Does it really pay to do better? Exploring the financial effects of changes in CSR ratings

ABSTRACT

Previous literature on the link between corporate social responsibility (CSR) and financial performance has focused mainly on the financial implications of a firm’s level of CSR without considering the potential effects on financial performance of variations in CSR rating. We try to fill this gap by studying whether variations in a firm’s CSR rating affect systematic risk, firm value, and portfolio performance. First, our results show that an increase in firms’ CSR efforts, as reflected by an increase in their CSR ratings, significantly reduces systematic risk. Second, a positive variation in CSR ratings significantly improves firm value. Finally, from a portfolio perspective, a strategy that consists of buying stocks that have experienced a CSR ratings increase and selling stocks that have experienced a CSR ratings decrease (or remain stable) leads to lower financial performance. Taken together, our findings provide new evidence and financial implications for firms and portfolio managers.

KEYWORDS:

• Corporate social responsibility
• extra-financial ratings
• firm risk
• firm value
• portfolio management

JEL CLASSIFICATION:

• M14
• G30

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ In the US, more than 16% of assets under management are managed according to socially responsible principles (www.ussif.org).

² Several different approaches are used to manage SRI portfolios. For example, while the best-in-universe strategy aims to include the best firms in terms of CSR scores and exclude the worst, the best-efforts approach incorporated stocks whose ESG (environmental, social, governance) rating increased regardless of the score level.

³ The last year in our sample is 2011 because of changes in KLD’s methodology after the firm’s acquisition by MSCI.

⁴ For a detailed description of concerns and strengths for each CSR dimension, see the appendices to El Ghoul et al. (2011).

⁵ The dummy sinstock was not included in the systemic risk regressions, as Albuquerque, Durnev, and Koskinen (2013) find that this dummy has no significant impact on firm beta.

⁶ We construct 8 portfolios consisting of stocks that experienced an upgrade in their KLD scores, 8 portfolios consisting of stocks that experienced a downgrade in their KLD scores, and 8 portfolios consisting of stocks that did not experience CSR ratings changes.

⁷ In results unreported here because of space limitations, we run our analysis using the market model and the Fama-French three-factor model. Overall, the results from these additional analyses are completely in line with the results from the Carhart (1997) model.

⁸ Because the number of stocks that experienced human rights ratings changes is limited (see Table 3), the results for this dimension should be viewed with caution.

⁹ The results of this analysis are not reported here because of space limitations. They are available from the authors upon request.