Based on the articles you have read for Week 4, please discuss how the size of the firm and its financial performance may play a role in its implementation

Cornell Hospitality Quarterly XX(X) 1 –12 © The Author(s) 2013 Reprints and permissions: sagepub.com/journalsPermissions.nav DOI: 10.1177/1938965513505700 cqx.sagepub.com

Article

Although the triple bottom line (i.e., profits, people, and planet) has become a common framework for discussions of hospitality firms’ success, the fact remains that the key factor in a firm’s stance toward socially responsible actions is the profit portion of the triple bottom line, that is, eco- nomics. While firms are encouraged to invest resources in socially responsible initiatives by customers and other stakeholders, there is limited empirical evidence that such investments indeed lead to profitability or enhance firm value (Orlitzky, Schmidt, and Rynes 2003). Despite what appears to be a tenuous link between a firm’s environmental performance and its financial performance, numerous firms are investing in initiatives that involve recycling, pollution prevention, and reduction of waste. The firms then commu- nicate their initiatives to stakeholders, including investors, customers, media, and regulatory authorities on the expec- tation that this will encourage brand loyalty, build reputa- tion, and proactively prevent onerous regulation (Bird et al. 2007; Miles, Covin, and Heeley 2000).

Studies of the interaction of economic conditions and social and environmental programs have indicated that firms often cut back on corporate social responsibility (CSR)1 programs when economic conditions are unfavor- able. Lee, Singal, and Kim (2013) found this to be true of hospitality firms that, for instance, curtail their nonopera- tional CSR initiatives (e.g., environment and community

programs), although they continue to invest in operations- related programs, such as product quality and employee relations. However, I have seen little research that explains the connection between an individual firm’s financial per- formance and its investment in sustainable initiatives (Myung, McClaren, and Li 2012). This gap is important to fill because firms often face difficult conditions that may tempt them to focus on short-term tactics while cutting down on long-term sustainability initiatives, which may eventually result in loss of customer and employee loyalty, and reputation, thus eroding sustained competitive advan- tage. Therefore, in this article, I seek to answer the follow- ing question: Does firm financial performance affect investment in sustainability initiatives? To address this mat- ter, I compare the level of environmental investments made by firms in the hospitality industry with that of firms in other industries. More critically, I test the impact of envi- ronmental investment on firm financial performance to

505700 CQXXXX10.1177/1938965513505700Cornell Hospitality QuarterlySingal research-article2013

1Virginia Polytechnic Institute and State University, Blacksburg, USA

Corresponding Author: Manisha Singal, Pamplin College of Business, Virginia Polytechnic Institute and State University, 362 Wallace Hall, Blacksburg, VA 24061-0489, USA. Email: [email protected]

The Link between Firm Financial Performance and Investment in Sustainability Initiatives

Manisha Singal1

Abstract While sustainability initiatives by firms are increasingly encouraged by customers, investors, and the government, the economics of sustainable decisions remains in question. The study described in this paper examines the link between sustainability and economic performance for the hospitality industry, as compared with other businesses. Using data spanning 1991 through 2011 from MSCI’s Environmental, Social, and Governance (ESG) Indices and credit ratings from Standard and Poor’s representing 16,325 firm-years, the analysis finds that hospitality firms on average invest more in environmental programs than do businesses in other industries; that hospitality firms have significantly fewer environmental concerns; that strong financial performance leads to increased investments; and that going green, in turn, pays off in future periods, creating a virtuous cycle. One implication is that hospitality firms should go forward confidently in establishing their sustainability programs, as it appears that customers support the effort financially.

Keywords environmental concerns, corporate finance, hospitality and tourism industry, competitive strategy, strategy formulation and strategy implementation.

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2 Cornell Hospitality Quarterly XX(X)

evaluate whether socially responsible behavior toward the environment pays off financially.

To summarize the findings, based on a data set of 16,325 firm-years covering the period from 1991 through 2011, I find that hospitality and tourism firms score higher on environmental performance than their nonhospitality and tourism peers, and that investment in environmental mea- sures varies directly with financial performance. Most important, I find that superior environmental performance improves future financial performance in this sample, sup- porting the value of greening initiatives.

This paper contributes to the literature in three ways. First, it compares investments made by firms in the hospi- tality industry with those of other firms, thus adding to the sustainability literature both in the services sector generally and the hospitality sector specifically (Singal 2012). Second, the study applies a hitherto unexamined variable, financial performance as measured by credit ratings, in explaining differential investment in sustainability initia- tives, whereas most studies have examined managerial motives and personal proclivities as explanations of corpo- rate greening programs (Ayuso 2006; Tzschentke, Kirk, and Lynch 2008). Finally, this study establishes a critical link between CSR and financial performance by demon- strating that investment in environment management (which consists of several measures) affects firm financial performance—a link that has previously shown mixed results.

Theory Development

Hospitality and Tourism Industry and Investment in Environmental Initiatives

The involvement of stakeholders is particularly crucial to the success of hospitality and tourism industry sustainabil- ity initiatives for at least two reasons. First, the hospitality sector has a substantial environmental footprint, and it also sees opportunities for reducing this footprint through sus- tainability programs, which are encouraged by industry associations such as the American Hotel and Lodging Association’s Green Resource Center, the National Restaurant Association’s Conserve initiative, and the Global Sustainable Tourism Council. Moreover, reducing environmental impact gives firms a competitive advantage, given customers’ demands for sustainability. Research has established the willingness of some consumers to pay more to stay at green hotels or eat at green restaurants. Choi et al. (2009), for instance, reported that consumers in Greece and the United States were willing to pay higher prices to patronize hotels with environmentally friendly policies and some hotels have tested higher prices for green initiatives (Choi and Parsa 2007). In other studies, green hotels with sustainable practices attracted positive word-of-mouth

intentions, higher willingness to pay, and greater return intentions (Kang et al. 2012; Millar and Baloglu 2011). Similar results were found by Hu, Parsa, and Self (2010), Schubert et al. (2010), and Namkung and Jang (2013) for green restaurants. In a survey by the National Restaurant Association, it was found that 60 percent of consumers would prefer to patronize a green restaurant, and 51 percent would pay a median of 10 percent more at a restaurant that adopts green practices.

While sustainability initiatives may seem more neces- sary in industries where pollution is actually visible, like oil refining, mining, or chemical manufacturing, hospitality operations often involve the support of a wide spectrum of physical components and reliance on natural resources (Sloan, Legrand, and Chen 2013). Sloan, Legrand, and Chen (2013) stated, for instance, that the U.S. Environmental Protection Agency calculates that a one-night stay in a hotel room generates an average of 29.53 kg of CO

2 . Moreover, a

survey of twenty-eight InterContinental Hotel properties in 2007 led to an extrapolated estimate that, at 59 kg per night, the average hotel room’s carbon footprint is roughly equal to that of the average U.S. home.

Since the hospitality and tourism industry requires close contact with customers who experience the service, the industry’s firms should be more responsive to demands of multiple stakeholders like shareholders, regulators, domestic and international travelers, and corporate clients. As services in hospitality are coproduced and concurrently consumed, and quality of service is perceived based on the spillover effect of corporate reputation and investment in customer salient issues, I posit that hospitality firms will invest more in sustainability initiatives than nonhospitality firms. Thus,

Hypothesis 1: Firms in the hospitality sector will invest more in sustainability initiatives than firms in the non- hospitality sectors.

Financial Performance and Investment in Sustainable Initiatives

Among the motives for organizational investment in sus- tainable initiatives are reputation, customer and employee loyalty, and self-regulation (Hart 1995; Turban and Greening 1997). However, the forces governing the timing of such investments are not clear. Macroeconomic condi- tions clearly have an effect (Lee, Singal and Kang 2013), and a firm’s stable financial condition and organizational slack can also have a positive correlation with sustainability investments (Bowen 2002; Tuzzolino and Armanndi 1981). Financial performance, resource levels, and managerial interpretations of munificence have led to increased invest- ment in environmental initiatives (McGuire, Sundgren, and Schneeweis 1988; Seifert, Morris, and Bartkus 2004; Sharma 2000).

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Singal 3

Within the hospitality industry, organizational perfor- mance, which contributes to slack resources and stable financial condition, is also likely to influence firm invest- ment in environmental initiatives. Green initiatives require upfront investment that firms with good financial perfor- mance are more likely to consider adopting than firms in financial distress. Garay and Font (2012), for instance, found that for firms in the hospitality and tourism industry, financial slack is an important determinant of investment in CSR. Therefore, I expect that hospitality firms with higher financial performance will likely invest more in sustainabil- ity programs.

Consumer attitudes are also a driver of the hospitality and tourism industry’s environmental investment. In a Deloitte survey of more than 1,000 business travelers (Weissenberg, Redington, and Kutyla 2008), 95 percent of respondents thought that lodging companies should be undertaking green initiatives. Similarly, the 2012 Canadian Travel Intentions Survey found that 42 percent of business travelers surveyed said that practices like recycling and energy efficiency matter to them when choosing where to stay, a figure that had increased by 5 percentage points from the prior year.

Thus, I expect that given a similar level of financial per- formance, firms in the hospitality and tourism sector will invest more in sustainability measures than their nonhospi- tality peers, as summarized in the following hypotheses:

Hypothesis 2a: Financial performance will affect invest- ment in sustainability initiatives in all firms. Hypothesis 2b: Higher financial performance will lead to higher investment in sustainability initiatives in the hos- pitality sector. Hypothesis 2c: Controlled for financial performance, firms in the hospitality sector will invest more in sustainability initiatives than firms in the nonhospitality sector.

Impact of Environmental Sustainability Initiatives on Financial Performance

Scholars in both strategic management and hospitality lit- erature have examined the impact of environmental initia- tives on firm performance and financial performance, but the results are mixed. For example, using a broad sample of firms, Berman et al. (1999) did not find any significant effect of environmental factors on firm performance, although they did find a positive correlation between employee and product safety factors with firm performance. Also relying on a cross-industry sample of firms, Bird et al. (2007) found that there is a conflict between environmental strengths and stock price performance though the market seems to value firms that meet minimal environmental stan- dards. Similarly, a meta-analysis of corporate social respon- sibility and corporate social performance conducted by

Orlitzky, Schmidt, and Rynes (2003) found that environ- mental responsibility pays off only weakly in firm perfor- mance, and Hillman and Keim (2001) reported that stakeholder management led to improved shareholder value, while social issue participation was negatively asso- ciated with shareholder value.

In contrast, other studies have found a positive link between environmental performance and economic perfor- mance, with industry growth moderating the relationship (Russo and Fouts 1997); havesuggested that the market rewards ecoefficiency, although environmental information is incorporated with a drift, and valuation increases over time (Guenster et al. 2011); and have concluded that pollu- tion prevention, rather than pollution treatment, helps per- formance (King and Lenox 2002). An intriguing meta-analysis of the moderators that define the corporate environment–financial performance relationship found that smaller firms benefit more than larger firms, U.S.-based firms benefit more than international firms, and that market measures of performance react most to environmental investments (Dixon-Fowler et al. 2013).

Hospitality industry results are likewise varied. Studies of Spain’s hotels have shown a positive link between socioenvironmental responsibility and firm performance (Rodriguez and Cruz 2007) and between revenue genera- tion and environmental certification (Segarra-Oña et al. 2012). While studying the commitment to levels of quality jointly with environment management, Tari et al. (2010) found that both initiatives influenced hotel performance. However, Claver-Cortes et al. (2007) did not find a link between environmental proactivity and organizational per- formance. Similarly, Park and Lee (2009) and Lee and Park (2009) reported that financial rewards for social responsibility benefitted U.S. hotels, while casinos and res- taurants did not experience a clear benefit.

Although some scholars have attributed the mixed findings in the hospitality sector to the use of diverse measures (Zhang, Joglekar, and Verma 2012), a literature review of thirty-two quantitative studies on the link between environmental perfor- mance and financial performance (Molina-Azorín et al. 2009) and the meta-analysis by Dixon-Fowler et al. (2013) con- cluded that studies reporting a positive link dominate.

For these reasons, I propose the following:

Hypothesis 3: There will be a positive link between investment in environmental initiatives and financial performance, especially in the hospitality sector.

Method

Sample and Sources of Data

Data come from three primary sources. The first data set, MSCI’s Environmental, Social, and Governance (ESG)

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4 Cornell Hospitality Quarterly XX(X)

Indices (also known as the KLD database), is an annual data set originated in 1991 with ESG performance infor- mation, which is used to evaluate investment in environ- mental corporate social responsibility.2 The ESG database has been extensively used and validated for studying cor- porate social performance (Agle, Mitchell and Sonnenfeld 1999; Hillman and Keim 2001; Mattingly and Berman 2006; Waddock and Graves 1997). The other two data sets are standard in the finance and accounting literatures: his- torical and current credit ratings of firms from Standard and Poor’s (S&P) Compustat and stock returns and market capitalization from Center for Research in Security Prices (CRSP) at the University of Chicago.

The intersection of ESG data and S&P credit ratings data generates a total sample of 16,325 firm-years of which 624 firm-years relate to the hospitality and tourism sector. To identify hospitality and tourism firms, we match the firms in the ESG ratings sample with a sample of hospitality and tourism firms that traded on any U.S. exchange between 1980 and 2011.3 In the regression analysis, hospitality and tourism firms are identified with a hospitality and tourism dummy set to 1.

Variables and Methods

Environmental CSR variables are constructed from 1991 through 2011 using two types of indicators: strength indica- tors such as pollution prevention, recycling, and waste man- agement systems, and concerns indicators such as gaps in regulatory compliance, severity of controversies related to land use, and biodiversity. Each ESG indicator is a binary variable, which is set to 1 if the firm meets the criteria for that indicator, and 0 otherwise. Hence, higher scores on strength environmental indicators imply stronger environ- mental performance, whereas greater scores on concern indicators denote poorer performance. Following estab- lished practice, I sum each category of indicators to arrive at composite assessment of strengths (EnvStr) and concerns (EnvCon; Bartkus and Glassman 2008; Berrone, Surroca, and Tribó 2007; Hillman and Keim 2001; Ruf, Muralidhar, and Paul 1998). Such composites have been successfully used in other studies (Bird et al. 2007; Dyer and Whetten 2006). In addition, I compute an overall environmental CSR composite (EnvAll) as the ratio of the two composites:

EnvAll = ( )

( )

1

1

+ + EnvStr

EnvCon .4

Financial performance is measured by historical long- term issuer ratings assigned to a firm by S&P.5 Flow vari- ables such as stock returns, return on assets, sales growth, and return on equity suffer from their transitory nature in measuring the impact of CSR on financial performance unless there is a significant change in CSR during the period under observation (Gregory and Whittaker 2013). If firms consistently have high CSR, for instance, flow variables would show no change, and it would be difficult to relate

CSR to financial performance. Most stock variables (mea- sured at a point in time) depend greatly on accounting num- bers such as Tobin’s Q, which is subject to accounting policy choices, or must be benchmarked to an accounting number such as market-to-book value instead of just market capitalization. I therefore chose credit rating as it is a better measure of firm performance than other measures. Kisgen (2006, 1038-39) states, for instance: “Credit ratings may provide information on the quality of a firm beyond other publicly available information. Rating agencies may receive significant company information that is not public . . . and thereby provide more reliable measures of a firm’s credit- worthiness.” The relationship between equity performance measures and credit ratings is evidenced by the reaction of stock prices to rating changes, which Hand, Holthausen, and Leftwich (1992) and Holthausen and Leftwich (1986) found to directly affect both bond and stock prices. Credit ratings are also easily comparable across different firms and provide direct information about financial slack available for discretionary investments.

The sample’s S&P rating ranges from AAA, which I give a numerical value of 25, to D, which I assign a value of 1. Following standard industry practice, ratings are further partitioned into investment grade (InvGrade), which has a dummy value of 1 for ratings at or above BBB− and nonin- vestment grade, based on ratings at or below BB+.

Control and other variables. With credit rating as the measure of a firm’s financial condition, this analysis does not need variables controlling for leverage, risk, and other factors intended to measure the financial condition of a firm. In addition, since the primary analysis is concerned with firms in the hospitality and tourism industry, industry-specific control variables are redundant. In the end, the two most relevant control variables are size of the firm, which may affect credit rating and investment in environmental initia- tives, and stock performance, a flow measure of firm per- formance. Consequently, size and stock performance are included in regressions as control variables. Size is mea- sured using the log of market capitalization (LogSize) at the end of the previous year following Graves and Waddock (1999),6 and performance is measured by stock return.

In addition, to isolate the effect of financial performance on environmental initiatives in the hospitality industry, I use an interaction term Hospitality and tourism firm dummy with the investment grade dummy. Using unbalanced panel data from the sources described earlier, I conducted t tests and multivariate regression analysis to evaluate the three hypotheses proposed here.

Results

The summary statistics and correlation matrix reported in Exhibit 1 are generally consistent with the hypotheses. The high positive correlation between environmental CSR and

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Exhibit 1: Summary Statistics and Correlations.

Variable N M Median SD 1 2 3 4 5 6 7 8

Hospitality and tourism dummy (1) 16,325 0.04 0.00 0.19 1.00** EnvAll (2) 16,325 1.07 1.00 0.63 0.04** 1.00** EnvStr (3) 16,325 0.33 0.00 0.75 −0.02 0.69** 1.00** EnvCon (4) 16,325 0.45 0.00 0.91 −0.08** −0.40** 0.26** 1.00** LogSize (5) 16,089 8.12 8.04 1.46 −0.05** 0.10** 0.28** 0.25** 1.00** StockReturn (6) 16,058 0.16 0.11 0.63 0.01 −0.02* −0.03* −0.01* −0.18** 1.00** InvGrade (7) 16,171 0.66 1.00 0.47 −0.12** 0.05** 0.15** 0.13** 0.52** −0.06** 1.00** Rating (8) 16,171 15.75 16.00 3.53 −0.13** 0.06** 0.16** 0.13** 0.64** −0.06** 0.81** 1.00**

Note: N is reported in firm-years; size is the log of market capitalization in millions of dollars. *p < .05. **p < .01.

credit ratings shows that CSR is likely to be more prevalent in firms that have higher financial performance. The corre- lations also show that the hospitality and tourism firms in this sample are smaller and have lower credit ratings and lower investment grades than the firms in other industries. In spite of their smaller size, I observe from Column 1 in the exhibit that hospitality and tourism firms are positively cor- related with the overall environmental CSR, EnvAll. This finding is in accordance with Hypothesis 1 and suggests that hospitality and tourism firms have higher investment in the environment than firms in other industries. Hospitality and tourism firms have slightly lower strengths (EnvStr) than other firms but significantly lower environmental con- cerns (EnvCon) than the other firms.

Hospitality and tourism firms’ comparative effective- ness at environmental CSR is underscored by the data in Exhibit 2, which contains results related to Hypotheses 1 and 2.7 Again consistent with Hypothesis 1, Panel A1 shows that EnvAll is larger for hospitality and tourism firms than for the other firms by a statistically significant 0.126. Despite the fact that hospitality and tourism firms have fewer strengths and fewer concerns, the magnitude of the difference in concerns (EnvCon) is much greater at −0.393 than the magnitude of difference in strengths (EnvStr) at −0.077.

Consistent with Hypothesis 2a, investment grade firms have a better record of environmental CSR than noninvest- ment grade firms (Panel A2), such that the overall environ- mental score, EnvAll, is higher by a statistically significant 0.067 for investment grade firms. The results become clearer in Panels A3 and A4, where firms are evaluated by financial performance. In both cases, consistent with Hypothesis 2b, we find that investment grade firms gener- ally have a better record of overall environmental CSR than noninvestment grade firms, both for hospitality and tourism firms and nonhospitality and tourism firms. For hospitality and tourism firms, investment grade companies outperform noninvestment grade firms by a statistically significant 0.214, while in other industries the outperformance of investment grade firms is a statistically significant 0.069.

Both strengths and concerns are higher for investment grade firms, although the difference in strengths is relatively much higher than for concerns.

The relatively higher environmental effort of the hospi- tality and tourism industry is summarized in Panel A5, which compares firms with similar financial performance. In that regard, EnvAll is significantly greater for investment grade hospitality and tourism firms than for comparable firms in other industries (0.236), and the same is true for noninvestment grade firms, in which hospitality and tour- ism firms are also relatively higher (0.091). While there is no statistically significant difference in strengths in either sets of firms, I find that hospitality and tourism firms have significantly fewer concerns than comparable firms in other industries. For investment grade firms, the difference is −0.412, and for noninvestment grade firms, the difference is −0.274. Thus, the results for overall CSR and environmen- tal concerns are consistent with Hypothesis 2c because, controlled for financial performance, hospitality and tour- ism firms have significantly superior environmental CSR performance than nonhospitality and tourism firms. An analysis of variance inflation factors (VIFs) for Panel B of Exhibit 2, and Exhibit 3 indicated no instances of multicol- linearity. In addition, statistical significance is based on heteroskedasticity-consistent standard errors.8

The models presented here further support the hypothe- ses and tabular material. The first set of three models, 1 to 3, relate to Hypothesis 1 and Panel A1 (see Exhibit 2). Model 1 reveals that hospitality and tourism firms have a statistically significantly greater EnvAll score (0.127) when compared with other firms, primarily because hospitality and tourism firms have far fewer concerns than other firms (−0.404 in Model 3) and the hospitality and tourism firms have marginally fewer strengths (−0.082 in Model 2). Consistent with Hypothesis 1, the results show that hospi- tality and tourism firms have significantly greater invest- ment in environmental initiatives than do firms in other industries.

Models 4 to 6, corresponding to Hypothesis 2a and Panel A2, examine the relationship between environmental

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6 Cornell Hospitality Quarterly XX(X)

Exhibit 2: Environmental CSR and Financial Performance.

Panel A: Indicators of Environmental CSR

Panel A1 All Hospitality and Tourism Firms All Nonhospitality and Tourism Firms Difference

EnvAll 1.196 1.070 0.126** EnvStr 0.260 0.337 −0.077** EnvCon 0.074 0.467 −0.393**

Panel A2 All Firms, Investment Grade All Firms, Noninvestment Grade Difference

EnvAll 1.097 1.030 0.067** EnvStr 0.413 0.181 0.231** EnvCon 0.537 0.291 0.245**

Panel A3 Hospitality and Tourism,

Investment Grade Hospitality and Tourism, Noninvestment Grade Difference

EnvAll 1.328 1.114 0.214** EnvStr 0.437 0.150 0.287** EnvCon 0.134 0.036 0.098**

Panel A4 Nonhospitality and Tourism,

Investment Grade Nonhospitality and Tourism,

Noninvestment Grade Difference

EnvAll 1.092 1.023 0.069** EnvStr 0.412 0.184 0.228** EnvCon 0.546 0.311 0.235**

Panel A5 Difference between Hospitality and Tourism and Nonhospitality and Tourism Firms, by Financial Performance

EnvAll 0.236** 0.091** EnvStr 0.025 −0.033 EnvCon −0.412** −0.274**

Panel B: Regression Results For Environmental CSR in Hospitality and Tourism Firms and Nonhospitality and Tourism Firms

Dependent Variable

EnvAll EnvStr EnvCon

Independent Variables Model 1 Model 2 Model 3

Intercept 1.073** 0.338 0.464** Hospitality and tourism dummy 0.127** −0.082** −0.404** Stock return −0.007 0.013† 0.035** LogSizea 0.041** 0.151** 0.159** N 15,907 15,907 15,907 Adjusted R2 (%) 0.8 6.2 5.4

Independent Variables

Dependent Variable

EnvAll (All Firms) EnvStr (All Firms) EnvCon (All Firms)

Model 4 Model 5 Model 6

Intercept 1.032** 0.179** 0.

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