Corporate Social Responsibility (CSR) denotes the measures that are taken by an organization to “integrate social and environmental concerns in their business operations and their interaction with their stakeholders on a voluntary basis” (Nollet, Filis & Mitrokostas, 2016). The concept of CSR guarantees a company’s adherence to laws while ensuring that its operations are centered on the good of the society (Rodriguez-Fernandez, 2016). Essentially, when many people hear the term corporate social responsibility, they think of the environmental protection measures taken by a company, its treatment of employees and even how it gives back to the community (consumers). Therefore, many kinds of research on CSR focus on the aspects mentioned earlier, excluding the integral stakeholders of a company- the shareholders (Neal & Cochran, 2008). According to the Sarbanes-Oxley Act of 2002, CSR is incumbent to all companies and can be achieved through progressive auditing, financial reporting and good corporate governance (Neal & Cochran, 2008). McGuire, Sundgren and Schneeweis (1988) define this concept as the modern stakeholder theory. According to this theory, firms not only fulfill their fiduciary obligations to shareholders but also to government agencies that have stringent regulations for them to follow. As such, companies that have a good CSR- in the context of their shareholders and government agencies- often record a great financial performance. In this article, I review the theories of CSR, the relationship between CSR and financial performance as well as the approaches to measuring the financial performance of an organization through CSR.
According to Rodriguez-Fernandez (2016), the conflicting interests of corporate managers and shareholders are resolved by the stewardship theory. The stewardship theory states that the ethical and professional motives of an organization alleviate the conflicted interests of both parties since managers progressively pursue the interests of shareholders to maintain good financial performance. Meanwhile, the resource dependency theory asserts that shareholders provide financial resources to an organization so that they can hold corporate managers socially and financially responsible for their investments (Rodriguez-Fernandez, 2016). Further, the theoretical institutional perspective states that businesses continuously seek legitimacy (Rodriguez-Fernandez, 2016). Subsequently, they develop legitimate rules not only to define how businesses’ goals of profitability will be attained but also how the interests of other stakeholders may be pursued.
The three theories depict corporate managers as the agents of the shareholders who are, in turn, the principals. The fundamental premise of CSR in this context is that as agents, corporate managers are held socially and financially responsible for the undertakings of the business by the principals, the shareholders. This is solely achieved within a non-conflicted business environment characteristic of legitimate rules that guide corporate managers on how to balance the interests of all stakeholders. The overarching responsibilities invoked by corporate managers depicts the relationship between CSR and financial performance. According to Neal and Cochran (2008), the quality of a firm’s corporate governance determines its “profitability, operating performance, and stock returns.” Ultimately, the social and financial undertakings of corporate managers determine to a great extent what the business/organization will achieve in the long run.
Nollet, Filis & Mitrokostas (2016) assert that the relationship between CSR and financial performance is underwritten by the term corporate social responsibility performance (CRP). Further, the two researchers argue that there is a negative relationship between CSR and financial performance. The argument that there is a non-linear relationship between CSR and financial performance is often premised from the idea that CSR results in additional costs for businesses, therefore, putting them at a disadvantage to businesses that rarely engage in CSR. Nonetheless, Nollet, Filis & Mitrokostas (2016) concluded that when firms’ investments in CSR reach a certain threshold, CSR seemingly pays off in improved financial performance. What is more, firms that adopt CSR as a strategic decision often attract more stakeholders to invest in their businesses.
Businesses can reap economic benefits when they establish a good relationship with banking institutions, government officials and investors through CSR (McGuire, Sundgren & Schneeweis, 1988). This strategic decision creates a pool of capital that businesses can access for their growth as investors often associate CSR initiatives with great financial management, making them more likely to invest in such firms. On the other hand, a firm with poor CSR practices deters investors who may become doubtful of its ability to fulfill its fiduciary obligations. The positive impact of CSR on financial performance, however, requires that firms spend a considerable amount of investments in CSR. At the same time, they continue to pursue shareholders’ interests in the long run (Nollet, Filis & Mitrokostas, 2016). Moreover, McGuire, Sundgren and Schneeweis (1988) affirm that firms that engage in CSR also motivate the morale of their employees, which, in turn, increases their productivity.
In most studies, researchers establish the relationship between CSR and financial performance by exclusively measuring each business aspect, then determining the correlation between the two (McGuire, Sundgren & Schneeweis, 1988). Thus, to determine the impact of CSR on business performance, researchers begin by measuring CSR through the approaches of one-dimensional measures, content analyses, reputation indices and questionnaire surveys (Galant & Cadez, 2017). One-dimensional measures focus on an individual dimension of CSR. These dimensions may range from the philanthropy of a business to the initiatives that it takes to protect the environment. The approach of questionnaire-based surveys is most valuable to businesses during instances when corporate reports and agency ratings are unavailable (Galant & Cadez, 2017). These questionnaires are often premised on the notion that consumers will give feedback about a firm’s discretionary, economic, legal and ethical dimensions (Galant & Cadez, 2017). Unlike the first approach, one-dimensional measures that biasedly focus on one dimension of CSR, questionnaires are highly flexible and can measure a range of CSR dimensions. Content analysis is a voluntary approach that focuses on collecting qualitative data on the firm’s CSR activities, then grouping and coding this information on a rating scale. For instance, a firm may develop ranking criteria from 0-5, where 0 may indicate that the CSR dimension failed to meet the criteria. In contrast, a rating of 5 indicates that the full criteria were met. However, this approach faces the limitation of biasedness since researchers select the type of CSR dimensions to analyze and the weightings that should be assigned to each dimension in their ratings. Finally, reputation indices are conducted by external firms as they attempt to rate the performance of businesses in different CSR dimensions. Some of the popular indices include the Dow Jones Sustainability Index, Vigeo Index and Fortune magazine reputation index. The advantage of this approach is that knowledgeable and unbiased organizations measure these indices.
On the other hand, corporate financial performance (CFP) is measured through market-based and accounting-based performance indicators (Galant & Cadez, 2017). The accounting-based indicators include sales growth, return on assets (ROA), return on equity (ROE), net operating income, net income and return on capital employed (ROCE). Meanwhile, the market-based indicators may include changes in the returns from stock and the market value of the company (Galant & Cadez, 2017). A study conducted by McGuire, Sundgren and Schneeweis (1988) highlights that the accounting-based indicators of sales growth and ROA are perceived to indicate high social responsibility for firms. Similarly, the market-based performance indicators are positively correlated to the high CSR performance of businesses (Galant & Cadez, 2017). As such, businesses endeavor to report their market-based and accounting-based performance indicators as a CSR practice to appeal to stakeholders to invest in their organizations. Moreover, businesses disclose these indicators to the public to fulfill the disclosure requirements in the Sarbanes-Oxley Act of 2002.
This article affirms that CSR is not only a legal requirement in accordance with the Sarbanes-Oxley Act of 2002 but is highly beneficial to firms who can appeal to investors to contribute to their capital. The three theories- stewardship theory, resource dependency theory and the theoretical institutional perspective- assert that corporate managers have a social and financial responsibility to their shareholders, which entails the pursuit of their interests. In so doing, corporate managers not only improve the financial performance of businesses but also attract more investors. Additionally, the relationship between CSR and financial performance is underpinned by the correlation between the measures of CSR and the accounting-based and market-based indicators of financial performance. The positive correlation between CSR and the indicators of financial performance is, however, premised on the assumption that businesses will disclose their financial performance to the public. Also, CSR only leads to positive business performance once businesses invest a considerable amount in their CSR practices.
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