The effect of corporate social responsibility on the branding of financial services

In today's global world, corporate social responsibility (CSR) is increasing public demand for greater transparency from multinational companies. CSR is a new and growing financial risk factor. If it is mismanaged, a firm's corporate reputation can be badly damaged and a direct negative impact on its business and bottom-line may result. Instead of simply campaigning directly against industrial groups and lobbying governments and international organisations to issue new legislation, non-governmental organisations (NGOs) are increasingly putting pressure on the financial services groups and insurance companies. This new global tactic may affect a bank's relationship with its clients and shareholders.There are market benefits and competitive advantages for those companies whose business policies integrate CSR. The growth in socially responsible investments and in CSR awareness among City people persuades some bankers that the most successful firms of the future will be those who proactively balance short-term financial goals with long-term sustainable franchise building. To respond to this challenge, corporations will have to convince citizens they can trust both their brands and the people behind them. In this context, one must recognise that finance brands have been clumsily managed. Nowadays, several big consumer brands are used as societal role models, but they are also the targets of anti-globalisation and anti-logo activists. In order to avoid such an outcome — not to mention corporate mortification — the key social marketing strategy must be to communicate proactively the business activity's raison d'être to opinion leaders and the general public. In general, industry does not yet care enough and many companies are reacting only when put under pressure by public opinion. It is time, however, to market the social raison d'être of a business and indeed to contest its current exclusion from ‘civil society’. Consumer and service sectors lead the field. In view of the downturn of the global economy, more than ever before, CSR branding is of paramount importance to the financial sector if bankers do not want to become the easy scapegoats. It is necessary to make it clear that financial services companies are global citizens too.     

The Corporate Social Responsibility (CSR) Trend

Corporate Social Responsibility, or “CSR,” has recently become a subject of study by financial economists. While there is no shortage of anecdotal evidence to support all variety of positions, broad‐based statistical evidence about the CSR movement is in short supply. This article presents some new empirical evidence that aims to answer three related questions about CSR: First, are corporations increasing their “investment” in what is considered socially responsible behavior? Second, does corporate investment in social responsibility affect a company's financial performance and shareholder value? Third, why do companies invest in CSR: to increase shareholder value, or to uphold a “moral” commitment to non‐investor stakeholders and “society”? Using a social responsibility metric that measures the net CSR strengths (i.e., strengths less concerns) of each S&P 500 and Domini 400 company, the authors report that the average net CSR for both indexes decreased during the 15‐year period (1991‐2005) of the study—though the Domini 400, as might be expected, experienced a smaller decline. The authors also report that corporate strengths have increased, on average, but at a slower rate than the “concerns,” which suggests that corporate CSR efforts may be aimed at a moving target with steadily rising expectations and requirements. Second, the authors report that companies with more CSR strengths or fewer CSR weaknesses produced higher ROA over the same 15‐year period. The authors' findings here suggest a “circular” causality in which profitable companies are more likely to invest in CSR initiatives to begin with, but then find their performance further improved by such investment. Third, the authors' findings suggest that most companies devote resources to CSR initiatives as a means of maximizing long‐run value rather than out of a prior commitment to stakeholders. More specifically, the study shows that companies appear to invest more heavily to build CSR strengths than to eliminate CSR concerns. And as the authors conclude, this behavior is consistent with a strategy of using CSR as a form of “risk management” that promotes corporate strengths in order to limit the potential negative effects of—perhaps by diverting attention from—their weaknesses.     

Corporate social responsibility versus corporate shareholder responsibility: A family firm perspective

Recent literature suggests that some socially responsible corporate actions benefit shareholders while others do not. We study differences in policy toward corporate social responsibility (CSR) between family and non-family firms, using environmental performance as the proxy for CSR. We show that family firms are more responsible to shareholders than non-family firms in making environmental investments. When shareholder interests and societal interests coincide, i.e., when it comes to alleviating environmental concerns that have potential to harm society and elevate the firm's risk exposure, family firms do at least as well as non-family firms in protecting shareholder interests. However, when shareholder and societal interests diverge, i.e., when it comes to making environmental investments that might benefit society but do not benefit shareholders, family firms protect shareholder interests by undertaking a significantly lower level of such investments than non-family firms. Our findings suggest that lack of diversification by controlling families creates strong incentives for them to act in the financial interest of all shareholders, which more than overcomes any noneconomic benefits families may derive from engaging in social causes that do not benefit non-controlling shareholders.     

Social Capital,Trust, and Corporate Performance: How CSR Helped Companies During the Financial Crisis (and Why It Can Keep Helping Them)

The authors summarize the findings of their study, published recently in the Journal of Finance, that shows that CSR investments can help companies when they perhaps need it most—that is, during sharp downturns when overall trust in companies and markets declines. Companies with high‐CSR rankings experienced stock returns that were five to seven percentage points higher than their low‐CSR counterparts during the 2008–2009 financial crisis, and even larger excess returns during the Enron crisis of 2001–2003. High‐CSR companies during the crisis also reported better operating performance, higher growth, higher employee productivity, and greater access to debt markets—while continuing to generate higher shareholder returns as late as the end of 2013. Many of these operating improvements continued well into the post‐crisis period, though at more modest levels. As the authors view their findings, the ‘social capital’ built up by corporate CSR programs complements effective financial capital management in increasing shareholder wealth mainly by limiting companies' downside risk. CSR is seen as not only reducing systematic as well as firm‐specific risk, but as also providing protection against overall ‘loss of trust.’ The social capital created by CSR programs is said to provide a kind of insurance policy that pays off when investors and the overall economy face a severe crisis of confidence.     

Value‐Added Per Share (VAPS): A Value‐Relevant Corporate Performance Metric

The authors introduce Value Added Per Share (VAPS) as a value‐relevant metric that is intended to complement earnings per share (EPS) in helping corporate managers and analysts understand and overcome the limitations of GAAP‐based reporting. VAPS discounts a firm's past and projected cash flows at its “cost of capital,” allowing companies to avoid the subjective accounting accrual process and other practices that often make EPS misleading. A company's VAPS is calculated in three main steps: (1) estimate the change in the capitalized value of after‐tax operating cash flow by taking the net change (plus or minus) of the firm's operating cash flow after taxes and dividing that number by the firm's cost of capital; (2) subtract total investment expenditures; and (3) divide by the number of shares outstanding. By capitalizing the change in after‐tax operating cash flow, one finds the net change in a firm's current operations value. By subtracting investment expenditures from that change in current operations value, the analyst gets a clearer picture of the benefit to shareholders net of the funds used to create that benefit. Consistent with basic theory, VAPS is positive when a company earns a return at least equal to its cost of capital and negative otherwise. Because of their fundamental differences, EPS and VAPS are likely to send different signals, and VAPS is expected to provide greater insight into stock price changes. The authors provide the findings of statistical tests showing the superior explanatory power of VAPS and recommend that companies publish statements of VAPS along with standard GAAP results, especially since the former can be readily calculated using the available income statement, balance sheet, and cash flow statement data.     

RISK MANAGEMENT FOR MIDDLE MARKET COMPANIES

This article reinforces the message of the one immediately preceding by showing that small to medium‐sized firms have even stronger (non‐tax) motives for hedging risks than their large corporate counterparts. Although middle market companies have traditionally been viewed as less sophisticated than their larger corporate counterparts in the risk management arena, the authors suggest that such companies have become increasingly receptive to new hedging strategies using derivative products. When used appropriately, such products allow companies to stabilize their periodic operating cash flow by eliminating specific sources of volatility such as fluctuations in interest rates, exchange rates, and commodity prices. Smaller companies recognize that a single swing in a budgeted cost can have a catastrophic effect on an entire budget, whereas a larger company can more easily absorb such a cost. Moreover, because the principal owners of mid‐sized firms often have a substantial part of their net worth tied up in the business, they are likely to have a far stronger interest than typical outside shareholders in using risk management to reduce the volatility of corporate profits and firm value. Perhaps most important to owners whose firms rely on debt financing, the greater cash flow stability resulting from active risk management significantly reduces the possibility of financial distress or bankruptcy. In this article, three representatives of Bank of America's risk management practice discuss three different exposures faced by middle market companies—those arising from changes in interest rates, foreign exchange rates, and commodity prices—and show how these risks can be managed with derivatives. Besides shielding companies from financial trouble, risk management is also likely to improve their access to the money and capital markets. By protecting the firm's access to capital, risk management increases the odds that the firm will not be forced to pass up good investment opportunities because of capital constraints or fear of getting into financial difficulty.     

On the Foundations of Corporate Social Responsibility

Using corporate social responsibility (CSR) ratings for 23,000 companies from 114 countries, we find that a firm's CSR rating and its country's legal origin are strongly correlated. Legal origin is a stronger explanation than “doing good by doing well” factors or firm and country characteristics (ownership concentration, political institutions, and globalization): firms from common law countries have lower CSR than companies from civil law countries, with Scandinavian civil law firms having the highest CSR ratings. Evidence from quasi‐natural experiments such as scandals and natural disasters suggests that civil law firms are more responsive to CSR shocks than common law firms.     

Corporate social responsibility and stock split

This study examines whether socially responsible companies are likely to conduct a stock split. We argue that these companies, compared to their counterparts, could use their strong corporate social responsibility (CSR) performance to reduce information asymmetry with shareholders, and therefore, are less likely to rely on stock splits to signal their future growth potentials. We find empirical evidence to support our hypothesis and investigate the reasons for the lower frequency of stock splits among CSR oriented firms. We find that more socially responsible firms experience a smaller increase in trading volume and a greater increase in bid-ask spread following a stock split than less socially responsible firms. Furthermore, our study finds that, when more socially responsible firms decide to conduct a stock split, they attract a greater proportion of institutional investors with long-term investment horizons.

     

UNIVERSITY OF GEORGIA ROUNDTABLE ON ENTERPRISE-WIDE RISK MANAGEMENT

For many years, MBA. students were taught that there was no good reason for a company that hedged a large currency exposure to trade at a higher P/E than an otherwise identical company that chose not to hedge. Corporate stockholders, simply by holding well‐diversified portfolios, were said to neutralize any effects of interest rate and currency risk on corporate values. And thus corporate efforts to manage risk were thought to be “redundant,” a waste of corporate resources on a function that was already accomplished by investors at far lower cost. But the theory underlying this “perfect markets” framework has changed in recent years to focus on ways that corporate risk management can add value. The academics and practitioners who participated in this roundtable began by discussing in general terms how risk management can be used to support a company's strategic plan and investment policy. At Merck, for example, where R&D spending was determined as a percentage of earnings, a policy of hedging foreign currency exposure to reduce earnings volatility was viewed as adding value by “protecting” the firm's R&D. The panelists also agreed that a well executed risk management policy can increase corporate debt capacity and, in so doing, reduce the cost of capital by lowering the likelihood of financial distress. For example, companies with debt covenants might undertake a risk management program to lower earnings volatility and ensure a minimum level of earnings for debt compliance purposes. But one of the clear messages of the roundtable is that risk management and earnings management are not the same thing, and that companies that view risk management as primarily a tool for smoothing reported earnings have lost sight of its real economic functions. Moreover, in making decisions to retain or transfer risks, companies should generally be guided by the principle of comparative advantage. That is, if there is an outside firm or investor willing to bear a particular risk at a lower price than the cost to the firm of managing that risk internally, then it makes sense to lay off that risk. In addition to the cost savings and higher return on capital promised by such an approach, a number of the panelists also pointed to a less tangible benefit of an enterprise‐wide risk management program—namely, a marked improvement of the internal corporate dialogue, leading to a better understanding of all the firm's risks and how they are affected by the interactions among the firm's business units.     

Cultural diversity among directors and corporate social responsibility

We examine the relationship between board diversity and a firm's corporate social responsibility (CSR) performance in a novel way. The relation between visible forms of board diversity (gender, ethnic, age diversity) and CSR may arise endogenously due to visible diversity management. In contrast, we focus on cultural diversity (based on directors' ancestry), which is less visible. We demonstrate that cultural diversity, unlike visible diversity, is not considered in director replacements, consistent with cultural diversity not being affected by firms signaling their CSR commitment by ‘looking’ diverse. We show that board cultural diversity is positively related to CSR performance. This result holds when we control for visible board diversity, directors' foreignness and diversity in nationalities, and endogeneity. We also show that CSR performance decreases when a firm increases its visible board diversity at the cost of cultural diversity.     

The Value Relevance of Corporate Social Responsibility Expenditure: Evidence from Regulatory Decisions

We examine the value relevance of the corporate social responsibility (CSR) expenditure of Bangladeshi banks from 2007–2014 in response to a regulatory directive on banking firms’ engagement in CSR activities. We find a positive association between CSR expenditure and a firm's market value. Evidence of an inverse U-shaped curvilinear association between CSR expenditure and market value suggests that the impact of CSR expenditure on a firm's market value has a certain limit. We also document that unexpected or abnormal components of CSR expenditure comprise value-relevant information. Our study provides empirical evidence to support the value relevance of CSR expenditure as an explanation for why firms should invest in CSR and why they should inform various stakeholders about their CSR activities.     

Analysing Perceived Downside Risk: the Component Value‐at‐Risk Framework

Multinational companies face increasing risks arising from external risk factors, e.g. exchange rates, interest rates and commodity prices, which they have learned to hedge using derivatives. However, despite increasing disclosure requirements, a firm's net risk profile may not be transparent to shareholders. We develop the ‘Component Value‐at‐Risk (VaR)’ framework for companies to identify the multi‐dimensional downside risk profile as perceived by shareholders. This framework allows for decomposing downside risk into components that are attributable to each of the underlying risk factors. The firm can compare this perceived VaR, including its composition and dynamics, to an internal VaR based on net exposures as it is known to the company. Any differences may lead to surprises at times of earnings announcements and thus constitute a litigation threat to the firm. It may reduce this information asymmetry through targeted communication efforts.     

Risk and Regulation in Derivatives (or Why Derivatives Are a Blessing,Not a Curse)

In this article, first published in 1994, the authors aimed to defuse the widespread hysteria about derivatives fueled by media accounts (like Fortune magazine's cover story in the same year) by offering a systematic analysis of the risks to companies, investors, and the entire financial system associated with the operation of the relatively new derivatives markets. Such analysis ended up providing assurances like the following:

• As long as most companies are using derivatives mainly to limit their financial exposures and not to enlarge them in efforts to pad their operating profits, reported losses on derivatives should not be a matter for concern. “Complaining about losses on a swap used to hedge a firm's exposure,” as the authors note, “is like objecting to the costs of a fire insurance policy if the building doesn't burn down.”
• To the extent that companies are using derivatives to hedge—and what evidence we have suggests that most are—the default risk of derivatives has been greatly exaggerated. An interest rate swap used by a B‐rated company to hedge a large exposure to interest rates will generally have significantly less default risk than a AAA‐rated corporate bond issue.
• Thanks to the corporate use of derivatives, much of the impact of economic shocks such as spikes in interest rates or oil prices is being transferred away from the hedging companies to investors and other companies better able to absorb them. And in this fashion, defaults in the economy as a whole, and hence systemic risk, are effectively being reduced, not increased, through the operation of the derivatives markets.

Moreover, the authors warn in closing that the likely effect of then proposed derivatives regulation would be to restrict access to and increase the costs to companies of using derivatives markets. As one example, the excessive capital requirements associated with derivatives facing bank dealers—based on gross rather than net measures of exposure—and which regulators have since proposed extending to nonbank dealers—were expected to have the unintended effect of encouraging dealers to sell precisely the kinds of riskier, leveraged derivatives that Bankers Trust sold Procter & Gamble, and that functioned as Exhibit A in the Fortune article.     

“I Do”: Does Marital Status Affect How Much CEOs “Do”?

This paper explores whether a CEO's marital status reveals unobservable risk preferences which influence their firm's investment and compensation policies. Using biographical data for CEOs of large domestic companies, we find that corporate deal‐making activity (e.g., mergers, joint ventures, major capital expenditures, etc.) and overall firm riskiness both increase significantly with personal life restructuring (e.g., marriages and divorces). This relation is supported by an instrumental variables analysis and also an investigation surrounding CEO turnover. Finally, the link between a CEO's marital status and preference for option‐based compensation further suggests that personal restructuring may be an indicator of executive risk appetites.     

Do religiosity and political beliefs affect female representation and firm performance?

We investigate the effect of the community values surrounding a firm's headquarters on the percentage of women on a firm's board of directors. We use religiosity and political affiliation measures to capture the values associated with the community norms. We find that firms headquartered in counties with lower religiosity and a lower percentage of Republican voters are more likely to have a greater number of female board members. Furthermore, firms with more female directors located in more Republican areas or more religious cities are more likely to have lower valuations, as measured by Tobin's Q. These results have implications for corporate culture and the supply of female directors.     

How do independent directors view corporate social responsibility (CSR)? Evidence from a quasi-natural experiment

We investigate how independent directors view corporate social responsibility (CSR). Exploiting the passage of the Sarbanes-Oxley (SOX) Act and the associated exchange listing requirements as an exogenous regulatory shock, we document that independent directors view CSR activities unfavorably. In particular, firms forced to raise board independence reduce CSR engagement significantly relative to those not required to increase board independence. Our results are consistent with the risk-mitigation view and the agency cost hypothesis where managers over-invest in CSR to mitigate their own exposure to nonsystematic risk. The over-investments in CSR are curbed in the presence of a stronger, more independent, board of directors. Several robustness checks confirm the results, including fixed-effects and random-effects regressions, dynamic panel data analysis, instrumental-variable analysis, propensity score matching, Lewbel's heteroscedastic identification, and Oster's method for coefficient stability. We also confirm the risk-mitigation hypothesis by showing that CSR activities reduce firm risk significantly. Our research design is much less vulnerable to endogeneity and is therefore likely to show a causal effect of board independence on CSR.     

Firms and social responsibility: A review of ESG and CSR research in corporate finance

We review the financial economics-based research on Environmental, Social, and Governance (ESG) and Corporate Social Responsibility (CSR) with an emphasis on corporate finance. In doing so we focus on the most debated and researched issues. Although a firm's ESG/CSR profile and activities are shown to be strongly related to the firm's market, leadership and owner characteristics as well its risk, performance and value, there still exist conflicting hypotheses and results that we show are not resolved, leading to continued questions and a need for more research.     

Corporate Insurance Strategy: The Case of British Petroleum

The authors provide a fundamental rethinking of how corporations should evaluate various kinds of risks and risk management solutions—a rethinking that leads to a major shift in British Petroleum's approach to insuring property and casualty losses, product liability suits, and other insurable events. Conventional corporate practice—and until the early 1990s (when this article was written) the longstanding policy of BP and most large oil companies—was to insure against large losses while self‐insuring against smaller ones. In this article, the authors explain why BP has chosen to go against the conventional wisdom and instead buy insurance for mainly smaller losses while self‐insuring larger ones. The BP decision came down to factors affecting the market supply of insurance as well as the corporate demand for it. On the demand side, the authors demonstrate that the primary source of demand for insurance by large public companies is not, as standard insurance textbooks assume, to transfer risk away from the corporation's owners. Because corporate stockholders and bondholders effectively manage the effects of such risks by diversifying their own portfolios, the corporate demand for insurance in BP's case stems from the insurers' comparative advantage in evaluating and monitoring BP's smaller risks and in processing claims. On the supply side, the authors explain why the capacity of insurance companies and markets to underwrite very large or highly specialized exposures—when compared to the industry expertise and financial resources of companies like BP—is quite limited, and likely to remain so. Since premiums would be experience‐rated and prior years' losses simply rolled into the following years' premiums, there would be no effective transfer of risk, and so no gain to BP from buying insurance.     

ESG as a Value‐Creation Tool for Active Investors: A Profile of Inherent Group

A growing number of investment managers claim to integrate environmental, social, and governance considerations into their investment strategy and processes, but few have described how they do so in depth. Even fewer reinforce the importance of sustainability within their own firms by becoming a certified ‘B Corporation.’ This article offers a rare, inside look at how one such value‐oriented manager uses ESG as a tool for differentiated investment sourcing, underwriting, and corporate engagement with the aim of achieving superior risk‐adjusted returns. One of the main arguments of the article—and a key principle of the firm's investment approach—is that ESG, as applied to both corporate strategy and operations, is an important factor in determining a company's cost of capital. The authors present specific examples of their investment process at work, highlighting how active engagement with management on ESG issues can catalyze progress that becomes valued by the capital markets.     

Do shareholder views affect corporate political activities?

In this paper, we study shareholder views on corporate political contributions. We find that, with shareholders' explicit approval, firms are more likely to have higher corporate political contribution, measured by the amount of donations to the US political parties in the next election cycle. Firm's political contributions also have a positive long-run impact on firm valuations. When analysing firm's political ideology, we find weak evidence that Democratic party may benefit more from this shareholder's support than Republican party, particularly in case of firms which have recently switched their political ideology to Democratic party. Our results show that shareholders' explicit approval has an impact on firm's engagement of political activities and imply that if the shareholders stand at the same side of the firms, firms engage more in politically-related corporate activities. Our key results are supported in a regression discontinuity design and are robust to two-way clustered standard errors.