Pinpointing the Value in CSR
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Social Impact Mar 4, 2013

Pin­point­ing the Val­ue in CSR

The unex­pect­ed link between CSR spend­ing and finan­cial performance.

Pro­po­nents of cor­po­rate social respon­si­bil­i­ty (CSR) ini­tia­tives tend to jus­ti­fy their posi­tion by argu­ing that these expen­di­tures improve a company’s eco­nom­ic performance―allowing it to earn high­er prof­its through enhanced brand rep­u­ta­tion, more-pro­duc­tive employ­ees, and insu­la­tion from reg­u­la­to­ry penal­ties. In oth­er words, exec­u­tives pro­mote the company’s own inter­ests by pur­su­ing a strat­e­gy of doing well by doing good.”

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In con­trast, econ­o­mist Mil­ton Fried­man pro­claimed in 1970 (the rel­a­tive infan­cy of the mod­ern CSR move­ment) that in a free soci­ety, there is one and only one social respon­si­bil­i­ty of busi­ness — to use its resources and engage in activ­i­ties designed to increase its prof­its so long as it stays with­in the rules of the game.” The seem­ing con­tra­dic­tion between Fried­man and CSR pro­po­nents lies in how each defines CSR. Fried­man focus­es on true” CSR expen­di­tures, which pro­vide only social ben­e­fits. As a result, under Friedman’s view, com­pa­nies under­tak­ing CSR ini­tia­tives do so to the detri­ment of share­hold­er value.

These find­ings should serve as a wake-up call to exec­u­tives who are either cur­rent­ly under­tak­ing CSR or con­sid­er­ing future CSR investments.

Our research on the impact of CSR expen­di­tures on finan­cial per­for­mance sug­gests that the views of both CSR pro­po­nents and Fried­man are incom­plete. We find that CSR expen­di­tures gen­er­ate insuf­fi­cient returns and hence reduce share­hold­er val­ue, con­sis­tent with the Fried­man view. How­ev­er, we also find that com­pa­nies whose CSR spend­ing exceeds investor expec­ta­tions expe­ri­ence pos­i­tive stock returns, con­sis­tent with evi­dence pro­mot­ed by CSR proponents.

We rec­on­cile these con­flict­ing results by iden­ti­fy­ing a sig­nal­ing com­po­nent to CSR expen­di­tures. When investors see a firm with­hold or devote resources to CSR ini­tia­tives, they infer that its exec­u­tives are act­ing on pri­vate infor­ma­tion about the future earn­ings and cash flows of the firm. For exam­ple, if a firm spends more on CSR than investors expect, the excess com­po­nent of CSR is viewed as an indi­ca­tor of pos­i­tive future finan­cial per­for­mance. We find that the pos­i­tive stock returns expe­ri­enced by CSR firms do not arise because the eco­nom­ic ben­e­fits of CSR exceed their costs but because investors inter­pret excess CSR expen­di­tures as a pre­cur­sor to pos­i­tive future finan­cial per­for­mance. To put it sim­ply, CSR is what rich” com­pa­nies do!

At a time when more and more cor­po­ra­tions pur­sue CSR ini­tia­tives, often unteth­ered from busi­ness strat­e­gy or per­for­mance met­rics, exec­u­tives need to under­stand the long-term val­ue of these efforts and recal­i­brate their strate­gies accord­ing­ly. They must con­sid­er whether the cor­po­rate ben­e­fits from CSR jus­ti­fy their costs. Our research shows that, on aver­age, they do not.

A Grow­ing Empha­sis on Cor­po­rate Social Responsibility

Over the past decade, more com­pa­nies have embraced CSR and now dis­close their activ­i­ties to investors on an annu­al basis. In 2011, for instance, 57 per­cent of For­tune 500 com­pa­nies issued cor­po­rate account­abil­i­ty reports, up from 20 per­cent the pre­vi­ous year. The growth of CSR can be traced in part to the expec­ta­tion that com­pa­nies can prof­it by serv­ing the greater social good. For exam­ple, one of the jus­ti­fi­ca­tions for CSR is that it builds pride and cohe­sion among employ­ees, which results in bet­ter oper­a­tional performance.

Many cor­po­ra­tions have sought to use social impact as a core ele­ment of busi­ness strat­e­gy, iden­ti­fy­ing ben­e­fits and mak­ing informed choic­es. Oth­ers have pro­ceed­ed in a more slip­shod way, assum­ing that mar­kets and cus­tomers would reward them for their cor­po­rate cit­i­zen­ship and virtue. How­ev­er, absent a direct con­nec­tion between CSR and finan­cial per­for­mance, Fried­man and his fol­low­ers would seem to be right: exec­u­tives would be irre­spon­si­ble to pur­sue CSR initiatives.

Moti­va­tions for CSR Expenditures

Our research address­es two pri­ma­ry issues. Is CSR asso­ci­at­ed with improved finan­cial per­for­mance? If so, what is the direc­tion of the causal­i­ty? In oth­er words, do CSR expen­di­tures lead to improved finan­cial per­for­mance or does the antic­i­pa­tion of improved finan­cial per­for­mance lead to CSR expen­di­tures. We address these issues by focus­ing on three broad cat­e­gories of strate­gic goals for CSR expenditures.

Are CSR expen­di­tures char­i­ta­ble dona­tions? The truest form of CSR is when a com­pa­ny makes a direct mon­e­tary con­tri­bu­tion for which it expects no return. An anony­mous gift to a good cause would be one exam­ple.Do cor­po­ra­tions view CSR as a busi­ness invest­ment? As not­ed above, many com­pa­nies use CSR to address a social issue (such as the envi­ron­ment) while earn­ing a pos­i­tive eco­nom­ic return (for exam­ple, in the form of enhanced rep­u­ta­tion). Although the ben­e­fits can some­times be less tan­gi­ble and thus hard­er to mea­sure, exec­u­tives expect some return on this invest­ment. Spend­ing need not be direct­ly relat­ed to operations―McDonald’s estab­lish­ment and sup­port of the Ronald McDon­ald House char­i­ties is one exam­ple. By seek­ing to serve the greater social good, these efforts may increase the corporation’s image, boost rev­enues, and reduce costs (for exam­ple, if employ­ees val­ue such con­tri­bu­tions and there­fore accept low­er direct wages).

Do CSR expen­di­tures pro­vide new infor­ma­tion about future finan­cial per­for­mance? Con­sid­er a busi­ness that has expe­ri­enced a break­through that will cause prof­itabil­i­ty to soar in future peri­ods. Infor­ma­tion about this devel­op­ment is known only to the company’s exec­u­tives. If exec­u­tives were to increase the cur­rent lev­el of CSR expen­di­tures because of this infor­ma­tion, then the CSR expen­di­tures act as a mech­a­nism that sig­nals infor­ma­tion about the company’s future prospects to investors.

To explore the link between CSR expen­di­tures and finan­cial per­for­mance, we col­lect­ed infor­ma­tion on CSR activ­i­ties from the Thom­son Reuters ASSET4 data­base, which pro­vides com­pre­hen­sive CSR data for com­pa­nies in the Rus­sell 1000. ASSET4 eval­u­ates com­pa­nies using 250 key per­for­mance indi­ca­tors (KPIs) in four cat­e­gories of per­for­mance: eco­nom­ic, envi­ron­men­tal, social, and cor­po­rate gov­er­nance. Our sam­ple con­sists of hun­dreds of com­pa­nies from 2002 to 2010 across a num­ber of indus­tries, and the pri­ma­ry mea­sure of CSR invest­ment relies on envi­ron­men­tal and social fac­tors only.

We com­pare a company’s CSR expen­di­tures with its finan­cial per­for­mance as mea­sured by return on assets, oper­at­ing cash flow, and size-adjust­ed stock returns. A key assump­tion in our analy­sis is that, based on a company’s cur­rent observ­able per­for­mance, oper­at­ing char­ac­ter­is­tics, and indus­try, investors expect a cer­tain lev­el of CSR invest­ment. To under­stand how CSR expen­di­tures affect future per­for­mance, we dis­tin­guish between the expect­ed and unex­pect­ed com­po­nents of CSR expen­di­ture. A pos­i­tive asso­ci­a­tion between finan­cial per­for­mance and the expect­ed com­po­nent of CSR expen­di­tures is con­sis­tent with CSR behav­ing much like a busi­ness invest­ment, where­as a pos­i­tive asso­ci­a­tion between finan­cial per­for­mance and the unex­pect­ed com­po­nent is con­sis­tent with sig­nal­ing. Our results are incon­sis­tent with the invest­ment expla­na­tion but con­sis­tent with the sig­nal­ing explanation.

How CSR Sends a Sig­nal to Investors

When investors see a com­pa­ny devote sig­nif­i­cant resources to CSR ini­tia­tives, they infer that its exec­u­tives are act­ing on pri­vate infor­ma­tion about future earn­ings and cash flows. In essence, only busi­ness­es that expect to have excess cash down the road can under­take such ini­tia­tives now. Even if a com­pa­ny took pains to com­mu­ni­cate that it is a social­ly respon­si­ble enter­prise, our results indi­cate that infor­ma­tion in the cor­po­rate account­abil­i­ty report can be used as a more accu­rate pre­dic­tor of future finan­cial performance.

These find­ings con­tra­dict the cur­rent school of thought, which holds that CSR expen­di­tures cre­ate val­ue by being mutu­al­ly ben­e­fi­cial to the com­pa­ny (through bet­ter oper­a­tions or per­for­mance) and soci­ety (by help­ing to make a pos­i­tive social impact). Our results show that CSR expen­di­tures typ­i­cal­ly destroy share­hold­er val­ue: the return they gen­er­ate, on aver­age, is below the company’s cost of cap­i­tal. So while exec­u­tives may believe that CSR cre­ates good­will among con­sumers and reg­u­la­tors — and it may do so in tar­get­ed cir­cum­stances —our research indi­cates that from the per­spec­tive of investors, these expen­di­tures do not make a suf­fi­cient con­tri­bu­tion to the bot­tom line to jus­ti­fy their cap­i­tal costs.

Iden­ti­fy­ing Where the Val­ue Lies

How­ev­er, the over­all lev­el of CSR invest­ment does have an impact on mar­ket per­cep­tions. In short, investors expect that only suc­cess­ful com­pa­nies have enough cash and resources to sus­tain CSR expen­di­tures. Com­pa­nies that exceed the expect­ed lev­el of CSR spend­ing are per­ceived by investors as sig­nal­ing bet­ter future per­for­mance. To high­light our approach and results, assume that in the pre­vi­ous year a com­pa­ny spent $9 mil­lion on CSR efforts. Investors, antic­i­pat­ing con­tin­ued strong per­for­mance, might expect its lev­el of CSR invest­ment to be $10 mil­lion for the com­ing year. If exec­u­tives spend $10.5 mil­lion — thus exceed­ing the expect­ed lev­el — investors inter­pret it as a pos­i­tive sign and respond by bid­ding up the company’s stock price. Sim­i­lar­ly, if CSR expen­di­tures only total $9.5 mil­lion, investors will per­ceive this under­in­vest­ment as a neg­a­tive indi­ca­tor of future performance.

These find­ings should serve as a wake-up call to exec­u­tives who are either cur­rent­ly under­tak­ing CSR or con­sid­er­ing future CSR invest­ments. Imag­ine that a com­pa­ny has a set amount to spend on CSR for the com­ing year and can choose between two options: sup­port safe-water projects in Africa or sim­ply give mon­ey away on a street cor­ner. The choice seems ridicu­lous on its face. After all, the for­mer would seem to con­fer rep­u­ta­tion­al ben­e­fits, while the lat­ter could result in deri­sion or even seri­ous mis­giv­ings about the judg­ment of the exec­u­tive lead­er­ship. How­ev­er, both choic­es pro­vide com­pa­ra­ble infor­ma­tion about the company’s future cash flows: it would not engage in either activ­i­ty unless it expect­ed to have excess cash in the future. In sim­ple terms, CSR is what rich” com­pa­nies can afford to do and poor” com­pa­nies cannot.

Strik­ing a bet­ter balance

We rec­og­nize that our find­ings high­light a con­tra­dic­tion: while CSR expen­di­tures do not cre­ate val­ue for the typ­i­cal busi­ness, investors expect that cor­po­ra­tions will engage in a basic lev­el of CSR, and devi­a­tions from this lev­el will be inter­pret­ed as an indi­ca­tion of health and prof­itabil­i­ty. As exec­u­tives reex­am­ine their approach to CSR, they should keep the fol­low­ing lessons in mind:

Rec­og­nize the sig­nal­ing pow­er of CSR expen­di­tures. Many exec­u­tives have oper­at­ed under the impres­sion that CSR expen­di­tures are indi­ca­tors of their company’s virtue and pro­gres­sive pri­or­i­ties and that investors would inter­pret these qual­i­ties as a sign of a high-func­tion­ing orga­ni­za­tion. Instead, these expen­di­tures appear to be anoth­er chan­nel through which a busi­ness com­mu­ni­cates its finan­cial prospects. There­fore, exec­u­tives should be aware of how investors will per­ceive their organization’s lev­el of CSR expenditure.

Become more strate­gic about CSR. Since our results indi­cate that CSR, on aver­age, does not increase share­hold­er val­ue, exec­u­tives have the respon­si­bil­i­ty to be even more strate­gic about which CSR efforts to pur­sue. Some com­pa­nies have made inroads in inte­grat­ing CSR into busi­ness strat­e­gy. For exam­ple, when expand­ing into inter­na­tion­al mar­kets, exec­u­tives might choose to sup­port caus­es or pro­grams in these coun­tries. Since investors expect suc­cess­ful com­pa­nies to main­tain CSR invest­ment, cor­po­rate lead­ers should deter­mine where these expen­di­tures will make the great­est impact.

Our find­ings high­light a chal­lenge around CSR: investors per­ceive it as dis­cre­tionary spend­ing unre­lat­ed to oper­a­tional per­for­mance. Pro­po­nents of CSR can­not rely on gen­er­al asso­ci­a­tions between finan­cial per­for­mance and CSR expen­di­tures in pro­mot­ing these activ­i­ties. Rather, they must clear­ly demon­strate the impact of spe­cif­ic ini­tia­tives in mea­sur­able terms to advance the mer­its of CSR.

Featured Faculty

Thomas Lys

Professor Emeritus of Accounting Information & Management

James Naughton

Assistant Professor of Accounting Information & Management

Clare Wang

Member of the Department of Accounting Information & Management faculty until 2017

About the Research

“Signaling Through Corporate Accountability Reporting,” SSRN Working Paper, Social Science Research Network, February 2013.

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