Item response models to measure corporate social responsibility

Abstract

Corporate social responsibility (CSR) is a multidimensional concept that involves several aspects, ranging from environment to social and governance. Companies aiming to comply with CSR standards have to face challenges that vary from one aspect to the other and from one industry to the other. Latent variable models may be usefully employed to provide a unidimensional measure of the grade of compliance of a firm with CSR standards, which is both understandable and theoretically solid. A methodology based on item response theory has been implemented on the multidimensional sustainability rating as expressed by KLD data-set from 1991 to 2007. Results suggest that companies in the oil and gas industry together with firms in industrials, basic materials and telecommunications have a higher difficulty to meet the CSR standards. Criteria based on human rights, environment, community and product quality have a large capacity to select the best performing firms, as they are very discriminant, while governance does not exhibit similar behaviour. A stock selection based on the ranking of the firms according to the proposed CSR measure supports the hypothesis of a positive relationship between CSR and financial performance.