The relationship between firm beta and its ES scores is an interesting one because it allows us to predict the sensitivity of low and high ES stocks to market returns. The graph below depicts a scatter plot of average, decimated Environmental and Social scores for firms on the FTSE-100 over the period 2002-2014, against their beta (calculated from monthly returns for the same period 2002-2014). From this graph, one can surmise that higher betas roughly tend to favor firms with higher ES scores, and vice versa.
Figure 9. Plot of firms’ E and S scores against their Beta (FTSE-100)
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
0 1 2 3 4 5 6 7 8 9 10
ENVSCORES SOCSCORE Linear (ENVSCORES)
Linear (ENVSCORES) Linear (SOCSCORE)
This result is not unintuitive. For instance, it may be argued that firms with higher investment in Environmental and Social initiatives are more exposed to systematic risk than the market.
But on the other hand, investment in CSR ventures would suggest that overall firm exposure to systematic risk should be reduced. The trend could be explained away once firm ES scores are evaluated per component of CSR for their relation with beta. For the purposes of this study, a linear representation of the relationship would suffice. However, given a larger number of observations and a more detailed empirical analysis, a causal link may be found between high ES scores and high firm beta.
The graph below depicts similar results when plotting Environmental and Social scores for firms in HDAX against their beta.
Figure 10. Plot of firms’ E and S scores against their Beta (HDAX)
0 0.5 1 1.5 2 2.5
0 SOCSCORE2 ENVSCORE4 6 Linear (SOCSCORE)8 Linear (ENVSCORE)10 12
A similar trend can be detected in the HDAX scatterplot, where firms with higher Environmental and Social scores tend to have slightly higher betas. Additionally, the slope of the trendline through HDAX data for both social and environmental scores is smaller than the slope of the trendline through FTSE-100 data, meaning the result is less pronounced.
8 EMPIRICAL RESULTS
This section details the results of the empirical analysis. The section is divided into three subchapters. The first two chapters concern the results of the test of the first hypothesis, breaking it down to the two dependent variables under study, namely the operating profits margin and the dividends per share. In the first chapter, results of the regression of equation (1) are detailed for FTSE-100 and HDAX, while the second subchapter details the results of the regression of equation (2). The third chapter concerns tests of the third hypothesis, with the natural log of net debt as the dependent variable.
8.1 Operating Profit Margins
First, Operating Profit Margins for FTSE firms are regressed against Social and
Environmental rankings while controlling for firm size, asset turnover ratio, earnings per share, interest coverage, payout ratio and the market to book value. Least Squares
regression with fixed effects cross section is applied to the equation and period weights (PCSE) are used. This is because for this balanced panel data, the number of observations (N) is greater than the number of time periods (T).
The results of this regression for firms in the FTSE 100 are displayed in Table 3.
This table reports results from regressing variables in equation (1) against operating profit margins for companies in the FTSE 100. After removing newly incorporated firms and firms with missing values, there are 91 cross sections across the period 2002-2014, and 1011 observations in total. Least Squares regression with fixed effects cross-section is conducted while using period weights (PCSE). *, ** and ***
denote coefficients significant at the 10%, 5% and 1% level respectively.
Variable Coefficient Std. Error Prob.
C 15.493 1.983 0.0000
(7.814)
Earnings Per Share 1.6968 0.224 0.0000
(7.552***)
Asset Turnover 3.5791 1.246 0.0042
(2.871***)
Interest Coverage 0.0035 0.0006 0.0000
(5.302***)
Payout Ratio 0.0042 0.011 0.7155
(0.367)
Market to Book Value -0.0002 0.008 0.9746
(-0.032)
Total Assets -1.29E-08 2.18E-09 0.0000
(-5.906***)
Table 3. The Relationship between Environmental and Social Scores and firms’ Operating Profit Margin (FTSE100)
Unsurprisingly, both Environmental and Social scores appear to be negatively correlated with Operating Profits Margins. Moreover, the relation between operating profits margin and social scores is significant at the 1% level, while that between OPM and environmental scores is not significant. Based on the results of this regression, we are unable to reject H1, which states that firms with high ES scores would have lower operating profits margins. H0 is however partially accepted for Environmental scores, since no significant relation can be found.
We repeat the regression for firms in the HDAX. Table 5 shows results of the regression, which are very similar to the results for the firms in FTSE-100. However, in HDAX, Market to Book Value ratio has a more significant correlation with operating profits margin that in FTSE-100. Moreover, firm size doesn’t appear to be significant for firms’ operating profit margin in the HDAX.
Both social and environmental scores are once again negatively related to operating profits margin. For firms in the HDAX, the coefficient for both variables is significant. The coefficient for social scores is significant at the 5% level, while that for environmental scores is significant at the 10% level.
This table reports results from regressing variables in equation (1) against operating profit margins for companies in the HDAX. After removing newly incorporated firms and firms with missing values, there are 72 cross sections across the period 2002-2014, and 668 observations in total. Least Squares regression with fixed effects cross-section is conducted while using period weights (PCSE). *, ** and
*** denote coefficients significant at the 10%, 5% and 1% level respectively.
Variable Coefficient Std. Error Prob.
C 5.439922 1.525780 0.0004
(3.565***)
Earnings Per Share 0.362788 0.056601 0.0000
(6.409***)
Asset Turnover -1.189443 0.731468 0.1045
(-1.626)
Interest Coverage 0.017768 0.002868 0.0000
(6.195***)
Payout Ratio 0.039195 0.012641 0.0020
(3.100***)
Market to Book Value 0.647454 0.183041 0.0004
(3.537***)
Total Assets -7.91E-10 2.50E-09 0.7512
(-0.317)
CGV-SCORE 0.042542 0.015981 0.0080
(2.662***)
ENV-SCORE 0.029970 0.017833 0.0934
(1.680*)
SOC-SCORE -0.036913 0.018763 0.0496
(-1.967**)
Table 4. The relationship between Environmental and Social ratings and firms’ Operating Profits Margin (HDAX)
Once again, based on these results, we cannot reject H1 for HDAX firms, since Social scores
in this case show a significant negative relation to operating profits margin. However, Environmental scores are significant only at the 10% significance level and appear to be positively related to operating profits margin.
Based on the results of the first tests, we can conclude that there are marked differences in the effects of CSR practices in both markets. While social scores are negatively related to OPMs in both markets, there are differences in the way environmental efforts are translated on the firms’ balance sheets. Another reason for environmental scores to have no significant relation to OPM in HDAX would be the ‘voluntariness’ of CSR efforts in Germany, where government and corporations have unanimously opposed the incorporation of CSR components in legislature (Beier 2012).
When investigating the relationship between CSR and operating profits margin, it is interesting to note that in both the case of FTSE-100 and HDAX, Corporate Governance scores are significant at 1% levels and positively related to operating profits margins. There may or may not be a causal link in the relationship, but from the face of it firms with better corporate governance tend to outperform those that do not measure up.
8.2 Dividends per Share
This subchapter reports the results of testing the relationship between ES scores and dividends per share. The table below shows the results of this regression of equation (2) for firms in the FTSE-100. Dividends per share are regressed against Environmental and Social scores, while controlling for Earnings per Share, firm size (represented by total assets), market to book value, payout ratio, sales per share and the corporate governance score.
Similar to the regression for operating profits margin, least squares regression with fixed effects cross-section is used, while applying period weights (PCSE). After controlling for
variables that affect dividends per share, Environmental and Social scores have no explanatory power over the dependent variable. The coefficients for corporate governance and social scores are positive, while that of environmental scores is negative.
This table reports results from regressing variables in equation (2) against dividends per share for companies in the FTSE-100. After removing newly incorporated firms and firms with missing values, there are 93 cross sections across the period 2002-2014, and 1101 observations in total. Least Squares regression with fixed effects cross-section is conducted while using period weights (PCSE). *, ** and *** denote coefficients significant at the 10%, 5% and 1% level respectively.
Variable Coefficient Std. Error Prob.
C -0.583636 0.257805 0.0238
(-2-263)
Earnings per Share 0.173465 0.013356 0.0000
(12.988***)
ln(Total Assets) 0.027613 0.017087 0.1064
(1.616)
Market to Book Value 0.000492 0.000356 0.1680
(1.379)
Payout Ratio 0.003085 0.000533 0.0000
(5.785***)
Sales per Share 0.015875 0.002286 0.0000
(6.945***)
CGVSCORE 0.001074 0.000687 0.1183
(1.563)
ENVSCORE -8.96E-05 0.000666 0.8930
(-0.134)
SOCSCORE 8.16E-05 0.000768 0.9153
(0.106)
Table 5. The relationship between Environmental and Social scores and Firms’ Dividends per Share (FTSE-100)
When testing for the relationship between ES scores and dividends per share in HDAX, the results are similar yet more definite. Environmental scores are still not significant for dividends per share, but social scores in HDAX are significant at the 5% level and are positively related to dividends per share. The results are displayed in the table below.
This table reports results from regressing variables in equation (2) against dividends per share for companies in the HDAX. After removing newly incorporated firms and firms with missing values, there are 72 cross sections across the period 2002-2014, and 668 observations in total. Least Squares regression with fixed effects cross-section is conducted while using period weights (PCSE). *, ** and *** denote coefficients significant at the 10%, 5% and 1% level respectively.
Variable Coefficient Std. Error Prob.
C -3.208503 1.202183 0.0078
(-2.669***)
Earnings Per Share 0.100653 0.006845 0.0000
(14.705***)
ln(Total Assets) 0.154322 0.075347 0.0410
(2.048**)
Market to Book Value 0.065460 0.019939 0.0011
(3.283***)
Payout Ratio 0.007996 0.001470 0.0000
(5.438***)
Sales per Share 0.008637 0.001142 0.0000
(7.561***)
CGVSCORE 0.002790 0.001894 0.1414
(1.472)
ENVSCORE -0.001005 0.002187 0.6459
(-0.459)
SOCSCORE 0.005597 0.002418 0.0210
(2.314**)
Table 6. The relationship between Environmental and Social scores and Firms’ Dividends per Share (HDAX)
According to these results, the null hypothesis (H0) may be partially rejected (for firms in the HDAX), while H4 may be partially accepted. This is contrary to the intuitive claim that both environmental and social efforts reduce the dividends paid out to shareholders. The explanation may lie in the theory that value firms in Germany tend to also have higher CSR scores, while growth firms have lower CSR scores. Since value firms pay more dividends than growth firms, the relationship between these variables may be more coincidental than causal.
8.3 Net Debt
This section details the results of the regression of equation (3), where the relationship between Net Debt and environmental and social scores is tested while controlling for other explanatory variables. The reason for testing this relationship is to determine whether firms with higher ES scores tend to finance their CSR activities through borrowing. For this purpose, hypothesis (3) proposes that the relationship between net debt and ES scores should be positive. This hypothesis is tested on the FTSE-100 and HDAX markets consecutively.
Table 7 lists the results of the regression of the logarithm of firms’ net debt against their environmental and social scores, while controlling for Interest coverage ratio, Operating income, Payout Ratio, Firm Size and Corporate Governance score for firms in the FTSE-100.
Least squares regression with fixed effects cross-section is conducted while using period weights (PCSE).
This table reports results from regressing variables in equation (3) against logarithm of net debt for companies in the FTSE-100. After removing newly incorporated firms and firms with missing values, there are 72 cross sections across the period 2002-2014, and 668 observations in total. Least Squares regression with fixed effects cross-section is conducted while using period weights (PCSE). *, ** and *** denote coefficients significant at the 10%, 5% and 1% level respectively.
Variable Coefficient Std. Error Prob.
C 2.495154 0.944833 0.0084
(2.641***)
Interest Coverage Ratio -0.009145 0.001900 0.0000
(-4.813***)
ln(Operating Income) 0.104708 0.053619 0.0512
(1.952*)
Payout Ratio 0.002545 0.001364 0.0625
(1.865*)
ln(Total Assets) 0.654952 0.062096 0.0000
(10.547***)
CGVSCORE -0.004639 0.002058 0.0245
(-2.254**)
ENVSCORE 0.000637 0.002056 0.7569
(0.309)
SOCSCORE 0.001611 0.002183 0.4607
(0.739)
Table 7. The relationship between Environmental and Social scores and firms’ net debt (FTSE-100)
The results in the table show that the relationship between ES scores and the logarithm of firms’ net debt is positive but insignificant for FTSE-100 firms. The null hypothesis in this case cannot be rejected. While firms in the UK may rely on borrowing to finance CSR activities, there is no significant impact on the net debt on their balance sheets from their CSR policies.
Regression of the same equation is carried out for firms in the HDAX. The table below lists the results of the regression, and these results indicate perhaps the most vivid difference between the German and UK markets.
This table reports results from regressing variables in equation (3) against logarithm of net debt for companies in the HDAX. After removing newly incorporated firms and firms with missing values, there are 72 cross sections across the period 2002-2014, and 668 observations in total. Least Squares regression with fixed effects cross-section is conducted while using period weights (PCSE). *, ** and *** denote coefficients significant at the 10%, 5% and 1% level respectively.
Variable Coefficient Std. Error Prob.
C -5.944463 1.749765 0.0007
(-3.397***)
Interest Coverage Ratio -0.026692 0.005213 0.0000
(-5.119***)
ln(Operating Income) -0.039658 0.056308 0.4816
(-0.704)
Payout Ratio -0.001771 0.001896 0.3507
(-0.934)
ln(Total Assets) 1.329587 0.112479 0.0000
(11.821***)
CGVSCORE -0.000861 0.002505 0.7312
(0.343)
ENVSCORE -0.004290 0.003056 0.1610
(-1.404)
SOCSCORE -0.004876 0.003089 0.1151
(-1.579)
Table 8. The relationship between Environmental and Social Scores and Firms’ net debt (HDAX)
While the relationship between ES scores and the logarithm of firms’ net debt is still insignificant for firms in the HDAX, this relationship is now negative. Hypothesis 3 is therefore rejected for firms in the HDAX. If anything, firms with higher involvement in CSR tend to have lower net debt. One reason for the difference may be the tendency for German firms to have a lower debt-to-equity ratio than firms in the UK. This however, does not explain the negative relationship between debt and ES scores.
9 CONCLUSION
While Corporate Social Responsibility and its implications for a firm’s value and profitability have been active concerns since the 1950’s, market perceptions of participation in CSR activities have changed over the decades. Whereas in the past, CSR initiatives may have represented a badge of merit for the company in question, in recent years, these behaviors are expected in the course of a business’s operations. Higher demand for CSR among investors and consumers has led to increased competition between large corporations, and hence returns on additional CSR activities are expected to have decreased over the years.
However, operational costs of undertaking and maintaining good social and environmental practices are still are a leading concern for businesses.
While the effects of good governance practices on stock price and profitability have been studied in depth in recent years, the effects of environmental and social aspects of CSR on a firm’s balance sheet still remains a relatively underdeveloped area in financial research. In this study, the correlation between Environmental and Social scores, and operating profit margins, dividends per share and net debt are studied for firms in the FTSE-100 and the HDAX. Since both are developed markets with approximately similar socio-economic statistics, there is expected to be an equally high demand for CSR in both countries.
The results indicate that the studied variables (OPM, Div/Share and Net debt) tend to have higher correlations with E and S scores for firms in the HDAX than in FTSE-100. In particular, OPM has the highest correlation with E and S scores, yet while it is positively correlated with the Environmental score, there is negative correlation with the Social score.
One explanation for this could be reverse causality, i.e., firms with higher OPMs tend to invest more in Environmental responsibility, and firms with lower OPMs tend to invest more in Social responsibility. Another explanation could be the higher operating costs of ‘social’
projects, such as employee benefits and salaries, as opposed to the higher fixed costs of
‘environmental’ initiatives, such as investment in eco-friendly resources and energy supplies.
Lastly, while there are similarities in the direction of correlation between both markets for Operating Profits Margins and Dividends per share, the FTSE-100 firms’ net debt has a positive insignificant correlation with both E and S scores, while the HDAX firms’ net debt has a negative insignificant correlation. One explanation for this observation could be that firms in the UK have a higher ratio of debt-to-equity as opposed to firms in Germany. Firms in the FTSE-100 are therefore more likely to finance Environmental and Social activities through borrowing than firms in the HDAX.
10 FURTHER RESEARCH
So far, the correlation between Social and Environmental factors for firms’ operating profit margins, dividends per share and net debt has been studied in two separate markets, the HDAX and the FTSE-100. The markets themselves, although operating in separate countries, and governed by a separate set of corporate equity laws, are similar in geography and level of development of the economy. Germany being the largest economy in Europe, and Britain the second largest, the two markets share similarities that in turn effect the similarities in the correlations discovered. In addition to these parallels, the results reflect the differences in perception of CSR in the two markets. Therefore, it would be interesting to distinguish the specific variables in firm management that drive those differences and vice versa.
Moreover, applying similar regressions on economies across the developed and developing world can help establish how firms in different countries perceive CSR differently, and how their actions have varying effects on firm and shareholder profitability. This in turn will allow the construction of a model that can determine, given geographic constants, the expected economic impact of decisions relating to corporate, social and environmental responsibility.
This will reduce decision time and improve estimation of results for a firm’s CSR based policies.
Another possible development from this research is an explorative study that determines the changes in demand and supply of CSR over the past decade. Building on previous research by McWilliams (2001) and Wood (2008), the study would build and improve upon the existing model by specifying updated determinants for the demand for CSR activities and the supply of CSR reporting. While Mackey et al. (2007) employ a model to determine the changes in firm value through changes in CSR, a similar model may be reemployed to determine the increase (or decrease) in supply and demand of CSR over the years by studying the increase (or decrease) in firm value over the years. In addition, the costs and benefits of CSR may be factorized based on a firm’s market capitalization, industry and country of
operations, and this data would in turn be used in a cost-benefit anaylsis to determine optimum involvement in CSR activities.
There are numerous options of economies and market conditions to conduct research on optimization of CSR decision making. What holds true for Europe may not hold true for the U.S., and even less so for China, Japan, Taiwan or India. This is because firm decisions with regards to CSR policy are largely behavior based, and often prejudiced by the sensitivity of the market to CSR and current laws and regulations. However, this in itself is not always a certainty, as seen in Germany, where CSR regulations tend to be laxer in comparison to the U.K, and in spite of this CSR involvement appears to be higher. These studies will therefore not only be of use to the firms of the countries they research in policy-making and implementation, but also provide valuable insight into the behavioral and operational responses to CSR as shaped by economic, administrative and ethical concerns.
11 REFERENCES
Albuquerque, Rui, Art Durnev & Yrjo Koskinen (2014). Corporate Social Responsibility and Firm Risk: Theory and Empirical Evidence. Discussion Paper. Center for Economic Policy Research. Available online: www.cepr.org/pubs/dps/DP9533.asp
Ball, Ray, Joseph Gerakos, Juhani T. Linnainmaa & Valeri Nikolaev (2014). Deflating Profitability. Chicago Booth Paper No. 14-10. Available Online:
http://www.bengrahaminvesting.ca/Outreach/Symposium/2014_papers/Linnainmaa.
Bebchuk, Lucian, Alma Cohen & Allen Ferrell (2009). What matters in Corporate
Bebchuk, Lucian, Alma Cohen & Allen Ferrell (2009). What matters in Corporate