Do Perceptions of Corporate Social Responsibility Contribute to Explaining Differences in Corporate Price-Earnings Ratio
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Volume 3 Number 2
Do Perceptions of Corporate Social Responsibility Contribute to Explaining Differences in Corporate Price-Earnings Ratios? A Research Note Philip L. Little and Beverly L. Little College of Business, Western Carolina University
ABSTRACT Past research has shown that variations in price-earnings ratios are primarily in¯uenced by expected earnings growth potential and perceived investment risk. However, these factors do not explain all the variation. This paper examines whether particular dimensions of corporate reputation contribute separately to priceearnings ratios. The study uses data on 141 companies from the 1992 Fortune magazine corporate reputation survey. The dimensions of the reputation survey (with the ®nancial `halo' removed) were used in a regression model along with ®ve-year earnings per share growth projections and betas from Value Line reports to explain variation in price-earnings ratios. The results indicate that corporate reputation for social responsibility explains additional variation in price-earnings ratios, along with the traditional variable of earnings per share growth. Companies with stronger reputations for social responsibility have marginally higher priceearnings ratios. WHAT DRIVES PRICE-EARNINGS RATIOS? The price-earnings ratio has long been used as a tool by investment analysts to assess earnings growth potential and investment risks. In their original study, Beaver and Morse (1978) concluded that earnings growth potential and risk, on average, explained only 50 per cent of the variation in price-earnings ratios. Recent studies by
Zarowin (1990) and Allen and Cho (1999) con®rm the long-held belief that variations in price-earnings ratios are primarily in¯uenced by expected earnings growth potential and perceived investment risk. However, both studies also conclude that these factors do not explain all of the variation and suggest that further research be conducted to identify other important factors. One factor that could in¯uence the price-earnings ratio is corporate reputation. Reputations capture a combination of social and economic contributions that ®rms make. Previous research suggests that positive reputations allow ®rms to charge premium prices, attract better applicants for their workforces, attract investors, lower costs of capital, and enhance competitive status (Alsop, 1999; Beatty & Ritter, 1986; Caminiti, 1992; Milgrom & Roberts, 1986; Fombrun & Shanley, 1990). If these assertions are true, then a measure of corporate reputation should contribute to variance in price-earnings ratios beyond traditional measures of risk and growth potential. Little, Jones, and Jones (1999) found this assertion to be true. In their model, an overall rating of corporate reputation added to the variance explained in priceearnings ratios after controlling for projected earnings per share growth, beta, and choice of accounting method. While this
Corporate Reputation Review, Vol.3, No. 2, 2000, pp. 137±142 # Henry Stewart Publications, 1363±3589
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