the impact of corporate social responsibility (csr) on the company’s financial performance

THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY CSR ON THE COMPANY’S FINANCIAL PERFORMANCE BY CHU MAI LY Graduation Project Submitted to the Department of Business Studies, HELP Universi

THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY (CSR) ON THE

COMPANY’S FINANCIAL PERFORMANCE

BY CHU MAI LY

Graduation Project Submitted to the Department of Business Studies, HELP University College, in Partial Fulfilment of the Requirements for

the Degree of Bachelor of Business (Accounting) Hons

Octorber 2011

DECLARATION OF ORIGINALITY AND WORD COUNT

I hereby declare that the graduation project is based on my original work except for quotations and citations which have been duly acknowledged I also declare that it has not been previously or concurrently submitted for any other course/degree at HELP University College or other institutions The word count is 9,875 words

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NAME OF CANDIDATE

Date:

Acknowledgement

This project would not have been made possible without the assistance, support and encouragement of many people I wish to take this opportunity to thank all the people who have helped me during the time of completing the dissertation I would like to express gratitude towards Dr Pham Duc Hieu and Dr Le Van Lien and to Ms Shumathi for their support and guidance I would also thank some my friends for their financial support for this project

THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY (CSR) ON THE

COMPANY’S FINANCIAL PERFORMANCE

By

CHU MAI LY Octorber 2011

Supervisor: Dr PHAM DUC HIEU

Abstract

Does CSR impact on firms' profits? CSR will lead to increase or decrease of financial performance of the firms Firms face complex market conditions, external effects and asymmetric information which may lead to market failure and sub‐optimal profits In the literature, market failures could build the theoretical base for corporate social responsibility (CSR) implementation by firms In fact, firms in competitive markets could use CSR as a management tool to gain more profits through diversification Further, the implementation of CSR requires the detection of future trends and developments which makes the firms more stable to sudden events Therefore, CSR may offer firms the opportunity to gain higher profits than they would get without CSR Alternatively, CSR could lead to higher costs and thus to worse financial performance Many studies are taken in which the method of study is quantitative or using the KLD data base In this study, I will examine the relationship of CSR and financial performance in a different view and different method This study makes clear relationship in the aspect of identifying the costs and benefits of CRS, how those costs and benefits will affect the accounting earnings or profits of the firms Those issues will

be improved by the case of Vedan and Miwon in Vietnam

2.4 Theories describing the CSR/financial performance relationship 15

2.5 The link between corporate social performance and corporate financial

2.6.4 How economic costs are reflected on accounting earnings 25

Chapter 4 ANALYSIS 36

Chapter 1: Introduction

1.1 Background of study

In today‘s society, there is a growing interest in and demand for Corporate Social Responsibility (CSR) Reasons for this can be multinational corporations‘ increasing influence on the world economy as well as scandals revealing horrible working conditions in different industries

The field of corporate social responsibility has grown exponentially in the last decade More than half of the Fortune 1000 companies issue corporate social responsibility (CSR) reports A larger number of companies than at any time before are now engaged

in serious efforts to define and integrate CSR into all aspects of their businesses An increasing number of shareholders, analysts, regulators, activists, labor unions, employees, community organizations, and news media are asking companies to be accountable for an ever-changing set of CSR issues There is increasing demand for transparency and growing expectations that corporations measure, report, and continuously improve their social, environmental, and economic performance

Corporate social responsibility is not a new issue According to Business for Social Responsibility (BSR), corporate social responsibility is defined as ―achieving

commercial success in ways that honor ethical values and respect people, communities, and the natural environment.‖ McWilliams and Siegel (2001:117) describe CSR as

―actions that appear to further some social good, beyond the interest of the firm and that which is required by law.‖ A point, which is worth noticing, is that CSR is more than just following the law (McWilliams & Siegel, 2001) Alternatively, according to Frooman (1997:227), the definition of what would exemplify CSR is the following: ―An

action by a firm, which the firm chooses to take, that substantially affects an identifiable social stakeholder‘s welfare.‖ A socially responsible corporation should take a step forward and adopt policies and business practices that go beyond minimum legal requirements and contribute to its key stakeholders‘ welfare CSR is viewed and then, a comprehensive set of policies, practices, and programs is integrated into business operations, supply chains, and decision-making processes throughout the company and usually includes issues related to business ethics, community investment, environmental concerns, governance, human rights, the marketplace as well as the workplace

1.2 Statement of purpose

This thesis tries to find out the impact of CSR on the company‘s financial performance but does not focus on why and how firms behave socially responsible The relationship between CSR and firms‘ accounting performance will be thoroughly analyzed to estimate impacts of CSR policy changes Additionally, costs and benefits of CRS are also accounted for One other interesting question is raised that whether CSR can increase profit of the company and after reading and researching, two Vietnamese companies are selected: Miwon and Vedan, which are the outcome of adopted CSR

In order to analyze the question ―what is the impact of CSR on the company‘s profitability?‖ the project is divided into five parts:

 What is the relationship between CSR and finance performance?

 The role of CSR to increase profit of the company

 The outcome of adopted CSR in Vedan and Miwon in Vietnam

1.3 Structure of Study

The thesis will be divided to main parts:

Chapter 2 provides some basic understandings about CSR; the relevant theories

describe the relationship between CSR and finance performances as well as empirical studies of CSR and financial performances The relevant theories will be examined in two aspects of positive and negative relationship Chapter 2 also discusses three main problems of CSR: The link between corporate social performances and corporate financial performances, how CSR affects accounting performances, and additional accounting issues and implications The framework for the subsequent analysis will be created from this chapter

Chapter 3 discusses about the relationship between CSR and financial performance of

the firm and it will be presented and analyzed according to the literature review

Chapter 4 also analyses the outcome of CSR adopted by Vedan and Miwon in Vietnam Chapter 5 recaps the study and provides concluding remarks

Chapter 2: Literature review

At this point in history, as globalization surges on while technology continues to shift the foundations of economic reality at local, national, and international levels, ushering

in new challenges to all firms and governments and blurring traditional distinctions among social institutions, it is critical to examine the notion of Corporate Social Responsibility (CSR)

2.1 The history of CSR

Since 1960s when CSR is initially mentioned, its nature has changed several times Until now, the concept of CSR is also redefined and becomes a new definition However, unlike the economic, legal and ethical expectations placed on organizations varies from societies to societies, all societies in the world at any period of their development have some similar expectations about what organizations should act under their social responsibilities

In the eighteenth century, the great economist and philosopher Adam Smith partly expressed the CRS in his economic research He concluded that market participants must act honestly, a form of CRS, to reach the ideal situation of the free market His theory was espoused by many new principles contributed by the Industrial Revolution in the nineteenth century, when many huge organizations were developed Those organizations, however, were not aware of the importance of CRS and did not act in a proper way for social welfare

Hence, in twentieth century, there is a backlash against the large corporations was appearance They were criticized as being too powerful, creating monopoly markets and

practicing socially irresponsible policies Consequently, laws and regulations were enacted to regulate those large organizations, reduce their power and protect employees, consumers, and society The labor movement also occurred to require a greater social responsibility in business activities As a result of it, all businesses over the world began

to gradually increase their social responsibilities further rather than pursuit the highest profit with impacts on social welfare

In the 1960s and 1970s the civil rights movement, consumerism, and environmentalism changed society's expectations about organizations' activities They required the large organizations must have large responsibilities and contribute more to reduce social problems and engage in solving them Many governments issued legal mandates related

to employees‘ rights, product safety, working condition and environmental protection They were the first bricks to build up the modern concept of CSR today, which refers that corporations should aim towards the new goal above their current economic goal and legal responsibilities to contribute to the betterment of society

a firm, which the firm chooses to take, that substantially affects an identifiable social stakeholder‘s welfare.‖ A socially responsible corporation should take a step forward and adopt policies and business practices that go beyond the minimum legal requirements and contribute to the welfare of its key stakeholders CSR is viewed, then,

as a comprehensive set of policies, practices, and programs that are integrated into business operations, supply chains, and decision-making processes throughout the company and usually include issues related to business ethics, community investment, environmental concerns, governance, human rights, the marketplace as well as the workplace Each company differs in how it implements corporate social responsibility The differences depend on such factors as the specific company‘s size, the particular industry involved, the firm‘s business culture, stakeholder demands, and how historically progressive the company is in engaging CSR Some companies focus on a single area, which is regarded as the most important for them or where they have the highest impact or vulnerability—human rights, for example, or the environment—while others aim to integrate CSR in all aspects of their operations For successful implementation, it is crucial that the CSR principles are part of the corporations values and strategic planning, and that both management and employees are committed to them Furthermore, it is important that the CSR strategy is aligned with the company‘s specific corporate objectives and core competencies The Dean of Rotman School of Management, Roger L Martin (2002), developed the ―virtue matrix‖ as a framework for how socially responsible behavior enters business practice The matrix is framed by four quadrants The two bottom quadrants include socially responsible conduct in which corporations engage by choice, by following norms and customs, or by compliance to existing laws or regulations Those actions both promote social responsibility and

enhance shareholder value On the other hand, the two top quadrants of the matrix include the strategic and structural frontiers, which include activities whose value to shareholders is either clearly negative or not immediately apparent The boundaries between the different categories of socially responsible conduct are porous, since a change in the law or in common practices can cause an activity to migrate from the upper quadrants to the bottom ones

2.3 The term of CSR

―CSR has often been criticized for running fast and loose with its concepts‖ (Barnett, 2007) During the first years of the modern CSR concept, some researches indicate that social responsibility of business has been focused thoroughly but unfortunately, it leaded

to excessive effort in estimating accountability‘s performance Therefore, Archie B Carroll (1979), Professor of University of Georgia, concluded that it was too narrow and too static to fully describe the social efforts or performance of business Additionally, two new terms: Corporate Social Responsiveness (CSR2) and Corporate Social Performance (CSP) were also defined and emerged during this period Corporate Social Responsiveness requires companies to link CSR with strategic management On the other hand, Carmen Valor (2005) wrote that Corporate Social Performance probably builds the managerial framework to deal with CSR and simultaneously measures CSR Ackerman and Bauer (1976) were the first researchers provide the differences between responsiveness and responsibility In 1994, Frederick defined Corporate Social Responsiveness as the capacity of a corporation to respond to social pressures and gave

it the popular shorthand name, CSR2 He also described this new term as a conceptual transition from Moral contemplation to responsive action of Litz (1996): the

―philosophical – ethical concept of corporate social responsibility…to the action oriented managerial concept of corporate social responsiveness‖ It represents ―an effort

to treat as a management issue one which had been predominantly treated as a social and/or ethical issue‟ (Ackerman and Bauer, 1976)

According to a new definition of corporate social responsiveness, Vallentin, in 2009, stated that a counterpoint to the principle of CSR now appeared It was similar to the argument of Sethi in 1979, which proved that a responsive company was by definition also responsible and responsiveness was a replacement concept for the old-defined responsibility On the other hand, Carroll (1979) obtained the conclusion that responsibility could not replace by responsiveness because of the conceptual inadequacy Responsiveness gives permissions without reflection or responsibility is not

a better reinstatement of a concept of CSR that merely enhances responsibility It is possible for a corporation to become responsive and irresponsible

Following this trend, the Corporate Social Performance (CSP) was defined from the increasing pragmatic of social and ethical issues It was emerged as an inclusive and global approach to appreciate corporate social responsibility, responsiveness and the entire numbers of socially beneficial business activities Backhaurs et al (2002) represented a multidimensional construct of CSP He viewed CSP as the interaction between the principles of social responsibility and the processes of social responsiveness combined with the organizations‘ policies and programs, which are designed to solve social issues (Watrick and Cochran, 1985)

From Winsor‘s viewpoint (2001), CSP is a broader definition of CSR CSP conceptually highlights an improvement in emphasis of obligations and motivations to corporates‘ activities and then operationalizes CSR CSR contains a redistribution as motivation

tools which are generated by moral and ethic principles while CSP involves in the redistribution processes from firms to public (Barron, 2001) In contrast, Davenport (2000) criticized that it was just as a theoretical construct from the academic community

In general, it is still difficult to precisely define the terms CSR, CSR2 and CSP They are often used interchangeably Turban and Grennings (1997) stated that CSP as a firm accepting responsibility whereas Ullman (1985) gave the nearly identical definitions for CSR and CSR2, which were related to social demands Recently, the term ―Corporate Social Responsibility‖ have been used to refer to not only a firm‘s acceptance of responsibility but also its actual activities and policies, which have a close relationship with the Social welfare

2.4 Theories describing the CSR/financial performance relationship

With the long stream of literature examining the association between corporate social responsibility and financial performance come a number of theories describing the relationship This section provides a summary of the most common theories used to describe associations between CSR and financial performance Many of the theories are similar or overlap to some extent with one another

A theory suggesting a positive relationship between CSR and financial performance is stakeholder theory Stakeholder theory argues that a firm‘s boundary extends beyond the primary stakeholders to include any group that is affected by, or can affect the achievement of the firm‘s objectives (Freeman, 1984) Instrumental stakeholder theory suggests managers ―must induce constructive contributions from their stakeholders‖ (Donaldson and Preston, 1995, pp 71-72) to achieve organizational goals efficiently A hybrid position between normative and instrumental stakeholder theory maintains CSR

is will not result in financial performance gains if it is not based on moral principles or is not genuine (Jones, 1995; Frank 1988) From an agency perspective, stakeholder relationships act to monitor managerial decision-making and encourage long-term achievement of organizational goals (Cornell and Shapiro, 1987; Hill and Jones, 1992; Jones, 1995; Jensen, 2001) Using this reasoning, one would have to assume the cost of voluntarily engaging in better environmental and/or social performance is less than the costs that the firm would incur absent any such action This is similar to what Jensen (2001) calls ‗enlightened value maximization‘ Jensen states, ―Enlightened value maximization utilizes much of the structure of stakeholder theory but accepts maximization of the long run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders‖ (p 9, 2011)

2.4.1 The Stakeholder Theory

The importance of stakeholders in terms of CSR was formally recognized by Freeman in the middle of the 1980 However, its concept seemed to be unclear until 1995, Donaldson and Preston with their wide range of research paper, classified and formulated a three-part typology of the theories of stakeholder theory: descriptive, instrumental and normative Jones (1995) also supported Donaldson and Preston that the stakeholder theory answers the following questions: what happens? (Descriptive) What happens if? (Instrumental) and what should happen? (Normative)

To answer the first question: what happens? (Descriptive), the stakeholder theory describes corporate characteristics and behaviors and then the corporation is constructed

as a constellation of cooperative and competitive interests over intrinsic values For answering the second question: What happens if? (Instrumental), the connection

between stakeholder approaches and generally desired objectives of firms such as profitability, growth and stability will be created Finally, the question: What should happen? or a normative theory is used to explain the social function of organizations and identify their moral and philosophical guidelines for their operation

Donaldson and Preston also stated that the three theories are closely related to each other The general aspect, which possibly considered as the external shell, is the descriptive theory It explains the stakeholder relationships inside the firm and will be supported by the instrumental theory with its forecasting values Some certain practices and experiments are necessarily carried out to create the predictions in this level Lastly, the central core of the theory is normative, which points out ―what should happen?‖ by legitimating stakeholder interests and requiring managerial attention as a matter of moral right

As earlier definition of instrumental, it is used to make a connection between stakeholder approaches and commonly desired objectives such as profitability, stability and growth (Donaldson and Preston, 1995) The nature of Instrumental aspect can be found in the arguments of General Robert Woods (1950) He represented four parties in order of importance for every business including customers, employees, community and shareholders If the first three parties are cared and their welfare is protected effectively, the shareholders of the company will benefit as a result Maintaining the interests of those groups and receiving their support is the key for the survival of the organization (The 1963 International memorandum at the Stanford Research Centre)

Post et al (2002) believes that effective and creative stakeholder management is a vital requirement to stabilize and improve the wealth creating capacity and profitability of the organization The stakeholder management is kind of a competitive advantage source Its

evidence is as contracts between organization and stakeholders, which is based on trust and coordination and therefore less expense are required in monitoring and enforcing such contracts (Jones, 1995) The failure of the corporate system and its ability to continue as a going concern can be a result of the failure of remaining the participation

of a primary stakeholder group (Clarkson, 1995)

Similarly, Jarillo (1988) and Jones (1995) cited that the coordinative working relations with stakeholders would contribute organization success In reality, stakeholders even have power to severely affect the continuity of the organization (Freeman, 1984) However, Orts and Strudler opinion about the instrumental theory in 2002 was different They argued that ―the best interests of stakeholders will inevitably also promote the best interests of shareholders is unreasonably optimistic‖ because of the conflict of interests and ethics among those stakeholders

From Hemphill (2004) and Berman and Wicks (1999)‘s argument, an instrumental basis

of the stakeholder theory is perfectly consistent with shareholder theory It stated that the last result, after enhancing the first three stakeholders‘ welfare, is the organization could have nothing to do with the welfare of the last stakeholder group: the shareholders It is almost identical to the nature of Friedman‘s view (1970), which proved the social responsibility of business is to increase its profits However, those arguments of CSR above seem to be a bias motivation towards the previous outcome of CSR – increasing corporation social responsibility for social betterment

The ultimate clarification for stakeholder theory is possibly found in its normative base

In order to support the stakeholder theory, Gibson (2000) referred to the theory of deontology, which represents that individuals have the right to be treated as ends in themselves and not merely as a means to an end (Shankman, 1999; Metcalfe, 1998)

In terms of the theory‘s descriptive aspect, some empirical studies showed that many managers believe themselves, or are believed by others in operating the organization They often did their managerial work without making reference to stakeholder theory Donaldson and Preston (1995) argued that the major role of managers adhere in practice

of the core idea of stakeholder theory, which implies that managers‘ role is to satisfy a wider number of stakeholders, not simply the shareholders Clarkson (1995) supported this claim that the strength of stakeholder theory is the precise description if business‘s function, whose evidence can be found from corporate sources

Overall, while stakeholder theory has been justified as a descriptive, instrumental and normative theory, the relationship between CSR and corporate‘s performance is not merely positive if stakeholders‘ welfare is remained The trade-off between CSR and firms‘ performances is also worth to be referred

2.4.2 Theory suggest a negative relationship

Trade-off theory hypothesizes a negative relationship between CSR and financial performance Based on Friedman (1970), this theory views investments as tradeoffs between stakeholders leading to tradeoffs between profit maximization and socially responsive objectives (described in Aupperle et al., 1985; Preston and O‘Bannon, 1997) Corporate social performance, therefore, may lower a firm‘s financial performance because CSR investments use up resources that could be used in a more profit-maximizing way Managerial opportunism also suggests a negative relationship between corporate social performance and financial performance Preston and O‘Bannon (1997) were the first to suggest managers may avoid CSR investment because of compensation packages linked with short-term firm earnings and stock price behavior They explain,

when financial performance is strong, managers may attempt to ‗cash in‘ by reducing social expenditures in order to take advantage of the opportunity to increase their own short-term private gains Conversely, when financial performance weakens, managers may attempt to offset, and perhaps appear to justify their disappointing results by engaging in conspicuous social programs Managerial opportunism could lead to negative financial performance effects in other ways as well

Managers may engage in corporate philanthropy to augment their own personal reputation in the community (Balotti and Hanks, 1999) Jensen (2001) argues more strongly that a firm attending to multiple stakeholders without a clear, single-valued objective leaves managers with unclear direction on resource allocation decisions, politicizing the corporation The consequence is that managers are ―empowered to exercise their own preferences in spending the firm‘s resources‖ (p 10) In such cases, the profit maximizing benefits of CSR investment are not maximized; but rather the manager‘s utility is maximized This potentially leads to less than optimal CSR investment from the firm perspective CSR that is intended to benefit the organization‘s financial performance must be integrated with corporate strategy to be effective (Brammer and Pavelin, 2006; Porter and Kramer, 2006) Another way to move this stream of research forward is by describing CSR benefits and costs and articulating how these costs and benefits would be reflected in financial performance

2.5 The link between corporate social performance and corporate financial performance

The question whether there is a real relationship between corporate social performance (CSP) and corporate financial performance (CFP) has been raised as an interesting

debate topic for many researchers during the twentieth century (Dodd, 1932, Jarell and Peltzman, 1985, Hoffer et al., 1988, Preston and O‘Bannon, 1997, McWilliams and Siegel, 2000, and Simpson and Kohers, 2002) Some researchers supported the idea that the relationship between CSP and CFP is positive some argued it is negative based on their own empirical studies whereas others concluded that there is no relationship at all Those researchers supporting the concept of positive relationship suggested that following CSP policies exposed explicit costs to the organization but reduced the hidden costs that are imposed on other stakeholders Thus, this viewpoint is based on the perspectives of avoiding costs to major stakeholders group and fulfilling their satisfaction This argument is reasonable and meaningful because while CSR increased costs to competitiveness of the corporation, the good relationship with customers, employees and suppliers are essential for its survival and development Bowman and Haire (1975) pointed out that some shareholders consider CSR as a significant management skill, which can constantly construct the corporate‘s reputation through activities supporting community Therefore, this results in positive influence on sales and increasing in competitive advantages Overall, the corporation sacrifices the short-term CFP to improve the long-run CFP

On the other hand, some researchers argued that the correlation between CSP and CFP is negative The fulfillment of CSR will bring competitive disadvantages to the company

as the consequential costs appear If the corporation neglects some stakeholders, such as employees or the environment, the CSP will be lower and CSP may be improved in both short run and long run period Waddock and Graves‘s theory in 19974 is an example of negative correlation between CSP and CFP

The final concept is that there is no relationship between CSP and CFP at all Ullmann (1985) represented that because there are a large number of variables in measuring the CSP and CFP‘s relationship, it is no obvious evidence to anticipate the existence this relationship

2.6 CSR and accounting performance

2.6.1 Economic benefits of CSR

Each researcher has his own opinion about CSR‘s benefits To sum up, this study summarizes and investigates in detail only three major economic benefits to firms engaging in CSR First, firms avoid or mitigate impacts to financial performance arising from negative events and/or externalities Second, firms create goodwill and/or other intangible assets, favorably impacting financial performance The last CSR‘s benefit is that firms gain efficiencies, reducing costs and improving financial performance

2.6.2 How economic benefits are reflected in accounting earnings

From the previous part relating to economic benefit of CSR, there are three major types

of economic benefits, which an organization can receive by acquiring increasing CSR policies

Firstly, in terms of avoiding the economic impact of negative externalities, increasing CSR and the firm‘s social reputation reduce the probability of compliance and/or regulatory costs in the future periods Some empirical evidence resulted from recent researches showed negative impacts on firm that have bad environmental performance Additionally, an organization sometimes has to deal with industrial accidents, which easily impose numerous amounts of expenses of remediation, litigation, etc More

socially responsible organizations are generally considered to be less likely to cause those accidents Furthermore, saving those expenses also associates with the lower regulatory requirements and an organization‘s operation activities are more welcomed

by people and the government Thus, if the organization scarifies the costs of being more socially responsible, the higher sales and higher accounting earnings will be the last outcome of CSR policies

Another positive impact of CSR is like the growing insurance for accounting earnings of the firm or, in other way, maintaining accounting earnings less volatile Firms that are more socially responsible try to reduce conflicts among stakeholder groups and align corporate and social goal In contrast, less socially responsible firms ignore their negative externalities of their operating activities that are imposed on society In the future, some of those externalities will be realized and, therefore, lawsuits, political or social conflicts will be raised, which results in penalties, regulations to those firms Consequently, their revenue will suffer from a significant fluctuation Although those negative impacts of social conflicts are transitory, they add volatility and noise to accounting earnings for less socially responsible firms and decrease their financial performance

Secondly, the corporation‘s benefit can be from generating goodwill and other intangible assets, which positively affect accounting earnings CSR can differentiate firms into levels of reputation and the higher level means the higher competitive advantage A firm that does not sufficiently invest to maintain its intangible assets may be slower to recognize social and environmental threats and slower to respond to social and environmental opportunities In terms of accounting perspectives, the total assets of one firm include the book value of money, short-term investment, long-term investment,