Understanding the need for corporate social responsibility

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Corporations' ultimate goal is to maximize profits and shareholder wealth. Thus, corporations definitely care about whether discharging their social responsibilities would jeopardize the pursuit of profit. Today's investors do not only focus on how a business is doing financially, but also on how a business responds to social interactions. This requires modern businesses to strike a balance between profit maximization and discharging social responsibilities. This paper reviews literatures from the birth of the CSR concept to the empirical research proving that discharging social responsibility has a positive impact on businesses' financial performance, thus an integral part of wealth maximization. In the process, the development of CSR theories and other derivative theories regarding this topic are also reviewed. Finally, with the empirical evidence from researches on the relations between CSR and financial performance, a conclusion is made that discharging corporate social responsibility and financial performance are positively related.

Executive Summary

As business evolves, people focus more and more on corporate ethical behavior. The extent of discharging corporate social responsibility has been used as a critical measurement of a company's overall performance along with financial performance. This growing trend attracted many researchers trying to find out whether there was relation between corporate social responsibility and financial performance, or they were only isolated. Nevertheless, since the introduction of the concept of CSR in the 1950s, arguments never stopped.

This paper reviewed the development of corporate social responsibility. In the 1950s, researchers began to define corporate social responsibility. Since the concept was just introduced, definition was quite unified. Later in the 1960s, researches on corporate social responsibility grew more popular. The concept was widely extended. A fierce debate, however, was ignited in the 1970s. Difference of opinions arose. Researchers could not agree on the definition of corporate social responsibility. Thus, in this phase, the theory of corporate social responsibility grew very fast. As opinions went differentiated, researchers realized focusing only on the definition of the concept would not go a long way. Thus, in the 1980s, researchers began to seek the practical application of the theory, especially the effect of CSR on financial performance which was paid a lot of attention by entrepreneurs. In the same decade, many derivative theories were established. In the 1990s, mainstream empirical research showed that there was a positive relation between CSR and financial performance. A new opinion was formed that corporations should integrate CSR into strategic management. As Berman et al. (1999) asserted, CSR could build up strategic advantage. Finally, this paper raised possible improvements for empirical research in this area.

Development of Corporate Social Responsibility

Adam Smith and other economists who believed in free market economy believe that "only when the entities of a society were allowed to pursue maximum wealth and profits to the utmost and society's resources were automatically allocated by the "invisible hand", could the greatest social welfare be achieved "(Windsor, 2001). This point of view had been highly thought by both researchers and entrepreneurs as the single goal of businesses was to maximize profits. Friedman (1970) believed that corporations had and only had one social responsibility which was to follow professional ethics and increase profits by participating in open, fair and free competition. Under this guidance, corporate social responsibilities were ignored.

However, the Great Recession in 1929 prompted people to rethink the classic free economy. From then, Keynesian School was gradually accepted by most economists and entrepreneurs. They almost conformably believed that modern businesses were not merely entities existing to pursue profits, rather in an open and multifunctional system. Modern businesses conduct productive and operating activities in an interdependent social circumstance which means that, as pursuit of profits is a major aspect of corporation market behaviors, the responsibilities assumed by corporations should be beyond the results of profit maximization. Economists such as Andrews believed that corporations should be dedicated to not only maximizing shareholder wealth, but philanthropy, applying moral standards beyond laws and customs and improvement of quality of life (Windsor, 2001). Drucker (1984) also thought that corporations were "organs of a society"; their very existence was to meet the demands of society, communities and people as a whole.

Beginning of Corporate Social Responsibility

Under that circumstance, the concept of corporate social responsibility was brought forth. The theories and practice regarding corporate social responsibility have been developing and exerting profound influences on modern businesses, even the society. The landmark work by Bowen (1953), "Social responsibility of the Businessman", was thought to be the opening of the era of corporate social responsibility. His theory stemmed from the point that hundreds of the biggest entities of the society were centre of power and decision-making, so the behaviors of these entities would involve every aspect of civilian life (Bowen, 1953). Bowen initially defined social responsibility of businessman as decisions made, policies adopted and actions taken should be in accordance with the objectives and values of the society as a whole. The Fortune magazine undertook a survey showing that 93.5% of the businessmen who were surveyed agreed with Bowen's definition of social responsibility. The definition by Bowen represented major theoretical researches in the 1950s. Heald reviewed relevant researches and discussions on corporate social responsibility during the period from 1900 to 1960 in his work, "The social responsibilities of business: Company and community, 1900-1960". Heald found that Bowen's point of view was in accordance with the mainstream of both academia and practice circles (Heald, 1970).

Extension of Corporate Social Responsibility

In the 1960s, researchers aimed to strictly define corporate social responsibility. The first and the most influential researcher of that period was Davis. Davis (1960) believed that social responsibility was a general concept which must be interpreted in the context of management. He also asserted that discharging corporate social responsibility would be justified in the long-run because it would bring corporations long-term benefits as a reward of discharging social responsibility. Later, he proposed the famous "Law of responsibility"-the social responsibility of businessman must match his influence on the society (Davis, 1960). Further he mentioned that if social responsibility and influence were in equilibrium, avoidance of social responsibility would lead to deterioration of influence. Because of the magnificent contribution by Davis to the study of social responsibility, he was thought to be the successor of Bowen's research. Frederick, another famous researcher, believed that social responsibility meant that businessmen should look at economic operation from the level of fulfilling public expectation. This meant that production should aim to increase the welfare of the society. Social responsibility implied using resources to meet demands of society rather than simply serving personal willingness (Frederick, 1960). McGuire made such statement in his book "Business and society", corporations have responsibilities towards society besides the economic and legal ones, and the responsibilities towards society are extended from the economic and legal ones (McGuire, 1963). Thus, he believed that corporate behavior should be as legitimate as citizens'. In Davis further researches, he was trying answer "what businessman owes to the society" (Davis, 1967). Based on his definition, he went further proposing that the essence of social responsibility was the attention paid to the ethical result of that the behavior of one party might have influence on the interest of the other parties (Davis, 1967). He also believed that social responsibility extended people's horizon to the whole society (Davis, 1967).

Divergence of Corporate Social Responsibility

In 1972, a fierce debate on the definition of corporate social responsibility was ignited between Manne and Wallich. Manne believed that any viable definition must include three elements, the action to discharge social responsibility, the marginal return of the expense must be smaller than that of other options, completely voluntary and true corporate behavior other than personal generosity (Manne & Wallich, 1972). In reality, it's difficult to differentiate the expenses incurred for public interest from the expenses for philanthropic purposes, if not impossible. Researchers also noticed the difficulty that business expenses were with multiple motives, so that the expense factor could not be used as an effective measurement of social responsibility. Nevertheless, the voluntary factor was used by many modern CSR definitions, though it was still difficult to determine whether an action was voluntary or merely a response to social norms. Wallich gave CSR a wider definition; responsibility meant that corporations acted as free entities, and if corporations tried to achieve any objectives that were required by laws, then they would not be discharging social responsibilities (Manne & Wallich, 1972). Wallich's definition also included three factors, setting of an objective, decision to achieve the objective and financial conditions. In 1973, Davis joined the debate. He analyzed and discussed the points of views that were for and against CSR. He quoted two opposite viewpoints of two famous economists, Friedman asserting that recognizing the trend of discharging corporate social responsibility would completely destroy the foundation of free society (Friedman, 1970), and Samuelson believing that not only should corporations assume social responsibilities, but try their best (Samuelson, 1971). Based on these, Davis defined corporate social responsibility; corporate social responsibility involves responses to issues other than economic, technological and legal requirements; evaluating impact on social system by decisions made is an obligation for corporation, in a sense, it realizes social welfare and economic benefit that corporations pursue; social responsibility starts where legal requirement ends, if a corporation merely follows laws and regulations, it obvious does not assume social responsibility because following the law is what any 'good' citizen would do (Davis, 1973). Apparently, Davis strictly defined CSR. In the 1970s, corporate social performance was mentioned more and more as much as corporate social responsibility. One of the main researcher s was Sethi. In his work, he discussed the "dimensions of corporate social responsibility", and categorized corporate social behaviors into social obligation, social responsibility and social response (Sethi, 1975). Social obligation was corporation's response to market and law restrictions. On the other hand, social responsibility was beyond social obligation as it meant to match corporate behaviors to the expectations of mainstream social norms and values. Sethi believed that, in essence, social obligation was mandatory while social responsibility was voluntary. Social response was corporations' adjustment to social demands which was defensive (Ackerman, 1973). In 1975, Preston and Post tried to shift attention from corporate social responsibility to public responsibility in their work, "Private management and public policy". They elaborated on public responsibility as that the scope of management responsibility was not unlimited as indicated by the concept of social responsibility, but rather with clearly defined primary and secondary categories (Preston & Post, 1975). They replaced "social" with "public" emphasizing the importance of the process of public policy. Unlike individual assertion and conscience, public policy could be used as a measurement. Although Preston and Post provided important insights, the concept of public responsibility did not replace social responsibility in later researches. The landmark research of the 1970s was the four segments of corporate social responsibility proposed by Carroll. Researches before Carroll focused the responsibility of businesses which were making profits, obeying the law and responsibilities beyond economic and legal requirements. Carroll believed that the definition must contain all the responsibilities assumed by businesses. Thus, he defined that the social responsibilities of businesses included, at a specific time, society's expectations of economic, legal, ethical and discretionary behaviors of businesses (Carroll, 1979). The nature of business determines that it assumes economic responsibilities. And businesses participate within rules set by society, so society expects businesses to follow laws and regulations. The third part of Carroll's definition expands to ethical behavior beyond legal requirements. Discretionary means the decisions must be made freely or guided by social norms, instead of required by laws.

Less Definition, More Empirical Research

Researches on corporate social responsibility shifted focus from definition of CSR to derivative theories in the 1980s. In 1983, Carroll (1983) adjusted his Four Part definition of CSR. He redefined discretionary as philanthropic with the rationale that philanthropy was the best manifestation of discretionary behavior. What was significant about researches in the 1980s was that researchers grow more interested in the relations between discharging CSR and corporate financial performance, unlike before the focus was on definitions. The typical example would be the research conducted by Cochran and Wood. They noticed that people were keen about whether a responsible corporation was also a profitable one. If research showed positive results, it would enhance and support the CSR theory. Cochran and Wood decided to use "reputation" as a measurement of discharging CSR. They adopted the "Moskowitz reputation index" developed by Moskowitz which rated corporations into three levels, "outstanding", "honorable mention" and "worst companies" (Moskowitz, 1972). Cochran and Wood admitted that there were flaws in this index system which called for new systems for measurement (Cochran & Wood, 1984). Another empirical research on this issue was conducted by Aupperle, Carroll and Hatfield in 1985. What was unique was that definition structure of CSR was, for the first time, introduced as a measurement. They categorized Carroll's Four Parts Definition into economic orientation and social orientation which represented economic responsibility and legal, ethical and discretionary responsibility respectively (Aupperle, Carroll & Hatfield, 1985). In the 1980s, there was another stream of research that accepted corporate social performance as a wider theory which included CSR. Wartick and Cochran extended the "Three dimensional conceptual model" developed by Carroll. The "social responsibility", "social responsiveness" and "social issues" were extended into "principles", "processes" and "policy" (Wartick & Cochran, 1985).

Derivative Theories

In the 1990s, corporate social responsibility theories did not develop much. It was more considered and used as basis for other relevant theories and concepts. The main development would be the modification of CSR model by Wood (1991). She based the modification on the new "three dimension" model by Wartick and Cochran, and formed three principles. The CSR principle adopted the Four Part Definition by Carroll and further identified the connection between public responsibilities on organizational level. For the process of social responsiveness, she used environmental analysis on regulation level. She then redefined Wartick and Cochran's policy dimension as "orientation-result" dimension. Wood's model was more detailed than Carroll's and Wartick's. The significance of Wood's model was that she emphasized results of corporate behavior which was only implied in earlier models. In 1991, Carroll perfected his Four Part Definition changing "discretionary" into "philanthropic", and asserted that responsive businessmen accepted corporate social responsibility, so it was necessary to provide a framework to contain all aspects of business responsibilities (Carroll, 1991). In the same article, Carroll pointed out that CSR had a natural connection between the stakeholders of an organization. The ambiguity of the concept of CSR had been criticized. However, the stakeholder concept asserted by Freeman (1984) corrected that ambiguity. Carroll bridged the gap between classic CSR theory and stakeholder theory. From the 1990s till today, three derivative theories from CSR attracted most of the researchers' attention. The emphases had been focused more on empirical researches on the relation between CSR and financial performance. As researches went on, people found that there was positive relation between the two.

Corporate Social Responsibility and Financial Performance

There are two basic types of empirical researches on relations between CSR and financial performance. One type use specific corporate behaviors as measurement of discharging corporate social responsibility. The other use corporate social performance as measurement (McWilliams & Siegel, 2000).

Corporate Social Responsibility Behavior and Financial Performance

In the 1980s, American corporations withdrew investments from or terminated businesses in South Africa because of the racial segregation policy. Some of the researchers used this case with the rationale that investing in a country adopting racial segregation would be against corporate social responsibility. American corporations publicly announced their decisions to withdraw or terminate businesses. So researchers chose certain period before and after the publication of the announcement, and observed the abnormal fluctuation of return on investment of the two periods, in order to analyze the impact of the announcement. However, results were not quite desirable. Wright and Ferris (1997) found that corporations' declaration of withdrawal led to significant decrease in return on investment. Posnikoff's (1997) research told an opposite story; withdrawal from South Africa, which was an ethical behavior, led to significant increase in return on investment. Teoh, Welch and Wazzan (1999) found that the declaration had no distinctive impact on return on investment. The same situation also appeared in Clinebell & Clinebell's research on closing down plants with advanced notice (Clinebell & Clinebell, 1994), Hannon & Milkovich's research on good reputation of human resource policy (Hannon & Milkovich, 1996), and Worrell, Davidson & Sharma's research on dismissing personnel without notice (Worrell, Davidson & Sharma, 1991). Results from these researches also varied, showing no consistent relation between CSR and financial performance. The main reason for the inconsistency was flaws in the methodology. In the business operating environment, many variables could influence return on investment. It was necessary to rule out the influence of other variables so that the true influence of CSR behaviors on return on investment could be identified. Also, timing was an important variable. In the South Africa research, Wright and Ferris chose a period of ten days while Posnikoff chose 250 days and Teoh used a period of 200 days. Different timing would lead to inaccurate analysis. Industries of the analyzed corporations were different causing low comparability. Finally, specific CSR behavior could differ which again decrease comparability. Since researches on specific behavior had gone unsuccessful, researchers gradually turned to the second type of research.

Corporate Social Performance and Financial Performance

In 1985, Aupperle, Carroll and Hatfield chose corporations from the Forbes list using 117 indices derived from Carroll's Four Part Definition. They examined the relations between "social orientation" type of responsibility and corporations' short-term and long-term financial performance. They used one-year return on investment and five-year return on investment as measurements of short-term and long-term financial performance respectively. From the results, they found that there was no significant relation between discharging CSR and profitability in long term or short term (Aupperle, Carroll & Hatfield, 1985). In 1982, Fortune magazine conducted annual survey on corporate social performance of top ten corporations of all industries. In 1988, McGuire, Sundgren and Schneeweis used the results from this survey as evidence to conduct evaluation of corporate social performance. They used return on investment, total assets, sales growth rate, asset growth rate and revenue growth rate as financial performance measurements. Also, they collected data from 1977 to 1984 with the belief that corporate social responsibility had relations with prior financial performance as well as current financial performance. The results showed that CSP of 1983 to 1985 was not related significantly with financial performance of 1982 to 1984, which meant that CSP did not have significant relations with current financial performance. However, it showed that CSP had positive relation with prior financial performance because financial performance of 1977 to 1981 had significant positive relation with CSP. The interpretation was that prior financial performance could influence current social performance. If prior financial performance was desirable, current social performance would also be at a relatively higher level, and vice versa (McGuire, Sundgren & Schneeweis, 1988). The research by Waddock and Graves in 1997 showed satisfactory results. They used data of the S&P500 companies from KLD database and evaluated the current social performance of these companies. The financial performance measurements were similar to what McGuire used. They found out that not only could prior financial performance influence current social performance, current social performance also showed significant positive relation with subsequent financial performance. Better financial performance depends on better social performance (Waddock & Graves, 1997). This was the result that all researchers would like to see. Further researches went on, and they tended to include more aspects of corporate social responsibilities to derive more robust results.

Summary and Conclusion

Judging by theoretical and empirical researches done so far, corporations discharging social responsibilities can enhance financial performance significantly. Unlike what businesses worry about that it might negatively impact corporate performance. Indeed discharging social responsibility would increase operating costs, but it can still enhance performance more than it costs. Because it helps corporations build up differentiation strategic advantage even though it weakens cost advantage. Strategically speaking, this is an even more advanced competitive advantage by embedding discharging social responsibility directly into corporate strategy as an integral part of wealth maximization. Berman et al. (1999) conducted empirical research on a strategic level showing how integrating CSR into strategy could improve financial performance. There are, however, improvements in the methodology that need to be addressed. First of all, when researchers collect data, they need to understand what the variables that can truly reflect the extent of discharging corporate social responsibility are. It is important for the viability of the research to exclude and control disturbance variables. Secondly, timing should be carefully chosen in order to truly reflect the influence of CSR on financial performance. Thirdly, industries should be chosen with caution as different industries might have different orientations.