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This report highlights leading literature and empirical research on ‘sustainable investment’. Given the extensive body of literature in the field it is not meant to be all-encompassing, but is meant to provide the reader with a strong base from which to carry out further research and investigation.
As this subject has already been studied extensively in the past (both theoretically and empirically), this report focuses on high-level issues and conclusions from a finance point of view. More specifically, in this report ‘sustainable investment’ is interpreted as covering two closely related topics: Corporate Social Responsibility (CSR) and Socially Responsible Investment (SRI).
There is no uniform definition of Corporate Social Responsibility (CSR). In this report Renneboog et al. (2007) is used, defining corporate social responsibility as a combination of good corporate In practical terms, the UN Global Compact – a framework for the development, implementation, and disclosure of sustainability policies and practices – has translated this into ten principles in the areas of human rights, labour, the environment and anti-corruption. These principles enjoy universal consensus (www.unglobalcompact.org).
governance, environmental efficiency and good stakeholder relations. CSR refers to sustainability at the individual company level. (Eurosif, 2008, p. 6) defines Socially Responsible Investment as the “generic term covering ethical investments, responsible investments, sustainable investments, and any other investment process that combines investors’ financial objectives with their concerns about environmental, social and governance (ESG) issues”. Contrary to CSR, SRI concerns sustainability at the investment, fund or portfolio level. It has an investors perspective, instead of
a company perspective.One could argue that CSR and SRI are two sides of the same coin:
investing in sustainable companies (SRI) requires the availability of companies that are socially responsible.
Literature and studies on the (financial) value of CSR are discussed in Chapter 2, focusing on the the financial drivers behind CSR and the consequences of CSR for company value. After that, literature about SRI will be addressed in Chapter 3, focusing on the profitability of sustainable investment and its success drivers.
2 Corporate Social Responsibility
2.1 Introduction At the core of Corporate Social Responsibility (CSR) is the conviction that ‘‘business organizations have societal obligations which transcend economic functions of producing and distributing scarce goods and services and generating a satisfactory level of profits for their shareholders’’ (Epstein, 1989, p. 585). There is a myriad of definitions of CSR, which leads to different evaluations on its impact on company ‘outputs’ – more specifically, its impact on company performance (Aras & Crowther, 2009; Hill, Ainscough, Shank, & Manullang, 2007;
Van Dijken (2007), after citing numerous CSR definitions, summarizes three main points that
each of these definitions have in common:
• CSR addresses a company’s different stakeholders (as opposed to shareholders only), such as employees, communities, customers and suppliers and Non-Governmental Organizations (NGOs);
• CSR initiatives are voluntary and go beyond what is required by law; and
• CSR can have a strategic dimension – e.g., reaching a goal (long-term survival) with a limited amount of resources.
In short, there is no uniform definition of CSR. In this report, the definition of Renneboog et al.
(2007) is adopted, as it offers a helpful framework for categorizing the various (empirical) research on the performance drivers and implications of CSR. Renneboog et al. (2007) define
corporate social responsibility as a combination of:
• good corporate governance: protecting shareholders’ interests;
• environmental efficiency: protecting environmental stakeholders’ interest; and
• good stakeholder relations: protecting the interests of stakeholders other than shareholders and environmental stakeholders, including those of employees and the local community.
A fundamental question is whether there is a tradeoff between maximizing shareholder value and maximizing stakeholder value (Harold, Spitzer, & Emerson, 2007; Renneboog et al., 2007; Steger, 2004). One group of scholars – e.g., Friedman (1970) and Jensen (2002) – has argued that social responsibility detracts from a firm’s financial performance: “[a]ny discretionary expenditures on social betterment unnecessarily raise a firm’s costs, thereby putting it at an economic disadvantage in a competitive market” (Barnett & Salomon, 2006, p. 1102).
Another group of scholars has argued that a firm’s social performance can enhance its ability to attract resources, obtain quality employees, market its products and services and to create unforeseen opportunities (Barnett & Salomon, 2006; Cochran & Wood, 1984; Crowther, 2000;
Fombrun, Gardberg, & Barnett, 2000; Greening & Turban, 2000; Harold et al., 2007; Steger, 2004; Turban & Greening, 1997; Waddock & Graves, 1997).
SEO ECONOMIC RESEARCH
4 CHAPTER 2According to the theory of Adam Smith (1776), both goals can be achieved without any conflicts of interest: in competitive and complete markets, when all firms maximize their own profits, the resource allocation is Pareto-optimal and the social welfare is maximized. This would imply there is no trade-off between CSR and company performance. However, modern economic theory shows that with the existence of externalities, profit-maximization does not necessarily imply social-welfare maximization (Renneboog et al., 2007; Renneboog, Ter Horst, & Zhang, 2008b;
Steger, 2004). The point of view by the authors directly challenging Friedman’s approach – both on economic and ethical bases – seems to be gaining momentum (Harold et al., 2007). The focus of the remainder of this chapter is on economic/financial rather than ethical arguments for CSR.
2.2 Value Drivers and Measurement Steger (2004, p. 3) points out that “After about 450 interviews in 16 developed countries and a survey of over 1000 respondents, the bottom line [for CSR] is still not easy to draw” because “sustainability issues are extremely fragmented, uncertain, controversial and difficult to quantify”.
Relevant sustainability issues are numerous, they differ from industry to industry, are highly uncertain and their business relevance is often either unclear or discussed in a confusing cloud of controversy. Renneboog et al. (2008b) also mention that in order to make CSR a “workable concept”, corporate performance should be measurable.
This raises the question how companies (should) value their sustainable activities: how can they measure the value that is created by CSR? In this regard, finance literature focuses on monetization of shareholder or stakeholder value.3 This usually concerns either market prices (such as stock prices/returns) or other corporate finance ratios, such as return on equity or return on assets (Kim & Van Dam, 2003; Orlitzky et al., 2003; Peloza & Shang, 2010).4 Other, more indirect approaches exist as well. Godfrey et al. (2009), for instance, focus on the preservation of Corporate Financial Performance (CFP) through CSR, rather than the generation of economic value. They argue that the goodwill or moral capital a firm builds up through CSR activities, acts as ‘insurance-like’ protection (or value preservation) when negative events occur.
Contrary to the economic value generation research angle, the insurance perspective is, the authors note, relatively under exposed in current empirical literature.
Another approach is the ‘customer/marketing outcome’ of sustainability. CSR activities have been attributed to increase customer loyalty, a willingness to pay premium prices, a decreased blame attribution in the face of a (product-harm) crisis and increased brand value (Creyer & Ross, 1996; Du, Bhattacharya, & Sen, 2007; Klein & Dawar, 2004; UNEP, 2006).5 Barnett (2005) There are other perspectives to value CSR rather than from a financial point of view. ‘Doing things the right way’ (or even altruism) might also provide value/utility to the individual company owner, manager or employee. However, this paper focuses on financial criteria.
UNEP (2006) mentions five valuation tools that have emerged in recent years: benchmarking, scenario analysis, proprietary valuation methodologies and case studies. They admit, however, that “further development [of valuation tools] is clearly desirable”. Kim et al. (2003) suggest that the economic value and reputational value created by CSR, should be measured using respectively Value Based Management (VBM) and Economic Value Added (EVA) and the ‘Reputation Quotient’ (developed by the Reputation Institute).
Peloza & Shang (2010, pp. 9-11) provide an extensive overview of empirical literature on the causality between CSR and marketing outcomes (generally customer-related).
adopts a slightly wider perspective by arguing that the ability of CSR to create firm value lies in its ability to generate positive stakeholder relations (i.e., not just customer relations) for the firm.
Kim et al. (2003) add ‘parenting advantage’ to CSR’s value drivers – leveraging existing CSRrelated capabilities throughout the company (through the horizontal and vertical linkages that exist within a company) or by building a ‘CSR business line’ (a business model that is entirely based on corporate social responsibility).
Godfrey et al. (2009) make the point that given that risk reduction, customer/stakeholder outcomes and ‘parenting advantages’ (eventually) could also add value to shareholders, they can eventually be measured by the same bottom line.
2.3 The Business Case for CSR 2.3.1 The Value of Sustainable Companies In general, empirical literature concludes that CSR enhances a company’s financial performance (Godfrey et al., 2009; Hill et al., 2007; Renneboog et al., 2007, 2008b; Shank, Manullang, & Hill, 2005; UNEP, 2006).
In theory, the ‘value drivers’ that support the business case for CSR include operational efficiency opportunities, increased brand value and reputation, better risk management, attracting and retaining talented employees and pre-empting regulatory intervention (Crowther, 2000; Steger, 2004). Harold et al. (2007) point at similar theoretical linkage between environmental and financial performance (Table 1).
Table 1 Environmental performance and company value
Source: Adapted from Harold et al. (2007, p. 9) Empirical literature is diverse in its research angles. The remainder of this section is dedicated to studies on the empirical relationship between company value and CSR. Empirical findings are categorized according to the three ‘pillars’ of CSR that were introduced in paragraph 2.1: (i) corporate governance (protecting shareholders’ interests), (ii) environmental efficiency (protecting environmental stakeholders’ interest), and (iii) stakeholder relations. Although diverse
in its research questions and methodologies, empirical literature generally points to a positive link between CSR and company performance.
Corporate Governance The relationship between corporate governance, defined by Tirole (2001) as “the design of institutions that induce or force management to internalize the welfare of stakeholders”, and the firm’s (subsequent) value (e.g., measured by stock price or stock return) has been examined empirically by various authors.
Gompers et al. (2003) have shown a positive relation between corporate governance and stock returns. Based on a research on 1,500 companies, they conclude that by buying companies with the strongest shareholder rights and selling those with the weakest shareholder rights, an abnormal yearly return of 8.5% resulted in the 1990s.
Bauer et al. (2004) applied the same (GIM6) methodology for European companies, and found that good corporate governance – they use the overall governance ratings from Deminor Corporate Governance Ratings, which are the aggregates of 300 criteria covering shareholder rights, takeover defense, information disclosure and board structure – leads to higher stock returns and higher firm value.
From their empirical analysis Godfrey et al. (2009) conclude that participation in institutional CSR activities (ICSRs), aimed at a firm’s secondary stakeholders7 or society at large, which provides an ‘insurance-like’ benefit and thus creates value for shareholders. They focus on the preservation of a company’s value through insurance-like protection (see also paragraph 2.2).
Other studies pointing at a positive relation between corporate governance and a firm’s value, include La Porta et al. (2002) and Cremers & Nair (2005).
Environment A growing body of empirical literature reports a positive relation between corporate environmental performance and firm value (Renneboog et al., 2007, 2008b).
Klassen & McLaughlin (1996) find (statistically) significant positive abnormal returns after a firm receives environmental performance awards, and significant negative returns after an environmental crisis. Dowell et al. (2000) find that US-based multinational enterprises adopting a stringent global environmental standard have much higher market values than firms with less stringent standards. Konar & Cohen (2001) conclude that poor environmental performance is negatively correlated with the intangible asset value. Derwall et al. (2005) show that a portfolio of firms with high environmental scores (based on positive screening) outperforms a portfolio of firms with low scores by 6% per annum over the period 1997-2003.
The GIM methodology refers to the empirical analysis by Gompers, Ishii and Metrick (2003).
Primary stakeholders make legitimate claims on the firm and its managers and have both urgency and power (utilitarian, coercive, or normative) to enforce those claims. Secondary stakeholders have legitimate claims on the firm, but lack both urgency and power to enforce those claims (Mitchell, Agle, & Wood, 1997).