Purpose & Profit: A Materiality-Based Approach to Corporate Social Responsibility and Value Creation

Abstract

This study contributes to the field of corporate social responsibility (CSR) by understanding if, and to what extent, materiality moderates the causal relation between CSR and value creation. Since the materiality, or operational relevance, of CSR policies varies across industries, this approach may further inform corporate and investor strategy by isolating key environmental and social (ESG) issues among the glut of non-financial information. We first make a theoretical distinction between firms who “do good” and firms who “do not harm” by limiting CSR to voluntary ESG efforts and relegating ESG controversies into a separate corporate social irresponsibility (CSiR) measure. Using recent innovations in sustainability standards, we classify varying ESG issues by materiality across 77 industries to develop a hand-mapped dataset of industry-bespoke CSR and CSiR measures. Further, we take numerous steps to resolve the systemic endogeneity bias in the extant literature. Using four years of corporate financial data – including market-based and accounting-based measures of Tobin’s q, market-to-book ratio and return on assets – from 2013 – 2016, as well as firm-level CSR and CSiR indices on a universe of US-listed companies, we estimate lagged firm-year fixed effect panel regressions with ordinary least squares (OLS) and instrumental variable (IV) specifications to assess the differential financial impacts of material CSR compared to its overall and immaterial counterparts. We demonstrate that material CSR investments generate outsized profitability and value creation versus a more indiscriminate approach that is at best, not value-destroying. In contrast, CSiR does not seem to predict financial performance regardless of materiality, though its emerging construct beckons further research. In sum, these results imply that CSR is not a one-size-fits-all approach. For both companies and investors, applying materiality beyond headline data can help their capital allocation decisions. This paper suggests that it is in companies’ financial interest to contribute to society’s needs in a way that aligns with their core operations.