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Published in: Review of Quantitative Finance and Accounting 4/2023

07-03-2023 | Original Research

Does corporate social responsibility affect leverage adjustments?

Authors: Trung K. Do, Henry Hongren Huang, Te-Chien Lo

Published in: Review of Quantitative Finance and Accounting | Issue 4/2023

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Abstract

This research outlines and tests two corporate social responsibility (CSR) views of the corporate leverage speed of adjustment (SOA). The first view (stakeholder value maximization) indicates that socially responsible firms commit to ethical behavior and provide reliable financial information, which is advantageous to access external financing, and thus these firms tend to gain faster leverage adjustments. The second view (overinvestment) predicts that if managers over-invest in CSR due to agency problems, CSR may raise external financing’s concerns and is related to slower leverage adjustments. Our findings strongly support the first view. We further find that the positive effect of CSR on SOA is more pronounced for firms with high information asymmetry, high financial constraints, and high adjustment costs. Taken together, this study generates important insight that CSR can reduce leverage adjustment costs stemming from information asymmetry, thereby leading to faster leverage SOA.

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Appendix
Available only for authorised users
Footnotes
1
KLD rates companies along seven dimensions of corporate social responsibility: community, diversity, employee relations, environment, human rights, product, and corporate governance.
 
2
We also report the impact of CSR on SOA controlling for corporate governance in the Internet Appendix (Table IA.2).
 
3
We do not report market leverage results in our main tests since recent studies document an upward bias of market SOA. Specifically, by decomposing the market SOA into a passive component related to the firm value growth rate and an active component associated with a firm’s net debt issuance or repurchase policies, Yin and Ritter (2019) argue that the high level of the estimated market SOA is due primarily to the passive component. The high variance of the market value growth rate, caused by changes in stock valuation, leads to downward bias on the coefficient of the lagged dependent variable (market SOA being biased upwards) in panel dataset regressions with firm fixed effects. Not only the market value speed of adjustment estimates is biased, but also the marginal effects of other explanatory variables on market leverage are biased (Yin and Ritter 2020). As presented in Table IA.5 in the Internet Appendix, our result still holds using market SOA.
 
4
Appendix A presents variable definitions and data sources.
 
5
The system GMM approach includes lagged levels and differences of the dependent variable and exogenous variables in the instrument set to address the problem of persistent regressors.
 
6
Over variable can be regarded as the control variable for the target leverage and financial needs, and Deficit can be regarded as the control variable for cash flows.
 
7
The definition of the CSR score in this article is described in Sect. 4.2
 
8
Titman (1984) argues that if customers of a firm assess its probability of liquidation, the firm will indirectly bear these liquidation costs ex ante since the price a customer is willing to pay for firm’s durable goods declines as the probability of the firm’s liquidation increases. Moreover, from the employee perspective, Maksimovic and Titman (1991) further argue that in order to avoid immediate bankruptcy, a highly leveraged firm in financial distress may have an incentive to cut costs related to employee benefits. Since rational employees recognize these incentives of the firm, they require higher wages for their labor, and this in turn decreases firm value. Hence, firms that place a higher value on their reputation for high-quality products and/or treat employees fairly should limit their use of debts.
 
9
The list of blue or red states is based on the electoral results obtained from the U.S. Electoral College, available at https://​www.​archives.​gov/​federal-register/​electoral-college/​historical.​html.
 
10
The first-stage IV regression results are reported in Table IA.3 in the Internet Appendix.
 
11
Additionally, our results reported in the Internet Appendix (Table IA.2) show that the impact of CSR on SOA is robust to controlling for corporate governance, suggesting that the CSR effect comes from social objectives and stakeholders instead of governance components.
 
12
A clear example of industry-specific CSR is that industries with the closest ties to the consumer-base and the community (i.e. food retail) may disclose the most CSR information. Conversely, B-to-B industries report much less CSR information.
 
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Metadata
Title
Does corporate social responsibility affect leverage adjustments?
Authors
Trung K. Do
Henry Hongren Huang
Te-Chien Lo
Publication date
07-03-2023
Publisher
Springer US
Published in
Review of Quantitative Finance and Accounting / Issue 4/2023
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI
https://doi.org/10.1007/s11156-023-01141-8

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