KLD provides annual data “snapshots” relating to environmental, social and governance- related performance for rated companies. The earliest year of data available from KLD is 1991, from which year KLD starts rating all companies in the S&P 500 and Domini 400 Social indices (comprising almost 650 companies in total). In 2001, KLD extends its database to include all companies in the Russell 1000—while also including all companies in the Russell 3000 from 2003. For the purpose of this thesis, all rated companies are included, meaning that 650 firms form the data from 1991, increasing to 3000 firms in 2003 (it should be noted that Kempf and Osthoff (2007) only use companies belonging to the S&P 500 and DS 400).
In this thesis, KLD rating data involves two key assumptions. The first is that strengths must prefer and covary in opposing directions with concerns for each indicator in order to avoid the KLD rankings becoming distorted and, therefore, misleading (Mattingly and Berman, 2006). Researchers usually use the overall score for each indicator, which is the sum of the strengths minus the concerns. Carver (1989) argues that, when grouping the independent variables or non-convergent variables into a composite score, the basic relationship for these variables becomes distorted, thus affecting and confusing further testing and the subsequent relationship. Thus, if the strengths and concerns do not covary in opposing directions, and if there is no convergent validity between them, the strengths minus the concerns does not return an opposing score for each indicator. Thus, the combined score is misleading when the variables do not converge. As a result, this thesis assumes that the strengths and concerns indicate perfect opposing directions for each KLD indicator. The second assumption is that all criteria and sub-criteria are treated as being of equal importance. Although some researchers consider certain criteria to be more important than others, no standard rules are given to allocate the weighting for each of the criteria and sub-criteria. As such, in this thesis (and as in most studies), equal weight is given to all criteria and sub-criteria.
Having understanding the KLD data, there are two different methods to present the CSR ratings from the KLD database. The first method is binary presentation, which means that each sub-criterion has a score of either one or zero (which is discussed in detail later in this section). The second method is that, for each qualitative criterion, KLD uses a five- step scale to rate a company from having “major strengths” to “major weaknesses”. For the exclusionary criteria, KLD only evaluates the weaknesses of companies. Waddock and Graves (1994) convert all of these ratings into numerical values (meaning that, for qualitative criterion, +2 is used to represent a major strength and -2 a major weakness). The KLD rating for qualitative criterion ranges from major strength (+2), strength (+1), neutral (0), concern (-1), and major concern (-2). For exclusionary criteria, the rating score can only be -2, -1, or 0. Hillman and Keim (2001) also use this method of rating to test the relationship between shareholder value, stakeholder management and social issues. They report that shareholder value can be improved by stakeholder management,
and also that a negative relationship exists between social issues and shareholder value. Waddock and Graves (1997) also use the latter KLD rating method to test the link between CSP and CFP. They note that strategic managers have to allocate scarce corporate resources for social issues, and they find a positive relationship between CSP and prior financial performance under the slack resource availability theory. They also find a positive relationship between CSP and future financial performance under the good management theory.
KLD uses several different sources to determine companies’ ratings for each criterion. For example, a “concern” is given if a company has fines or penalties relating to a specific criterion, and the amount of fines or penalties is used to determine whether it is a “concern” or “major concern”. It is considered a “strength” if a company has good employee-related policies, and the extent of benefits available to employees is used to determine whether this is a “strength” or a “major strength”. Judgement also forms an important part of KLD data, as it is necessary to determine various qualitative criteria, such as how “good” a company’s community relationship program is. As such, KLD discusses such aspects internally and makes a rating decision for each company. (The detailed factors that determine the ratings for each criterion are discussed in Section 3.3.5.)
KLD uses multiple criteria to rate companies, with the two broad categories of rating data being “qualitative” and “exclusionary” criteria. Seven qualitative criteria are considered—namely community, corporate governance, diversity, employee relations, environment, human rights and product. The exclusionary criteria means that, where a company is involved in controversial business areas. Six controversial criteria are used— namely alcohol, gambling, firearms, military, nuclear power and tobacco. The qualitative indicators have both positive and negative ratings (i.e., “strengths” or “concerns”), while controversial indicators have only negative ratings.
Multiple sub-criteria exist for each KLD criteria. For example, at the end of 2003, there are 10 sub-criteria listed under the community criterion, 7 for corporate governance, 11
for diversity, 11 for employee relations, 13 for environment, 7 for human rights and 8 for product. Additionally, these sub-criteria can be divided into “strengths” and “concerns”. Each sub-criterion is presented by a binary summary, which means that each sub-criterion has a score of either one or zero. Where a company has a strength or concern on a particular issue, this is indicated by one. Where the company has neither a strength nor a concern, this is indicated by zero. However, the number of criteria and sub-criteria changes over the years, and, as such, this thesis includes the new criteria and sub-criteria as soon as they are added by KLD. Likewise, this thesis also deletes criteria or sub- criteria as soon as they are removed by KLD. As such, this thesis uses the latest rating information available to investors to compute the annual rating score for each company. (It should also be noted that the number of controversial indicators varies over the years; for example, there is no “firearm” indicator before1998.)
Table 3.1 introduces the number of strengths and concerns for each qualitative indicator, as well as the number of concerns for each controversial indicator. In the case that the sub-criteria are not rated by KLD, these sub-criteria are not included in the table. As has been previously noted, the number of strengths and concerns varies over the years. For example, for “community”, the number of strengths increases to seven in 2008, whereas the number of concerns stays almost stable (except for in 1993, when one concern is removed). For “corporate governance”, the number of strengths and concerns increases up until 2008; whereas for “diversity”, a new strength is added in 1995, while the number of concerns does not change from 1993. For “employee relations”, the number of strengths decreases to five in 1995, and then increases to six in 2003, with the number of concerns remaining stable throughout. For “environment”, the number of strengths fluctuates over the period, while the number of concerns increases to seven in 1999. For “human rights”, no strengths are given for the first three years, while three are recorded from 2002 and the number of concerns fluctuates throughout the period. For “product”, the number of strengths and concerns remains stable over the period (at four each). For controversial indicators, the number of concerns for all indicators remains the same until 1997, while there is only one concern for each of the controversial indicators from 2002 to 2008.
Table 3.1 Summary of number of strengths and concerns for each KLD indicator
There are two broad categories of KLD rating data, which being “qualitative” and “exclusionary” criteria. Seven qualitative criteria are considered—namely community, corporate governance, diversity, employee relations, environment, human rights and product. Six controversial criteria are used—namely alcohol, gambling, firearms, military, nuclear power and tobacco. The qualitative indicators have both positive and negative ratings (i.e., “strengths” or “concerns”), while controversial indicators have only negative ratings. NR means not available.
CSR 1991 1992 1993 1994 1995 1996 1997 1998 1999 Qualitative Indicators Community Strengths 4 4 4 6 6 6 6 6 6 Concerns 4 4 3 4 4 4 4 4 4 Corporate Governance Strengths 3 3 3 3 3 4 4 4 4 Concerns 3 3 3 3 3 2 3 3 3 Diversity Strengths 7 7 7 7 8 8 8 8 8 Concerns 2 2 3 3 3 3 3 3 3 Employee Relations Strengths 6 6 6 6 5 5 5 5 5 Concerns 5 5 5 5 5 5 5 5 5 Environment Strengths 6 6 6 6 6 5 5 5 5 Concerns 6 6 6 6 6 6 6 6 7 Human Rights Strengths NR NR NR 2 2 1 1 1 1 Concerns 2 2 2 5 3 3 3 4 4 Product Strengths 4 4 4 4 4 4 4 4 4 Concerns 4 4 4 4 4 4 4 4 4 Controversial Indicators Alcohol Concerns 1 1 1 1 1 1 2 2 2 Gambling Concerns 1 1 1 1 1 1 2 2 2 Tobacco Concerns 1 1 1 1 1 1 1 2 2 Firearms Concerns NR NR NR NR NR NR NR 1 1 Military Concerns 4 4 4 4 4 4 4 4 4 Nuclear Power Concerns 4 4 4 4 4 4 4 4 4
CSR 2000 2001 2002 2003 2004 2005 2006 2007 2008 Qualitative Indicators Community Strengths 6 6 6 6 6 7 7 7 7 Concerns 4 4 4 4 4 4 4 4 4 Corporate Governance Strengths 4 4 4 4 4 5 5 6 6 Concerns 3 3 3 3 3 6 6 7 6 Diversity Strengths 8 8 8 8 8 8 8 8 8 Concerns 3 3 3 3 3 3 3 3 3 Employee Relations Strengths 5 5 5 6 6 6 6 6 6 Concerns 5 5 5 5 5 5 5 5 5 Environment Strengths 5 5 5 5 5 5 6 6 6 Concerns 7 7 7 7 7 7 7 7 7 Human Rights Strengths 2 2 3 3 3 3 3 3 3 Concerns 5 5 4 4 4 4 4 4 4 Product Strengths 4 4 4 4 4 4 4 4 4 Concerns 4 4 4 4 4 4 4 4 4
Controve rsial Indicators
Alcohol Concerns 2 2 1 1 1 1 1 1 1 Gambling Concerns 2 2 1 1 1 1 1 1 1 Tobacco Concerns 2 2 1 1 1 1 1 1 1 Firearms Concerns 1 1 1 1 1 1 1 1 1 Military Concerns 4 4 1 1 1 1 1 1 1 Nuclear Power Concerns 4 4 1 1 1 1 1 1 1