Abstract
This paper argues the case that tests of how investors value corporate social performance (CSP) based upon realised stock market returns are liable to be weak tests if markets are efficient and firms change CSP policies infrequently. We provide a theoretical explanation of why this will be the case using examples to illustrate. Subsequently, we set out an alternative theoretical framework for the purposes of investigating whether markets place a positive, or a negative, valuation on CSP, and show why this is superior to tests based upon Tobin’s Q. Using US KLD data, we demonstrate that, as theorised, markets place a positive value on CSP that is not detected by conventional returns-based tests. Our conclusion is that researchers who are interested in the question of whether engagement with a corporate social responsibility agenda is a value-enhancing activity for a company (as argued by some stakeholder theorists) or value destructive (as argued by Friedman, The social responsibility of business is to increase its profits, The New York Times Magazine, 1970), need to look beyond returns-based tests to answer the research question posed.
Similar content being viewed by others
Notes
Note that it is simple to show that this result holds in a world where these firms are growing at a constant rate. For example, if both firms were expected to grow at 5 % beyond the current year, the value of both firms would double.
The KLD dimensions are described in detail below and are detailed in Appendix A.
Notably, soon after Friedman’s New York Times article Narver (1971) argued that to ignore the changing expectations of a broad base of stakeholders ‘can induce the capital market to perceive lower expected earnings and/or impute a higher risk factor resulting in a lower present value of the firm’.
Despite many papers referring to “Tobin’s Q”, almost invariably the original definition of the variable (market price to replacement cost of assets) is not used as replacement cost cannot be observed. Typically, some version of price to book value of assets is employed as a proxy for Tobin’s Q.
All source figures from www.ft.com.
Subject to appropriate assumptions concerning dividends (Ohlson 1995).
We implement this approach in Stata, and would like to thank Michell Petersen for making this code available on his website at http://www.kellogg.northwestern.edu/faculty/petersen/htm/papers/se/se_programming.htm.
Note that the argument over deflation is a rather complex one. For example, Barraclough (2007) warns about the dangers of inducing spurious correlations through the use of deflators. There is also the issue of whether it is appropriate to include the reciprocal of the deflator in the regressions. Whilst Shen and Stark (2011) include 1/deflator in their regressions, Barth and Clinch (2009) do not. We follow the latter here, but we check that including 1/book value in the regression does not alter inferences relating to CSR. While including 1/deflator results in that term being insignificant in the per share regressions, 1/book value is significant in the book value deflated regressions and leads to considerably higher explanatory power in the regressions. It does not, however, change the inferences with regard to CSR so we simply follow the Barth and Clinch (2009) approach here.
Full results are available from the authors on request.
Gregory et al. (2011b) use net scores and slightly different valuation model in their analysis.
Potentially, duplicates could arise if a firm changed its financial year end during the period of our study.
This recalibration effect would cause one of the dummy variables to be one for all firms that did not change CSP in the year when new indicators were introduced. However, using a net score measure changes will only be associated with firms that score either the new strength or concern measured by KLD. In years where no new indicators are introduced, the use of a dummy variable would accurately detect increases or decreases irrespective of whether net scores or normalised scores are employed.
For a formal proof, see Ohlson (1995).
We do not report these results for the simple reason that we think the valuation of the disaggregated CSR components is of more interest, and that other studies have focused on compound scores.
We are grateful to an anonymous reviewer for these suggestions.
References
Barnett, M. L. (2007). Stakeholder influence capacity and the variability of financial returns to corporate social responsibility. Academy of Management Review, 32(3), 794–816.
Barnett, M. L., & Salomon. (2012). Does it pay to be really good? Addressing the shape of the relationship between social and financial performance. Strategic Management Journal. doi:10.1002/smj.1980.
Barraclough, K. (2007). Scaling regression equations: Solution or problem? Vanderbilt University working paper. http://194.90.30.6/CaesareaAdmin/Uploads/ES/Events/Files/271.pdf. Accessed 20 July 2008.
Barth, M. E., Beaver, W. H., & Landsman, W. R. (1992). The market valuation implications of net periodic pension cost components. Journal of Accounting and Economics, 15, 27–62.
Barth, M. E., Clement, M. B., Foster, G., & Kasznik, R. (1998). Brand values and capital market valuation. Review of Accounting Studies, 3, 41–68.
Barth, M. E., & Clinch, G. (2009). Scale effects in capital markets-based accounting research. Journal of Business Finance and Accounting, 36(3–4), 253–288.
Bebchuk, L. A., Cohen, A., & Ferrell, A. (2009). What matters in corporate governance? Review of Financial Studies, 22(2), 783–827.
Bhagat, S., & Bolton, B. (2008). Corporate governance and firm performance. Journal of Corporate Finance, 14, 257–273.
Brammer, S., Brooks, C., & Pavelin, S. (2006). Corporate Social Performance and Stock Returns: UK Evidence from Disaggregate Measures. Financial Management, Autumn, 5–25.
Brown, L., & Caylor, M. (2006). Corporate governance and firm valuation. Journal of Accounting and Public Policy, 25, 409–434.
Chauvin, K., & Hirschey, M. (1994). Advertising, R&d expenditures and the market value of the firm. Financial Management, 22, 128–140.
Cohen, R. B., Polk, C., & Vuolteenaho, T. (2003). The value spread. Journal of Finance, 58, 609–641.
Cohen, R. B., Polk, C., & Vuolteenaho, T. (2009). The price is (almost) right. Journal of Finance, 64(6), 2739–2782.
Davidson, W. N, I. I. I., & Worrell, D. L. (1990). A comparison and test of the use of accounting and stock market data in relating corporate social responsibility and financial performance. Akron Business and Economic Review, 21(3), 7–19.
Edwards, E., & Bell, P. (1961). The theory and measurement of business income. Berkeley, CA: University of California Press.
El Ghoul, S., Guedhami, O., Kwok, C. C. Y., & Mishra, D. (2011). Does corporate social responsibility affect the cost of capital? Journal of Banking & Finance, 35, 2388–2408.
Fama, E. F., & French, K. R. (1996). Multifactor explanations of asset pricing anomalies. Journal of Finance, 50, 131–155.
Freeman, R. E. (1984). Strategic management: A stakeholder perspective. Boston, MA: Pitman Publishing Inc.
Friedman, M. (1970, September 13). The social responsibility of business is to increase its profits. The New York Times Magazine.
Galema, R., Plantinga, A., & Scholtens, B. (2008). The stocks at stake: Return and risk in socially responsible investment. Journal of Banking & Finance, 32, 2646–2654.
Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118(1), 107–155.
Gow, I. D., Ormazabal, G., & Taylor, D. J. (2010). Correcting for cross-sectional and time-series dependence in accounting research. The Accounting Review, 85(2), 483–512.
Green, P. J., Stark, A. W., & Thomas, H. M. (1996). UK evidence on the market valuation of research and development expenditures. Journal of Business Finance and Accounting, 23(2), 191–216.
Gregory, A., Tharyan, R., & A. Christidis. (2011). Constructing and testing alternative versions of the Fama–French and Carhart models in the UK. http://ssrn.com/abstract=1951831.
Gregory, A., Whittaker, J., & Yan, X. (2011). Stock market valuation of corporate social responsibility indicators. Discussion paper 10/06, Centre for Finance and Investment, University of Exeter Business School.
Gu, F., & Li, J. Q. (2010). The value-relevance of advertising: Evidence from pharmaceutical industry. Journal of Accounting, Auditing & Finance, 25(1), 85–120.
Guenster, N., Bauer, R., Derwall, J., & Koedijk, K. (2011). The economic value of corporate eco-efficiency. European Financial Management, 17(4), 679–704.
Hassel, L., Nilsson, H., & Nyquist, S. (2005). The value relevance of environmental performance. European Accounting Review, 14(1), 41–61.
Kempf, A., & Osthoff, P. (2007). The effect of socially responsible investing on portfolio performance. European Financial Management, 13(5), 908–922.
Kim, Y., & Statman, M. (2012). Do corporations invest enough in environmental responsibility? Journal of Business Ethics, 105, 115–129.
Lev, B., & Sougiannis, T. (1996). The capitalization, amortization, and value-relevance of R&D. Journal of Accounting and Economics, 21(1), 107–138.
Lewellen, J., Nagel, S., & Shanken, J. (2010). A skeptical appraisal of asset-pricing tests. Journal of Financial Economics, 96, 175–194.
Liston-Heyes, C., & Ceton, G. (2009). An investigation of real versus perceived CSP in S&P-500 firms. Journal of Business Ethics, 89, 283–296.
Lundholm, R., & O’Keefe, T. (2001). Reconciling value estimates from the discounted cash flow model and the residual income model. Contemporary Accounting Research, 18(2), 311–335.
Margolis, J., & Walsh, J. P. (2003). Misery loves companies: Rethinking social initiatives by business. Administrative Science Quarterly, 48(2), 268–305.
McWilliams, A., & Siegel, D. (2000). Corporate social responsibility and financial performance: Correlation or misspecification. Strategic Management Journal, 21(5), 603–609.
Narver, J. C. (1971). Rational management responses to external effects. The Academy of Management Journal, 14(1), 99–115.
Ohlson, J. A. (1995). Earnings, book values, and dividends in equity valuation. Contemporary Accounting Research, 11(2), 661–678.
Orlitzky, M., Schmidt, F. L., & Rynes, S. L. (2003). Corporate social and financial performance: A meta-analysis. Organization Studies, 24, 403–441.
Peasnell, K. V. (1982). Some formal connections between economic values and yields and accounting numbers. Journal of Business Finance and Accounting, 9(3), 361–381.
Petersen, M. A. (2009). Estimating standard errors in finance panel data sets: Comparing approaches. Review of Financial Studies, 22(1), 435–480.
Rees, W. P. (1997). The impact of dividends, debt and investment on valuation models. Journal of Business Finance and Accounting, 24(7), 1111–1140.
Renneboog, L., Ter Horst, J. R., & Zhang, C. C. (2008). ‘Socially responsible investments: Institutional aspects, performance, and investor behavior. Journal of Banking & Finance, 32, 1723–1742.
Sharfman, M. P., & Fernando, C. S. (2008). Environmental risk management and the cost of capital. Strategic Management Journal, 29, 569–592.
Shen, Y., & A. W. Stark (2011). Evaluating the effectiveness of model specifications and estimation approaches for empirical accounting-based valuation models. SSRN working paper no. 1888386.
Surroca, J., Tribó, J. A., & Waddock, S. (2010). Corporate responsibility and financial performance: The role of intangible resources. Strategic Management Journal, 31, 463–490.
van Beurden, P., & Gossling, T. (2008). The worth of values—a literature review on the relation between corporate social and financial performance. Journal of Business Ethics, 82, 407–424.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Gregory, A., Whittaker, J. Exploring the Valuation of Corporate Social Responsibility—A Comparison of Research Methods. J Bus Ethics 116, 1–20 (2013). https://doi.org/10.1007/s10551-012-1465-5
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10551-012-1465-5