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Impact of Corporate Social Responsibility on the financial performance of banks

Introduction

In the contemporary globally competitive market companies must portray themselves as socially
responsible companies. Through globalization companies pursue growth, and active
involvement in socially beneficial programs provides competitive advantages to the company in
pursuing such goals. Companies operating in multiple nations are often required to play a
significant role in social issues o the respective nations, otherwise government regulations,
environmental restrictions, labor exploitation issues and more can cost companies millions of
dollars. Under these circumstances, Corporate Social Responsibility (CSR) can increase both
long term profitability and sustainability of the company as well as enhance the reputation of the
organization. The last three decades have seen a mounting pressure on companies to engage
in CSR. Among most global companies, some simply view CSR as a costly hindrance, while a
few have managed to use CSR methodologies as a strategic tactic to obtain public support for
their presence in the global markets. Nevertheless, this helps the companies to sustain a
competitive advantage by using their social contributions. Researchers around the world, over
the past few decades, have reported positive, negative, mixed and neutral impact of CSR on
Corporate Financial Performance (CFP). Building upon this premise, the objective of this study
is to draw a conceptual framework for examining the direction of the linkage between corporate
social responsibility and corporate financial performance and apply the framework on the
banking sector in Pakistan in order to examine the impact of CSR on CFP in this sector.

Objective of the study:

Corporate social responsibility (CSR) is integral to long-term business success. Today's

organizations must be increasingly mindful of the impact that their operations have on
society at large, and this requires much more than isolated measures. In a climate of
heightened social awareness and instant access to information, CSR must be a
fundamental part of company's targeted practices, broad objectives, and overall culture.

This research is designed to help executives fully integrate social responsibility in ways that benefit
both society and business. To learn how to develop an overarching CSR strategy suited to the
unique requirements of company one that addresses the social, economic, and environmental

effects as better position of organization for immediate and future success.

To evaluate the relationship between corporate social responsibility and financial

performance

To evaluate the impact of CSR on environment

To evaluate the impact of CSR on overall Pakistans economy

To evaluate the impact of CSR on society

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To Evaluate the effect of improvement in environmental, economic and social conditions

leads to financial performance of the firm

Research problem:
Financial institutions, such as banks, do not produce hazardous chemicals or discharge toxic
pollutants into the air, land or water and thus apparently they might be viewed as uninvolved
with environmental issues (Cowton and Thompson, 2000). But through their financing practices
they are supporting commercial activity that ultimately degrades the natural environment (Smith,
1993). They act as facilitators by supplying the fund to support the production process which
ultimately causes environmental degradation (Sarokin and Schulkin, 1991). Thus banks should
admit the responsibility of indirect involvement in environmental damages and recognize their
environmental responsibility, which is a part of their CSR, to strike a balance between economic
and social goals to encourage the efficient use of resources. It is not just philanthropy and
obeying the laws, rather an attempt to ensure their own sustainability and profitability (Wanless,
1995). Involvement in environmental degradation will not only invite public criticism and negative
customer reaction, but also might make regulations more stringent which can impair the bank
profitability by curbing market for the products of their customers . For example, the Montreal
protocol has banned the production of ozone-depleting substances, which is threatening for
companies operating in that area and the banks financed these companies.

Research Question:

The following research questions can be addressed in the view of above perspective.

What is the role of banks in measuring the impact of corporate social responsibility on
the financial performance?

Is the relationship between corporate social responsibility and financial performance

positive and significant?

Scope and Significance of the study:

In the contemporary globally competitive market companies must portray themselves as socially
responsible companies. Through globalization companies pursue growth, and active involvement in
socially beneficial programs provides competitive advantages to the company in pursuing such
goals. Companies operating in multiple nations are often required to play a significant role in social
issues of the respective nations, otherwise government regulations, environmental restrictions, labor
exploitation issues and more can cost companies millions of dollars. Under these circumstances,
Corporate Social Responsibility (CSR) can increase both long term profitability and sustainability of
the company as well as enhance the reputation of the organization. The last three decades have
seen a mounting pressure on companies to engage in CSR. Among most global companies, some
simply view CSR as a costly hindrance, while a few have managed to use CSR methodologies as a
strategic tactic to obtain public support for their
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presence in the global markets. Nevertheless, this helps the companies to sustain a competitive
advantage by using their social contributions. Researchers around the world, over the past few
decades, have reported positive, negative, mixed and neutral impact of CSR on Corporate
Financial Performance (CFP). Building upon this premise, the objective of this study is to draw a
conceptual framework for examining the direction of the linkage between corporate social
responsibility and corporate financial performance and apply the framework on the banking
sector in Pakistan in order to examine the impact of CSR on CFP in this sector.

Literature Review

Corporate social responsibility (CSR) is influenced by how businesses align their values and
behavior with the expectations and needs of stakeholders not just customers and investors,
but also employees, suppliers, communities, regulators, special interest groups and society as a
whole. CSR describes a company's commitment to be accountable to its stakeholders. CSR is a
growing term that still does not have a standard definition or a fully recognized set of specific
criteria. CSR is generally understood to be the way a company attains a balance or integration
of economic, environmental, and social imperatives while at the same time addressing
shareholder and stakeholder expectations, with the understanding that businesses play a key
role on job and wealth creation in society. Corporate social responsibility (CSR) has become a
prominent topic in the both business and academic press. Nevertheless, opinions differ as to
whether a firms CSR activity provides any economic benefits.

According to Frankental (2001) CSR is a vague and intangible term which can mean anything
to anybody, and therefore is effective without meaning. On the other hand, The Commission for
the European Communities (2001) defines CSR as a concept whereby companies integrate
social and environmental concerns in the business operations and in their interactions with their
stakeholders on a voluntary basis. According to Wood (1991), the basic idea of CSR is that
business and society are interwoven rather than distinct entities and for Mallenbaker (2006),
CSR is about how companies manage the business process to produce an overall positive
impact on society. More generally, a distinction has been drawn between CSR seen as
philanthropy as opposed to CSR as a core business activity (Jones et al., 2007). Carroll (1979)
observed that the social responsibility of business encompasses the economic, legal, ethical,
and discretionary expectations that society has of organizations at a given point in time.

CSR in Banks

Financial institutions, such as banks, do not produce hazardous chemicals or discharge toxic
pollutants into the air, land or water and thus apparently they might be viewed as uninvolved
with environmental issues (Cowton and Thompson, 2000). But through their financing practices
they are supporting commercial activity that ultimately degrades the natural environment (Smith,
1993). They act as facilitators by supplying the fund to support the production process which
ultimately causes environmental degradation (Sarokin and Schulkin, 1991). Thus banks should
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admit the responsibility of indirect involvement in environmental damages and recognize their
environmental responsibility, which is a part of their CSR, to strike a balance between economic
and social goals to encourage the efficient use of resources. It is not just philanthropy and
obeying the laws, rather an attempt to ensure their own sustainability and profitability (Wanless,
1995). Involvement in environmental degradation will not only invite public criticism and negative
customer reaction, but also might make regulations more stringent which can impair the bank
profitability by curbing market for the products of their customers . For example, the Montreal
protocol has banned the production of ozone-depleting substances, which is threatening for
companies operating in that area and the banks financed these companies.

In contrast, the status of environmental risk management by banks is not satisfactory in least
developed countries like Bangladesh, largely due to inadequate existence and poor enforcement of
existing laws and inadequate pressure from civil society and interest groups. In June 1997,
Bangladesh Bank, the Central Bank of the country, asked all commercial banks (BRPD-No-12 dated
8.10.1997) to undertake necessary steps in light of the implementation of certain decisions with
regard to environmental conservation and protection of environmental pollution by the National
Environment Committee and implement the provisions of Environment Conservation Act 1995.
Commercial banks are asked to ensure that steps have been undertaken to control environmental
pollution before financing a new project or providing working capital financing to the existing
enterprises. However, enforcements of these have been very weak in the country. Consequentially,
environmental protection is not in the priority list of the banks in Bangladesh during lending and in
other operations. A lot needs to be changed in terms of policies and mindsets, and in formulation of
new and implementations of existing regulations.

Relationship between CSR and financial Performance

Mostly there are two types of empirical studies on the relationship between CSR and financial
performance (Clinebell and Clinebell, 1994; Hannon and Milkovich, 1996; Posnikoff, 1997; Teoh
et al., 1999; Worrell et al., 1991; Wright and Ferris, 1997). Some studies uses the event study
methodology to assess the short-run financial impact (abnormal returns) when firms engage in
socially responsible or irresponsible acts and the results of these studies have been mixed.
Teoh et al. (1999) found no relationship between CSR and financial performance, Wright and
Ferris (1997) found a negative relationship and Posnikoff (1997) reported a positive relationship;
and McWilliams and Siegel (1997) studies are inconsistent on the relationship between CSR
and short run financial returns. Through a broad-based index of corporate social performance,
Waddock and Graves (1997) analyses whether there is a positive relationship between
corporate social performance and financial performance and whether both slack resource and
good management theory may be operating simultaneously. Using the improved measurement
version, they found that corporate social performance does depend on financial performance
and that the sign of the relationship is positive. Researchers view that, corporate social
performance is a kind of virtuous circle , there is a simultaneous relationship, and corporate
social performance is both a predictor and consequence of company financial
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performance. McWilliams and Siegel (2000), found that, when research and development (R&D)
and industry factors are excluded, the coefficient on corporate social performance (CSP) ( a
measure of CSR ), is positive and statistically significant. However, when research and
development (R&D) and industry factors are included, the degrees of the coefficient reduce
dramatically and are no longer significant and CSP showed a neutral effect on profitability.

Conceptual framework of the research

When the size of the organization increases total assets of the organization will increase. With
the increase in total asset, return on investment will increase. Return on investment will increase
when the financial performance of the company will be good. Good financial performance will
increase the return on assets and return on equity. Good financial performance will decrease
the risk of the organization which will increase the return on investment. Increase in advertising
intensity will increase the financial performance of the organization and return on investment.
Decrease in risk increases the return on investment of the organization.

Various empirical studies around the world have reported a positive, negative, mixed
and neutral impact of corporate social responsibility (CSR) on corporate financial
performance (CFP). Hence rather than having any preconceived idea on the direction of
the relationship, there needs to be an open view on this: the linkage between CSR and
CFP will depend on various factors, e.g., industry, location, size etc. Corporate Financial
Performance (CFP) will be measured both by investors return and accounting return.

For measuring CSR there are two generally accepted methods. The first method is a
reputation index, where knowledgeable observers rate firms on the basis of one or more
dimensions of social performance. One reputation index was generated by Moskowitz
(1972), who over a period of several years rated a number of firms as outstanding,
honorable mention, or worst (Moskowitz, 1972). Content analysis is a second method of
measuring CSR. Normally, in content analysis the extent of the reporting of CSR activities in
various firm publications and especially in the annual report (used by Bowman and Haire,
1975; Abbott & Monsen, 1979; Anderson & Frankle, 1980; Ingram, 1978).

General measures of financial performance fall into two broad categories: investor returns
and accounting returns. The basic idea of investor returns is that, the return should be
measured from the perspective of shareholders. Whereas, Accounting Return measures of
financial performance focuses on how firm earnings respond to different managerial
policies. In the Fleet Factors case of U.S.A., a lender was held liable for clean up costs at a
site owned by a defaulting client since it was adjudged to have been in a position to
influence the companys business decisions (Cowton and Thompson, 2000).
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Market performance measures by risk-adjusted return, or alpha, and total return are used
by McGuire et al . (1988) as measures of financial performance. Accounting-based
performance measures are return on assets (ROA), total assets, sales growth, asset
growth, and operating income growth. The ratio of debt to assets, operating leverage, and
the standard deviation of operating income were other accounting-based measures of risk.
Waddock and Graves (1997) measured financial performance using three accounting
variables: return on assets, return on equity, and return on sales, providing a range of
measures used to assess corporate financial performance by the investment community.

Earnings per share (EPS) or price/earnings (P/E) ratios are used in some studies as the
most common measure of accounting returns (Bragdon and Marlin 1972). On the other
hand, Cochran and Wood (1984), used three account returns measures: the ratio of
operating earnings to assets, the ratio of operating earnings to sales, and excess
market valuation. In addition to this, three other measures of financial performance are
used by researchers: market-to-book ratio; accounting profit ratio (return on assets,
return on equity, return on investment, and return on sales) and stock market returns.

Hypotheses Development

If organization size is increased then the financial performance of the organization will
be increased.
If the financial performance of the company is increased the risk of the company will be
decreased.
If the financial performance is increased return on investment will be increased.

Population: universe or population is defined as the total number of people living in a

specific area; the present study has taken out the public of Pakistan population for this research.

Sampling: For the data collection convenience sampling will be used. The data will
be collected through the Top and middle level Managers of different organizations.
Banking sectors will be taken in the study to observe the problems.

Sample unit: organizational employees

Sample area: Pakistan

Sample techniques: stratified sampling

Sample size: 150

Data collection and source

To verify the linkage between CSR and CFP, the authors have primarily graded the level of
corporate social responsibility of banks by measuring a corporate social performance (CSP)
index. Based on the grades banks were separated into two categories: CSR banks and non-
CSR (NCSR) banks. Afterwards, correlation, regression, t-test were conducted to examine
whether there is a difference between these two categories of banks with respect to their ROA,
EPS and P/E ratio data collected from the published annual report of the banks.
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Variables and items:

Dependent variables are return on asset, return on equity, return on investment, total asset.
Independent variables are organization size, risk, advertising intensity. For measuring CSR
there are two generally accepted methods. The first method is a reputation index, where
knowledgeable observers rate firms on the basis of one or more dimensions of social
performance. One reputation index was generated by Moskowitz (1972), who over a period
of several years rated a number of firms as outstanding, honorable mention, or worst
(Moskowitz, 1972). Content analysis is a second method of measuring CSR. Normally, in
content analysis the extent of the reporting of CSR activities in various firm publications and
especially in the annual report (used by Bowman and Haire, 1975; Abbott & Monsen, 1979;
Anderson & Frankle, 1980; Ingram,1978).

Statistical Tools:

Statistical tools will be used to analyze the data collected from respondent with the help
of questionaire. SPSS software package will be employed to perform correlation,
regression, factor analysis, t- test and other tests.

Conclusion
We have undertaken a modest attempt to examine the linkage between corporate social
responsibility performance and financial performance and present the results of the study
conducted on the banking companies in Pakistan. The results of the study can be summarized
as follows: In particular, banks are lagging behind in the environmental and workplace aspects.
This might be due to the fact that, banks are yet to incorporate environmental aspects in project
selection, loan disbursement and regular day to day activities. However, the workplace aspect
reflects an overall inadequacy of good working condition in the publicly traded banking
companies of Pakistan.Various empirical studies around the world have reported a positive,
negative, mixed and neutral impact of corporate social responsibility (CSR) on corporate
financial performance (CFP). Hence rather than having any preconceived idea on the direction
of the relationship, there needs to be an open view on this: the linkage between CSR and CFP
will depend on various factors, e.g., industry, location, size etc.

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