The corporate social performance-financial performance link
Summary (4 min read)
- Strategic managers are consistently faced with the decision of how to allocate scarce corporate resources in an environment that is placing more and more pressures on them.
- Further, watchdog groups like the Council on Economic Priorities (CEP) have long evaluated company performance on a range of social dimensions.
- These ratings services seem to be having an effect on some investment decisions, which is evident in research that shows that institutional investors are favorably inclined toward companies with higher corporate social performance when other factors are held constant and independent information about CSP is available (Teoh and Shiu, 1990; Graves and Waddock, 1994).
The Measurement Problem
- One fundamental reason for the uncertainty about the relationship between CSP and financial performance is that a serious problem has plagued researchers to date: the problem of measuring CSP.
- Thus, many measures are either unidimensional and may not properly reflect the overall level of a company's CSP or they are difficult to apply consistently across the range of industries and companies that need to be studied.
- Together, these two issues result in a total of six possible hypotheses (O'Bannan and Preston (1993).
- Those arguing for a negative relationship between social and financial performance believe that firms that perform responsibly incur a competitive disadvantage (Aupperle, Carroll, and Hatfield, 1985) because they are incurring costs that might otherwise be avoided or that should be borne by others (e.g., individuals or government).
- The weight of these arguments about the potential positive benefits of CSP suggests to us that the sign of any relationship between financial and social performance will be positive, hence the authors will hypothesize that the relationship between social and financial performance is a positive one.
Direction of Causality: Slack Resources or Good Management?
- The second aspect of the CSP-financial performance relationship has to do with the direction of causality.
- Two views, mentioned earlier can be contrasted and tested empirically.
- Slack resource theorists argue that better financial performance potentially results in the availability of slack (financial and other) resources that provide the opportunity for companies to invest in social performance domains, such as community relations, employee relations, or environment (e.g., IBM's or Digital Equipment Corporation's philanthropy programs during earlier good times).
- Excellent community relations might provide incentives for local government to provide competition enhancing tax breaks (e.g., Dayton Hudson's anti-takeover campaign), improved schools (and a better workforce over the long term), or reduced regulation, thereby reducing costs to the firm and improving the bottom line.
- Improved CSP leads to better financial performance, ceteris paribus, also known as H2.
- To deal with the measurement problems noted above, the authors constructed an index of CSP (as proposed by Ullman, 1985), based on the eight corporate social performance attributes rated consistently across the entire Standard and Poors 500 by the firm Kinder, Lydenberg, Domini (KLD).
- Second, each company is rated on multiple attributes considered relevant to CSP.
- In each of the areas, KLD investigates a range of sources to determine, for example, whether the company has paid fines or penalties in an area (for concerns) or has major strengths in the area (e.g., strong family policies for the Employee Relations category).
- Values from 0-100 were derived, representing the relative importance of each attribute to the overall index.
- For the models that treated CSP as a dependent variable, financial data from 1989 were used.
- Table 1 gives a listing of the industries, SIC codes, and average industry CSP ratings, Table 2 gives descriptive statistics for all variables used in the study; and Table 3 gives the relative weights assigned to each CSP attribute.
- Regression analysis was used to test their hypotheses, first using CSP as the dependent variable, while controlling for size (three size measures were used: total sales, total assets, and number of employees), debt level, and industry, then using profitability as the dependent variable and employing the same control variables.
- A total of 469 companies remained in the sample after companies missing either financial or CSP data were eliminated.
- Note first that CSP is positively and significantly correlated at p<.10 or better with all three of the financial performance measures (ROA--return on assets; ROE--return on equity; ROS--return on sales) for the 1989 financial data, and with those measures at the p<.05 level or better for the correlations with the 1991 financial data.
- These results strongly support hypothesis 1, which posits that better financial performance leads to improved CSP.
- The second finding is somewhat more difficult to explain.
- Even if CSP and quality of management can be differentiated, the meaning-making that goes with creating strong social performance may elicit greater loyalty to firms from two important constituencies: employees and customers, while simultaneously providing at least certain categories of owners (i.e., those with social concerns) even more reason to invest in a particular firm.
Implications for Future Research
- Much remains to be learned about the relationship between CSP and financial performance, which has been explored in the present study.
- As more CSP data become available it would be useful to determine whether or not the relationships that the authors have examined hold consistently over time.
- Additionally, it would be useful to examine lags other than the one-year time period used in the present study.
- Further, if quality of management is a critical variable in financial outcomes, as the relationships identified in this study suggest, then controlling for the quality of management while assessing the CSP-financial performance link might also be beneficial.
- Additional research is clearly necessary to explore these specific relationships between the stakeholder categories and financial performance, the findings here are suggestive of the need to alter current definitions of CSP to bring them more closely into line with stakeholder relations (c.f., Wood & Jones, 1995; Waddock, forthcoming) as the weighted index does.
Implications for Management
- As strategic managers consider where to place their investments, they may wish to take into account the results reported above.
- If good management theory and the virtuous circle hold, as this research begins to suggest, then CSP involves more than doing the extras: it is a way of doing business.
- Wood, D. J. 199 la. Corporate Social Performance Revisited.
- Fines or civil penalties paid, or major litigation or controversies, relating to communities in which a company operates; general corporate relations strained because of plant closings or general breach of agreements; if the company is a financial institution, there are investment controversies, also known as Areas of Concern.
- Philanthropic giving over 1.5% of pretax earnings or otherwise notably generous giving; known for "innovative giving," prominent participant in public-private partnerships supporting housing initiatives for the disadvantaged; supports education through long-tern commitments or is prominent support of job training program, also known as Areas of Strength.
- Diversity (formerly treatment of women and minorities) Areas of Concern: paid substantial fines or civil penalties, or has major controversies re affirmative action; no women on board of directors or senior line management.
- CEO is a woman or minority; notable progress in promotion of women and minorities, especially to line positions; diverse representation on board of directors; outstanding employee benefits addressing work/family concerns; strong purchasing record with women/minority owned firms; initiatives in hiring disabled; progressive gay, lesbian, and bisexual policies, also known as Areas of Strength.
- Relatively poor union relations; significant fines or civil penalties over employee safety or major safety controversies; recent layoffs of > 15% in one year, 25% in two years; substantially underfunded pension plan or inadequate benefits plan, also known as Areas of Concern.
- Strong relative union relations; long-term policy of company-wide cash profit sharing (profitable firms only); worker involvement/ownership through gainsharing, ESOP, sharing of financial information, participation in decision making; strong retirement benefits or other innovative/generous benefits, also known as Areas of Strength.
- Liabilities for hazardous waste >$30 million or significant involvement in >30 Superfund sites; significant fines or civil penalties, pattern of regulatory problems, or major controversies on environmental degradation; top producer of CFCs, HCFCs, methyl chloroform, or other ozone-depleting chemicals; high relative legal emissions (or acid rain formation); producer of agricultural chemicals, also known as Areas of Concern.
- Substantial revenues from remediation products, innovative products with environmental benefits (excludes landfill, incineration, waste-to-energy and deep-well injection), company-wide changes in processes to reduce emissions and toxins; substantial user of recycled materials in manufacturing; substantial revenues from fuels with environmental advantages or notable conservation projects; environmentally sensitive PP&E (new equipment), also known as Areas of Strength.
- Recent product safety controversies or product liability lawsuits or regulatory action; major marketing controversy or fines or civil penalties related to advertising, consumer fraud, or regulatory actions; paid fines or civil penalties relating to antitrust laws, also known as Areas of Concern.
- Long- standing, company-wide quality program judged among industry's best; leader in industry R&D; products/services benefit the economically disadvantaged, also known as Areas of Strength.
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Cites methods from "The corporate social performance-fi..."
...An empirical test of the CSP framework is presented in the work of Waddock and Graves (1997), who report a positive association be-...
Cites background from "The corporate social performance-fi..."
...…and financial performance of corporations in most cases (Frooman, 1997; Griffin and Mahon, 1997; Key and Popkin, 1998; Roman et al., 1999; Waddock and Graves, 1997) However, these findings have to be read with caution since such correlation is difficult to measure (Griffin, 2000; Rowley…...
...We will return to these points afterwards....
Cites background from "The corporate social performance-fi..."
...Because firms that are less profitable have fewer resources to spare for socially responsible activities than firms that are more profitable—an argument that is often referred to as slack resource theory (Waddock & Graves 1997)....
...There are also several dimensions that we might use to identify important aspects of socially responsible corporate behavior (Rowley & Berman, 2000; Waddock & Graves, 1997)....
...For example, Waddock and Graves (1997) found through regression analysis that an increase in corporate financial performance was associated positively with an increase in corporate social responsibility....
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Frequently Asked Questions (8)
Q1. What are the contributions in this paper?
Using a greatly-improved source of data on corporate social performance, this paper reports the results of a rigorous study of the empirical linkages between financial and social performance.
Q2. How did the panelists evaluate the attributes of the CSP?
Using the simple multi-attribute rating technique (SMART) (Von Winterfeldt andEdwards, 1986), the authors asked each panelist to evaluate the eight CSP attributes, perform tradeoffs among the attributes, then construct a scale.
Q3. What is the significance of the weights in the CSP index?
the heavier weights in the CSP index are those that most closely represent critical stakeholders, such as employees, customers, and community, while less directly stakeholder-related categories of involvement in nuclear industries, military contracting, or South Africa receive considerably less weight.
Q4. What are the sources of information used by KLD?
External data sources include articles about a company in the general business press (e.g., Fortune, Business Week, Wall St. Journal), trademagazines, and general media.
Q5. What is the relationship between slack resources and financial performance?
If slack resources are available, then better social performance would result from the allocation of these resources into the social domains, and thus better financial performance would be a predictor of better CSP.
Q6. Why are previous studies mixed on the relationship between profitability and corporate social performance?
In part because of the measurement difficulties, previous findings on the relationship between profitability and corporate social performance have been mixed.
Q7. What is the significance of controlling for industry in the analysis of the KLD data?
Table 5 presents the results of the regression analysis using CSP as the dependentvariable and financial performance as the independent variable, controlling for debt, size, and industry (industry controls are omitted from the table in the interest of space), using a one-year lag between the financial performance (1989 data) and the CSP measurement (1990 data).
Q8. What is the relationship between CSP and debt-to-asset ratio?
CSP is negatively related to debt-to-asset ratio in each of the first nine models, but is only significant (p<.10) when ROE is used.