Corporate Social Performance, Competitive Advantage, Earnings Persistence and Firm Value

• Published date: 01 January 2016
• Date: 01 January 2016
• DOI: http://doi.org/10.1111/jbfa.12182
• Author: Xiaojuan Yan,Julie Whittaker,Alan Gregory

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 43(1) & (2), 3–30, January/February 2016, 0306-686X

doi: 10.1111/jbfa.12182

Corporate Social Performance,

Competitive Advantage, Earnings

Persistence and Firm Value

ALAN GREGORY,JULIE WHITTAKER AND XIAOJUAN YAN∗

Abstract: In this paper, using a generalised valuation framework inspired by Ohlson, we show

that corporate social performance (CSP) is value relevant and that, in particular, it appears

to be associated with a higher coefficient on earnings. This could be attributable to either a

lower cost of equity for these firms, or greater earnings persistence. We show that, once industry

membership is controlled for, any cost of capital effect is minimal. Regression tests based on

realised earnings confirm that the valuation effect is attributable mainly to greater earnings

persistence in firms with higher levels of CSP. These outcomes are consistent with higher CSP

conferring a competitive advantage on firms.

Keywords: corporate social responsibility, corporate social performance, competitive advantage,

value relevance, earnings persistence

1. INTRODUCTION

Can a firm’s corporate social performance (CSP) endow it with a competitive advan-

tage and, thereby, improve its earnings? Friedman (1962, 1970) famously expressed

disquiet about agency losses from socially responsible actions but, notably, he was

not opposed to corporate social responsibility if it enhanced firm value. His views

motivated a large body of empirical work investigating if there is a business case for

corporate social responsibility (CSR). Renneboog et al. (2008) review this literature

and conclude that whether or not CSR is priced in capital markets is an open question.

However, recent studies that focus on firm value, as we do here, find evidence that

CSP does impact positively on firm value (Galema et al., 2008; Guenster et al., 2011;

Jo and Harjoto, 2011; Kim and Statman, 2012; and Gregory and Whittaker, 2013).

Nonetheless, even if firms with a high corporate social performance (CSP) are found

to have a higher stock value than firms with low CSP, this still leaves open the

∗The first and second authors are from the University of Exeter. The third author (Xiaojuan Yan) was a

Phd student at the University at the time the paper was commenced. The authors are grateful to session

participants at the FMA Conference in Porto, to seminar participants at Glasgow University, St Andrew’s

University and Exeter University, Rajesh Tharyan and Grzegorz Trojanowskiand to an anonymous referee.

They are particularly grateful to Andy Stark (the JBFA Editor for this paper) for his helpful and constructive

suggestions during revisions to this paper. The usual disclaimers with regard to errors and omissions apply.

(Paper received December 2014, revised version accepted January 2016).

Address for correspondence: Alan Gregory, University of Exeter,Exeter, Devon EX4 4PU, United Kingdom

e-mail: a.gregory@ex.ac.uk

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4GREGORY, WHITTAKERAND YAN

possibility that this is a consequence of greater investor demand for the stocks of

‘good’ companies (Mackey et al., 2007) while, as suggested by El Ghoul et al. (2011),

companies with an inferior CSP may have a smaller investor base. The contribution

of this paper is not only simply to show that CSP is value enhancing, but also to show

that the reason CSP is value relevant is that CSP appears to be associated with greater

earnings persistence. The implication is that the relationship between CSP and firm

value is driven by an underlying economic effect that is consistent with firms that have

higher levels of CSP having a competitive advantage over rival firms.

Our investigative approach is consistent with that of Agarwal et al. (2011) and

Gregory and Whittaker (2013). Both papers argue that firm value, rather than realised

returns, is the more appropriate metric when assessing the financial implications of

the objects of their investigations. The reason is straightforward, in that the analysis

of realised returns will tell us nothing if markets are efficient. As Agarwal et al.

(2011) point out, ‘In efficient markets, there should be no relationship between

quality of management and subsequent stock returns as implications of management

quality will already be impounded in the stock price. This is irrespective of whether

it has a positive, negative or no impact on firm operating performance’. Gregory and

Whittaker (2013) make a similar point with regard to CSP, emphasising that if CSP is

associated with a lower cost of capital (as suggested by Sharfman and Fernando, 2008

and El Ghoul et al., 2011), then we would expect to observe high CSP firms having

lower returns on average than low CSP firms.

In this study we use a more sophisticated value-based model than that employed in

Gregory and Whittaker (2013) and apply it not only to retest the impact of CSP on firm

value but, after finding that firms with a high CSP do have a higher value, also explore

whether this is because earnings themselves are more persistent and whether they

have a lower risk-adjusted cost of capital resulting in a higher capitalisation of future

earnings. In this respect, our approach is similar to that adopted in Agarwal et al.

(2011), although our modelling of valuation and earnings effects is subtly different. In

common with Agarwal et al. (2011), we also investigate whether risk-adjusted costs of

capital differ between firms with good and poor CSP performance with respect to our

chosen metrics. In contrast to the findings of Sharfman and Fernando (2008) and El

Ghoul et al. (2011), we find that, once industry membership is controlled for, any cost

of capital difference between high and low CSP firms is minimal. However, we find

that CSP positively predicts future earnings and therefore high CSP would appear to

be associated with higher future abnormal earnings. Therefore we conclude that CSR

engagement can endow firms with a competitive advantage by raising future earnings.

2. THEORY AND HYPOTHESES

The ability of a firm to gain a competitive advantage is normally considered from the

resource-based view (RBV), which assumes firm heterogeneity. Firms with resources

and capabilities that are valuable and rare attain economic rents and, when these are

difficult to imitate or substitute, the competitive advantage is sustainable over the long

term (Barney, 1991). However, Oliver (1997) argues that an institutional perspective is

also relevant for understanding competitive advantage, because conforming to social

expectations is pertinent for organisational success and survival (Scott, 1987; Carroll

and Hannan, 1989; and Oliver, 1991). An early response to Friedman’s concern with

agency losses associated with CSR is provided by Narver (1971), who stresses the

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