Name and ID number: Ingrid Marie Zeiner Marie Therese Johansen Master Thesis - The Effect of Corporate Social Responsibility Announcements on a Company’s Stock Returns and Market Efficiency - Due-date of delivery: 02.09.2013 Campus: BI Norwegian Business School- Oslo Thesis Examination code and name: GRA 19003 - Master Thesis Programme: Master of Science in Business & Economics, Major in Finance Supervisor: Ilan Cooper “This thesis is a part of the MSc programme at BI Norwegian Business School. The school takes no responsibility for the methods used, results found and conclusions drawn." Master Thesis GRA 19003 02.09.2013 Table of Content ABSTRACT ................................................................................................................................ II 1. INTRODUCTION .............................................................................................................. 1 1.1 CORPORATE SOCIAL RESPONSIBILITY ............................................................................... 1 1.2 MARKET EFFICIENCY ....................................................................................................... 2 1.3 DISCUSSING THE THESIS ................................................................................................... 3 1.4 THE STRUCTURE OF THIS THESIS ....................................................................................... 5 2. RELATED LITERATURE ................................................................................................ 6 3. METHODOLOGY ............................................................................................................. 9 4. DATA ................................................................................................................................ 15 5. EMPIRICAL RESULTS .................................................................................................. 18 5.1 RESULTS OF ABNORMAL RETURNS .................................................................................. 18 5.2 RESULTS OF CUMULATIVE ABNORMAL RETURNS ............................................................. 23 5.3 DISCUSSING THE RESULTS OF AAR AND CAAR .............................................................. 30 5.4 ROBUSTNESS TESTS ........................................................................................................ 35 5.5 COMPARING AAR AND CAAR BEFORE, DURING AND AFTER THE 2008 CRISIS .................. 36 6. CONCLUSION ................................................................................................................. 41 7. BIBLIOGRAPHY ............................................................................................................ 45 8. APPENDIX: EXHIBITS .................................................................................................. 48 9. APPENDIX: PRELIMINARY MASTER THESIS ........................................................ 51 Page i Master Thesis GRA 19003 02.09.2013 Abstract In this thesis we study the effects of Corporate Social Responsibility (CSR) announcements on a company’s stock returns. We focus on announcements among American corporations from 2005-2012. We perform an event study where we use the Market Model, the Fama & French Model and the Carhart Model, and we look for abnormal returns on a firm’s stock returns. Furthermore, we investigate whether the potential excess returns can be considered an anomaly to market efficiency. We conclude that CSR announcements result in negative abnormal returns, and result in negative cumulative abnormal returns. Furthermore, we conclude that CSR announcements may represent an anomaly to market efficiency. Page ii Master Thesis GRA 19003 02.09.2013 1. Introduction Over the last decade(s), companies all over the world have increased their Corporate Social Responsibility (CSR) efforts. Many companies take the responsibility of contributing to creating a better environment, reducing global warming, improving health- and social situations for poor countries, improving the working conditions for employees, etc., very seriously. Therefore, these companies have established comprehensive CSR programs to combat with many of the serious issues and problems that the world is dealing with; both on a local and global level. However, these CSR plans do not only help improving the world; oftentimes they also increase the value of the respective companies. When a large company has made an announcement about a significant prospective CSR investment, it has been reported that these announcements have led to increasing stock returns for the company (Arx and Ziegler, 2009; Cellier and Chollet, 2011). However, is this really the case? Do CSR announcements actually increase stock returns of a company, even though these CSR programs oftentimes cost the business a large amount of money without generating directly related revenues? In this thesis we will investigate the relationship between companies’ CSR announcements and the development of the stock returns of these companies. More specifically, we will examine whether the firms experience abnormal returns which can be related to the CSR announcement. We will see whether historic data from 2005-2012 can show that CSR announcements create abnormal returns, and if they may be considered an anomaly to market efficiency. Thus, the research question for this thesis is as follows: “Does a Corporate Social Responsibility announcement among American multinational companies over the last seven years indicate abnormal returns? If so, can this be considered an anomaly to market efficiency?” 1.1 Corporate Social Responsibility There are many definitions of CSR, several of which include the fact that CSR is considered to be a firm’s responsibility and commitment to the society and the firm’s stakeholders. This commitment is also seen as a contribution which exceeds what is actually required from a firm by different legal aspects and expectations form regulators (Investopedia 2012). We will use the following Page 1 Master Thesis GRA 19003 02.09.2013 definition of CSR in our thesis, as we feel that this statement comprehensively involves important aspect of corporate social responsibility: “A process to integrate social, environmental, ethical and human rights concerns into their business operations and core strategy in close collaboration with their stakeholders” (EU Commission 2012). CSR can be divided into five different dimensions (Dahlsrud 2006), where each of the dimensions will define CSR regarding different criteria and thus make distinct areas of CSR. The five dimensions are of environmental, social, economic, stakeholder and voluntariness characters. We choose to focus on the two dimensions of environment and social CSR efforts only. This is due to the fact that these are the most common CSR efforts, and we want to research the effects of what is “most commonly done” in the market place. Furthermore, we have an interest in focusing on these two types due to the fact that two previous studies on the US market have found different effects of CSR investments in these two dimensions. Bird et al. (2007) found that investments above minimum requirements in social and environmental CSR efforts were punished in the American market in the time period of 1991-2003, while Arx and Ziegler (2009) found that investments into these two dimensions were positively valued in the American market in the time period of 2003-2006. Thus, it will be interesting to compare and contrast our findings to these two studies. The two dimensions of environmental and social CSR consider CSR regarding “the natural environment” and “the relationship between the business and the society”, respectively. The environmental dimension contributes to a better environment by for example introducing recyclable products, while the social dimension contributes to a better society by for example providing school books for children in primary schools. 1.2 Market Efficiency An efficient market is a market where stock prices reflect all available information. One can separate between weak, semi-strong and strong form market efficiency. Weak form means that stock prices reflect all information available by examining market trading data, a semi-strong form means that prices additionally reflect all public information about the prospect of a company, while strong form means that stock prices reflect all information relevant to the company; including Page 2 Master Thesis GRA 19003 02.09.2013 inside information. We will refer to market efficiency as a semi-strong form in this thesis. New information is immediately embedded into the prices, and the only way to obtain higher expected returns is to take on higher risk. Thus, neither technical nor fundamental analysis should be able to give investors abnormal returns, as abnormal returns represent returns above what is justified by risk (Bodie, Kane and Marcus 2011, 371-402). Anomalies to market efficiency represent patterns of returns that seem to contradict market efficiency. Easily accessible statistics such as a stock’s P/E ratio, dividends announcements and book-to-market size sometimes seem to give abnormal returns above what is justified by risk, and can represent anomalies to the efficient market hypothesis (Bodie, Kane and Marcus 2011, 371-402). For example, when a firm has a dividend announcement, the stock prices may rise and the investors may be able to get increased returns when investing in this company. This increase in returns is not caused by increased risk of the company, but by the announcement of a dividend distribution. Hence, investors experience abnormal returns above what is justified by the risk of a certain company, and the dividend announcement acts an anomaly to market efficiency. In this study we are going to examine whether we may claim that a company’s CSR announcements provide a company with abnormal returns, and also if CSR announcements represent an anomaly to market efficiency. 1.3 Discussing the Thesis CSR has become a central theme for most American corporations, and many executives, investors and researchers question the effects of CSR on a company’s financial performance. It is important to get an estimate of the financial effects of CSR, as this is likely to have an impact on future CSR efforts by various corporations. CSR efforts are undoubtedly important around the globe, and contribute to improving or solving numerous issues that the world is facing. If researchers and experts are able to prove that CSR efforts not only improve the world, but also have a positive impact on a firm’s financial performance, it is more likely that firms will continue to maintain, and hopefully expand, their CSR programs. Thus, the importance of this research topic cannot be underestimated, Page 3 Master Thesis GRA 19003 02.09.2013 as positive results and valid evidence may contribute to improving the world through increased CSR efforts. In this thesis we will proceed with an event study to examine whether CSR announcements create abnormal returns and may be an anomaly to market efficiency. There are 68 announcements in the data set of this thesis. Our contribution to existing literature lies in the way that we will combine the various specifications in our study; meaning how we will combine the time frame of data collection, methods and data. Our main specifications are as follows: 1) we will look at the effects of CSR for American companies from 2005-2012, 2) we will analyse the effect of the companies’ CSR announcements themselves; and not the overall rating of companies’ CSR programs; and 3) we will use the CAPM, the Fama & French Model and the Carhart Model. While some of these specifications have been applied in previous studies, the way that we combine them in this study makes our thesis unique. Thus, it is interesting to see the results from this study, and how they coincide with existing literature on the topic of CSR’s effect on financial performance. Before performing all the analyses of this thesis, we expected that CSR announcements would have a positive effect on a company’s abnormal returns, and that CSR announcements would be an anomaly to market efficiency. There were several reasons why we expected to make this observation. First, it is because firms can create positive publicity and reputation by contributing to society. This is likely to improve people’s impression of the company, which can lead to increased sales, more investors, improved supplier deals, etc. Overall, this can lead to higher earnings for the company, which furthermore can have a positive influence on the stock return of the company. Second, performing CSR efforts may have a positive signaling effect towards the investment community. The fact that a firm is able to invest in CSR programs signals that the firm has sufficient funding for investment into projects that do not generate directly related returns. This furthermore signals financial stability which will be positively valued by the market, and this may increase the stock return of the company. Additionally, the fact that a company performs CSR may make people wanting to associate themselves with the company, which furthermore may help firms recruit new and talented employees. Thus, CSR activities might attract more employees Page 4 Master Thesis GRA 19003 02.09.2013 with higher qualifications, which increases the overall quality of the workforce and hence the company as well. Although there are many reasons why CSR investments can be positively related to stock returns, there are also some reasons why there might be a negative relationship. First and foremost, CSR efforts are generally expensive. They do not generate any directly related income, which means that CSR investments may be seen as pure expenses for a company. This can decrease the profitability of the company, and thus the investment community might see CSR investments as something that lowers the financial value of a company, and the stock returns of a company may thereby decrease. Furthermore, CSR efforts can in some situations create negative publicity for a company if the company is accused of doing CSR “only for creating positive publicity and higher returns” rather than for the “good will”. This negative publicity can lead to loss of customers and investors, and this is likely to have a negative effect on a company’s stock returns. After having performed all the analyses in the thesis, we observed that our conclusions are opposite from our expectations; we mostly found a negative relationship between CSR announcements and abnormal returns. Also, the Market Model and the Carhart Model have very similar results, yet surprisingly provide different results than the Fama & French Model. Overall, we find mostly negative abnormal returns and negative cumulative abnormal returns. Therefore, we conclude that CSR announcements result in negative abnormal returns for a company, and may be considered an anomaly to market efficiency. 1.4 The Structure of this Thesis This thesis will have the following structure: in section two we will introduce the main findings of related literature on this topic. In the third section we will present the methodology of our research, and will go into the details of the event study. In section four we will present the data that we use in our research. Furthermore, in section five we will present and analyse the empirical results of our study, and we will proceed to conclude the thesis in section six. We will also include a detailed bibliography and appendix in the end of the thesis. Page 5 Master Thesis GRA 19003 02.09.2013 2. Related Literature During the recent decades, the amounts of CSR efforts that companies have commit to have grown significantly, and discussions about the wider effects of these social actions have risen. Several claimed that such CSR programs influenced the value of the companies in a positive manner, and this incentivised researchers to further examine the relationship between companies’ CSR programs and the value of the respective companies. Thus, previous research does exist on the topic of this thesis, and the researches vary in their findings. Some studies have results indicating that CSR affects returns positively; others claim that CSR affects returns negatively, while some also claim that CSR does not really have an effect on financial returns at all. Furthermore, some studies looked at all CSR dimensions as one whole, while some studies separated between the different dimensions of CSR. In this literature review we will present several studies that have performed various studies and present various findings. Brammer, Brooks and Pavelin (2006) researched the relationship between corporate social performance and stock returns in the UK for the time period of 2002-2004. Their main finding was that firms with high scores on CSR (meaning that they have invested quite significantly in CSR) have lower stock returns, while companies with the lowest possible score on CSR outperformed the market and experienced abnormal returns. Thus, this study found that CSR investment is largely destructive on shareholder value. The study also differentiated between social, environmental, employment and community CSR performance. It found that social CSR efforts tend to perform the worst relative to stock returns, sequentially followed by environment, employment and community CSR activities. Bird et al. (2007) researched what CSR activities are valued by the market in the US, and had a time frame of data collection from 1991-2003. They researched the five dimensions of community, diversity, employee relations, environment and product both on the scale of strengths and concerns; implying ten dimensions all together. Their main finding was that the market seems to value most firms that satisfied only the minimum requirements of the dimensions of environment and diversity (mostly as required by law), and that the market punished firms that Page 6 Master Thesis GRA 19003 02.09.2013 exceeded minimum investment in environmental CSR efforts. They also found that the social dimension was no longer being valued, and that the market is most proactive towards CSR in the dimension of employee relations. Furthermore, they found that the market’s attitude towards CSR activities change over time, and that the activities recently being valued by the market appear to be diversity, and employment. Finally, they also found evidence to suggest that companies being identified in the market as having a wide spectrum of CSR activities are being rewarded in the market place (and vice-versa), indicating that there are reputational benefits (and costs) related to CSR programs. Arx and Ziegler (2009) measured the effect of corporate social responsibility on stock performance in the US and in Europe for the time period of 2003-2006. Their analysis showed that financial markets do value environmental and social activities of a firm compared with other firms within the same industry. Furthermore, they found that the positive effects on average monthly stock returns seemed to be more robust in the US rather than in Europe. Arx and Ziegler used three different models in their study; including the CAPM, Fama & French Model and the four-factor Carhart Model. They found that the results were more significant for the simple CAPM than for the Fama & French and the Carhart Models. Cellier and Chollet (2011) measured the impact of CSR rating announcements on stock prices on the European Market from 2004-2009 on short term European stock returns. Their study showed that CSR really matters for financial markets, and that different CSR components have different effects on the stock prices. CSR announcements regarding human rights seem to have a positive effect, environment and human resources seem to have a negative effect, while community involvement has a mixed effect. Mollet and Ziegler (2012) measured the impact of socially responsible investing (SRI) on American and European stock markets in the time period of 1998-2009. They used the four-factor Carhart Model, including risk factors for common market return, size, value and momentum. The researchers found that SRI is mostly related to large-sized firms. Furthermore, they also found that when all four risk factors are included, there was no evidence suggesting that SRI was Page 7