Corporate Social Responsibility and

Corporate Social Responsibility and Environmental Management Corp. Soc. Responsib. Environ. Mgmt. 16, 61–78 (2009) Published online 24 February 2009 in Wiley InterScience (www.interscience.wiley.com) DOI: 10.1002/csr.182
Corporate Financial Performance and Corporate Social Performance: An Update and Reinvestigation

Scott J. Callan and Janet M. Thomas*
Economics Department, Bentley University, 175 Forest Street, AAC-171 Waltham, Massachusetts, 02452 USA.


ABSTRACT
For some time, researchers have been investigating the relationship between a firm’s cor- porate financial performance (CFP) and its corporate social performance (CSP). Although most studies indicate that CSP is a determinant of CFP, other aspects of this research have been inconsistent. Some studies are criticized for using unreliable CSP measures; others for missing control variables; and still others for assuming linearity without valid testing. This paper responds to these issues with an updated study of the CSP–CFP relationship, testing two approaches to measuring CSP, controlling for key variables identified in the literature, and testing for nonlinearity of certain independent variables. Chief among our findings is a positive CSP–CFP relationship, which supports proponents of stakeholder theory. We also determine that empirical models specifying two CSP component measures are stronger than those using a fully aggregated measure. Lastly, we find that control variables must be properly specified to avoid bias and that some of these measures are quadratically related to CFP. Copyright © 2009 John Wiley & Sons, Ltd and ERP Environment.

Received 18 June 2008; revised 6 August 2008; accepted 7 August 2008
Keywords: corporate social responsibility (CSR); corporate social performance (CSP); corporate financial performance (CFP); social performance measures; stakeholder theory; sustainable development

Introduction

N RECENT YEARS, BUSINESSES HAVE BECOME MORE AGGRESSIVE ABOUT ADVANCING AND PROMOTING EFFORTS TO ACHIEVE
more socially responsible decision-making, commonly known as corporate social responsibility (CSR).1 With some regularity, firms are integrating social, environmental and governance objectives into their business models by making tangible changes in virtually all aspects of their operations, such as research and develop- ment, production plans, and accounting practices. Recognizing the potential benefits of improved public relations, many firms publicize their dedication to CSR, and some even provide stockholders with a formal report of their
CSR accomplishments.
As this trend has emerged, there has been a resurgence of scholarly interest in the motivations behind CSR and the implications for the firm’s profitability and market capitalization – an effort that began in earnest in the 1970s

* Correspondence to: Janet M. Thomas, Economics Department, Bentley University, 175 Forest Street, AAC-171 Waltham, Massachusetts, 02452 USA. Email: jthomas@bentley.edu
1 For an interesting overview of how CSR is defined, see Dahlsrud (2008).

Copyright © 2009 John Wiley & Sons, Ltd and ERP Environment


(Bragdon and Marlin, 1972). In the process, researchers have been looking for better ways to measure CSR and to quantify the financial and economic benefits of CSR practices.2
Despite the rather large literature that has evolved in this area of study, several observed shortcomings are noteworthy. First, many published studies are dated, and in those cases, the CSR measure, commonly referred to in the literature as corporate social performance (CSP), may not be entirely relevant to practices considered to be socially responsible by today’s standards. Second, many papers either present theoretical models without empirical evidence or use regression models that do not test for nonlinearity or specify lags between financial performance and CSP. A third observation is that proper measurement of social performance can be elusive. Yet this task is critical to achieving credible and consistent results. As a consequence of these and other concerns identified in the literature, many questions are in need of answers.
To that end, the objective of this research is to provide an updated assessment of the relationship between corporate financial performance (CFP) and CSP that responds to the known shortcomings and follows the most consistent thread through the existing literature. In so doing, we offer a current benchmark of this critical relation- ship, using up-to-date financial data and social performance indicators along with a list of control variables that responds to the cumulative literature. The goal is to identify and test various measures of both CFP and CSP and rigorously examine the most commonly hypothesized relationship between the two. We also test the nonlinearity of selected independent variables, which has not been commonly investigated in the literature. Not only should our findings contribute to the CSR literature, they also should provide support for policy initiatives aimed at encouraging corporate efforts in such endeavors as energy conservation, climate change, human rights, and diversity.
This research paper is organized as follows. The next section presents a discussion of the literature. Following this, we present the theoretical model of the CSP–CFP relationship. In the subsequent section, we discuss our empirical model and data sources, with full results presented and analyzed after that. Concluding comments follow in the closing section of the paper.

Literature Review

There is an extensive literature examining the relationship between the firm’s financial performance and its socially responsible activities, with the first empirical studies credited to Bragdon and Marlin (1972) and Moskowitz (1972). This body of work is clearly transdisciplinary, with much of it published in accounting, management, and business ethics journals, using methods that vary widely in approach and degree of sophistication. That this collective research is large and important is evidenced in part by several major studies aimed at reviewing and analyzing the results of this accumulating research. Perhaps the most extensive review is the one conducted by Margolis and Walsh (2001), which is a compendium of some 95 research studies. An update of this comprehensive review is given in Margolis and Walsh (2003). Other ambitious reviews of research on CSR include Pava and Krausz (1996), Preston and O’Bannon (1997), Griffin and Mahon (1997), and Roman et al. (1999).
Because this literature is so vast and because it has been so thoroughly reviewed by others, a comprehensive assessment of the accumulated research is not offered here. Instead, in the subsequent discussion, we identify selected empirical and theoretical papers that motivate and have particular relevance to the present study and that collectively define the direction and evolution of empirical findings to date.
Interestingly, one of the original sources of debate in the CSR literature has been about the direction of causal- ity between the firm’s financial performance and its social behavior. More to the point, scholars and theorists have deliberated about whether CSP is an independent or dependent variable in the CSP–CFP relationship. Although the debate is ongoing, the existing research seems to be moving toward common ground. According to Margolis and Walsh (2001), 80 of the 95 papers they reviewed, which were published between 1972 and 2000, posit that CSP predicts or helps to determine CFP.3 Examples range from the early work by Bragdon and Marlin (1972) to

2 An excellent review of this literature is provided by Margolis and Walsh (2001, 2003). More recent papers include Lindgreen et al. (2008) and Wahba (2008). Specific detail on individual studies is provided in the subsequent literature review.
3 In the updated review, Margolis and Walsh (2003) identify 109 of 127 studies that specify CSP as a predictor of a firm’s financial performance.


more recent papers, such as the commonly cited Graves and Waddock (1994), Hart and Ahuja (1996), and McWilliams and Siegel (2000).
Perhaps just as contentious, particularly in the early phases of CSR research, has been the debate about the qualitative nature of the relationship between CSP and CFP. Both theorists and empirical scholars participate in this debate, but again, some consensus is beginning to form. Of the 80 papers identified by Margolis and Walsh (2001) as modeling CSP as a determinant of CFP, over half report a positive relationship; included among these are Waddock and Graves (1997), Dowell et al. (2000), and Graves and Waddock (2000). Similarly, Pava and Krausz (1996) find that of the 21 empirical papers they reviewed, which were published between 1972 and 1992, 12 of them, or 57%, determine that a positive relationship exists. In fact, Pava and Kraus (1996, p. 324) argue that ‘. . . the overwhelming preponderance of the evidence indicates that CSR firms perform at least as well as other firms.’ This assertion and the findings upon which it relies are supported by proponents of stakeholder theory, which is defined and briefly discussed in the next section of this paper.
As the literature has evolved, so too have efforts to identify and test various measures of both financial and social performance, although the latter is considered to be the more difficult to capture empirically. Researchers have used a wide array of sources of CSR data over time, such as government environmental reports, various surveys, and information gathered by the Council on Economic Priorities. Some studies use a one-dimensional CSR measure, such as emissions reduction or charitable donations, with environmental activity being the most common.4 Other papers employ an aggregate measure or index of various CSR indicators.
Two of the more prominent aggregate measures use the Fortune ratings data o