Does investing in CSR boost a company's value?
03 June 2019
By Chendi Zhang
By the end of the financial crisis in December 2009 the Conservative party estimated almost 27,000 businesses in the UK had gone into liquidation or been declared insolvent.
Meanwhile, the US had seen three of its biggest banks go to the wall in Lehman Brothers, Washington Mutual and Bear Stearns and The Treasury Department injected $412 billion into banks, carmakers and other struggling companies, while investors saw $8 trillion dollars wiped from the stock market between late 2007 and 2009.
The Great Recession was the severest example of a systematic risk to businesses since the Great Depression of the 1930s – that is the risk from macroeconomic factors beyond the influence of an individual organisation.
It means planning for the next systematic shock should be a priority for investors, especially those surveying the UK’s imminent exit from the European Union, the world’s biggest free trade zone. Plus, investors know systematic risk is the main driver of their portfolio as idiosyncratic risk – that at the firm level – can be diversified away.
My research with Rui Albuquerque, of Boston College, and Yrjo Koskinen, of the University of Calgary, has discovered one avenue for investors to futureproof their portfolio against recessions and economic shocks and that is Corporate Social Responsibility (CSR).
By developing an industry equilibrium model within an asset-pricing framework, and analysing the performance of 4,670 US listed companies from 2003 to 2015 - and so covering the Great Recession - we have found that investing in CSR reduces a firm’s systematic risk.
This is because firms investing in CSR face relatively less price-elastic demand – that is demand for their goods does not fall that much with a price hike - so they can have higher product prices and retain higher profit margins.
It was thought because of this more firms would adopt CSR policies and so with every firm increasing their costs it would wipe away any reduction in systematic risk.
But our model found that there is a limited amount of consumer spending on CSR products and so limiting the number of companies that can effectively adopt it. Thus, we found that CSR firms had lower systematic risk compared to companies who had not invested in CSR, with this backed up by us also finding that those invested in CSR saw their profits not as affected by the boom and bust business cycle.
Customers are more loyal because they appreciate the firm’s green credentials and environmentally and socially responsible products, which are in line with their values and concerns about sustainability, so they are not so swayed by price.
Can investing in CSR help companies during a recession?
In fact, environmentally conscious consumers are willing to pay a premium for products like organic food or electric vehicles, with CSR becoming a form of differentiation for firms. For those companies in tune with the changing demands of society and growing concerns around climate change, they can build a loyal customer base, making profits more stable and less correlated with economic cycles, which reduces their systematic risk and in turn increases firm value.
And the impact on firm value is substantial, with an average increase of five per cent across the firms we studied. Investing in CSR is akin to an insurance policy to make a company less sensitive to economic cycles.
In the model we created, we assume investors are not interested in CSR and are instead standard investors only interested in their risk and returns, so what is generating our results are consumers. And as they are the driving force our model predicts the reduction in systematic risk is 40 per cent stronger for consumer-facing companies, especially as these firms spend more on marketing, which will amplify the effect of CSR. And the effect on firm value for these firms is 20 per cent stronger.
To come to this startling conclusion we used investment analyst company Morgan Stanley Capital Investments’ ESG (Environmental, Social and Governance) research database, which has assessed around 6,800 companies, to construct an overall CSR score for each of the 4,670 firms in our study each year. The score combines information on the firm’s performance across community, diversity, employee relations, the environment, product and human rights attributes.
Combining this with the firm’s Capital Asset Pricing Model, which measures a stock’s expected rate of return compared to its risk, and a company’s beta, a measure of its systematic risk, we created a model to measure CSR firms and non-CSR firms. We then controlled for many factors and tested the causality, but found the link between CSR and systematic risk still strong.
Of course not all CSR is geared towards customers, but employees as well. Further research I have done has discovered that higher job satisfaction among staff leads to higher share prices and so investing in CSR could also lead to other spin-off benefits.
The case is growing for companies to invest in CSR. In fact in this increasingly fast-changing and volatile world with trade wars escalating and the rise of populism across the developed world, is not investing in CSR a risk worth taking?
Albuquerque, R., Koskinen, Y. and Zhang, C. (2018) "Corporate social responsibility and firm risk : theory and empirical evidence", Management Science.
Renneboog, L., Ter Horst, J. and Zhang, C. (2011) "Is ethical money financially smart? Nonfinancial attributes and money flows of socially responsible investment funds", Journal of Financial Intermediation, Vol.20, No.4, 562-588.
Chendi Zhang is Associate Professor of Finance and teaches Corporate Finance on the Executive MBA and Executive MBA (London). He also lectures on Mergers and Acquisitions on the Undergraduate programme.
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