Academic journal article Academy of Accounting and Financial Studies Journal

Corporate Social and Financial Performance: A Canonical Correlation Analysis

Academic journal article Academy of Accounting and Financial Studies Journal

Corporate Social and Financial Performance: A Canonical Correlation Analysis

Article excerpt

INTRODUCTION

The relation between a firm's financial performance and its corporate social performance (CSP) has been investigated for more than half of a century (Preston & O'Bannon, 1997), yet the nature of the relationship remains unresolved. One view suggests that greater CSP will manifest in superior financial performance, in part because managers who are more socially responsible are perceived as being more likely to generate profits (Alexander & Bucholz, 1978). A contrary view suggests a negative relation between financial performance and CSP. Although reasons are somewhat varied, at the root is Friedman's (1970) argument that "managerial attention to interests other than those of investors is a breach of trust" (Preston & O'Bannon, 1997, p. 420).

Not surprisingly, empirical evidence also spans the continuum. Some research shows a negative relation between CSP and financial performance (Shane & Spicer, 1983 and Vance, 1975); others show a positive relation (Riahi-Belkaoui, 1992; Waddock & Graves, 1997; Margolis & Walsh, 2003); some suggest no relation (Aupperele et al, 1985; Ingram & Frazier, 1983); and yet others find mixed evidence (Cochran & Wood, 1984 and Coffey & Fryxell, 1991). Griffin & Mahon (1997) and Callan & Thomas (2009) provide a more comprehensive discussion of previous findings. This broad spectrum of findings suggests that the relation between CSP and financial performance may not be consistent across firm-specific contexts and/or for all types of corporate social actions.

Consequently, several causes of these varied findings have been identified. For instance, Waddock and Graves (1997) show that the extent of CSP varies across industries while Russo and Fouts (1997) provide evidence that the relation between CSP and financial performance is related to industry growth. Measurement of CSP has also been at issue because researchers frequently combined multiple aspects of a firm's attributes to arrive at a single measure of social performance. Further complications arise concerning the direction of causation (O'Bannon & Preston, 1993). On one hand, positive financial performance may be the precursor of higher CSP via the availability of slack resources (McGuire et al, 1990). On the other hand, higher CSP may foster better relations with stakeholder groups which, in turn, could lead to higher profitability.

The current research addresses these issues by examining the relation between financial performance and CSP separately for each industry and for positive and negative firm social performance attributes as reported by the Kinder Lydenburg Domini (KLD) ratings data. Further, the analysis is performed using canonical correlation which allows the interpretation of the results without imposing an assumption of causality. Findings suggest that financial performance is related to both CSP strengths and weaknesses (Mattingly & Berman, 2006) but this relation differs across industries. Enhancing our understanding of this relation is important to investors as they strive to assess the performance implications of their investment strategies. Managers also should strive to understand how their actions are related to overall firm value, from the perspective of increasing and maintaining stakeholder wealth.

The remainder of the paper is organized as follows. The next section contains a literature review, identifying the important relationships and variables examined in prior research. The following section describes the variables, the methodology and the results of this investigation. The paper ends with the conclusions and limitations.

LITERATURE REVIEW

Predictions on the relation between CSP and financial performance range from expecting a positive association to the other end of the spectrum of expecting a negative association. One school of thought predicts a positive relation because managers who are effective at social performance may simply have superior management skills and are thus more likely to generate profits (Alexander & Buchholz, 1978). …

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