We now have empirical evidence that being socially responsible is not merely altruistic, but actually pays dividends, even in the business world. A forthcoming article in the Journal of Banking and Finance demonstrates a strong relationship between firms with strong corporate social responsibility performance and reduced risk of stock price crashes.
The authors of the article, Yongtae Kim, Haidan Li and Siqi Li, undertook a study investigating whether corporate social responsibility (CSR) mitigates or contributes to stock price crash risk. They summarize the results of their study below.
“Using a large sample of U.S. public firms from 1995 to 2009, we find a significantly negative association between firms’ corporate social responsibility performance and one-year-ahead stock price crash risk, suggesting that socially responsible firms have a lower future stock price crash risk. The results are robust after controlling for other predictors of future stock price crash risk identified in prior studies, including divergence of investor opinion, past returns, firm size, and accounting opaqueness.”
Greater social responsibility means less “hoarding” of bad news
The authors argue that the key dynamic in why firms with strong corporate social responsibility have less crash risk is that socially responsible firms commit to a high standard of transparency and rarely delay announcing bad news. They point to a number of studies that show when senior management withholds bad news from investors due to career and compensation concerns, that means bad news accumulates and eventually reaches a tipping point and comes out all at once, often leading to a stock price crash.
Corporate social responsibility especially important for firms with less effective corporate governance
Another finding of interest in the study was that firms with strong corporate social responsibility but relatively weak corporate governance did not have a high risk of crashes. This means these firms are in effect “protected” from crashes by their high CSR. High CSR scores did not mean less risk of crashes for companies with strong corporate governance, but this makes sense as strong corporate governance itself prevents the behaviors that lead to crashes.
“We find that when firms have less effective corporate governance (indicated by lower governance ratings by MSCI ESG, CEO being the chairman of the board, and lower shareholder rights based on the Gompers et al. (2003) governance index) or a lower level of long-term institutional ownership, the negative relation between corporate social responsibility and future crash risk is significant. On the other hand, when firms have more effective corporate governance or a higher long-term institutional ownership, CSR does not appear to have a significant impact on crash risk. The results are consistent with the notion that the role of CSR in reducing stock price crash risk is particularly important when internal monitoring by the boards or external monitoring by institutional investors is weak.”