CSR or Just “Good Management” — Which Drives Financial Performance?

CSR and profit are difficult to link. Firms are better off focusing on overall good management than striving for index listings and third-party ratings.

Managers often anecdotally claim that their firm’s investments in CSR initiatives have “paid off.” But much of the research seeking to quantify the effects of CSR on a company’s financial performance suggests the relationship is mixed.

CSR and Profit: The Missing Link

Why do some studies show CSR helps the bottom line, while others say it does not? Roberto Garcia-Castro, Miguel Ariño, and Miguel Canela (all from IESE Business School) suggest that critical variables are missing from studies that examine the relationship. They argue that social performance and financial performance are driven by hard-to-measure variables like culture, quality of top management, decision-making styles, and values.

Valuing Firm Intangibles

Garcia-Castro and his co-authors claim the relationship between CSR and financial performance is complicated by what researchers call the “endogeneity problem”: managers make decisions in accordance with a firm’s culture or organizational structure, for instance, which in turn affects how they expect their choices will impact the firm’s performance. Thus, both CSR and financial performance are driven by elements fundamental to the firm, and the decision-making processes of individual managers.

The authors examined 658 firms using data from the independent rating agency KLD (on employee relations, customer/product issues, community relations, diversity issues and environmental issues) and Datastream between 1991 to 2005.

To test their hypothesis, the authors developed a new model in which firm-specific factors account for part of financial performance. When the researchers included factors like executive compensation and the firm’s public visibility, the positive relationship between CSR and financial performance that had been observed, disappeared.

The results suggest that it is not measures of CSR per se that impact financial performance. The same factors drive firms to choose policies that enable financial performance and lead to high rankings in social indices. The KLD ranking is therefore not a driver.

Scrap CSR? Not so fast.

So should managers reallocate the funds earmarked for that new employee engagement program? Absolutely not. This research doesn’t imply social performance cannot drive financial performance; it simply suggests other variables are involved in the relationship.

As a manager you must recognize the role that firm attributes like culture and executive values play in CSR decisions. While an employee engagement program might not drive quarterly earnings, it may play a significant role in the overall good management of the firm.

Ultimately, it is not the rating of an agency or naming to an index that drives financial success. Recognition by a rating organization should not be your goal. Focus on the underlying principles of good management and you’re more likely to realize your economic and social objectives. (For further reading, see the research of Doh et al. in the NBS article “How Third-Party CSR Ratings Impact your Share Price“.)

Source: Garcia-Castro, R., Ariño, M., and Canela, M. 2010. “Does Social Performance Really Lead to Financial Performance? Accounting for Endogeneity.” Journal of Business Ethics. 92: 107-126.

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