Corporate Social Responsibility has been attributed a variety of dissimilar meanings by scholars of different communities, highlighting that it is subject to social understanding and interpretation (Dahlsrud 2006). For instance, it was defined by Frederick et al. (1992) as a principle stating that corporations should be accountable for the effects of their actions on society and the environment, and by the Commission of European Communities (2001) as
‘a concept, whereby companies integrate social and environmental concerns in their business operations and in their interaction with
stakeholders on a voluntary basis’.
This paper will lean toward the latter definition, as it emphasizes that the actions and reactions of corporations for the benefit of the community and environment are voluntary.
The components of CSR can also vary to some extent. However, ‘society’ and ‘environment’
are always recurring associations of CSR, and Economic and Stakeholder dimensions are often included (Dahlsrud 2006). As discussed earlier in the section on literature review, recent studies show that the effects of good and bad CSR are significant yet asymmetrical.
While returns are largely reduced by an oversight in CSR, they do not improve by the same amount when information about good CSR practice is released. Excluding legally required components and keeping only activities that fall under ‘voluntary’ bounds of company action should help reduce this mismatch.
5.2 Corporate Social Responsibility in recent times
What makes Corporate Social Responsibility relevant and interesting is that amid growing discontent over inequality in a capitalist society in the US and in the aftermath of lobbying scandals, an increasing extent of investor confidence and optimism can be attributed to a
firm’s involvement in CSR (Forbes 2012). Moreover, with several corporations going global over the last decade and outsourcing their production and assembly supply chain, consumers are increasingly conscious of the effects of firm activity on global communities. These concerns could translate into higher value for CSR firms.
In fact, several industries are already facing fierce competition in upholding and improving their CSR. Businesses with few growth opportunities remaining turn to CSR as an avenue for market capitalization. This is evident from the recent bid by fast food giants in North America to switch to cage-free eggs by as early as the end of 2016 (Forbes 2016). Despite constrictive profit margins in the fast food industry, McDonalds, Dunkin Donuts and Taco Bell have all voiced their commitment to switching to the pricier, eco-friendly alternative, and while 47% of consumers welcome the change, only 17% of those are willing to pay more for it. The response of profitability to CSR is tricky to gauge. While the restaurants may benefit from a 17% increase in revenues after the switch, is it likely to cover the costs of the move, and will they lose sales to more economic options?
These problems suggest that CSR must be separated layer by layer because each category of components is likely to have a distinct relation with external and internal response.
The Commission for European Communities in its Green Paper (2001) segments CSR into an internal and external dimension. The Thompson Reuters ESG matrix is used in this paper.
According to this matrix, subcategories of CSR may be separated by the following distinctions:
Environmental Concerns
1. Management of Environmental impact of outputs (emission & waste) 2. Management of natural resources (inputs such as energy, water)
Social Concerns
1. Local Communities
2. Human Rights
3. Product Safety, Responsible Marketing 4. Impact on development in third countries
Governance Concerns:
Concern for corporate social responsibility has been gaining strength since the early 1950’s and since that period has ballooned from concepts of employee management and philanthropy into direct strategic and performance implications for firms and investors (Carrol 2008). Over the decades, corporate social responsibility has helped bridge the gap between stakeholders and firm management (Moura-Leite & Padgett 2011).
One of the earliest publications on the importance of corporate social responsibility is Howard R. Bowen’s Social Responsibilities of the Businessman (1953). Howard R. Bowen, along with author Morrell Heald both cite examples of institutional changes following the incorporation of corporate social responsibility since the beginning of the twentieth century (Moura-Leite & Padgett 2011). These writers provide evidence that CSR has long since been intriguing not only due to its impact on society but also due to its impact on corporate governance. In spite of this initial interest, Carroll and Shabana (2010) note that studies of the impact of CSR on benefits to firm and shareholders did not emerge until later in the century.
Similar early literature on CSR focuses on normative principles and the definition of boundaries for ‘necessary’ corporate social responsibility. Early CSR mainly involved philanthropy on the part of corporations and also struggled to incorporate a common ground for evolving labor union demands.
Two significant contributions to the literature on CSR were made by Joseph McGuire and Milton Freidman. McGuire argued in his book in 1963 that corporations had a responsibility to society that extended beyond their fundamental ‘economic and legal obligations’ (Moura-Leite & Padgett 2011). Freidman (1962) emphasized that CSR could not undermine the focus of a corporation toward profit maximization because such CSR would then be detrimental to its shareholders. Freidman’s argument suggests that CSR should not go as far as outright philanthropy; even while social responsibility and good governance are two separate distinct areas of CSR, a firm’s efforts at benefiting society should not cost its shareholders to the extent that the net result is a negative impact on firm CSR. The implications of these arguments present a further area of interesting research – how separate efforts can be evaluated while ranking firms, given the multifaceted nature of their effects.
A similar understanding went into the development of the ‘enlightened self-interest model’
in 1970’s. In the following decade, corporations were brought even closer to their stakeholders while the notion of philanthropy evolved into one of ‘public liability’ (Moura-Leite & Padgett 2011). Therefore, actions that were once construed as the ‘good will’ of corporations were now increasingly being viewed as a social accountability. From this it might be inferred that prior to the 1980’s, the decision to engage in CSR would have a greater positive impact on a company’s reputation and in contrast, after the 1990’s, lack of CSR would have a greater negative impact.
Because the relationship between a business and society has always been implicit, a significant proportion of literature from the 1970’s and 80’s seeks to explore and define this relationship in order to establish what fell under the definition of public liability for a firm, and whether CSR initiatives were complimentary or contrary to a firm’s business practices.
Both Peter Drucker (1984) and Cochran and Wood (1984) find that higher CSR improves a firm’s financial performance (Moura-Leite & Padgett 2011).
In conclusion, while corporate social responsibility was initially much more voluntary, modern laws and regulations regarding corporate governance and employee provisions, evidence of positive correlation between CSR and firm performance, and a large investor base following of a firm’s social and environmental reputation have resulted in majority of firms on world-wide stock indices to be awarded annual rankings, and these rankings are consistently negatively skewed. This can be seen in the section on Descriptive Statistics.
6 DATA AND METHODOLOGY
This chapter presents the data and the research methods used to conduct empirical tests. First it explains the sources and selection of data and then moves on to the empirical equations and the choice of control variables.
6.1 Data Selection
For the purposes of this study, separate Environmental, Social and Governance rankings, along with financial performance and stock returns are collected for firms on Stock market indices in the UK and Germany. The sample therefore includes FTSE 100 and HDAX firms from the period 2002-2014. Developed markets are chosen for this paper because it is presumed that investor following on CSR trends is greater in these markets. In addition, the evaluation of the effects of CSR in two separate markets also allows a comparison between the geographical influences on the effects of Environmental and Social scores between these markets.
Data is gathered from Thompson Financial and Worldscope databases. The Thompson Reuters ESG database awards each company one point for compliance in each of its 278 governance, 516 social and 322 environmental subcategories. These subcategories can be summarized by the main concerns listed in Table 1.
The data is first screened for missing values. Firms with more than 4 years of missing financial data or missing ES&G ratings are not included in this empirical study. This leaves us with 93 firms from FTSE-100 and 91 firms from HDAX. Variables for these firms regressed over a period of 13 years provides a sample with approximately 2000 observations.
6.2 Empirical models
This paper studies two separate relationships, and likewise, two types of empirical tests are employed to obtain the results. For the first hypothesis, a multivariate time-series regression model is applied between Operating Profits Margin and Social and Environmental scores.
The following equation is used to estimate the relationship:
(1) OPMarginit = β0 + β1 ln Assetit + β2Earnings_Shareit + β3ASSETTURNit + β4Interest_Cover + β5MTBVit + β6Payout_Ratioit + β7GOVit + β8ENVit + β9SOC + εit
The control variables included in this equation are the size of the firm (ln Assets), earnings per share (Earnings_Share), asset turnover ratio (ASSETTURN), interest coverage ratio (Interest_Cover), market to book value ratio (MTBV), the payout ratio (Payout_Ratio) and the score for Corporate Governance (GOV). Fixed effects cross section panel data regression method with period weights is used to estimate this equation.
The second part of the hypothesis relates Environmental and Social scores to dividends per share.
(2) Div_Shareit = β0 + β1 ln Assetit + β2Earnings_Shareit + β3Sales_Share + β4MTBVit + β5Payout_Ratioit + β6GOVit + β7ENVit + β8SOC + εit
(3) ln(Net Debt)it = β0 + β1 ln Assetit + β2Interest_Coverit + β3lnOperating_Incomeit + + β4Payout_Ratioit + β5GOVit + β6ENVit + β7SOC + εit
6.3 Limitations of the Study
One of the primary limitations of this study is the current adverse selection present in analyst and ESG rankings data. For some firms in the sample, ESG rankings are missing for earlier years with poorer firm performance. Such firms have been excluded from the analysis. Stocks that are listed on FTSE and HDAX are more susceptible to this adverse selection, and it can be inferred that similar if not more severe omissions are present in developing markets which would make studies of firm performance and ESG rankings more challenging.
In addition, this study only focuses on incorporated firms with stocks selling on the FTSE-100 and HDAX. In reality, many firms whose main focus is CSR tend to be smaller, private firms, known in the US as Benefit corporations, or B corps. Since a majority of B corporations are not publicly traded, there is no reliable source of financial data for these firms, and an analysis of their financial performance alongside those of large, publicly trader for-profit corporations could not be conducted.
7 DESCRIPTIVE STATISTICS
This section details descriptive statistics for the data collected on Environmental and Social scores, and how these scores appear to relate to firm beta.
7.1 Summary Statistics of Key Variables
The following tables list the descriptive statistics for firms in FTSE-100 and HDAX respectively. Each table lists the mean, median, minimum, maximum, standard deviation, skewness and kurtosis for key variables in our analysis.
Table 1. Descriptive Statistics for firms in FTSE-100 (2002-2014) Social
According to the table above, firms in FTSE-100 have environmental and social rankings that are positively skewed, and from 2002-2014, have overall positive operating margins The following graphs depict the trends in average environmental and social ratings of firms over 2002-2014.
Figure 5. Average Social Rankings of Firms in FTSE 2002-2014
68 70 72 74 76 78 80 82 84
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Average Social Rankings, 2002-2014
Figure 6. Average Environmental Rankings of Firms in FTSE 2002-2014
The graphs above suggest that Environmental and Social Ratings move closely together from 2007-2014; both ratings fell in 2007 and peaked in 2010. However, this relationship is not detectable before the year 2007. Average social ratings have been slightly higher than average environmental ratings on the FTSE. These graphs could also represent trends in CSR awareness among corporations and investors in the UK from 2002-2014.
Table 3 shows the descriptive statistics for Operating profits margin, social and environmental scores for firms on the HDAX from 2002-2014.
66 68 70 72 74 76 78 80 82
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Average Environmental Rankings, 2002-2014
Table 2. Descriptive Statistics for Firms in HDAX (2002-2014)
Once again, both Social and Environmental scores are negatively skewed, though for HDAX, minimum scores in both areas are lower than scores by FTSE-100 firms. These scores also have a higher standard deviation than their counterparts in FTSE-100. Operating profits margin for firms on the HDAX have a minimum value of 0.03, as opposed to the negative minimum margin for firms on FTSE-100. These values point toward a possible negative correlation between operating profits margin, Social and Environmental scores.
The following graphs depict the average Social and Environmental Scores for firms on the HDAX from 2002-2014. Similar to the graphs for FTSE-100, these show that the average of the two ratings move closely together from 2008-2014, but appear to be uncorrelated before 2008.
Figure 7. Average Social Rankings of Firms in the HDAX 2002-2014
Figure 8. Average Environmental Rankings of Firms in the HDAX 2002-2014
62 64 66 68 70 72 74 76
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Average Social Ratings in HDAX 2002-2014
62 64 66 68 70 72 74 76
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Average Environmental Ratings in HDAX 2002-2014
7.2 Relationship between Beta, Environmental and Social Scores
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
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