According to Klein and Dawar, CSR is like an insurance policy against negative events of a firm, and proactive social activities achieve and maintain good reputations. The studies in CSR and reputation relationship have been related to many stakeholders such as bankers and investors, corporate FP, a company’s reputation and sense of loyalty among customers and employees.
In an empirical study by Siltaoja, the researcher has concluded that there exists a link between
CSR and reputation based on the notion of value priorities. The individual’s perception about CSR activities is very important to build reputation generated by such activities for an organization.
Reputations are outcomes of a competitive process in which firms signal their key characteristics to stakeholders to maximize their socioeconomic and moral status. Reputation is additional to the market value of a firm and that can be attributed for an organization to be a responsible citizen. It is generally believed that corporation’s social responsibility activities can be used for image enhancement of an organization, which can build more legitimacy in the eyes of its stakeholders.
Corporation’s social responsibility toward environmental management, economic growth and philanthropy are categorized as external CSR activities, and help in building reputations and goodwill of organizations.
There is a positive relationship between external CSR practices and reputational capital.
In today’s business environment, intangible assets, such as reputation, are increasingly important in determining the value of a company. Evidence that corporate reputation is positively related to firm value raises the question of how a firm can develop a favourable reputation. Stakeholders increasingly expect companies to behave in an ethically, socially and environmentally responsible manner and to communicate transparently about their actions. Satisfying these expectations is one way to earn a favourable reputation as a sustainable company. The challenge then becomes how to signal that the company is meeting stakeholder demands for sustainable practices. One mechanism that is available is to seek inclusion on a reputable sustainability index. If stakeholders value sustainability practices, then inclusion on a sustainable index should be associated with a positive increase in value.
There is a vast literature that examines the relationship between different aspects of sustainability, such as corporate social responsibility and reputational capital. It is often explained by using stakeholder theory and the positive relationship between CSR and Financial Performance For example, according to McGuire, Sundgren and Schneeweis (1988) a firm has an investment in reputation, including its reputation for being socially responsible. An increase in perceived social responsibility may improve a firm’s reputation and permit it to exchange costly explicit claims for less costly implicit charges whereas, if stakeholders perceive a decline in social responsibility, this may increase explicit claims.
This idea is expanded by Fombrun and Shanely (1990) who suggest that favourable reputations can generate excess returns by permitting companies to charge premium prices, attract better job applicants, and attract investors. Firms with a good reputation for sustainability will be able to negotiate better terms of trade with all stakeholders (customers, suppliers, employees, etc.) because they are able to signal the quality of their products and services and their ability to honour claims in the future. Customers may be willing to pay a higher price for firms with a better reputation since reputation serves as a signal of the quality of the product. Similarly, employees should prefer to work for high reputation firms and therefore should either work harder or accept lower compensation, lowering the firm’s costs. These examples help to illustrate the perspective that investments in sustainability are not simply altruistic but rather value maximizing. When firms invest in safer products, a safer work environment, or green technology, they do so recognizing the impact it will have on future revenues and costs. Being socially responsible has its costs, but these costs may be justified when compared to the benefits: a reduction in other costs or an increase in revenue.
There is another interesting theory explained by Fombrun et al. (2000) “…the activities that generate CSR do not directly impact the company’s financial performance, but instead affect the bottom line via its stock of ‘reputational capital’ – the financial value of its intangible assets.” Citizenship activities help a company build reputational capital, which enhances its ability to negotiate more attractive contracts with suppliers and governments, to charge premium prices for its products, and to reduce its cost of capital. Further, CSR activities can mitigate the risk of reputational losses by hedging against downside risk.
The studies cited above imply that a reputation for CSR impacts stakeholders’ perception of a company in a way that increases expected cash flows, and therefore value. The challenge then becomes how to build a reputation for CSR. The desire of companies to credibly signal socially responsible behaviour and to benefit from a good reputation has contributed to the development of a whole new business sector that is charged with reviewing and reporting on the CSR activities of companies.