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Corporate Social Responsibility and Firm Value: Disaggregating the Effects on Cash Flow, Risk and Growth

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Abstract

This paper investigates the effect of corporate social responsibility (CSR) on firm value and seeks to identify the source of that value, by disaggregating the effects on forecasted profitability, long-term growth and the cost of capital. The study explores the possible risk (reducing) effects of CSR and their implications for financial measures of performance. For individual dimensions of CSR, in general strengths are positively valued and concerns are negatively valued, although the effect is not universal across all dimensions of CSR. We show that these valuation effects are principally driven by CSR performance associated with better long run growth prospects, with an additional minor contribution made by a lower cost of equity capital.

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Notes

  1. Firms can be valued in various ways, for example, at the enterprise level (that is to say, the combined value of the firm’s debt and equity) or at the equity or shareholder level (which involves valuing firm level cash flows at the equity cost of capital), but properly calculated the results are always equivalent (Lundholm and O’Keefe, 2001). In this paper, the equity level is the focus, purely because the models employed in this paper have originated at this level.

  2. The clean-up and compensation costs to BP of the Deepwater Horizon accident have been estimated at up to $37bn (Financial Times 26 February 2012). This cash flow effect resulting from firm-specific risk, however unpalatable it may seem, can be diversified away by shareholders. For instance, at the worst point in the spill disaster, BPs shares roughly halved in value. However, a well-diversified investor with just 1 % of her portfolio in BPs stocks would have suffered a loss of around 0.5 % on such a portfolio. Contrast this situation with the collapse of Lehman Brothers. On the single day that this event occurred, the US market as a whole fell by 4.71 %. Therefore, even if the investor was perfectly diversified across the 500 stocks that comprise the S&P 500 index, in just 1 day she would have suffered a near 5 % fall in her wealth. Of course, international diversification helps, but all major markets fell when Lehman’s filed for bankruptcy.

  3. Precisely, β is the firm’s standard deviation of the firm’s return multiplied by the market’s standard deviation of return multiplied by the correlation between the firm’s and the market’s return, divided by the market variance of returns (i.e. the firm’s covariance of return with the market return, divided by the market variance).

  4. This database is well-known in the CSR literature and more detailed descriptions of KLD database can be found in Hillman and Keim (2001), Mattingly and Berman (2006), Bird et al. (2007) and Barnett and Salomon (2012).

  5. If a firm has both strengths and concerns, it is unambiguously ‘Grey’ using the Fernando et al (2010) categorisation. By contrast, the net score could be positive, negative or zero in such circumstances.

  6. We are grateful to an anonymous reviewer for pointing out this potential difficulty.

  7. Note that for our sample of US firms, while the reporting of the expense is mandatory, there is always the materiality consideration. An entity may choose not to report such an amount if it is viewed as non-material. So our view is that it is entirely reasonable to assume R&D expenditures are approximately zero when they are not disclosed. Unreported robustness checks on firms that only have reported values confirms that this does not seem to qualitatively affect the results, save for the sample size being considerably smaller.

  8. From Ken French’s data library: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Results are robust to an alternative 10-industry classification.

  9. The additional factors are motivated by the observation that average returns on stocks of small stocks and on stocks with a high book to market ratio (value stocks) have been historically higher and as such may represent proxies for exposures to sources of systematic risk not captures by CAPM.

  10. Note that results are robust to the use of the alternative Carhart (1997) four factor model, which uses an additional momentum factor in addition to the three systematic risk factors in the three factor model. However, as our context is corporate cost of capital, we prefer the three factor model given the ambiguity on whether momentum is a rationally priced risk factor or an anomaly.

  11. All industry returns are from Ken French’s data library.

  12. Value-weighted results are available from the authors on request.

  13. Strictly, although Lee et al. (1999) claim that their model is based on Ohlson (1995) it is actually a version of the Peasnell (1982) model, as there is neither an “other information” parameter, nor a “linear information dynamic” in the model estimated.

  14. This is one of the approaches taken in El Ghoul et al. (2011), who find that for two CSR indicators (environment and employee relations) high CSR firms have a lower implied equity cost of capital.

  15. Given this, we also re-ran our tests using an assumption that all industries have a true β of unity, i.e. we assume that in any given year, all firms face the same cost of capital. The results were qualitatively identical.

  16. Defined as in Eq. (4) from Easton et al. (2002).

  17. We also note a small but marginally significant alpha for the Overall indicator for the industry-adjusted portfolio returns, suggesting that a portfolio long in ‘Green’ stocks and short in ‘Toxic’ stocks outperforms by about 0.141 % per month on an industry-adjusted basis, although such an effect is statistically insignificant if the Carhart (1997) four factor model is employed.

  18. In unreported robustness checks, we obtain similar results using an alternative ‘positive’, ‘negative’ and ‘zero’ net score classification.

  19. Although our results are robust to Winsorising at the 1 and 5 % levels.

  20. Other studies (in particular, El Ghoul et al. 2011) implement (6) by solving for r e rather than g. This requires g to be held constant across all firms. If we do so, the results are striking, with ‘Green’ firms having the lowest ICC for all categories of CSR except Diversity (where ‘Neutral’ firms have the lowest, and ‘Toxic’ firms have the highest, except in the case of Community where ‘Grey’ firms have a marginally higher ICC. Full results are available from the authors on request.

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Acknowledgments

The authors gratefully acknowledge the comments of Louis Ederington, Alex Edmans, Chitrou Fernando, Scott Linn, Vahap Uysal and Pradeep Yadav, together with seminar participants at the 2011 PRI Conference in Sigtuna, Sweden, the University of Bristol, the University of Oklahoma (Price College of Business), the University of Piraeus and the University of Swansea. We are also grateful to XiaoJuan Yan, PhD student at the University of Exeter, for her help in assembling the data for this paper.

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Authors and Affiliations

  1. Xfi-Centre for Finance and Investment, University of Exeter Business School, Rennes Drive, Exeter, EX4 4PU, UK

    Alan Gregory & Rajesh Tharyan

  2. Department of Organisation Studies, University of Exeter Business School, Rennes Drive, Exeter, EX4 4PU, UK

    Julie Whittaker

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Correspondence to Alan Gregory.

Appendix

Appendix

Dimensions

Strengths

Concerns

Community

Generous giving

Investment controversies

Innovative giving

Negative economic impact

Support for housing

Indigenous peoples relations

Support for education (added in 1994)

Tax disputes

Indigenous peoples relations strength (2000–2002)

Other concern

Non-US charitable giving

 

Volunteer programmes strength (added 2005)

 

Other strength

 

Diversity

CEO

Employee discrimination (renamed from controversies 2007 August)

Promotion

 

Board of directors

Non-representation

Family benefits

Other concern

Women/minority contracting

 

Employment of the disabled

 

Progressive gay/lesbian policies (added in 1995)

 

Other strength

 

Employee

Union relations strength

Union relations concern

No layoff policy (through 1994)

Health and safety concern (renamed from safety controversies in 2003)

Cash profit sharing

 

Employee involvement

Workforce reductions

Strong retirement benefits

Pension/benefits concern (added in 1992)

Health and safety strength (added in 2003)

Other concern

Other strength

 

Environment

Beneficial products and services

Hazardous waste

Pollution prevention

Regulatory problems

Recycling

Ozone depleting chemicals

Alternative fuels

Substantial emissions

Property, plant, and equipment (through 1995)

Agricultural chemicals

Management systems (added 2006)

Climate change (added in 1999)

Other strength

Other concern

Product

Quality

Product safety

R&D/innovation

Marketing/contracting controversy

Benefits to economically disadvantaged

Antitrust

Other strength

Other concern

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Gregory, A., Tharyan, R. & Whittaker, J. Corporate Social Responsibility and Firm Value: Disaggregating the Effects on Cash Flow, Risk and Growth. J Bus Ethics 124, 633–657 (2014). https://doi.org/10.1007/s10551-013-1898-5

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