Social and Financial Performance across Heterogeneous CSR Approaches

By | September 29, 2021

In the face of climate change, investors, consumers, regulators, and many other stakeholders increasingly demand firms to become more sustainable and enhance their corporate social performance (CSP). Firms respond to this institutional pressure by pursuing corporate social responsibility (CSR). Where the combined CSP of firms is instrumental in fighting climate change, capturing the individual CSP of firms is difficult due to the non-standardized nature of CSP and the information asymmetries surrounding it. Consequently, both researchers and firm stakeholders predominantly proxy the CSP of firms with Environmental, Social and Governance (ESG) ratings.

Since ESG ratings only indicate good or bad CSP, they are an inherently linear estimate of CSP, implicitly assuming that CSR is homogeneous in nature. This implicit assumption contrasts with the heterogeneous CSR approach provided in theoretical CSR literature, and thus clouds the social and financial performance associated with CSR. Aggregating divergent social and financial performance across heterogeneous CSR approaches could potentially explain the diverging financial consequences related to social performance, a major source of uncertainty which dampens CSR investment.

In a new working paper, titled “Heterogeneous CSR Approaches, Corporate Social Performance and Corporate Financial Performance,” we move beyond this implicit homogeneity assumption by showing that it is precisely the heterogeneity in CSR approaches that determines the social and financial performance associated with CSR. Institutional theory and instrumental stakeholder theory argue that firms face diverse stakeholder demands that push firms to approach CSR heterogeneously. In our paper, we focus on three prevalent CSR approaches in theoretical CSR literature, namely strategic CSR, CSR-as-insurance, and corporate greenwashing.

Strategic CSR, CSR-as-insurance, and corporate greenwashing firms fundamentally differ in the way in which they approach CSR and thus dissimilarly provide social and financial performance. First, strategic CSR firms pro-actively incorporate CSR into their core strategy, often by providing sustainable goods and production processes, which bolsters their realized CSP. However, strategic CSR firms sometimes provide less promised CSP to protect their intellectual property. Second, CSR-as-insurance firms are more reactive in nature as they create moral capital buffers to mitigate risks. This produces little CSR controversies with moderate promised and realized CSP. Last, corporate greenwashing firms provide empty CSR reporting, policies, activities, or targets, while decoupling CSR from their core business model. When undetected, corporate greenwashing firms attain excessive promised CSP that overshoots their realized CSP. These fundamental differences in the promised-to-realized CSP across heterogeneous CSR approaches underlines their importance in CSR regulation and investments.

By segregating the promised-to-realized CSP of firms, we show that 50%, 24%, and 26% of the firms respectively pursue strategic CSR, CSR-as-insurance, and corporate greenwashing. In a first step, we identify firms with similar CSR approaches by performing separate firm-level clustering analyses for each industry. Subsequently, we perform a non-parametric rank ordering analysis to compare the relative performance of firms across CSR reporting, policies, activities, targets, and CSR controversies and performance as a proxy for their promised and realized CSP respectively. Because our methodology does not assume any prior CSR approach and consistently identifies strategic CSR, CSR-as-insurance, and corporate greenwashing in every industry throughout our global sample over 17 years, we provide empirical support for the theoretical models on strategic CSR, CSR-as-insurance, and corporate greenwashing. These findings are often generalizable to individual firms since clusters show little overlap and little internal variation in the promised and realized CSP of firms.

The way in which firms approach CSR largely affects their societal impact. Since there is no unified definition or identification strategy for the societal impact of firms, we consider their emissions, labor conditions and controversies as representative for their respective environmental, social and (lack of proper) governance impact. Unsurprisingly, strategic CSR firms outperform CSR-as-insurance firms and especially corporate greenwashing firms in terms of their societal impact. They have respectively 2.10 and 6.29 times fewer controversies, 2.99 and 4.41 times smaller CO2emission intensities, and they less frequently exhaust water pollutants or VOC and particular matter emissions. In addition, strategic CSR firms experience fewer strikes and employee fatalities, while simultaneously creating more net employment. Even though these measures do not provide a holistic overview of the societal impact of firms, they consistently display superior societal performance for strategic CSR firms and inferior societal performance for corporate greenwashing firms. Due to the large discrepancy in societal impact across heterogeneous CSR approaches, we urge regulators to put more emphasis on separately considering the reporting, policies, activities, and targets of firms and the realizations thereof.

In addition to the societal impact of firms, strategic CSR, CSR-as-insurance, and corporate greenwashing firms similarly differ in their financial performance. Theoretical CSR literature argues that firms with heterogeneous CSR approaches differ in their profitability due to the extent to which they incorporate CSR into their core business model. Strategic CSR firms are expected to attain price premium via socially responsible consumers. Furthermore, CSR-as-insurance firms reduce the large losses associated with CSR controversies. Alternatively, corporate greenwashing firms face an inter-temporal trade-off between temporary gains and future reputational losses when their greenwashing is uncovered. In our paper, we show strategic CSR firms outperform CSR-as-insurance firms and especially corporate greenwashing firms in terms of financial performance. Strategic CSR firms outperform the market with an average 5-factor α of 1.42% per year, while CSR-as-insurance and corporate greenwashing firms underperform with respective alphas of -0.38% and -1.33%. These results hold throughout our global sample from 2003 to 2019 and are robust across domicile, industry, and firm size.

Similar to short-term financial performance, strategic CSR firms also outperform in terms of long-term profitability. We capture the long-term profitability developments of firms for heterogeneous CSR approaches by considering their return on asset (ROA) developments up to thirteen years since they first implemented CSR. Strategic CSR, CSR-as-insurance, and corporate greenwashing firms start with approximately similar ROA. Strategic CSR and CSR-as-insurance firms greatly improved their ROA since they first implemented CSR. Similarly, corporate greenwashing firms display an initial performance improvement. However, greenwashing firms strongly underperform in terms of ROA in the medium and long run. These findings are not explained by discrepancies in risk, as all firms have approximating and persistent 5-factor market betas. By showing that strategic CSR, and to a lesser extent CSR-as-insurance firms, improve their financial performance by approaching CSR, we argue that both managers and investors should focus on the realized CSP of firms, rather than their CSR promises to simultaneously enhance their social and financial performance. Notably, our long-term profitability analysis indicates that an initial phase in which firms promise CSP is rewarded, but that these promised need to be completed in the medium run to prevent large financial losses.

In conclusion, 50%, 24%, and 26% of the firms approach strategic CSR, CSR-as-insurance, and corporate greenwashing on a global sample. Their choice of CSR approach is instrumental for both societal and financial performance, where strategic CSR firms strictly outperform corporate greenwashing firms. Our findings contribute to theoretical and empirical CSR literature by first verifying the theoretical models for strategic CSR, CSR-as-insurance, and corporate greenwashing on a global scale and subsequently identifying the aggregation of the social performance of firms across heterogeneous CSR approaches implicit in ESG ratings as a potential explanation for the diverging social to financial performance relation. Our findings provide managerial, regulatory, and investor implications by noting that it is the realized CSP, not the promise thereof, that instigates social and financial performance. Therefore, managers should focus on contributing to society, investors should allocate funds to firms with ample realized CSP, and regulators should clearly separate promised CSP and realized CSP in their reporting requirements.

Dr. Dennis Bams is a Professor of Financial Risk Management Finance at Maastricht University, Open University Netherlands

Bram van der Kroft is a PhD Candidate at Maastricht University, Open University Netherlands

Dr. Karen Maas is a Professor of Accounting and Sustainability at Erasmus University Rotterdam, Open University Netherlands

This post is adapted from their paper “Heterogeneous CSR Approaches, Corporate Social Performance and Corporate Financial Performance,” freely available on SSRN.

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