Corporate Social Responsibility and firm financial performance

Social Responsibility & Financial Performance Linkage: P a g e | 14 An International Journal J. Org. Management 1(1), 14-21, 2012 HATAM Publishers Journal of Organizational Management Journal homepage: http://www.hgpub.com/jorm.html Corporate Social Responsibility and Financial Performance Linkage‐ Evidence from the Banking Sector of Bangladesh Sarwar Uddin Ahmed1, Md. Zahidul Islam2, *, Ikramul Hasan1, 3 1 School of Business, Independent University, Bangladesh Plot- 16, Block- B, Aftabuddin Ahmed Road, Bashundhara R/A, Dhaka, Bangladesh Phone: 880-17206405020; E-mail: [email protected], 3 [email protected] 2 Faculty of Business, Economics and Policy Studies, University Brunei Darussalam (UBD), Jalan Tungku Link, Gadong BE 1410, Brunei. Phone: +(673) 2463001 - Ext – 1818; E-mail: [email protected] , [email protected] ARTI CLE I NFORMATI ON Art icle hist ory Received 10 April 2011 Revised 20 August 2011 Accepted 30 November 2011 Available online 05 Jan. 2012 Keywords Corporate Social Responsibility, Financial Performance, Corporate Social Performance, Bank ABSTRACT The main objective of this paper is to examine the nature of relationship between corporate social responsibility (CSR) and corporate financial performance (CFP). In doing so we have summarized the findings of the empirical studies, drawn the conceptual framework, measured CSR by developing a measure of corporate social performance (CSP) and finally made an investigation on the banking sector of Bangladesh. The results of the study revealed that the average return on asset ratios of the banks having high CSP is higher compared to that of the banks having low CSP, though this could not be proved statistically. However, we should not write off the possibility of this linkage and continue the study. In this respect, the CSR status measured in this study would serve as an important benchmark for further studies. © 2011 HATAM Publishers. All rights reserved. 1. Introduction In the contemporary globally competitive market companies must portray themselves as socially responsible companies. Through globalization companies pursue growth, and active involvement in socially beneficial programs provides competitive advantages to the company in pursuing such goals. Companies operating in multiple nations are often required to play a significant role in social issues of the respective nations, otherwise government regulations, environmental restrictions, labor exploitation issues and more can cost companies millions of dollars. Under these circumstances, Corporate Social Responsibility (CSR) can increase both long term profitability and sustainability of the company as well as enhance the reputation of the organization. The last three decades have seen a mounting pressure on companies to engage in CSR. Among most global companies, some simply view CSR as a costly hindrance, while a few have managed to use CSR methodologies as a strategic tactic to obtain public Electronic copy available at: http://ssrn.com/abstract=1999140 Social Responsibility & Financial Performance Linkage: P a g e | 15 support for their presence in the global markets. Nevertheless, this helps the companies to sustain a competitive advantage by using their social contributions. Researchers around the world, over the past few decades, have reported positive, negative, mixed and neutral impact of CSR on Corporate Financial Performance (CFP). Building upon this premise, the objective of this study is to draw a conceptual framework for examining the direction of the linkage between corporate social responsibility and corporate financial performance and apply the framework on the banking sector in Bangladesh in order to examine the impact of CSR on CFP in this sector. 2. Methodology and data collection To verify the linkage between CSR and CFP, the authors have primarily graded the level of corporate social responsibility of banks by measuring a corporate social performance (CSP) index though a questionnaire survey. Based on the grades banks were separated into two categories: CSR banks and non-CSR (NCSR) banks. Afterwards, t-tests were conducted to examine whether there is a difference between these two categories of banks with respect to their ROA, EPS and P/E ratio data collected from the published annual report of the banks. 3. Overview on CSR Corporate social responsibility (CSR) is influenced by how businesses align their values and behavior with the expectations and needs of stakeholders – not just customers and investors, but also employees, suppliers, communities, regulators, special interest groups and society as a whole. CSR describes a company's commitment to be accountable to its stakeholders. CSR is a growing term that still does not have a standard definition or a fully recognized set of specific criteria. CSR is generally understood to be the way a company attains a balance or integration of economic, environmental, and social imperatives while at the same time addressing shareholder and stakeholder expectations, with the understanding that businesses play a key role on job and wealth creation in society. Corporate social responsibility (CSR) has become a prominent topic in the both business and academic press. Nevertheless, opinions differ as to whether a firm’s CSR activity provides any economic benefits. According to Frankental (2001) “CSR is a vague and intangible term which can mean anything to anybody, and therefore is effective without meaning.” On the other hand, The Commission for the European Communities (2001) defines CSR as “a concept whereby companies integrate social and environmental concerns in the business operations and in their interactions with their stakeholders on a voluntary basis”. According to Wood (1991), “the basic idea of CSR is that business and society are interwoven rather than distinct entities” and for Mallenbaker (2006), “CSR is about how companies manage the business process to produce an overall positive impact on society”. More generally, a distinction has been drawn between CSR seen as philanthropy as opposed to CSR as a core business activity (Jones et al., 2007). Carroll (1979) observed that “the social responsibility of business encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time”. 3.1 CSR in Banks Financial institutions, such as banks, do not produce hazardous chemicals or discharge toxic pollutants into the air, land or water and thus apparently they might be viewed as uninvolved with environmental issues (Cowton and Thompson, 2000). But through their financing practices they are supporting commercial activity that ultimately degrades the natural environment (Smith, 1993). They act as facilitators by supplying the fund to support the production process which ultimately causes environmental degradation (Sarokin and Schulkin, 1991). Thus banks should admit the responsibility of indirect involvement in environmental damages and recognize their environmental responsibility, which is a part of their CSR, to strike a balance between economic and social goals to encourage the efficient use of resources. It is not just philanthropy and obeying the laws, rather an attempt to ensure their own sustainability and profitability (Wanless, 1995). Involvement in environmental degradation will not only invite public criticism and negative customer reaction, but also might make regulations more stringent which can impair the bank 1 profitability by curbing market for the products of their customers . Also lenders can even be held 1 For example, the Montreal protocol has banned the production of ozone-depleting substances, which is threatening for companies operating in that area and the banks financed these companies. Electronic copy available at: http://ssrn.com/abstract=1999140 Social Responsibility & Financial Performance Linkage: P a g e | 16 2 responsible for their clients’ environmental impacts . Thus banks have strong prudential reasons for trying to avoid lending in ways that expose them to environmental risk and have clear incentive to incorporating environmental criteria into the lending decision making process. In contrast, the status of environmental risk management by banks is not satisfactory in least developed countries like Bangladesh, largely due to inadequate existence and poor enforcement of existing laws and inadequate pressure from civil society and interest groups. In June 1997, Bangladesh Bank, the Central Bank of the country, asked all commercial banks (BRPD-No-12 dated 8.10.1997) to undertake necessary steps in light of the implementation of certain decisions with regard to environmental conservation and protection of environmental pollution by the National Environment Committee and implement the provisions of Environment Conservation Act 1995. Commercial banks are asked to ensure that steps have been undertaken to control environmental pollution before financing a new project or providing working capital financing to the existing enterprises. However, enforcements of these have been very weak in the country. Consequentially, environmental protection is not in the priority list of the banks in Bangladesh during lending and in other operations. A lot needs to be changed in terms of policies and mindsets, and in formulation of new and implementations of existing regulations. 3.2 Relationship between CSR and financial Performance Mostly there are two types of empirical studies on the relationship between CSR and financial performance (Clinebell and Clinebell, 1994; Hannon and Milkovich, 1996; Posnikoff, 1997; Teoh et al., 1999; Worrell et al., 1991; Wright and Ferris, 1997). Some studies uses the event study methodology to assess the short-run financial impact (abnormal returns) when firms engage in socially responsible or irresponsible acts and the results of these studies have been mixed. Teoh et al. (1999) found no relationship between CSR and financial performance, Wright and Ferris (1997) found a negative relationship and Posnikoff (1997) reported a positive relationship; and McWilliams and Siegel (1997) studies are inconsistent on the relationship between CSR and short run financial returns. Through a broad-based index of corporate social performance, Waddock and Graves (1997) analyses whether there is a positive relationship between corporate social performance and financial performance and whether both slack resource and good management theory may be operating simultaneously. Using the improved measurement version, they found that corporate social performance does depend on financial performance and that the sign of the relationship is positive. Researchers view that, corporate social performance is a kind of virtuous circle, there is a simultaneous relationship, and corporate social performance is both a predictor and consequence of company financial performance. McWilliams and Siegel (2000), found that, when research and development (R&D) and industry factors are excluded, the coefficient on corporate social performance (CSP) (a measure of CSR), is positive and statistically significant. However, when research and development (R&D) and industry factors are included, the degrees of the coefficient reduce dramatically and are no longer significant and CSP showed a neutral effect on profitability. 4. Measuring CSR For measuring CSR there are two generally accepted methods. The first method is a reputation index, where knowledgeable observers rate firms on the basis of one or more dimensions of social performance. One reputation index was generated by Moskowitz (1972), who over a period of several years rated a number of firms as outstanding, honorable mention, or worst (Moskowitz, 1972). Content analysis is a second method of measuring CSR. Normally, in content analysis the extent of the reporting of CSR activities in various firm publications and especially in the annual report (used by Bowman and Haire, 1975; Abbott & Monsen, 1979; Anderson & Frankle, 1980; Ingram, 1978). 5. Measuring Financial Performance General measures of financial performance fall into two broad categories: investor returns and accounting returns. The basic idea of investor returns is that, the return should be measured from the perspective of shareholders. Whereas, Accounting Return measures of financial performance focuses on how firm earnings respond to different managerial policies. 2 In the Fleet Factors case of U.S.A., a lender was held liable for clean up costs at a site owned by a defaulting client since it was adjudged to have been in a position to influence the company’s business decisions (Cowton and Thompson, 2000). Social Responsibility & Financial Performance Linkage: P a g e | 17 Market performance measures by risk-adjusted return, or alpha, and total return are used by McGuire et al. (1988) as measures of financial performance. Accounting-based performance measures are return on assets (ROA), total assets, sales growth, asset growth, and operating income Independent Variables CSR CSP SIZE Risk (debt/Asset ratio) R&D (expenditure/Sales) Advertising intensity Environmental performance Prior Financial performance Social performance disclosures Dependent Variables Financial Performance Return on assets (ROA) Return on equity (ROE) Return on investment (ROI) Return on sales (ROS) Earnings per share (EPS) Price/earnings (P/E) ratios Share price returns Total Assets Sales growth Assets growth No. of Employees Excess market Valuation Asset Age Asset turnover Operating earnings to assets Operating earnings to sales Figure 1: Conceptual Framework growth. The ratio of debt to assets, operating leverage, and the standard deviation of operating income were other accounting-based measures of risk. Waddock and Graves (1997) measured financial performance using three accounting variables: return on assets, return on equity, and return on sales, providing a range of measures used to assess corporate financial performance by the investment community. Earnings per share (EPS) or price/earnings (P/E) ratios are used in some studies as the most common measure of accounting returns (Bragdon and Marlin 1972). On the other hand, Cochran and Wood (1984), used three account returns measures: the ratio of operating earnings to assets, the ratio of operating earnings to sales, and excess market valuation. In addition to this, three other measures of financial performance are used by researchers: market-to-book ratio; accounting profit ratio (return on assets, return on equity, return on investment, and return on sales) and stock market returns. 6. Conceptual framework of the research The authors have conducted a comprehensive literature review on both direction of relationship between CSR and CFP, and ways to measure them. The result of this review might be concluded in the following manner, and by drawing a conceptual framework as shown in Figure 1: 1. Various empirical studies around the world have reported a positive, negative, mixed and neutral impact of corporate social responsibility (CSR) on corporate financial performance (CFP). Hence rather than having any preconceived idea on the direction of the relationship, there needs to be an open view on this: the linkage between CSR and CFP will depend on various factors, e.g., industry, location, size etc. 2. Among the two common methods of measuring CSR, to the authors are going to use a reputation index to measure the CSP in Bangladesh. It may be noted that there are no published source of knowledgeable observer rating of social performance. The authors will have to develop a questionnaire and ask the knowledgeable observer to rate the firm on five dimensions of social performance. Social Responsibility & Financial Performance Linkage: P a g e | 18 3. Corporate Financial Performance (CFP) will be measured both by investors return and accounting return. 6.1 Measuring Corporate Social Performance (CSP) The authors have used the reputation index to measure corporate social performance (CSP) of the banks. The contents of the questionnaire and score ranges are summarized in Table 1. 6.2 Applying to the Banking Sector of Bangladesh The financial system of Bangladesh comprises of Bangladesh Bank as the central Bank, four State Owned Commercial Banks (SCB), five government owned specialized banks, thirty domestic private banks, nine foreign banks and twenty-nine non-bank financial institutions (BB, 2009). For this study, the CSP survey was conducted on twenty domestic private banks, out of which seventeen questionnaires could be used in order to investigate the CSR-CFP linkage. Table 1: Contents of the corporate social performance (CSP) questionnaire used in the survey CSR Indicators I. VALUES AND TRANSPARENCY 1. Adoption and scope of ethical principles 2. Communication of the company’s ethical values 3. Communicating socially responsible actions Total Score of Segment 1 Maximum Score 10 10 10 30 II. WORKPLACE 1. Worker’s participation in unions/society activities 2. Involvement of employees in management 3. Profit sharing and performance bonuses 4. Handling of dismissals 5. Development of human resources 6. Concern for health, safety and working conditions 7. Preparation for retirement of workers Total Score for Segment 2 10 10 10 10 10 10 10 70 III. CORPORATE GOVERNANCE PRACTICES 1. Meeting with stakeholders 2. Board meeting 3. Board structure 4. Financial reporting 5. Management structure, system and procedures Total Score for Segment 3 10 10 10 10 10 50 IV. ENVIRONMENT 1. Management of environmental impact 2. Environmental management practices 3. Commitment to the environmental cause 4. Environmental education activities Total Score for Segment 4 10 10 10 10 40 V. COMMUNITY 1. Relation with the local community 2. Relation with community organizations 3. Philanthropy/ social investments 4. Action strategies in the social area 5. Mobilization of resources for social investment 6. Recognition and support for volunteer work by employees Total Score for Segment 5 Grand Total 10 10 10 10 10 10 60 250 Social Responsibility & Financial Performance Linkage: P a g e | 19 a e &T a 80 a e cy 60 40 C i y ac e 20 0 E i C G e e a e a ce Figure 2: Status of surveyed banks in segments 7. Findings 7.1 CSR indicators CSR has been measured by five board categories. In these five categories, the surveyed banks had highest average score of 72 percent in corporate governance and lowest average score of 49 percent in environmental activities. Thus it can be observed from figure 2 that the banks are lacking in environmental and workplace aspects of social responsibility. 7.2 Test results The t-tests results are summarized through Tables 2- 4. Table 2 shows the results of the difference of means of return on assets (ROA) between NCSR (3 and below) and CSR (4 and above) banks. From the table we can see that the ROA of the CSR banks are higher when compared against the NCSR banks. Thus we can comment that CSR banks are performing better than the NCSR banks. However, our two-tailed t-test does not support this observation. It should be noted here that equal variances were assumed on all statistical tests. This leads us to accept the null hypothesis. Table 2: Return on Assets Sample Size(valid N ) Mean S.D. t-test of paired samples: Difference in sample means CSR 5 2.42 0.89 NCSR 12 1.80 1.45 0.616 t-test statistic 0.872 Decision: Do not reject the null hypothesis On the other hand, the results of the difference of means of EPS and P/E ratio are summarized through Table 3 and 4. As shown in Table 3 EPS of the CSR banks are higher compared to that of NCSR banks. So we can comment that CSR banks are performing better than the NCSR banks. However, in this regard too, we could not get any statistically significant result from these analyses. The two-tailed t-test does not support this observation. Table 4 shows the results of comparison of P/E Ratio between CSR and NCSR banks. It can be seen that the P/E Ratio of the CSR banks are lower when compared against the NCSR banks. Thus it can Social Responsibility & Financial Performance Linkage: P a g e | 20 be observed that CSR banks are performing better than the NCSR banks. Again the two-tailed t-test does not confirm this observation. Thus, the authors had to accept the null hypothesis. Table 3: Earnings per share Sample Size(valid N ) Mean S.D. t-test of paired samples: Difference in sample means CSR 5 275.71 503.95 NCSR 12 64.3 47.8 211.406 t-test statistic 1.507 Decision: Do not reject the null hypothesis Table 4: Price earnings ratio Sample Size(valid N ) Mean S.D. t-test of paired samples: Difference in sample means CSR 5 9.01 4.86 NCSR 12 14.9 15.2 -5.842 t-test statistic -0.827 Decision: Do not reject the null hypothesis 8. Conclusion We have undertaken a modest attempt to examine the linkage between corporate social responsibility performance and financial performance and present the results of the study conducted on the banking companies in Bangladesh. The results of the study can be summarized as follows: I. The results of the analysis revealed that the banks’ social performances were below 75 percent in all the five categories of CSR indicators, especially value & transparency, workplace, governance and community (see Figure 2). In particular, banks are lagging behind in the environmental (49 percent) and workplace (50 percent) aspects. This might be due to the fact that, banks are yet to incorporate environmental aspects in project selection, loan disbursement and regular day to day activities. However, the workplace aspect reflects an overall inadequacy of good working condition in the publicly traded banking companies of Bangladesh. II. In all cases of absolute comparison between ROA, EPS and P/E ratio it was found that CSR banks outperformed the NCSR banks. However, in all the two-tailed t-tests, no significant evidence was found to show that CSR banks outperform the NCSR banks. This finding is consistent with the study conducted by Ramasamy et.al (2007) on Malaysian firms. 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