Over 30 years of research on the relationship between corporate social performance (CSP) and financial performance (FP) has yielded no conclusive results. Researchers have tried to legitimize (or discredit) social performance on the basis of its surmised impact on corporate profitability. However, the empirical evidence on the topic has been as divisive as the theoretical propositioning. By reviewing the theory and evidence on the topic, this article puts forth four intertwined propositions that could be confounding these results: failure to consider the impact of corporate governance, lumping together all sorts of expenditures under the rubric of social performance, failure to consider the stakeholder relationships, and above all, not accounting for the past reputation and stakeholder influence capacity of the firm. In particular, we contend that it is the employment relations that run like a common thread among these factors and hold the key to the dynamics of CSP-FP link.
Before proceeding further, however, let us briefly review the past literature. There are two dominant and competing strands of research on corporate social performance. The first, agency theorists, believes that the only social responsibility for the business is to make money for its shareholders. This is best exemplified by the oft-quoted Milton Friedman’s (1962) statement: the business of the business is to do business. From this perspective, managers are the agents for the owners and their role is to make money for them. If the corporation achieves its economic goals, it has fulfilled all its social responsibilities. Any expenditure on social causes is tantamount to managers using their excessive discretion and squandering the shareholders’ money away on the projects that only enhances their own prestige.
The stakeholder theorists, on the other hand, believe that the managers are responsible not just to shareholders but to all stakeholders. Therefore, when managers undertake projects aimed at fulfilling their obligations to society at large, they enhance the value and reputation of the corporation. However, this argument is countered by the agency theorists with a claim that if shareholders want to do any good, they can choose to do so by themselves and that they do not need managers to do good on their behalf.
There is a sharp divide in the empirical literature as well. It would be pertinent to mention some classical and recent studies; Moskowitz (1972), Orlitzky, Schmidth, and Rynes (2003) and Waddock and Graves (1997) all found that the CSP and FP are positively related. Researchers like Bromiley and Marcus (1989) and Vance (1975), on the other hand, found that the firm performance was negatively related to the socially responsible behavior. Yet another stream in research believes that there is no relationship between CSP and FP (e.g., Alexander & Buchholz, 1978; Seifert, Morris, & Bartkus, 2003). This divide can be adduced further by citing a large number of similar studies, over 150 at last count, that have been carried out since 1975 with equally equivocal evidence.
This equivocal evidence has important implications both for the practitioners and the researchers. Should the managers focus just on shareholders’ interests? Should they ignore all other demands placed on them? But, would it not affect the long-term sustainability of the firm? Are there any circumstances where higher CSP itself can be considered in the interest of the shareholders? Managers would like to know since their performance hinges on receiving the satisfactory answers to these questions.
Key Terms in this Chapter
Absorptive capacity: A firm’s ability to assimilate and apply new knowledge in conjunction with its past knowledge. The concept has been made use of in such fields as organizational learning, innovation, risk-taking, and human resource management.
Corporate Governance: The processes, laws, and institutions that determine the way in which a corporation is managed. In the Anglo-American model, its primary function is to ensure that the rights and interests of owners are protected against misappropriation by the managers; frequently referred to as agency problem caused by separation of ownership and management in the modern corporations. In Europe and rest of the world, corporate governance is often viewed from a broader stakeholder perspective.