From: The Senior Accountant
To: The Finance Director
Re: Corporate Social Responsibility
This report deals with various concerns raised by the Finance Director in a recent report issued to the Senior Accountant. The Finance Director’s main concern is whether the company’s public reputation may have a material impact on its Balance Sheet. To clarify, this report deals with the following issues: firstly, the report provides a discussion as to whether there are differences between social performance and environmental performance, as well as whether there is any connection between the two. Secondly, the report provides a discussion of the regulations that govern the disclosure of social and environmental performance by public companies. Thirdly, the report provides a discussion as to whether there is any relationship between share value and corporate social responsibility. Finally, the report provides the accountant’s opinion on whether the disclosure of a positive statement on CSR issues has any effect on the net worth of the company.
- Social Versus Environmental Performance
Social performance refers to “the results of the interaction of an organisation’s activities, products or services with the social environment (including social perceptions of environmental performance) and relevant stakeholder wants within it” (Bennett et al., 1999: 17). Environmental performance refers to “the results of the interaction of an organisation’s activities, products or services with the natural environment (for example, carbon dioxide (CO2) emissions, which create global warming)” (Bennett et al., 1999: 17). Based on the foregoing definitions for social performance and environmental performance, one can observe that the difference between the two lies in the words “social” and “natural”. Both social performance and environmental performance concern the results of the interaction of the organisation’s activities, products or services with the environment. The environment can be divided into two groups: the social environment and the natural environment. Both environmental performance and social performance can be grouped under corporate social performance (CSP).
According to Wood (1991), CSP can be divided into three components. The first component concerns itself with the platform of corporate social responsibility. This platform depends on legitimacy within society, public policy within the organisation, and managerial direction by each individual within the organisation (Wood, 1991). The processes of corporate responsiveness, which encompass stakeholder management, environmental assessment, as well as issues of management, constitute the second component of CSP (Wood, 1991). The third and final component of CSP has to do with the results of organisational activities. These include social programs, social impacts and social policies (Wood, 1991). Social performance can be categorised under the third group, while environmental performance can be placed under the second group. The environmental performance of a firm is a critical component in measurement of its CSP. For example, Poduska et al. (1992) and Reilly (1992) provide evidence that environmental performance is a critical success factor of CSP. Poduska et al. (1992) suggest that Kodak’s CSP improved following its conscious effort to reduce the level of pollution emissions through technological innovations. In like manner, Reilly (1992) observes that the relationship between CSP and environmental performance is positive in a study examining the pollution reduction activities at Minnesota Mining and Manufacturing. It is therefore clear that the social performance of an organisation has a significant impact on the measurement of its CSP. Therefore, the main difference between social performance and environmental performance is that social performance concerns itself with the interaction of an organisation with the social environment while environmental performance concerns itself with the interaction of an organisation with the natural environment. What the two have in common is that they both serve as critical success factors in the measurement of the organisation’s CSP.
- Regulations Governing social and environmental Performance Disclosure
Until recently, most social responsibility disclosures were voluntary and unaudited. Few efforts were being made to monitor firms’ social activities or to validate their disclosures (Ingram and Frazier, 1980). A number of regulations around the world govern the disclosure of environmental performance. For example, in the U.S the Toxic Release Inventory (TRI) is a database that keeps annual inventory on the level of toxic chemicals, as well as waste management actions by organisations operating in certain industries and federal agency organisations. (http://www.epa.gov/TRI/). It is a legal requirement for all companies operating in particular industries to file Toxic Release Inventory reports by 1st July of each year (http://www.epa.gov/TRI/). In Norway, the Norwegian Enterprise Act enacted in 1989 requires corporations to include information relating to emission levels and contamination as well as proposed environmental clean-up measures in the directors’ report. Under the Norwegian Accounting Act 1998, companies are required to report any pollution emissions, as well as remedial or preventive actions taken (Richardson, 2002). Other European countries such as Denmark, the Netherlands and Sweden have instituted mandatory environmental reporting. In the United Kingdom, a new framework of statutory accounts and reports has been proposed by the Company Law Review Group (Richardson, 2002). The framework is expected to cover environmental issues as part of the objective to increase the scope of reporting to cover qualitative, or “soft”, or intangible and forward looking information (Richardson, 2002). Despite this regulation, the business sector has not embraced the consolidation of regulations regarding environmental issues into mainstream company law statutes. Rather, they have preferred the retention of the voluntary approach (Richardson, 2002). The Australian Society of Certified Public Accountants and the Institute of Chartered Accountants, for example, in 1998 opposed an attempt to amend the Australian Corporation Law to provide for environmental disclosure. The Accounting Bodies held that it was best for such measures to be narrowly confined to the requirements under environmental regulation per se (Richardson, 2002).
- Corporate Social Responsibility and Firm Value
Various stakeholder groups require organisations to devote more resources to corporate social responsibility (CSR). CSR is defined as “actions that appear to further some social good beyond the interests of the firm and that which is required by law” (McWilliams and Siegel, 2001: 117; Carroll, 1999). According to Dr Deborah Anderson, President of Farsight Associates Inc. and former vice president for environmental quality worldwide at Procter and Gamble, stakeholders include “anyone who can help or hurt a business” (cited in Chris, 2003: 5). This definition indicates that in addition to shareholders, other stakeholders include customers, local communities, employees and business partners; government; NGOs; worldwide public opinion; and activists trying to defend the natural environment from corporate hazards (Chris, 2003: 5-6).
The issue as to whether or not corporate social responsibility provides benefits to a firm is often a controversial one. On the one hand, it can be argued that corporate social responsibility leads to increased firm value since stakeholders perceive a socially responsible firm as being a good corporate citizen and, as such, reward the firm with a good reputation. On the other, it can also be argued that corporate social responsibility does not lead to an increase in firm value because of the costs incurred by the firm in meeting the requirements of stakeholders. In the final analysis, this paper argues that corporate social responsibility leads to increased firm value. Before reaching its conclusion, the paper reviews literature on the relationship between CSR and firm performance. A number of research studies have been conducted to determine whether CSR activities enhance firm value or not. These studies have produced results that can be placed at two extreme ends of a continuum. At one end of the continuum it is argued that firms do not benefit from CSR activities because the costs they incur in undertaking socially responsible actions significantly outweigh the benefits derives from such actions; as such firms that engage in socially responsible actions are less competitive when compared to their counterparts who care less about CSR activities (Aupperle et al., 1985; Ullman, 1985). At the other end of the continuum, a contrasting view argues that the benefits of CSR activities significantly outweigh the costs, indicating that firms can effectively enhance their performance by engaging in socially responsible behaviour (Moskowitz, 1972; Parket and Eibert, 1975). As earlier mentioned, this paper argues in favour of the positive view which suggests that socially responsible firms tend to benefit from their socially responsible actions. Davis (1960) argues that some socially responsible actions have a good probability of attracting long-term economic benefits to the corporation. As such these actions should be justified during board debates on whether to undertake socially responsible actions or not. McGuire et al. (1988) in a study analysing “Fortune Magazine’s ratings of corporate reputation” argues that socially responsible actions lead to an enhancement in both stock market based and accounting based measures of performance. Roberts (1992) contends that there is a significant positive relationship between “measures of stakeholder power, strategic posture and economic performance” and CSR disclosure levels. This indicates that firms are motivated to disclose social responsibility reports because of the positive reaction they anticipate receiving from such disclosure.
- Effects of a Positive Statement on CSR issues on the Net Worth of a Company
A positive statement on CSR issues in the annual report is normally expected to have a positive impact on a company. Corporate reputation is an important source of competitive advantage. When a company discloses a positive statement, this increases its corporate reputation and thus its sales potential. Higher sales potential will reflect positively on the company’s share price. By issuing a positive statement, the company reiterates its commitment to meeting the needs of the different stakeholders and not just those of shareholders. As earlier mentioned, stakeholders include employees, customers, local communities, government, NGOs and activists. Each of these stakeholders has their own, specific and self-interested expectations from the company. By demonstrating a commitment to meeting their various requirements through the issue of a public statement on corporate social responsibility, the company arguably gains more trust from multifarious stakeholders. Customers can thus be more confident that the goods and services provided by the company are in line with regulatory requirements: for example, companies are increasingly required to disclose the calorie content of their food products, and how they are produced, and by whom in a personalised ‘touchy-feely’ way, so as to enable customers to determine whether these products suit their individual needs and wants. A company that fails to disclose such information may well witness declining sales because customers concerned about their calorie intake, or animal or environmental welfare and where their food comes from, may not buy from such companies. For example, a Muslim would probably not buy a product if he/she is unclear about whether the product contains pork: thus, it is essential for companies to make such disclosures clearly in all labelling. In addition, NGOs and activists usually confront organisations with regards to their actions and the effects on society and the environment. By disclosing positive information, NGOs and activists can be more convinced that any given organisation is committed to meeting minimum requirements with regards to CSR, although a cynic may say it’s all about the bottom line in the end and this is all really a form of advertising and marketing designed to reassure potential customers. Adopting human resource programs aimed at enhancing employee personal development, developing and adopting non-animal testing procedures, reducing pollution, and reducing CO2 emissions represent examples of CSR activities that go beyond what is required by the law (McWilliams and Siegel, 2001). An organisation that demonstrates a commitment toward improving the living standards of society as a whole rather than satisfying only the interests of shareholders is more likely to remain competitive as opposed to one that fails to act in this manner. Consequently, disclosing this information in the annual report can greatly enhance an organisation’s performance. For instance, an organisation which adopts progressive human resource management programs aimed at helping employees achieve personal development is more likely than not to attract skilled labour as opposed to one that fails to adopt such strategies. As Chris (2003) states:
“Companies that make the transition from focusing exclusively on shareholders to managing for stakeholder satisfaction will survive consolidation and attrition in today’s market place and become leading actors in the global world of the twenty-first century” (p. 6).
In addition, Ryzaburo Kabu, Honorary Chairman of Canon Inc states that:
“Global corporations rely on educated workers, consumers with money to spend, a healthy natural environment, and peaceful existence between nations and ethnic groups…. At this watershed period in history, it is in the interests of the world’s most powerful corporations to work for the advancement of global peace and prosperity. To put it simply, global companies have no future if the earth has no future” (cited in Chris, 2003: 5).
It should be noted that firms’ social efforts are not closely monitored: i.e. they can more or less claim whatever they like and express positive intentions so as to follow public opinion without actually doing anything positive. Moreover, few efforts have been made to validate the CSR disclosures by firms. (Ingram and Frazier, 1980: 614). As a result, management can be motivated to distort disclosures to ensure that they are in line with stakeholder expectations irrespective of whether they actually represent what they purport to represent. Disclosures are only useful if there is a correspondence between the disclosures and actual events. Consequently, if the different stakeholders do not perceive such a correspondence, then the social responsibility disclosures will be discounted and thus lead to a negative relationship between corporate social responsibility reporting and firm value. Thus, a company should only disclose information if it is confident that this information represents a true and fair view of its CSR activities. Otherwise, it will not benefit from the increase in value associated with the disclosure of positive information and stakeholders may well feel cheated and betrayed if they later discover that they have been deceived by a firm.
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