Causality Between Corporate SocialPerformance and Financial

Performance

Rim Makni GargouriClaude Francoeur

François Bellavance

November 12th, 2010Cirano & École Polytechnique de Paris

Presented by Claude FrancoeurCGA Professorship in Strategic Financial Information

Theoretical link between CSP and FP

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CSPPositive / Negative

Positive / Negative

Positive / Negative Synergy

CSP

CSP FP

FP

FP

Theoretical link between CSP and FP(Preston & O’Bannon 1997)

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Causality Positive Negative

CSP => FP Social Impact Hypothesis(Freeman, 1984)

Trade-Off Hypothesis(Vance, 1975)

Social Impact Hypothesis(Freeman, 1984)

FP => CSP

Slack Resources Hypothesis(Waddock & Graves, 1997)

Managerial OpportunismHypothesis(Preston & O’Bannon, 1997)

Managerial OpportunismHypothesis(Preston & O’Bannon, 1997)

CSP <=> FP Positive Synergy(Preston & O’Bannon, 1997)

Negative Synergy(Preston & O’Bannon, 1997)

Social Impact Hypothesis Based on the instrumental view of Stakeholder Theory. Meeting the needs of various corporate stakeholders will

lead to favourable FP. Serving the implicit claims of stakeholders enhances a

company’s reputation which will have a positive impact on its FP.

Conversely, disappointing these groups of stakeholders may have a negative financial impact by increasing the perceived risk and consequently, the cost of capital (Cornell & Shapiro, 1987).

CSP => FP

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Trade-Off Hypothesis Social accomplishments involve financial costs which will

reduce profits and comparative performance. Corporations displaying strong social credentials experience

declining stock prices relative to the market average (Vance 1975).

CSP => FP

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Slack Resources Hypothesis Better FP potentially results in the availability of slack

resources that may increase a firm’s ability to invest in socially responsible domains such as community and society, employee relations or environment.

FP => CSP

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Managerial Opportunism Hypothesis Corporate managers may pursue their own private

objectives to the detriment of both shareholders and other stakeholders.

When FP is strong, managers may reduce social expenditures in order to maximize their own short term private gains.

Conversely, when FP weakens, managers may try to offset their disappointing results by engaging in conspicuous social programs.

FP => CSP

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Positive Synergy Hypothesis Higher levels of CSP lead to an improvement of FP funds

(social impact hypothesis), which offers the possibility of reinvestment in socially responsible actions (slack resources hypothesis).

There may then be a simultaneous and interactive positive relation between CSP and FP, forming a virtuous circle.

CSP FP

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Negative Synergy Hypothesis Corporate higher levels of CSP lead to decreased FP (trade-

off hypothesis), which in turn limits the socially responsible investments.

There may then be a simultaneous and interactive negative relation between CSP and FP, forming a vicious circle.

CSP FP

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Empirical results concerning the nature of the relationship between CSP and FP are mixed.

The largest number of investigations found a positive relationship between CSP and FP (See meta-analyses by Orlitzky et al., 2003; Allouche and Laroche, 2005b and Wu, 2006).

Studies using perceptual based measures tend to report a stronger CSP-FP relationship (Wu, 2006).

Past research falls short of showing a clear causal relationship between FP and CSP.

Empirical studies

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Conceptual model

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Corporate Social Performance

Aggregate score Community and society Corporate governanceCustomersEmployeesEnvironmentHuman rights

Financial Performance

ROAROEMarket return

Size Risk Industry

Granger causality

Measure of CSP(MJRA – Now SustainAnalytics)

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COMMUNITY AND SOCIETY ENVIRONMENTReporting on Community Exposure to Environmental IssuesCharitable Donations Program Management SystemsCommunity Relations Public ReportingAboriginal Relations Impact and InitiativesImpact on Society Regulatory ComplianceCORPORATE GOVERNANCE Environmental Impact of Product/ServiceManagement Systems Other Environmental DataOther Governance Data HUMAN RIGHTSCUSTOMERS Exposure to Human Rights IssuesManagement Systems Management SystemsImpact on Customers Public ReportingEMPLOYEES Impact and InitiativesEmployee Programs and BenefitsDiversityHealth and SafetyUnion RelationsOther Employee Data

Granger causality model

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Granger causality can measure : temporal ordering high correlation predictive abilitywhich are the necessary elements of causality (Malina, 2007).

Granger causality model

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(1)

(2)

Results

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Dependent variableEnvironment in 2005

(N = 168)Market return in 2005

(N = 168)

Independent variable Estimated coefficient

Standard error p-value Estimated

coefficientStandard

error p-value

Intercept 1.604 0.319 0.001 0.063 0.318 0.842Environment in 2004 0.923 0.035 0.001 -0.111 0.035 0.002*Market returns in 2004 -0.051 0.073 0.489 0.149 0.073 0.042

Natural log of assets -0.054 0.019 0.006 0.050 0.019 0.010Debt level 0.296 0.211 0.163 -0.245 0.210 0.246Beta factor 0.002 0.045 0.968 -0.074 0.044 0.099Industry

Communications & Media -0.413 0.142 0.004 -0.280 0.141 0.049

Consumer products -0.581 0.139 0.001 -0.035 0.139 0.801Financial services -0.497 0.116 0.001 -0.298 0.115 0.011Gold & precious metals -0.233 0.117 0.049 -0.231 0.117 0.049Industrial products -0.363 0.104 0.001 -0.096 0.103 0.352Merchandising -0.430 0.123 0.001 0.059 0.123 0.628Utilities -0.572 0.139 0.001 0.117 0.138 0.398Oil & Gaz -0.554 0.107 0.001 0.190 0.107 0.077Metals, Minerals & Paper reference reference

R-square 0.858 0.283

We find a robust unidirectional and negative ‘‘Granger causal’’ relationship between the environmental dimension of CSP and all three FP measures.

This is consistent with the trade-off hypothesis, but we do not find evidence of a vicious circle.

Our results are consistent with environmental programmes leading to poor performance in the short term.

Government subsidies may be necessary to compensate for the short-term negative impact on financial performance that these firms suffer.

Conclusions

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As Ambec and Lanoie (2007) argue, augmented environmental expenses could be compensated in the long run by : increases in revenues through better access to certain markets the possibility to differentiate products and sell pollution-control

technology and the reductions of costs related to regulations and capital

market.

Conclusions

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The Relationship betweenCorporate Social Performance

and Earnings Management

Rim Makni GargouriClaude Francoeur

Ridha Shabou

November 12th, 2010Cirano & École Polytechnique de Paris

Presented by Claude FrancoeurCGA Professorship in Strategic Financial Information

Generally Accepted Accounting Principles (GAAP) gives managers the flexibility to manage reported earnings.

EM follows a continuum :

Earnings Management (EM)

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Within GAAP Violates GAAP

Conservative Accounting

Neutral Accounting

Agressive Accounting

FraudulentAccounting

EM also goes by : Fancy accounting, Income smoothing, Cooking the books,

Borrowing Income from the Future, Window Dressing…

Multivariate Analysis(Population-Averaged Probit)

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it 1 2 it 1 3 it 1 4 it 1 5 it 1 6 it 1

7 it 1 8 it 1 9 it 1 10 it 1 11 i 3

EM CSP STOCKRET SIZE DEBT BONUSRISK MBRATIO BLOCK AUDIT SECT

− − − − −

− − − −

= α + α + α + α + α + α+α + α + α + α + α + ε

Results

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Dependent Variable = Earnings ManagementModel 1 Model 2 Model 3 Model 4

Variables Coeff. Prob. Variables Coeff. Prob. Variables Coeff. Prob. Variables Coeff. Prob.

Constant 3.614 0.011** Constant 3.396 0.022** Constant 3.206 0.027** Constant 3.991 0.005***

CSP 0.419 0.027** CG 0.090 0.356 ENV 0.317 0.033** EMP 0.229 0.085*

STOCK-RET -0.068 0.769 STOCK-RET -0.051 0.824 STOCK-RET -0.047 0.839 STOCKRET -0.070 0.763

SIZE -0.292 0.004*** SIZE -0.203 0.026** SIZE -0.248 0.009*** SIZE -0.263 0.009***

DEBT -0.130 0.893 DEBT -0.292 0.761 DEBT -0.194 0.841 DEBT -0.304 0.752

BONUS -1.000 0.168 BONUS -0.780 0.270 BONUS -0.892 0.214 BONUS -0.694 0.331

RISK -0.180 0.344 RISK -0.198 0.296 RISK -0.224 0.239 RISK -0.183 0.338

MB-RATIO 0.120 0.059* MB-RATIO 0.104 0.101 MB-RATIO 0.101 0.108 MBRATIO 0.114 0.073*

BLOCK 0.004 0.458 BLOCK 0.004 0.444 BLOCK 0.006 0.284 BLOCK 0.006 0.247

AUDIT -0.796 0.109 AUDIT -0.534 0.268 AUDIT -0.709 0.153 AUDIT -0.715 0.149

GOLD -0.288 0.523 GOLD -0.263 0.556 GOLD -0.464 0.317 GOLD -0.236 0.601

OIL -0.557 0.155 OIL -0.390 0.304 OIL -0.439 0.253 OIL -0.454 0.236

CONS -1.071 0.030** CONS -1.038 0.034** CONS -1.008 0.04** CONS -1.044 0.035**

IND -1.185 0.002*** IND -1.000 0.006*** IND -1.114 0.003*** IND -1.078 0.003***

COM -0.541 0.248 COM -0.544 0.246 COM -0.573 0.216 COM -0.386 0.426

MERCH -0.666 0.112 MERCH -0.644 0.123 MERCH -0.724 0.086* MERCH -0.693 0.099*

N 162 N 162 N 162 N 162

Wald chi-sq. 31.73 Wald chi-sq. 29.77 Wald chi-sq. 31.98 Wald chi-sq. 31.14

Prob > chi-sq. 0.0070*** Prob > chi-sq. 0.0128** Prob > chi-sq. 0.0065*** Prob > chi-sq. 0.0084***

Statistic C 0.761 Statistic C 0.747 Statistic C 0.760 Statistic C 0.752

Our results are consistent with the environment dimension of CSP being postively associated with EM.

This could be attributed to the costs borne by firms engaged in environmental activities, which reduce FP and give managers an incentive to manage earnings.

Conclusions

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