On the relation between corporate social responsibility and financial performance

• Author: Jared I. Wilson,Amrou Awaysheh,Randall A. Heron,Tod Perry
• Published date: 01 June 2020
• DOI: http://doi.org/10.1002/smj.3122
• Date: 01 June 2020

RESEARCH ARTICLE

On the relation between corporate social

responsibility and financial performance

Amrou Awaysheh | Randall A. Heron | Tod Perry |

Jared I. Wilson

Kelley School of Business, Indiana University, Indianapolis, Indiana

Correspondence

Amrou Awaysheh, Kelley School of

Business, Indiana University,

Indianapolis, IN 46202.

Email: awaysheh@iu.edu

Abstract

Research Summary: This study reexamines the rela-

tion between corporate social responsibility (CSR) and

financial performance by benchmarking firms against

industry peers in a given year to identify best-in-class

and worst-in-class firms. We also address distributional

issues when using CSR ratings (clustering of CSR scores

around the median and material differences across

industries and time) and financial performance ratios

(the possible influence of extreme values). We find that

the best-in-class firms outperform their industry peers

in terms of operating performance and have higher rel-

ative market valuations (Tobin's Q). When we control

for endogeneity, we find that the significant relation

between operating performance and CSR categories dis-

appears, calling into question whether this relation is

causal. However, we continue to find that best-in-class

firms receive higher relative market valuations than

industry peers.

Managerial Summary: The conflicting evidence on

the relation between CSR and firm performance may

influence a manager's decision to invest in CSR activi-

ties and an investor's decision to invest in a firm. Our

research provides managers and investors with impor-

tant implications regarding the value of relative

benchmarking. Managers should understand that

expectations of CSR performance evolve over time and

Received: 27 June 2018 Revised: 8 October 2019 Accepted: 18 November 2019 Published on: 13 January 2020

DOI: 10.1002/smj.3122

Strat. Mgmt. J.. 2020;41:965–987. wileyonlinelibrary.com/journal/smj ©2020 John Wiley & Sons, Ltd. 965

that investors place higher valuations on the best-in-

class CSR firms within an industry.

KEYWORDS

CSR, firm performance, firm value, MSCI KLD, operating income

1|INTRODUCTION

Corporate social responsibility (CSR) continues to be a hot topic for firms, the business press,

and the investment community. Many of the largest firms around the world not only invest sig-

nificant resources implementing CSR initiatives, but also work to disclose their CSR activities

to various stakeholders and potential investors through different channels including annual

sustainability reports (Wang, Hsieh, & Sarkis, 2018). Firms are also incorporating CSR criteria,

such as adding the cost of carbon or the cost of water in financial projections, when assessing

the merits of capital allocation decisions (Flammer, 2015).

The investment community has responded as well, with many funds now explicitly consid-

ering CSR among various investment criteria. The US Sustainable Investment Foundation

reports that the number of investment funds incorporating environmental, social, and gover-

nance (ESG) factors in their investment decisions has grown dramatically, with over $11.6 tril-

lion of assets under management in 2018 (SIF, 2018). In addition, “Green Bonds”are becoming

more prevalent to finance projects with a CSR focus among firms where environmental issues

are particularly acute (Flammer, 2018), with over $120 billion in new Green Bond issuances in

2017 and $500 billion in 2018 (World Bank, 2017, 2018). Given the increased attention to CSR

from financial markets, it is not surprising that firms with good CSR performance appear to

have better access to capital (Cheng, Ioannou, & Serafeim, 2014).

1.1 |Related literature on value of CSR

Despite evidence that CSR is increasingly considered to be important by firms and capital mar-

ket participants, there remains an unsettled debate among researchers regarding the relation

between CSR and firm performance. Friedman (1970) framed one side of the theoretical debate

decades ago, suggesting that CSR investments that ultimately benefit other stakeholders at the

expense of shareholders will lead to reduced corporate profits and stock prices. An alternative

view, however, is that CSR investments can generate a sustainable competitive advantage that

allows firms improved financial performance that is valued by financial markets and benefits

shareholders. The empirical evidence is, at best, mixed. For example, in an early and influential

study of the relation between CSR and financial performance, Waddock and Graves (1997)

report a positive relation between CSR ratings and prior financial performance and a positive

relation between CSR ratings and subsequent financial performance. Mcwilliams and Siegel

(2000) suggest that Waddock and Graves' model suffered from an omitted variable problem

since it did not include R&D intensity, which is highly correlated with CSR. They show that

when R&D intensity is included, the positive relation between CSR and subsequent financial

performance disappears. In addition, a recent replication study using a much larger sample

across a longer timeframe conducted by Zhao and Murrell (2016) confirms the original finding

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