Corporate environmental responsibility

As corporate social responsibility is originally considered as way of creating profit while serving the societal and communal interests (Kao & Kao 2009, 9-11), corporate environmen-tal responsibility focuses on the environmenenvironmen-tal side of social responsibility, such as mitigation of emissions, resource drains and environmental damage as well as efficient use of resources.

Resources cover energy and material usage in land, air and sea, in all industries, in buildings, agriculture, communications and lighting to name a few. Mismanagement of resources as much as corruption, stock markets and terrorism can be classified under resource drains. (Kao 2009, 135.)

Before starting the conversation about corporate environmental responsibility (CER), it should be taken a bit further, to corporate social responsibility (CSR) and the origins of CER.

CER, is one field of orientation of CSR and their implications are sometimes hard to separate from one another. The definition of the concept is not fixed, but it varies in national contexts and by who promotes it. (Adi et al 2015.) This chapter discusses about the development of CER and to the first- and second-generation of CER. Later on, different measurement meth-odologies of CER used in previous research are introduced.

2.1.1 Corporate social responsibility – the origins of corporate environmental responsibility The commonly argued aspect of corporate social responsibility is, whether it is adopted solely to increase profit, as stated by Milton Friedman in 1970. Later on, the argument was widely challenged, since profit maximization does not benefit the society. As corporation is defined to be a legal person, it consists of the moral responsibilities of its stakeholders, employees and managers. The importance of social responsibility has been understood by many classical and neo-classical economists, and for example Adam Smith (1776) in The Wealth of Nations be-lieved that an individual promotes public interest best by pursuing his own interest and secu-rity. In the early 20^th century, John Stuart Mill (1920) had a similar approach to CSR in Prin-ciple of Political Economy. (Kao 2009, 9-13.) Researchers studying CSR share a view of the value adding benefits of the subject, and they are improved shareholder value, increased cus-tomer loyalty, sympathetic media at critical times, cost savings due to eco-efficiency and abil-ity to attract motivated, top class employees, to name a few. (Idowu, Schmidpeter & Fifka 2015, 2-3.)

The measurement of CSR has increased in the 21^st century, as corporations are being evalu-ated by their achievements and performance in CSR (Newell 2014). Corporate profit and so-cial responsibility are closely related and therefore soso-cial costs should be included into ac-counting practices. These social costs are labor costs, non-renewable versus renewable re-sources and environmental contribution. (Kao 2009, 14-15.)

2.1.2 Development of corporate environmental responsibility

Steger (1993) introduced a goal structure of a corporation, where he claims that the most im-portant objective of a corporation is survival, which requires strengthening its resources and capabilities to serve the needs of a changing business environment. Second most important aspect is to set strategic goals, so called missions. These goals are listed in the figure below.

Already in the early 1990’s, Steger stated, how profit and market objectives are studied to have a positive correlation. The interest lies on the question of how they relate to environmen-tal protection, which is a contradictory goal as it carries additional costs that may deteriorate competitiveness. (Steger 1993, 149-150.)

Figure 1. Goal structure of a corporation (Steger 1993, 150)

Gunningham (2009) refers to the report of World Business Council for Sustainable Develop-ment and defines corporate environDevelop-mental responsibility as “practices that benefit the envi-ronment (or mitigate the adverse impact of business on the envienvi-ronment) that go beyond that which companies are legally obligated to do”. World Business Council for Sustainable Devel-opment (1999) argued in the report of Corporate Social Responsibility: Meeting Changing Expectations, that environmental ethics and profitable business can have positive correlations, since the adoption of coherent corporate social responsibility strategy creates a broader world view, which helps businesses to keep track of changes in social expectations and to control

risks and to identify market opportunities. It was also argued by Gunningham (2009), that the managerial values to environmental issues have an effect on the corporation’s responsiveness.

Hoffman (1997) suggested that institutional factors, such as “historical legacies, cultural mo-res, cognitive scripts and structural linkages” often lead organization to adapt to social norms.

As Burke (1997) stated it, CER practices are most commonly applied for risk management and reputational capital reasons.

There are various reasons to invest in CER. The reasons can be divided into the corporation’s external environment, to intra-organizational factors and to an interaction of internal and ex-ternal factors. Corporation’s exex-ternal environment contains the exex-ternal political, legal and economic business environment. Portney (2005) suggested in his article that investing in CER would serve the very purpose of a company’s existence, which is to provide goods and ser-vices to consumers, through saving resources that can provide competitive returns in the fu-ture. Porter and Kramer (2006) stated that corporations influence positively on the society by investing capital and operating every-day business, providing jobs and purchasing goods.

Many researchers, such as Yosie and Herbst (1997) have emphasized the meaning of external factors in corporations’ environmental policies. Prakash (2001) introduced the intra-organiza-tional factors to reinforce the external factors, which, as he stated, are necessary, but not suffi-cient enough to determine environmental investment decisions. Intra-organizational factors are related to enhancing, developing or protecting the core of the organization which may re-quire adaptation of green strategies. Roome (1992) stated that company’s commitment to CER practices is a result of both, external pressure and internal incentives. He also argues, that managerial attitudes and values have an independent role in investing in CER, and

Ghobadian et al. (1998) added a factor of company’s ability, which includes human and finan-cial resources as well as flexibility. Christmann and Taylor (2002, 127-133) suggested a framework of firm-level capability to address environmental issues based on Roome’s (1992) model of scientific significance of environmental impact. This framework introduces four strategies for participation in international voluntary environmental initiatives (VEIs) that are proactive, accommodative, defensive and/or capability-building and reactive.

In proactive strategy, managers need to consider the environmental issues that have a central role to a firm’s strategy and to which the firm has strong capability to develop solutions. In accommodative strategy, a firm has strong resources and capabilities in implementing a strat-egy, but they are not central to the firm’s strategy. These issues are likely to have only little

positive effects on the company’s competitiveness. The defensive and/or capability-building strategies have a high strategic importance to a firm’s strategy but the capability to address these issues is weak. These issues are the most difficult ones and may require a firm to defend itself from negative impacts on competitiveness. (Christmann & Taylor 2002, 127-133.) Christmann and Taylor (2002, 131) state that “Firms that rely on their reputation for environ-mental responsibility as a source of competitiveness will benefit more from focusing on build-ing capabilities than on defensive strategy.” The reactive strategies are those strategies that are not central to a firm’s strategy and the capability of implement them is weak. These issues have only a little negative effect on competitiveness and the company does not gain much by implementing them. (Christmann and Taylor 2002, 127-133.)

Ghobadian, Viney, Liu and James (1998, 16-17) introduced a linear model for mapping cor-porate environmental behavior. In the model, the goal is to adapt environmental strategies through a decision-making process affected by three factors: external, mediating and moderat-ing factors. External factors have an impact upon the company and mediatmoderat-ing and moderatmoderat-ing factors influence the extent of the impact of these external factors. The dynamics between these factors seem to influence a company’s decision-making process and therefore the devel-opment of company’s strategic environmental policies. External factors in the model are such as market behavior, legal-regulatory influences and social expectations. Mediating factors are leadership, corporate tradition and corporate ethics. Moderating factors are technology, oppor-tunity, cost assessment, human resource availability, capital availability and organizational adaptability. In the decision-making process moderating factors are those elements that con-strain the company’s activities either through the complexity of processes or the availability of resources. (Ghobadian et al 1998, 16-18.)

2.1.3 The First-generation of corporate environmental responsibility

The discussion about CSR started in 1970 from Milton Friedman’s declaration how the main task of managers in public organizations was to maximize the value of the company’s out-standing shares. This created a debate since the common view was that environmental protec-tion measures are expensive, and they do not provide any marketplace advantage. In 1990’s the common view was challenged. Business strategists, environmental commentators and even some corporations stated that businesses could successfully combine objectives of envi-ronmental responsibility and economic growth. They introduced some specific actions, such

as preventing pollution and thereby cut costs, avoid direct waste by more effective risk man-agement and reach a market share in the growing green markets. (Gunningham 2009.) Russo and Fouts (1997) found out in their research that corporations with high levels of environmen-tal performance had better financial performance, but it was argued whether firms with better financial performance could in fact afford higher environmental protection.

Another significant step forward was Porter’s (1991) suggestion that “properly constructed regulatory standards, which aim at outcomes and not methods, will encourage companies to re-engineer their technology.” This would result a process that pollutes less, lowers costs and improves quality. Mol and Sonnenfeld (2000) introduced a theory known as ecological mod-ernization, which specified that economic and environmental views can be reconciled and by reducing costs there is a potential in increasing profits when appropriate framework is given by the government. It was widely argued, that if CER did not have any financial burden, it would be applied by most corporations. Walley and Whitehead (1994) proved that win-win situations with CER initiatives are rare and insignificant to the expenditures they create.

2.1.4 The Second-generation of corporate environmental responsibility

During the second-generation, the context of CER was seen more broadly. The main question left unanswered was, that if considerable win-win situations do exist, why the majority of cor-porations had not put them into practice. Rappaport and Flaherty (1991) stated, that the proba-ble reason for this was that companies focus more on the short-term profits and environmental investments can only offer medium- or long-term profits. Simon (1992) suggested that people have neither the knowledge nor the power to calculate the optimal economic benefit from en-vironmental activities and that only where, for example energy, is a major component of the business, investments in energy efficiency will be made. Greer and van Löbel Sels (1997) ar-gued that management is focused on the core functions in business and ignores all less re-markable costs saving, even if it would support environmentally responsible behavior. Man-agers will ignore a win-win situation if they think that they can do a better investment else-where or the benefits are not sufficient enough to overrun other corporate priorities.

As stated by Gunningham (2009), one of the most influential second-generation analysts was Reinhardt (1998; 1999) who analyzed the circumstances in which investing in CER would create a strategic advantage. Reinhardt (1998; 1999) suggested that environmental policies

should be applied if they increase the company’s expected value or reduce the plausibility of a business risk. A useful environmental strategy depends on the structure of the industry, the firm’s position in it and its organizational capabilities. By developing a functional environ-mental strategy and a business logic that meets the corporate environenviron-mental policies, it is pos-sible for a corporation to gain competitive advantage from its environmental strategy. (Gun-ningham 2009.)

A broader understanding and better empirical analyses of CER started in the 21^st century. Vo-gel (2005) argued that CER is not central to a company’s business strategy and it should not be applied if it is inconsistent with the broader business plan. He also suggested that a corpo-ration can gain competitive advantage by developing its environmental guidelines for the fa-vor of a successful basic business model. Vogel’s (2005) arguments have been widely ap-proved and supported by other researchers. Esty and Winston (2006) predicted that a so-called

‘green wave’ is approaching the corporate world and that proactive companies would identify ways to profit from it, such as cutting costs and increasing revenues, reducing risk and creat-ing stronger brands. Dyllick and Hockerts (2002) argued in their article, that there are six cri-teria to satisfy by managers aiming for corporate sustainability: eco-efficiency, socio-effi-ciency, eco-effectiveness, socio-effectiveness, sufficiency and ecological equity.

The similarity in both of the generations is that the research concerning CER has concentrated on whether to what extent or in which circumstances it is strategically sensible to invest in CER, and ethics, moral and altruism are rarely concerned in the matter (Gunningham 2009).

2.1.5 Measurement methodologies

Auld, Bernstein and Cashore (2008) developed a framework of the new social responsibility, where it is divided into taxonomic categories of: individual firm endeavors, firm-NGO (non-governmental organization) partnerships, public-private partnerships, information approaches, environmental management systems, industry association codes of conduct and nonstate mar-ket-driven. Of these categories, Environmental management systems (EMS) represent CER activities, and it is found out that implementing EMS causes indirect benefits of acting posi-tively towards the society. The two most significant EMS’s are Europe’s Eco-Management and Audit Scheme (EMAS) and the International Organization for Standardization (ISO) 14001 procedures for environmental management. (Auld et al 2008, 417-422.)

Testa and D’Amato (2017) measured the bidirectional causality of CER and CFP on a sample of manufacturing firms. They used a fixed effect panel data regression and checked the ro-bustness of the results with alternative econometric techniques. Testa and D’Amato (2017) used a formalized EMT to measure CER. A formalized EMT assists in managing, measuring and improving environmental initiatives in an organization and reduces a risk to accidental non-compliance with environmental regulations. Cai and He (2013) used alternative portfolio weighting methodologies, controlling of firm characteristics and removal of outliers and they tested the results by using industry-adjusted Tobin’s Q for the study. Researchers have often used KLD Environmental Ratings in measuring CER. MSCI ESG KLD Stats, initiated in 1991, is an annual data gathered from positive and negative environmental, social and govern-ance (ESG) performgovern-ance indicators applied to a universe of publicly traded companies. The ESG environment performance indicators are divided to positive and negative performance indicators (MSCI 2015.) In KLD dataset, companies are evaluated through environmental, community, corporate governance, diversity, employee relations, human rights and product quality and safety issues (Hasan, Kobeissi, Liu & Wang 2016).

Kim and Statman (2011), Kim and Oh (2019) as well as Cho, Chung and Young (2019) meas-ured corporate financial performance with Tobin’s Q ratio and ROA (return on assets). Mon-tabon et al (2006) used ROI (return on investment) and sales growth to measure the impact of environmental management practices (EMPs) to financial measures. Semenova and Hassel (2014) introduced other environmental performance ratings, such as ASSET4, Global En-gagement Services (GES), which correlated highly and provided convergent scores in US companies. King and Lenox (2001) measured environmental performance by the organiza-tions total emissions, relative emissions and industry emissions. They used RQ, reportable da-tabase, to weight each chemical by its toxicity. Montabon, Sroufe and Narasimhan (2006) used corporate environmental reports to create data, since comprehensive measurement efforts are limited and not available for researchers when analyzing corporate environmental man-agement and firm performance. They identified significant EMPs (environmental ment practices) which were associated with firm performance. These environmental manage-ment practices were recycling, proactive waste reduction, remanufacturing, environmanage-mental de-sign, specific design targets and surveillance of the market for environmental issues. (Monta-bon et al 2006, 1006-1008.)