Corporate Culture and Social Responsibility of a Corporation - Report Example

What is corporate culture? Let’s break this down. Corporate is refers to of or relating to a corporation. A corporation is born when a group of people invest their money in a business or company; apply for a charter as a corporation, and the government issues a charter to that corporation. After they are issued the charter, they are no longer a group of people. They are defined as a corporation, and under the law, that corporation operates as a legal person. Culture refers to customs, interactions, traditions, and achievements of a group of people. A group’s culture is a reflection of the group’s values and beliefs. After this explanation, it is easy to conclude that corporate culture is simply the way corporations act and interact based on their values and beliefs. At the very center of the corporate idea through its culture, there something called corporate social responsibility. Corporate social responsibility plays a significant and haunting role in the world of corporate culture. If the only social responsibility of a corporation is to make a profit, then my question is how do the corporate leaders make decisions when it comes to ethical and moral issues? This is how: when it comes to honesty, there are corporations like Nike trying to claim the right to lie. The expansion of sweatshops around the world today is a direct result of corporate globalization. Logging companies like Weyerhaeuser are damaging the biosphere, and yet their home webpage claims in huge font, “Making the most of our resources” (Weyerhaeuser). There is no law that says corporations have a responsibility to uphold the public good. This modern corporate culture presents a major dilemma in business ethics. The requirement for profit-based performance, based on corporate social responsibility, negatively influences a corporation’s moral and ethical capacity. One metric through which CSR impacts on business performance is via the Newsweek Green Rankings. Environmental performance, in terms of being green, clean-technology, corporate social sustainability, and other “green” issues are at the forefront of current economic discussions. In helping to better understand consequences of firm environmental behavior it is useful to examine relationship between environmental decisions and stock market reactions/performances. The paper undertakes an analysis of the 2009 Newsweek Green Rankings on financial performance of firms’ as measured through stock market returns. Literature on the same reveals two manor trends in attempts to link corporate environmental decisions to financial performance. The link between stock market reactions and major environmental legislations announce is of great importance to this research and to firm stakeholders. Event analysis is used in this paper. Event study models are believed to capture the impacts of Newsweek Rankings. As a matter of fact, an event study examines various variable or more precisely, measure trends before and after an event occurs. As a result, the impact of the event is captured through variable changes. It is known that events take place prior to reaction of a strong causality case.in this paper, stock prices and abnormal company returns are used to measure stock market reaction to Newsweek Rankings. Stock prices are changing variables which helps in explaining deeply, the Newsweek Rankings and investor reactions to their release. The study purports that stock market does not react to a majority of individual firm rankings, but does in deed react negatively to Newsweek Rankings in entirety. This implies that investors fail to take into consideration the relative environmental firm choices or that stock market lacks preference for environmental news. Additionally, the data used in the study suggests a negative reaction by investors, to news that a company is more environmentally friendly that previously considered. This is essence means investors place a value on environmentally consciousness of a corporation. Theoretical background Theoretical knowledge suggests that positive environmental decision made by firm’s results into two possible paths from an economic perspective (Konar & Cohen 2001). One economic theory purports that positive benefits exceed the costs of environmentally friendly behaviors. Positive benefits give rise to things such as increased demand as a result of better public image, reduced input waste in production, and lesser negative attention from industry regulators (Konar & Cohen 2001). It is expected that environmentally friendly behaviors will mean increased profitability and this is reflected in stock performance. The other economic explanation for impacts after firms engage in environmentally friendly behavior offers a totally divergent perspective. It suggests that the behavior produces high economic costs as a result of the technology invested in compliance as well as other efforts aimed at ensuring an environmentally friendly environment. If this theory were to hold over the other one, then positive environmental choices have a negative effect on company value and hence on stock value. The relationship’s visual representation is available in the flow chart below, Unanticipated News Such studies require that the event/news studied be unanticipated or else it results into a flawed and possibly biased study. Theoretically, stock prices represent available information about company security. Consequently, anticipated news released to the public should be factored in stock prices in advance. Nonetheless, unanticipated news causes an adjustment in stock prices as a result of the belief that there will be a change in future cash flows or stock risk. News and events are not sternly binary with respect to whether or not; the news/events are unanticipated. There exists varied levels of the effect of anticipated an event is by the market. For instance, Bromiley & Marcus (1989) argued in favor of the fact that automotive recalls are somewhat anticipated due to market expectations about two to three recalls in a year. The Newsweek rankings used in the study represent unanticipated news. The other concern is as a result of leakage of information from within the company (Klassen & McLaughlin 1996). Insider trading is also possible as a result of major announcement appearing in unanticipated news to outsiders. This insider trading could distort the results of an event study by changing the price of the relevant stocks before the event period studied. To help regulate this possibility, Klassen & McLaughlin (1996) excluded ten days before event in estimation period and included a day prior to the event period. On the other hand, Bromily & Marcus (1989) ended estimation period sixteen days prior to studied event and used fifteen days before and ten days after for event period bonds. Event Studies with Stock Prices Stock prices offer significant insight into corporations’ performances and how events affect companies. As per the efficient market theory, stock prices represent all information available about the respective companies (Fama 1970). Incorporating all information available, theoretically, leads to a holistic representation of the expected net present value of future cash flows (Bromiley & Marcus 1989). When unanticipated news becomes available, there is expected to be an adjustment of the affected stock’s prices. As a result, the appropriate ways of determining relationship between an event and a corporation is to look at stock change following event becoming a publicly available knowledge. Event study approach has been successfully employed in many past studies. The studies conventionally used the prices of stocks as the dependent variable and independent variables may include environmental awards, automotive recalls, and change in company name. Nonetheless, it is never sufficient to simply examine a rise in stock price during event period. Generally, different securities experience varying risks. As a result, it is more important to consider how much better the stock performed during the event period in relation to what one normally expects of the performance without the event. This measure the return observed above or below the expected return (abnormal return). However, one may ask, how is normal stock return determined? This is the baseline for solution of the problem. It is always important to create a benchmark for comparison of the same to returns during actual period of the event’s occurrence. A number of models are used in creation of the benchmark, these include, mean adjusted returns, market adjusted returns, as well as market and risk adjusted returns. A strong point of event study is in inference of the causality relationships which arising from the timing of event and corresponding stock return variations. It is therefore important to show correlation, in addition to providing evidence of causality direction. A potential area of weakness of event study methodology is in the possibility of other event occurring during the event period. A good way of controlling this is by ensuring number of days during the event study are as limited as possible without compromising the credibility of the results. This lowers the likelihood of confounding events affecting the data and regression results. Estimation Period for Event Study Stock prices are a useful indication of likely relationships, and hence they must be analyzed appropriately. With stocks all beginning at varying prices and varying share numbers outstanding, stock price cannot be used to successfully model stock relations. A common approach to the problem, examination of stock returns to the event being studied, normally, a period of between 20 and 250 trading days are chosen. Bromiley & Marcus (1989), Klassen & McLaughlin (1996), and Gupta & Goldar (2005), use pre-event periods of 228, 200, and 150 days respectively. The mean number of trading days in any calendar year is often 250 which is quite a wide period to presume other events might not affect the results. However, estimation within these period ranges includes all possible seasonal cycles of a corporation. There is nonetheless a danger of using lengthy estimated period, as companies will experience significant changes during the period in addition to operations or other factors which affect stock return patterns. Consequently, estimation period in lower 200 is a better way of capturing a company’s normal performance. Methods This paper uses abnormal stock returns of companies as a proxy for the event market reactions. The stock market does not misprice stock market due to the fact that this would result into an arbitrage possibility. The event considered in this paper is the Green Rankings, which is accurate considering the level of credibility enjoyed by Newsweek. The paper seeks to explain how the stock market reacts to environmental issues and hence corporations can use this knowledge to environmental decisions and their consequences. A necessity is identified to use OLS for the describing the relationship between Green Rankings and abnormal stock returns. It is the most appropriate considering that they both contain positive and negative values. Green Rankings make a comparison of environmental behavior of big companies. OLS offers an avenue to develop a linear relationship assuming that stock market will record a positive or negative value in response to good or bad rankings by Newsweek. It would be prudent to argue if the stock market believes that environmental actions are friendly, it responds by adding a positive value to the company and hence it is expected that stock prices are likely to increase. Alternatively, if the stock market believes there are costs alongside the announced environmentally friendly behavior, there is likely to be a negative change in firm value and hence a drop in stock price for the respective companies. Newsweek rankings This is a ranking of companies on environmental issues and as such offer a good opportunity for examination of the relationship between ranking of the companies and the stock prices in the period prior to and after release of the rankings. For this study, no information is available to suggest that a relationship other than linear relationship will exist between the variables. As a result, the study will simply examine for possibility of a linear relationship using OLS. The paper uses Market and Risk Adjusted Returns model is assessing stock returns. Using this approach, the paper provides the best estimates of relationship between the company and market proxy. The chosen method allows for control of varying growth rates of corporations due to the fact that each corporation has its individual regression of returns against market proxy. This is observable in the alphas of the different companies. Additionally, companies react in different ways to market proxy movements and controls for beta estimation, which is used to measure stock changes in relation to market proxy. The Model and Data As already mentioned, the Event Study Model is used. However, before looking at stock prices and returns around release date of 2009 Newsweek Green Rankings, it is necessary to determine normal return for each of the companies. Without these, it is not easy to interpret stock prices and establish significance. An estimation period lying between October, 2008 and September 2009 is selected. Returns of each of the individual companies and the whole S&P 500 index are calculated as shown below, The days return is ten regressed against S&P 500 return on corresponding days and the regression equation displayed. Alpha (α) is intercept estimation from regression analysis and Beta (β) is estimation of the slope for S & P 500 Return variables. Resulting slope measures how dependent variable varies with a unit increase of the independent variable (S&P 500 Return). This is characteristic, or normal, return of firm giving performance of S&P 500. This regression is run for each and every company and as a result, 394 Alpha’s and Beta’s are estimated, which are then used in the calculation of abnormal returns. This allows then possibility of turning the event period, the time around rankings release is evaluated for any expected unexpected returns. With baseline established through estimation of Alphas and Betas, the question to ask now is, how much stock prices from is expected given performance of S&P 500? Consequently, the next step is examination of a day during event period and calculating expected return of the company and subtracting it from real return observed on the specific day. This is given as follows, Constant term for firm (From OLS regression of stock data) Slope of characteristic return of firm (From OLS regression of stock data) Abnormal returns calculation only looks at a day during event period. To acquire full picture of effect of Green Rankings, it is important to examine more than a single day. Consequently, a calculation of a number of days is required. Cumulative Abnormal Returns is summation of all abnormal returns during event period. For the paper, the 1st event period examined are the three trading days around release of 2009 Newsweek Green Rankings, that is, 9/18/09 to 9/22/09. The period is chosen due to the fact that it includes actual day rankings release, that is, 21st and a day prior to and after. Further, the study looks at event period of ten trading days starting on 18th. All of the previous calculations and regressions are all for purpose of getting Cumulative Abnormal Returns values representing dependent variable in ultimate regression which attempts to answer main question, that is, Did the 2009 Newsweek Rankings have significant effect on ranked companies? And further explains and gives the magnitude of the impact. In answering this question, an equation similar to the one in Klassen & McLaughlin (1996) is used in running regression analysis. The regression equation is as shown below, The Data Newsweek (2009) released online and print, first annual Green Rankings on 21st of September, 2009. The project took ran for more than 18 months. Newsweek (2009) ranked 500 biggest public companies in the United States on basis of revenue, market capitalization, as well as employees. The companies were identified using Dow Jones Industry Classification Benchmark. The companies are ranked from 1 to 500 based on overall “Green Score”. The Green Score is derived from three weighted components, including, Environmental Impact Score (45%), Green Policies score (45%), and Reputation Score (10%). Nonetheless, since Green Score uses undisclosed environmental impact ratio score, it is impossible to apply weights to individual components to get overall Green Score. Descriptive statistics for 2009 Newsweek Green Ranking are shown below, Green Rank Green Score Environmental Score Green Policies Score Reputation Score Mean 239.84 70.95 49.71 41.75 35.36 Std. dv 147.18 10.564 29.24 18.43 14.18 Median 235.0 71.081 49.40 40.19 33.39 Skewness 0.101 -.423 0.018 0.418 1.27 Also of importance are the stock prices of the companies over the specified trading period. Cumulative Abnormal Returns (CARs) are calculated by regressing output from company returns and S&P 500 returns. The CAR values indicate returns observed during event period not explained by S&P 500 returns in the event period. Summary statistics are as shown in table below, Mean of CARs is -0.026 and represents average abnormal loss of 2.6 % for companies evaluated. Regression 1: Green Score on Cumulative Abnormal Returns Coefficient Standard Error T-Statistic P-Value Intercept -.02197** .008770 -2.505 .0126 Green Score -.0000599 .000122 -0.491 .6246 Multiple R-squared: 0.000607 Adjusted R-squared: -0.001923 * Significant at the 95% level **Significant at the 99% level The linear regression examines effect of different variables on Cumulative Abnormal Returns. Regression model used two tailed linear regression due to uncertainty of whether or not environmentally friendly behaviors impact on stock returns. The regression model above shows a relationship between Green Score and corresponding CAR of each of the companies. Coefficient values are delta estimates. The green score coefficient .0000599 shows that a unit increase in Green Score of company results into a decrease of .00599% for company’s CAR during event period. The negative coefficient shows a weak tendency of green behavior by firms to result into lower stock returns. The estimator value is however small and insignificant, as shown by the small T- Statistic and large P-Value. The low R-squared show that model does not successfully explaining variation in variables. The residuals are displayed below, The residual plot highlights a couple of important features of relationship between Green Score and CAR. It firstly shows potential outliers and secondly, the plot shows trend that variance of residuals increases with Green Score value. This is well represented by residuals fanning further to the plots right. Conventionally, the variance of residuals should be fairly constant rather than exhibit any patterns. Non-constant variances suggest existence of heteroskedasticity. To test for heteroskedasticity, two tests; Cameron & Trivedi IM-Test and Breusch-Pagen/Cook-Weisberg Test were used. For P values less than 0.05, heteroskedasticity will be concluded to exist. Cameron & Trivedi IM-Test 0.4728 Breusch-Pagen/Cook-Weisberg Test 0 .0675 Both tests fail the threshold for heteroskedasticity. However, the research proceeded to adjust for heteroskedasticity but the results were close to the ones recorded in the initial regression and hence, it is concluded that heteroskedasticity is minimal and does not largely affect the results. The results are shown below, Coefficient Robust Std. Error T-Statistic P-Value Intercept Green Score -.02197** -.0000598 .007866 .000112 2.791 -0.531 0.0050 0.5931 Notably, the next step, just like the prior, reveals that Green Rankings are inversely related to Green Scores given that the number one ranking is linked to highest Green Score. As a result, high numbers in Green Rankings represent environmentally un-friendly companies and as such, sign on coefficient should be opposite to that of previous regression. The results are shown below, Green Ranking on Cumulative Abnormal Returns Coefficient Standard Error T-Statistic P-Value Intercept -.02788** .002468 -11.299 0 Green Ranking .0000069 .0000088 0.789 0.431 Multiple R-squared: 0.002 Adjusted R-squared: -0.0001 * Significant at the 95% level **Significant at the 99% level The average of Cumulative Abnormal Returns is substantially negative for the study. This is a pointer to trend of negative reactions from investors to environmental news reflecting on the companies. This is however not conclusive as only Newsweek Rankings are used to represent environmental study. There is therefore a need for further research taking into consideration multiple announcements of environmental behavior of corporations in order to conclusive establish if in deed such announcements have negative impact on stock returns or if this finding is only confined to Newsweek Green Rankings. References "2009 Green Rankings for US Companies." Newsweek. 21 Sept. 2009. Web. Alexander, G. J. and R. A. Buchholz (1978). "Corporate Social-Responsibility and Stock-Market Performance." Academy of Management Journal 21(3): 479-86. Atkins, A. B. and E. A. Dyl (1990). "Price Reversals, Bid-Ask Spreads, and Market-Efficenty." Journal of Financial and Quantitative Analysis 25(4): 535-47. Bromiley, P. and A. Marcus (1989). "The Deterrent to Dubious Corporate Behavior: Profitability, Probability and Safety Recalls." Strategic Management Journal 10(3): 233-50. Brown, S. J. and J. B. Warner (1980). "Measuring Security Price Performance." Journal of Financial Economics 8(3): 205-58. Chan, W. S. (2003). "Stock price reaction to news and no-news: drift and reversal after headlines." Journal of Financial Economics 70(2): 223-60. Cox, D. R. and D. R. Peterson (1994). "Stock Returns Following Large One-Day Declines-Evidence on Short-Term Reversals and Longer-Term Performance." Journal of Finance 49(1): 255-67. Galema, R., A. Plantinga and B. Scholtens (2008). "The stocks at stake: Return and risk in socially responsible investment." Journal of Banking & Finance 32(12): 2646-54. Gupta, S. and B. Goldar (2005). "Do stock markets penalize environment- unfriendly behavior? Evidence from India." Ecological Economics 52(1): 81-95. Horsky, D. and P. Swyngedouw (1987). "Does it pay to change your companys name? : a stock market perspective." Marketing Science 6(4): 320-35. Irvine, P. J. (2003). "The incremental impact of analyst initiation of coverage." Journal of Corporate Finance 9(4): 431-51. Jarrell, G. and S. Peltzman (1985). "The Impact of Product Recalls on the Wealth of Sellers." Journal of Political Economy 93(3): 512-36. King, A. A. and M. J. Lenox (2001). "Does It Really Pay to Be Green." Journal of Industrial Ecology. Klassen, R. D. and C. P. McLaughlin (1996). "The impact of environmental management on firm performance." Management Science 42(8): 1199-214. Russo, M. V. and P. A. Fouts (1997). "A resource-based perspective on corporate environmental performance and profitability." Academy of Management Journal 40(3): 534-59. Read More