The effect of CSR on financial performance

24-05-2011

Guilherme Luttikhuizen dos Santos Rotterdam School of Management, Erasmus University

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Introduction

Corporate social responsibility (CSR) has clearly gained importance on the corporate agenda of many

firms. There is an increased focus of firms on CSR and there is an increased focus by society on the

social actions of companies (Moir, 2001: 21). One indicator of this is that many companies now

publish yearly CSR or sustainability reports. In addition, CSR is given high priority by executives. A

survey of 1.192 global executives by the Economist Intelligence Unit (2007) on behalf of The

Economist (2008) notes that 39,5% of executives currently give CSR high priority, while 3 years ago

this was only 22,8%. In addition, 16,7% of executives give CSR currently very high priority, while 3

years ago that was only 11,3%.

The proliferation of CSR reports has been paralleled by growth in corporate social responsibility

ratings & rankings (Porter & Kramer, 2006: 2). In addition there is also an increased interest in CSR by

the academic community. This is apparent in the increasing number of academic articles being

published about CSR (see figure 1).

Figure 1: number of academic CSR and CSP (corporate social performance) publications per year (De

Bakker et al., 2005: 293)

Firms have to make choices about how to spend their scarce resources. Usually they spend money in

a way that yields a profitable return. However, many customers nowadays expect firms to be socially

responsible (Mohr et al., 2001). This has led academics and practitioners to question whether CSR

has any effect on profitability. This paper reviews the literature on this topic, and tries to answer the

question ‘what is the effect of CSR on the financial performance of firms?’

Theoretical framework

The nature of the firm

For decades, authors have debated over what the nature of the modern corporation is. Some authors

argue that firms mainly exist to make profit. The main proponent of this view is Milton Friedman,

although his ideas are supported by findings from several others (e.g. Lantos, 2001). In 1962,

Friedman wrote “few trends could so thoroughly undermine the very foundations of our free society

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as the acceptance by corporate officials of a social responsibility other than to make as much money

for their stockholders as possible” (Friedman, 1962: 133). This is also called the Friedman doctrine:

the primary purpose of the firm is to serve the owners of the firm, which are the stockholders. The

firm should focus on making as much money as possible. Friedman (1970) argues that if corporate

executives have a social responsibility that means that these executives act in a way that is not in the

interest of its employer, the stockholders. Spending the money of other people (the stockholders) on

a general social issue is not a task of business. Corporate managers are agents serving the interests of

the principal (the stockholders). If customers, stockholders or employees really want to support a

particular cause, they would separately spend their own money to do so. Vogel (2005) in this regard

quotes a Harvard Business School student saying “if people are really interested in tackling social

problems, they will have nothing to do with business”. Friedman (1970) states: “insofar as his [the

corporate executive’s+ actions in accord with his ‘social responsibility’ reduce returns to stockholders,

he is spending their money. Insofar as his actions raise the price to customers, he is spending the

customers’ money. Insofar as his actions lower the wages of some employees, he is spending their

money”. Thus he claims that social responsibility of corporations comes at the expense of the

interests of its stockholders, customers and/or employees. He further states that the case of an

individual proprietor or entrepreneur is a bit different: “If he *the entrepreneur+ acts to reduce the

returns of his enterprise in order to exercise his ‘social responsibility’, he is spending his own money,

not someone else’s. If he wishes to spend his money on such purposes, that is his right and I cannot

see that there is any objection to his doing so”. Friedman (1970) concludes by saying that “there is

one and only one social responsibility of business – to use its resources and engage in activities to

increase its profits as long as it stays within the rules of the game, which is to say, engages in open

and free competition without deception or fraud”. Other authors disagree, saying that business

undeniably has social responsibilities. This is the idea of corporate social responsibility.

Early work by Davis (1973) summarizes the arguments for and against business assumption of social

responsibilities. Arguments for this include: it is in the long-run self-interest of business, it improves

public image, it is in the interests of stakeholders, business has the resources, let business try, it

avoids government regulation, problems can become profits, prevention of social problems is better

than curing, and there is a substantial loss of business power if business doesn’t take social

responsibility and socio-cultural norms. Arguments against business assumption of social

responsibilities include: the costs of social involvement, many businessmen lack the skills to do the

job, dilution of business’s primary purpose, weakened international balance of payments, business

already has enough social power, business has to strive for profit maximization, lack of broad support

among all groups in society, and that business has no line of accountability to the community so

business shouldn’t become responsible in areas for which they are not accountable (Davis, 1973).

Wood (1991: 695) notes that “the basic idea of corporate social responsibility is that business and

society are interwoven rather than distinct entities; therefore society has certain expectations for

appropriate business behavior and outcomes”. Fact is that business and society are interdependent:

firms need a healthy society (education, health care and equal opportunity are essential to a

productive workforce) and a healthy society needs successful companies (no social program can rival

the business sector when it comes to creating the jobs, wealth, and innovation that improve

standards of living and social conditions over time; Porter & Kramer, 2006: 7). Hemphill (2004) notes

that business has entered areas which once were only the domain of the government: education,

transportation, social welfare, law enforcement, etc. He mentions that “one potential area of

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concern is delineating where the corporation’s social responsibilities stop and where government’s

role begins” (Hemphill, 2004: 356).

Corporate social responsibility

Already in the 1960s, McGuire (1963: 144) mentioned that “the idea of social responsibilities

supposes that the corporation has not only economic and legal obligations but also certain

responsibilities to society which extend beyond these obligations”. He argued that firms have to act

‘justly’, just as a normal citizen should. CSR is basically a consequence of how the relationship

between business and society is understood (Garriga & Mélé, 2004: 52).

There are many definitions of corporate social responsibility (CSR), and nobody can seem to agree on

a particular one. According to Van Marrewijk (2003), this is because people interpret CSR differently

and different definitions of CSR relate to specific contexts. Van Marrewijk (2003: 102) broadly defines

CSR as “company activities – voluntary by definition – demonstrating the inclusion of social and

environmental concerns in business operations and in interactions with stakeholders”. Another

popular broad definition is the one from the Commission of the European Communities (2001: 6):

CSR is “a concept whereby companies integrate social and environmental concerns in their business

operations and in their interaction with their stakeholders on a voluntary basis”.

Dahlsrud (2008) categorizes CSR definitions as belonging to one or more of the following categories:

- The environmental dimension (refers to the natural environment);

- The social dimension (refers to the relationship between business and society);

- The economic dimension (refers to socio-economic or financial aspects);

- The stakeholder dimension (refers to stakeholders or stakeholder groups);

- The voluntariness dimension (refers to actions not prescribed by law).

A CSR definition can thus include several of the above dimensions. In his article, Dahlsrud (2008)

examines 37 CSR definitions and finds that the stakeholder and the social dimensions are most used,

and the environmental dimension is least used in defining CSR. In addition, he finds that from the 37

definitions, 8 definitions include all 5 categories, and 4 definitions stress only 1 category. Dahlsrud

(2008: 6) concludes by saying that “the definitions are predominantly congruent, making the lack of

one universally accepted definition less problematic than it might seem at first glance”. Cramer et al.

(2004: 218) say that “CSR clearly is a new buzzword with which companies are confronted. They are

urged to adopt this buzzword, although its meaning is still open for debate”.

The main CSR theories and related approaches are categorized in 4 groups (Garriga & Mélé, 2004):

- Instrumental theories, in which the corporation is seen as only an instrument for wealth

creation, and its social activities are only a means to achieve economic results. CSR is a mere

means to the end of profits;

- Political theories, which concern themselves with the power of corporations in society and

a responsible use of this power in the political arena;

- Integrative theories, in which the corporation is focused on the satisfaction of social

demands. Business depends on society for its continuity and growth and even for the

existence of business itself;

- Ethical theories, based on ethical responsibilities of corporations to society. Firms ought to

accept social responsibilities as an ethical obligation above any other consideration.

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In other words, CSR theories are focused on 1 of the following aspects: (1) economics (meeting

objectives that produce long-term profits), (2) politics (using business power in a responsible way),

(3) social integration (integrating social demands) or (4) ethics (contributing to a good society by

doing what is ethically correct; Garriga & Mélé, 2004).

According to a global survey by the Economist Intelligence Unit (2007) of corporate executives, the

main business benefit of CSR is seen as having a better brand or reputation (52,9%), followed by

making decisions that are better for the business in the long-term (42,4%) and being more attractive

to potential and existing employees (37,5%). Orlitzsky et al. (2003) says CSR “helps the firm build a

positive reputation and goodwill with its external stakeholders”. Similarly, Peloza (2006: 69) sees CSR

as insurance for a good company reputation. He states that “the reputation of a firm is arguably the

most valuable asset, and thus an asset worth protecting”.

There are 2 major sources of demand for CSR: (1) consumer demand, and (2) demand from other

stakeholders, like the community, employees and investors (McWilliams & Siegel, 2001: 119).

Campbell (2007) argues that the probability that a firm will act socially responsible depends on the

relative health of the firm and the economy, and the level of competition to which firms are exposed.

An examination of the literature indicates that the rationale and assumptions behind the CSR

discourse are (Banerjee, 2008):

- Corporations should think beyond making money and pay attention to social and

environmental issues;

- Corporations should behave in an ethical manner and demonstrate the highest level of

integrity and transparency in all their operations;

- Corporations should be involved with the community they operate in terms of enhancing

social welfare and providing community support through philanthropy or other means.

Realizing this, many companies started to engage in CSR. The Economist (2004) calls CSR “one of the

biggest corporate fads of the 1990s”. Firms massively started to take social responsibility and strived

for sustainability. This is reflected in the fact that many firms started using the ‘triple bottom line’ of

people, planet & profit. The Economist (2005) says that “one problem with the triple bottom line is

quickly apparent. Measuring profits is fairly straightforward; measuring environmental protection

and social justice is not”. However, according to The Economist (2005), CSR advocates maintain that

“the triple bottom line is just shorthand for saying: take other things into account, acknowledge that

profit isn't everything, and don't pursue profit relentlessly, as you would otherwise be inclined to,

even at the expense of damage to the environment and infringements of the rights of workers and

other stakeholders. You cannot be precise about these things, but at least you can recognize the

social and environmental peril of too narrow a focus on profit”. The Economist (2005) then argues

that “that is a perfectly reasonable line of argument—or it would be, if a narrow focus on profit really

did endanger the environment, systematically infringe the rights of workers and stakeholders, and in

general fail to serve the public interest. That is the world according to CSR, but is the world really like

that? The short answer is no”.

Approaches

One CSR approach is corporate philanthropy (Halme & Laurila, 2009). This means that companies

donate money and other support to local organizations and/or communities. Campbell et al. (2002:

29) say that “charitable contribution as an expression of social responsibility, however, is somewhat

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less explored than the more general theme of social responsibility, despite the fact that the

quantities of money donated are substantial”. Companies nowadays donate billions of dollars every

year to a wide range of non-profit organizations in education, arts, social services, and public policy

(Himmelstein, 1997). Corporate philanthropy helps society. This is important, because “no individual

corporation or big business can prosper if society as a whole does not prosper. *…+ A business and its

community are closely interrelated” (Himmelstein, 1997). Campbell et al. (2002) state that there are

4 possible motivations for corporate philanthropy: altruistic, strategic, political, and managerial

utility. Porter & Kramer (2002: 5) observe that a lot of firms engage in ‘strategic philanthropy’, since

corporate philanthropy in many companies is used as public relations or advertising. When a firm

decides about which philanthropic causes it will support, it turns out that the personal values and

ethics of corporate managers are important determinants of what CSR activities their company will

pursue (Duarte, 2010). The Economist (2008) says that “companies typically allocate about 1% of pre-

tax profits to worthy causes because giving something back to the community seems ‘the right thing

to do’”. For example, Coca Cola spent $88 million in 2009 on corporate philanthropy, which is 1,1% of

their operating income (Coca Cola, 2010: II).

Another view is that CSR can’t be separated from corporate strategy (Galbreath, 2006). CSR is

incorporated into the business strategy and becomes an integral part of the business. Halme &

Laurila (2009: 330) call this corporate responsibility integration, which brings “improvements of

environmental and social aspects of core business”. It emphasizes conducting current business

operations more responsibly (Halme & Laurila, 2009: 329).

Halme & Laurila (2009) distinguish another approach: corporate responsibility innovation. This

means developing new products in order to help social or environmental problems. See figure 2 for

an overview of the 3 approaches discussed by Halme & Laurila (2009: 334).

Figure 2: three CSR approaches and their potential benefits (Halme & Laurila, 2009: 334)

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Another approach to employ CSR is the community-based strategy (Newell, 2005). Here, the

company engages in a continuous dialogue with local communities, and puts the community first in

decision-making.

Porter & Kramer (2006: 8) argue that the social issues affecting a company fall into 3 categories:

- “Generic social issues (may be important to society but are neither significantly affected by

the company’s operations nor influence the company’s long-term competitiveness);

- Value chain social impacts (social issues that are significantly affected by the company’s

activities in the ordinary course of business);

- Social dimensions of competitive context (social issues in the external environment that

significantly affect the underlying drivers of a company’s competitiveness in those places

where the company operates)”.

Porter & Kramer (2006: 8) then state that “every company will need to sort social issues into these 3

categories for each of its business units and primary locations, then rank them in terms of potential

impact. Into which category a given social issue falls will vary from business unit to business unit,

industry to industry, and place to place”. They then distinguish 2 CSR approaches: strategic and

responsive CSR; “while responsive CSR depends on being a good corporate citizen and addressing

every social harm the business creates, strategic CSR is far more selective” (Porter & Kramer, 2006:

13). They state (p. 10): “typically the more closely tied a social issue is to a company’s business, the

greater the opportunity to leverage the firm’s resource – and benefit society”. This is what they call

‘strategic CSR’: “strategic CSR moves beyond good corporate citizenship and mitigating harmful value

chain impacts to mount a small number of initiatives whose social and business benefits are large

and distinctive. It is here that the opportunities for shared value truly lie” (Porter & Kramer, 2006:

10). They conclude (p. 13): “strategy is always about making choices, and success in CSR is no

different. It is about choosing which social issues to focus on”.

CSR reporting

Many companies now produce (yearly) dedicated CSR or sustainability reports. These reports “detail

the environmental, social and economic impacts of a company’s operations” (PWC, 2010: 51). They

often discuss major stakeholder groups, summarize what the company has done last year for the

community, assess the progress against its CSR objectives and explain what CSR strategies the

company uses to tackle environmental and social issues. Most big multinationals have such reports,

because “most companies recognize that their CSR report is a companion document to their annual

report, containing information that is as important to stakeholders as their financial and operating

data” (PWC, 2010: 8). Some examples of CSR reports of major multinationals are IBM (2009), Coca

Cola (2009), McDonalds (2010), Nike (2009), Sony (2010), Air France-KLM (2010), Toyota (2010), Shell

(2010), and Nokia (2009). In addition to CSR reports, many companies now prominently display their

CSR activities on their corporate website (Capriotti & Moreno, 2007; Gomez & Chalmeta, 2011). PWC

(2010) finds in a study of 602 major companies that 81% of these companies have CSR information

on their corporate website. They state: “the role of a website in CSR reporting is to engage, and many

companies are using web tools to go beyond reporting on their own performance and initiatives”

(PWC, 2010: 42). For example, they found that 33% of the companies in their sample integrated

video into the CSR reports, describing CSR initiatives, or providing case studies and testimonials

(PWC, 2010: 46).

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CSR and related concepts

De Bakker et al. (2005: 288) say that CSR is “a concept that relates to, but sometimes also competes

with other concepts such as business ethics, sustainable development, corporate philanthropy,

organizational citizenship, or social accountability”. Another very related concept of CSR is corporate

social performance (CSP), which is defined by Wood (1991: 693) as “a business organization’s

configuration of principles of social responsibility, processes of social responsiveness, and policies,

programs, and observable outcomes as they relate to the firm’ societal relationships”. Thus it can be

seen as the operational construct of CSR. Many authors that want to examine the relationship

between CSR and profitability measure CSP instead of CSR. Mohan (2003: 74) notes that over time,

several new concepts have been added to the debate about the business-society relationship. This is

depicted in figure 3.

Figure 3: the development of CSR-related concepts over time (Mohan, 2003: 74, found in De Bakker

et al., 2005: 288)

Ethics is defined as “the code of moral principles that sets standards of good or bad, or right or

wrong, in one’s conduct. Ethics provides principles to guide behavior and help people make moral

choices among alternative courses of action” (Schermerhorn, 2008: 32). Similarly, business ethics are

“the principles and standards that guide behavior in the world of business” (Ferrell et al., 2008: 6).

Fisher (2004) acknowledges that the relationship between ethics and social responsibility is often

unclear because different authors have different ideas of the relationship between ethics and social

responsibility. Based on a review of the literature, he distinguishes the following 4 views of the

relationship between social responsibility and ethics:

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- Social responsibility is ethics in an organizational context;

- Social responsibility focuses on the impact that business activity has on society while ethics is

concerned with the conduct of those within organizations;

- There is no connection between social responsibility and ethics;

- Social responsibility has various dimensions one of which is ethics.

He then mentions that the last view of these 4 is the most plausible.

Corporate citizenship, or the view that corporations are citizens of society, is gaining popularity.

However, there is no consensus in the literature on what corporate citizenship means. Matten &

Crane (2005: 173) say that corporate citizenship “describes the role of the corporation in

administering citizenship rights for individuals”. They see corporate citizenship as “the administration

of a bundle of individual citizenship rights – social, civil, and political – conventionally granted and

protected by governments” (Matten & Crane, 2005: 166). Hemphill (2004: 339) defines corporate

citizenship as “the extent to which businesses meet the economic, legal, ethical, and discretionary

responsibilities imposed on them by their stakeholders”. He sees corporate citizenship as the new

model for corporate governance in the 21st century. Fombrun et al. (2000) argue that corporate

citizenship is a strategic tool that firms can use to manage reputational risk from stakeholder groups.

It manages stakeholder groups, so that firm reputation remains high. They mention 5 motivations for

pursuing corporate citizenship: (1) build community ties and maintain a license to operate, (2)

increase morale and attachment of current employees, (3) prepare and attract potential employees,

(4) develop potential customers, and (5) enact an environment where the company can prosper.

CSR and profitability

Vogel (2005) argues that decades ago the motivation for companies to engage in CSR was to help

society. Nowadays, he argues, the main CSR motivation for companies is to make more profit. In this

regard Vogel (2005) mentions a 2002 survey by PWC, which found that 70% of global CEO’s believe

that CSR is essential to the profitability of their company. The thought that CSR leads to increased

profitability has historically never had so much influence as it has today. Vogel (2005) mentions 2

factors that are responsible for this development:

- A change in the structure of the business system (the changing nature of the firm);

- Changes in attitudes toward business (the popular embrace of business and the values of

moneymaking).

Vogel (2005) says that “one might have thought that these changes in both management incentives

and the competitive environment would have led to the conclusion that it has become much more

difficult for firms to act responsibly. Instead it has led to a shift in the rationale for CSR. Now the main

justification for CSR is its contribution to the bottom line”. This shift in motivation is remarkable,

especially since nobody knows for sure if CSR leads to more profits. A fashionable CSR mantra is

nowadays ‘doing well by doing good’ (The Economist, 2008). Some authors argue that there is a

positive relationship between CSR and financial firm performance, while others argue for a negative

relationship, neutral relationship or a mixed relationship. There is absolutely no consensus.

The argument for a negative relationship between CSR and profitability is that CSR costs money, and

everything that costs money reduces profits.

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The argument for a positive relationship is that CSR leads to several benefits, some of them financial.

This means that the benefits associated with investing in CSR outweigh the costs of doing so (Callan

& Thomas, 2009: 70). Orlitzsky et al. (2003: 407) argue that CSR “Increases managerial competencies,

contributes to organizational knowledge about the firm’s market, social, political, technological, and

other environments, and thus enhances organizational efficiency”.

The argument for a non-significant relationship is that there are many intervening variables in the

relationship between CSR and profitability, so that a clear relationship between the two shouldn’t be

expected (Waddock & Graves, 1997; Tsoutsoura, 2004: 11).

It is unsure whether CSR leads to short-term earnings or share performance, but CSR advocates (e.g.

Lin et al., 2009) argue that more responsible firms will perform better in the long run (Vogel, 2005).

Figure 4 explains how CSR might lead to better financial performance.

Figure 4: how CSR contributes to financial performance (Weber, 2008: 254)

There have been 3 ways with which the relationship between CSR and financial performance has

been analyzed in the literature (Busch & Hoffmann, 2011: 3-4):

- Event studies (examine the mean stock returns of corporations);

- Portfolio analyses (compare the risk-adjusted returns of stock portfolios that consist of firms

with a high environmental or social performance with stock portfolios that consist of firms

with a low environmental or social performance);

- Multivariate econometric approaches (explore the long-term relationship between CSR and

financial performance, and usually apply accounting-based indicators for financial

performance and a variety of measures for CSR).

Many companies have asked themselves ‘what is the business case for CSR?’, whereby the “business

case refers to the bottom-line financial and other reasons for businesses pursuing CSR strategies and

policies” (Carroll & Shabana, 2010: 85). If there is a clear business case (i.e. if there is a clear positive

relationship between CSR and financial performance), then it would also be in the self-interest of

companies to engage in CSR. Margolis & Walsh (2003) have examined the relationship between CSR

and financial performance in the academic literature based on 127 academic articles. The results are

summarized in table 1.

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Table 1: literature review of the relationship between CSR and financial performance (Margolis &

Walsh, 2003)

Number of studies with:

Nature of relationship: CSR as independent variable CSR as dependent variable

Positive relationship 54 16

Negative relationship 7 -

Non significant relationship 28 3

Mixed relationship 20 3

Four studies investigated the relationship in both directions, but are only counted as 1 study. This

explains that there are 131 results for 127 studies. It can be seen in table 1 that in 109 of the 131

studies the influence of CSR on financial performance is examined, while in the other 22 studies this

is the other way around. Thus Margolis & Walsh (2003) observe that 70 studies find a positive

relationship and only 7 studies find a negative relationship. A review by Orlitzsky et al. (2003) of 52

academic articles dedicated to the CSR-financial performance relationship yielded a similar result: a

positive relationship was the most observed outcome. This would suggest that there is a positive

relationship between the two constructs. Margolis & Walsh (2003: 277) state that based on these

findings there is “very little evidence of a negative association” between CSR and financial

performance.

However, there are several problems. These studies often measure different things because they use

different indicators of CSR and financial performance (Vogel, 2005). For example, in the 127 studies

examined by Margolish & Walsh (2003), CSR is measured in at least 43 different ways. Some

examples of these CSR indicators were charitable contributions, environmental reputation rating by

Fortune, expenditures on environmental practices, environmental awards, environmental lawsuits,

customer service complains, surveys measuring director’s concern for CSR and the inclusion of an

explicit statement of an ethics code in the annual report. Likewise, financial performance is

measured in numerous different ways as well. There two main categories to measure financial

performance: (1) accounting-based measures, such as profits, return on assets, and similar

indicators, and (2) market-based measures, such as stock returns. It appears that CSR has a higher

positive correlation with accounting-based measures of financial performance than with market-

based indicators (Orlitzsky et al., 2003), which complicates all studies trying to examine this

relationship.

Margolis & Walsh (2003: 278) themselves also warn for “methodological and theoretical weaknesses

in past studies”. They cite various past criticisms on some studies: “sampling problems, concerns

about the reliability and validity of the CSP [corporate social performance] and CFP [corporate

financial performance] measures, omission of controls, opportunities to test mediating mechanisms

and moderating conditions, and a need for a causal theory to link CSP and CFP”. Orlitzsky et al. (2003:

409) write that “a large proportion of cross-study variance is due to statistical or methodological

artefacts (sampling error and measurement error)”.

In addition Vogel (2005) says that the validity of many studies is questionable. He gives an example:

“one of the most commonly employed measures of CSR is based on Fortune’s annual reputational

survey of America’s most admired corporations. One of the attributes rated by Fortune is a

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‘company’s responsibility to the community and the environment’. However, its raw scores appear to

be heavily influenced by a company’s previous financial performance, which means that any

relationship between it and corporate profitability is tautological”. He further states that when

studying a firm’s financial performance, it is necessary to control for other antecedent factors, but

not all studies adequately do so. In conclusion: “virtually every measure *of CSR and/or financial

performance] employed has been subject to substantial criticism: no consensus has emerged as to

how either environmental responsibility or corporate responsibility more generally can or should be

measured” (Vogel, 2005).

Furthermore, “correlations between social and financial performance may reflect the fact that well-

managed firms are also better at managing CSR, making it difficult to discern whether or to what

extent they are more profitable because they are more responsible” (Vogel, 2005).

Since the study of Margolis & Walsh (2003), several others have explored the same relationship. In

addition, there have been a few studies that haven’t been included in the literature review of

Margolis & Walsh. Table 2 lists some of these studies.

Table 2: a literature review of the relationship between CSR and financial performance; articles not

included in Margolis & Walsh (2003)

Nature of relationship

Authors Measure of CSR Measure of financial performance

Mixed Barnett & Salomon (2006)

Screened SRI (socially responsible investing) funds

The risk-adjusted financial performance of a given SRI fund

Mixed Boesso & Michelon (2010)

KLD evaluation of CSR EBITDA, return on sales, intangible assets, capital expenditures, company market value

Mixed Brammer & Millington (2008)

Charitable donations Growth in market price of firm’s shares, dividend payout

Mixed Busch & Hoffmann (2011)

Carbon emissions, carbon management

Return on assets, return on equity, Tobin’s q

Mixed Choi et al. (2010)

KEJI index Return on assets, return on equity, Tobin’s q

Mixed Goll & Rasheed (2004)

Survey Return on assets, return on sales

Mixed Lee & Park (2009)

KLD evaluation of CSR Return on assets, return on equity, average market value

Mixed Lee & Park (2010)

KLD evaluation of CSR Return on assets, return on equity, return on sales, average market value, excess market value

Mixed Lee et al. (2009)

Dow Jones Sustainability Index Return on assets, return on equity, return on sales, total raw returns, one-factor alphas, six-factor alphas

Mixed Mahoney & Roberts (2007)

Canadian Social Investment Database ratings

Return on assets, return on equity

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Mixed Makni et al. (2009)

MJRA CSR indicators Return on assets, return on equity

Mixed Park & Lee (2009)

KLD evaluation of CSR Return on equity, total shareholder return

Mixed Wang et al. (2008)

Charitable donations scaled by firm size

Return on assets, Tobin’s q

Mixed Yang et al. (2010)

AReSE indicators Return on assets, return on equity, return on sales

Negative Brammer et al. (2006)

Ethical Investment Research Service (EIRIS) data

Stock returns

Negative Lean & Chang (2011)

Taiwanese Global View Magazine CSR listings

Stock returns

Negative Moore (2001) Several measures, found in annual reports, and factsheets from the Ethical Investment Research Service

Growth in turnover, profitability, return on capital employed, growth in earnings per share

Negative Renneboog et al. (2008)

Socially responsible investment funds from the S&P index

Stock portfolio performance

Negative Shen & Chang (2007)

FTSE4Good UK index Return on assets, return on equity, return on sales, earnings per share

Non-significant

Aras et al. (2010)

Content analysis in annual reports

Return on assets, return on equity, return on sales

Non-significant

Brine et al. (2007)

Sustainability reports Return on assets, return on equity, return on sales

Non-significant

Collison et al. (2008)

FTSE4Good Indices Sharpe ratio, Treynor ratio, Jensen measure

Non-significant

Nelling & Webb (2009)

KLD evaluation of CSR Return on assets, stock returns

Non-significant

Surroca et al. (2010)

SiRi PRO ratings Tobin’s q

Non-significant

Van de velde et al. (2005)

Vigeo CSR scores Stock portfolio performance

Positive Byus et al. (2010)

Firms included in the Dow Jones Sustainability Index vs. firms not included in this index

Gross profit margin, net operating profit, profit margin, return on assets

Positive Callan & Thomas (2009)

80 CSR behaviors from KLD STATS, consisting of 13 components in 2 categories: (1) qualitative issue areas: community, corporate governance, diversity, employee relations, environment, human rights, product, (2) controversial business issues: alcohol, gambling, tobacco, firearms, military, nuclear power

Return on assets, return on sales, return on equity, Tobin’s q

Positive Chang & Kuo Sustainable asset Return on assets, return on

14

(2008) management data equity, return on sales

Positive Derwall & Koedijk (2009)

SRI (socially responsible investing) funds

Mutual fund performance

Positive Derwall et al. (2005)

SRI (socially responsible investing) stocks

Stock portfolio performance

Positive Guenster et al. (2010)

Eco-efficiency scores developed by Innovest Strategic Value Advisors

Return on assets, Tobin’s q

Positive Jin & Drozdenko (2010)

Survey of managers’ CSR values

Profits, market share

Positive Kaltenböck (2008)

KLD evaluation of CSR Stock returns

Positive Kapoor & Sandhu (2010)

CSR score based on how many of the 44 items of the CSR measurement instrument a company has adopted

Return on assets, return on sales, return on equity

Positive Kempf & Osthoff (2007)

KLD evaluation of CSR Stock portfolio performance

Positive Lin et al. (2009) Charitable donations as a percentage of corporate pre-tax profit

Return on assets, the Jensen measure, the amended Jensen measure, Treynor ratio, Sharpe ratio, MCV measure

Positive Moneva et al. (2007)

Sustainability reporting of an organization

Profits, assets investments, growth, liquidity, profitability-risk

Positive Ngwakwe (2009)

Survey Return on total assets

Positive Ruf et al. (2001)

Survey measuring changes in relative importance of KLD social performance dimensions

Return on equity, return on sales, growth in sales

Positive Simpson & Kohers (2002)

Community Reinvestment Act (CRA) rating

Return on assets, loan losses to total loans

Positive Stanwick & Stanwick (1998)

Fortune corporate reputation index

Profitability, yearly profits divided by annual sales

Positive Tsoutsoura (2004)

KLD evaluation of CSR, Domini 400 Social Index

Return on assets, return on equity, return on sales

Positive Vergalli & Poddi (2009)

A combination of Domini 400 Social Index, Dow Jones Sustainability World Index and FTSE4Good Index data

Return on equity, return on capital employed, market capitalization, market value added

Positive Wang & Choi (2010)

KLD evaluation of CSR Tobin’s q

15

Table 2 shows that since Margolis & Walsh (2003) summarized 127 studies on this topic, several new

studies have emerged. Table 2 includes 44 new studies, of which 19 find a positive relationship

between CSR and financial performance, 14 studies find a mixed relationship, 6 a non-significant

relationship and 5 studies find a negative relationship. This broadly supports the findings of Margolis

& Walsh (2003): there is little evidence for a negative relationship and the most encountered finding

is that of a positive relationship between CSR and financial performance.

A number of authors have claimed that the relationship between CSR and financial performance is

moderated by one or more variables. Some of these moderators include: industry growth (Russo &

Fouts, 1997), consistency in corporate social performance (Wang & Choi, 2010) and stakeholder

influence capacity (Barnett, 2007). Goll & Rasheed (2004) argue that the relationship between CSR

and financial performance is context specific; they argue that environmental dynamism and

environmental munificence both positively moderate the relationship between CSR and financial

performance. Thus, in environments with high dynamism and munificence, CSR is expected to

positively contribute to financial performance, and vice versa. Environmental dynamism is hereby

defined as “the extent of unpredictable change in an organization’s environment”, and munificence

refers to “an environment’s ability to support sustained growth of an organization” (Goll & Rasheed,

2004: 44-45).

An essential aspect of the relationship between CSR and financial performance is the direction of

causality (Waddock & Graves, 1997: 306; Aras et al., 2010: 233). Orlitzsky et al. (2003) argue that the

relationship between CSR and financial performance is bidirectional (positive). That means that CSR

increases financial performance, but that financial performance also enhances CSR. However, Vogel

(2005) is still skeptical: “researchers have yet to demonstrate that environmental expenditures

improve firm profitability in a structural way, and that it is not a matter of reverse causality, where

profitable firms can afford to invest in environmental performance”.

Van der Laan et al. (2008) argue that the effect of bad CSR on financial performance is bigger than

the impact of good CSR, ceteris paribus.

What does a relationship prove?

Vogel (2005) argues: “even if it were possible to convincingly demonstrate a positive causal link

between CSR and business financial performance, it is unclear what this would prove. If some firms

are actually more profitable because they are more responsible, it does not necessarily follow that

their less responsible competitors would be more profitable if they were more responsible. It is

equally possible that the market niche for relatively responsible firms is limited and that they would

be better off continuing to pursue a less responsible strategy. And a link between responsibility and

profitability doesn’t necessarily mean that firms would be even more profitable if they were more

responsible, since there may be declining returns for behaving more responsibly. In fact, if all firms

behaved responsibly – which presumably is the goal of the CSR movement – then at least some of

the advantages a firm receives from being more responsible than its competitors would disappear,

and thus, ironically, future studies of the links between CSR and profits would find no statistically

significant relationship”. If it was really proven that CSR leads to increased profitability of firms, then

it would be in the self-interest of all firms to engage in CSR. But if all firms subsequently engaged in

CSR, it would be unclear if the positive link with financial performance would still hold. Vogel (2005)

continues about socially responsible investing: “ironically, if more socially responsible firms did

16

systematically perform better, we would expect all fund managers to heavily weight their portfolios

with those firms’ securities. This would both erase all differences in financial performance between

socially responsible and ‘normal’ funds and raise the price of the shares of more responsible firms so

as to reduce the return from future purchases of them” (Vogel. 2005).

Vogel (2005) states: “although CSR may not make firms any less profitable, it is possible that some

more responsible firms might be even more profitable if they were less responsible”. As Vogel (2005)

further observes: “if CSR were actually a significant source of competitive advantage, then it might

logically be in the interest of more responsible firms to discourage their competitors from following

their example. But in the case of CSR, rather than seek to protect their ‘first mover’ advantages, firms

frequently encourage their less responsible competitors to emulate their behavior”.

What really matters

Several authors have argued that the relationship between CSR and financial performance isn’t

relevant. They argue that what matters is that firms should strive for sustainability and also think

about the planet and the next generations inhabiting it. For example, Marcus & Fremeth (2009: 19)

argue that “whether it *CSR and being ‘green’+ pays is not relevant. Nonetheless, the attention given

to whether it pays continues to be important, for if it pays then progress toward sustainability is

likely to be more rapid. Businesses will not necessarily introduce green management practices

because of the normative obligation, but because green management coincides with their economic

interest to satisfy key stakeholders and thrive as profitable enterprises”. They argue that firms should

accept the universal norm of striving for sustainability. They state: “regardless of whether it pays,

society expects management to be green. If one accepts an absolute imperative that management

must strive toward greening, then the question of whether it pays or not is not that relevant. *…+ If

the carrying capacity of the earth is limited, then what humans extract from nature in the present is

at the expense of future generations. Thus, there are deeper implications to green management”

(Marcus & Fremeth, 2009: 24).

Conclusion

Many authors have explored the relationship between CSR and financial performance since

Friedman’s (1970) challenge that the social responsibility of business is to make profits.

Analyzing the impact of CSR on financial performance is a very complex issue (Lin et al., 2009: 61).

The studies mentioned in this paper point to a positive relationship between CSR and financial

performance of firms. Although there is also some evidence for a mixed relationship, there is little

evidence for a negative relationship. Margolis & Walsh (2003: 277-278) argue that if there is a

positive relationship between CSR and profitability (which the evidence suggests), the Friedman

doctrine doesn’t hold anymore. As explained before, the Friedman doctrine (Friedman, 1970) claims

that spending money on CSR is not in the interest of shareholders. However, if a firm spends money

on CSR and there is a positive relationship with profitability, then the resources of the firm are used

in the interest of the stockholders (Margolis & Walsh, 2003: 277-278). Likewise, Karnani (2011: 83)

says that CSR faces an “inherent conflict between private profits and social welfare”, which doesn’t

hold anymore if there is a positive relationship between CSR and financial performance.

17

However, many studies measure different things, and the validity of some studies is disputed, which

makes it hard to draw broad conclusions (Vogel, 2005). Margolis & Walsh (2003: 278) observe that

research on the link between CSR and profitability has become self-perpetuating with the imperfect

nature of many previous studies: “each successive study promises a definitive conclusion, while also

revealing the inevitable inadequacies of empirically tackling the question. As the acceleration in the

number of studies reveals, research that investigates the link between CSP [corporate social

performance+ and CFP *corporate financial performance+ shows no sign of abating”. Vogel (2005)

states that CSR may well matter, but its impact on financial performance is usually dwarfed by many

other variables, which makes the exact relationship hard to measure. In addition he claims that “it is

not necessary to find a positive statistical relationship between CSR and profits to claim that some

firms may benefit financially from being more responsible or suffer from being irresponsible”. Vogel

(2005) concludes that “neither academics nor practitioners should rely on the research results

because they are incomparable”.

Managers have to decide how to allocate scarce corporate resourced in a high-paced, dynamic

environment (Waddock & Graves, 1997: 303). McWilliams & Siegel (2001: 125) state that “managers

should treat decisions regarding CSR precisely as they treat all investment decisions”. Vogel (2005)

argues that CSR is better understood as a dimension of corporate strategy, instead of a necessary

condition for success. He states: “the risks associated with CSR are no different than those associated

with any other business strategy; sometimes investments in CSR make business sense and sometimes

they don’t. *…+ CSR does make business sense for some firms in specific circumstances”. In these

cases, CSR can be a source of opportunity, innovation, and competitive advantage (Porter & Kramer,

2006). Vogel (2005) concludes that “there is a place in the business system for responsible firms, but

the market for virtue is not sufficiently important to make it in the interest of all firms to behave

more responsibly”. However, Porter & Kramer (2006: 13) think that CSR will become increasingly

important to competitive success. Newell (2005: 556) summarizes: “CSR can work, for some people,

in some places, on some issues, some of the time. The challenge is to identify and specify those

conditions in order that inappropriate models of ‘best practice’ are not universalized, projected and

romanticized as if all the world were receptive to one model of CSR”.

18

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