Today’s dynamic corporate world has presented new sets of challenges to the business world; some of which are not economic-related. For any business entity to prosper and uphold competitiveness in the market, it must strive to bridge the gaps in economic and social systems. The main objective of any organization is to maximize the owner’s equity and survive in the market, in the long-term. However, fulfilling this objective is not an adequate measure of business prosperity. A business can be successful if it has a proper balance between economics and social systems (Visser, 2011). As long as the shareholders are pertinent to the business entity, it would be suicidal if the management of any organization despised the plight of the community within which it operates. This is where the concept of corporate social responsibility (CSR) becomes essential. Corporate social responsibility is concerned with the broad incorporation of business practices with social and ecological concerns with an aim of improving lives and attracting a solid client base (Sun, 2010). Most organizations in today’s world are working day and night to meet the current generation’s communal and financial needs, and at the same time preserving the future generation’s needs. As a matter of fact, the public has little or no regard for any company that operates in economic opulence in segregation. In this report, the reader will gain a proper understanding of the impacts of CSR to the financial performance of any organization.
What Is Corporate Social Responsibility?
Over the years, the concept of CSR has attracted a lot of consideration from different quarters and business men. Today, most companies operate with the sole intention of increasing their financial capacity and at the same time giving back to the society; in other words, any business entity should be like a ‘‘communal citizen’’. Different people have expressed their different levels of the comprehension of this concept; for this reason, it a subject of controversy and one that draws conceptual differences. Different people define CSR differently; the most common definition is the requirement for the businessmen to carry out policies, decisions, and follow the guidelines that ensure the spread of objectives and values that the society considers desirable. In other words, any business entity that engages in CSR not only makes economic gains or legal obligations, but also embraces responsibility in societal matters that go beyond its obligations. While doing this, business entities stay abreast with the current trends by revising their agendas, models, and obligations from time to time. As such, organizations must comprehend themselves fully with regard to the wide range of business entities. What is more, the relationship that each business entity has with its clients, employees, and the public determine the successful implementation of CSR activities.
Other definitions assert that CSR is the consideration by the corporate world of issues that go beyond a business entity’s economic obligations and the technological equal. The CSR concept should integrate the all economic, legal, ethical, and philanthropic expectations that attract respect from the public over time. It is advisable that all organizations go about their activities on the basis of sustainable expansion. Today, most organizations adopt CSR as a defensive strategy especially when they are faced by adversity or criticism. In essence, one can classify CSR in four categories namely the economic responsibility, legal liability, responsibility ethics, and responsibility discretion (Michie, 2014).
The countless definitions of CSR have made it difficult for scholars and other interested parties to gain a clear understanding of the concept. For instance, modern scholars have summarized the concept and defined it as one that appears to further social good beyond the primary interests of a firm and the law requirements. It encourages businessmen to make decisions on their businesses and pay close attention to the social interests of the people in the community. The concept defines a business entity as an economic, social, and political entity. Decisions in corporate bodies do not only affect the stockholders, but also have great effects on stakeholders such as creditors, debtors, employees, and the society within which a business operates (Schreck, 2009).
Approaches to CSR Measures
Measuring corporate social responsibility is a significant step as it creates an understanding of the organization’s social responsibility and enables the management to make decisions on the environmental and social impacts. This involves assessing the business’ development in non-financial fronts. The information is essential not only to the stockholders, but also those that require information on the best performing entities. For companies to have an effective measure of CSR, they have to establish legal and socio-technical infrastructures. At the same time, they should implement proper strategies, create awareness, improve their personality or identity, and promote integrity. Today, there is the assumption that any business entity that engages in CSR or looking after the public survives the harsh business environment. However, it is imperative for one to understand that the concept of measuring CSR is a complex one just as it is to define CSR itself. For this reason, it has been extremely difficult for companies to have an objective report in matters concerning measures of CSR (Visser, 2011). It is extremely imperative for business entities to keep in mind that the public expects accountability. Therefore, they should strive to prove themselves as ethical while at the same time seeking to influence lives positively.
Most empirical studies have been criticized in the past for using inappropriate measures of CSR. Different researchers have adopted various proxy measures in their assessment of CSR such as surrogate measures that rank companies on pollution control performance. Other proxy measures commonly used include Moskowitz’s social responsibility ratings and Fortune corporate reputation index. However, all these approaches have been criticized for not considering the stakeholders issues. These limitations brought about development of agencies to evaluate social responsibility activities on stakeholders perspective. For instance, ISO 26000, UNGC, GRI give an outline of the variety range of social responsible activities that businesses are expected to fulfill (Zu, 2009).
What Is Financial Performance?
For one to understand the impact of CSR on the financial performance of a business, it is imperative that they understand what the concept entails. For a long time, the public has defined financial performance as the market efficiency that ensures the optimal allocation of resources and avoids any notion of corporate responsibility other than increasing the owners’ wealth. In most cases, this performance is ascertained in the stock exchange market; a time when most companies take action. Business entities obtain information on financial performance from financial statements. For a financial indicator, the financial performance of the organization is measured by its financial validity. It entails accessibility to different sources of funding or profitability compared to its investments, assets or equity. It is the objective of the management of any business to ensure reduced costs and an increase in return on investment (Fernando, 2006).
Measurement of Financial Performance
For one to undertake an effective comparison of the CSR and financial performance of an organization, it is imperative that they understand how to effect the measurement of the latter. Such information will be critical in providing the link between the two concepts. Results from the previous studies have shown that more than 80 different measures have been functional in the measurement of a firm’s financial performance. Some of the most frequently used measures include return on equity (ROE), return on assets (ROA), size of the firm, return on sales, and the asset age. Of all these measures, return on assets is considered the most authentic measure of financial performance. Its authenticity is based on its ability to resist the effects of a differential degree of leverage that is common in different firms. The return on asset is positively correlated to the stock price. As a result, a higher ROA implies that there is a high-value creation for the shareholders (Fernando, 2011).
Most of the financial performance measures are concerned with the historical performance arising from tangible assets. Intangible assets such as employee satisfaction, customer relationships, innovation, investment in research, and development are not always considered in the measurement of the performance. These are essential considerations, which have been the driving force for companies to achieve a competitive edge in the modern dynamic economy. Non-financial performance measures are extremely critical in assessing the overall success of the organization. Any business entity can obtain indirect indicators of the performance by considering the non-financial indicators. It is also imperative to understand that the financial indicators are objective whereas the non-financial indicators are subjective in nature since they include the managers’ perception of the firm’s performance on market share, employee health and safety, as well as, investment in research and development to mention a few (Mullerat, 2010).
As long as there are several measures of the financial performance of the firm, accounting measures have the advantage of providing a relevant economic performance of any business entity. As a result, one can predict a more reliable possible link between CSR and financial performance. Nevertheless, stock market measures are more advantageous since managers of these firms cannot manipulate them easily. Different researchers issue contrasting results in the relationship between financial performance and CSR after using the stock market measures. Results from market-related measures are usually negative and highly suitable for the increased use of accounting measures.
The Relationship between CSR and Firm Performance
The question of the relationship between CSR and financial performance has been of great concern to many business entities. The main area of concern is the compatibility between market logic and the profit maximization goal that underpins the economic rationale of the business and concerns within the society such as integration unity or sustainable development. The neoclassical theory based on market efficiency is against the idea of any firm’s social responsibility apart from profit maximization. In contrast, proponents of teleological principle argue that there is a moral responsibility of policymakers towards future generations and a large number of societal problems (Tricker & Tricker, 2014).
The theory of stakeholders is turning out to be an acceptable framework that specifies the societal responsibilities that corporate bodies should practice. The stakeholder theory is not exempt from a normative vision and ethics, but it seeks to integrate economic goals; it states that cooperation contracts ought to establish trust between the firm and its stakeholders, and give the company a competitive advantage over others. One might wonder whether the inclusion of stakeholder expectations is the result of traditional rules of management or the outcome of a deliberative process of integrating moral principles (Visser, 2011).
Despite the fact that the theory is a common issue in the literature field particularly in regards to corporate social responsibility, it has remained an ambiguous theoretical issue that presents a lot of limitations. On one hand, it is part of a relational representation of the firm based on fair contracts that involve conflicts of interest that it may resolve by ensuring a maximization of the interests of each group. Then again, it would be unrealistic for one to consider a comprehensive consideration of all potential stakeholders (Sun, 2010).
The rationality of leaders is necessarily limited by the urgency of problems, pressure, and the available information systems. The first theoretical approach suggests that any business entity that embraces CSR is more successful socially, but more efficient financially and cost-effectively. This way, it will be more efficient economically and less efficient socially. Finally, beyond these two extreme views, one may consider the assumptions of positive and negative synergy that cross the different conceptual foundations. With these assumptions come the generic assumption of neutrality of interactions and the assumption of a more complex relationship.
CSR and Financial Performance
There have been several theoretical explanations for the relationship between the social and financial responsibility. These explanations are classified into three distinct categories: the first category asserts that the two variables have a linear relationship; the other explanation postulates that the two variables do not have a relationship whereas the last explanation assumes that there is a non-linear relationship between the two constructs.
Positive relationship model
Previous literature has two theoretical models that are proponents of positive relation on the impact of CSR and the financial performance of an organization. The first explanation is from the social impact hypothesis or available fund hypothesis where it is assumed that the organizations have excess funds at the managers’ discretion. The theory assumes that the availability of excess funds will enable the managers to use a substantial amount of funds for CSR activities without compromising corporate profits margins. This hypothesis is advanced by the stakeholders theory, in which the financial success in a corporate body is fulfilled after satisfaction of booth the stockholders and the stakeholders in an organization (Fernando, 2011).
In contrast, the organizational slack model addresses the link between the CSR and financial performance in a different perspective. Corporate social responsibility is not a condition for achieving high levels of economic gains. He argues that it is the high levels of financial performance that provides organizations with an opportunity to engage in social activities. The improvement in financial levels could also trigger a positive engagement in social activities. Kraft and Hadges (1990), argues that the profitability of the business differential is a necessary condition of social behavior. It is, therefore, evident that most managers will tend to spend substantial amounts in social projects if the business is experiencing high-profit margins.
Negative relationship between CSR and financial performance
There are also some theoretical explanations for the existence of a negative relationship between CSR and the financial performance in an organization. Some scholars have asserted that a corporate that has tremendous economic gains is one with poor social performance and vice versa. There are two models that explain the existence of a negative relationship between these two variables. The trade-off hypothesis assumes that engagement in corporate social responsibility activities entails extra financial costs and subsequently competitive disadvantage. This hypothesis stipulates that organizations should only focus on profit maximization. Making of profit is fundamentally incompatible with the social responsibility of the business.
Positive or negative synergy
Economists have also argued in favor of an economic situation whereby both positive and negative synergies are realized. They argue that a high level of social performance will lead to improved economic gains, and the cash can be reinvested in social activities; this translates to the realization of a positive synergy. In contrast, a low lever societal performance will result in a decline in financial performance and subsequent reduction in socially-responsible activities, and therefore, a negative synergy.
No link model
The third theoretical explanation to the relationship between corporate social responsibility and financial performance asserts that there is no relationship between the two constructs. A Major contribution to this concept is by McWilliams and Siegel, they have proposed a model of demand and supply for social responsibility that gives an explanation for the lack of consensus results obtained through empirical research. They argue that there exist a demand and supply for social responsibility which led each other to invest socially and meet the demand of the stakeholders. According to them, the effects of market equilibrium will eventually cancel out costs and gains generated by the supply of social responsibility. As a result of these arguments, a hypothesis of neutrality of the interactions between the two constructs is defined (Tricker & Tricker, 2014).
Complex relationship model
Further literature also explains the existence of a more complex relationship between CSR and financial performance. Preston and O’Bannon, explained the hypothesis of a positive relationship between a more complex two-dimensional relationship. In this hypothesis, they argue that there is a point in the investment in social responsibility, where there is no further change in financial performance. This is an optimum point where the improvement in financial performance does not improve (Sun, 2010).
Empirical Approaches to CSR and Financial Approaches
The relationship between the financial performance and the CSR has been very inconclusive as a result of different contradicting results from empirical studies. Likewise, the relationship between financial performance and the society has been a subject of concern to many researchers. There have been a lot of empirical works with a sole objective of unearthing the relationship between the two constructs. There is the belief that by 2007, there will be the conclusion of more than 160 empirical studies on this subject (Mullerat, 2010). All of these empirical studies shed light on the nature of interactions between the organizations’ ability to achieve both financial and CSR consecutively. One can only achieve this by understanding how the two concepts interact. There have been several studies through two levels as discussed below.
There has been the continuous publication of been several studies over the last twenty years, which have all tried to explain the link between social responsibility and financial performance in different companies. However, it is imperative to note that most of these empirical studies have given conflicting results and failed to establish the existence of a positive or negative relationship between the two concepts. The lack of theoretical foundation and conceptual studies explain the obtaining of these poor results in such studies. However, recent studies indicate a slight advantage for the detection of positive links, CSR performance, and financial performance as discussed by Griffin and Mahon. It is also noteworthy to understand that there are several publications that indicate a negative relationship between the two constructs (Fernando, 2006).
Social Impact of the Hypothesis
The stakeholders’ theory explains the favorable influence of social behavior on financial performance as discussed in Freeman and Preston’s work. Corporate social responsibility serves as a great indicator of organizations’ ability to meet the demands of their various stakeholders. This leads to increased confidence and hence profitability. Waddock and Graves in their work have also discussed at length about the good management theory. They argue that there exists a high correlation between corporate social responsibility and good management practice. The improvement in social activity leads to an improved relationship with the key stakeholders of the organization. This further translates to improved financial performance. Additionally, other empirical literatures have confirmed a positive relationship between the two constructs as evidenced by the works of Preston, Mc Guire et al. and Kohers and Simpson, among others. Most of these researches have confirmed that CSR and financial performance have a positive relationship. Allouche and Laroche confirmed this when they identified 72 out of 85 researches, who had confirmed a positive relationship. Margolis and Walsh also confirmed 54 out of 127 studies that also confirmed a positive link (Fernando, 2006).
As earlier discussed, this hypothesis stipulates that CSR activities lead to increasing costs and, are therefore, detrimental to the financial improvement of the organization. They argue that if an organization invests in environmentally-friendly equipment and their competitors fail to follow suit, then they generate a competitive disadvantage. This leads to a continuous reduction in profits and creates discontent among the stockholders. This Aupperle et al. (1985) has also confirmed this hypothesis, when he argues that investing in social activities such as charity and community development projects leads to the use of more resources that could be disadvantageous. It is even more drastic if the competitors are not engaging in those practices. The negative relationship has been attributed to abnormalities; in particular, methodological tools used in measuring financial performance. The use of the market variable as a measure of financial performance is one of the major reasons for the negative relation according to Griffin and Mahon. As a conclusion, the number of empirical researches with negative relation is minimal (Zu, 2009).
Lack of Relation between CSR and FP
As one can see, some authors have asserted that there is no relationship between CSR and financial performance within an organization. The proponents of this hypothesis argue that the relationship between the two is just a coincidence from unpredictable sources. Some have also attributed this to methodological problems that have obscured the exercise as explained by Waddock and Graves. A substantial number of empirical studies indicate no relationship while others show weak or no links between the constructs. Other authors have found inconclusive results and the selected variables failed to account for the efficiency and the success of the firms in question.
As a result of the above discussions, one deduces the following three hypotheses:
H1: Social responsibility has a positive impact on financial performance.
H2: The social responsibility has a negative impact on financial performance.
H3: There is no link between social responsibility and financial performance.
Effect of control variables
Previous researches have indicated inconsistence in the results concerning the relationship between CSR and financial performance. The differences in these results are attributed to the difference in the control variables, in the different companies. These variables are discussed.
The Effect Risk
Several researches have confirmed the risk element as a major variable that controls the relationship between the constructs. There is an assumption that corporates have low risks in committing resources in social activities, and the reverse is true. Organizations with low risks have constructive investment in CSR activities and, therefore, have a stable performance model as explained by the work of Robert. In contrast, Aupperle et al., argues that better risks management in an organization lead to increased activities in social responsibility. He also found a positive relationship between cost accounting and risk management.
The size of the organization is also a major determinant in the relationship between CSR and financial performance. Some authors argue that small organizations pay little or no attention to social activity. On the other hand, others are of the position that the social activities in an organization increase with the size of the organization. According to Stanwick, there is a positive relationship between the size of the organization and CSR especially if sales volume and total assets are functional parameters that measure the size. However, Mc Guire found a positive, but insignificant relationship when total assets are functional as the measure of the size of the organization (Michie, 2014).
The Effect Sector
The sector within which the organization operates is a critical variable in assessing the relationship between financial performance and CSR. For instance, the environmental consideration in a chemical manufacturing company is different from a consultant company.
From the literature discussed above, it is difficult for one to conclude the kind of relationship that exists between CSR and financial performance of an organization. While some have proposed a linear relationship, others have proposed a negative relationship. Others have proposed the non-existence of any relationship among the constructs while others have advocated the existence of a complex two-dimension relationship between the two concepts. What comes out clear is that different organizations will have different results for their relationships. Methodological differences and control variables have brought out most of these differences, and they have been very instrumental in determining the results of the study. The differences in approaches to measuring the financial performances have played a significant role in such analysis. One can also conclude that control variables such as size, risk, and sectors are significant in determining the relationship between the two constructs (Michie, 2014).
Fernando, A. (2006). Corporate governance: Principles, policies and practices. New Delhi: Pearson Education.
Fernando, A. (2011). Business environment. Chennai: Pearson.
Michie, J. (2014). Reader’s Guide to the Social Sciences. Hoboken: Taylor and Francis.
Mullerat, R. (2010). International corporate social responsibility: The role of corporations in the economic order of the 21st century. Austin: Wolters Kluwer Law & Business ;.
Schreck, P. (2009). The business case for corporate social responsibility understanding and measuring economic impacts of corporate social performance. Heidelberg: Physica-Verlag. Bottom of Form
Sun, W. (2010). Reframing corporate social responsibility lessons from the global financial crisis. Bingley, U.K.: Emerald.
Tricker, R., & Tricker, G. (2014). Business Ethics a stakeholder, governance and risk approach. Hoboken: Taylor and Francis.
Visser, W. (2011). The age of responsibility CSR 2.0 and the new DNA of business. Chichester, West Sussex: John Wiley & Sons.
Zu, L. (2009). Corporate social responsibility, corporate restructuring and firm’s performance empirical evidence from Chinese enterprises. Berlin: Springer.
Do you need an Original High Quality Academic Custom Essay?