THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY

ON FINANCIAL PERFORMANCE

BY

Muniira Ali Sheikh

&

Abdirahiim Abduqaadir Moamud

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2.0 Introduction
This chapter presents the followings such theoretical frame work, empirical study, conceptual
frame work and conclusion .

2.1 Theorotical Framework

several theories to explain the reasons why companies engage in corporate social

responsibility. These include legitimacy theory, stakeholder theory, institutional

theory, political economy theory, stewardship theory and agency theory. However,

there is no single theory which can be used to completely explain the engagement in

CSR. There is a view that a given single theory could have some limitations in

explaining CSR practices.

2.1.1 Legitimacy Theory

Legitimacy theory has been widely used in social and accounting literature to

explain why companies disclose social and environmental information. Suchman

(1995) defined legitimacy theory as: “a generalized perception or assumption that the

actions of an entity are desirable, proper, or appropriate within some socially

constructed system of norms, values, beliefs, and definitions.” (p.574)

Legitimacy theory is based on the perception that the rights and responsibility

of companies come from society. Business has to operate within the boundaries of

society in order to meet the expectations of society, which include provision of better

goods and services to society. As an organisation is a part of a large social system,

business needs to operate within a social system, without any negative impact to

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society (Deegan, 2002). This could lead organisations to achieve their goals and

sustain their profits. Suchman (1995) identified three forms of legitimacy: pragmatic

(based on audience self-interest); moral (based on normative approval) and cognitive

(based on comprehensibility and taken-for-grantedness), which is used in terms of

manipulation and garnering societal support. These three forms have been used to

explain the link of CSR with legitimacy theory. Guthrie and Parker (1989) and O’Donovan
(2002) argued that legitimacy theory is based on the perception that

business is conducted in society through a social contract which management agrees

to achieve, based on a number of social requirements, in return for approval of its

goals. Organisations need to behave and disclose enough information for society to

judge whether or not a company is a good corporate citizen. The companies

perceived as “good corporate citizens” perform according to social commitments.

For this purpose, (i.e. performing as good corporate citizens), businesses may

need to change the process of their organisations. Newson and Deegan (2002) argued

that legitimacy theory is supposed to be influenced by the disclosure of information

and not just by changes in business actions. When society’s expectations change,

businesses will be required to demonstrate a change in their operation strategies.

O’Donovan (2002) argued that business attempts to change social expectations,

perceptions or values via several approaches as a part of the legitimating process.

This is very important to the organisations, because some activities of organisations

are subject to risks which may impact the objective of these organisations.

Lindblom (1994) and Gray et al, (1995a) identified four strategies or

approaches on how organisations gain legitimacy. The first approach is that an

organisation may need to educate and inform its relevant public about the changing

of the organisation’s performance and actions. This approach is used to identify the

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legitimacy gap between action and actual failure performance of the organisation.

The second approach is to change the perceptions of the society without changing

actual organisational behaviour. This approach is to be used when a legitimacy gap

has risen between business and society. The third approach is that organisations may

need to manipulate social perception by drawing public attention away from current

issues to other related issues. This approach could divert public expectations from a

given current situation. The fourth approach is that an organisation may need to

change public expectation when society has an incorrect expectation of its

performance. However, this study is not focused on the process of legitimacy, but on the

application of legitimacy to CSR literature.

2.1.2 Legitimacy Theory and Corporate Social Responsibility Disclosure

Legitimacy theory is commonly used in academic literature to address the

link between a company’s financial performances with CSR disclosure. A number of

studies have adopted legitimacy theory to explain why companies engage in CSR

activities, how organisations gain and maintain their legitimacy. Legitimacy theory

can be used as motivation for companies to disclose their social and environmental

activities. It is argued that managers will report more CSR activities when they are

forced to do so by communities. Legitimacy theory is the main theory to describe

social and environmental disclosure (Deegan and Gordon, 1996; O'Donovan, 2000;

Deegan, 2002).

Patten (1991) investigated whether the voluntary social disclosures are related

to public pressure or profitability in the USA. He claimed that the disclosure of CSR

in annual reports has been applied to report the movement of social activities in

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firms. Due to public pressures, companies with large size and specific industries may

report more frequently about CSR and compare those characteristics to their

company’s performance. Larger firms are more exposed in the media, and thus are

more likely to undertake CSR activities to cultivate their public image. Some

industries receive more public attention than others, which put pressures on firms in

these industries to undertake CSR activities. Thus, firm size and industry type can be

used as variables related to CSR according to legitimacy theory.

Gray et al, (1995a) adopted legitimacy theory to examine corporate social

and environmental reporting in the UK from 1979 to 1991. Their results indicate that

CSR disclosure increased significantly throughout the period of their study. An

increase in CSR disclosure can be explained by legitimacy theory. The disclosures on

customer relations, health and safety, environmental and energy increased during the

period of study. The health and safety disclosures tend to represent the “changing

perceptions” of society and provided an example of legitimation strategy. However,

the extent of customer and energy disclosure could not be explained by using

legitimacy theory, because these two dimensions of disclosures constituted only a

small proportion of environmental disclosure (Gray et al,, 1995a).

Deegan and Rankin (1996) used legitimacy theory to clarify the systematic

changes in corporate environmental disclosure policy of prosecuted firms in

Australia. Their results indicate that there is a significant increase in disclosing

positive environmental information by prosecuted Australian firms. Corporate

management of these firms used disclosure policy mainly to gain legitimation. In

particular, the legitimation attempts were focused on disclosure of good

environmental news.

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Further research by Clarke and Gibson-Sweet (1999) examined corporate

social disclosures in the management of company reputation in the UK. They argued

that companies used annual reports as media to communicate their CSR activities to

society. They concluded that larger firms and firms with a high public presence are

likely to disclose and communicate about corporate social responsibility

involvement. Only a very few firms produced a separate report for their

environmental activities. It can be argued that annual reports were used as

legitimisation tools to communicate with the relevant public in order to maintain

their legitimacy.

Campbell (2000) conducted a study on a UK company, Marks and Spencer,

to examine whether legitimacy theory or political economy theory is more applicable

in explaining corporate social responsibility disclosure and to understand the causes

of variability in the amount of social disclosure for the period 1969-1997. Their

results show that the level of CSR disclosure of the British company Marks and

Spencer increased in the period from 1969 to 1997. They found support for

legitimacy theory because variations of CSR reporting by Marks and Spencer came

as a result of social opinion and were motivated to garner social support. He also

argued that the findings were consistent with legitimacy theory.

Deegan et al, (2000), reviewed the response of Australian firms to five major

events that impact the environment, health, and safety of employees and community

members by examining the reports of the Exxon Valdez, Bhopal disasters, the Moura

Mine disaster in Queensland, the Iron Baron oil spill and the Kirki oil spill. The

results of their study indicate that after the incident, the amount of total and positive

incident-related disclosure is larger than before the incident. This finding is

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consistent with legitimacy theory, since firms want to improve their social image

after disaster. This provides further evidence on changes in the disclosure policies of

firms after major disasters. These are examples of legitimisation of CSR reporting.

Cormier and Gordon’s (2001) used legitimacy theory to analyse changes in

social and environmental disclosure strategies of three electric utilities, two publicly owned
firms and one privately owned firm in Canada. They found that government-

owned enterprises disclosed more CSR information than the privately-owned firms.

The level of disclosure correlated with the size of the company and ownership type.

The largest utility owned by government provided better disclosure of CSR activities

than the smaller firms. These findings support the view that environmental disclosure

helps in dealing with public pressure on government firms. When the size of

government-owned enterprise increases, firm appears to be more visible and

accountable.

Mobus (2005) used legitimacy theory to investigate the association between

mandatory environmental performance disclosure and subsequent environmental

regulatory performance by examining refining firms in the USA. The findings of this

study illustrate that mandatory disclosure of environmental legal sanctions violations

were followed by subsequent regulatory compliance. The result suggests that

companies would disclose higher amounts of environmental regulatory compliance

information after being penalised for noncompliance. Thus, legitimacy theory

provides an explanation for the corporate reaction after legal sanctions for non-

compliance.

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2.2 Empirical Study
Menassa (2010) investigated the characteristics and nature of CSR disclosure

in the Lebanese banking industry. The findings illustrated that human resources and product
and customers-related disclosures were largely reported by Lebanese banks, while the
disclosure on quality and degree of environment activities was weak.

Noronha et al, (2013) examined corporate social reporting in China. Their results

show that the practices of CSR disclosure for Chinese listed enterprises are in the

early stage. It is still far behind those in the western countries.

Rouf (2011) showed that the number of independent non-

executive directors was associated with the extent of CSR disclosure. Other control

variables such as board audit committee, board of directors and return on equity were
positively correlated with CSR disclosure.

Sobhani etal, (2009) examined CSR practices of companies listed on the stock exchange in

Bangladesh in the year 2008. Their results indicate that the disclosure level has been
increasing over the decade, with all the firms in their sample disclosing at least one item on
human resources. About 47% of firms disclosed community information, 23% disclosed
consumer and product information, 19% disclosed environmental information, and 18%
disclosed other issues.

Tsang (1998) provided evidence on CSR disclosure of banking,

hotel and food and beverages industries. The findings of this study show that the

level of CSR disclosure in three sectors was growing from 1986 to 1995.

Bayoud and Kavanagh (2012) explored the practices of CSR disclosure in Libya by using
interviews from managers of organisations. Their results indicate that reporting CSR
information in annual reports is important for company performance

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 2.3 Conceptual Framework

CSR

Financial
Community
Performance

Employee

Conclusion
The literature on CSR disclosure and its connection to financial performance
has been reviewed in this chapter. The two primary theoretical stances that are
most frequently employed to explain CSR disclosure are the legitimacy and
stakeholder theories. Nonetheless, no one explanation can fully account for CSR
participation (Belkaoui, 1989; Gray et al., 1995a). Stakeholder groups'
expectations about CSR operations and disclosure are characterized by the
application of stakeholder theory. Legitimacy theory examines how
organizations view CSR initiatives and disclosures as well as how to control
social movements in society to maintain their legitimacy (Deegan et al., 2002;
O'Donovan, 2002). According to Kuasirikun and Sherer's (2004) literature
analysis, the primary conclusions on CSR disclosure in Thailand include a
growing trend of companies focusing onet al,, 2009.

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Tsang, E. W. (1998). A longitudinal study of corporate social reporting in Singapore: The

Bayoud, N. S., Kavanagh, M., & Slaughter, G. (2012). Factors influencing levels of corporate
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