CHAPTER 2

THEORETICAL BACKGROUND

Review of Related Literature

This chapter includes related studies of different researchers particularly on Corporate

Social Responsibility and stock valuations of companies that are socially responsible.

Theoretical and conceptual framework are also presented and discussed in this chapter.

Corporate Social Responsibility

Corporate Social Responsibility (CSR) has been commonly attached to the discussion on

social responsibility, mainly because, it enhances the overall value of the company and it

supports the objective of helping address social issues. Those companies with good and

outstanding CSR are generally described as socially responsible. Corporate Social

Responsibility (CSR) is a company’s obligation to give back value to its stakeholders

(employees, customers, communities, suppliers, shareholders and the natural environment)

who are said to be the players helping the company survive (Domini, 2001). This is the

effort of the firms to give sustainable developments to them (Rehman et.al, 2015). Thus,

CSR guides company’s activities in developing and implementing sustainable programs

that defends human rights, labor, environmental protection, and legal compliance (Baker &

Nofsinger, 2012).
Academic literatures about corporate social responsibilities arise largely during the 1950s.

The term used during this time was Social Responsibility (SR) and not yet Corporate Social

Responsibility (CSR). This time until 1960s, a lot of efforts were made to provide definition

of SR. Initially, philanthropy or community service and employee welfare as part of social

obligation were the common terms used to define SR (Hack, et.al, 2014). There was an

inherent expectation that as companies grow in size, they should be more impactful to the

society (Wang, 2011). In the late 1960s, the term philanthropic was little by little dismissed

in SR’s definition. 1970s marked the development of the definition of CSR. In 1970s, CSR

was described as an activity done not only to satisfy or comply an obligation but a

company’s desire to promote harmony in the society. It is not just an obligation but a

behavior (Hack et.al, 2014). In 1980s, the term sustainability was attached to the definition

of CSR and environment protection was later included in its definition (Flammer, 2012). In

1990s specifically in 1991, the famous pyramid concept was introduced by Carroll. In her

research, Carroll (1999) said that CSR is characterized by four levels of responsibilities –

economic responsibilities, legal responsibilities, ethical responsibilities and philanthropic

responsibilities. The bottom level, which is the economic, is the fundamental social

responsibility of the firm which means that it is the important reason of implementing

CSR. When the economic responsibility has been met, the firm should now meet the next

level which is the legal obligations. The firm should abide the laws and other legal rules in

dealing with social issues. The third level is ethical responsibilities, which means that the

firm should observe and maintain good ethics to promote peace and prevent any unethical

practices. And after all the obligations have been met, the next level to meet is human

responsibility or the philanthropic. This means that the firm should serve as a noble

example in being a good citizen (as corporation) by helping the

people in the society (Wang, 2011). Today, there are still researches about CSR definition

and its scope. But considering its evolution from 1950s to 2000s, the term CSR is now

being linked to sustainable development. Meaning, it is now beyond an obligation to meet

both social and legal expectations (Hack et.al, 2014).

Corporate Social Responsibility as a Legal Obligation

Conducting corporate social responsibility is not just to meet the expectations of the

society but also to meet a legal obligation (Wang, 2011). In the Philippines, Senate bill #

1239, then later on replaced by Senate bill #2747 was presented, deliberated and issued to

institutionalize the conduct of CSR last March 16, 2011. This bill or act is known as the

Corporate Social Responsibility Act. This is stated in section 1 of this bill. Section 2 stated

the reason for its implementation. Conducting CSR could contribute to sustainable

development and environmental protection. Hence, its compliance should be monitored

and supported both by the firms and the government agencies and other private

organizations. Section 3 of this provided the definition of CSR, which is referred to as “a

commitment of business to behave ethically and to contribute to sustainable economic

development by working with relevant stakeholders to improve their lives in ways that are

good for business, sustainable development agenda and society at large”. This section also

enumerated the suggested CSR activities including but not limited to charitable, scientific,

youth and sports development, cultural or educational purpose, services to veterans and

senior citizens, social welfare, environmental sustainability, health, and disaster relief and

assistance. Section 4 of this act provided that all expenses incurred in connection with the

conduct of CSR, may be deducted from its taxable income. Section 5 stated that the Local

Government Units are

encouraged to extend their assistance to support the CSR of the firms around them. As part

of the government monitoring process, section 6 of this act included that all large tax payer

corporations must submit to SEC, along with their annual reports, the list of their CSR

activities conducted. The SEC shall be the one in charge to monitor these taxpayers by

maintaining a system for proper control and recording. Section 7 stated that the secretary of

finance, in coordination with the Department of Trade and Industry, Securities and Exchange

Commission, and the private sectors are the ones promulgating rules and regulations of this

Act. The remaining sections emphasized its reparability, repealing and effectivity clauses

(SB 1239, 2011; SB 2747, 2013). This document is an evidence that conducting CSR is not

just an optional practice by the firms but an obligation.

In the current year 2019, the Securities and Exchange Commission made a move requiring

all Philippine publicly listed companies to submit Sustainability Reports starting next year,

2020, for the commission to assess and manage the economic, environmental and social

impacts of these companies. The commission issued the “Sustainability Reporting

Guidelines for Publicly Listed Companies” through SEC Memorandum Circular No 4,

series of 2019 last February 15, 2019. This guideline outlined disclosures related to

economic, social and environmental indicators that will serve as the basis in measuring the

company’s influence or impact. The guidelines also provided framework for reporting

company’s contributions to achieving universal sustainability goals like that of the United

Nations Sustainable Development Goals (UNSDG). Hence, publicly listed companies will

have to submit their sustainability reports in the reporting template prescribed, together

with their annual reports (SEC.GOV, 2019).

Sustainability Report is a document published by a company or organization about their

economic, social and environmental impacts caused by its daily operations. It did not only

contained plans to solve issues, but it also contained reports on the actual results of their

implemented plans. Hence, sustainability report can be considered synonymous with CSR

reporting. But unlike other companies, the CSR focus here is not only on community

activities, or what we call philanthropic, but it also included the economic, legal and ethical

(GRI, 2019).

The Four Areas or Levels of Corporate Social Responsibility

As introduced by Carroll (1999), CSR has four levels – economic, legal, ethical and

philanthropic. In today’s literature, these four are described as the scope of CSR or the four

areas or four levels of CSR (Baker & Nofsinger, 2012).

Economic is the obligation of the business to earn profits. This is to meet the demands of

the firm itself, because of their need to survive financially; the employees, because of their

need and right to be paid right; the suppliers and creditors, because of their need to be paid

when something is due to them; and also, the demand of the consumers and the society as a

whole. In short, this is for the welfare of the stakeholders with respect to financial returns

(Ferell et.al, 2013; Mohr et.al, 2001; Wang, 2011).

Legal, the second area or level of CSR, is the responsibility of the firm to abide the laws and

rules. It is a way to assure the public that the business is existing and operating legally.

There is a presumption that a law-abiding firm is a socially responsible firm as well

(Carroll, 1999; Ferell, et.al, 2013; Hack, et.al, 2014; Wang,

2011).

Ethical, the third level, sees to it that the business is acting and operating morally, taking

into considerations the behaviors and standards that are generally good and of value. It

includes being environment-friendly. The firm have obligations to be aware of their

activities and behavior and how they affect the society morally and the environment as well

(Carroll, 1999; Ferell et.al, 2013; Baker & Nofsinger, 2012; Wang, 2011).

Philanthropic, the forth and the last area of CSR, is the expectation to the firms that as they

grow in wealth, they should as well grow in helping the society. There are different ways to

help. It may include donating funds or goods, opening or supporting education, helping in

times of disaster or calamity and other related activities. Hence, philanthropic

responsibility is the firm’s way of giving back what is due to the community (Wang, 2011;

Ferell et.al, 2013; Baker & Nofsinger, 2012; Carroll, 1999).

Understanding Socially Responsible Investing (SRI) and the SRI Compliant

Companies

Socially Responsible Investing (SRI) is defined as investing decisions integrating personal

values and societal, environmental and ethical concerns along with the goal of achieving

financial gain (Schueth, 2003). SRI is otherwise known as ethical or green investing or

ESG, which stands for “Environment, Social and Governance”. It is investing that involves

a mindful choice of companies that maximizes their financial and social well-being

(Camey, 1994). Hence, in here, investors limit their investment

to those companies whose products or operations are socially acceptable (Baker &

Nofsinger, 2012). It is investing with value – thus, looking into (1) the financial health of

the company, which reflected in its financial statements, and also to its stock valuation or

stock performance, and at the same time, (2) its impact to its stakeholders, which is through

their corporate social responsibility (CSR) that addresses human rights, working

conditions, economic growth, corporate governance, health and safety, environmental

effects and their contributions to the community (Hill et.al, 2007). Therefore, the objective

of SRI is getting fair financial return while simultaneously achieving CSR goals (Hill et.al,

2007).

Socially Responsible Investing (SRI) started in the mid-1700s. During this time, a founder of

the Methodist Church, John Wesley stressed a point about the use and making money. He

said, that making money or profiting should be done without hurting others (Schueth, 2003).

He gave instructions on how to protect (not to hurt) a neighbor. These includes not having

harmful lending practices or engaging in any unfair business practices, not trading alcohol or

liquor, not letting them work so long as to degrade their freedom and not allowing the trade

of unhealthy chemicals or food. He also impulses people to avoid companies that harm the

environment. He then encouraged his flock to just live simply (Domini, 2001). This has

become the deepest root of socially responsible investing, hence, avoiding the “sin stocks”

or those companies in alcohol, tobacco, and gaming industries. The modern roots of SRI

evolved and expanded during 1960s and early 1970s. These times, ethical considerations,

along with more emphasis on fair labor and the environment protection were included in

the concept of SRI (Schueth, 2003).

Socially responsible investors grew intensely throughout 1980s up until today. There are

still issues on child labor, abused or employees deprived from necessary benefits (labor law

violations), products being manufactured causing harm to the community and the

environment or even companies that support gambling and manufacture harmful equipment

or weapons. SR investors are calling people to do the same - To invest wisely because it

will shape the tomorrow. To integrate social or ethical criteria into every investment

decision, to align investment with value and to have the strong desire to contribute to social

change (Domini, 2001). SR investors are becoming stronger in their campaign (Camey,

1994) because they want to involve the people to discourage harmful companies from

spreading and to involve them in dealing with social issues. They also want to encourage

them to support companies which are socially responsible or what we call the SRI

compliant.

To help with this move, Socially Responsible Investors created or established approaches

in order to help them identify SRI compliant companies. These approaches include

screening portfolios (social screening), direct dialogue with corporations (Shareholder

Advocacy) and investment in community development financial institutions that supports

SRI (Community Investing) (Domini, 2001). Ciocchetti (2007) described these three as

“Three Categories of SRI” while Schueth (2003) described this as the “Three Dynamic

Strategies of SRI”.

The 1st approach is the screening of portfolios or otherwise known as social screening. This

allows investors to identify companies with positive or negative profiles. This approach

has two types. The NEGATIVE SCREEN, which excludes companies that have products

like tobacco, alcohol, or with operations supporting

gambling, and the POSITIVE SCREEN or otherwise described as qualitative screen, which

identifies company with better records on CSR as compared to the other companies. This

approach uses an SRI criterion to effectively identify SRI companies (Domini, 2001).

The second approach is the direct dialogue with shareholders or otherwise known as

shareholder advocacy. This approach serves a different purpose than social screening.

Shareholder advocacy is applied when a certain investor wishes to directly influence

specific company towards becoming a socially responsible compliant company. This is

done through the following tactics: (1) the investor engaged a discussion with the

management; (2) the investor, who may also be a shareholder, makes a shareholder

resolution stating the proposed changes towards being a socially responsible company; and

(3) through boycotts in cases when the first two are ineffective (Ciocchetti, 2007).

The last approach, which is the community investing, is described as putting funds to those

in low-income communities which have been deprived by most of the financial services

but are supporting SRI. The goal of this approach is to provide fair access even to these

communities by creating jobs, providing affordable housing and small businesses to them.

These are the actions taken by SR investors to encourage people (investors) to consider

social values in their investing decisions (Schueth, 2003).

Company’s Stock Valuation

Stock valuation is the way to determine the value of the firm. To simply define it, stock

valuation describes the value of the stock or the firm itself (Donovan, 2017). There are a

lot of ways to measure value of the firm. Some base it in the financial performance of the

company wherein, the common way is using the financial statements and the use of

financial ratios to analyze returns and financial growth or standing of the firm like in the

study used by Rehman et.al, (2015) and Saeidi et.al (2015). Other researchers like Wang

(2011), Zhang (2017), Flammer (2012), Kempf (2007) and Hill et., al. (2007) used stock

performance like stock returns on stock prices to assess the value of the firm. They believe

that using stock prices or stock performance is more reliable since it assesses the whole

value of the firm (Zhang, 2017). Therefore, in stock valuation, the company is valued in its

entirety, considering both the financial and non-financial factors.

In the discussion of Donovan (2017) in his e-book entitled “An Introduction to Stock

Valuation”, stocks are valued based on the assumptions that the following are considered -

(1) the future value like the future cash flows of the company and the market values of its

assets, (2) the competitive value of the firm as it compares with its competitors, and (3) the

current or existing financial information of the firm like their assets and liabilities.

There are different methods that the investors use in valuing stocks. The three most

common methods are (1) the discounted cash flow methods or the absolute valuation, (2)

the comparable or the relative valuation model, and (3) asset-based

valuation. In discounted cash flows model or the absolute valuation, the investor tries to

find the intrinsic value of a stock based on the firm’s cash flows, discount rates, and

growth rates. In the relative valuation model, the investor uses the information of the other

companies that are in the same sector. This method calculates the values or ratios of these

companies of the same industry, size, geography and financial conditions. These ratios are

averaged to create a one common value. In the asset-based valuation, the balance sheet is

adjusted to reflect the market value This may be simple but in reality, determining the

market values of the assets alone is difficult and so others use the stock price (Donovan,

2017; Nguyen, 2019).

It is true that there are a lot of valuation models available for investors today and that no

single method fits to all. Investors could even use different models at a time depending on

the situation or on the company. It is not an issue if they will use a lot of valuation models

for as long as the right variables are considered in the process, then the valued stocks are

reliable and can be used for investing decisions (Nguyen, 2019).

Corporate Social Responsibility and Company Stock Valuation

The influence of the corporate social responsibility to the firm’s performance or value has

become a special topic in the literature nowadays (Hill et.al, 2006; Wang, 2011; Saeidi

et.al, 2015). However, its concrete link has not yet been established because of inconsistent

results (Ioannis & Serafeim, 2010; Rehman et.al, 2015). Furthermore, researchers use a lot

of sources or basis in determining the performance of the firm such as the information in

the income statement and the use of financial ratios like return on assets, return on sales,

and the return on equity (Rehman et.al,

2015), but many researchers now use the stock valuations or stock performance to

represent the firm’s performance and linked that with corporate social responsibilities

(Wang, 2011; Zhang, 2017; Flammer, 2012; Kempf, 2007; Ioannou & Serafeim, 2010; Hill

et.al,2007).

There are different opinions or research conclusions about this topic. Some concluded that

there is a negative effect of CSR to stock performance because fulfilling CSR would only

give additional costs to the company leading to a decreased financial result. Example for

this is the CSR activity to prevent pollution. Engaging such kind of CSR activity is

expensive and would reduce financial wealth. Aside from this, investment to costly CSR

may put the shareholder in an unfavorable position (Zhang, 2011).

There are as well researches that supported the positive relationship between corporate

social responsibility and the company’s stock valuation. Some of the identified reasons for

its positive influence are the effects of CSR activities to the image of the firm, their

competitive advantage, reputation, and marketing tactics (McWilliams & Siegel, 2012;

Saeidi et.al, 2015). The value of the stocks of the firm is also affected by how investors

perceive the employee’s satisfaction while working in the organization. If the company is

operating ethically, well managed, with satisfactorily benefits to its people, if employees

are engaged in conducting CSR activities, and if there are programs intended for the

protection and welfare of the workers, there is a high positive feedback and a high support

of the employees to the firm which would lead to a higher performance and value to the

company as a whole. Yes, additional operating expense will be incurred because of these

activities but through this social

impact, the good image of the firm will be promoted, and this would attract investors and

encourage them to engage and invest more in these companies (Wang, 2011). Another

research conducted by Flammer (2012) supported this positive link of CSR to the stock

performance. The research concluded that the companies with good impact to the

environment experience a significant stock price increase. This means that stock prices are

affected too by how well the company behave and protect the environment. If there is a

positive behavior of the firm towards the environment like having CSR programs to protect

the nature, there is a positive impact of it to its stock price. Another research conducted by

Ioannou & Serafeim (2010) supported the same conclusion as to the influence of CSR to

stock valuation. Their research findings concluded that the more the firms are visible in

their favorable influence through their CSR activities, the higher their stock value

performance is.

Today, there are still researchers that do not depend entirely on stock prices. To be sure,

they use both the accounting-based (ROA, ROI and ROE) and at the same time, the market

based (excess stock returns or the stock performance) (Nollet et.al, 2016). To some

researchers, the use of both is too much and could provide confusion, but to others, it could

increase the reliability of their studies. This only shows that even today, the determination

of the right formula or tool as a basis for determining value or performance of the firm, is

still an area of research.

In this study, the researcher used the stock performance through the stock valuations to

examine any of its relationships with corporate social responsibilities. Accounting based

tools such as financial ratios were disregarded since the researcher believed that stock

valuation is enough to measure the company’s performance.

Investment Portfolio

Investment portfolio is a collection of investments that an investor uses in order to earn

income and at the same time ensuring that assets or capital are preserved. It usually

contains equity securities (stocks), debt securities (bonds), and other alternative investments

like property investments on real estate and tangibles like jewelries, metals and golds.

Stocks are the common component of an investment portfolio. When an investor has

stocks, he/she has a portion or share in the income of the company invested because they’re

considered as part owners (CFI, 2019; Value Stock Guide, 2019).

There are different types of investment portfolio, growth portfolio, income portfolio, and

value portfolio are the common. Growth portfolios, by the word itself, aim to promote

growth in investing. The investors having this kind of portfolio invest in younger

companies who have the potential for growth. This involved higher risk because younger

companies are considered than larger, and well-established firms.

Income portfolio on the other hand, is more focused on making sure that they have regular

income from their investments. In this type, the investors look into the stock dividends

information of the companies and how frequent these companies distribute it to its

shareholders.

Value portfolio is a bit different than the first two. Although investors in this kind of

portfolio focus on companies with profit and growth potential, the same with growth and

income portfolio, but they consider bargaining in the market by looking into cheap prices.

This is advantageous and common in difficult economic times. The

investors buy cheap priced stocks during this time but earns more when these companies’

performances rise. However, there’s a higher risk in this portfolio type (CFI, 2019). There

are other types of investment portfolio such as the Tax-Managed vs. Tax-Deferred

Investment Portfolios, Active vs. Passive Investment Portfolios, and the Focused vs.

Diversified Investment Portfolios (Value Stock Guide, 2019).

Theoretical Framework

SRI Corporations

Stock
CSR Valuation

Time Horizon
Asia 3-year

Europe 5-year

USA 10-year

SRI in a Global Perspective

Source: Hill et.al, 2007

Figure 1: Theoretical Framework of the Study

Figure 1 shows the theoretical framework of the study. This is based on the study

conducted by Hill et.al (2007) entitled “Corporate Social Responsibility and Socially

Responsible Investing: A Global Perspective” wherein the aim was to examine the

relationship between corporate social responsibility and the company stock valuation (in a

3, 5 and 10 time horizon) across SRI companies in three regions of the world (Asia, Europe

and USA) in order to describe its implications to Socially Responsible Investing in a global

perspective. The results of the study concluded that

being regarded as socially responsible may infer positive impact to the firm’s stock

performance in the long run. Therefore, the more the company becomes socially

responsible (investing and empowering more on their CSR and their good social influence)

the more support they gain from investors.

Conceptual Framework

Philippine Publicly Listed Companies

Social Screening

SRI Compliant Companies

Company
CSR classification
Culture Stock Valuation
Economic

Time Horizon
Vision 3 – year
Profile

Legal
Mission Ethical 5 – year
Industry Philanthropic 8– year
Size
Age

SOCIALLY RESPONSIBLE INVESTMENT PORTFOLIO

Figure 2: Conceptual Framework

Figure 2 illustrates the conceptual framework of the study. This is anchored on the study

conducted by Hill et.al (2007), but the focus of this study was the publicly listed companies

in the Philippines. Illustrated in the figure above, that the Philippine publicly listed

companies were screened, called social screen, in order to determine who are those

companies that are SRI-compliant. After identifying the companies, details on their profile,

CSR practices, which were classified into economic, legal, ethical and philanthropic, and

their stock valuations in 3-year, 5-year, and 8-year time

horizons, were gathered, and this information were used to determine any relationship between

CSR and the company’s stock valuations. Observed that in the study of Hill et.al (2007), the

time horizons considered were up to 10 years but in this study, since the issuance of the CSR

Act based on Senate Bill no. 2747 was last 2011 and the SEC’s support to this bill evidenced by

their press release was last February 2019, the researcher considered the current period,

November 2019 and the last years covering until November 2011, for a total of 8 years to see

how Philippine Publicly Listed companies improved their reporting and CSR implementation in

response to these government regulations. And so, all of the findings extracted in this process

were used in proposing socially responsible investment portfolio. This study was conducted to

support the move in supporting Socially Responsible Investing in the Philippines.