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Journal of Business Ethics
Published in: Journal of Business Ethics 1/2021

12-05-2020 | Original Paper

Can CSR Disclosure Protect Firm Reputation During Financial Restatements?

Authors: Lu Zhang, Yuan George Shan, Millicent Chang

Published in: Journal of Business Ethics | Issue 1/2021

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Abstract

We investigate the effectiveness of corporate social responsibility (CSR) disclosure in protecting corporate reputation following financial restatements. As expected under legitimacy theory, firms can signal their legitimacy via nonfinancial disclosure after the negative effects of financial restatements. Our results show that restating firms make substantial improvements to overall CSR disclosure quality by changing their standalone reports to a more conservative tone, increasing readability and report length, even though they strategically disclose less forward-looking and sustainability-related content. Such improvements are more pronounced in restating firms with prior low-quality CSR disclosure. Moreover, restating firms with CSR disclosure have smaller forecast errors than non-CSR disclosers, yet the change in CSR disclosure after restatements does not further improve analyst forecast accuracy. Finally, we find that compared with nondisclosers, restating firms with CSR disclosure suffer smaller firm value losses. Overall, the evidence supports the view that consistent CSR reporting alleviates reputational damage and plays an insurance-like or value protection role during crisis periods.
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Appendix
Available only for authorised users
Footnotes
1
A survey of 388 mainstream fund managers and financial analysts initiated by Deloitte, CSR Europe, and EuroNext (2003) shows 79% of respondents indicating that CSR activities’ positive impact on firm value in the long-term, and about half of them indicating that they take CSR information into account.
 
2
Griffin (2003) reported that analyst revision occurs in the month of a restatement announcement and can last up to six months following the restatement.
 
3
A product-harm crisis is a well-publicized instance of defective or dangerous products following the definition of Dawar and Pillutla (2000).
 
4
Most firms in the sample publish periodical CSR reports (usually annually), and the frequency of CSR reporting remains largely unchanged during the financial restatement period. However, three firms (Nordstrom Inc, ManpowerGroup and CF Industries Holding Inc) started to issue CSR reports after the financial restatement. Exclusion of these restating CSR firms does not change our results.
 
5
SocialFunds.com has been inaccessible since 2019.
 
6
There is an evolving trend towards integrated reporting. However, mainstream CSR reporters still provide standalone CSR reports. A 2018 report released by the Sustainable Investments Institute (Si2) and IIRC Institute finds that a total of 395 firms among the S&P 500 (78%) issue CSR reports for the most recent reporting period, while a minority of the S&P 500 references a recognized integrated reporting framework (35 firms citing SASB and 4 firms citing IIRC). Nevertheless, we checked sample firms that publish standalone CSR reports and find that none of them adopt integrated reporting during the event window. Some CSR reporters adopted integrated reporting many years after the restatement, for example, TransAlta Corporation had a restatement in 2005 and began to issue integrated reports from 2015, which goes beyond the investigation period.
 
7
In untabulated analysis, we compare CSR-related content in standalone CSR reports to corresponding content in annual reports (or 10-Ks) for restating firms and find that firms disclose this information mostly in the Chairman’s Letter, Business Overview, and Management’s Discussion & Analysis. Standalone CSR reports are longer in length (55.6 versus 2.5 pages) and cover more general issues (9.5 versus 2.1 issues) compared to annual reports or 10-Ks. Standalone reports also divulge more details about CSR activities (27.3 specific issues on average). One example is Avery Dennison which used 10 pages to disclose its environmental efforts in 2010 CSR report, showing how it reduced environmental footprint, managed energy consumption and greenhouse emissions, reduced waste, reduced water consumption, obtained environmental certifications, achieved sustainability in its supply chain and sources responsibly. In its 2010 annual report, there was only half a page of a section titled “Environmental Matters” showing the environmental liability figures.
 
8
Some firms publish CSR reports biennially or every three years. If that is the case, we retain the CSR reports published five years before and after a financial restatement (year t − 5 to t + 5).
 
9
Adams and Hardwick (1998) and Baumann-Pauly et al. (2013) suggested that large firms are implicitly considered capable of assuming responsibility by implementing CSR practices, which affects the probability of firm CSR participation.
 
10
We checked to ensure that there is no confounding event such as change in dividend rate, M&A announcement and executive turnover in the month of the restatement announcement for both treatment and control firms, which might interfere with firms’ disclosure behavior.
 
11
Among treatment firms, there are 51 restatements due to accounting rule application failure, one restatement due to financial fraud and irregularities, four restatements due to clerical errors, and three restatements due to other significant issues. This represents 86.4% of Treatment Group (51 out of 59 restatements). Among control firms, there are 69 restatements due to accounting rule application failure, one restatement due to clerical errors, and eight restatements due to other significant issues noted. Similarly, this represents 88.5% of Control group 2 (69 out of 78 restatements).
 
12
The Pearson correlation coefficient between DSCORE and KLD strengths (KLDSTR) is 0.37 at the 1% significance level while the coefficient of DSCORE and KLD concerns (KLDCON) is − 0.07 and insignificant. This is consistent with a firm’s CSR disclosure being positively related with its CSR performance (Clarkson et al. 2008; Lyon and Maxwell 2011), yet there is a potential disconnect between voluntary CSR disclosure and third-party CSR performance ratings (Cho et al. 2013; Shane and Spicer 1983). The third-party CSR performance ratings, such as KLD indices, affect the decision-making of investors, managers, and other parties. For instance, Lee (2017) reported a positive association between CSR proxied by KLD and management forecast accuracy.
 
13
Financial disclosure quality is measured by absolute value of discretionary accruals (ADA) from the Modified Jones model (Dechow et al. 1995). A high level of ADA indicates greater financial opacity. We expect a positive coefficient on ADA, as financially opaque firms are more likely to be associated with forecast errors.
 
14
For control variables, the CSR group outperforms the non-CSR group in CSR performance with a higher KLDSTR of 4.91 and a lower KLDCON of 1.80. Compared with non-CSR firms, restating CSR firms have slightly better financial disclosure quality (0.44 compared to 0.45 of non-CSR firms), attract more financial analysts, have longer forecast horizon, are larger in size, experience less losses and less volatile earnings, and are more profitable on average.
 
15
To ensure that forecast is only affected by the restatement announcement, we keep the last forecast EPS prior to a restatement and the first forecast EPS after the restatement for all following analysts of a firm in a given year. The analyst forecast EPS refers to current-year forecast EPS, that is, forecast made in year t for earnings in year t (the restatement year).
 
16
In untabulated analysis, we use the CSR measure from Muslu et al. (2019) as an alternative to DSCORE and similar results are obtained.
 
17
The difference of 0.39 in the Column 1 is calculated as the difference of coefficients \(({\alpha }_{LHDS}-{\alpha }_{HHDS})\)= (–0.96) – (–1.35) = 0.39. The difference is not statistically significant.
 
18
In untabulated analysis, we control for corporate governance-related factors using institutional ownership and our main inferences remain largely unchanged.
 
19
Because our sample period covers the subsequent four years after a financial restatement (year t + 1 to t + 4), we also run the regression models with two-year-ahead ROA (F2ROA), three-year-ahead ROA (F3ROA), and four-year-ahead ROA (F4ROA). The untabulated results show that CSR and DSCORE are significantly positively associated with all forward-looking ROA measures.
 
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Metadata
Title
Can CSR Disclosure Protect Firm Reputation During Financial Restatements?
Authors
Lu Zhang
Yuan George Shan
Millicent Chang
Publication date
12-05-2020
Publisher
Springer Netherlands
Published in
Journal of Business Ethics / Issue 1/2021
Print ISSN: 0167-4544
Electronic ISSN: 1573-0697
DOI
https://doi.org/10.1007/s10551-020-04527-z

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Book Review

Review of Homeland Elegies by Ayad Akhtar

Original Paper

A Nozickian Case for Compulsory Employment Injury Insurance: The Example of Sweatshops

Original Paper

Do Management Training Grounds Reduce Internal Auditor Objectivity and External Auditor Reliance? The Influence of Family Firms

Original Paper

The role of Corporate Social Responsibility in Organisational Identity Communication, Co-Creation and Orientation

Original Paper

Responsible Leadership and Reputation Management During a Crisis: The Cases of Delta and United Airlines

Original Paper

When is Sustainability a Liability, and When Is It an Asset? Quality Inferences for Core and Peripheral Attributes