The Relationship between Corporate Social Responsibility and Corporate Financial Performance

Table of Contents

1. Introduction 2

2. Corporate social responsibility 2

2.1 Definition of corporate social responsibility 2

2.2 Corporate social responsibility’s Drivers 3

2.3 Corporate social responsibility Implementation 3

2.4    Corporate social responsibility measurement 4

3. Corporate Financial Performance 5

4. Relationship between corporate social responsibility and corporate financial performance 5

4.1 Positive relationship: 9

4.2 Negative relationship: 11

5. Conclusion 12

6. Research gap 13

7. List of Abbreviations 14

8. References 15

  1. Introduction

As Egypt is shifting its strategy towards into privatization, gearing towards the private sector, it became eminent that corporate social responsibility is very important. Since Egypt still in the developing stage of corporate social responsibility, it became a focal area in the corporate life. 

It is essential that each entity build its strategy with a focus on the application of CSR, relying on cultural, size, industry and value to the shareholder. Management and employees should be aligned to that strategy and work towards its implementation.

CSR requires additional investments which involve costs such as purchase of environment friendly equipment, stringent quality control measurement, hiring competent management etc. These investments should definitely generate benefits to the entity in order to increase the shareholder value.

There are indeed pressures that face the entities to adopt CSR, not only from CSR’s supporters but also investors to meet socially responsible customers’ expectations.

This paper will discuss the relationship between CSR and financial performance, the drivers and measures of each. It will also discuss financial performance KPIs including return on equity (ROE), return on assets (ROA) and the price per earning (P/E).    

  1. Corporate social responsibility 
    1. Definition of corporate social responsibility

CSR has many definitions, all carry the same concept. The most commonly used definitions will be highlighted. 

The first definition for social responsibility started in 1930 (Okoye, 2009). Since then, many researchers tried to define CSR from their point of view. Some of them was confirming and supporting the idea of applying corporate social responsibility and some other refusing it (Davis, 1973). 

Corporate social responsibility defined as a voluntary business activity that has a social impact (Douglas, A. Schuler & Margaret, Cording (2006). From another prospective, CSR is the company’s obligation toward society to provide social welfare (Margaret & John, 2011)

Davis (1960) considered CSR as activities done by the business not for financial or technical needs but for another purposes. Carroll (1979) has added the economic part of CSR that was not included before by identifying the CSR as the legal, ethical, economic, and evaluative expectations that are applied by the firm in the society. Recently, CSR defined by Frooman (1997)as, “CSR is the actions that concern social stakeholder’s welfare”. 

  1. Corporate social responsibility’s Drivers

Several CSR drivers can be considered as an encouragement toll for the firms to be socially and environmentally responsible. Friedman (1970) was the first to point out that CSR’s objective is to make a profit, but many other researches tried to set the justifications beyond firms’ contribution in the CSR. Kusyk and Lozano (2007) studied CSR in depth through 34years from 1973 to 2006 to differentiate CSR drivers in 83 countries. They found that 80 drivers in small and enterprises, they found that the most noticeable drivers were concerning improving reputation, ethical, employees’ moral values, firm image, customers’ loyalty and to be strongly linked to the community (Kusyk & Lozano, 2007). Other studies by Worthington (2008) tried to identify more reasons of applying CSR initiatives by the firms by discovering the concepts of diversity forms evolution from suppliers in U.S. and U.K., where it has been verified that the main drivers for CSR are stakeholder pressures, ethical influences and economical imperatives.

  1. Corporate social responsibility Implementation

             There are several issues facing CSR implementation, among them is how to get started. An important factor in the implementation of the CSR is to promote compliance of CSR with the legislations. Christie (2009) ”Firms could promote their CSR by evaluating current processes and strategies through inputs of external stakeholders, and ensuring that CSR programs are consolidated into all levels of business processes and strategies”.

2.4    Corporate social responsibility measurement

A lot of approaches used to measure CSR, where it is not easy to be measured (Padgett & Galan, 2010; Turker, 2009). There are no specific measurement tools in the market to measure corporate social performance (Liston-Heyes & Ceton, 2009). Many ways have been established to measure CSR, but the limitation is being the difficulty for all of them (Turker, 2009). Three approaches were suggested by Maignan and Ferrell (2000) to measure CSR containing the surveys of managers, the single- and multiple-issue indicators, and the evaluation of experts. Then Turkey (2009) added many indicators to the earlier studies as practical methods to measure CSR including single-and multiple-issue indicators, the reputation indices or databases, scales that measure CSR at the individual level, scales that measure CSR at the organizational level, and content analysis of corporate publications. Also, Turkey (2009) mentioned that from all of these methods, the reputation indices or databases is the most widely spread.

Adding to the previous methods to identify the measure of CSR, Slater and Dixon-Fowler (2009) stated that Canadian Social Investment Database (CSID) and Kinder, Lydenberg, and Domini (KLD) assess and classify organizations through many aspects such as community relations, environment, diversity, products and employee relations. While, Mahoney & Thorne (2005) notifies that CSID evaluates organizations’ corporate social performance according to seven aspects such as product and business practices, diversity, community, corporate governance, employee relations, international operations, and the environment. Also, Liston-Heyes and Ceton (2009) emphasized that many studies are using the scores of the environment and community components evidence and indicator or measurement of corporate social performance. 

  1. Corporate Financial Performance

Entity financial performance has many various indicators. Accordingly, analyzing the relationship between CSR and financial performance will be well-defined when calculating the financial performance through analyzing these indicators. The following sections cover some key financial performance indicators that have been used to measure the relationship between CSR and financial performance. 

There are many studies focused on the return on equity (ROE) as one of the main financial performance indicators as a dependent variable to examine the relationship between CSR and financial performance (De-los-Ángeles, Gil-estallo, Giner-de-la, Fuente & Gríful-miquela, 2009).

Also, (De-los-Ángeles, Gil-estallo, Giner-de-la, Fuente & Gríful-miquela, 2009) stated that there are other two main key financial performance indicators such as the return on assets (ROA) which is considered to be a main indicator  of financial performance, and The price/earnings (P/E). 

  1.   Relationship between corporate social responsibility and corporate financial performance 

There are many studies tried to determine whether the positive or negative relationships are linked to the financial performance and corporate social responsibility. But many scholars did not get a description of the relationship between corporate social responsibility and corporate financial performance as there was a discrepancy between the corporate social responsibility and its measurement which can happen whether there is restricted methodology steps or main ideas bias (Aupperle, Carrol, & Hatfield, 1985). On another note, Aupperle, Carrol, and Hatfield (1985) demonstrated that some academics found no relationship between corporate financial performance and corporate social responsibility by using the data of a force-choice survey of a sample of 241 CEOs recorded in the annual directory in 1981and the American business magazine (Forbes). 

Waddock and Graves (1997) illustrated that it is difficult to get a direct relationship between corporate social responsibility and financial performance, due to the fact that entities operate in an extremely complex environment. Hillman and Keim (2001) illustrated that there in some cases there is a direct positive relationship between corporate social responsibility and financial performance, and sometimes may affect it negatively. The main reason behind this positive impact on financial performance happens as the companies improve the relationship with their primary stakeholders which enhance the competitive edge. On another note, decreasing the financial performance can happen when the entities allocate their resources the social matters rather than a balance which affects the financial performance and decrease the competitive edge.

Barnett (2007) illustrated that there are many methods to approach the corporate social responsibility and he tried to evidence that there is an alignment of corporate social responsibility with maximization of profits target. Additionally, he illustrated that there are positive relationships between corporate social responsibility and the corporate financial performance.  

Academics who support the idea of no relationship between corporate social responsibility and corporate financial performance, Nelling and Webb (2009) highlighted that corporate social responsibility of organizations can not affect the financial performance. Also, if using the main key financial performance indicators to measure the relationship between corporate social responsibility and financial performance, there will be no relationship (De-los-Ángeles, Gil-estallo, Giner-de-la, Fuente & Gríful-miquela, 2009). 

Fauzi (2009) stated that there is no relationship between corporate social responsibilities and corporate financial performance, after using a sample of 101 organizations listed on the New York Stock Exchange (NYSE). He concluded that corporate social responsibilities can be the independent variable and the financial performance is the dependent variable in the correlation model.

In order to determine the relationship between corporate social responsibility and financial performance, Chih and Chen (2010) studied 520 financial institutions in 34 countries in the period from 2003 till 2005, using the Dow Jones Sustainability World Index as an indicator, and they found that the relationship is unclear.

Garcia-Castro, Arino, and Canela, (2010) stated that in the past 30 years, there were more than 100 experimental studies trying to identify the relationship between corporate social responsibility and financial performance but the findings are uncertain. But, Pava & Krausz (1996) illustrated that there are three types of results to get the relationship between corporate social responsibility and corporate financial performance which is Positive, negative and neutral relationships. They recommended that when they applied 21 experimental studies and they found eight negative relationships, one neutral relationship, and 12 positive relationships between corporate social responsibility and financial performance.   

Some theories support that there is a relationship between corporate social responsibilities and corporate financial performance, among them Carroll and Shabana (2010) indicated that even though there are differences in approaches, measures and results of this relationship, but all the studies confirmed that the social and environmental pressures can result in generating profit for firms, which indicates that corporate social responsibility can be considered as a strategic tool for the company.  

Based on the theory of corporate social responsibility and its reputation, Janney and Gove (2011) tested the relationship between the companies’ financial results and the market reaction in the US stock option backdating scandal. It illustrates how the earlier actions from companies toward the ethical behavior and values as corporate social responsibility methodology application can impact and increase the reactions of market. It was found that the companies with good reputation were supporting corporate social responsibility and accordingly these companies had a good financial position and are not included in this scandal. 

To identify the relationship corporate social responsibilities and corporate financial performance on the industries, Baird and Geylani (2012) checked 58 industries by applying experimental studies.  The findings showed that there is a strong relationship between corporate social performance and corporate financial performance. Also, they highlighted that there is more that 17% positive relationship in the applied sample between corporate social performance and corporate financial performance.

To understand the impact of stakeholders’ management on the relationship between corporate social performance and corporate financial performance, Barnett and Salomon (2012) tried to apply a certain model which demonstrates the relationship between corporate social performance and corporate financial performance. They highlighted that even if the entities pay costs to exercise the social responsibilities, the aforementioned costs can be reduced and payback through improving the relationship with the stakeholders. But, focusing on these potential benefits, and achieving high profits from corporate social performance, is based on the company’s stock of stakeholder influence capacity (SIC). So, the companies with a fragile social performance have inappropriate stakeholder impact on capacity, these benefits will not happen and it will result to a negative relationship between corporate social performance and corporate financial performance.

Additionally, Barnett and Salomon (2012) stated that more losses can be generated if companies focus on social issues and disregarding shareholder satisfaction. On the other hand, companies must take advantage of the stakeholder influencecapability and increase levels of social performance to get more profits from improving the relations with stakeholders. So good social performance will enable the company to convert these costs in social issues into good financial returns and profits.

Ramchander, Robert, Schwebach, and Staking (2012) stated that the intra-industry effects of additions and removals to the Domini Social 400 index to check the effect of corporate social responsibility on the financial performance. The results proved that entities which participates stakeholder management successfully will achieve a positive share value effect, including the CSR statement. Activities that develop relations among essential stakeholder group, for example, creating consistent practices, reinforcing labor relations, making reputational acquaintances with customers and different stakeholders, are a means for giving a sign to external investors that the company is putting resources into that stakeholder- related CSR actions leading to having competitive edge and that will make long-term value for shareholders (Ramchander, Robert, Schwebach, & Staking, 2012). 

Other studies highlighted that identifying the impact of corporate social responsibility on financial performance is significantly challenging (McWilliams, 2006). The most noticeable issues in the observed research are the exclusivity and the use of different metrics in measuring economic and social performance (Arlow and Gannon 1982). Moreover, the lack of measurement validity for social responsibility was identified as one of the issues in sampling (Arlow and Gannon 1982).  McWilliams and Siegel (2000) determined that facilitating mechanisms and curbing conditions could be measured. Additionally, Barnett and Salomon (2006) agreed with McWilliams and Siegel, they stated an example such as investments in R&D. While Surroca (2010) mentioned that firm’s intangible resources can be also formed in human capital, innovation and reputation.

     4.1 Positive relationship: 

There are many scholars like Waddock and Graves (1997) explained that good financial performance can lead to good corporate social performance. As the companies generate profits will secure investment in socially responsible initiatives. 

Another experimental study was applied by Van Beurden and Gossling (2008) to identify the effect of corporate social performance on financial performance and the outcome showed that good financial performance can be achieved by good corporate social performance. However, it identified that, it is not a must for all companies to achieve the balance between good corporate social performance and good financial performance. And they added that there is no agreement on what should be considered as part of the company’s social responsibility because social performance has many dimensions.

Moreover, the environmental management can impact the corporate financial performance as it was observed in studying 14 manufacturing companies (Klassen & McLaughlin, 1996). Also, Konar and Cohen (2001) tried to discover the impact of environmental management on financial performance regarding to the share value, and the outcome showed that a good environmental management has a strong positive impact on its market value and reputation.

Most of the studies that supported the positive relationship between corporate social responsibility and financial performance (Pava & Krausz, 1996). Pava and Krausz (1996) got the available data by the Council of Economic Priority (CEP) that identifies the companies according to their socially performance, and in the study they managed the sample to be matched by industry and size for 53 entities and compared their long-term financial performance. They used two time-periods 1985-1987 and 1989-1991 to be analyzed. The outcome clarified that there was a positive relationship between corporate social performance and financial performance.

Additionally, Pava and Krausz (1996) studied 21 experimental studies that focused on identifying the impact of corporate social responsibility and financial performance. 12 out of 21 these studies pointed a positive relationship; eight pointed a negative relationship, and one with no relationship between corporate social performance and financial performance.

Rettab (2009) utilized information from 280 entities working in Dubai to check the relationship between corporate social performance and companies’ financial performance identifying positive relation between corporate social performance and company’s employee dedication, financial performance and corporate reputation.

Peters and Mullen (2009) discovered positive impact of corporate social performance on companies’ financial performance after some time. These highlights are the consequences of observation examination for the effect of corporate social performance on companies’ financial performance applying time sorting for the data of the main 100 entities on the Fortune 500 rundown in 1996. 

Subsequently, Lindorff and Peck (2010) checked the principles of the forerunners of Australian financial foundations related to corporate social performance. They found out that a significant number of these pioneers identified that corporate social performance has a financial advantage on the association. Notwithstanding the financial advantages, corporate social performance actions creates corporate maintainability, the legitimacy and social capital of the association, and expand worker engagement and performance (Lindorff & Peck, 2010).  

Cheung, Tan, Ahn and Zhang (2010) tested the effect of corporate social performance on financial performance in emerging markets of Asia through 3 years, 2001 to 2004. The outcome showed a positive relationship between corporate social performance and business valuation among Asian entities. Later, the business sector has respectful organizations that met their base social and environmental preconditions (Bird, Hall, Momente, & Reggiani, 2007). Additionally, Cheung (2010) highlighted that good social planning expand organizations’ reputation and brand name, which enhances financial performance. 

4.1.1 Indirect positive relationship

There are many academics discussed the relationship between corporate social responsibility and financial performance based on its relationship with stakeholder’s dimension, that reflects on the financial performance.  Barnett (2007) hypothesized that the entities involved in the socially responsibility activities will get stakeholder influence capacity (SIC).

 Then, Marin, Ruiz, and Rubio (2009) studied the relationship between corporate social performance and loyalty with regard to social character hypothesis. They used a sample of genuine buyers to test the model. The findings highlighted a positive relationship between corporate social responsibility and buyer loyalty.

Aguilera, Rupp, Williams, and Ganapathi (2007) said that the responsibility or irresponsibility of the companies toward social actions has effect on their workers, while Rettab (2009) cleared that the relationship between corporate social responsibility and workers’ loyalty is positive. 

Turker (2009) studied corporate social performance effect on the workers’ responsibility. Sample of 269 businesses working in Turkey used to test the model. The findings highlighted that no relationship between corporate social performance and employees’ loyalty. 

     4.2 Negative relationship: 

Friedman (1970) argued that corporate social performance increases expenses which affects profits and this reduce corporate financial performance. This cost gets from the limitations of business regions, and the increment in costs identifying with actions or plans to meet stakeholder requirements.

Moore (2001) examined the relationship between corporate social performance and financial performance using the social and financial information of eight entities in the UK general store industry for the time of 3 years (1997/1998-1999/2000). The study has examined the relationship between corporate social performance and financial performance. The findings showed an adverse relationship between the overall corporate social performance and financial performance. However, a constructive relationship was pointed between good financial performance and consequent great corporate social performance. Moore (2001) reasoned that this positive relationship between financial performance and resulting in a great corporate social performance affect the entities and lead to unfavorable financial performance. 

Through experimental analysis of a sample of 179 publicly done by Canadian organizations and the measures of Corporate Social Performance gave by Canadian Social Investment Database for the years 2004 and 2005, Makni, Francoeur, and Bellavance (2009) assessed the causal relationship between corporate social responsibility and financial performance. The academics pointed that, there is no critical relationship between corporate social responsibility and financial performance except for market return. Also, the utilization of individual measure of corporate social responsibility can alert a clear negative relationship between environmental measurement of corporate social responsibility and three measures of financial performance which are return on equity, return on assets, and market returns. 

  1.   Conclusion

The purpose behind this study is to understand the relationship between Corporate social responsibility and corporate financial performance, and as per the literature review its very hard to define and to measure the corporate social responsibility. Many studies over the last few years tried to define the link between corporate social responsible activities and corporate profitability.

Additionally, some entities forced to apply CSR by (SIC) stakeholder influence capacity, where some other adapted to implement CSR activities, while the rest refused. Entities that refused to apply CSR activities in their strategy and operations tried to find another ways to compromise between CSR and profitability. Hence, many studies tried to highlight the effect of CSR on profitability. However, experimental studies highlighted that many results revealed the relationship between CSR and profitability with the three results positive, neutral and negative.

There are two main factors that will make the difference in the relationship between corporate social responsibility and corporate financial performance, the region where the entity exist and the stakeholder’s interest. Accordingly, it is very important to determine if the entities need to meet their stakeholder’s requirements or not, because if the entity is applying CSR to satisfy stakeholder’s interest, this will lead to have a good social responsibility performance. Also, this can result in better financial performance based on growing customer’s loyalty, enhancing their market position. In the contrary, if the organizations ignore their stakeholder’s requirements, this will result in negative relationship. Accordingly, balancing between the level of participating in corporate social responsibility and the stakeholders’ interest is vital for achieving positive relationship since as highlighted earlier corporate social responsibility continuously involves cost, and the business target is to gain profits to ensure the sustainable growth.

  1. Research gap

The literature review stated that the corporate social responsibility may vary depending on the industry and the region where the firm exist, as the stakeholder interest will vary accordingly based on these variables. Although numerous studies have been done to discuss the relationship between social corporate responsibility and corporate financial performance, not enough studies were done in the Middle East. Hence it is recommended to make more researches in the Middle East to study this relationship taking into consideration the different industries or sectors and the different stakeholder interest that should be covered in the Middle East region. 

  1. List of Abbreviations

CFP

Corporate financial performance

CSID

Canadian Social Investment Database 

CSR 

Corporate social responsibility

NYSE

New York Stock Exchange

P/E

Price per earning

ROA

Return on Asset

ROE

Return on equity

SIF

Social Investment Forum 

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