and that "consensus regarding the best, or sufficient, set of indicators of effectiveness is impossible to obtain" (1986: 541). The same arguments can be made regarding social performance as a specific aspect of overall corporate performance. Social responsibility continues to be a poorly defined as well as difficult to measure concept. There appears to be no real agreement as to what constitutes social performance. What is indicated, however, is the need to apply measures which address multiple criteria of social performance. This study attempts to specify the underlying dimensions of a multiple measure of corporate social responsibility and investigate the relationship between corporate social performance and multiple measures of financial performance. For the purposes of this study, corporate social performance represents a measure of a firm's attentiveness to multiple stakeholder groups. We employ previously unavailable objective measures of social responsibility which overcome some of the methodological problems which have stalled prior research efforts, and propose a working model of social responsibility and its relationship to financial performance. Historically, the responsibility of firms was defined purely in economic terms. For example, Friedman (1990) considered maximization of shareholder wealth as the sole objective and responsibility of the well managed firm. This perspective generally cast corporate activity as a zero-sum game. Whatever resources were expended in the interests of social responsibility came at the expense of shareholders (Wartick and Cochran, 1985). The interests of shareholders and other stakeholders were defined implicitly as conflicting and mutually exclusive. Many criticisms have been leveled at this perspective and it seems safe to conclude that corporations are no longer viewed, even theoretically, as solely economic institutions (Sharfman, 1992). At a very minimum, there appears to be a consensus that firms serve multiple constituencies and stakeholder groups whose memberships are overlapping and whose interests are interdependent (Aram, 1989; Freeman, 1984; Nash, 1990). An understanding of such relationships and an attendant concern for the interests of all stakeholder groups may force firms to act in a socially responsible way regardless of their motivation (Sen, 1993). Out of these perspectives come varied hypotheses regarding the relationship between social responsibility and corporate economic performance. When corporations are viewed as economic institutions, a negative relationship between social responsibility and profitability is assumed (Ullmann, 1985). The opposing hypothesis suggests a positive relationship between social responsibility and performance. Proponents of this perspective argue that socially concerned management is likely to also possess the skills necessary to achieve superior financial performance (Alexander and Buchholz, 1978; Metzger et al., 1993). A final perspective hypothesizes an inverted U-shaped correlation between social and economic performance. To an optimal level, social and economic performance are positively related. Beyond an optimal level, however, social performance and the commensurate resource allocations negatively affect economic performance (Ullmann, 1985). The findings reported by the large body of work investigating the relationship between social and economic performance are inconsistent and evidence exists to support each of the hypothesized relationships. Vance (1975) has applied Moskowitz's (1972) and the Business and Society Review's reputational surveys and has found a negative relationship between social performance and stock price changes. The majority of other studies have not supported these findings. In fact Moskowitz's (1972) own study, over a much shorter 6 months time frame, reveals a positive correlation between social performance and stock price. Alexander and Buchholz (1978) also fail to support Vance's findings regarding the Business and Society Review's measures. Their finds do not indicate any correlation between social performance and stock returns. Other work employing Moskowitz's measures indicates only a weak positive relationship between social reputation and economic performance when controlling for the age of the firm's assets (Cochran and Wood, 1984). Sturdivant and Ginter's (1977) results show that executives of firms classifed as "best" by Moskowitz exhibit more liberal social attitudes and that these attitudes are positively associated with both corporate social and economic performance. Reputational indexes have been the most widely used measures of social responsibility. As previously noted, the Moskowitz (1972) reputational measure has been used in numerous studies (Moskowitz, 1972; Vance, 1975; Sturdivant and Ginter, 1977; Cochran and Wood, 1984). The primary problem associated with this measure is its undetermined reliability. Moskowitz provides very little information regarding his assessment methods. As a result, the derivation should be conservatively viewed as ad hoe with all the attendant caveats usually applied to this relatively subjective measurement. The concerns also apply to the use of the Business and Society Review's measures also used by Vance (1975) and Alexander and Buchholz (1978). An equally prevalent reputational measure of social responsibility has been provided by the Council on Economic Priorities (CEP) (1972). The CEP reported the pollution control performance of 24 firms in the paper and pulp industry. This measure has been subsequently used as a proxy for social responsibility in numerous studies (Bragdon and Martin, 1972; Bowman and Haire, 1975; Folger and Nutt, 1975; Chen and Metcalf, 1980; Spicer, 1978a, 1978b). This measure is inadequate for several reasons. First, it assumes that social responsibility is a unidimensional concept which can be captured in an investigation of the firm's pollution control record. This assumption in turn requires assuming the commonality of interests of all stakeholder groups. The validity of the assumption is questionable in light of the sheer number of affected stakeholder groups. Second, the pollution control measure has only been provided for a single industry. This severely limits the external validity of the findings since it is probably inappropriate to assume that the dimensions of social responsibility are similar across industries. The interests of stakeholder groups and their ability to affect corporate activities are also likely to vary with respect to the nature of the industry, be it upstream manufacturing, consumer products or service oriented. McGuire et al. (1988) have more recently employed the Fortune reputational measure which is comprised of executive rankings of firm performance within certain industries. The largest 10 firms within each industry are rated on eight dimensions: financial soundness, long-term investment value, use of corporate as. sets, quality of management, innovativeness, quality of products and services, ability to hire and maintain qualified personnel, and community and environmental responsibility. It is not clear whether McGuire et al. (1988) used only the social responsibility measure or an aggregate measure of all eight dimensions. They cite previous work indicating a strong correlation between the Fortune rankings and financial performance as evidence of the validity of the measures. In fact, the opposite is likely true. Other work (Slater and Brown, 1988) has shown a strong "halo effect" within the Fortune rankings. The results of principal component analysis Slater and Brown (1988) report indicates that a single component explains 83% of the total variance and that all attributes loaded at least 8 on the single factor. They suggest that financial Performance is most likely the source of the halo since available public information is generally limited to financial results. This may explain McGuire et al.'s (1988) findings that past performance is more strongly related to social responsibility than future performance. At a minimum, the evidence casts suspicion on the use of the Fortune reputational survey as a valid measure of social responsibility. A counterattack against the corporate 'social-responsibility' movement is taking shape. Like a political debate in which a no-show candidate is represented by an empty chair, the push for "corporate responsibility" has been notable for its lack of opponents. On issues ranging from pollution to pornography, politicians and activists of diverse ideological stripes have pressed the case that companies should balance profits against the broader social good. Even corporate America has joined the crusade -- and not just companies such as Ben & Jerry's, well-known for promoting environmental and other causes. In the spring, President Clinton met with about 100 business executives to discuss social responsibility and unveil a new "corporate citizenship" award named after the late Commerce Secretary Ron Brown. Moreover, reinforcing good corporate behavior with legislation is a priority for some policymakers. Sen. Jeff Bingaman, a New Mexico Democrat, seeks to create a category of "A-Corporations" that would receive tax and regulatory rewards for meeting approved standards regarding employee health insurance and other matters. Labor Secretary Robert Reich and congressional Democratic leaders endorse this idea. Lately, however, vocal criticism of the movement has emerged from a growing circle of conservative researchers and writers. Objections once buried in academic papers -- or whispered behind closed doors in executive suites -- are gaining prominence in books, speeches and op-ed pieces aimed at a broader audience. "I think the duty of the corporate manager is to stay within the law and deliver profits to shareholders -- and that's pretty much it," says John M. Hood, president of the North Carolina-based John Locke Foundation and author of The Heroic Enterprise: Business and the Common Good, a book that has become a rallying cry for such criticism. According to Hood, society benefits from a clear division of labor between the private sector and governmental or nonprofit institutions, a distinction the corporate-responsibility movement seeks to blur. Corporations serve the public by finding better and cheaper ways to provide goods and services; plus, they train employees, conserve resources and develop more flexible work arrangements -- precisely because they are focused on profits. For Hood and other "antiresponsibility" mavens, true corporate misbehavior consists of using force or fraud -- or lobbying for government subsidies or protection against competition. "It is the height of irresponsibility and in no way serves the long-term interests of corporate shareholders for corporations to ignore free-enterprise principles when it suits them," says Hood. Indeed, such self-serving behavior may explain corporate enthusiasm for current notions of social responsibility; big companies may support the A-Corporations proposal, for example, because its standards are unaffordable to their smaller competitors. "If there is a subset of corporations that think they will benefit from such a system, they will not be shy about advocating it," says Jonathan Adler, environmental-studies director at the Competitive Enterprise Institute and author of Environmentalism at the Crossroads. Critics of the corporate-responsibility movement also turn a skeptical eye toward much corporate philanthropy, noting that such donations often go to groups hostile to free enterprise. "A lot of corporations do give money to environmental groups," says Adler, "sometimes because they believe it helps them from a public-relations standpoint, and sometimes because there's someone at the company who really believes it's the right thing to do, even if the environmental group in question is advocating policies that would put the corporation out of business." Issues regarding the choice of performance measures are slightly more straightforward. Choices are limited to relatively common financial accounting: or market based measures. There are advantages and disadvantages associated with each. Accounting based measures are more easily manipulated and are historical rather than reflective of performance expectations. In addition they do not allow for the easy incorporation of risk considerations and economic and market factors. On the other hand, accounting based measures are equally relevant for most stakeholder groups. Market based measures have limited relevance for stakeholder groups outside the investment community. These measures are, however, reflective of expectation and incorporate risk and market and economic factors. The use of accounting and market based measures of financial performance are not mutually exclusive. In light of the fact that inconsistent performance valuations may have contributed to the consistent results previously reported, this study includes both accounting and market based measures of performance, More recent studies have taken this approach (McGuire et al. 1985). The number of benefits from introducing corporate social responsibilities at companies is enormous. In many case the benefits are difficult to measure and can crop the results much later in the life cycle of the company. I have tried to summarize and provide the benefits below: Increased profit Several academic studies have shown a direct correlation between socially responsible business A 1997 DePaul University study found that companies with a defined corporate commitment to ethical principles do better financially (based on annual sales/revenues) than companies that don't. An 11-year Harvard University study found that "stakeholder-balanced" companies showed four times the growth rate and eight times the employment growth when compared to companies that are shareholder-only focused. Access to capital Companies that are committed to CSR often have access to capital that would not otherwise be available, due to the increase in Socially Responsible Investment (SRI). A 2001 study showed that 12% of total investment in the USA was of a socially responsible nature. Likewise, there are were 313 green, social and ethical funds operating in Europe in June 2003, showing a 12% increase in the last eighteen months. Reduced operating costs/increased operational efficiency Contrary to widely-held opinion, improved environmental management systems do not automatically result in greater cost. Over time, they improve operational efficiency by reducing waste production and water usage, increasing energy efficiency and in some cases, selling recycled materials. There re also company specific ways of reducing operating costs e.g. Dow Chemical Co has set themselves a target of reducing production of 26 toxic chemicals which will save them 5.4 million Euros per year - 2.3 million Euros more than was spent on the initial investment to do so. By considering impacts, a company's actions can result in environmental, social and economic benefits. Construction firms, for example, reusing products on-site: reduces landfill, reduces community and noise disturbance of additional trucks bringing material to the site, reduces the environmental impact of damage caused by heavy truck wheels and reduces cost for the client of buying new material. Increased sales and customer loyalty Research has shown that consumers not only want good and safe products, but they also want to know that what they buy was produced in a socially and environmentally responsible way. A CSR Europe/MORI study in 2000 showed that 70% of European consumers say that a company's commitment to csr is important when buying a product and 1 in 5 would be willing to pay more for products that are socially and invironmentally responsible. Conversely, 1 in 6 shoppers frequently boycott (or buy) products because of the manufacturer's reputation. Likewise, CSR can lead to new markets and product lines. As Dr Richard Steckel and Robin Simons pointed out in their book 'Doing Best by Doing Good' "F. Schumacher & Co produces high quality fabrics, wall coverings and carpets which are sold through interior designers to residential and commercial customers. IN 1984, when Schumacher wanted a new product line, the company went to the National Trust for Historic Preservation. Increased ability to attract and retain employees A company's dedication to csr can help to attract and retain employees. People want to work for a company that is in accordance with their own values and beliefs. Employees are not just worried about promotion and salary any more. Since Novo Nordisk launched their Values in Action programme which aligns their business objectives with sustainable development, they have seen a 5% drop in staff turnover. "78% of employees would rather work for an ethical and reputable company than receive a higher salary." (The Cherenson Group, www.csreurope.org) Reducing risk, and increased risk management The more a company is committed to CSR, the less they are exposing themselves to business risk. This could be reputational risk following bad press, e.g. the highly publicised "Nike sweatshops", financial risk, or environmental risk. So how can companies use the principles of CSR to take meaningful steps towards sustainability' New business models can provide a framework for corporations interested in conducting business in a sustainable manner. The Natural Step, for example, moves beyond CSR. Founded in Sweden in 1989, The Natural Step requires businesses to meet specific ecological and human conditions for all aspects of their corporate agendas. The Natural Step framework is appealing because it effectively draws a line in the sand in terms of what is sustainable practice and what is not sustainable practice, something that CSR has not done. It also recognizes that economic progress should not be carried out at the expense of natural systems and human welfare. The principles of The Natural Step recognize that the economic sphere operates within the parameters of the natural and social spheres, rather than the other way around. Over 100 corporations around the world have started to work with The Natural Step framework, including Nike, Interface, McDonald's and Ikea. The level of integration, however, varies from company to company. McDonald's restaurants in Sweden, for example, began integrating The Natural Step in the 1990s and now serve organic milk and beef, recycle 97 percent of all waste, and have reduced 1200 tonnes of packaging by switching to "smarter packaging."1 Outside of Sweden, the integration of the framework has been slower and more cautious. According to The Natural Step, however, McDonald's is in the early stages of "moving forward on a vision of building a sustainable global food supply chain."2 Now that would be something worth buying a Happy Meal for. This is not to argue that companies currently engaged in CSR should throw away their work in this area and start anew with The Natural Step or a similar framework. What models like The Natural Step demonstrate is the direction that CSR programs must take to guide business toward sustainability. Without such an integrated and focused model, CSR may strengthen a company's public image and perhaps even see it develop some longer-term competitive advantages--but it will not lead to a sustainable company as its proponents claim. "Sustainable business" does not have to be an oxymoron. 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