Corporate social responsibility, earnings management and firm performance: evidence from panel VAR estimation

Research that relates corporate social responsibility (CSR) to earnings management (EM) interprets directional relations between CSR and EM as indicators of opportunistic or ethical behavior by managers. On the one hand, EM leads to higher levels of CSR by opportunistic managers seeking reputational benefits from CSR. On the other hand, CSR leads to lower levels of EM by managers whose engagement in CSR reflects their ethical values. The attribution of opportunistic and ethical behaviors to managers in a firm setting is incomplete without also considering how EM and CSR relate to what firms strive to do as economic entities – create value. Therefore, we introduce financial performance (represented by Tobin’s Q) as an endogenous variable that influences managers’ engagement in CSR and EM. We estimate a panel vector auto-regression (PVAR) model to evaluate the complex directional relations between CSR, EM and Q. We find that EM positively affects CSR, consistent with reputation-building, but we find no directional relation from CSR to EM. We find that firm performance (Q) positively affects EM, suggesting that EM may be economically motivated, and that CSR positively affects Q, consistent with economic motives driving engagement in CSR. Our analysis addresses endogeneity concerns and provides a more complete basis for ascribing managers’ decisions about CSR and EM to economic and behavioral motives.