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Journal of Business Ethics (2007) 76:189–206  Springer 2007

DOI 10.1007/s10551-006-9268-1

Ron Bird
Anthony D. Hall
What Corporate Social Responsibility Francesco Momentè
Activities are Valued by the Market? Francesco Reggiani

ABSTRACT. Corporate management is torn between market is not only influenced by the independent CSR
either focusing solely on the interests of stockholders (the activities, but also the totality of these activities and that
neo-classical view) or taking into account the interests of the facets that they value do vary over time. It seems
a wide spectrum of stakeholders (the stakeholder theory that most recently, the market has valued most firms that
view). Of course, there need be no conflict where taking satisfied minimum requirements in the areas of diversity
the wider view is also consistent with maximising and environmental protection but were most proactive in
stockholder wealth. In this paper, we examine the extent the area of employee-relations.
to which a conflict actually exists by examining the
relationship between a company’s positive (strengths) and KEYWORDS: corporate social responsibility, corporate
negative (concerns) corporate social responsibility (CSR) performance, shareholder value, value-based management
activities and equity performance. In general, we find
little evidence to suggest that managers taking a wider
stakeholder perspective will jeopardise the interest of its
stockholders. However, our findings do suggest that the
The neo-classical economists’ view of the role of
professional management within a company is that
their decisions should be solely predicated on the
Ron Bird is an Emeritus Professor in the School of Finance and objective of maximising the corporation’s long-term
Economics at the University of Technology, Sydney. His market value and so the wealth of the company’s
research interests focus on market implications of corporate
owners. In contrast, stakeholder theory suggests that
social responsibility and also dysfunctionality within capital
managements’ concern should extend to a much
markets. He received his Master’s degree in economics at
Monash University in 1971. wider spectrum of stakeholders (e.g., employees,
Anthony D. Hall is currently the Head of the School of Finance customers, suppliers and the general community)
and Economics and Director of the Quantitative Finance whose interests should all be taken into account in the
Research Centre at the University of Technology, Sydney. decision processes of management. There is clearly
His research interests cover all aspects of financial econometrics. the potential for conflict between these two views in
He was awarded a PhD in econometrics from the London those instances where maximising the wealth of
School of Economics in 1976. owners is not the natural outcome of a process where
Francesco Momentè is Professor of Corporate Finance at the the decisions by management are influenced by the
Bocconi University, Milan (Italy). His research intersts focus interests of a broad spectrum of stakeholders.
on the market valuation of corporate social responsibility and The focus of this paper is on examining the extent
the value relevance of accounting information.He received his
of this potential conflict faced by management. In the
PhD in General Management at Ca’ Foscari University,
Venice (Italy) in 1998.
first section of the paper, we will consider the
Francesco Reggiani is Professor of Corporate Finance at the foundation of this potential conflict in more detail,
Bocconi University, Milan (Italy). His research interests focus highlighting the need to resolve the extent of any
on the market valuation of corporate social responsibility and relationship that might exist between management
corporate governance. He received his PhD in General using the company’s resources on what is best de-
Management at Bocconi University in 2001. scribed as corporate social responsibility (CSR)
190 Ron Bird et al.

activities and the consequential impact of these which ‘‘all persons or groups with legitimate inter-
activities on corporate performance. This is an issue ests in participating in an enterprise do so to obtain
that has been the subject of much investigation over benefits, and there is no prima facie priority of one
the last 30+ years and we will provide a summary of set of interests and benefits over another’’. It goes
some of this literature in ‘‘Corporate social respon- beyond the simple idea that organisations have many
sibility and corporate performance’’ section. The different stakeholders to the more fundamental
question that we want to answer is just what types of questions of what interest should drive the compa-
CSR activities, if any, are rewarded by improved nies and in whose interest the companies should
market performance. In other words, we want to operate. Stakeholder theory gives rise to the concept
isolate the areas where there is no apparent conflict that companies have a CSR to take into consider-
between neo-classical economists and stakeholder ation the impact of its activities on all of its
theory. We outline the data and method that we constituents.1 For example, the company may aim to
employ in this analysis in ‘‘Data and method’’ section benefit the community by such activities as sup-
and report and discuss our findings in ‘‘The findings’’ porting the construction of a theatre complex or
section. We wind up the paper in ‘‘Summary and reducing the pollution in the river systems; to ben-
conclusions’’ section where we summarise the major efit its employees by providing childcare facilities or
implications of our findings and present some by including a performance-based bonus scheme in
thoughts for future research. its salaries packages; to benefit its clients by
producing cheaper and/or safer products.
One might ask where stakeholder theory actually
Neo-classical economics and stakeholder leaves management given that it suggests that they
theory have to take into account the sometimes potentially
conflicting interests of a wide and diverse spectrum
The starting point for this paper as it has been for of stakeholders when deciding how best to employ
many preceding papers on similar topics, is the fa- corporation’s resources. As Jensen (2001) points out,
mous quote from Milton Friedman (1970) who under Stakeholder Theory management is given no
wrote that ‘‘there is one and only one social direction as to how to differentiate between the
responsibility of business – to use its resources and interests of the different stakeholders and so there is
engage in activities designed to increase profits so no best outcome and so no way of judging manager
long as it stays within the rules of the game, which is performance. In effect, the boundaries of legitimate
to say, engages in open and free competition with- stakeholders are not defined nor are the weights to
out deception and fraud’’. Friedman argued that the be attached to the interests of each stakeholder and
management of a public company are agents for its so the objective function on which management is
shareholders and it is their sole responsibility to act in to base their decisions is ill-defined.2 De George
the shareholders’ interests, which suggest that man- (1990) provides an insight to the possible resolution
agement has no right to expropriate shareholder of this conflict affirming that ‘‘A stakeholder analysis
wealth to the benefit of other parties. Further, he does not preclude the interests of the shareholders
suggests that it is the role of the Government to overriding the interests of the other stakeholders
consider the potential impact of companies on other affected but it ensures that all affected will be con-
stakeholders and to take these into account when sidered’’. Jensen (2001) brings the original idea of
setting the rules (e.g., taxation, regulation) that De George a step further in proposing the Enlight-
govern the behaviour of companies. ened Stakeholder Theory, which recognises that a
In contrast, the stakeholder theory of the firm single-minded approach to realise maximum value
(Freeman, 1984) widens the focus of management for shareholders to the detriment of various stake-
beyond using the resources of the companies for the holder groups is unlikely to succeed. For example,
sole benefit of shareholders to using these resources paying minimum salaries to employees and requiring
to the benefit of a much wider group of stake- them to work in very poor conditions is likely to
holders. As Donaldson and Preston (1995) stated, have a negative effect on productivity which may
stakeholder theory posits a model of the firm in more than offset any cost-savings and so actually
What CSR Activities are Valued by the Market? 191

reduce the value of the firm. Indeed the capacity of a may translate to increases in both profitabil-
firm to generate sustainable wealth over time, and ity and market valuation in the longer-term.
hence its long-term value, is determined by its • Other activities that dissuade future action
relationships with critical stakeholders (Post et al., by Government and other regulatory bodies
2002). This suggests that consistent with stakeholder which might impose significant costs on the
theory, management has to consider the impact of its company. An example of this might be tak-
decisions on a broad spectrum of stakeholders but, ing action to voluntarily control pollution
consistent with the neo-classical view, to ultimately emission which may again come at an initial
evaluate all of these decisions on the basis of their cost but might dissuade government from
impact on the market value of the company. introducing regulations and/or taxes on the
Putting a corporate finance interpretation to the company which may have imposed even
enlightened stakeholder theory proposed by Jensen, greater costs on the company and so resulted
what he is suggesting can be interpreted as saying in even a greater erosion in the company’s
that management should still apply net present value market value.
analysis to every decision. In other words, no
investment or financing should be undertaken by the What the above examples emphasise is that man-
firm unless the present value of the associated agement in companies already have strong incen-
incremental benefits exceeds the present value of the tives to consider the interests of a wide spectrum
incremental costs. In this framework, it is highly of stakeholders in the pursuit of a goal of value
possible that investment in some CSR activities will maximisation. As a consequence the extent of the
have a positive impact on the value of the firm and actual conflicts that exist for management drawn
thus be justified within Jensen’s enhanced stake- between the demands placed on them by share-
holder theory.3 For example, the provision of holders and those placed by a wider circle of stake-
childcare facilities for staff will come at a cost to the holders might be somewhat limited. Where no
company which may be more than offset by conflict exists, then there is likely to be a market
improvements in employee productivity. solution, which ensures that the interests of that
Indeed, there are various ways in which expen- particular stakeholder are protected. Where there is
ditures on CSR activities may translate into increases a conflict, then management might compromise
in value for the company: the interests of shareholders by taking account of
those of other stakeholders or may choose not to
• Activities that result in an immediate cost- do so which leaves the option for interested parties
saving which will flow through to increased to lobby the government to change the rules of
profitability and supposedly an increase in the game to protect one or more stakeholder
the company’s market valuation. An example groups.
of this is a company which decides to be- In the next section of the paper, we consider the
come more energy efficient which will not existing evidence on the relationship between CSR
only have a positive impact on the environ- activities and financial and market performance as a
ment, but will also reduce its costs and so precursor to conducting our own analysis.
will boost it profitability and flow through
to a higher market valuation.
• Other activities that bring reputational bene- Corporate social responsibility
fits (goodwill) to the company which in- and corporate performance
crease both profitability and market valuation
in the longer-term. Examples of this could We are interested in the association between CSR
include decisions to improve product quality and corporate performance because of its implica-
or donate to medical research, both of which tions for corporate management who potentially face
might have an initial detrimental impact on a conflict because of the narrow definition of their
profitability but contribute to the improve- role which stems from the neo-classical economics’
ment in the company’s market image which view and that which stems from stakeholder theory.
192 Ron Bird et al.

The existing literature would provide support for all sation of the results of a number of papers. Roman
possible outcomes in terms of the direction of this et al. categorised 33 studies finding a positive rela-
relationship: tionship between CSR and corporate performance,
14 that failed to find any relationship and only five
(i) The neo-classical view suggests that any that found a negative relationship. Overall, their
expenditure on CSR activities will put the findings are much more supportive of a positive
company at a competitive disadvantage and relationship between CSR and performance than
so result in a negative relationship between were the findings in Griffin and Mahon.
these activities and market performance Oritzky et al. (2003) argued that the ‘‘vote
(Aupperle et al., 1985) counting’’’ used by Griffin and Mahon and Roman
(ii) Those that say that there are so many other et al is flawed. They proposed meta-analysis as the
more important events that impact on finan- appropriate way of aggregating the finding across a
cial and market performance resulting in large number of studies. In particular they claim that
there being no observable relationship be- meta-analysis will enable them to overcome the
tween the extent of a company’s CSR problems associated with sampling errors and mea-
activities and the performance realised by surement errors which might be the cause of the
the company (Ullman, 1985) variation in the findings of previous writers. Based
(iii) Others that argue that there will be a positive on the meta-analysis that they conducted using
relationship between CSR activities and cor- 61 prior studies, they conclude ‘‘that (1) across
porate performance for reasons such that the studies CSP (corporate social performance) is posi-
costs are small while the benefits as outlined tively correlated with CFP (corporate financial
in the previous section are potentially large performance), (2) the relationship tends to be bidi-
(Moskowitz, 1972) and/or that those man- rectional and simultaneous, (3) reputation appears to
agers who embark on such activities are just be an important mediator of the relationship...’’. The
better managers who will be able to generate problem with their analysis is that there are
higher profitability and so better market per- approximately 30 different dependent variables (i.e.,
formance (Alexander and Buchholz, 1982). measures of financial performance) utilised across the
61 studies and further there is also great variability in
The fact that there is such an obvious disagreement the measures of CSP utilised. As Griffin and Mahon
on a priori grounds as to the relationship between (1997) had already pointed out ‘‘the use by various
CSR activities and corporate performance has been researchers of a wide range of multiple measures for
the stimulus for the numerous empirical studies that both CSP and CFP with little or no replications or
have been reported over the last 30+ years. Perhaps checks for validity and reliability, suggests the need
not surprisingly, but maybe disappointingly, the to focus of a few, key CSP and CFP research mea-
conflicting findings has meant that the empiricists sures to increase the internal validity rather than the
have not been able to resolve the dispute within the generalizability.’’ We would suggest that this lack of
theoreticians. Griffin and Mahon (1997) review 51 homogeneity brings into question the interpretation
papers on this topic and reported that 33 reported a that can be placed on the findings in Oritzky et al
positive relationship, nine reported no relationship study. The reason for why we have failed to achieve
while 20 reported a negative relationship.4 This lead closure on the direction of the relationship between
them to conclude that ‘‘even though there is hope CSR and corporate performance has been the sub-
in the large number of studies that have a positive ject of consideration in a number of papers.5 Sug-
relationship, academics and practitioners alike gestions include (i) the lack of a strong conceptual
should be concerned with the variability and incon- foundation, (ii) the lack of appropriate measures of
sistency in these results’’ and they went on to report the extent of a company’s CSR activities, (iii) the
some reasons for these inconsistencies and how the lack of a sufficient sample size, and (iv) the lack of
research design could be improved in the future. methodological rigour. We suggest that Enlightened
Roman et al. (1999) reworked and extended the Stakeholder Theory provides the conceptual rigour
Griffin and Mahon paper questioning their categori- to support the analysis undertaken in this study. The
What CSR Activities are Valued by the Market? 193

use of the KLD CSR ratings addresses the second economists’ owner-focussed definition of the
and third points in that this database is acknowledged appropriate objective for a corporation and the
as the best database available on CSR activities6 and much broader definition stemming from Stake-
provides more than 10 years of data on more than holder Theory are only in conflict in those situations
500 US companies. The introduction in our study of where corporate management by giving consider-
several factors as control variables that have previ- ation to the interests of one or more stakeholders
ously found to be correlated with corporate financial does so at the expense of the wealth of the com-
performance addresses the major methodological pany’s owners. As a consequence, no conflict exists
concern. where expenditures on CSR activities have either a
Perhaps the most important feature of our neutral or a positive impact on the company’s
methodology is that we do not focus on a total market valuation. Given the focus of this paper on
CSR score for each company but rather analyse the potential conflict for management following the
five distinct CSR activities separately. Further, we stakeholder theory view, the obvious analysis is to
examine both a strengths and a concerns score for determine the impact of CSR activities on the
each activity where strengths can be taken to market value of a corporation’s stock.
broadly mean the extent that a company exceeds This gives clear direction that market returns
legal requirements and/or minimum community should be one dependent variable we should consider
standards with respect to that activity and concerns in our study in preference to any accounting measure
can be taken to broadly mean the extent that a of financial performance, as it is market returns that
company falls short of legal requirements and/or directly impact on owner wealth. It is interesting to
minimum community standards with respect to that note that market returns were a focus in less than 20%
activity. We suggest that examining the strengths of the studies evaluated by Oritzky et al. (2003)
and concerns for separate CSR activities will pro- indicating that prior studies have largely concentrated
vide us with the most useful insights into which are on the relationship between CSR and accounting
valued by market participants. For example, Froo- measures of performance. Although a positive asso-
man (1997) undertook a meta-analysis and con- ciation between CSR activities and financial
cluded that companies engaging in socially performance and a negative association between
irresponsible and illicit behaviour suffered in terms CSR activities and risk7 may provide a strong case for
of their market valuation but that there was expecting that CSR activities to be positively asso-
insufficient evidence to determine whether com- ciated with market returns, there is no guarantee of
panies that behaved in a positive way were re- this as market prices are based on expectations
warded in terms of their market valuation. These relating to the future rather than current events. For
findings were confirmed by Johnson (2003) who this reason, we also consider as dependent variables
found that companies that act in an illegal or valuation multiples such as market-to-book and
irresponsible manner are punished by investors. price-to-earnings as they encapsulate the market
However, he concluded that there is no evidence expectations relating to both future earnings and the
to suggest that companies that go beyond legal and risks associated with those earnings.
community standards are rewarded by way of a
higher market valuation. Data
In the next section, we provide more details on
the data and method employed in this study The CSR data used in this study was obtained from
while the results are reported and discussed in ‘‘The KLD Research & Analytics, Inc., (KLD) which
findings’’ section. provides social issue ratings across a range of cor-
porate activities that impact on the various stake-
holders. Since the coverage of the database is limited
Data and method to the US market, our analysis is confined to the
American corporate system. We utilise the KLD
As discussed in ‘‘Corporate social responsibility and ratings issued during the period from 1991 to 2003
corporate performance’’ section, the neo-classical for US companies included in the S&P500 index.
194 Ron Bird et al.

KLD provides ratings under seven headings but we In summary, the ratings supplied by KLD provide
restrict our analysis to the following five activities for a measure of corporate activities which are
which KLD provides both a positive (‘‘strengths’’) demonstrative of either strengths or concerns with
and negative (‘‘concerns’’) score:8 respect to a diverse set of CSR activities that have
the potential to impact on a wide range of stake-
1. Community (COMMUNITY) which on the holders including employees, customers and the
positive side (STRENGTHS) measures various community at large. In order to assist in inter-
contributions that the company makes to the preting our findings, we suggest that it is appro-
community such as charitable contributions priate to regard a strength (concern) score as being
and support for the disadvantaged; while on the indicative of the extent to which a company ex-
negative side (CONCERNS), it measures ceeds (falls short of) legal requirements and mini-
activities that are judged to have had a negative mum community standards with respect to each
economic impact on the community and/or CSR activity considered.
possibly mobilised community opposition. A significant positive (negative) relationship
2. Diversity (DIVERSITY) which on the between a strength (concern) score and future stocks
positive side measures the activities of the returns and/or a valuation multiple is a clear indica-
company in such areas as providing employ- tion that there is no conflict between a company
ment opportunities for minorities and pursuing a particular type of CSR activity and the
providing working conditions that meet the maximisation of owner wealth. Hence, we are
special needs of minorities; while on the interested in the sign of the relationship between the
negative side it measures such things as the KLD scores for both strengths (STRENGTHS) or
non-representation of minorities in senior concerns (CONCERNS) for each of the five activ-
positions within the company and major ities being evaluated with our dependent variables,
controversies on affirmative action issues. future stock returns and valuation multiples. How-
3. Employee Relations (EMPLOYEE) whose ever, we would not be surprised to find instances
positive employee relations are indicated by where the coefficients provide evidence inconsistent
such practices as strong worker involvement with owner wealth maximisation as the KLD criteria
within the company, generous profit sharing were not drawn up with any specific consideration
across the majority of employees, good retire- being given to their association with shareholder
ment benefits and/or a good safety record; wealth. For example, donations and other charitable
while on the negative side the company activities which are described as community strengths
might have bad unions relations, a poor safety (COMMUNITY_STRENGTHS) are unlikely to
record and/or a poorly funded pension plan. be undertaken by management with the expectation
4. Environment (ENVIRONMENT) where a that they will have a positive impact on owner wealth
company obtains a positive score as a results (Seifert et al., 2004). Therefore we would not be
of environmentally sound practices such as surprised to find evidence of some activities that
pollution prevention, and recycling; while would seem to be at variance with owner wealth
the company will obtain a negative score for maximisation, perhaps reflecting that the KLD cri-
practices such as producing hazardous waste teria were not drawn up with this function in mind.
and/or environmentally unfriendly products. KLD awards a one to each company that satisfies
5. Product (PRODUCT) which on the positive each criterion and a zero to those that fail to satisfy
side measures activities such as high product the criterion. We should first mention that the
quality, high innovation and the develop- number criteria on which KLD scores a company
ment of products to meet the special needs varies across the different items. For example, there
of the disadvantaged; while on the negative are seven criteria on which a company is scored for
side, the company will be graded for prac- Community strengths and three criteria on which
tices as low product safety, controversies over they are scored for Community concerns. The
how it advertises its products and other prod- maximum that a company can obtain for each
uct-related community concerns. activity are set out in Table I. One option for using
What CSR Activities are Valued by the Market? 195

TABLE I calculated by deducting from each stock’s return,

Maximum score for each CSR activity the market weighted return for our universe of
stocks. The two valuation multiples, market-to-
Activity Maximum score book and price-to-earnings, were also obtained
from DataStream.
STRENGTHS CONCERNS We also included in our analysis a number of
control variables chosen on the basis that they had
DIVERSITY 8 3 been identified in previous studies to explain some
EMPLOYEE 6 5 of the variation of returns across stocks. The actual
RELATIONS control variables utilised were:10
PRODUCT 4 4 • The log of the company’s market capitalisa-
tion as measured by the market value of the
company’s shares (Banz, 1981).
• The company’s market-to-book ratio as
the KLD scores in our analysis is simply to award measured by dividing the market value of
each company a score equal to the number of criteria the company’s shares by the book value of
that it satisfies for each activity. For example, if a the company’s ordinary shares (Lakonishok
company satisfies four of the seven Community et al., 1994).
strength criteria, then it will be awarded a • The momentum in the company’s stock as
COMMUNITY_STRENGTHS score of four. An measured by the return over the previous 6-
analysis of the distribution of these scores by activi- months (Jegadeesh and Titman, 2001).
ties identified wide variations and suggested to us a • The company’s financial leverage as mea-
second option for using the KLD scores in our analysis. sured by its debt-to-total assets ratio (Fama
This involved using a three-point scale for each and French, 1993).
activity where a 0 indicated that they satisfied none These control variables were determined as at the
of the KLD criteria, a 1 indicated that they satisfied a end of March each year using data obtained from
small number of the criteria, while a 2 indicated that DataStream.
the company satisfied most criteria.9 However, in
those cases where there were a small number of
criteria or very few companies satisfied many crite- Method
ria, we only used a two-point scale indicating those
companies that either did or did not satisfy any of the In the years 1991–2001, the KLD social ratings for
criteria. The third option to investigate for using the each company became available in August while in
KLD scores was to evaluate whether a company’s 2002 and 2003, they became available as at the end
score for a particular criteria changed from 1 year to of December. By far the most important implication
the next. There were three possible outcomes here: for the analysis flows from the interpretation that we
the scores increases (+1), the score stays the same (0), place on the KLD ratings. It is important to note that
the score decreases ()1). This third option allowed we do not regard the release of the ratings by KLD
us to analyse how changes in KLD scores impact the to be the source of new information to the market
financial performance of the firm. because these ratings are based on public information
We include these CSR variables as either raw relating to events that have already occurred. As
scores (in the case of option one) or dummy such, the KLD ratings provide a convenient way of
variables (in the case of options two and three) providing confirmatory information as to how active
where the dependent variable are either the excess a company is in a particular area of CSR activity.
return on a company’s shares or a valuation mul- Most importantly, the ratings allow us to categorise a
tiple (either price-to-book or price-earnings). The company’s performance on the basis of various types
returns on each company’s shares were obtained of CSR activities with the proposition being that
from DataStream and then the excess returns were these activities will have long-term implications for
196 Ron Bird et al.

the company in terms of the performance of its where rit is the excess return on stock i between the
stock. In order to analyse this and take account of the period t and t + 1, CVjit is the control viable j for
possibility of the impact of these activities to take stocks i at time t, CSRpit is the CSR classification for
time to be reflected in the company’s valuation, we activity p for stock i at time t and it is the error term
evaluate five dependent variables: the excess return for stock i at time t.
over the year commencing at the beginning of April A number of other points relevant to our analysis
each year (one-year returns), the excess return over are briefly summarised below:
the two-year period commencing at the beginning
of April each year (two-year returns), and the excess • The data for each of the 13 years is pooled
return over three-year period commencing at the in order to obtain our estimate of the coeffi-
beginning of April each year (three-year returns), the cients for the explanatory variables.
market-to-book ratio (MTBV) and the price-to- • We also divide the sample up into two peri-
earnings ratio (PE). ods (1991–1997 and 1998–2003) and repeat
To summarise, each year the excess returns and the analysis to see if the coefficients on the
the valuation multiples are calculated as from the explanatory variables change significantly
beginning of April, the control variables are deter- over time.
mined as at the end of March and the CSR variable • We examine each of the strengths and
become available in August as from 1991 to 2001 concerns associated with the five CSR activi-
and as at the end of December in 2002 and 2003. ties independently in order to determine the
Our data set for each year consists of all stocks impact of these activities when judged in
included in the S&P500 index for which we have all isolation.
of the required data. We also delete from our sample • We repeat the analysis for two composite
all stocks that have a negative book value and in a few scores across all criteria which we suggest
cases those stocks that have a very small positive book provides a good indication of the impact on
value which results in extreme market-to-book ra- markets of having either a good, bad, or
tios. Finally, we exclude stocks each year which have indifferent CSR reputation.
annual returns and valuation multiples that lay more
than three standard deviations from the mean. The In each case we start with the regression similar to
number of stocks that remain in our sample each year that outlined in equation 1 which includes all of
are reported in Table II. the control and CSR variables independently. We
The regression equation that is evaluated when then examine both the direction and significance
using the excess returns as the dependent variable is of the sign attached to each CSR variable in order
set out below: to gain insights into its market impact. Where we
use dummy variables (options two and three), we
use the Wald test on grouping of the CSR vari-
n X
rit ¼ at þ ajt CVjit þ apt CSRpit þ eit ð1Þ ables to test for significance (e.g., we evaluate the
j¼1 p¼1 impact one-by-one of a combination of all of the
variables pertaining to community strengths, per-
taining to community concerns, pertaining to
diversity strengths, and so on). This analysis is con-
TABLE II ducted first over the total period of our sample and
Number of stocks in data set each year then over the two sub-periods. The same analysis
is repeated for the entire sample period for the
Year 1991 1992 1993 1994 1995 1996 1997 composite scores across all criteria. Finally much of
the same analysis is repeated where the two valua-
Number 340 351 347 357 371 369 372 tion multiples replace excess returns as the depen-
Year 1998 1999 2000 2001 2002 2003
dent variables.
Number 380 389 386 399 417 420 The results of this analysis are reported and dis-
cussed in the next section.
What CSR Activities are Valued by the Market? 197

The findings them as control variables in this study.

The objective of the empirical analysis is to Dependent variable: excess return over next
determine the relationship between the various 12 months (1991–2003)
CSR activities (both strengths and concerns) and In Table IV, we report the model that best explains
their market valuation in order to gain insights into the variability in the 12-month returns over the
their eventual impact on owner wealth. The period of our sample. In this case, we have com-
method that we employ is outlined in the previous pleted the analysis using the first two of the options
section and we will now report and discuss our previously discussed for utilising the KLD ratings. A
findings. review of the table indicates that the two options
yield an identical finding which is a trend that is
maintained over the remainder of our analysis.11
Analysis of independent CSR activities over entire Therefore, in the future we will only report the
sample period findings obtained from using option one.
Of the five CSR activities evaluated (with
Using equation (1) as the basis for our analysis, we strength and concern scores for each), the only two
determined the optimum model for each of the five that proved to have a significant relationship with
dependent variables (returns over the next one year, returns realised over the next 12-months was the
two years and three years, market-to-book and strength score for diversity and the concern score for
price-to-earnings) by pooling the data over our the environment. The positive relationship between
whole sample period. Subsequently we divide out diversity strengths and future returns is as expected
sample up into two periods in order to be able to see indicating that the market rewards a company for
whether there have been any significant changes in being proactive in its diversity activities (e.g.,
the relationships that we are examining. employing and promoting minorities, providing
benefits that address work/family concerns). The
Control variables negative relationship between environmental con-
The first results that we report in Table III are those cerns and future stock returns is also as one might
where we only include the control variables to expect and indicates that the market takes a negative
explain the variability of the annual excess returns view of those companies whose activities are
earned by stocks over our complete sample period. inconsistent with regulations and environmental
In summary, our findings confirm that these control norms with respect to environmental protection
variables are all highly significant and with the ex- (e.g., produces toxic chemicals and hazardous waste,
pected sign which confirms both the findings from does not comply with environmental regulations).
previous studies and the desirability of including We identified eight activities (four strengths and
four concerns) which have no discernible impact
on future stock returns and so shareholder wealth.
TABLE III To a certain extent this is good news for managers
Coefficient attached to the control variables: one-year in terms of suggesting that there is no conflict
excess returns (1991–2003) between managing the firm in the interests of the
shareholders alone or taking account of the
Variable Coefficient p-Value interests of a wider spectrum of stakeholders. On
the other hand, it does not provide an incentive
Constant 0.2438 0.0000 for managers following the narrower neo-classical
MTBV )0.0067 0.0003 objective for the firm to pay much attention to
Momentum 0.1500 0.0000 the interests of a wider spectrum of stakeholders
Gearing 0.0005 0.0031
with respect to the majority of CSR activities that
LOGMV )0.0263 0.0000
Adjusted R2 2.76%
we are considering in this paper.
198 Ron Bird et al.

Coefficients of significant CSR variables: one-year excess returns (1991–2003)

Variable Coefficient p-Value Joint test p-value

Option one: use aggregated KLD ratings

Adjusted R2 2.34%
Option two: use dummy variables based on KLD ratings
DIVERSITY_STRENGTHS_2 0.0398 0.0057 0.0002
ENVIRONMENT_CONCERNS_2 )0.0226 0.1094 0.0380
Adjusted R2 2.30%

Dependent variable: excess return over next one, two rewarded and so where they would be well-advised
and three years (1991–2003) to take account of the interests of a wide spectrum
One potential reason for why we identify so few of stakeholders.
significant relationships when considering there What might be regarded as somewhat surprising is
impact on 12-month excess returns is that the that there are three instances where the sign attached
market is slow in recognising the benefits associated to the CSR activity is the opposite to what one
with CSR (e.g., it takes time a company to build up would expect if that activity had a positive impact
goodwill as a result of these activities). If this is the on the market value of the firm. It would appear
case, then, we might see more significance associated that a company is punished in the market for being
with the CSR variables when we extend our proactive in their environmental practices while it is
dependent variable to be stocks returns over longer rewarded in the market for violating both com-
time periods. munity and product concerns as measured by the
We report in Table V, the significant CSR KLD ratings. The finding that environmental
variables for each of the three independent variables strengths have a negative impact on market perfor-
(i.e., one-, two- and three-year excess returns). We mance combined with the previously discussed
do find that the number of significant CSR vari- finding that environment concerns also have a
ables increases where excess returns are measured negative impact on market valuations suggest that
over periods greater than 12 months which is market participants recognise the need to meet
consistent with the market taking some time to regulatory requirements in this area and so not
either reward or punish a company for these subject a company to potential litigation but punish
activities. Indeed, the CSR activities prove to be those companies that expend corporate resources on
significant in explaining both two-year and three- environmental activities that go beyond meeting
year excess returns in six of the ten cases examined. minimum requirements. The market seems to en-
In three of these six cases the sign on the rela- dorse the idea that profit generation from invest-
tionship is as we might expect. Those companies ments in cleaner technologies might make business
that fail to take account of diversity issues and/or sense in certain circumstances, but not in all. It is
fail to perform with respect to environmental con- management’s duty to identify the circumstances
cerns are punished by the market while those that favouring the generation of both public benefit and
follow good employment practices are rewarded in corporate profits.
the market. This sends a clear message to manage- There would appear to be no logical explanation
ment as to the CSR activities for which they will be for why the market would reward a company for
What CSR Activities are Valued by the Market? 199

Coefficients of significant CSR variables: one-, two- and three -year excess returns (1991–2003)

Variable One-year returns Two-year returns Three-year returns

Coefficient p-Value Coefficient p-Value Coefficient p-Value

COMMUNITY_CONCERNS 0.1053 0.0009 0.1785 0.0000

DIVERSITY_CONCERNS )0.0673 0.0018 )0.1010 0.0007
EMPLOYEE_STRENGTHS 0.0370 0.0022 0.0447 0.0070
ENVIRONMENT_CONCERNS )0.0180 0.0019 )0.0414 0.0000 )0.0637 0.0000
ENVIRONMENT_STRENGTHS )0.0458 0.0080 )0.0454 0.0566
PRODUCT_CONCERNS 0.0345 0.0079 0.0564 0.0015
Adjusted R2 2.34% 2.28% 2.14%

being involved in controversial issues relating to would summarise our main findings to date as
both its products and its dealing with the commu- follows:
nity. We would suggest that the public nature of the
poor performance in these two areas possibly pro- • With the exception of CSR activities that
vides the explanation for these findings. As noted are best described as events (e.g., announce-
previously, the KLD ratings reflect events that have ments of litigation or fines), the market is
already occurred and in the case of both products generally slow to absorb the implications of
and community concerns typically they are events these activities into valuations.
that became public knowledge well in advance of • There are two activities, diversity and the
the release of the KLD ratings. Given this scenario, a environment, where it would appear benefi-
possible explanation for our findings is that there has cial for a firm to satisfy both regulatory
been an overreaction to the news around the time requirements and meet community norms in
the relevant event(s) became public knowledge and order to avoid being punished by the market.
what we are observing is the market correction to • Being proactive in the employments area
this initial overreaction.12 This explanation gains (i.e., being regarded as a ‘‘good’’ employer)
some support from the fact that the correction is would be one area that is rewarded by the
only observed in the two-year and three-year returns market.
and so possibly reflects a slow market response to an • In contrast, being proactive with respect to
initial market overreaction.13 environmental issues would appear to have a
The major focus of this paper is on whether negative impact on market valuation.
there is any conflict between a manager acting in
the interests of a wide spectrum of stakeholders We return to further consider these findings later in
and the maximisation of shareholder wealth. Per- the paper but before doing so we will extend our
haps the only clear evidence of such a conflict is analysis to (i) examine whether there has been any
that the market does not take kindly to those noticeable change in the relationship between CSR
companies that over invest on environmental activities and market valuation over the period of
protection. In other areas, a company might ex- our sample and (ii) consider whether the overall
pect that CSR activities will either have a positive reputation created by these activities has an impact
or neutral impact on its market valuation. We on market valuation.14
200 Ron Bird et al.

Analysis of independent CSR activities over tionship between community concerns and future
two sub-periods excess returns held only during this period. This
represents a quite significant turnaround as in the
In order to identify trends in the relationships that first sub-period the market had been rewarding
we are evaluating, we divided our data period up companies for their contributions to the community.
into 1991–1996 and 1997–2003 and then repeated Diversity seems to only be an activity on which the
our analysis. We report details in Table VI only of market has concentrated in recent times either
the CSR variables that prove to be significant in the rewarding companies for being proactive in this area
case of each of the three dependent variables. or punishing companies who had failed to satisfy
The only relationship, which consistently holds minimum standards. The same can be said for
over the entire sample period is the negative employee-related activities, which also have only
relationship between environmental concerns and come under the notice of the market in recent times.
future market returns. There are two CSR activities In particular, the market would seem to now be
that had a definite impact on market returns during rewarding companies for following ‘‘good’’ em-
the first half of our sample period but which were ployee practices. Finally, there are the environmental
not apparent during the second half. One of these activities where the market has always been con-
relationships was community strength with the cerned about companies that fall short in this area.
evidence suggesting that the market more than However, in more recent times, the market has not
amply rewarded those companies who practiced looked favourably on companies that are proactive
philanthropic activities in earlier times but more in the area of environmental protection.
recently has turned neutral to such activities. The The one overriding finding from the analysis is
other relationship was the previously discussed sur- that the markets reaction to different CSR activities
prising positive relationship between product con- would appear to change over time and that this
cerns and market performance, which also seems to provides a challenge to managers trying to juggle the
have been reflective of market behaviour in the interests of the company’s shareholders with those of
earlier period. a wider stakeholder group. The indication from our
There would appear to be four strong findings, in analysis of the more recent period would suggest that
addition to environmental concerns, that held diversity, employee-related activities and the envi-
through the more recent sub-period. The somewhat ronment are key areas of concern to the market with
perplexing but previously discussed positive rela- the market being neutral to activities in other areas

Coefficients of significant CSR variables: 1991–1996 and 1997–2003

Variable 1991–1996 1997–2003

One-year Two-year Three-year One-year Two-year Three-year

returns returns returns returns returns returns

COMMUNITY CONCERNS 0.1267* 0.1498*

COMMUNITY STRENGTHS 0.0193* 0.0425* 0.0551*
DIVERSITY CONCERNS )0.0766* )0.1150*
EMPLOYEE STRENGTHS 0.0212** 0.0460*
ENVIRONMENT CONCERNS )0.0322* )0.0718* )0.0237* )0.0394* )0.0431*
ENVIRONMENT STRENGTHS )0.0298** )0.0441**
PRODUCT CONCERNS 0.0233* 0.0834* 0.1480*
Adjusted R2 7.15% 5.23% 4.51% 2.72% 2.33% 2.41%
What CSR Activities are Valued by the Market? 201

with the exception of having a negative disposition requirements and community standards. This finding
towards those companies that undertake what they is paralleled by our previous experience with
regard as excessive expenditure in the area of envi- diversity where being proactive with respect to
ronmental protection. women and minorities benefited market perfor-
mance in the short-term but it was avoiding con-
Analysis of combined scores across all CSR activities troversies and meeting minimum standards, which
over the entire sample period brought longer-term benefits.
The overall results are encouraging for a manager
The analysis to date has concentrated on the rela- wishing to merge stakeholder theory with the nar-
tionship between the ratings of companies on single rower neo-classical objective of the firm as they
CSR activities and their future stock returns. Many suggest that firms who are most active in pursuing
of the previous studies relating to CSR activities and CSR activities will be rewarded in the market place.
performance have used an aggregated score across However, we have previously seen that such man-
several CSR activities with the majority finding a agement might be best advised to be discriminating
positive correlation between this aggregated score in the activities that they most actively pursue paying
and future performance. This may suggest that even particular attention to avoiding concerns in the areas
if individual activities are not that highly valued by of diversity and the environment, being proactive in
the market, a company embracing a large numbers of the area of employee relations but avoiding over-
these activities may well earn the support of the expenditure on community and environmental
market. Such an outcome would be consistent with activities.
a large proportion of any benefits that a company
may enjoy from its CSR activities being a conse-
quence of the overall reputation of the company Changes in CSR activities
attributable to the breadth of such activities rather
than the individual activities themselves. In order to The results reported to date have been based on the
obtain a better insight into this issue, we evaluate absolute CSR scores as provided by KLD. We
whether the aggregate of each company’s strength propose that we obtain greater insights from analy-
scores across all CSR activities, and also its concern sing these absolute scores, rather than changes in the
scores, were correlated with future market returns. scores because we believe that the impact that CSR
Our findings as reported in Table VII suggest that activities have on company valuation will more re-
a company might more immediately benefit using its flect the market’s perception of the extent of these
CSR activities to create a reputation of it being a activities rather than be influenced by marginal
good corporate citizen. However in the longer- changes in the extent of these activities.
term, it would appear that the market places more In order to test this proposition further, we
weight on a company avoiding obtaining a tainted analysed the relationship between changes in the
image as a result of failing to meet regulatory CSR scores and future market returns and our
findings are reported in Table VIII. The most
TABLE VII striking facet of the reported findings is that very few
Coefficients attached to combined CSR variables of the changes identified impact on future market
(1991–2003) excess returns. There are 20 change variables but
only two of them (10%) would appear to provide
Variable 1-year 2-year 3-year any consistent explanatory power, supporting the
Returns Returns Returns proposition that markets do not attach much sig-
nificance to the announcement of a change in a
ALL_CONCERNS )0.0043 )0.0084** )0.0171*
company’s score for each of the various CSR
ALL_STRENGTHS 0.0063* 0.0080* 0.0083
activities. The one variable that seems to explain a
Adjusted R2 1.99% 1.29% 1.13%
consistent explanation is the increase in Community
*Significant at 5% level. concerns where such increases are taken as providing
**Significant at 10% level. positive news to the market. This might appear a
202 Ron Bird et al.

Coefficients attached to changes in CSR variables (1991–2003)

Variable 1-year Returns 2-year Returns 3-year Returns

Coefficient p-Value Coefficient p-Value Coefficient p-Value

COMMUNITY_CONCERNS PLUS 0.1438 0.0023 0.1817 0.0153 0.2603 0.0179

EMPLOYEE_CONCERNS MINUS )0.0980 0.0354 -0.1710 0.0144
Adjusted R2 1.53% 1.37% 2.27%

surprising result, but it does confirm our previous The findings obtained using valuation multiples as
finding that company’s with higher community dependent variables confirm strong previous findings
concern scores do perform better in the market that avoiding environmental concerns and pursuing
place. employment strengths are both considered impor-
tant activities by the market which can have a
positive impact on market valuation. However, they
CSR activities and valuation multiples also identified community, diversity and product
strengths and employment concerns as CSR activi-
The analysis to date has concentrated on the rela- ties that impact on valuation which are variables that
tionship between CSR activities and future excess previously had been found to have little or no
market returns over various holding periods on the relationship with future excess returns. The reason
basis that these returns provide the best basis for for these different findings probably lies in the fact
providing insights into the impact of these activities that the valuations multiples represent the sentiment
on what is of most concern to us, owner wealth. of the market at a specific date while the returns
Valuation metrics such as market-to-book or measure the market reaction over a much longer
price-to-earnings provide an alternative basis for period of time (up to three years). As a consequence
measuring this impact in that they encapsulate in one the valuation multiples are picking up different
number the market expectations with respect to phenomena although it is encouraging that the
both future returns and the perceived risks attached results from using the valuation multiples do not
to these returns. contradict our previous findings except in the case of
Table IX reports the significant relationships that the apparent reaction to community concerns.
we found between these valuation metrics and each We also evaluated the relationship between the
of the CSR activities. Perhaps, the first observation aggregate of the concern and sentiment scores with
to make is that we get a broader spectrum of sig- the valuations multiples and found that they were both
nificant results with these valuation multiples as the significant and also had the expected sign. This largely
dependent variables than we obtained using the confirms previous findings, which suggest that com-
excess returns. A priori one would assume that panies habitually breaching community norms and
strengths would have a positive effect on a valuation regulations with respect to CSR issues are likely to be
multiple and concerns would have a negative im- punished by market participants whereas those that
pact. This was the case in all instances other than create an image of being generally proactive in these
community strengths where increased activities in activities are likely to benefit in the market place.
this area was associated with a fall in a company’s
valuation multiple. As strengths in this area reflect Summary and conclusions
philanthropic activities, it may well be that the
market does not reward companies that they con- In introducing Enlightened Stakeholder Theory,
sider to be overly generous. Jensen (2001) provided a compromise to resolve the
What CSR Activities are Valued by the Market? 203

Valuation multiples: coefficients of significant CSR variables (1991–2003)

Variable Market-to-book Price-to-earnings

Coefficient p-Value Coefficient p-Value


COMMUNITY_STRENGTHS )0.2664 0.0000 -1.2950 0.0000
DIVERSITY_STRENGTHS 0.4274 0.0000 1.1289 0.0000
EMPLOYEE_CONCERNS )0.3422 0.0000
EMPLOYEE_STRENGTHS 0.2766 0.0000 1.2487 0.0000
ENVIRONMENT_CONCERNS )0.2670 0.0000 -0.5921 0.0039
PRODUCT_STRENGTHS 0.2412 0.0001 1.3328 0.0068
Adjusted R2 8.30% 9.47%

conflict for corporate management drawn between • Another area in which good CSR practice is
managing a firm solely in the interests of its share- rewarded is in the diversity area where the
holders (the neo-classical view) and managing the evidence suggests a negative relationship ex-
firm in the interests of stakeholders very broadly ists between diversity concerns and excess
defined (the stakeholder theory view). The source of returns and a positive relationship between
the compromise being that it is extremely unlikely strengths and excess returns.
that management can maximise the value of the • The area of community issues would seem
company to its owners by following a strategy of to be where there is the greatest potential
ignoring the interest of the other stakeholders. conflict between CSR activities and market
Under this ‘‘enlightened’’ approach, management valuation. It seems that the market no longer
will automatically take account of the interests of values philanthropic activities nor does it
other parties in making their decisions where by so seem too concerned in instances where a
doing it does not conflict with the interests of the company publicly conflicts with the commu-
company’s stockholders. nity. One observation we would make is
The focus of this paper has been on evaluating a that the KLD ratings were not necessarily
range of CSR activities to determine their impact on developed to correlate with market valuation
the value of the firm to its owners. It is only where and this might be particularly true with re-
this impact is demonstrably negative that a conflict spect to the community area.
exists with a neutral or positive impact being • There are a few areas where the evidence sug-
indicative that pursuing these activities is not coming gests a possible conflict for management trying
at the direct cost of owners. Our major findings are: to balance the interests of stockholders with
those a broad spectrum of stakeholders. The
• The most consistent results that we obtained most surprising being the environmental area
are related to employment strengths and where the market would appear to punish those
environmental concerns. The evidence sug- companies with a high environment strength
gests that the valuation of those companies score. Although the market would appear to
will be positively impacted if they are not want companies to meet minimum environ-
proactive in the area of industrial relations mental standards, it is not supportive of compa-
and negatively impacted if they are identified nies who voluntarily go well beyond this.
as failing to meet regulatory and community • We do document that the markets attitude
standards with respect to the environment. towards CSR activities would appear to
204 Ron Bird et al.

change overtime. In particular, we have seen Notes

that diversity, employment and environmen-
tal issues have been of greatest interest in It is not the purpose of this paper to argue the case
more recent years. for and against Stakeholder Theory being the driving
• Finally, we found evidence to suggest that force for decision-making within the company but ra-
companies that are identified as either devot- ther our concern is with the conflicts that Stakeholder
Theory brings management in deciding how to best
ing significant resources (pursuing poor prac-
utilise the scarce capital resources of the company.
tices) across a wide spectrum of CSR 2
Several writers have attempted to propose a solu-
activities will be rewarded (penalised) in the tion to this problem (e.g., Pava and Krausz, 1997) but
market place. In other words, there seems to they all involve ill-defined trade offs.
be reputational benefits (costs) flowing from 3
In a similar vein De George (1978) makes the
CSR activities that go beyond those associ- point that there will be many instances where moral
ated with the independent CSR activities. behaviour is consistent with realising one’s business
objectives but where this is not the case then public
The weight of evidence from our study suggests that pressure or legal measures can be brought to bear to
management can consider the interests of a diverse make immoral behaviour unprofitable.
set of stakeholders without significantly compro- The reason that these numbers add up to more
than 51 is because some papers found more than one
mising the wealth of company stockholders. In
relationship (e.g., some that were positive and some that
particular, we observed that stockholders of com- were negative).
panies that particularly target the interests of a broad 5
See, for example, Ullman (1985), Waddock and
spectrum of stakeholders will probably benefit while Graves (1997) and Ruf et al. (2001).
those in companies that are continually fail to meet 6
See Wood and Jones (1995).
regulatory and social norms are likely to suffer. 7
See Boutin-Dufresne and Savaria (2004).
The implications that we can draw from our There were insufficient ratings to evaluate the
analysis is that the neo-classical view that manage- other two activities: Corporate Governance and Human
ment should seek to maximise the owner wealth will Rights.
(i) encourage them to meet legal requirements and This second option allowed us to empirically
minimum community standards across a broad range investigate more complex relationships between CSR
of CSR activities and (ii) in certain activities, par- scores and financial performance other than simply lin-
ear ones. In particular, as Bowman and Haire (1975)
ticularly employee-related, to go well beyond these
and, more recently, Moore (2001) pointed out, there
minimum legal and community requirements.
may be an optimal level of social performance beyond
However, the study does highlight some areas of which the expenditures devoted to such activities de-
possible concern and, in particular, that management tract from rather than contribute to financial perfor-
pursuing the objective of maximising owner wealth mance. In those cases, the sign of the coefficients
will not have the incentive to be proactive in their associated to the score ‘‘1’’ should differ from the sign
environmental policy. This suggests that areas still of the coefficient associated, for the same activity, to a
exist where the Government will have to play an score of ‘‘2’’.
active role in ensuring that companies meet the We also including each companies industry classifi-
legitimate concerns of certain stakeholders. cation as a dummy, but these proved insignificant so we
excluded them from our final analysis.
The evidence that the two options yield identical
finding do not support the idea (Bowman and Haire,
1975; Moore, 2001) that it may be an optimal level of
social performance beyond which the expenditures de-
Funding was provided by Telecom Italia - Group voted to such activities detract from rather than con-
Sustainability. We would like to thank Mauro Bini, tribute to financial performance.
Enrico Parazzini and Paolo Nazzaro for precious 12
There is much evidence in the finance literature of
suggestions and support throughout the develop- security prices overreacting to corporate events. See, for
ment of this work. example, De Bondt and Thaler (1985).
What CSR Activities are Valued by the Market? 205
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analysis might be more appropriate to evaluate those Performance and Corporate Financial Performance
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Brammer and Pavelin (2006) demonstrate that the Momentum Strategies: An Evaluation of Alter-
reputational effect of social performance will not always native Explanations’, Journal of Finance 56, 699–
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Jensen, M.: 2001, ÔValue Maximization, Stakeholder
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Ron Bird and Anthony D. Hall,
School of Finance and Economics,
University of Technology, Sydney
NSW, 2007, Australia