THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY (CSR) ON THE COMPANY’S FINANCIAL PERFORMANCE BY CHU MAI LY Graduation Project Submitted to the Department of Business Studies, HELP University College, in Partial Fulfilment of the Requirements for the Degree of Bachelor of Business (Accounting) Hons Octorber 2011 DECLARATION OF ORIGINALITY AND WORD COUNT I hereby declare that the graduation project is based on my original work except for quotations and citations which have been duly acknowledged I also declare that it has not been previously or concurrently submitted for any other course/degree at HELP University College or other institutions The word count is 9,875 words _ NAME OF CANDIDATE Date: Acknowledgement This project would not have been made possible without the assistance, support and encouragement of many people I wish to take this opportunity to thank all the people who have helped me during the time of completing the dissertation I would like to express gratitude towards Dr Pham Duc Hieu and Dr Le Van Lien and to Ms Shumathi for their support and guidance I would also thank some my friends for their financial support for this project THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY (CSR) ON THE COMPANY’S FINANCIAL PERFORMANCE By CHU MAI LY Octorber 2011 Supervisor: Dr PHAM DUC HIEU Abstract Does CSR impact on firms' profits? CSR will lead to increase or decrease of financial performance of the firms Firms face complex market conditions, external effects and asymmetric information which may lead to market failure and sub‐optimal profits In the literature, market failures could build the theoretical base for corporate social responsibility (CSR) implementation by firms In fact, firms in competitive markets could use CSR as a management tool to gain more profits through diversification Further, the implementation of CSR requires the detection of future trends and developments which makes the firms more stable to sudden events Therefore, CSR may offer firms the opportunity to gain higher profits than they would get without CSR Alternatively, CSR could lead to higher costs and thus to worse financial performance Many studies are taken in which the method of study is quantitative or using the KLD data base In this study, I will examine the relationship of CSR and financial performance in a different view and different method This study makes clear relationship in the aspect of identifying the costs and benefits of CRS, how those costs and benefits will affect the accounting earnings or profits of the firms Those issues will be improved by the case of Vedan and Miwon in Vietnam TABLE OF CONTENTS Page Declaration of Originality and word count ii Acknowledgement iii Abstract iv Table of Content v CHAPTER INTRODUCTION 1.1 Background of study 1.2 Statement of purpose 1.3 Structure of study 8 Chapter LITERATURE REVIEW 2.1 The history of CSR 2.2 The definition of CSR 2.3 The term of CSR 2.4 Theories describing the CSR/financial performance relationship 2.4.1 The theory suggest positive relationship 2.4.2 Theory suggest a negative relationship 2.5 The link between corporate social performance and corporate financial performance 2.6 CSR and accounting performance 2.6.1 Economic benefits of CSR 2.6.2 How economic benefits are reflected in accounting earning 2.6.3 Economic benefits of CSR 2.6.4 How economic costs are reflected on accounting earnings 2.7 Additional accounting issues and implications 10 10 11 13 15 16 19 Chapter 29 METHODOLOGIES 3.1 Research objective 3.2 Research strategy 3.2.1 Data resource 3.2.1.1 Secondary data 3.2.2 Qualitative Research 3.3 Measurement 3.3.1 Measurement of Corporate Social Performance 3.3.2 Measurement of financial performance 3.4 Case study 3.4.1 Vedan 3.4.2 Miwon 3.5 Limitations 20 22 22 22 24 25 27 29 29 29 29 30 31 31 32 34 34 35 36 Chapter 4.1 4.1.1 4.1.2 4.1.3 4.1.4 4.2 4.2.1 4.2.2 4.2.3 ANALYSIS Vedan Case study of Vedan Vedan before apply CSR Vedan after apply CSR Vedan resolves their problem Miwon Case study of Miwon Miwon before apply CSR Miwon after apply CSR 36 36 36 37 38 39 40 40 40 41 Chapter CONCLUSIONS 5.1 Summary 5.2 Conclusion 5.3 Recommendation 42 42 43 44 REFERENCES/BIBLIOGRAPHY 45 Chapter 1: Introduction 1.1 Background of study In today‘s society, there is a growing interest in and demand for Corporate Social Responsibility (CSR) Reasons for this can be multinational corporations‘ increasing influence on the world economy as well as scandals revealing horrible working conditions in different industries The field of corporate social responsibility has grown exponentially in the last decade More than half of the Fortune 1000 companies issue corporate social responsibility (CSR) reports A larger number of companies than at any time before are now engaged in serious efforts to define and integrate CSR into all aspects of their businesses An increasing number of shareholders, analysts, regulators, activists, labor unions, employees, community organizations, and news media are asking companies to be accountable for an ever-changing set of CSR issues There is increasing demand for transparency and growing expectations that corporations measure, report, and continuously improve their social, environmental, and economic performance Corporate social responsibility is not a new issue According to Business for Social Responsibility (BSR), corporate social responsibility is defined as ―achieving commercial success in ways that honor ethical values and respect people, communities, and the natural environment.‖ McWilliams and Siegel (2001:117) describe CSR as ―actions that appear to further some social good, beyond the interest of the firm and that which is required by law.‖ A point, which is worth noticing, is that CSR is more than just following the law (McWilliams & Siegel, 2001) Alternatively, according to Frooman (1997:227), the definition of what would exemplify CSR is the following: ―An action by a firm, which the firm chooses to take, that substantially affects an identifiable social stakeholder‘s welfare.‖ A socially responsible corporation should take a step forward and adopt policies and business practices that go beyond minimum legal requirements and contribute to its key stakeholders‘ welfare CSR is viewed and then, a comprehensive set of policies, practices, and programs is integrated into business operations, supply chains, and decision-making processes throughout the company and usually includes issues related to business ethics, community investment, environmental concerns, governance, human rights, the marketplace as well as the workplace 1.2 Statement of purpose This thesis tries to find out the impact of CSR on the company‘s financial performance but does not focus on why and how firms behave socially responsible The relationship between CSR and firms‘ accounting performance will be thoroughly analyzed to estimate impacts of CSR policy changes Additionally, costs and benefits of CRS are also accounted for One other interesting question is raised that whether CSR can increase profit of the company and after reading and researching, two Vietnamese companies are selected: Miwon and Vedan, which are the outcome of adopted CSR In order to analyze the question ―what is the impact of CSR on the company‘s profitability?‖ the project is divided into five parts:  What is the CSR? -  The definition of CSR The theories of CSR What is the finance performance?  What is the relationship between CSR and finance performance?  The role of CSR to increase profit of the company  The outcome of adopted CSR in Vedan and Miwon in Vietnam 1.3 Structure of Study The thesis will be divided to main parts: Chapter provides some basic understandings about CSR; the relevant theories describe the relationship between CSR and finance performances as well as empirical studies of CSR and financial performances The relevant theories will be examined in two aspects of positive and negative relationship Chapter also discusses three main problems of CSR: The link between corporate social performances and corporate financial performances, how CSR affects accounting performances, and additional accounting issues and implications The framework for the subsequent analysis will be created from this chapter Chapter discusses about the relationship between CSR and financial performance of the firm and it will be presented and analyzed according to the literature review Chapter also analyses the outcome of CSR adopted by Vedan and Miwon in Vietnam Chapter recaps the study and provides concluding remarks Chapter 2: Literature review At this point in history, as globalization surges on while technology continues to shift the foundations of economic reality at local, national, and international levels, ushering in new challenges to all firms and governments and blurring traditional distinctions among social institutions, it is critical to examine the notion of Corporate Social Responsibility (CSR) 2.1 The history of CSR Since 1960s when CSR is initially mentioned, its nature has changed several times Until now, the concept of CSR is also redefined and becomes a new definition However, unlike the economic, legal and ethical expectations placed on organizations varies from societies to societies, all societies in the world at any period of their development have some similar expectations about what organizations should act under their social responsibilities In the eighteenth century, the great economist and philosopher Adam Smith partly expressed the CRS in his economic research He concluded that market participants must act honestly, a form of CRS, to reach the ideal situation of the free market His theory was espoused by many new principles contributed by the Industrial Revolution in the nineteenth century, when many huge organizations were developed Those organizations, however, were not aware of the importance of CRS and did not act in a proper way for social welfare Hence, in twentieth century, there is a backlash against the large corporations was appearance They were criticized as being too powerful, creating monopoly markets and 10 However, there is no rating system like DSI 400 in Vietnam The only one source reporting about corporate social performance is annual reports of those companies on the HNX and HOSE (Hanoi Stock Exchange and Ho Chi Minh Stock Exchange) Although those reports are audited by audit firms, they possibly still contain some bias because of the complicated and unstandardized market in Vietnam 3.3.2 Measurement of financial performance of the firm Financial performance is measuring the results of a firm's policies and operations in monetary terms These results are reflected in the firm's return on investment, return on assets, value added, etc (businessdictionary, 2011) There is a wide range of criteria to measure corporate financial performance and most of them are simple to calculate However, measuring financial performance still involves some specific complications because there is little consensus about which measurement instrument to apply Some researchers suggested to estimate based on market measures (Alexander and Buchholz in 1978, Vance and S C in 1975) In contrast, other researchers try to convince that using accounting measures is much more accurate (Waddock and Graves in 1997, Cochran and Wood in 1984) In the middle, some tried to adopt both of the measures (McGuire, J B., Sundgren, A., Schneeweis, T in 1988) Hillman and Keim (2001) indicate that the two measures, because representing different perspectives of how to evaluate a firm‘s financial performance, have different theoretical implications and different biases Thus, it is difficult to compare the results of them In detail of differences between the two measures, accounting measures capture only historical data about firm financial performance (McGuire, Schneeweis & Hill, 1986) Their biases are resulted from managerial manipulation and differences in accounting 32 procedures (Branch, 1983; Brilloff, 1972) On the other hand, market measures are forward-looking and focus on market performance According to Mc Guire, J B., A Sundgren, and T Schneeweis (1988), market measures show the investor‘s evaluation of the firm‘s ability to create future earnings and therefore, it is the better method for firms‘ financial performance measurement Subject to the limitation of this study, collecting information for the market measurement method is difficult Thus, the accounting measurement will be used instead of market measurement This study used accounting variable, which are operating ROA (return on total asset), ROE (return on equity), equity capital ratio (ECR) (equity capital/total capital), and return on sale (ROS) to measure financial performance of the firm Return on assets is a measure of how effectively the firm's assets are being used to generate profits It is defined as: Return on Assets = Net Income Total Sales Return on equity is the bottom line measure for the shareholders, measuring the profits earned for each dollar invested in the firm's stock Return on equity is defined as follows: Return on Equity = Net Income Shareholde r Equity Return on sale is a ratio widely used to evaluate a company's operational efficiency ROS is also known as a firm's "operating profit margin" It is calculated using this 33 formula: Return on sale = Net Income (before tax) Total Sales 3.4 Case study: The outcome of adopted CSR in Vedan and Miwon in Vietnam 3.4.1 Vedan The company is headquartered at Vedan Phuoc Thai (Long Thanh - Dong Nai), operating under the investment license No 171 A / GP dated 01/08/1991 of the State Committee for Cooperation and Investment (now The Ministry of Planning and Investment) in an area of 120 adjacent to the Thi Vai River, with total staffs employees are 2,393 people Vedan has been established officially since 1993 in the manufacturing sector: MSG, lysine, starch, sugar, caustic soda (NaOH), acid (HCl), animal food, fertilizer and some biotechnology products, using the average level of water from 20,000 to 25,000 m3/day and cooling water from the Thi Vai River, which is approximately 40,000 m3 As in the financial report of Vedan, the total investment is $460,724,000; revenue from 1994 to 2007 is $2,265,498,382 (approximately USD 151 million / year), profit before tax from 1994 - 2007 is $169,794,312 (about USD 11.3 million / year), profit after tax from 1994 to 2007 is $144,803,132 (about USD 9.6 million / year), tax paid from 1994 - 2007 is $133,151,086 (about USD 8.9 million / year) and per capita wage is 2,167,307 VND / month 34 3.4.2 Miwon Vietnam Co Ltd Miwon was established on 04 May 1994 under the investment license No 935/GP of the Committee for Cooperation and Investment On a newly formed joint venture between South Korea Miwon Group with two partners in Vietnam (Hai Ha Confectionery Company and Hoang Minh JSC) The company began manufacturing in late 1995 In 2003 Miwon became 100% foreign company The main product of Miwon Vietnam Co Ltd is glutamate - MSG named Miwon Its production capacity is 40,000 tons / year During 17 years operation, the company has successfully strengthened its position in the domestic and international market Miwon Vietnam Co., Ltd will support the Humanitarian Fund of Central Vietnam Red Cross with funds deducted from the cost of high quality products of the company in response to the campaign "Every organization or individual associates to run a humanitarian program "addressing troubles caused by natural disasters, catastrophes and helping war victims, victims of Agent Orange, the disabled and other difficulties in the society with funding of at least 500 million awarded scholarships to poor students And to help the poor and victims of natural disasters, Miwon contributes directly 300 million VND to The Central Humanitarian Fund In addition, Miwon also coordinates with local Red Cross offices, where Miwon‘s offices are located, run humanitarian aid activities with the 200 million VND fund Miwon‘s attitude towards CSR is very clear and simple: ―it is not about writing a cheque but it is about using its competencies to help address the concerns and priorities of the communities in the country where it operates‖ In that way, it continues to entrust to the three key CSR supports that we have successfully built in partnership with the 35 Government of Vietnam: (1) children‘s education and development; (2) health and hygiene and (3) women's empowerment Moreover, Miwon also focuses on sustainability by an important partnership plan with the Ministry of Agriculture and Rural Development, which subjects to closely coordinate with tea farmers and processors in Vietnam to raise exports of sustainably grown and processed tea from Vietnam 3.5 Limitations A qualitative study of this character can imply certain limitations to the analysis The collected information was not qualified such as the reports of Vedan or Miwon, which the researcher cannot know whether they have any misstatement or fraud Chapter 4: Analysis 4.1 Vedan 4.1.1 Case study of Vedan Vedan Vietnam Co plant in 1991 in Phuoc Thai commune, Long Thanh district, Dong Nai, the total area of 120 hectares In 1994, shortly after starting operation (only few industrial bases of operation were located on the Thi Vai River basin at this time), Vedan littered wastes causing environmental pollution, which resulted in fishes‘ mortality in the Thi Vai River Recent survey results also show that the radius of the pollution in the Thi Vai River is approximately 4.4 km downstream, and the Institute of Natural Resources and Environment identified that 80% to 90% of pollution was caused by Vedan and the rest 36 of pollution was from other agents and industrial enterprises, which are adjacent to the Thi Vai River Aquaculture area influenced by pollution in the Thi Vai River is also determined Dong Nai province suffered heavy losses on 1,700 and 56.54 mildly affected; Ba Ria - Vung Tau has 326.28 farming area affected By charging dirty waster to Thi Vai River, Vedan saved 300 millions vnd once month and company had saved some billions per year 4.1.2 Vedan before apply CSR After three months, the environmental police asked Vedan stoped directly discharging waste water into the Thi Vai River in the province of Dong Nai According to Mr Le Viet Hung - Director of the Dong Nai Department of Natural Resources and the Environment: ―Vedan used a two-way pumping system to discharge untreated waste water into the Thi Vai River This act is unacceptable We don‘t know when Vedan built this system This act is very serious; it is considered an environmental crime.‖ Mr Hung also said that Vedan was fined three time which have total more than VND20 million ($1,300) by Dong Nai‘s environmental police in the past In middle 2006, the Environmental Protection Agency found Vedan directly discharging waste water into the Thi Vai River through three pipes Vedan repeated its fault although the company was fined many time before Mr Luong Minh Thao who is Vice Head of the Environmental Police Agency, stated that the violation of Vedan is very serious and this is the caused of Thi Vai‘s pollution Police had carried out the investigation during whole three months to collect all the relevant evidence According to the Environmental Police Agency, Vedan was discharging around 50,000cu.m of waste water into the Thi Vai River per day According to the Environmental Resources Institute, based on survey 37 results, from May / 2008 until the system detects unauthorized discharge of this company in the Thi Vai River (September / 2008), the average monthly wastewater discharge of Vedan company into Thi Vai River was 105,600 m3, which exceeded the minimum polluted level hundreds thousands times Recent survey results also show that the radius of the pollution in the Thi Vai River is approximately 4.4 km downstream, and the Institute of Natural Resources and Environment identified that 80% to 90% of pollution was caused by Vedan and the rest of pollution was from other agents and industrial enterprises, which are adjacent to the Thi Vai River Aquaculture area influenced by pollution in the Thi Vai River is also determined Dong Nai province suffered heavy losses on 1,700 and 56.54 mildly affected; Ba Ria - Vung Tau has 326.28 farming area affected On September 8, 2008, the Environmental Police Agency and inspectors of the Ministry of Natural Resources and the Environment caught Vedan because of discharging untreated waste water into the Thi Vai River 4.1.3 Vedan after apply CSR Vedan had to accept 100% of compensation as required by the Ba Ria - Tau and Ho Chi Minh City In detail, farmers of Ba Ria - Vung Tau will be compensated 53.6 billions VND and for Ho Chi Minh City‘s farmers is 45.7 billions VND Vedan sets up an environmental protection emergency taskforce after the incident came to light to implement immediate and mid-term improvement measures Short-term improvements included enhancing the current wastewater treatment capability and quality, optimizing production processes, reducing wastewater discharge and lowering production capacity to ensure compliance with environmental protection standards yet continue production As for mid-term improvements, they included drawing up an improvement proposal 38 based on ―3R‖ (waste reduction, reuse and recycling) entailing plans to install additional wastewater treatment equipment and expand the production facilities in the liquid and solid fertilizer plants The Group expects the major equipment for related works to be delivered around June in 2009 and installation and testing of them to be completed in the third quarter, and full scale production to resume in the fourth quarter As learning from the previous mistakes, Vedan is now determining to not only meet the legal requirements for environmental protection in Vietnam, but also go beyond those requirements and become an outstanding green manufacturer Vedan has started implementing the ISO14001 environmental management system and expects to gain this accreditation of ISO14001 by the end of 2009 It aims to become a green enterprise that is capable of continuously improving and protecting the environment by running an operation contributing to the sustainability of environment and the society 4.1.4 Vedan resolves their problem Vedan company proposed level of compensation to farmers three provinces is 160 billion, of which Ba Ria - Vung Tau 50 billion, Ho Chi Minh City and Dong Nai 40 billion 70 billion Ba Ria - Vung Tau and Ho Chi Minh did not accept the compensation levels and continue to carry out procedures to court to sue the company By late afternoon meeting / 8, the company Vedan had to accept 100% of compensation as required by the Ba Ria - Tau and Ho Chi Minh In particular, farmers in Ba Ria - Vung Tau will be compensation 53.6 billion, Ho Chi Minh is 45.7 billion 39 4.2 Miwon 4.2.1 Case study of Miwon Miwon Vietnam Co Ltd was established on 04 May 1994 under the investment license number 935/GP of the Committee for Cooperation and Investment It is a newly formed joint venture between South Korean conglomerates Miwon with two partners in Vietnam (Hai Ha Confectionery Company and Hoang Minh JSC) The company began operating in late 1995 However, Miwon Vietnam Company transformed to the company with 100% equity invested from Korea starting in 2003 - specializing in gourmet products and food products such as mixed salt, fried dough, chilly sauce, fermented soy sauce, versatile spices Miwon has the 68,600 m2 factory, including some categories: chemical factory line, factory fermentation, recovery workshops, molasses tanks, boiler plant, the packaging line, food production facilities, the drinking water treatment, wastewater treatment area, transformers area and other ancillary facilities 4.2.2 Miwon before apply CSR In the last day of September, many people in Viet Tri city, Phu Tho province came to Miwon factory and required it to stop discharging wastewater into the environment As reported by local people, the plant's wastewater is black and stinking, which cause people to wear a mask when sleeping It severely affects the quality of water supply for households nearby Miwon factory in particular and the water environment the Red River in general 40 4.2.3 Miwon after apply CSR Miwon have created a fund to open many actions of the social activities and community of Miwon in Vietnam The funds of Miwon, there are many projects of environmental sanitation and public health were declared, which includes nine projects in the water group, five in sanitation group and projects in waste and environmental group These projects will help improve the quality of life and improve health for people through improved water sources, treatment and reduction waste in the community After five years,with mission is raising raising and improving the living environment of people across Vietnam, especially those poverty people who are living in rural areas and mountain Miwon's fund has sponcored more than 30 billions vnd which have been bring various programs and projects to help thousands of people across the country The position of company is in top and potential markets were reinforced and completed encouraging development in re-operating volume growth in Vietnam Miwon is more rapidly and more responsive and focused on serving over billion consumers each day The volume growth was increase by underlying sales growth in 2008 was 3.6%, underlying volume growth at 2.3% went faster through this year, getting 5.0% in the fourth quarter Cash flow from operating activities raised by $1.6 billion compared with 2008, which are determined by a major development in working capital, and after a $0.4 billion raise in cash assistance to pension funds 41 Chapter 5: Conclusion 5.1 Summary The relationship between CSR and corporate financial performance has been repeatedly researched from the last thirty-year period of the nineteenth century until now Despite it took a tremendous amount of time and money for economic researchers to investigate, there is still no conclusive findings about how strength or what is the accurate direction of the relationship between CSR and CSP By investigating thoroughly the history of CSR, its definition, and how the term CSR is created, this study provided a fundamental knowledge to understand the CSR/corporate financial performance relationship There are three major economic benefits of increasing CSR for firms Firstly, firms avoid or mitigate impacts on financial performance arising from negative events and/or externalities Secondly, firms create goodwill and/or other intangible assets, favorably influencing financial performance Lastly, firms gain efficiencies, reducing operating costs Accounting performance is the most visible and convenience source for financial analysis, which provide information for investors as well as other group of stakeholders Thus, this study tried to highlight the positive economic impacts of enhancing CSR on firms‘ accounting performance as most effective measurement for CSR influences On the other hand, firms adopting a higher level of CSR also have to take into account with its economic costs There are two types of economic costs, which occur immediately (donation and charity for example) and permanently (higher price of inputs, higher labor costs and higher R&D costs) And similarly to economic benefits, the impacts of CSR‘s economic costs on accounting performance are also analyzed thoroughly in this study 42 Overall, although this study cannot answer the question of how exactly CSR policies affect firms financial performance, its contributions provide a better fundamental framework to analyze the case studies of Vedan and Miwon in Vietnam The case study of Vedan Co Ltd is an example of neglecting CSR, which leads to the severe damage for not only Vedan Co Ltd in particular but also for social welfare in general Vedan Co Ltd faced a significant decrease in sales and profit because of penalties and customers‘ volte-face By contrast, Miwon Vietnam Co Ltd, with many programs supporting the society, has a high reputation and increasing profits, which are well deserved for its CSR costs 5.2 Conclusion Understanding how CSR affects accounting performance is particularly important today, as corporations appear to be devoting more resources and managerial attention towards its end In public appearances, in press interviews, and in survey research, corporate executives report CSR is critical for financial success and contributes to bottom-line profitability (Price Waterhouse Cooper‘s Global CEO Survey, 2002; Center for Corporate Citizenship at Boston College State of Corporate Citizenship Report, 2005) However, some arguments criticized that CSR is nothing more than a new invention of PR (Peter Frankental, 2001, Corporate social responsibility – a PR invention?, Corporate Communications: An International Journal, Vol 6) Corporations have been recently using CSR to polish their images or conceal their negative social and environmental impacts, which are resulted from their operations Similarly, the distraction of management is also a disadvantage that some critics argue about CSR 43 Limited resources, which should be allocated for potential projects, are possibly invested to some projects for the main purpose of increasing a firm‘s reputation In terms of the continuing debate over the relationship between CSR and financial performance and the lack of consensus of academic researches, it is unclear how users of financial statements should utilize CSR information from the variety of internal and external information sources Because firms are now increasing their devotion to become more socially responsible, investors should understand how CSR policies have an influence on firms‘ accounting earnings to make more beneficial investment decisions The final reason for investigating CSR is that is a key for managers to estimate the tradeoff between profits and the social image of a firm 5.3 Recommendation From the two case studies of Vedan Co Ltd and Miwon Vietnam Co Ltd If Vedan and Miwon want to apply suitable strategic CSR, Vedan and Miwon should research and 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