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Exploring the Valuation of Corporate Social Responsibility—A Comparison of Research Methods

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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.

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Notes

  1. 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.

  2. The KLD dimensions are described in detail below and are detailed in Appendix A.

  3. 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’.

  4. 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.

  5. All source figures from www.ft.com.

  6. Subject to appropriate assumptions concerning dividends (Ohlson 1995).

  7. 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.

  8. 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.

  9. Full results are available from the authors on request.

  10. Gregory et al. (2011b) use net scores and slightly different valuation model in their analysis.

  11. Potentially, duplicates could arise if a firm changed its financial year end during the period of our study.

  12. 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.

  13. For a formal proof, see Ohlson (1995).

  14. 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.

  15. We are grateful to an anonymous reviewer for these suggestions.

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Correspondence to Alan Gregory.

Appendices

Appendix A

See Table 11.

Table 11 KLD indicators

Appendix B

See Tables 12 and 13.

Table 12 Barth et al. (1998) pooled regressions for price on CSR indicators—for only those firms with recorded values of both advertising and R&D expenditures
Table 13 Pooled regressions of price deflated by book value (a proxy for Tobin’s Q) on CSR indicators and control variables—for only those firms with recorded values of both advertising and R&D expenditures

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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

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