Abstract/Summary

Recent years have witnessed an increasing number of firms motivated to be socially responsible and environmentally friendly. In spite of the intuitively non-financial nature, the financial impact of corporate social responsibility (CSR) is always an appealing topic for the academic community. Studies on the financial effects of CSR could help the management team better understand the potential economic benefits of CSR activities and prompt more socially responsible and environmentally friendly business environment. This thesis starts from the mixed and inconclusive results on the relation between CSR endeavours and financial reporting quality documented in extant studies. The inconsistent evidence may be because prior literature overlooks the potential heterogeneity in CSR activities, which has been demonstrated in the relation between CSR endeavours and firm financial performance. Identifying the heterogenous nature of CSR activities, in Chapter 2, I provide further evidence on the legitimacy of CSR endeavours in the context of financial reporting quality. By classifying firms into two sub-groups (entities underinvesting and overinvesting in CSR activities), the empirical results show that the level of CSR underinvestment is positively associated with the magnitude of both accrual-based earnings management (AEM) and real earnings management (REM) and, hence, negatively related to earnings quality. For firms overinvesting in CSR activities, I do not find a significant relation between CSR overinvestment and AEM. The empirical analyses for real activities manipulation exhibit mixed results throughout the four REM proxies. However, the mixed evidence for firms with CSR overinvestment cannot fully exclude the possibility that overinvesting in CSR activities has a significant impact on financial reporting quality. Varying incentives for CSR overinvestment in different firms could drive the inconsistent results. The positive effect of CSR overinvestment by some firms may offset the negative effect brought about by other entities, making the overall effect minor and unnoticeable. Given the heterogeneity in CSR activities, investors call for greater transparency on CSR reporting to have a better understanding on the social and environmental risks facing firms. Different from financial reporting that is usually subject to strict auditing procedures, CSR disclosures still remain voluntary and free from assurance in most jurisdictions around the globe. Both professional and academic evidence indicate that investors have lost confidence in the materiality, objectivity, and reliability of the current social and environmental reporting system to a large extent. Hence, in Chapters 3 and 4, I explore two possible mechanisms that may restore investors’ confidence in CSR disclosures. Specifically, Chapter 3 examines whether mandatory CSR reporting can increase capital market confidence, whereas Chapter 4 investigates whether investors reward the external assurance on CSR disclosures. The empirical evidence implies that neither the simple disclosure regulation per se nor the third party assurance alone seems sufficient to answer investors’ call for greater transparency on social and environmental activities. An integrated and systematic approach may be indispensable to restore capital market confidence in CSR information in future.