IMPACTS OF CORPORATE SOCIAL RESPONSIBILITY ON THE FINANCIAL PERFORMANCE OF THE FIRMS

IMPACTS OF CORPORATE SOCIAL RESPONSIBILITY ON THE FINANCIAL PERFORMANCE OF THE FIRMS BY NGO THI LINH ID: E0700042 Graduation Project Submitted to the Department of Business Studies, HE

IMPACTS OF CORPORATE SOCIAL RESPONSIBILITY ON THE

FINANCIAL PERFORMANCE OF THE FIRMS

BY NGO THI LINH ID: E0700042

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

APRIL 2011

DECLARATION

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 10,668 words

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NAME OF CANDIDATE

Date:

Acknowledgement

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 like to some my friends for their financial support for this project

IMPACTS OF CORPORATE SOCIAL RESPONSIBILITY ON THE

FINANCIAL PERFORMANCE OF THE FIRMS

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 Unilever in Vietnam

2.4.2 Economic costs of CSR

2.5.1 How economic benefits are reflected on accounting earnings

2.5.2 How economic costs are reflected on accounting earnings

2.5.3 Additional accounting issues and implication

2.6 How CSR can reduce the cost of the company

2.6.1 Reduce the financing cost

2.6.2 Reduce the cost of human resourches

2.6.3 Reduce the operating cost

3.1 Research objective

3.3 Measurement

3.3.1 Measurement of Corporate Social Performance

3.3.2 Measurement of financial performance

3.4 Case study

3.4.1 Vedan

3.4.2 Unilever

3.5 Limitations

Chapter 1: Introduction

1.1 Background of study

Nowadays, the importance of corporate social responsibility (CRS) has been more considered by firms than ever Most of the Fortune 1000 companies issue CSR reports, they not only care for their responsibility but also they consider it as a key to business Many firms know that they can get benefits from their social actions Some of the most significant advantages of CSR are: improved company image and reputation, raised ability to draw and keep employees, and potentially decreased regulatory mistake The study in economics and direction on the benefits and costs of CSR is growing very fast Marketing researches prove that ―70% of European consumers consider important a firm‘s commitment to CSR when buying a product or service and, moreover, 1 in 5 consumers would be willing to pay more for products that are socially and

environmentally responsible‖ In 2003, many current studies disclosed that ―more than eight in ten British consumers consider important that a firm shows a high degree of social responsibility, when making their purchasing decisions‖ Also, most of customers feel that firms do not pay attention and take action to their environment and social concern In a study of Mohr and Webb (2005) about the impact of CSR on price and consumer responses, the results show that CSR has a positive impact on consumers‘ valuation of a company and on their buying habits The study also discovers that a low price does not emerge to recompense for a low level of CSR

CSR is an important issue which concerns about the ethics, society, natural environment, employees and also working environment as a whole in which how the firm behave On September 13, 1970, in the New York Times, Milton Friedman wrote: ―There is one and only one social responsibility of business— to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is

to say, engages in open and free competition without deception or fraud.‖ According to The Australian Government Corporations and Markets Advisory Committee, Corporate Social Responsibility Discussion Paper (2005) emphasizes that ―as companies‘ play a prominent role in contemporary society, the relationship that exists between a company and society is an important community issue Through the provision of goods and

services, companies have substantial power to impact society Correspondingly, a firm‘s

CSR suggests whether this impact is positive or negative Thus CSR is a particularly relevant issue for evaluating firms from a community perspective.‖

The Economist Intelligence Unit (2005) global survey showed that in 2000, 54% of company executives regarded CSR as ‗central‘ or ‗important‘ to their business decision-making In 2005 this response grew to 88% This shows that companies are more and more focusing on CSR Thus it is essential to look whether investment in CSR is

connected to higher or lower financial performance

The question of how CSR affects financial performance of the firms is still being

researched by many people besides many academic researches of this issue were taken before Although there are many preponderancy evidences showing the positive

relationship between CSR and financial performance, it still has some limitations of conclusions and mixed results Margolis and Walsh stated in a review of 95 empirical studies conducted between 1972- 2001 that: ―When treated as an independent variable, corporate social performance is found to have a positive relationship to financial

performance in 42 studies (53%), no relationship in 19 studies (24%), a negative

relationship in 4 studies (5%), and a mixed relationship in 15 studies 19%)‖ Moreover, there is no literary deal with the relationship between CSR activities and accounting earning performance; or the affect of the systems on financial performance and

accounting earning is not clear so far

1.2 Statement of purpose

The purpose of this study is to figure out the impact of CSR on the company‘s financial performance The aim of this study does not answer why and how firms behave socially responsible The study is looking closely at how likely CSR impact the accounting performance This study is interested in economic benefit and cost of CSR This study tries to analyse the relationship between CSR and accounting performance This study also questions how CSR can increase the profit of a company Furthermore, this study will examine CSR among two companies in Viet Nam: Vedan and Unilever to see the

outcomes of adopted CSR

The main question is what is the impact of CSR on the company‘s profitability? This question is divided into three sub problems which must be answered throughout this study:

 The economic benefit and cost of CSR

- Economic benefits of CSR

- Economic costs of CSR

 CRS and accounting performance

- How economic benefits are reflected in accounting earnings

- How economic costs are reflected in accounting earnings

- Additional accounting issues and implications

 How CSR can reduce the costs of a company

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

1.3 Structure of study

The thesis will be organized as follows: First, the literature review chapter (chapter 2) will provide a basic understanding of the concept of CSR; the relevant theories describe the relationship between CSR and financial performance as well as empirical studies of CSR and financial performance The relevant theories will be examined in two aspects

of positive and negative relationship In chapter 2, study also includes the theoretical framework which answers three problems of this study: benefits and costs of CSR, how CSR reflects on accounting performance, and how CSR can increase profits (or reduce the costs) of a firm This will provide the framework for the subsequent analysis A methods chapter (chapter 3) will precede the analysis in chapter 4, in which the

relationship between CSR and financial performance of the firm will be presented and analyzed according to the literature review Chapter 4 shall also analysis the outcome of CSR adopted by Vedan and Unilever in Vietnam Study will complete with concluding remarks in chapter 5

Chapter 2: Literature review

The impact of CSR on the financial performance will be found on the relationship between CSR and accounting performance In order to answer this question, it will be divided into three issues: the economic benefit and cost of CSR, the relationship

between CSR and accounting performance, how CSR can reduce the cost or increase profits of a firm This literature review will include three parts of analyzing and

evaluating based on those issues

2.1 Definition of CSR

Since Bowen (1953) defined CSR as a method employed by corporations to pursue policies, decisions, and actions for the social purpose and value, many researchers have defined CSR in a number of different ways Such definitions have typically been based

on two representative theories: agency theory and social contract theory CSR

researchers following agency theory have suggested that corporations are responsible only to stockholders because stockholders authorize the management to operate

corporations (Friedman, 1970; Jensen, 2000) On the other hand, those researchers following social contract theory have suggested that corporations have an implied

contract with society and that this contract necessitates them to be faithful to their roles

to develop the society under the contract (Davis, 1967; Donaldson & Dunfee, 1999) Carroll (1979, 1991) provides a notable definition of CSR: ―corporate social

responsibility involves the conduct of a business so that it is economically profitable, law abiding, ethical and socially supportive.‖ Carroll also developed a CSR pyramid composed of economic, legal, ethical, and philanthropic responsibilities The present study is based on Carroll‘s definition and analysis of CSR

There are various definitions of CSR from many organizations But those definitions also have a common ground McWilliams and Siegel (2001) stated CSR as ―actions that appear to further some social good, beyond the interest of the firm and that which is

required by law.‖ It means that CSR is not only obeying the law According to Business

for Social Responsibility (BSR), CSR is defined as ―achieving commercial success in

ways that honor ethical values and respect people, communities, and the natural

environment.‖ On the other hand, Frooman (1997) represent the definition of CSR should be: ―An action by a firm, which the firm chooses to take, that substantially affects

an identifiable social takeholder‘s welfare.‖

2.1.1 Historical definition of CSR

Although the name CSR appear to be new to the business world, the concept of CSR has taken over a number of decades through out many literatures The fact that the

terminology of CSR has modified over this time, and the meaning attribute to concepts

of CSR will also continue to grow with the development of business, political and social

Because of the rapid influence of globalization and mass communication, the meaning and awareness of CSR will not only reflect local situation, but will be also strongly impacted by global development and changes in international law such as consolidation

of law among countries

continues to be recognized as the ―dominant paradigm‖ in CSR

According to Carroll, in the 1980s, ―the focus on developing new or refined definitions

of CSR gave way to research on CSR and a splintering of writings into alternative concepts and themes such as corporate social responsiveness, CSP, public policy, business ethics, and stakeholder theory/management‖ Carroll also figured out many studies of other authors such as Tuzzolino and Armandi who ―sought to develop a better mechanism for assessing CSR by proposing a need-hierarchy framework patterned after Maslow‘s‖, and Jones who ―posited that CSR ought to be seen not as a set of outcomes but as a process‖ The authors created a conceptual tool which called organizational hierarchy to evaluate socially responsible performance of the firm

One of the most emerged events in the 1980s was the global debate on sustainable development The interdependence of protection and development was stated on The World Conservation Strategy which was published in 1980, this was also the first concept of ―sustainable development‖ The World Commission on Environment and Development (WCED) issued the Brundtland Report in 1987 which was named ―Our Common Future‖ This report showed that ―Sustainable development seeks to meet the needs and aspirations of the present without compromising the ability to meet those of the future‖ This definition of sustainable development is usually used in many studies and literature However, one of the interesting perspectives of CSR debate was not seem

to use that stated in the report: ―Far from requiring the cessation of economic growth, it recognizes that the problems of poverty and underdevelopment cannot be solved unless

we have a new era of growth in which developing countries play a large role and reap large benefits.‖

The report which connected the relationship between sustainable development and economic growth set the way for future discussion on this problem While there were many examples of earlier studies which subjected to solve the problem of CSR and financial profit, Carroll considered the 1980s as the time when ―scholars were becoming interested in the question of whether socially responsible firms were also profitable firms If it could be demonstrated that they were, this would be an added argument in support of the CSR movement‖ The study of Carroll, Aupperle and Hatfield in 1985 which researched the link between CSR and profitability suggested the priorities of four components of CSR earlier found out by Carroll, as ―economic, legal, ethical, and discretionary‖

CSR in the 1990s

In the 1990s, the meaning of CSR was not expanded wider, but according to Carroll the concept of CSR used ―as the base point, building block, or point-of-departure for other related concepts and themes, many of which embraced CSR-thinking and were quite compatible with it CSP, stakeholder-theory, business ethics theory, and corporate citizenship were the major themes that took center stage in the 1990s‖

When Wood repeated the CSP model and ―placed CSR into a broader context than just a stand-alone definition An important emphasis in her model was on outcomes or

performance‖, Wood was made a key part of the literature

The CSP structure created by Wood and the hierarchy of responsibilities created by Carroll which has economic responsibilities at the bottom and charity at the top, are used in many literature such as Windsor (2001) According to Swanson (1995), there were three key types of incentive for CSR:

i The practical perspective (an tool to complete performance objectives);

ii The negative duty approach (force to approve socially responsible initiatives to propitiate stakeholders); and

iii The positive duty approach (business self-motivated in spite of social

pressures)

Beside that, Wood also defined three major types of processes which can be used by a company to apply CSR motivational principles: environmental management, issues management and stakeholder management According to Wood in Maignam and Ralston

―Once implemented throughout the organization, these processes help the firm to keep abreast of and to address successfully, stakeholder demands‖ However, this view of CSR and the relationship with stakeholders may be simple In 1990s, this view was occurring in following years on the debate of the theory of stakeholder According to Nahan in Ryan in 2002 discussed whether ―the first priority of a corporation is to its shareholders‖ or whether policy makers should build up ―a flexible multi stakeholder approach to promoting CSR‖

O‘Rourke also explained the group that called primary stakeholder who is the

shareholders as ―the boundary zone of CSR is currently being negotiated‘ with the firms O‘Rourke stated that: ―A trend also noteworthy in the late 1990s was that of shareholder activists linking their environmental or social issue to financial performance and/or risks faced by the company By claiming that environmental and social issues have a direct effect on shareholder value, shareholder activists are moving the rhetoric of their

activism out of the realm of ―ethics‖ or good versus bad behavior, and into that of

traditional issues of profitability, risk and shareholder value‖

The establishment of group BHP Shareholders for Social Responsibility in 1994 which

is the result of shareholder worry about environmental damage made by the firm in Papua New Guinea is a special example of shareholder activism This group takes care about environmental, social and economic issues Beside that, this group has also

actively connected BHP Billiton management about its focuses There are some similar supported groups for shareholders of Boral Green, PaperlinX, Gunns which have been established in Australia In 1990s, the CSR continued to influence in global as the

function of business while the influences of government continued to haze In 1997, Solomon wrote in Joyner and Payne that ―now that businesses are often the most

powerful institutions in the world, the expanse of social responsibility has enlarged to include areas formerly considered the domain of governments…The more powerful business becomes in the world, the more responsibility for the well-being of the world it will be expected to bear‖

In 1999, Carroll defined a new millennium approached which stated that ―the CSR concept will remain as an essential part of the business language and practice, because it

is a vital underpinning to many of the other theories and is continually consistent with what the public expects of the business community today‖

st Century? Many writers continued the discussions about the position of CSR in the global economy, for example Sherer ans Smid who talk about Solomon‘s view that multinational companies ―should take responsibility for the

improvement of world-wide social and environmental conditions‖ By examining

examples of Western oil production plans which have operated in some country where war is happening, and poor countries of African where the human rights abuse and corruption is very seriously According to James Buckee – COE of one of these

organizations said that ―it is socially responsible for a corporation to invest in certain places that some elements of popular opinion find objectionable‖ This idea exemplifies exactly the conclusion of Windsor that ―There are fundamental differences of opinions and values in the global economy‖ The argument of Oketch is that ―there is need to ensure that the global market operates according to a certain set of rules and institutions that a majority of people see as being legitimate‖ increase more problems than it

answers

Follow with the fast moving of global business, many recent literatures are being moved away from debates in US to other countries in over the world There are many authors as Maignan and Ralston stated ―CSR in France, the Netherlands and the UK‖, Aaronson in

UK in 2003, Lucas in Australia, Perroni in Italia have expanded the discussion to across border Moreover, they also compared the differences of perspective in different

countries and the function of business in society In March 2000, the new appointment

of a United Kingdom Minster for CSR has strong influenced on the movement of CSR‘s debate Beside that, the establishment of the United Nations Global Compact, Promoting

a European Framework for Corporate Social Responsibility and the European

Commission‘s Green Paper which concern about human right, the environment, society

and labor also have impact on this movement Many literatures in which the relationship between government and CSR in has been investigated also reflected those

developments

2.2 Relevant theory on relationship between CSR and financial

performance

There are many studies figure out the relationship between CSR and financial

performance of the firm that are based on a number of theories relevant to this issue Those theories are divided into three aspects: theories suggest the positive relationship, the other describe this relationship as a negative impact, and beside that some theory state a neutral relationship between CSR and financial performance But this study only focuses on theories which describe the positive and the negative relationship

2.2.1 Relevant theory suggest the positive relationship

- Stakeholder theory: After publication of A Stakeholder Approach (1984) of Edward

Freeman‘s Strategic Management, stakeholder management, stakeholder theory, and other variation of stakeholder study have taken a big deal of management research Freeman said that business relationships should comprise all people who can ―affect or

be affected by‖ a firm Many studies in stakeholder theory have required analytically dealing with the problem of which stakeholders merit or requiring management concern such as study of Wood Methods to solve this problem have focused on relationships between firms and stakeholders based on trade transactions, authority dependencies, legitimacy claims, or other claims Researchers have attempted to mix stakeholder theory with other management perspectives, mostly theories of governance and agency Stakeholder theory is helpful as both an instrumental and normative frame Normative stakeholder arguments have emerged declaring firms have a moral obligation to uphold the interests of all corporate stakeholders (Wicks, Gilbert, and Freeman, 1994; Evans and Freeman, 1983) According to Donaldson and Preston, Instrumental stakeholder theory recommends managers ―must induce constructive contributions from their

stakeholders‖ to attain goals of company efficiently If a cross point between normative and instrumental stakeholder theory retains CSR is not stand on moral values or not actual, it will not effect on financial performance gains (Jones, 1995; Frank 1988)

- Competitive advantage theory Harrison, Bosse and Phillips (2007) develop on the

definition of competitive advantage representing that companies must perform more than build a competitive advantage which is attractive to customers In order to build a right competitive advantage, Harrison state that: ―Competitive advantage implies more than merely creating value Rather, the key is to create more value than competitors are able to create A firm is said to have a competitive advantage if it creates and

appropriates more value than the least efficient rival capable of breaking even Simply extending the prior logic, this occurs when the firm drives a wedge between the

willingness to pay it generates among buyers and the costs it incurs and then collects returns in excess of its own opportunity costs‖ Socially complex resources or

capabilities that are not easily copied are necessary to retain a company‘s competitive

advantage CSR helps firms develop internal resources making a firm more prepared and able to adapt to the fast moving of demands and crises CSR also expands external

reputation benefits, increasing its attractiveness to customers and potential employees, investors and bankers

2.2.1 Relevant theory suggest the negative relationship

-Trade-off theory assumes a negative relationship between CSR and financial

performance Stand on Friedman (1970), this theory analysis investment as trade offs between stakeholders leading toward to tradeoffs between profit maximization and socially responsive purposes Therefore, corporate social performance (CSP) might lower than financial performance of the firms because CSR funds use the resources that could be used in a more profit-maximizing way

- Managerial Opportunism Theory Managers may avoid CSR investment that would

improve firm value because of recompense packages linked with short-term company revenue and stock price behavior Alternatively, managers may engage in CSR

initiatives or show preference towards certain initiatives to maximize their personal

reputation or utility

2.3 Experiential studies of CSR and financial performance

According to Margolis and Walsh (2002), there are one hundred twenty-two published researches from 1971 to 2001 empirically investigated the relationship between

corporate social responsibility and financial performance Narver is a person who

publish the first his study in 1971

The first type is using the event study methodology to analysis the short run financial impact (abnormal returns) in the whether of the firm carry on either socially responsible

or irresponsible action The outcomes of these studies have been combined Welch and Wazzan (1999) discovered that there is no relationship between CSR and financial performance, while Wright and Ferris (1997) found a negative relationship; Posnikoff (1997) stated a positive relationship Studies of McWilliams and Siegel (1997) are in the same way of inconsistent concerning the relationship between CSR and short run

financial impact

The second type is the examining of the relation between measurement of corporate

social performance (CSP) and measurement of long term financial performance This

type uses financial measures or accounting of profitability to study the relation ship between social responsibility and accounting based performance The results are also mixed up Waddock and Graves (1997) found a major positive relationship between an index of CSP and performance measures, example is ROA in the following year Beside that, after managing the time of assets, Cochran and Wood (1984) suggested a positive correlation between social responsibility and accounting performance While Aupperle, Carroll, and Hatfield (1985) detected no major relation between CSP and a firm‘s risk adjusted return on assets In the other hand, studies which use measures of return on the stock market also give various results Vance (1975) refutes Moskowitz‘s research by expanding the time period for examine from 6 months to 3 years, thus results are differ with Moskowitz and show a negative CSP/CFP relationship But Alexander and

Buchholz (1978) improved on Vance‘s examination by assess stock market performance

of an equal group of stocks on a risk adjusted basis, yielding an uncertain result

The effects of CSR on financial performance are continued to be concerned in the literature Windsor lines the resulting of Verschoor, that ―among the 500 largest US public corporations, the 26.8% committing in annual reports to ethical behavior toward stakeholders or compliance with corporate code of conduct have higher financial

performance measures than other firms that do not‖ However, this result dose not permit for the real that companies as Enron can take on charity while being guilty of

moral misconduct and the result also is very narrow measurement of CSR Windsor also stated that ―The Enron collapse is a reminder that such deviation between responsibility and wealth is never far away in the increasingly competitive landscape of global

business operations‖ Windsor thinks that there has ―A marked tendency in the relevant literature…to examine alternatives – such as citizenship or stakeholder management – precisely because of the difficulties inherent in the responsibility construct‖

In a study of Orlitzky, he shows a positive correlation which CSP really decreases financial risk between corporate social performance (CSP) and corporate financial performance in which organizations may gain benefits financially from social activities Hopkins show in an argument about the business case for CSR that an in benefit-cost analysis of CSR by the Cooperative Bank of the UK ―declared that between 15 and 18%

of its pre-tax profits could be directly attributed to its ethical stance‖, while it is difficult

to prove a fundamental link between CSR activities and financial indicators (Hopkins 2003) Beside that, Hopkins also has well known about the study of the top UK

companies, analyzing the correlation between their CSR and their stock market

performance Hopkins stated that ―the public‘s purchasing of shares was still not greatly affected by the companies‘ level of social responsibility [but]…that CSR standing does not necessarily badly affect a company‘s share price‖ Certainly, share market price is only one of various measure of profitability, and the problem of Hopkin‘s study supports his argument that, ―Definition, measurement and data problems exist for assessing both social responsibility and financial performance‖

In other study of McWilliams and Siegel about corporate financial investment in CSR which is stated that ―there is some level of CSR that will maximize profits while

satisfying the demand for CSR from multiple stakeholders The ideal level of CSR can

be determined by cost-benefit analyses.‖

In the other term of investment in CSR which uses financial implications, Brammer and Pavelin defined as ―insurance-motivated social investment‖, a risk-management strategy focus on decreasing reputation or firm‘s image and financial losses which are caused by negative stakeholder response to negative events Brammer and Pavelin showed that

―Social investment, by establishing a positive reputation in the eyes of stakeholder

groups, helps to mitigate the impact of those negative events by reducing the likelihood that stakeholders attribute blame to the company concerned‖

2.4 Relevant literature about benefit and cost of CSR

2.4.1 Economic benefits of CSR

Based on prior research, there are three major economic benefits to firms engaging in CSR Firstly, firms avoid or mitigate impacts to financial performance arising from negative events and externalities Environmental economic theory, organizational

legitimacy, political cost theory, and stakeholder management theory all predict CSR reduces negative effects to economic earnings when corporate goals and

social/environmental goals are not aligned Williams and Barrett (2000) find that while a firm‘s reputation is diminished by Occupational Safety and Health Administration (OSHA) and EPA violations, the extent of the decline is reduced by charitable giving In studies involving the Bhopal disaster (Blacconiere and Patten, 1994) and the 3-Mile Island accident (Bowen, Castanias, and Daley, 1983), there is evidence consistent with a mitigated negative impact to financial performance for firms that would be considered more socially responsible, relative to industry peers that would be considered less

socially responsible

Secondly, firms create goodwill and other intangible assets, favorably impacting

financial performance As early as 1966, Johnson links corporate giving with

competitiveness in the industry including arguments on when differentiation is

worthwhile Such theory grounds some management and marketing literature arguing firms use CSR to attract customers that want to buy products from socially responsible corporations Marketing statistics support such an argument5 as does analytical research (Lutz et al., 1998; Arora and Gangopadhyay, 1995) Fombrun and Shanley (1990), Neheilson (1994), Brammer and Millington (2005) provide arguments and evidence linking corporate giving, reputational benefits (goodwill), and financial performance Each paper maintains these benefits provide a way of differentiating the firm from its industry peers

Finally, firms gain efficiencies, reducing costs and improving financial performance Smart (1992), Porter and Van der Linde (1995), Boyd (1998) and Heal (2005) provide case study and anecdotal evidence showing costs savings for more socially responsible