CORPORATE SOCIAL PERFORMANCE AND THE FINANCIAL PERFORMANCE LINK: AN AUSTRALIAN ANALYSIS

Corporate sustainability is an alternative management strategy which goes beyond focusing on growth and profit maximisation of a company. Specifically, it places additional expectations on companies to perform in the areas of social justice, equity, environmental matters and governance issues. In this study a corporate sustainability rating is used to capture corporate social performance (CSP). Two hypotheses are tested. The first null hypothesis is that no relationship exists between financial performance and CSP. The alternative prediction is that firms with higher CSP will have lower financial returns (See for example, Lee and Faff, 2006), and firms with lower CSP have higher CSP returns (See for example, Derwall et al., 2005). The second null hypothesis is that no relationship exists between idiosyncratic risk and CSP. The alternative prediction in this case is that firms with a higher CSP will have less idiosyncratic risk. This study adopts a Best of Sector (BOS) framework within an Australian setting. A sample of approximately three hundred companies is employed over the period 2001 to 2006. Australian corporate sustainability ratings from Monash Sustainability Enterprises (MSE) have been used to construct two mutually exclusive value weighted portfolios or models. One consists of firms with a high social performance rating and the other contains firms with a low social performance rating. These portfolios are compared to test if there is any relationship between corporate social performance and corporate financial performance. The analysis reveals that there is a significant difference between the financial performance of firms that have adopted sustainable practices and non-sustainability practising firms. Specifically, the findings reject the first null hypothesis in favour of the alternative prediction that leading sustainability firms underperform their lagging sustainability counterparts. Following this analysis, additional tests are also conducted on the same set of portfolios and find that idiosyncratic risk is lower for larger firms with higher corporate social performance. However, once firms are matched according to size and industry, no difference in idiosyncratic risk is observed between leading and lagging groups. Thus, the second null hypothesis regarding idiosyncratic risk is supported.