Growth in corporate social responsibility (CSR) practices is an undeniable fact of modern business. 90% of S&P 500 firms published a corporate sustainability report in 2020, up from merely 20% in 2011. As more and more firms adopt CSR practices, a key question emerges: how do such activities impact investor perceptions of firms? Proponents of CSR cite muted return reactions during the 2008–2009 global financial crisis for high-CSR firms as proof that it helps build social capital and investor trust. However, more recent evidence from the COVID-19 global pandemic challenges this claim. To understand whether CSR increases investor trust in firms, we study the relation between firm-level CSR and stock price discovery around corporate disclosures.
Investor trust is essential to efficient information flow in capital markets. Because corporate disclosures can be manipulated, investors face uncertainty about information they receive from management. As this uncertainty increases, the informational efficiency of security prices declines. We posit that investors view higher CSR as a commitment by management to incorporate less bias into their reports. By reducing the amount of uncertainty about managerial reporting bias, investor trust leads to greater price informativeness. Therefore, if CSR helps build investor trust, we expect to observe faster price discovery for firms with higher levels of CSR.
We test this proposition by examining the intra-period timeliness (IPT) and intra-period efficiency (IPE) of stock prices around earnings announcements. Consistent with investors being more trusting of firms with more CSR, we observe a strong positive association between firm-level CSR and both the intra-period timeliness and intra-period efficiency of annual earnings announcements. This relation persists in a quasi-natural experiment based on narrowly passed shareholder proposals related to CSR.
Another dimension of price discovery is investor uncertainty around earnings announcements, which is highly sensitive to the amount of trust investors have in firms. It is well documented that there is an increase in investor uncertainty in anticipation of earnings announcements and a subsequent reduction in uncertainty after the disclosure is complete . If CSR bolsters investor trust about future firm disclosures, we expect that the ex-ante rise (or ex-post reduction) in investor uncertainty around earnings announcements will be smaller (or larger) for firms with higher levels of CSR. We indeed observe significantly smaller increases in investor uncertainty leading up to earnings announcements made by firms with high CSR. Then, after the earnings announcement is made, these firms experience significantly larger reductions in investor uncertainty. Overall, the evolution of investor uncertainty around earnings announcements for firms with higher levels of CSR supports the inference that investors are more trusting of these firms’ disclosures.
Moreover, when investors are more trusting of firms’ disclosures, they are likely to incorporate information about current and future earnings into stock prices faster. Therefore, if investor trust is increasing in CSR, we also expect to observe stronger returns-earnings associations for firms with higher levels of CSR. Consistent with this prediction, we find that CSR enhances the magnitude of the relation between current earnings and contemporaneous stock returns.
Our study identifies CSR as an effective tool for proactively increasing investor trust. At the same time, several studies argue that CSR might be the manifestation of agency problems inside the firm and primarily benefits managers who, at the expense of shareholders, earn a good reputation among key stakeholders (e.g., local politicians, non-governmental organizations, labor unions). Our findings highlight the importance of carefully monitoring and regulating firms’ CSR activities, as we demonstrate that investor perceptions of firms are materially shaped by firms’ CSR activities.
Jonathan Berkovitch is an Assistant Professor at Luiss Guido Carli University, Department of Business Management
Doron Israeli is an is an Associate Professor at IDC Herzliya, Arison School of Business and Nazarbayev University, Graduate School of Business
Atanu Rakshit is an Assistant Professor at Nazarbayev University, Graduate School of Business
Suhas A. Sridharan is an Assistant Professor of Accounting at Emory University, Goizueta Business School
This post is adapted from their paper, “Does CSR Engender Trust? Evidence From Investor Reactions to Corporate Disclosures,” available on SSRN.