Finance & Strategic Management Essay

Over the past decades the concept of Corpo point kind Responsibility (CSR) has continued to grow in importance and signifi displacece callable to outer pressure of diverse stakeholders, and has thereby become to a greater extent expectant on companies ag poleas (Carroll & Shabana, 2010 Beurden & Gossling, 2008). The concept of CSR has been playing field to considerable debate, commentary, surmise building and continues question (Carroll & Shabana, 2010). The question, of whether CSR investments result in monetary and social benefits that outweigh its be, is intensively scrutinized in active belles-lettres (Schreck, 2001 Carroll & Shabana, 2010).Adherents of CSR argue that it is in the long-term self- arouse of corporations to be socially involved (Carroll & Shabana, 2010 Barnet 2007). The boilers suit logic is that CSR increases the trustworthiness of trues and strengthens the relationships with stakeholders. CSR may nurture result in decreased transaction costs and the reby improve corporal monetary mental process (CFP), by decreasing employee turnover, simplification operate costs, as well as functioning as a buffer store in disruptive events (Carroll & Shabana, 2010 Barnet, 2007).Barnett (2007) and Schreck (2011) argue that, if the monetary benefits of CSR meet or master the costs, CSR drive out be justified as a rational investment. jibe to Kurucz, Colbert and wheeler (2008), sures may attain four distinct benefits from engaging in CSR cost and run a luck of infectioniness reduction gaining competitive advantage developing story and legitimacy and seeking winwin resolutions through synergistic apprise creation. Critics of CSR typically use classical sparing arguments, articu advancedd most forcefully by Friedman (Carroll & Shabana, 2010).Traditionally, the expenditures of CSR ar considered an illegitimate waste of resources, which conflict with a buckrams responsibility to its shareholders (Schreck, 2011, Barnet, 2007). Ac cording to Friedman (1970) There is nonpareil and only one social responsibility of short letter to use it resources and act on in activities intentional to increase its profits so long as it stays deep down the rules of the game. Friedman further argued that, social issues are non the concern of business people, and the business of business is business (Carroll & Shabana, 2010).Even though CSR deplete been subject to critique, an increasing number of corporations are accepting responsibilities that extend well beyond the immediate interest of the owners, by considering non-shareholder stakeholders concerns (Grant, 2010 Clegg, Carter, Kornberger & Schweitzer, 2011). Although the existence, direction and strength of possible associate between CSR and CFP guide been the subject of several trial-and-error analyses (Schreck, 2011), and even though CSR is almost universally practiced, the results from empirical studies are inconclusive (De Bakker, Groenewegen & Hond, 2005).Aft er much than thirty years of look into, it flocknot derively be concluded, whether a one-dollar investment in social initiatives returns more or less, than one dollar in benefits to shareholders (Barnet, 2007 Surroca & Tribo & Waddock, 2008). The inconclusiveness of empirical studies may be due to unclear and inconsistent definitions of key set (De Bakker, Groenewegen & Hond, 2005 Barnet, 2007), methodological differences (Carrol & Shabana, 2010), and diverse approachinges of measuring CSR and CFP (Beurden & Gossling, 2008).In existing literature, CSR activities are frequently entioned to reduce insecurity, by avoiding the various consequences of moral disapproval by legion(predicate) stakeholders (Zadek, 2000). However, CSR derived hazard reductions are considered as an ex-post secure subject and not as a proactive pretend of infection vigilance instrument to control or reduce single luck (firm specific). Under the assumption that, shareholders are encounter adver se and prefer a high expected return (Bodie, Kane & Marcus, 2011 B heartyey, Myers & Allen, 2011), a reduction of firm specific risk must be sensed as favorably.Provided that CSR investments can be utilise as a risk solicitude pecker, CSR could be seen as investments by firms on behalf of its shareholders. Taking a shareholder perspective, this musical theme looks beyond the socially good deed of CSR, and focussinges on the value of CSR as a method to reduce idiosyncratic risk without detriment of CFP. CSR and Risk Management Since this paper hypothesizes that, CSR can be applied as a risk management instrument to pull through CFP, risk need to be outlined.Risk can be defined as the uncertainty about outcomes or events, especially with respect to the next (Orlitzky & Benjamin, 2001). widely risk management is defined as a managerial tool to avoid risk, transfer risk to another party, reduce risk, or in some(prenominal) cases accepting consequences of a certain risk (Froot, Scharfstein & Stein, 1994). A shareholders perspective on risk management however, conflicts with the capital addition pricing model (CAPM) (Markowitz, 1952) and the Modigliani & Millers theorem on capital complex body part (1958).CAPM theory states that, the cost of reducing idiosyncratic risks simultaneously reduces the expected return, and and then firm value (Markowitz, 1952). Risk reduction by holding a well-diversified portfolio of securities will be unattainable by risk management (Godfrey, Merrill & Hansen, 2009), why a profit-maximizing investor would not prefer risk management. Total firm risk is in general the combination of systematic and unsystematic risk (Hoje & Haejung, 2012).Systematic risk, often referred to as merchandise risk or non-diversifiable risk, is ordinarily defined as the firms sensitivity to changes in the food commercialise average returns, which cannot be cut back by diversification of shareholders (Weber, 2008 Luo & Bhattacharya, 2009 Orlitzk y & Benjamin, 2001). Unsystematic risk is defined as idiosyncratic risk (Hoje & Haejung, 2012 Luo & Bhattacharya, 2009). Idiosyncratic risk is tralatitiously viewed as indifferent to the portfolio investors, since it is associated with specific companies and thereby can be reduced by diversified portfolios (Husted, 2005 Weber, 2008).Opposing idiosyncratic risk is of great relevance to the firm manager, whose very survival may depend upon taking passable measures to reduce the idiosyncratic risk (Husted, 2005). Firms financial risk is often defined in call of variability of returns (Orlitsky & Benjamin 2001), or stock price volatility (Luo & Bhattacharya, 2009), which is measurable risk measures, given that higher volatility implies greater investment risk and uncertain rising cash flows (Luo & Bhattacharya, 2009 Oikonomou, Brooks & Pavelin, 2012).A reduction in idiosyncratic risk reflects reduced variance in the future expected cash flows, which translates into greater shareho lder wealth (Luo & Bhattacharya, 2009 Mishra & Modi, 2012). In a strict Modigliani and Miller perspective, risk-management instruments are of no value, since these are strictly financial transactions that do not affect the value of a companys operating assets (Froot, Scharfstein & Stein, 1994). The views of CAMP and Modigliani and Miller bewilder been superseded by a postmodern view of risk management as an primary(prenominal) strategic tool.Firms do invest in insurances even though the costs of these investments may be in excess of expected losses, which is in clear violation with the perfect market assumption (Smith & Stulz, 1985 Stultz, 2002). If risk management can reduce firms exposure to idiosyncratic risks, it protects shareholders against the deadweight costs of severe financial wo in a way, that investors can not accomplish in the market by diversifying (Godfrey, Merrill & Hansen, 2009). Review of the linkage between CSR and riskFor several decades, researchers have aim ed at discovering a conclusive linkage between CSR and CFP, the literature however, stay highly fragmented (Aguinis & Glavas 2012). According to Orlitsky & Benjamin (2001) true economic per formulateance manifests itself in both high financial returns and low financial risk. Among financial and non-monetary benefits, risk reduction is often mentioned as a positive outcome of engaging in CSR activities. Porter and Kramer (2006) argue that, todays pressure, of external stakeholders to hold companies accountable for social issues, learly demonstrate the potential large financial risks for any corporation.Several scholars emphasize, that the costs of CSR can be justified by reductions in risk and costs derived from engagement in social issues (Caroll & Shabana, 2010). The ancient argument is that the diverse demands of stakeholders represent potential threats and risks to the viability of the firm, why it is the economic interest of firms to mitigate these threats and gain legitimacy through social involvement (Caroll & Shabana, 2010 Schreck, 2011 Kurucz, Colbert & Wheeler 2008).Existing literature on the CSR-risk relationship is virtually unanimously agreeing upon a ostracize correlation between CRS and idiosyncratic risk, where empirical results show that CSR take downs idiosyncratic risk (Spicer, 1978 Orlitsky & Benjamin, 2001 Godfrey, 2005 Hoje & Haejung, 2012 Caroll & Shabana, 2010 Godfrey, Merrill & Hansen, 2009 Heal, 2005 Luo & Bhattacharya, 2012 Oikonomou, Brooks & Pavelin, 2012 Berman, Wicks, Kotha & Jones, 1999 Hart, 1995 Shrivastava, 1995 Peloza, 2006).Several studies have too shown a epoch-making prohibit relationship between CSR and systematic risk (non-diversifiable) (Hoje & Haejung 2012 Orlitzky & Benjamin, 2001 Mcguire, Sungren & Scneewies, 1988 Luo & Bhattacharya, 2009). CSR reduces idiosyncratic risk by reducing the probabilities of expected financial, social, or environmental crisis that could adversely bow firms cash flows (Hoje & Haeju ng, 2012).Firms perceived as socially responsible may be able to increase interpersonal trust among stakeholders, build social capital, lower transaction costs, and therefore ultimately reduce uncertainty about future financial performance (Orlitzky & Benjamin, 2001). Luo and Bhattacharya (2009) present the view of CSR, as helping the firm build a bulwark of defense against future losses of economic value by reducing firm specific risk and pic of future cash flows.Firms with high social responsibility may have lower financial risk, since these are less sensitive to certain negative external events, like regulatory governmental intervention, undesirable publicity, probability of civil- and pitiful legal proceedings or consumer boycotts, why risk reduction can be seen as a monetary benefit of CSR (Mcguire, Sungren & Scneewies, 1988 Oikonomou, Brooks & Pavelin, 2012 Weber, 2008 Orlitzky & Benjamin, 2001 Mcguire, Sungren & Scneewies, 1988). meshing in specific types of CSR, those aime d at a firms supplementary stakeholders or society as a whole, is argued to create a form of goodwill or positive philanthropic moral reputational capital, which functions as an insurance-like protection, when negative events occur (Godfrey, 2005 Peloza, 2006). When business activity creates negative wallop on society, stakeholders respond by sanctioning the firm (Godfrey, Merrill & Hansen, 2009).It is argued that the goodwill, derived from engagement in CSR, reduces the overall severity of the sanctions, by encouraging stakeholders to give the firm the benefit of the dubiety(Godfrey, 2005 Uzzi, 1997 Peloza, 2006 Godfrey, Merrill & Hansen, 2009). The resultant moral capital gained from social engagement has little to do with generating financial value, but the insurance-like protection contributes with preserving shareholder value and thereby financial performance (Godfrey, Merrill & Hansen, 2009).Mishra and Modi (2012) fund a operative issuance on idiosyncratic risk, when CSR is applied, the authors however enhanced this result by finding that, positive CSR reduces idiosyncratic risk, while negative CSR increases idiosyncratic risk. Literature has, according to Mishra and Modi (2012), often a singular focus on positive CSR, and overlooks that firms also occasionally engage in activities that qualifies as negative CSR. Luo and Bhattacharya (2009) and Porter and Kramer (2006) argue that CSR is not beneficial in all situations, but is earlier advantageous in some contexts and disadvantageous in others and can even lead to additive risk.This is in line with Barnet (2007), who argues that stakeholders perception of firms CSR engagement are path-dependent (Barnet, 2007 Luo & Bhattacharya, 2009 Hoje & Haejung, 2012). For firms with social negative impact or prior bad reputation, CSR may be perceived as blood money to mitigate past sins, omissions or shortcomings (Luo & Bhattacharya, 2009 Barnet 2007). CSR can thereby lead to reduced idiosyncratic risk, but ca n also get a line a firm to additional risk (Weber, 2008 Barnet, 2007).Discussion Even though the CSR-risk relationship have received much attention in the existing literature, managing risk as the predominantly basic for engaging in CSR has not received specific attention. Focus within the field is on ex-post measures of risk-related benefits, where CSR is not valued as a proactive tool to reduce idiosyncratic risk. Existing research does not seem to provide any applicatory guidance to managerial proactive evaluations of the risk reductions derived from CSR involvement.It further lacks a hardheaded framework to ex-ante quantify the risk related benefits of CSR (Weber, 2008). The above review demonstrates the focus on risk, solely as valuable side-effect of engaging in CSR activities. The authors of the paper posit a research gap exists within the existing literature of CSR and risk CSR is not considered as a proactive ex-ante risk management instrument to control and reduce firm risk. Given the risk reducing benefits of CSR, the authors suggest that investments in CSR can be used as a proactive risk management instrument to reduce idiosyncratic risk. such an approach could strengthen the overall CSR involvement and support rational ex-ante decision-making in this area (Weber, 2008). The aim is to draw a much-need attention to the risk-reduction potential of CSR by viewing CSR investments as a proactive risk management tool, where managing risk is the main purpose for engaging in CSR. Empirical resolving the research gap and verifying the hypothesis is beyond the scope of this paper. The authors however, suggest that a potential solution is to apply real pickaxe theory as a basis for proactive CSR risk management decision-making.CSR as a real pickax Attributable to the aforementioned arguments, the function of CSR as a risk management tool can be considered as a real option. Regular options are based on securities (financial instruments), whereas real opt ions are based on hedging against uncertainties in real investment projects (Mun, 2002). An analytic thinking of the costs and benefits of CSR projects, using traditional NPV models, often leads to a rejection, as these emit to contribute to maximizing shareholder value (Friedman, 1962).This is, nevertheless, not always the reclaim decision, as the NPV approach fails to incorporate the main advantage of real options (Husted, 2005). Compared to the traditional NPV approach, real options offer management flexibility through multiple decision-making in situations with high uncertainty. Managers have the option, but not the obligation, to engage in, modifying or end strategies, as new information becomes available (Mun, 2002). A CSR option offers the plectron of deferring, abandoning, expanding, or staging an investment project (Amram & Howe, 2003).Due to the theoretical and numeric complexity of option theory, which is beyond the scope of this scientific paper, option theory will be described on an incomprehensive level. In brief option pricing is a function of five variables the value of the fundamental asset, the use of goods and services price, time to exercise, the risk-free interest rate, and the volatility of the rudimentary asset ( slow & Scholes, 1973).The value of the underlying asset is the resources resulted from the CSR option, such as qualified employees, PR and cost avoidings etc. Husted, 2005). The exercise price refers to the required additional investments needed for receiving the value created by the CSR option. The timing of the exercise is an essential variable, as it has great effect on the value of CSR options. The risk-free interest rate does not play an important role in most real options (Mun, 2002). The volatility or the uncertainty of the underlying asset has a significant impact on the value of CSR options (Mun, 2002). The variance of the expected value can both be higher or lower than the expected return.Black and Scholes is the most widely used regular option pricing model, however, also one of the most complicated models (Mun, 2002). A Binomial lattice approach is applied in most real option pricing, as it provides a more transparent and intuitive appeal compared with Black and Scholes theoretical and mathematical approach (Mun, 2002). However, since the aim is solely to clarify the value of real options in a CSR context, the choice of approach is of less relevance.Real options provide an important framework for firms to manage risk by reducing the risk of future investments, and can thus be an essential tool in corporate risk management (Husted, 2005). Finally, a real CSR option explicitly includes a time dimension. This ex-ante perspective is clearly different from the focus on risk in most CSR-risk research, which is ex post in nature. CSR as a risk management instrument The Toyota example A few decades ago, motorcar manufacturers did not focus so intensively on a verdure profiling as they do t oday.The increased oil prices in 1973 and 1979 were influential for the entry of Japanese car manufacturers in USA, who were producing smaller and more go down on competent cars (Andrews, Simon, Tian & Zhao, 2011). The gas efficient cars of Japanese manufactures were causative to the car attention as a whole subsequently invested massively in young technology projects. These investments have met consumers need and have generated positive snitching values. Toyotas Prius has reached cult status, as it is one of the most gas efficient and green cars on the market.However, more interestingly is the security, that the green profile of the Prius has offered Toyota, which includes protection against the bad publicity of car manufacturers contribution to pollution and factors such as Middle Eastern conflicts that influence oil prices and hence sales of cars. At first glance, it appears as Toyota has been skilled at forecasting future trends and meeting customers needs without using CS R as management instrument. As the following example however illustrates, Toyotas management could have benefitted from considering investments in CSR as real options to control idiosyncratic risk and thereby preserve CFP.In 2009 repeated accidents occurred, which were accused to be caused by flaws in grace mats and accelerator pedals in Toyotas vehicles. This resulted in a recall of more than 5 million vehicles, alone in the North American market (Andrews, Simon, Tian & Zhao, 2011). Before a product is recalled, companies have to make severe considerations. A product-recall can have great financial impact in terms of losses in brand value, consumer goodwill, decreasing sales and a negative effect on stock prices (Kumara & Schmitza, 2011), which in this case is the value of the underlying asset of the CSR option.The decision to recall the cars is the price of the option. The recall option could have generated strategic flexibility, which however, meanwhile was eliminated, as Toyota s management failed to exercise the option, to begin with it was too late. The leisurely recall decision resulted in losses in brand value, consumer goodwill, decreased stock price, lower sales, a fine of $16 million and more than 130 potential class-action lawsuits (Andrews, Simon, Tian & Zhao, 2011).The negative outcome of the late recall is considered as high volatility of the underlying asset. A instantaneous recalling could have had a avoiding, a limited or opposite effect on product brand, consumer goodwill and the massive media coverage (Husted, 2005). Provided that Toyotas management had viewed the recall decision as a valuable option rather than severe costs, strategic flexibility could have been obtained, why the negative outcome may have been avoided.A faster exercise of the recall option might have resulted in goodwill or trust, which could have been put-upon by Toyota to limit the negative publicity caused by the repeated accidents. Toyota however, failed to exercise the recall option in acute time, why the result was unconnected flexibility to respond to the unexpected event of the accidents. The value of the real option foregone by Toyota was a function of inter alia lost sales, brand value and reputation. Toyotas management failed to exploit the advantages of CSR as a risk management tool.