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Legal vs. Normative CSR: Differential Impact on Analyst Dispersion, Stock Return Volatility, Cost of Capital, and Firm Value

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Abstract

This study examines how the sell-side analysts interpret firms’ corporate social responsibility (CSR) activities. Specifically, we examine the differential impact of overall, legal, and normative CSR on the analysts’ earnings forecast dispersion, stock return volatility, cost of equity capital, and firm value. Employing a sample of U.S. public firms during 1993–2009, we find that overall CSR intensities reduce analyst dispersion of earnings forecast, volatility of stock return and cost of capital (COC), and increase firm value. However, its impact is reduced for firms with better accounting and disclosure quality. When we disaggregate CSR into legal and normative CSR, we find that legal (normative) CSR decreases (increases) analysts’ dispersion, stock return volatility, and COC, while legal (normative) CSR increases (decreases) firm value. The sell-side analysts tend to have less (greater) information asymmetry regarding the net benefits of pursuing CSR that is (not) required by laws. We find, however, that the benefit of having normative CSR realized in 1 year lag such that analyst dispersion, stock return volatility, COC decrease, respectively, and firm value increases. Furthermore, we find that the benefit of normative CSR is offset for firms with higher accounting and disclosure quality.

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Notes

  1. We contrast the analysts’ reactions toward CSR activities that are required by laws (legal CSR), such as labor rights, antitrust, and product safety violations; and CSR activities that follow the norms, ethics, and discretionary social responsibility (normative CSR), such as charitable giving, work life benefits, and employment of the disabled.

  2. A few corporations are able to provide more tangible evidence of “doing well while doing good,” such as Whole Foods (Whole Foods Markets Annual Report 2010) and Patagonia (Casadesus-Masanell et al. 2009). Others struggle to achieve both firm profits and social responsibilities (i.e., British Petroleum and Pfizer).

  3. Our hypotheses are based on a theoretical model of asymmetric information between managers and external market participants, namely shareholders and analysts (Leland and Pyle 1977; Grossman and Stiglitz 1980; Myers and Majluf 1984). Gennotte and Leland (1990) present a theoretical model based on Grossman and Stiglitz (1980) where asymmetric information plays a key role in generating price volatility and market crashes, when market participants are not completely informed about the existence of hedging activities. Attanasio (1990) argues that in the presence of asymmetric information, asset prices tend to be more volatile than in the financial markets with full information.

  4. For instance, Johnson and Johnson’s McNeil Consumer Healthcare division product recall during 2011 for consumer (product) safety that is required by the Food and Drug Administration (FDA) indicated that both the company and the media news continuously disclosed the net impact of product recall was expected to reduce its net sales by 12 % (Loftus 2011). In contrast, Johnson and Johnson was unable to disclose the impact of its recent initiative on its cost and profit to phase out formaldehyde from its cosmetic products to fulfill consumers and society pressures beyond what is required by law (Thomas 2012).

  5. Focusing on the CSR brand, Ogrizek (2002) argues that CSR branding is also becoming of paramount importance. If the firm mismanages the CSR branding, its reputation can be damaged, which could have direct and indirect negative effects on firm performance. Luo and Bhattacharya (2006) use CSR to investigate the relation between CSR and firm value. They develop a conceptual framework for predicting that (a) customer satisfaction partially mediates the relation between CSR and firm market value, (b) corporate abilities moderate the financial returns to CSR and (c) these moderated relations are mediated by customer satisfaction. They find the results supporting the reputation-building framework and customer satisfaction plays a significant role in the relation between CSR and CFP.

  6. When we exclude KLD corporate governance category from our sample, however, our main results remain qualitatively unchanged.

  7. We also conduct robustness check with CSR counts instead of CSR index. Our unreported results using CSR counts are consistent with results reported in this paper.

  8. Moffitt (1999) suggest using the IV method, which focuses on finding a variable (or variables) that influences the first-stage, but does not influence the second-stage dependent variable (and thus is not correlated with the random error term in the second-stage equation). Angrist (2000) asserts that the IV method works if the researcher focuses on the causal effects. Moffitt (1999) further suggests that each IV that is indeed uncorrelated with the random error term in the second-stage (i.e., analyst dispersion, firm risk, cost of capital, and firm value) equation will yield unbiased estimates. Certain IVs will yield more precise estimates, however. The more highly correlated the IV is with the first-stage dependent variable, i.e., CSR engagement, the more precise the estimates will be. Thus, the challenge in an IV estimation is to find an appropriate IV that is highly correlated with the first-pass CSR variable, but uncorrelated with the second-pass analyst dispersion, firm risk, cost of capital, and firm value. Unfortunately, it is often hard to find variables that meet both of these requirements, and therefore it is difficult to find good IVs among the many potential IVs.

  9. Our results remain qualitatively unchanged when we use discretionary accruals based on the Jones (1991) model instead of Kothari et al.’s (2005) performance-adjusted discretionary accruals.

  10. We also examine 2-, 3-, 4-, and 5-year lag effect, but find insignificant results.

  11. We further examine 2-, 3-, 4-, and 5-year lag effect, but find insignificant results.

  12. For instance, General Mills, Intel Corporation, Starbucks, and many other corporations listed and have improved their rankings in Corporate Responsibility Magazine 100 Best Corporate Citizens when they continuously provide news and media releases about their progresses in CSR activities especially those which are not required by laws.

  13. APCO Worldwide (2004) is a consulting firm that addresses firms’ interests and objectives through communication and public affairs and consulting that combines a global perspective with local expertise to understand the issues, events and trends that impact businesses and organizations around the world (http://www.apcoworldwide.com/).

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Acknowledgments

Hoje Jo appreciates Gerald and Bonita Wilkinson Professorship endowment, Leavey Research grant, and sabbatical support of the Leavey School of Business at Santa Clara University. We appreciate Gary Monroe, Section Editor, for insightful guidance and one anonymous referee for many constructive and valuable comments. Harjoto acknowledges the Julian Virtue Professorship endowment, and the Rothschild Fellowship awards for financial support.

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Authors and Affiliations

  1. Graziadio School of Business and Management, Pepperdine University, Malibu, CA, USA

    Maretno A. Harjoto

  2. Santa Clara University, Santa Clara, CA, USA

    Hoje Jo

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Appendix 1: Categories for legal and normative CSR

Appendix 1: Categories for legal and normative CSR

KLD variables

Legal

Normative

Strength

Concern

Community

 Charitable giving

 

Yes

1

 

 Innovative giving

 

Yes

1

 

 Support for housing

 

Yes

1

 

 Support for education

 

Yes

1

 

 Non-US charitable giving

 

Yes

1

 

 Volunteer programs

 

Yes

1

 

 Community other strength

 

Yes

1

 

 Investment controversies

Yes

  

−1

 Negative economic impact

Yes

  

−1

 Tax disputes

Yes

  

−1

 Community other concerns

Yes

  

−1

Corporate governance

 Limited compensation

Yes

 

1

 

 Ownership strength

Yes

 

1

 

 Transparency strength

 

Yes

1

 

 Political accountability strength

 

Yes

1

 

 Public policy strength

 

Yes

1

 

 Corp gov other strength

 

Yes

1

 

 High compensation

Yes

  

−1

 Ownership concern

Yes

  

−1

 Accounting concern

Yes

  

−1

 Transparency concern

 

Yes

 

−1

 Political accountability concern

 

Yes

 

−1

 Public policy concern

 

Yes

 

−1

 Corp gov other concerns

 

Yes

 

−1

Diversity

 CEO

 

Yes

1

 

 Promotion

 

Yes

1

 

 Board of directors

 

Yes

1

 

 Work life benefits

 

Yes

1

 

 Women and minority contracting

 

Yes

1

 

 Employment of the disabled

 

Yes

1

 

 Gay and lesbian policies

 

Yes

1

 

 Diversity other strength

 

Yes

1

 

 Controversies

Yes

  

−1

 Non-representation

Yes

  

−1

 Diversity other concerns

 

Yes

 

−1

KLD inclusionary variables

Legal

Normative

Strength

Concern

Employee relations

 Union relations

 

Yes

1

 

 No layoff policy

 

Yes

1

 

 Cash profit sharing

 

Yes

1

 

 Employee involvement

 

Yes

1

 

 Retirement benefits strength

 

Yes

1

 

 Health and safety strength

 

Yes

1

 

 Emp relations other strength

 

Yes

1

 

 Union relations

 

Yes

 

−1

 Health and safety concern

Yes

  

−1

 Workforce reductions

 

Yes

 

−1

 Retirement benefits concern

Yes

  

−1

 Emp relations other concerns

 

Yes

 

−1

Environment

 Beneficial products and services

 

Yes

1

 

 Pollution prevention

 

Yes

1

 

 Recycling

 

Yes

1

 

 Clean energy

 

Yes

1

 

 Property plant equipment

 

Yes

1

 

 Management systems strength

 

Yes

1

 

 Environment other strength

 

Yes

1

 

 Hazardous waste

Yes

  

−1

 Regulatory problems

Yes

  

−1

 Ozone depleting chemicals

Yes

  

−1

 Substantial emissions

 

Yes

 

−1

 Agriculture chemicals

 

Yes

 

−1

 Climate change

 

Yes

 

−1

 Environment other concerns

 

Yes

 

−1

Human rights

 Positive record in South Africa

 

Yes

1

 

 Indigenous peoples relations strength

 

Yes

1

 

 Labor rights strength

 

Yes

1

 

 Human rights other strength

 

Yes

1

 

 South Africa concern

 

Yes

 

−1

 Northern Ireland concern

 

Yes

 

−1

 Burma concern

 

Yes

 

−1

 Mexico concern

 

Yes

 

−1

 Labor rights concern

Yes

  

−1

 Indigenous peoples concern

Yes

  

−1

 Human rights other concerns

 

Yes

 

−1

Product

 Quality

 

Yes

1

 

 R & D innovation

 

Yes

1

 

 Benefits to economically disadvantage

 

Yes

1

 

 Product other strengths

 

Yes

1

 

 Product safety

Yes

  

−1

 Marketing contracting concern

Yes

  

−1

 Antitrust

Yes

  

−1

 Product other concerns

Yes

  

−1

  1. If a rating is categorized as legal CSR, the same rating cannot be categorized as normative CSR
  2. KLD variable descriptions are available at http://www.kld.com/research/stats/indicators.html

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Harjoto, M.A., Jo, H. Legal vs. Normative CSR: Differential Impact on Analyst Dispersion, Stock Return Volatility, Cost of Capital, and Firm Value. J Bus Ethics 128, 1–20 (2015). https://doi.org/10.1007/s10551-014-2082-2

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