Bridge over ocean
1 December 2013 CFA Institute Journal Review

Active Ownership (Digest Summary)

  1. Sandra Krueger, CFA

Corporate social responsibility (CSR) engagements address governance, environmental, and social issues. The authors use a propriety database of US public companies to analyze CSR engagements. Successful engagements result in average cumulative abnormal performance of 4.4% over the year following the engagement. They are more likely to be successful when the target firm is concerned about reputational damage and when it has a high capacity to implement change.

What’s Inside?

Although interest in active ownership has been growing, many fundamental questions have not been answered because of limited data. The authors use a dataset provided by a large institutional investor that has a commitment to responsible investment and that actively engages with more than 3,000 companies worldwide to improve target companies’ value. Through their analysis, the authors show positive market reactions to corporate social responsibility (CSR) activism in US public firms over a 10-year period (1999–2009). They find that CSR engagements are followed by one-year abnormal returns that average +1.8%.

How Is This Research Useful to Practitioners?

Traditional shareholder activism and hedge fund activism usually focus only on shareholder interest. CSR activism focuses on the interests of a range of such stakeholders as employees, customers, and creditors. Previous CSR/SRI (socially responsible investing) studies have reported an insignificant link between responsible investing and firm performance because they relied on static measures for CSR performance. The authors conduct event-study analysis, which offers a better prospect of determining causality.

They report on a range of performance measures, including return on assets, profit margin, asset turnover, and the ratio of sales to employees. Their results show that firms with successful CSR engagements experience improved operating performance and efficiency. Improvements in sales, profitability, and employee efficiency support the argument that CSR enhances customer and employee loyalty.

The authors’ findings could be considered by company directors, senior management, and investors seeking to increase shareholder value through CSR practices. They suggest that CSR activism reduces managerial myopia and helps minimize intertemporal losses of profits.

How Did the Authors Conduct This Research?

The sample consists of data provided by an institutional investor that had 2,152 engagements with 613 public firms between 1999 and 2009. This asset manager engages with large and mature firms with relatively low market-to-book ratios and sales growth, high liquidity, and low numbers of block shareholders.

Target companies are identified by using environmental, social, and governance (ESG) screening methods. An engagement is defined as a series of interactions with a target company and such action steps as “raising awareness” and “requests for change.” A “request for change” is a step where the investor asks for specific changes in the target company. Any improvements that the target company achieves are “milestones.” The dataset includes 405 milestones, which are achieved a year and a half after the initial engagement, on average.

Monthly stock returns are from CRSP, and the value-weighted average of the CRSP universe is used as a benchmark. For each event month, the authors calculate the average abnormal return using an equal-weighted portfolio of all target firms that initiated engagements.

Because managers can be unwilling to adopt costly projects, the sample has an average success rate of 17.8%. Engagements with firms that have lower R&D and capital expenditure and more cash holdings are more likely to succeed.

The authors note that the abnormal returns associated with successful engagement may be specific to the time period studied. Their analysis is based on the dataset of a single large investor, and thus their positive results may not be replicable by an underskilled CSR team.

Abstractor’s Viewpoint

The question of whether corporate social responsibility is profitable and adds value to a company is critical for investors. The authors provide a valuable research contribution, in part because of the dynamic nature of their proprietary dataset. Their use of the CRSP value-weighted index as a benchmark for measurement of abnormal performance is appropriate, but because portfolio managers are frequently measured against other indices, it would be helpful to look at outperformance using those other indices.

The authors’ research focuses on engagements with US public companies. It would be interesting as a follow-up to study engagement success rates in non-US companies.

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