Corporate Social Responsibility Builds Investor Trust

There’s little doubt that corporate social responsibility (CSR) is a good thing for businesses.  Whether it’s taking positive action on society, communities, the climate, or the planet, strong corporate citizenship tends to play well with the public, the media, and consumers alike. And that can translate into wins in terms of brand equity and reputation.

What is perhaps less clear are the concrete business returns that ethical business practices may or may not generate. Or, whether doing the right thing can create value for firms beyond image, brand, and customer or employee engagement.

To shed light on this, Goizueta Assistant Professor of Accounting Suhas A. Sridharan, has taken a rather novel approach. Together with colleagues from the universities of LUISS Guido Carli, Nazarbayev University, and IDC Herzliya, Sridharan has published a new study using measures of disclosure credibility to understand whether CSR builds investor trust and drives tangible benefits for corporations.

Corporate Social Responsibility Does Reap Rewards

Assistant Professor of Accounting Suhas A. Sridharan
Assistant Professor of Accounting Suhas A. Sridharan

“Disclosure credibility refers to how much your investors trust the information your organization provides – how much faith they have in your company’s ability to accurately convey opportunities for growth, and perhaps more critically, to navigate risk and uncertainty,” says Sridharan.

“Because CSR and responsible business practices have a role in addressing a range of risks–from climate change and environmental factors to socio-economic or political uncertainty and the impact on supply chains, talent and so on–we reasoned CSR can impact investor trust and disclosure credibility. And disclosure credibility, in turn, can impact investor decision-making and business outcomes.”

To study disclosure credibility, and capture shifts in investor sentiment towards firms, Sridharan and her colleagues decided to use the link between share prices and company earnings announcements–the public statements on profitability that firms are obliged to make over different periods.

“Earnings announcements are among the most salient and recurring areas of corporate disclosure, and managers and investors pay very close attention to them,” Sridharan says.

“Because of the nature of the information they contain, they have a direct link to security price discovery – the price that firms and investors will agree to buy and sell shares in the company. Simply put, earnings announcements can be used to examine how much investors value a firm.”

As reports, earnings announcements are also highly complex and typically time-consuming to process. Because of this, Sridharan and her colleagues opted to look at just how quickly or slowly investors were reading announcements and responding to them – and how quickly or slowly stock prices were adjusting to reflect earnings news within a five-day window after earnings announcements, as well as a longer period to allow for potential overreaction or error.

More Disclosure Credibility Equals Faster Results

Sridharan explains, “The intuition we brought to the study was that the more investors trust a firm’s disclosures, the more efficient or faster they will be to process its earnings report; in other words, the more they will be likely to take the report on face value and less inclined to dig into the finer minutiae or question its findings.”

Adopting this approach, she and her colleagues then compared and contrasted investor response to earnings reports from different firms, with greater or less involvement in CSR activities.

In total, they looked at a large-scale sample of more than 19,000 annual earnings announcements from just under 3,000 U.S. firms over a 25-year period, between 1992 and 2017. Using Morgan Stanley Capital International environmental, social, and governance ratings, they were also able to determine the degree of firm-level CSR across their dataset during this period. Crunching the numbers, Sridharan and fellow researchers were able to arrive at a concrete conclusion: CSR measurably increases investor trust and disclosure credibility.

“When we estimated our regression models, we found clear evidence that corporate social responsibility does indeed contribute to the average speed of price discovery around earnings announcements; and it does so positively. Our results reveal that CSR increases the speed with which stock prices incorporate earnings news. Breaking it right down, we see that a one unit increase in CSR activities corresponds to 1.96 percent increase in the average timeliness or efficiency of reported earnings.”

In other words, investors are reacting more quickly and favorably to performance reports made by organizations with more demonstrated social responsibility.

“We know that these types of announcements are lengthy and dense; they take time to process,” Sridharan says. “So, the intuition here is that when your firm plants a flag on responsibility and accountability, investors are more likely to take your disclosures at face value – they’re more likely to trust what you’re saying.”

Organizations would do well to take this finding on board, says Sridharan; especially in today’s climate of high volatility and uncertainty. Having investors on board is critical in weathering the bad times along with the good, she adds, and CSR can be a game-changing tool in building that necessary trust.

The Wild West of the Regulatory Landscape

Sridharan’s paper also informs the regulatory landscape around corporate responsibility which is still in its infancy and which she likens to something of a “Wild West.”

“The U.S. Securities and Exchange Commission (SEC) and other regulators are increasingly focused on improving the functioning of capital markets and understanding the role of CSR,” she says. “The SEC has included an examination of climate and ESG-related risks among its 2021 examination priorities which also underscores a growing investor interest in these issues. At the same time, research is showing that CSR can be misused or simply deployed to benefit managers looking to score reputational points with stakeholders–at the expense of shareholders. By demonstrating that investor perceptions of firms are materially shaped by firms’ CSR activities, our study highlights the importance of–and helps build the case for–monitoring and regulating firms’ CSR activities.”

Goizueta faculty research like Sridharan’s digs deep into business as we experience it today and imagines what key players will need to navigate in the future. Interested in exploring more expert research on topics impacting the corporate landscape? Learn more here.