CSP - Jayachandran

8/9/2019 CSP - Jayachandran

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Corporate Social Responsibility: The Differential Impact of Product

and Environmental Actions on Firm Performance

Satish Jayachandran

Kartik Kalaignanam

Meike Eilert

Department of MarketingMoore School of Business

University of South CarolinaColumbia, SC 29208

(Early Draft of the Working Paper. Please do not Cite without Permission)

January 2010


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Corporate Social Responsibility: The Differential Impact of Product and

Environmental Actions on Firm Performance

Abstract

Corporate social responsibility (CSR) is the expectation that firms should help social causes andact conscientiously to prevent, limit, or balance the negative externalities from their businessoperations. Prior research suggests that CSR has a small positive effect on firm performance,though a vast majority of studies show no effect for this relationship. The authors suggest, basedon instrumental stakeholder theory, that because CSR activities pertain to several domains product, environment, employee, community, human rights and corporate governance adisaggregated examination of its influence on firm performance is required to clarify the natureof the relationship. Therefore, they examine the impact of CSR actions on firm performance intwo domains that are relevant to marketing managers the product and the environment. Productsocial performance refers to product-related actions of a firm that are socially responsible.Environmental social performance, correspondingly, assesses socially responsible organizational

actions in the environmental realm. The impact of product social performance andenvironmental social performance on firm performance is estimated using a dataset of S&P 500and Domini 400 Social Index firms. Product social performance has a stronger impact on firmvalue than environmental social performance. Environmental social performance, however,reduces the systematic risk of the firm. The findings also indicate that while proactiveenvironmental actions do not enhance firm value, poor environmental social performancereduces firm value and raises the systematic risk of the firm. The results demonstrate 1) thecomplex nature of the CSR-firm performance relationship and 2) that a disaggregated assessmentof the relationship provides valuable insights that might not be evident otherwise.


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Corporate Social Responsibility: The Differential Impact of Product and

Environmental Actions on Firm Performance

Corporate social responsibility (CSR) is the expectation that firms should help social causes and

act conscientiously to prevent, limit, or balance the negative externalities from their business

operations. Corporate social performance (CSP) is an assessment of the extent to which firms

meet their CSR obligations (Lankoski 2009). Over the last couple of decades, CSR has become

an issue of substantial importance to firms. Corporate boardrooms, consultants, and NGOs have

all been keenly interested in understanding the relevance of CSR for firms. Correspondingly,

CSR has also emerged as an important topic of academic research. Scholars have examined, for

instance, the factors that motivate CSR and the relationship between CSP and firm performance

(see Margolies, Elfenbein, and Walsh 2007; Luo and Bhattacharya 2009).

The focus of this paper is on the CSP-firm performance relationship. This topic is

particularly fascinating because of the deep philosophical divide between academic perspectives

on whether firms should undertake CSR activities. The traditional viewpoint is that the only

purpose of firms is to maximize shareholder value. Therefore, actions that utilize firm resources

to undertake socially responsible activities are wasteful and indicate agency problems. However,

more recent perspectives advocate that firms should pursue CSR activities as they enhance

financial performance and reduce risk (Sen, Bhattacharya, and Korshun 2006; Margolies,

Elfenbein, and Walsh 2007; Luo and Bhattacharya 2009; Godfrey, Merrill, and Hansen 2009).

This view is also represented in the sentiment expressed in the following quote from a Coca Cola

executive: In the long run, a business cannot succeed if the communities are failing. Investment

in sustainability projects should be seen as an investment in the future of the business and not

just as a means to ensure business continuity (Singh 2010, p.4). In short, the fundamental

debate about the relevance of CSR hinges on the argument whether CSP augments firm


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performance or is an unauthorized redistribution of profits. If CSP does improve firm

performance, spending on it falls in the category of essential expenditures such as those on R&D

and advertising. If CSP does not enhance firm performance, then its relevance for firms is more

tenuous (Lev, Petrovits, and Radhakrishnan 2009).

There has been a substantial amount of research in the CSP-firm performance area,

summarized in a recent meta-analysis (Margolies, Elfenbein, and Walsh 2007). The overall

findings regarding the CSP-firm performance relationship is somewhat mixed. The meta-

analysis demonstrates that the average effect size for the relationship between CSP and

performance is small and positive (r = 0.132). However, the vast majority of studies show no

relationship between CSP and firm performance. In fact, 58% of the studies coded in Margolies

et al. (2007) did not show a significant relationship between CSP and firm performance while

only 27% showed a positive relationship. From the perspective of managers and academics, the

vast number of studies that show no relationship between CSP and firm performance is a matter

of concern and warrants attention.

One reason for the large number of studies that show no relationship between CSP and

firm performance could be the use of aggregate measures of CSP. CSR activities are of many

different types to satisfy the needs of various stakeholders. Stakeholders are groups or

individuals who are affected or can influence the realization of a firms objectives (Freeman

1984). Stakeholders have been classified into regulatory stakeholders, organizational

stakeholders, community stakeholders, and the media (Henriques and Sadorsky 1999). The

stakeholder approach highlights the fact that different stakeholders may react in varying fashion

to CSR initiatives in different domains, and some of these responses may benefit firms while

others may not. If CSR actions pertaining to different areas have varying impact on


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performance, omnibus measures of CSP, while providing valuable insights, limit the ability of

managers to understand which CSR-related activities are useful and which are to be avoided

(Margolies et al. 2007).

Furthermore, it is unclear whether positive and negative actions on the CSR front have

diametrically opposite effects on firm performance. There are reasons to expect such

asymmetric relationship with performance for at least some dimensions of CSP. For instance,

some stakeholders may not expect, or even desire, proactive actions by firms on the

environmental front. However, the same stakeholders may consider actions of the the firm that

cause damage to the physical environment to be a serious problem. Overall, some stakeholders

may merely expect a reduction in negative externalities and not an enhancement of positive

externalities as far as CSP is concerned. Therefore, the relationship between the strength and

weakness on a particular CSP dimension and firm performance should be examined individually.

For these reasons, the fundamental premise of this study is that we need to adopt a

disaggregated approach of CSP to understand how it influences firm performance. Thus, we

study the relationship between CSP and firm performance in two areas that are germane to

marketing managers the product and the environment. We assess how product social

performance and environmental social performance influence firm value and risk. Product social

performance refers to product or service-related actions of a firm that are socially responsible.

Environmental social performance refers to organizational actions that pertain to the physical

environment, such as limiting emissions and adhering to environmental standards. We also

examine how strengths and weaknesses of firms on product and environmental social

performance influence firm value and risk. Overall, we provide a disaggregated perspective of

how CSP influences relevant dimensions of firm performance.


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As a preview, the impact of product social performance and environmental social

performance on firm value and risk was assessed using a dataset of S&P 500 firms and Domini

400 Social Index firms. The results indicate that product social performance has a stronger

impact on firm value and cash flow than does environmental social performance. Environmental

social performance, however, reduces the systematic risk of the firm. The findings also indicate

that while proactive environmental actions do not enhance firm value, poor environmental social

performance reduces firm value and raises the systematic risk of the firm. Therefore, we

demonstrate the importance of taking a disaggregated view of CSR in examining its impact on

firm performance and risk. Furthermore, we show that positive and negative actions on the CSR

front may have asymmetric effects on firm performance and risk.

CSP and Firm Performance

CSP encompasses corporate actions aimed at enhancing social conditions. CSP includes actions

in the environmental, human relations, corporate governance, and product policy domains among

others. CSP could comprise actions that are not necessarily mandated by law. In that sense,

CSR actions often appear to go beyond the explicit transactional interests of a business (Godfrey

et al. 2009; McWilliams and Siegel 2000). While many of these actions from firms are

voluntary, they are not necessarily offered without desire for reciprocity from relevant

stakeholders. To the contrary, CSP is designed to create unspecified reciprocity in the form of

goodwill from stakeholders who can potentially impact the firms ability to thrive in its core

commercial activity. In other words, CSR actions may allow the firm to earn legitimacy in the

eyes of various stakeholders. This legitimacy enhances the ability of the firm to access resources

and opportunities, thereby improving its performance and reducing its risk. In short, through


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CSP firms earn moral capital which generates goodwill and reciprocal actions from

stakeholders. We examine these processes in detail next.

Firms are embedded in interlocking networks that have institutions of various types, apart

from consumers and investors, which can influence its success or failure. This embeddedness is

the nesting of firm and market behavior in a social and normative context through linkages

between institutional players with often divergent interests (Oliver, 1996, p. 167). As a

consequence of institutional embeddedness, firms are compelled to operate in ways that augment

their legitimacy in the eyes of stakeholders. Embeddedness could be a result of regulatory

strictures from government institutions, normative demands to do the right thing, and cognitive

pressures to act in ways that are generally established (Grewal and Dharwadkar 2002).

Normative demands on organizational structure and processes are a consequence of firms

dependence on stakeholders for success. Often, institutional pressures are generated to ensure

actions consistent with consumer welfare and larger social interests. As such, CSR actions from

a firm are likely to be driven by regulatory, normative, and cognitive pressures arising from its

embeddedness in a network of stakeholders.

In the debate on the relevance of CSR for firms, the stakeholder perspective highlights

the concerns of non-shareholder groups that have expectations about firm behavior, are affected

by the actions taken by a firm, and can influence its performance. Consequently, CSP is driven

by the expectation of reciprocity from stakeholders. The assumption of reciprocity recognizes

that stakeholders influence the principal actors ability to maximize its utility by virtue of the

embedded networks in which actions occur and their consequences are manifested.

Stakeholders significance is determined by their power and legitimacy, and by the urgency of

the specific issue (Murillo-Luna, Garces-Ayerbe, Rivera-Torres 2008). Reciprocity in decision-


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making has been attributed to bounded self-interest where each partys desire for utility

maximization is circumscribed by norms of fairness (Jolls, Sunstein, and Thaler 1998; Bosse et

al. 2009). That is, stakeholders reward firms they consider fair actors and punish those deemed

unfair in the social responsibility arena (Economist 2007; from Bosse, Phillips, and Harrison

2009).

Overall, it could be argued that a firm that undertakes CSR actions is seeking constrained

utility maximization by allowing itself to be subjected to the norms of fairness expected by

various stakeholders and expending resources on actions that do not contribute to enhancing its

performance. In this view, the firm sacrifices resources to be deemed a fair social actor, and as

such, wastes shareholder resources. The counter-argument to this viewpoint is that 'the firm gains

legitimacy through its actions in the CSR arena and earns reciprocal actions from stakeholders

that enhance its performance. The quantum of legitimacy that is bestowed on a firm by its

stakeholders constitutes its moral capital (Kane 2001), which enables the firm to be the recipient

of reciprocal actions. By spending resources on CSR, the firm recognizes the role of legitimacy

as a source of future performance and considers the resources expended on CSR as a necessity or

cost of doing business. Therefore, in this sense, the firm is considering long-term utility

maximization by its CSR efforts and expects that unspecified reciprocity from various

stakeholders for such actions will enhance its performance and chances of survival (McWilliams

and Siegel 2000).

CSR is not intended to send signals of complete altruism (lack of a profit motive).

Instead, the aim is to use CSR activities to signal that the firm is not completely self-centered,

and is capable of acting in ways that consider the impact of its profit-generating activities on

various stakeholders (Godfrey et al. 2009). By creating such attributions through CSR, as noted


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previously, firms hope to gain legitimacy and moral capital. Moral capital gained through CSR

can serve two purposes. First, it can attract stakeholders to the firms products and activities. In

this manner, the firm can benefit from customer patronage of its products and services, enhanced

employee morale and consequent lower employee costs, and investor support. Second, the moral

capital the firm generates through CSR could also act as insurance in those instances when a

firms actions have negative externalities. When a firms actions have well-publicized negative

consequences, stakeholders often subject the firm to severe punishments. Moral capital earned

through CSR can act as a buffer in such instances, thus reducing firm risk (Godfrey et al. 2009;

Luo and Bhattacharya 2009).

However, not all CSR actions may be equally capable of generating legitimacy and moral

capital for a firm. Research in marketing has referred to the role of fit in a firms pursuit of

CSR activities (Simmons and Becker-Olsen 2006). Fit in this context implies that CSR actions

should be appropriate for the firm given its domain of business. CSR activities that are not a

good fit for a firm could be considered opportunistic and self-serving, and not result in the

performance benefits that the firm seeks. Furthermore, not all CSR activities may be considered

equally informative when stakeholders decide whether a firm is a fair actor in the social arena.

Therefore, different CSR actions may have dissimilar implications for firm performance. In this

study, we address two such CSR dimensions and examine how they influence firm value and

firm risk.

Marketing-Related CSP Dimensions: Product and EnvironmentalSocial Performance

CSP activities can be classified into those that pertain to several domains product,

environment, employee, community, human rights and corporate governance. Prior research into

CSP, as mentioned earlier, has largely focused on aggregate measures of the phenomenon. From


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the perspective of marketing managers, some of the dimensions of CSP are more relevant than

some other aspects. While prior research has indeed examined the impact of some of the

marketing-related aspects of CSP, especially at the consumer-level (Strahilevitz and Myers 1998;

Du, Bhattacharya, and Sen 2007), a similar assessment at the firm-level is lacking. Therefore,

and as noted before, we examine the impact of product social performance and environmental

social performance on firm performance and firm risk. Firm performance in the context of this

study refers to firm value and cash flow while firm risk refers to the volatility of the earnings that

investors obtain from the firms stock.

Product social performance is the extent to which a firm pursues a product strategy that

offers quality products efficiently while providing notable social benefits and avoiding ethical

and regulatory problems. Examples of product social performance include efforts made by Coca

Cola Inc. to meet the nutrition needs of bottom-of-the pyramid consumers in India through a

supplement-fortified drink called Vitingo for less than 5 cents a beverage. PepsiCo plans to

introduce nutritionally enhanced snacks in the same price range while Nestle has already done so

with its Maggi noodles brand (Bhushan 2010). Environmental social performance is the extent

to which a firm follows a diligent policy of limiting the negative impact that its business has on

the natural environment and proactively acts to support and sustain the natural environment. For

both these dimensions, a firm could have strengths and weaknesses in terms of its position. On

the strength side of product social performance, a firm may proactively address socially

responsible issues through its products while on the weakness side it may be in trouble through

product recalls, anti-trust issues, and other actions that may run afoul of the concerns of various

stakeholders. Similarly, on the environmental front, a firm may be seen as having strengths or


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weaknesses based on its actions and responses to environmental concerns in its sphere of

business.

Product social performance will enhance the firms reputation, appeal to specific

customer segments, and earn customer loyalty. However, weaknesses in product social

performance could lead to lower legitimacy amongst important stakeholders, and consequently,

lower firm value and higher firm risk. Apart from similar advantages to be derived from strong

environmental performance, firms may also benefit from lower long-term cost structure on

account of more efficient use of resources (lower wastage). Overall, both product social

performance and environmental social performance will enhance the legitimacy of the firm in the

eyes of various stakeholders. This legitimacy will result in the generation of moral capital,

which, in turn, will cause reciprocal actions from these stakeholders. To the extent these

stakeholders deem the firm a fair actor as a result of its CSP, the reciprocal behavior will be to

the benefit of the firm. The firm will gain access to resources and markets at lower costs, leading

to performance improvements. Furthermore, the moral capital will also provide insurance

benefits with powerful stakeholders, where firms are liable to receive more support in cases of

negative actions than would firms that have not engaged in CSR. For these reasons, we propose:

H1a: Product social performance will enhance firm value and cash flow.

H1b: Strength (weakness) on product social performance will enhance (decrease) firm value

and cash flow.

H2a: Product social performance will lower firm risk.

H2b: Strength (weakness) on product social performance will reduce (increase) firm risk.

H3a: Environmental social performance will enhance firm value and cash flow.

H3b: Strength (weakness) on environment social performance will enhance (decrease) firm

value and cash flow.


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H4a: Environmental social performance will lower firm risk.

H4b: Strength (weakness) on environment social performance will reduce (increase) firm risk.

However, we do not expect product and environmental social performance to have equal

effects on firm performance and risk. A firms actions to enhance its social responsibility on the

product front are likely to be more consistent with its overall mission of providing customer

value because such moves are directly related to the explicit transactional interests of the firm.

Proactive environmental actions, by contrast, are likely to be less of a fit with the firms core

mission. That is, for most firms, proactive efforts on the environmental protection front may not

necessarily be directly related to their transactional interests. Research in the arena of cause-

related marketing has found that fit is an important consideration for consumers who respond

to a firms efforts in cause-related marketing. Fit in this context is the extent to which the cause

being supported has strong connections to the firms core business (Simmons and Becker-Olsen

2006). Low company-cause fit negatively influences consumer reactions to cause-related

marketing campaigns (Pracejus and Olsen 2004) and the company involved in the campaign

(Rifon, Choi, Trimble, and Li 2004). On account of limited fit, proactive actions by a firm in the

arena of environmental protection may not necessarily yield the dividends that it expects in terms

of legitimacy and moral capital because constituents may attribute opportunism as a motivation

for its efforts. Therefore, stakeholders may consider corporate claims of environmental social

performance more along the lines of corporate hypocrisy. Perceived hypocrisy where firms

claim credit for CSR actions that stakeholders pursue as empty can be counterproductive

(Wagner, Lutz, and Weitz 2009).

Researchers have also addressed CSR actions from the perspective of signaling theory

(Spence 1974). From this perspective, CSR actions are aimed at signaling to various


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constituencies that the firm is a responsible corporate citizen. Signals, to be effective, should

provide clear information and be credible (Groening, Swaminathan, and Mittal 2009). For

product-related CSR actions, compared to environment-related actions, the information is likely

to be of greater clarity because consumers can more easily verify the validity of the claims.

Therefore, product-related CSR claims are liable to be considered more credible relative to

environment-related claims. Consistent with this perspective, it has been noted that U.S.

investors do not consider many proactive environmental claims as relevant when they make

investment decisions. The fact that environmental actions may be weak signals to investors is

attributed to the fact that these data lack consistency and timeliness (Sustainable Enterprise

Institute 2009).

As we noted previously, the impact of stakeholders on firm performance varies with their

power and legitimacy (Murillo-Luna, Garces-Ayerbe, Rivera-Torres 2008). Customers and

investors are stakeholder groups with, arguably, the most power and legitimacy to influence the

performance of a firm compared to groups such as environmental and social activists. Overall,

while strong environmental social performance may generate goodwill, product social

performance is more directly related to stakeholders expectations of what the firm ought to do.

Therefore, product social performance is likely to generate higher levels of reciprocity (Jolls,

Sunstein, and Thaler 1998) in terms of patronage from powerful stakeholders who matter directly

to the firms performance consumers. Investors are also likely to be more pleased by product-

related actions that deliver customer benefits as they may not view such expenditures as beyond

the explicit mandate to managers to be good stewards of shareholder resources. Proactive

environmental social performance, on the other hand, may be considered to be of limited

relevance to customer stakeholders, not all of whom may care for such actions by a firm.


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Furthermore, when a firm undertakes proactive environmental actions that are not legally

mandated, investors may perceive such actions as wasteful of shareholder resources. In effect,

investors may view proactive environmental social actions as less likely to result in sufficient

reciprocity from other powerful stakeholders to justify the investment, compared to product-

related actions.

Overall, environmental social actions may offer firms some unspecified reciprocity in

the form of goodwill. However, their impact on firm performance is likely to be lower than

would be the case for product-related CSR actions because of the relatively limited appeal of

environmental social actions to powerful stakeholders. In effect, product social performance is

likely to have a stronger association with firm performance and have stronger risk insurance

properties than environmental social performance. Therefore:

H5a: Product social performance will have a stronger impact on firm value and cash flow than

environmental social performance.

H5b: Product social performance will have a stronger impact on lowering firm risk than

environmental social performance.

Regardless of whether proactive efforts aimed at environmental protection may not

payoff as expected, negative performance on this front will possibly harm the firms prospects.

Even if proactive environmental policies are not necessarily in the domain of what constituents

would expect a firm to undertake in the normal course of business, flagrant violation of expected

norms of behavior on the environmental front is likely to be punished. We attribute this to

negativity bias, where negative actions are weighted more heavily than positive actions in

decision-making considerations (Lankoski 2009; Folkes and Kamins 1999). Negativity bias is

likely to be more prevalent among stakeholders when the signals from positive actions are

considered less credible, a possibility, as discussed previously, for environmental actions. Due


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to negativity bias, violation of environmental norms will be more severely punished by

stakeholders than would positive actions be rewarded. Therefore, poor performance on the

environmental front will subject the firm to customer backlash that may affect its future

performance. Furthermore, violation of environmental performance norms may subject them

firm to stricter regulation, fines, and lawsuits. Customer backlash and regulatory actions are

both likely to have effects on cash flow and affect firm value through changes in stock price.

Furthermore, customer backlash and regulatory actions may also increase firm risk. Therefore,

firms may suffer more from poor environmental social performance than they would benefit

from good environmental social performance. Hence:

H6: Weakness on environmental social performance will have a stronger negative effect on firm

performance and risk than the positive effect of strength on environmental social performance.

RESEARCH METHODOLOGY

Data

Data on corporate social performance was drawn from the Kinder, Lydenberg and Domini

(KLD) database, a source that has been used in prior research (e.g., Waddock and Graves 1997;

Godfrey, Merrill, and Hansen 2009). KLD monitors and rates the corporate social performance

of approximately 700 companies that comprise the Domini 400 Social Index and S&P 500

between 1991 and 2007. Firms are rated in seven major areas -- community, corporate

governance, diversity, employee relations, environment, human rights and product -- and several

sub-areas within them using a proprietary framework of strengths and weaknesses indicators.

KLD draws on several distinct data sources to inform the ratings and analysis. Data are collected

from a wide variety of company, government, non-government organization and media sources.

KLD tracks each company through more than 14,000 global media sources daily.


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There are several advantages to this data source - 1) it rates firms on several attributes

considered important to corporate social performance, 2) the ratings are done by one group using

an objective set of criteria thus ensuring that the ratings are applied consistently, and 3) it

provides coverage across a broad spectrum of industries and over a significantly long time

horizon. To the best of our knowledge, KLD is the most comprehensive data source that tracks

corporate social performance. As such, it is well-suited to examine the impact of CSP on

financial performance.

Our final sample is an unbalanced panel consisting of 7816 observations that covers 695

firms across 200 SIC codes between 1991 and 2007. We used Compustat to collect data on

Tobins Q, cash flow, leverage, ROA, firm size, industry competition and industry growth. The

data on the Fama-French four factors required to estimate systematic and idiosyncratic risk were

collected from Kenneth Frenchs data library. Finally, the data on firm stock prices was

retrieved from the Center for Research in Security Prices (CRSP).

Measures

1) Product and Environmental Social Performance. We used the summated scores of the

product and environment dimension from KLD data to capture product social performance and

environmental social performance. The aggregate scores are the measures that are obtained from

differencing the scores on the strength and weakness dimension of each measure. Therefore, the

higher the score, the higher the firms social performance on each dimension. Furthermore, we

use the disaggregated strengths and weaknesses scores of product and environmental social

performance to test some of our hypotheses (see Appendix for KLD measures).

2) Firm Value. We use Tobins Q as a measure of firm value. Compared to accounting-

based measures, Tobins Q is a forward looking measure and reflects future profitability.


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Therefore, Tobins Q is an appropriate measure of firm value in the context of this study as

corporate social responsibility efforts of firms are likely to impact future profitability, and not

current profitability, because of greater stakeholder goodwill. Furthermore, Tobins Q has

several desirable characteristics such as scale independence and robustness to accounting

manipulations. In line with previous research, we use the approximation formula proposed by

Chung and Pruitt (1994) to compute our dependent measure. This approximation is computed as

follows:

Tobins Q= (MVE+ PS+ Debt)/ TA, where

MVE (market value of equity at the end of the year) = number of outstanding shares at

the end of the year* share price at the end of the year.

PS= Liquidated value of the firms preferred stock

Debt= (current liabilities - current assets) + (book value of inventories) + (long term debt)

TA= Book value of total assets

3) Cash Flow. Consistent with previous research, this is operationalized as the net cash

flow from operations (i.e., COMPUSTAT data item # 308). We normalized this measure by

dividing the net cash flows by the total assets of the firm (see Gruca and Rego 2005).

4) Firm Risk. We computed two distinct measures of firm risk -- systematic and

idiosyncratic risk. Systematic risk is a measure of an investment securitys volatility relative to

that of the market and is the covariation of the excess return from the stock with the excess return

from the market. We estimated systematic risk as the coefficient of the market return assessed

using the Fama-French four-factor model on monthly stock returns data over previous five years

(McAlister, Srinivasan, and Kim 2007). Risk in returns from an asset that is uncorrelated with

aggregate market returns is called 'specific risk' or 'idiosyncratic risk'. Idiosyncratic risk can be


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reduced through diversification. Consistent with Luo and Bhattacharya (2009), we measure

idiosyncratic risk as the variance of the residuals of the Fama-French four-factor model

estimated over a period of 252 trading days in a year.

5) Industry Covariates. Our measures for industry competition and industry growth are

consistent with measures used in previous research (Boyd 1990; Keats and Hitt 1988). We used

the Compustat database to construct measures of competition and growth at the four-digit SIC

code level. We collected revenue data for all publicly traded firms in each of the 200 SIC codes

between 1991 and 2007. For industry competition, we first computed an industry concentration

index akin to Herfindahl Index, which is sum of the square of the market shares of all firms

operating in a four-digit SIC code. Competition was then computed as (1 concentration index),

such that higher values imply greater competition and vice versa. Likewise, following previous

research (Boyd 1990; Keats and Hitt 1988), we computed industry growth in a given year as the

percentage change in industry sales over the previous year.

6) Firm Covariates. We obtained measures of leverage, ROA, and firm size as covariates

that influence firm performance and risk.

Model Estimation

We use a cross-section and longitudinal panel sample with observations at different levels (by

firm, industry, and period). Therefore, we employed hierarchical linear modeling (HLM) to

estimate random coefficient models to assess the impact of independent variables on firm

performance and risk. Basically, we modeled variation in the outcome variable Outijt (Tobins

Q, systematic risk, idiosyncratic risk, and cash flow) as a function of product and environmental

social performance (PSP and ESP), and a variety of firm-level and industry-level variables. To

test the effects of strength and weakness of product and environmental social performance, we


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modeled variation in the outcome variable Outijt (Tobins Q, systematic risk, idiosyncratic risk,

and cash flow) as a function of the strength and weakness dimensions of product and

environmental social performance, and firm and industry level variables.

The basic model is:

ijtjcijtiijtiijtiiijt CONTROLSESPPSPOutOut +++++= 32110

where

cccicci NTROLSINDUSTRYCO ++=0

The term Outijt-1 describes the output variable lagged by a period to account for inertial factors

that may not be captured in our model.

Because there are multiple observations per firm, the residual observations within firms

may be correlated. Therefore, the assumption of independence of the first level residuals, ,

may not be valid (Goldstein, Healy, and Rasbash 1993). To address this problem, different

structures for the covariance matrix were employed. These include an unstructured

covariance matrix, one with compound symmetry, and another one that is autoregressive. The

covariance matrix structure that best fits the data was selected from the three structures that were

used (Singer 1998; Wolfinger 1996).

Results

The correlation matrix for the variables is given in Table 1. The model with compound

symmetry covariance matrix did not converge. The model with the unstructured covariance

matrix had better fit for the firm value models, based on AIC criterion, compared to the model


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with autoregressive error structures. Hence the model with unstructured covariance matrix was

used to test the hypotheses. The results for the test of hypotheses are given in Tables 2 and 3.

(Insert Tables 1, 2, and 3 About Here)

The results show support for H1a and H1b. Product social performance has strong,

significant positive associations with Tobins Q and cash flow (p


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shows that weakness on environmental social performance enhances systematic risk. Therefore,

the positive effect that the aggregate measure of environmental social performance has on

systematic risk is driven by the risk enhancing influence of weakness on this measure of CSP.

Again, these results show the asymmetric effect of the strength and weakness dimensions of

environmental social performance on different outcome variables.

As expected, H5a is supported because the effect sizes for product social performance on

Tobins Q and cash flow are both positive and stronger than the effect sizes of environmental

social performance. Therefore, product social performance has stronger positive associations

with Tobins Q and cash flow than has environmental social performance, thereby supporting the

fit argument and the weaker signaling effect of proactive environmental actions. But H5b is not

supported as environmental social performance has stronger risk reducing effect than product

social performance, largely because poor environmental social performance increases systematic

risk.

We also find support for H6 because negative actions on the environmental front are

punished more than positive actions are rewarded. As evidenced in Table 3, the effect sizes for

environmental social performance weaknesses are larger than the effect sizes for environmental

social performance strengths on firm value and systematic risk. Proactive actions on the

environmental front hurt cash flow. However, as expected, weakness on environmental social

performance enhances firm risk and lowers firm value. Again, these results support our

contention that the impact of CSP on firm performance and risk is asymmetric.

Discussion

The objectives of this study were the following:


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1. Assess the effect of the two dimensions of CSP that are most relevant to marketing product and environmental social performance -- on firm value and risk.

2. Examine whether the effect of product and environmental social performance on firmvalue and risk varies across strong and weak performance on these dimensions.

We adopt a disaggregated view of the impact of CSR on firm performance because of the

potential variation in stakeholder response to its different aspects. For instance, while

environmental activists and regulatory agencies may welcome proactive environmental actions,

shareholders may view such actions as profligate managerial indulgence of their personal

preferences and as wasteful of shareholder wealth. We addressed the objectives of the study

using a large longitudinal panel of firms over the 1991-2007 period.

The results of this study offer new insights into the relationship between CSP and firm

performance. We show that socially responsible actions on the product front provide greater

benefits to firm value and cash flow than socially responsible actions on the environmental front.

We argued that this is likely because, in general, product-related socially responsible actions are

likely to be considered a better fit for a firm than environment-related actions. A second reason

for this could also be that environment-related actions provide weaker and less credible signals

than product-related actions, which stakeholders can evaluate with greater ease. Consistent with

this idea that environmental claims made by firms may not be considered very seriously by

relevant stakeholders, a report on the state of corporate environmental policy in the United States

prepared by the Sustainable Enterprise Institute finds that, while a typical corporation has an

enterprise-level environmental policy, the policy does not offer many specifics in terms of its

implementation. The implementation of environmental policy, in general, remains

geographically fragmented, not adequately monitored, and lacks in sophistication and


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meaningfulness. The report notes that corporations even fail to effectively report meaningful

actions they implement as part of a sustainable environmental policy. Therefore, it is more than

likely that investors and other stakeholders find it difficult to distinguish between firms that are

strong performers on the environmental front and those that are not, effectively discounting

disclosures made in this regard (Sustainable Enterprise Institute 2009).

It could also be that investors see proactive environmental actions as a net cash outflow

without compelling benefits (doing good, but not well), and hence do not consider such actions

efficient use of firm resources. This viewpoint is supported by our finding that strong

environmental social performance is negatively associated with cash flow. Regardless, failures

on the environmental front are considered salient and punished by stakeholders. For instance, we

find that though investors may discount proactive environmental actions that result in strong

ratings on environmental social performance, failures that lead to poor ratings are punished,

resulting in lower firm value and higher systematic risk. Is it then the case that environmental

performance is more of a failure preventer than a success producer (Varadarajan 1985)? The

evidence from this study indeed supports this contention.

Limitations and Research Implications

The findings from this study suffer from any limitations inherent in the index measures

constructed by KLD. The domain of the construct has to be captured exhaustively for index

measures to be effective. Second, the nature of the study does not permit a direct examination of

the underlying processes of legitimacy, fit, and signaling. Experimental and other research

where measures of these constructs can be manipulated or obtained are required for such an

assessment. The context-specific variation that is likely in the CSP-firm performance


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relationship also needs to be addressed in greater detail, as we discuss later. Notwithstanding

these limitations, the results have important implications for research.

First and foremost, the results demonstrate that it is necessary to examine the impact of

various dimensions of CSP on firm performance. Previous research has largely focused on

overall CSP and its effects on firm performance (see McWilliams and Siegel 2000; Godfrey et al

2009). In contrast, we show that CSR initiatives in the product and environmental domains have

quite different effects on firm value and risk. We further disaggregate product and environmental

social performance in terms of strengths and weaknesses and show that their impact on firm

performance is asymmetric. These results point to several issues that need to be addressed to

provide clarity to our knowledge about CSP and its impact on firms.

We addressed the impact of CSR dimensions on firm performance through the lens of

instrumental stakeholder theory. It is intuitive that different stakeholders will have varying

expectations for how firms should act out their social responsibility. We suggested that such

expectations will vary with the fit of the CSR action with the firms transactional interests. For

example, product social performance adds more to firm value compared to environmental social

performance potentially because it fits better with the firms basic role of providing better

products and resources. This is not to say that proactive environmental actions are not

necessarily a bad fit for all firms. Our data came from large firms quoted in the US stock

market. Within this sample, there might be specific firms from which stakeholders expect

greater stewardship on the environmental front through proactive actions. A preliminary

conjecture would be that firms with notorious reputations may find it necessary to demonstrate to

stakeholders that they pursue CSR actions on the environmental front proactively. In such cases,

stakeholders might view proactive firm actions in the environmental domain as better fit.


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Clearly, examining the underlying issue of fit of CSR actions on stakeholder expectations, and

how fit might influence the impact of CSR actions on firm performance warrants more research.

Second, given the current trend in marketing strategy research, much effort has been

expended on understanding the relationship between CSP and firm value or risk. However,

researchers have not provided adequate insights into stakeholder expectations of organizational

responsibility in the social arena. Descriptive work that examines the potential tension when

stakeholders play dual roles as when a pension fund is a large shareholder of a firm and cares

for stock performance and also takes strong positions on employee welfare or environmental

actions that add to the short-term cost of firms potentially negatively affecting their short-term

cash flow might be beneficial in clarifying stakeholder expectations.

CSR actions are implemented expecting unspecified reciprocity from stakeholders. The

nature of this reciprocity will obviously depend on stakeholder expectations. Clarifying

stakeholder expectations will, therefore, also allow researchers to examine the nature of

reciprocity that stakeholders exhibit towards various types of CSR activities. Descriptive and

experimental research that examines these issues will help researchers and managers understand

the relevance and importance of CSR.

The context specificity of the impact of various types of CSP needs more attention. In

the course of this research, we examined whether the influence of product social performance

and environmental social performance varies across business-to-business and business-to-

consumer context and services versus manufacturing industries. We did not find any variation

for the impact of product social performance and environmental social performance on firm

performance and risk across these contexts. It could be that the moderating effects of industry

and firm-related factors occur within more narrowly specified industry contexts. For example,


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stakeholders may expect and respond positively to proactive environmental actions from firms in

oil and mining businesses compared to businesses that have less of an impact on the physical

environment. Therefore, future research could examine the variation of CSR-performance

relationship across more narrowly specified contexts.

Managerial Implications

Ultimately, if shareholders are to offer long-term support for CSR activities, they would need

evidence that CSP enhances firm value and lowers firm risk. If CSP does not enhance cash

flows and lower firm risk, then they will end up being evaluated through other criteria of social

responsibility, the pursuit of which might very well be considered to belong in the domain of

government and non-profit organizations. Therefore, the findings from the study provide

insights that are relevant to managers.

First, the results emphasize that managers ought to take a disaggregated view of CSR.

Doing so will allow firms to determine the nature of stakeholder responses to positive actions on

various dimensions of CSP. In turn, firms can focus their resources on CSP actions that allow

them to enhance their value and reduce their risk. We find, for instance, that strong proactive

performance on the environmental front might not be of significant benefit to most firms.

However, meeting the goals of social responsibility through appropriate products and services

seems to enhance firm value. Our results do find that proactive environmental social actions that

lead to positive ratings reduce cash flow. However, it should be noted that prior research has

found that poor social performers may do well in the short-term, but in the long-term, good

social performers do better (Brammer and Millington 2008).

We also find that even when stakeholders do not reward proactive environmental actions,

negative actions on the environmental front are punished. Negative ratings on environmental


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social performance decrease firm value and increase firm risk. As such, paying inadequate

attention towards meeting their obligations to conserve resources and protect the natural

environment may not be advisable. However, it is important to assess the fit of CSR activities to

the basic operating environment of the firm. Otherwise, key stakeholders may not respond in a

manner that benefits the firm and develop appropriate relationships with the firm. Stakeholder

relationships have been shown to help firms recover from poor performance, in addition to the

expected benefits for sustaining performance (Choi and Wang 2009).

As we noted previously, studies find that firms do not report their CSR actions with

sufficient specificity. Therefore, our finding that proactive environmental actions do not pay-off

could be a result of inadequate reporting systems that offer information that is of poor

diagnosticity as far as stakeholders as concerned. Furthermore, it has been observed that several

firms do not have a strategic approach to CSR activities and no clear demarcation of

responsibility or accountability for CSR within the firm (Sustainable Enterprise Institute 2009).

As such, firms should also examine whether the approach to CSR and lack of transparency in

reporting could be diminishing the returns that could otherwise be feasible.


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TABLE 1

Correlation MatrixVariables 1 2 3 4 5 6 7 8 9 10

1. Tobins Q

2. Cash Flow .55

3.Idiosyncratic Risk .08 -.02

4. Systematic Risk -.14 -.18 .21

5. Product Social Performance .06 .10 .11 -.01

6.Environmental SocialPerformance

.15 .06 .05 -.00 .20

7.Product Social Performance(Strength)

.07 .03 .00 -.00 .42 .10

8.Product Social Performance(Weakness)

-.03 -.09 -.12 .00 -.89 -.17 .02

9.Environmental SocialPerformance (Strength)

-.09 -.00 -.11 -.02 -.02 .25 .14 .09

10.Environmental SocialPerformance (Weakness)

-.21 -.06 -.12 -.01 -.21 -.83 -.01 .22 .32

11.Size -.10 -.02 -.15 -.05 -.21 -.08 .14 .30 .14 .16

12.ROA .35 .45 -.23 -.17 .01 .03 .01 -.00 .00 -.03

13.Leverage -.27 -.20 -.20 -.00 -.06 -.13 -.06 .03 .07 .16

14.Industry Competition -.00 -.04 .01 -.00 -.05 -.05 -.09 .00 -.08 .01

15. Industry Growth -.00 -.00 -.02 .00 -.01 .00 -.01 .01 .04 .02


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TABLE 2

RESULTS FOR AGGREGATED MEASURES OF PRODUCT AND

ENVIRONMENTAL SOCIAL PERFORMANCE

Independent Variables Dependent Variables

Tobins Q CashFlow IdiosyncraticRisk SystematicRisk

Dependent Variablet-1 .452** .217** .237** .185**Product Social Performance .071** .003** .000 .007Environmental SocialPerformance

.028* -.001** .000 -.016**

Leverage -.928** -.070** .000 -.045Firm Size -.167** -.003** -.001** -.026**ROA 1.739** .133** -.013** -.436**Industry Growth .000 .000 .000 -.000

Industry Competition .056 -.007 .000 .000

N (Sample Size) 7816 7816 7816 7816

*** p < .01; ** p < .05; * p < .10


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TABLE 3

RESULTS FOR STRENGTH AND WEAKNESS DIMENSIONS OF PRODUCT

AND ENVIRONMENTAL SOCIAL PERFORMANCE

Independent Variables Dependent Variables

Tobins Q Cash Flow IdiosyncraticRisk SystematicRiskDependent Variablet-1 .452** .215** .237** .185**Product Social Performance (Strength) .106** .002 .000 -.007Product Social Performance (Weakness) -.060** -.003** -.000 -.010Environmental Social Performance (Strength) .028 -.003** .000 -.007Environmental Social Performance (Weakness) -.056** .001 .000 .019**Leverage -.911** -.070** .000 -.051Firm Size -.160** -.003** -.001** -.025**ROA 1.741** .133** -.013** -.435**Industry Growth .000 .000 .000 -.000Industry Competition .061 -.007 .000 .017

N (Sample Size) 7816 7816 7816 7816

*** p < .01; ** p < .05; * p < .10


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APPENDI X

KLD Measures for Environment and Product Social Performance

ENVIRONMENT

STRENGTHS

Beneficial Products and Services (ENV-str-A). The company derives substantial revenues frominnovative remediation products, environmental services, or products that promote the efficient use ofenergy, or it has developed innovative products with environmental benefits. (The term environmentalservice does not include services with questionable environmental effects, such as landfills, incinerators,waste-to-energy plants, and deep injection wells.)

Pollution Prevention (ENV-str-B). The company has notably strong pollution prevention programsincluding both emissions reductions and toxic-use reduction programs.

Recycling (ENV-str-C). The company either is a substantial user of recycled materials as raw materials inits manufacturing processes, or a major factor in the recycling industry.

Clean Energy (ENV-str-D). The company has taken significant measures to reduce its impact on climatechange and air pollution through use of renewable energy and clean fuels or through energy efficiency.The company has demonstrated a commitment to promoting climate-friendly policies and practices outsideits own operations. KLD renamed the Alternative Fuels strength as Clean Energy Strength.

Communications (ENV-str-E). The company is a signatory to the CERES Principles, publishes a notablysubstantive environmental report, or has notably effective internal communications systems in place forenvironmental best practices. KLD began assigning strengths for this issue in 1996, and then incorporatedthe issue with the Corporate Governance: Transparency rating (CGOV-str-D), which was added in 2005.In files prior to 2005, this column does not appear. In all spreadsheets it is incorporated into theTransparency rating.

Property, Plant and Equipment (ENV-str-F). The company maintains its property, plant, and equipmentwith above average environmental performance for its industry. KLD has not assigned strengths for thisissue since 1995.

Management Systems (ENV-str-G). The company has demonstrated a superior commitment tomanagement systems through ISO 14001 certification and other voluntary programs. This strength wasfirst awarded in 2006.

Other Strength (ENV-str-X). The company has demonstrated a superior commitment to managementsystems, voluntary programs, or other environmentally proactive activities.

WEAKNESSES

Hazardous Waste (ENV-con-A). The companys liabilities for hazardous sites exceed $50 million, or the

company has recently paid substantial fines or civil penalties for waste management violations.

Regulatory Problems (ENV-con-B). The company has recently paid substantial fines or civil penalties forviolations of air, water, or other environmental regulations, or it has a pattern of regulatory controversiesunder the Clean Air Act, Clean Water Act or other major environmental regulations.

Ozone Depleting Chemicals (ENV-con-C). The company is among the top manufacturers of ozonedepleting chemicals such as HCFCs. Methyl chloroform, methylene chloride, or bromines.


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Substantial Emissions (ENV-con-D). The companys legal emissions of toxic chemicals (as defined byand reported to the EPA) from individual plants into the air and water are among the highest of thecompanies followed by KLD.

Agricultural Chemicals (ENV-con-E). The company is a substantial producer of agricultural chemicals,i.e., pesticides or chemical fertilizers.

Climate Change (ENV-con-F). The company derives substantial revenues from the sale of coal or oil andits derivative fuel products, or the company derives revenues indirectly from the combustion of coal or oiland its derivative fuel products. Such companies include electric utilities, transportation companies withfleets of vehicles, auto and truck manufacturers, and other transportation equipment companies. In 1999,KLD added the Climate Change Concern.

Other Concern (ENV-con-X). The company has been involved in an environmental controversy that is nocovered by other KLD ratings.

PRODUCT

STRENGTHS

Quality (PRO-str-A). The company has a long-term, well-developed, company-wide quality program, or ithas a quality program recognized as exceptional in U.S. industry.

R&D/Innovation (PRO-str-B). The company is a leader in its industry for research and development(R&D), particularly by bringing notably innovative products to market.

Benefits to Economically Disadvantage (PRO-str-C). The company has a part of its basic mission theprovision of products or services for the economically disadvantage.

Other Strength (PRO-str-X). The companys products have notable social benefits that are highly unusualor unique for its industry.

WEAKNESSES

Product Safety (PRO-con-A). The company has recently paid substantial fines or civil penalties, or isinvolved in major recent controversies or regulatory actions, relating to the safety of its products andservices.

Marketing/Contracting Concern (PRO-con-D) The company has recently been involved in majormarketing or contracting controversies, or has paid substantial fines or civil penalties relating to advertisingpractices, consumer fraud, or government contracting. (Formerly: Marketing/Contracting Controversy)

Antitrust (PRO-con-E). The company has recently paid substantial fines or civil penalties for antitrustviolations such as price fixing, collusion, or predatory pricing, or is involved in recent major controversies

or regulatory actions relating to antitrust allegations.

Other Concern (PRO-con-X). The company has major controversies with its franchises, is an electricutility with nuclear safety problems, defective product issues, or is involved in other product-relatedcontroversies not covered by other KLD ratings.

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