Voluntary Non-Financial Disclosure and the Cost of Equity Capital: The Case of Corporate Social Responsibility Reporting

Dan Dhaliwal Oliver Zhen Li University of Arizona

Albert Tsang Yong George Yang The Chinese University of Hong Kong

February 2009

Abstract We examine a potential benefit associated with the voluntary reporting of corporate social responsibility performance, a reduction in firms cost of equity capital. We find that firms with high cost of equity capital tend to release corporate social responsibility reports and that reporting firms with relatively superior social responsibility performance enjoy a reduction in the cost of equity capital. Further, reporting firms with superior social responsibility performance attract dedicated institutional investors and analyst coverage. Superior social responsibility performance also serves to reduce forecast errors and dispersion. Finally, firms appear to exploit the benefit of a reduction in the cost of equity capital associated with social responsibility reporting: Reporting firms are more likely than non-reporting firms to raise equity capital in the two years following the reporting and among firms raising equity capital, reporting firms raise a significantly larger amount than non-reporting firms.

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We appreciate the invaluable comments from Ying Cao, Zhaoyang Gu, Michel Magnan, Morton Pincus, Suresh Radhakrishnan, and T. J. Wong. We thank Brian Bushee for generously sharing the classification of institutional investors. We also thank CorporateRegester.com and KLD Research & Analytics, Inc. for providing the corporate social responsibility data.

Voluntary Non-Financial Disclosure and the Cost of Equity Capital: The Case of Corporate Social Responsibility Reporting
1. Introduction The last fifteen years have witnessed a steady increase in stand-alone corporate social responsibility (CSR) disclosure in the U.S. as well as in the world.1 For example, according to CorporateRegister.com, a private company specializing in tracking CSR disclosures, there were few stand-alone CSR reports before the mid-1990s in the U.S. However, since then more and more U.S. firms have committed to making this type of disclosure. In 2007, about 300 CSR reports were registered, mostly by large firms. While compared with the universe of U.S. publicly listed firms, the CSR reporting firms represent only a small portion of the total number of firms, their aggregate market value constitutes over 10% of the total U.S. market capitalization in 2007.2 The rapid increase in CSR reporting naturally raises a question: What is the rationale behind this type of voluntary disclosure practice? Especially, what benefits do firms gain by spending resources on compiling and publishing these reports? The answer probably lies in a number of factors such as the growing influence of global enterprises, the intensified scrutiny of corporate impact on the society and the economy as a result of a loss of trust after a series of corporate scandals around year 2001, and the rapid growth in ethical/socially responsible investment in both the U.S. and around the world in recent years. For example, according to the Social Investment Forum (2007), from 1995 to 2005, assets
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Consistent with McWilliams and Siegel (2001), CSR is defined as instances where the company goes beyond compliance and engages in actions that appear to advance a social cause, such as committing to environmental protection, protection of human rights, and providing community support, etc. The World Business Council for Sustainable Development defines CSR as the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large. In practice and in academic research, CSR is often used interchangeably with sustainability. We also follow this convention in this paper. 2 Based on our mean firm market cap $14.47 billion in Table 3 and the total U.S. market cap of around $15.35 trillion on May 23, 2007. 1

invested in socially responsible investment grew from $639 billion to $2.29 trillion which accounted for approximately 11% of the total assets managed by professional managers. Overall, the heightened demand for corporations to take responsibility in the social, environmental and economic aspects of their actions has driven a dramatic growth in the need for information beyond what financial disclosures can provide (Holder-Webb et al., 2007). Our paper focuses on one specific factor, namely, the reduction in firms cost of equity capital that potentially provides an explanation for the increasing trend of CSR reporting. We investigate four related questions: (1) whether firms desire to reduce the cost of equity capital motivates them to publish CSR reports; (2) whether the publication of CSR reports leads to a lower cost of equity capital; (3) the potential underlying mechanisms that cause CSR disclosure to be associated with a lowering of the cost of equity capital; and (4) whether reporting firms exploit the benefit of a reduction in the cost of equity capital by issuing equity capital after CSR reporting. Among various other potential factors associated with CSR reporting, we focus on the cost of equity capital for three reasons. First, the cost of equity capital plays a critical role in firms financing and general operations decisions. Second, corporate executives appear to believe that voluntarily communicating information can reduce their firms cost of capital (Graham et al., 2005). Third, there has been a long-standing interest among academics in the relation between disclosure and the cost of capital (Diamond and Verrecchia, 1991; Clarkson et al., 1996; Botosan, 1997; Leuz and Verrecchia, 2000; Botosan and Plumlee, 2002). While there have been numerous studies on the relation between financial disclosure and the cost of equity capital, there is scant research on the interaction between voluntary stand-alone non-financial disclosure and the cost of equity capital. As such, our study adds to the broad disclosure literature from a new angle. Disclosure theory suggests that commitment to a better disclosure practice can reduce a
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firms cost of equity capital through at least two major channels. First, enhanced disclosure can reduce the estimation risk in the capital market (Leuz and Verrecchia, 2000; Easley and OHara, 2004; Lambert et al., 2007). Second, information transparency can mitigate the adverse selection problem by reducing transaction cost and/or information asymmetry and thus increases the overall liquidity of stocks (Graham et al., 2005; Verrecchia, 2001; Leuz and Wysocki, 2008). While the above arguments in general refer to financial disclosure for its roles in firm valuation, they should also apply to non-financial information as long as this information is useful in predicting firms future performance and cash flows. The value-relevance of non-financial information, in particular, information on CSR, is further elaborated below. A lot of work has been conducted to the examination of the value-relevance of the information related to CSR (Spicer, 1978; Anderson and Frankle, 1980; Ittner and Larcker, 1998; Al-Tuwaijri et al., 2004) and the consensus finding of this literature is that CSR information is value-relevant (for surveys of this literature, see Orlitzky et al., 2003; Margolis and Walsh, 2003). CSR practices can have an impact on firms financial performance and value through various channels. For instance, voluntary socially responsible behaviors can help the firm avoid potential governmental regulations and therefore reduce costs related to regulation compliances. Numerous laws presently exist in the U.S. coping with various social impacts of corporations including environmental preservation, social discrimination, and many other aspects of social responsibility issues. These laws impose financial burdens and litigation risks on firms and likely have a severe negative effect on their value. By voluntarily adopting and disclosing CSR practices, firms can preempt governmental interventions and save mandatory compliance costs. Moreover, socially responsible firms have a distinct appeal to consumers who care about the corresponding social issues, which in turn likely leads to superior sales and financial performance (Lev et al., 2006). In contrast, firms reputation and long-term sales may suffer from
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poor CSR performance.3 In addition, prior research also argues that investors with social awareness may be willing to pay a premium on securities of socially responsible firms (Andersen and Frankle, 1980; Richardson and Welker, 2001). Lastly, some CSR projects also bear direct implications for positive cash flows in the near future. For example, practices on protecting the environment and improving employee welfare can reduce potential litigation costs and pollution cleaning costs, boost employees morale and production efficiency. To determine whether and how CSR disclosure relates to firms cost of equity capital, we employ a sample of firms consisting of the intersection of two CSR databases: (1) a comprehensive list of firms releasing electronic or hard-copy stand-alone CSR reports since 1993 collected from various sources on the internet, and (2) the KLD STATS database that provides detailed CSR performance ratings for individual firms. We perform four types of analyses and the corresponding findings are as follows. First, firms with higher levels of cost of equity capital are significantly more likely than others to release stand-alone CSR reports. Second, while for the overall sample the publication of CSR reports is not significantly associated with a lower future cost of equity capital, cost of equity capital reduces for firms with relatively superior social responsibility performance. Therefore, it appears that investors do not merely appreciate CSR disclosure per se but also evaluate firms actual CSR performance. Third, CSR reporting firms with relatively superior CSR performance attract dedicated institutional investment and analyst coverage and have lower analyst forecast errors and dispersion. Finally, corroborating our results on the relation between CSR reporting and the cost of equity capital, we find that CSR reporting firms are significantly more likely than non-reporting firms to conduct seasoned equity offerings (SEOs) in the two years following such disclosure. Moreover, among firms conducting

For example, Nike struggled for years and spent huge amount of financial resources and effort to regain its reputation after the 1997 child labor scandal (http://www.bandt.com.au/news/25/0c00d225.asp). 4

SEOs, CSR reporting firms raise a significantly larger amount than non-reporting firms. Overall, our empirical evidence is consistent with our prediction that a reduction in the cost of equity capital motivates firms to publish stand-alone CSR reports and that CSR disclosure by firms with superior CSR performance leads to a lower cost of equity capital. To the best of our knowledge, our research is the first to study the impact of stand-alone voluntary disclosure of general corporate social responsibility issues on the cost of equity capital. Our analyses expand the traditional research on voluntary disclosure to a broader dimension beyond the narrowly-focused financial disclosure. The extant finance and accounting literature on voluntary disclosure primarily focuses on disclosures such as management forecasts or conference calls that are short-term oriented. In contrast, the broad-scope CSR disclosure relates to firms long-term development strategies and performance sustainability. Our results provide evidence on the rationales and incentives behind the recent trend of voluntary CSR disclosure. Indeed some firms also disclose limited information on CSR performance in their annual financial statements. However, voluntarily compiling and publishing stand-alone CSR reports demonstrates firms special efforts in and commitment to improving transparency regarding their long-term performance. Focusing on these stand-alone CSR reports can hence improve the power of our tests and shed light on this new form of non-financial disclosure. Two papers are related to ours. Plumlee et al. (2008) examine the impact of voluntary environmental disclosure quality on firm value. Our study distinguishes itself by examining a broader concept of corporate social responsibility including not only environmental protection, but also the protection of human rights, the provision of community support, the maintenance of product safety standards, the improvement of employee welfare, the protection of minority interests, and others. Moreover, while Plumlee et al. use a contemporaneous regression approach, we employ a lead-lag methodology, which enables us to better handle the potential endogeneity
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issue. Further, we provide an analysis on the underlying channels through which CSR disclosure likely affects the cost of equity capital. Our paper also differs from Richardson and Welker (2001) in that we study U.S. firms and they examine Canadian firms. More importantly, their social responsibility disclosure measure is based on annual reports and not stand-alone CSR disclosure. Their contemporaneous regression approach also raises the concern of potential endogeneity in the relation between social responsibility disclosure and the cost of equity capital. The rest of the paper is organized as follows. Section 2 introduces the related literature and develops our hypotheses. Section 3 describes our sample and methodology. Section 4 presents empirical evidence on the relation between CSR reporting and the cost of equity capital. Section 5 explores the underlying mechanisms linking CSR reporting and the cost of equity capital. Section 6 presents results on external financing activities after CSR reporting. Section 7 summarizes and concludes.

2. Related Research and Hypotheses Development There has been a lot of concern that the aggregate financial information on which the market depends skews investors perceptions of company values and inhibits investment in long-term corporate capability. Partly in response to this criticism, the American Institute of Certified Public Accountants (AICPA) suggests that To meet users changing needs, business reporting must: provide more information about plans, opportunities, risks, and uncertainties, focus more on the factors that create longer-term value, including non-financial measures indicating how key business processes are performing.4 In a survey study, Eccles and Mavrinac (1995) conclude that, investors and analysts clearly believe that non-financial information is important, especially

AICPA Special Committee on Financial Reporting, Improving Business Reporting A Customer Focus (New York: American Institute of Certified Public Accountants, 1994). 6

if the non-financial information can be used to augment their financial forecasting. Similarly, a survey by PricewaterhouseCoopers indicates that many top executives at multinational firms believe that non-financial performance measures outweigh financial performance measures in terms of revealing long-term shareholder value (PricewaterhouseCoopers, 2002). The provision of CSR disclosure is affected by both mandatory forces and voluntary motives. On the mandatory side, the U.S. Securities and Exchange Commission (SEC) requires companies to disclose known future uncertainties that may materially affect financial performance (i.e., Item 103 of SEC Regulation S-K). On the voluntary side, the last decade is characterized by a substantial increase in stand-alone CSR reporting. There are at least two driving forces behind this trend. First, investors have become increasingly aware of the relevance of non-financial information, in particular, information related to CSR or sustainability, in assessing a firms future risk, liability, and competitive advantage (Slater and Gilbert, 2004). Second, with companies coming under increased scrutiny for dubious accounting practices and ineffective corporate governance following major corporate scandals, regulators, shareholders, employees, and consumers start to demand better ways of tracking the health and value of companies using means other than the traditional financial reports (KPMG 2008). The relation between financial disclosure and the cost of equity capital has been extensively studied in the literature (Diamond and Verrecchia, 1991; Clarkson et al., 1996; Botosan, 1997; Leuz and Verrecchia, 2000; Botosan and Plumlee, 2002; Easley and OHara, 2004; Yee, 2006; Lambert et al., 2006, 2007; Hughes et al., 2007; Leuz and Schrand, 2008). Much of the empirical work finds a significant negative relation between financial disclosure and the cost of capital (for surveys of the literature, see Leuz and Wysocki, 2008; Core, 2001; Healy and Palepu, 2001; and Botosan, 2006). According to the disclosure literature, disclosure affects the cost of capital through both
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direct and indirect channels. Directly, greater disclosure enables investors to be aware of a firms existence and enlarge its investor base, which improves risk sharing and reduces the cost of capital (Merton, 1987). More importantly, investors need to estimate parameters such as betas in models determining the cost of equity capital. Better disclosure on the one hand can reduce the estimation risk and lower the betas and the expected returns (Barry and Brown, 1985; Coles et al., 1995). On the other hand, higher quality (or precision) firm-specific disclosure decreases the assessed covariance of a firms cash flow with the cash flows of other firms (Jorgensen and Kirschenheiter, 2003; Hughes et al., 2007; and Lambert et al., 2007). This effect essentially reduces individual firms betas and hence the cost of equity capital. The indirect channel mainly works through information asymmetry among investors or between the management and the investors. When disclosure is insufficient and some investors are perceived to be better informed than others, the adverse selection effect arises under which the informationally disadvantaged investors require price protection and become less willing to trade. The resultant illiquidity increases the bid-ask spread and transaction costs (Verrecchia, 2001), leading to a higher required rate of return (cost of equity capital) for the stock (Amihud and Mendelson, 1986). Another indirect effect of disclosure on the cost of capital is through its corporate governance role. Higher transparency reduces appropriation by managers, which generally lowers a firms cost of capital (Lambert et al., 2007). The above mechanisms to lower the cost of capital likely apply to all types of disclosure, financial and non-financial, as long as the information concerned is value-relevant. Prior studies have shown that commitment to socially responsible activities can lead to sustained competitive advantage (Hart, 1995; Russo and Fouts, 1997) and better financial performance (Margolis and Walsh, 2001; Orlitzky et al., 2003). These studies suggest that through these activities, firms gain greater abilities to differentiate their products, enhance their reputations and images, recruit and
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retain high quality workers, and maintain good relationship with key stakeholders (e.g., employees, government, and investors, suppliers, and community groups). These arguments highlight the importance of the CSR disclosure in reducing information asymmetry and uncertainty of the firms (Rodriguez et al., 2006). Studying voluntary disclosure, most prior studies focus on financial information such as management forecasts (Frankel et al., 1995) and conference calls (Brown et al., 2004; Francis et al., 2008a). The contents of these disclosures are usually verifiable in the near future, which implies that there is a certain degree of implicit assurance, for example, through litigation threats, on the credibility of the information disclosed. The scope of this type of disclosure is also limited, mainly focused on current or short-term earnings and/or some related financial measures. In contrast, the contents of CSR reports are prominently non-financial and cover a wide range of topics, including but not limited to, community support, corporate governance, human rights, and environmental protection.5 Our evaluation of the proportion of issues of each type of stand-alone CSR reports released in 2007 reveals that, on average roughly 76% of the topics are related to Social/Community and Corporate Social Responsibility while about 11% cover environment-related issues. However, these reports currently are subject to a limited amount of regulatory guidance. There is a common concern on the usefulness of this type of disclosure due to non-comparability and potential credibility issues (Ingram and Frazier, 1980).6 Therefore, while we have argued earlier that CSR disclosure can be associated with a reduction in firms cost of equity capital, due to the lack of regulations on this form of disclosure, it is an empirical question whether voluntary CSR reporting has an impact on firms cost of capital. In this paper, we specifically examine whether a high cost of equity capital induces firms to disclose CSR
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Appendix 1 provides a list of sample firms disclosing stand-alone CSR reports in year 2007. While there is now voluntary assurance service provided by some accounting and consulting firms, no governmental standard exists yet to regulate this service and the whole industry is still in its infancy. 9

performance and whether CSR disclosure helps reduce firms cost of equity capital. An endogeneity issue can arise if we examine the contemporaneous relation between social responsibility disclosure and the cost of equity capital. On the one hand, if social responsibility disclosure is motivated by a firms desire to reduce its cost of equity capital, then we should find a positive relation between social responsibility disclosure and the cost of the equity capital. On the other hand, if social responsibility disclosure leads to a lower cost of equity capital, then we should find a negative relation between social responsibility disclosure and the cost of equity capital. Therefore, the contemporaneous relation between social responsibility disclosure and the cost of equity capital is ambiguous. In order to better handle the potential endogeneity issue between social responsibility disclosure and the cost of equity capital, we employ a lead-lag approach. In particular, prior research (Healy et al., 1999; Frankel et al., 1995; and Lang and Lundholm, 2000) demonstrates that firms increase voluntary disclosures in order to raise capital in the future, which suggests that firms with relatively higher cost of capital have stronger incentives to enhance disclosure. Accordingly we conjecture that firms with higher levels of cost of equity capital in the past have stronger incentives to improve transparency by releasing CSR reports. Therefore, our first hypothesis is: Hypothesis 1: The level of a firms past cost of equity capital is positively associated with its likelihood of voluntarily disclosing social responsibility performance. Further, if reducing the cost of equity capital motivates firms to release CSR reports, we should observe a reduction in the cost of equity capital for reporting firms in the future. Otherwise, cost of equity reduction cannot be a sustainable goal of this reporting practice. We predict that CSR reporting leads to a lower future cost of equity capital. Therefore, our second hypothesis is: Hypothesis 2: CSR reporting is associated with a subsequent lower level of the cost of
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equity capital. Empirical support for Hypotheses 1 and 2 would provide justifications for the rationales behind CSR disclosure. We also test a corollary of Hypotheses 1 and 2 by examining whether reporting firms seek external financing after CSR disclosure. If CSR disclosure is motivated by a desire to reduce the cost of equity capital, then reporting firms are more likely than non-reporting firms to actually conduct SEOs after CSR disclosure to exploit the reduction in the cost of equity capital and they raise more external capital through SEOs than non-reporting firms who also conduct SEOs.

3. Sample and Methodology 3.1 Sample Description Our study focuses on stand-alone CSR reports provided by U.S. firms. We collect these reports from various sources including (1) Corporate Responsibility Newswire networks, (2) CorporateRegister.com, (3) search on the internet, and (4) company websites. The first two sources are the two leading organizations collecting and disseminating news and information related to CSR. We verify our CSR reporting sample by checking whether we can find their actual stand-alone CSR reports. Table 1 illustrates our sampling process. In total, for the period 1993-2008, we collect 1,416 stand-alone CSR reports. Due to our lead-lag analysis approach, the 143 reports in 2008 are not used because we require one-year-ahead cost of equity capital information. Some firms disclose multiple CSR reports in a year. We further delete 198 repetitive reports released by such firms. In order to use the KLD STATS data (Statistical Tool for Analyzing Trends in Social and Environmental Performance) as a proxy for firms CSR performance, we exclude 167 reports disclosed by firms not covered by KLD in our sample period. Lack of information to calculate
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variables used in our main analyses causes a loss of another 229 reports. Our final sample consists of 679 reports disclosed by 196 unique U.S. firms. The industry and year composition of our sample is exhibited in Table 2. The industry classifications are from Barth et al. (2005). Panel A shows that the CSR reports are widely distributed across all industries. The industry with the highest reporting frequency is Utilities with 26 firms releasing a total of 98 stand-alone CSR reports (14.43% of all firm-year observations) from 1993 to 2007. The second most frequent reporting industry is Computers, with 22 firms issuing 86 stand-alone CSR reports (12.67%). Consistent with the broad scope feature of CSR disclosures, many non-pollution-prone industries such as Food and Retail industries are also actively involved in disclosing their social responsibility performance. Panel B of Table 2 displays the year distribution of reporting firms. The period after year 2000 observes a dramatic increase in stand-alone CSR reporting. This is consistent with the notion that following the financial crisis in 2000 and the surge of corporate scandals, investors and regulators demand improved corporate transparency and enhanced voluntary disclosure of non-financial data due to the insufficiency of financial information in analyzing firms future risk and prospect (White, 2005). The largest expansion occurs in 2001: The number of CSR reporting firms increases from 22 to 57, representing a 159% increase. Firms releasing stand-alone CSR reports in any year from 1993 to 2007 that are also covered by KLD STATS serve as our treatment firms. The control firms are those covered by KLD STATS but do not have stand-alone CSR reports. Starting 1991, KLD STATS rates approximately 650 companies every year comprising mainly all the firms in the S&P 500 and Domini 400 Social SM Index. During 2001-2002, KLD expanded its coverage to include the largest 1,000 U.S. companies by market capitalization. From 2003 and on, it covers the largest 3,000 U.S. companies by market capitalization. KLD evaluates the CSR performance of all
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covered firms along a variety of dimensions regardless of whether they release stand-alone reports. We require all our firms to be covered by KLD because in our main analyses we need to control for firms relative social performance and the KLDs performance rating scores provide us an empirical proxy.

3.2 Empirical Models and Variable Definitions 3.2.1 Past Cost of Equity Capital and Current-Year CSR Reporting Under our lead-lag approach, our first hypothesis is to examine whether a high cost of equity capital in the past prompts firms to issue CSR reports in the future. In the empirical regression model, we need to control for other determinants of CSR disclosure to parse out potential confounding effects. However, the current literature provides limited information on what motivates a firms CSR disclosure. As CSR reporting is part of a firms overall voluntary disclosure practice, we identify from the voluntary disclosure literature the following list of potential factors that may influence a firms decision to commit to CSR reporting. (1) Corporate social performance (PERFORM): Given that firms commit to CSR reporting strategically, those with better corporate social performance are predicted to have greater incentives to disclose (Dye, 1985). We measure firms relative CSR performance using the CSR strength ranking scores provided by KLD, which have been widely used by academics (Sharfman, 1996). KLD ranks companies CSR performance on seven categories, using various information sources obtained from surveys, financial statements, government documents, peer-reviewed legal journals, and reports from mainstream media. The seven categories include community, corporate governance, diversity, employee relations, environment, human rights, and product. KLD defines a set of potential strengths under each category and assigns a value of one

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if the strength exists and a value of zero otherwise.7 For example, for the category community, there are a total of seven subcategories of strengths including charitable giving, innovative giving, non-U.S. charitable giving, support for education, support for housing, volunteer programs, and other strength. If a firm demonstrates strength in all of these subcategories, the total strength score for community is seven. The sum of the strength scores over all the seven CSR categories defined by KLD is our measure of a firms CSR performance. Different industries likely differ in their needs and criteria of being socially responsible and accordingly have systematically different average performance scores. We adjust the raw CSR strength scores each year by industry median to get a relative performance score that are comparable across industries. For this purpose, any industry-years with fewer than two observations in KLD are excluded from our final analyses. Results are quantitatively similar if we use the raw strength scores. (2) Risk concern (HICONCERN): Firms with high environmental and social risks are more likely to disclose their CSR performance. KLD also identifies a set of potential CSR concerns on each of the seven categories above. Similar to the strength scores, a value of one is assigned for each subcategory if there is a concern on the firms social performance. HICONCERN equals one if the firms total concern score is higher than the industry median. (3) Firm size (SIZE): Voluntary disclosure is expected to be greater for larger firms due to scale economies in information production costs (Lang and Lundholm, 1993). It is measured as the natural logarithm of the market value of equity (COMPUSTAT DATA25 * DATA199) at the beginning of each year. (4) Litigation risk (LITIGATION): Firms facing higher litigation risk are more likely to make

Appendix 2 provides more details on the seven categories defined by KLD and the average performance score of each industry. 14

voluntary disclosures in order to preempt potential lawsuits (Skinner, 1997; Field et al., 2005). Consistent with prior literature (Matsumoto, 2002; Richardson et al., 2005), LITIGATION is defined as an indicator variable that equals one if the firm operates in a high-litigation industry (SIC codes of 2833-2836, 3570-3577, 3600-3674, 5200-5961, and 7370), and zero otherwise. (5) Financial performance (ROA): Firms with better financial performance have more resources to produce CSR disclosures. We measure financial performance using the return on assets computed as income before extraordinary items (DATA18) scaled by total assets (DATA6) at the beginning of each year. (6) Product market competition (COMPETITION): Proprietary cost can dampen a firms disclosure incentives (Dye, 1985, 1986; Gal-Or, 1985), and firms facing more intense competition in the product market have greater concerns on the leakage of proprietary information to their competitors (Ali et al., 2008). We measure competition using the Herfindahl-Hirschman index. We multiply the Herfindahl-Hirschman index by (-1) so that a larger index value implies more intense product market competition. (7) Financing activities (FIN): Firms raising capital in the debt or equity market have a higher propensity to make voluntary disclosures (Frankel et al., 1995; Barth et al., 1997). We examine firms financing activities by assessing the amount of debt or equity capital raised by the firm during the year scaled by total assets of that year. Consistent with Richardson et al. (2004), FIN is measured as the sale of common and preferred shares minus the purchase of common and preferred shares (DATA108 - DATA115) plus long term debt issuance minus the long term debt reduction (DATA111 - DATA114). (8) Growth opportunities (TOBINQ): Firms in expansion period are more financially constrained and have fewer resources for CSR practice and disclosure. However, growth firms also tend to have higher information asymmetry, which could induce managers to make more
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disclosure to attract the interest of potential investors. The net effect is hence unknown ex ante. TOBINQ is the Tobin's Q defined as market value of common equity (DATA25 * DATA 199) plus book value of preferred stock (DATA10), book value of long term debt (DATA9) and current liability (DATA5), scaled by book value of total assets (DATA6). (9) Debt ratio (LEV): Voluntary disclosure is expected to increase with leverage because the monitoring demand for information rises when debt increases (Leftwich et al., 1981). Leverage is defined as the ratio of total debt (DATA9 + DATA34) divided by total assets. (10) Global business operation (GLOBAL): Firms with a global focus, especially when operating in emerging markets, face higher pressure to commit to social performance and are accordingly more likely to make the disclosure. GLOBAL is an indicator variable that equals one if the firm reports foreign income, and zero otherwise. (11) Liquidity (LIQUIDITY): Managers have incentives to increase the liquidity of their firms stocks (Healy and Palepu, 2001) in order to issue equities or sell shares of their firms obtained from options or other incentive compensation plans. One way to increase liquidity is to improve transparency and supply more information to investors. Our liquidity measure, LIQUIDITY is the ratio of the number of shares traded in the year to the total shares outstanding at the end of year. (12) Financial transparency (CIG) and financial information quality (ABS_EM): CSR disclosure may be correlated with firms general disclosure policies and financial transparency. If that is the case, our findings could be confounded by correlated omitted variables. To examine this possibility, we add to our models two variables to control for firms financial disclosure quality and the voluntary disclosure policy: earnings quality (ABS_EM) and management earnings forecasts (CIG). We use the absolute value of the abnormal accruals from the modified Jones model as a proxy for earnings quality (Francis et al., 2008b). Following prior studies which
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use management issued forecast as a direct measure of a firms disclosure policies (e.g., Rogers and Van Buskirk, 2008), we define CIG as a dummy variable that equals one if the firm issues earnings forecast in the year, and zero otherwise. (13) Industry effect (IND): Different industries may have different practices of CSR disclosure. (14) Year effect (YEAR): The incidences of corporate scandals in recent years increase the demand for information substantially. Our empirical logistic model to test Hypothesis 1 is as follows:
DISCi ,t = 0 + 1COCt 1 + 2 RERFORM i ,t 1 + 3 HICONCERNi ,t 1 + 4 SIZEi ,t 1 + 5 LITIGATIONi ,t 1 + 6 ROAi ,t 1 + 7COMPETITION i ,t 1 + 8 FIN i ,t 1 + 9TOBINQi ,t 1 + 10 LEVi ,t 1 + 11GLOBALi ,t 1 + 12 LIQUIDITYi ,t 1 + 13 ABS _ EM + 14CIG + IND + YEAR + i ,t

(1)

where DISCi,t is an indicator variable that equals one if the firm i discloses stand-alone CSR reports in year t, and zero otherwise. In alternative specifications of the model, we replace DISC in Equation (1) with two other variables proxying for firms commitment, in terms of effort and costs, to better disclosure and higher transparency. Specifically, we identify firms that provide assurance on their reports through independent third-parties, most often Big-4 accounting firms and international consulting firms. In this case, the dependent variable in Equation (1) is an indicator variable ASSURANCE that equals one if the firm employs a third party for the external assurance of its CSR disclosure, and zero otherwise. In our sample, a total of 117 firm-years CSR reports are assured by third parties. The second alternative proxy relies on the literature that uses the length of disclosure to measure disclosure quality (Leuz and Schrand, 2008). We assess the length of each CSR report

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relative to the average report length of the disclosing firms industry. The indicator variable HIPAGE equals one if the number of pages of the firm's CSR report is greater than the mean number of pages of its industry, and zero otherwise. There are a total of 301 reporting firm-year observations with HIPAGE equaling one. Further, to better capture firms incentives to lower the cost of equity capital while deciding whether to release CSR reports, we also use an alternative version of DISC, DISCN, that indicates whether the firm only sporadically publishes CSR reports. DISCN takes the value of one if a firm issues a CSR report in year t, but not in year t+1 (even though it may resume reporting in year t+2 or after), and zero otherwise. The main purpose of using this variable is to enhance the validity of our lead-lag approach. If a firm continuously reports CSR in all years, it is possible that our lead-lag methodology actually captures the contemporaneous relationship between CSR reporting and the cost of equity capital, which could raise concerns about the endogeneity issue. In addition, DISCN captures the possibility that firms may release CSR reports when needed. For this reason, most of our main analyses are based on DISCN. As an additional robustness check, we constrain our treatment firm-years to only including the earliest CSR reporting year of each reporting firm. Specifically, we define an indicator variable DISCI that equals one if it is the earliest reporting year of a firm (i.e., CSR report initiating year), and zero otherwise. This variable provides more powerful tests on firms motivation to publish CSR reports. However this approach causes a significant loss of observations. Our main variable of interest, the cost of equity capital in the year prior to CSR reporting, COC, is the ex ante or implied cost of equity capital. We calculate it using three different models proposed in the recent accounting and finance literature: (1) the Gebhardt et al. (2001) model, (2) the Claus and Thomas (2001) model, and (3) the price-earnings growth (PEG) ratio model
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developed by Easton (2004). The mean of the three measures serves as our main proxy for the cost of equity capital. To implement the estimation, we obtain data on expected future earnings per share from I/B/E/S and market price and dividend data from COMPUSTAT. As a robustness check, we also use the change in the cost of equity capital from year t-2 to year t1 (COCt-1) as the main independent variable. The argument is that when firms face an increasingly higher cost of equity capital, they have stronger incentives to take actions to improve transparency, in particular through broad-scope CSR disclosure.

3.2.2. Effect of CSR Disclosure on Future Cost of Equity Capital Our second hypothesis predicts that current period CSR reporting leads to a lower cost of equity capital in the future. To test this hypothesis, we estimate the following regression model:
COCi ,t +1 = 0 + 1 DISCN i ,t + 2 SIZEi ,t + 3 BETAi ,t + 4 LEVi ,t + 5 MBi ,t + 6 LTGi ,t + 7 LNDISPi ,t + IND + YEAR + i ,t

(2)

where BETAt is the change in beta from year t 1 to year t with BETA estimated from a market model using daily CRSP stock returns data. LEVt is the change in leverage ratio from year t 1 to year t and the leverage ratio (LEV) is defined as the ratio of total debt (DATA9 + DATA34) divided by total assets. MBt is the change in the market-to-book ratio (DATA 199*DATA25/ DATA60) from year t 1 to year t. LTGt is the change in long-term growth rate where LTG is measured as the difference between the mean two-year-ahead analyst consensus EPS forecast and the mean one-year-ahead analyst consensus EPS forecast divided by the mean one-year-ahead analyst consensus EPS forecast. LNDISPt is the change in analyst forecast dispersion from year t 1 to year t, with LNDISPt measured as the log of the standard deviation of analyst estimates of year t earnings divided by the consensus forecast for year t earnings. Analyst data are obtained from I/B/E/S. All other variables are defined as before. We predict 1
19

to be negative. Fama and French (1992) find that expected returns are negatively associated with firm size and positively associated with book-to-market ratios. Gebhardt et al. (2001) and Gode and Mohanram (2003) find similar results. Hence we include firm size (SIZE) and market-to-book ratio (MB) in the regression. The market model BETA is included to control for systematic risk. In addition, Gebhardt et al. (2001) and Gode and Mohanram (2003) find that the implied cost of capital is positively correlated with long-term growth rate. We therefore include an empirical proxy of long-term growth rate based on I/B/E/S analyst earnings forecasts (LTG) in the model. Further, prior studies (Gebhardt et al., 2001; Dhaliwal et al., 2005) find that analyst forecast dispersion is negatively associated with the implied cost of equity capital.8 As our empirical measure of cost of equity capital is based on analyst forecast data and stock prices, we add analyst forecast dispersion (LNDISP) to the regression model to control for the above empirical regularity or any potential stock price biases related to analyst forecast dispersion (Diether et al., 2002). Lastly, leverage (LEV) is included in the model because Fama and French (1992), among many others, suggest that the cost of equity capital increases as leverage gets higher. We use the change in the cost of equity capital from year t to year t+1 as the dependent variable because the cost of equity capital tends to be sticky over time. Using the change form can enhance the power of our tests and give us greater confidence that our inferences are not driven by the potential endogeneity between the cost of equity capital and CSR disclosure. Accordingly, our control variables also adopt the change form. While firms may be motivated by a possible reduction in the cost of equity capital when deciding whether or not to issue CSR disclosures, from the investors perspective, CSR

Diether et al. (2002) reject the hypothesis that analyst forecast dispersion represents risk and support the conjecture (Miller, 1977) that stock prices tend to reflect optimistic opinions, leading to lower future returns. 20

disclosure per se may not necessarily warrant a lower cost of equity capital. This is because corporate managers may attempt to manage public impression through such disclosures and therefore CSR information can be self-serving and non-credible (Cormier and Magnan, 2003). Investors are likely to return with a favorable perception and market reward only if the firm actually performs well in its CSR practices relative to its peers. To examine this possibility, we augment Equation (2) by including a measure of firms relative CSR performance from KLD:
COCi ,t +1 = 0 + 1 DISCN i ,t + 2 HIPERFORM i ,t + 3 DISCN i ,t * HIPERFORM i ,t + 4 SIZEi ,t + 5 BETAi ,t + 6 LEVi ,t + 7 MBi ,t + 8 LTGi ,t + 9 LNDISPi ,t , + IND + YEAR + i ,t

(3)

where HIPERFORM is an indicator variable that equals one if the firms CSR performance score, namely, PERFORM, is higher than its industry median (in other words, if the firm is classified as a superior CSR performer in its industry), and zero otherwise. All other variables are defined as before. We predict 3 to be negative. As a robustness check, we also use DISC and DISCI in place of DISCN in Equation (3). In addition, instead of using the interaction term between DISCN and HIPERFORM, we also estimate Equation (2) within each tercile of CSR performance scores.

4. Empirical Results 4.1 Descriptive Statistics Panel A of Table 3 provides descriptive statistics for the independent variables included in regression Equation (1) in the year proceeding the CSR disclosure. It also exhibits univariate comparisons of these variables between the two sub-groups of firm-year observations partitioned based on DISCN. The cost of equity capital does not significantly differ between the two groups of firm-years (note that we focus on non-habitual disclosers, i.e., DISCN=1, because DISCN is

21

used in most of our main analyses) (0.113 vs. 0.119 with t-value=-1.42). Consistent with the theory on voluntary disclosure (Verrecchia, 2001; Dye, 2001), firms voluntarily publishing stand-alone CSR reports tend to have superior CSR performance (PERFORM) relative to their industry peers. The difference in CSR performance between the two groups (3.621 for disclosers vs. -0.281 for non-disclosers) is significant (t-value = 32.23). On average, disclosing firms also have greater CSR concerns compared to their industry peers (HICONCERN: 0.779 for disclosers and 0.367 for non-disclosers with t-value of the difference test 26.35). This evidence is consistent with the notion that the potential risk (e.g., political risk or litigation risk) associated with CSR concerns serves as a motivation for firms to voluntarily engage in CSR disclosure. Disclosing firms are significantly larger than non-disclosers (SIZE: 9.57 for disclosers vs. 6.981 for non-disclosers, t-value = 57.19), probably because larger firms have more financial resources on the supply side and have a larger impact on the community and society on the demand side of CSR. The two groups do not significantly differ in terms of distribution in high litigation risk industries (LITIGATION) (t-value for difference: 1.44). Disclosing firms also appear to be significantly more profitable than non-disclosers (ROA: 0.057 for disclosers vs. 0.026 for non-disclosers, t-value = 8.24) in the year preceding CSR reporting, lending direct support to the financial resources argument for CSR disclosure. Contrary to the proprietary information argument, disclosing firms are in industries with greater competition (COMPETITION) (-0.054 for disclosing firms and -0.06 for non-disclosing firms, t-value =2.88). The full sample on average records a slightly negative net financing amount (FIN = -0.007) in the year prior to CSR reporting. However, disclosing firms demonstrate a significantly lower level of financing than non-disclosing firms (-0.033 for disclosers vs. -0.005 for non-disclosers, t-value = -5.77). On the basis of the definition of FIN, the more negative financing level for disclosers implies that these firms, in net effect, either have purchased back their stocks or
22

redeemed their debts. Firms normally conduct repurchases when they believe their stocks are under-valued, indicating a high cost of equity capital, which in turn provides an incentive for managers to improve disclosure and increase transparency. Similarly, redemption of mature debts likely implies that firms need future financing to maintain a normal capital level. These firms would also be willing to improve disclosure if it helps them to lower the cost of borrowing. We do not have an ex ante prediction about the effect of growth (TOBINQ) on firms voluntary CSR disclosure because it captures the contradictory effects from the supply side and demand side. The univariate comparison shows that non-disclosers actually have a significantly greater level of growth (2.184 for non-disclosers vs. 2.068 for disclosers; t-value = -2.09), suggesting that financial constraint among growth firms plays a dominant role in CSR disclosure. Supporting the argument in prior literature (Leftwich et al., 1981) that debt leads to information need for monitoring purpose, we find that disclosers have a higher level of debt (LEV) than non-disclosers (0.254 for disclosers vs 0.226 for non-disclosers, t-value = 4.14). Also, firms with a higher level of global operation (GLOBAL) are also more likely to disclose CSR (0.493 for disclosers vs. 0.180 for non-disclosers; t-value = 24.51), consistent with the notion that these firms attract more attention in the international community. Finally, disclosing firms have lower liquidity levels than non-disclosing firms in the year before the voluntary CSR disclosure (LIQUIDITY: 1.339 for disclosers vs. 1.690 for non-disclosers; t-value = -7.43). This evidence further points to firms incentives to improve their stocks liquidity through information disclosure. Since many of the above-mentioned variables appear to be related to firms voluntary CSR disclosure decisions, we next run multivariate regressions to control for the potential confounding effects while focusing on the effect of the cost of equity capital.

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4.2 Cost of Equity Capital and the Likelihood of CSR Reporting We display empirical results for regression Equation (1) in Panel B of Table 3. Column I reports results based on our main dependent variable, DISCN (reporting years with the subsequent year not observing any stand-alone CSR reports). Columns II and III exhibit estimation results for the alternative dependent variables DISC (all reporting firm-years) and DISCI (the earliest reporting year of each reporting firm). Across all three specifications of the dependent variable, the cost of equity capital in year t-1, is significantly positively associated with firms likelihood of voluntarily issuing stand-alone CSR reports in year t. The significance level is below 1% for DISCN, at 5.4% for DISC, and at 6.2% for DISCI. This result supports Hypothesis 1 that a higher level of past cost of equity capital is associated with a greater likelihood of voluntary CSR reporting in the current year. Take Column I results for instance, holding other factors constant, when the cost of equity capital increases by one percentage point, the odds of disclosing CSR increases by 5.65%. The estimates of the coefficients on the control variables are generally consistent with the univariate comparison in Panel A of Table 3. One exception is FIN. It becomes insignificant in the regression. Column IV and Column V further examine whether past levels of cost of equity capital is associated with the level of firms effort in publicizing CSR reports. Column IV shows that a higher past level of the cost of equity capital is associated with a greater likelihood that the report is assured by an independent third-party (coef.=3.591, p-value=0.045). Similarly, a higher level of the cost of equity capital in year t-1 is significantly associated with a longer report in year t (coef.=1.925, p-value=0.004). Easing the concern that the relation between cost of equity capital and CSR disclosure might be confounded by firms financial disclosure policy and financial transparency, Table 3 shows
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that neither CIG nor ABS_EM is significant at conventional significance levels. To find further corroboration of our results, we replace the main independent variable COCt with its change form COCt-1, namely, the change in the cost of equity capital from year t 2 to t 1. We expect that firms with greater increases in the cost of equity capital have a stronger incentive to make voluntary CSR disclosure. The empirical results are reported in Panel C of Table 3. Consistent with our conjecture, the increase in the cost of equity capital in the prior year is significantly positively associated with the likelihood of a firms issuing CSR reports in the current year (coef.=1.551, p-value=0.079 for DISCN; coef.=1.539, p-value=0.084 for DISC). Overall, our empirical evidence in this subsection supports Hypothesis 1 that the cost of equity capital plays a motivating role in firms voluntary CSR disclosure decisions.

4.3 CSR Reporting and Future Cost of Equity Capital Our second hypothesis predicts that voluntary disclosure of CSR leads to a lower future cost of equity capital. The empirical results testing this hypothesis are exhibited in Table 4. Columns I and II of Panel A display the results for regression Equation (3) using DISCN as the main independent variable. It is insignificantly different from zero. Using DISC in columns III and IV yields similar results. Column II tests the relation between the cost of equity capital and voluntary CSR disclosure conditional on whether a firm is a superior CSR performer. Indeed, the interaction term between DISCN and HIPERFORM is significantly negative (coef.=-2.623, t-value=-1.98). This negative coefficient is consistent with our conjecture that a lower cost of equity capital can be achieved if the reporting firm actually records superior CSR performance relative to its industry peers. Voluntary disclosure per se does not seem to generate any benefit related to the cost of equity capital.
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Combining the main effect on DISCN and the coefficient on the interaction term between DISCN and HIPERFORM, we infer that superior CSR performers enjoy a decrease in the cost of equity capital of 1.237% when they produce a stand-alone CSR report. The result is similar if we use DISC in place of DISCN, with the benefit of a 0.796% reduction in the cost of equity capital. Panel B illustrates results from estimating Equation (2) within each tercile of CSR performance (PERFORM). Consistent with findings in Panel A, we find a significantly negative relation (t-value=-2.02) between voluntary disclosure (DISCN) in year t and the change in the cost of equity capital from year t to year t + 1 for firms in the highest tercile of CSR performance. The coefficient indicates that benefit on the cost of equity capital by voluntarily disclosing CSR is about 1.68%. However, among firms in the other two groups with lower CSR performance, there is no significant association between CSR disclosure and the change in the cost of equity capital. To summarize, our empirical evidence in Table 4 demonstrates that voluntary CSR disclosure per se does not benefit a reporting firm. Nevertheless, when a reporting firm has relatively superior CSR performance, it enjoys a reduction in the cost of equity capital ranging from about 0.8% to 1.7%, depending on model specifications. Taken together, the results presented in this section support our Hypotheses 1 and 2.

5. Potential Mechanisms Linking CSR Disclosure and the Cost of Equity Capital The results in the previous section suggest that CSR disclosure has an impact on firms cost of equity capital. In this section, we provide evidence on the potential underlying mechanisms through which voluntary CSR disclosure lowers the cost of equity capital. We focus on two types of financial intermediaries, institutional investors and financial analysts. The literature on institutional investors (Jensen and Meckling, 1976; Shleifer and Vishny, 1986; Admati et al.,
26

1994) suggests that their large equity stakes in the invested firms and their level of sophistication enable them to monitor the firms and reduce the agency problems and the extent of information asymmetry between managers and shareholders. The effect from these roles of the institutional investors may lead to a lower cost of equity capital. For financial analysts, by analyzing whether their forecasts become more accurate and/or less disperse when CSR disclosure is available, we can infer whether CSR disclosure helps to reduce estimation risk and information asymmetry between mangers and shareholders, as well as that among shareholders.

5.1 CSR Reporting and Institutional Investors To determine whether CSR disclosure attracts more institutional investment, we follow Bushee and Noe (2000) and estimate the following model. Different types of institutional investors play different monitoring roles, following Bushees (1998) methodology we classify institutional investors into dedicated, transient, and quasi-indexers.
INSTi ,t +1 = 0 + 1 DISCN i ,t + 2 HIPERFORM i ,t + 3 DISCN i ,t * HIPERFORM i ,t + 4 INSTi ,t 1 + 5 MRETi ,t + 6TVOLi ,t 1 + 7 MVi ,t + 8 BETAi ,t 1 + 9 IRISK i ,t 1 + 10 LEVi ,t + 11DPi ,t + 12 EPi ,t + 13 MBi ,t + 14 SGRi ,t + 15 RATEi ,t + 16 SHRS i ,t + IND + YEAR + i ,t

(4)

where INST represents DED, TRA, or QIX in the three separate regressions, each denoting dedicated, transient, or quasi-indexer institutional investors ownership, respectively. MRETt = MRETt - MRETt-1 where MRET is the market-adjusted buy-and-hold stock return measured over a given year. Following Bushee and Noe (2000), we request a minimum of 125 observations in a year to calculate MRET. TVOLt-1 is the average monthly trading volume relative to total shares outstanding measured over the year. IRISKt-1 is the log of the standard deviation of market-model residuals calculated using daily stock return over a year. DPt = DPt - DPt-1 where DP is the

27

ratio of dividend (DATA21) to market value of equity. EPt = EPt - EPt-1 where EP is the ratio of income before extraordinary items (DATA 18) to market value of equity. SGRt = SGRt - SGRt-1 where SGR is the percentage change in annual sales (DATA 12). RATEt = RATEt - RATEt-1 where RATE is the S&P stock rating (9 = A+, 8 = A, 7 = A-; 6 = B+; 5 = B; 4 = B-; 3 = C; 2 = D; 1 = not rated). SHRSt = SHRSt - SHRSt-1 where SHRS is the log of shares outstanding. All other variables are defined as before. The control variables are included to capture other factors determining institutional ownership and disclosure policies. Annual market-adjusted return (MRET) measures firm performance, which is expected to be positively correlated with changes in institutional ownership (Lang and Lundholm, 1993; Lang and McNichols, 1997). Institutional investors also demonstrate a preference for liquid stocks (Eames, 1998; Gompers and Metrick, 1998), proxied by trading volume (TVOL). Beta (BETA), idiosyncratic risk (IRISK), and leverage (LEV) are included to capture firm risk on different dimensions (Bushee and Noe, 2000). Further, dividend yield (DP), the earnings-price ratio (EP), the market-to-book ratio (MB), and sales growth (SGR) are included to control for changes in firms fundamentals that may affect the investment decisions of institutional investors (Bushee, 2001). Lastly, we add the change in S&P stock ratings (RATE) to capture institutional investors preferences for well-reputed firms (Del Guercio, 1996) and the change in shares outstanding (SHRS) to control for equity issuance or repurchases that may affect both institutional investors following and firms disclosure policies. The empirical results are reported in Table 5. Panel A presents descriptive statistics of the one-year-ahead holdings and changes in holdings for the three types of institutional investors. Overall the univariate comparison does not reveal significant difference between the disclosing group and non-disclosing group. If anything, on average, the non-disclosing group even observes marginally greater dedicated institutional following (t-value for difference=-1.62).
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Regression results are displayed in Panel B. Voluntary CSR disclosure is only significantly positively associated with dedicated institutional investors (DISCN: coef.=0.399, t-value=1.64). There is no significant relation between CSR disclosure and transient or quasi-indexer institutional ownership. Panel C examines whether dedicated institutional investors care about firms relative CSR performance. We estimate regression Equation (4) separately within each tercile of CSR performance scores (PERFORM). The results show that CSR reporting is associated with an increase in dedicated ownership only in the highest tercile of CSR performance. In summary, the empirical evidence in this subsection shows that voluntary CSR disclosure appears to attract dedicated institutional investors, which has been shown to be especially effective in monitoring the firm (Bushee, 1998). Similar to our earlier finding that only superior CSR performers enjoy a lower cost of equity capital, the effect on the increase in dedicated institutional ownership is stronger if firms have relatively superior CSR performance than their industry peers.

5.2 CSR Reporting and Analyst Forecasts To determine the impact of CSR disclosure on the behavior of financial analysts, we conduct analyses on analyst coverage, forecast errors, and forecast dispersion. Following Lang and Lundholm (1996) and Ali et al. (2007), we run the following three regressions:

COVERAGE i ,t +1 = 0 + 1 DISCN i ,t + 2 HIPERFORM i ,t + 3 DISCN i ,t * HIPERFORM i ,t + 4 SIZEi ,t + 5 STDROEi ,t + 6 INVPRICE i ,t + 7 RETVARi ,t + 8 RDi ,t 1 , + 9 ROAi ,t + 10 CORRi ,t + i ,t

(5)

29

FE i ,t +1 = 0 + 1 DISCN i ,t + 2 HIPERFORM i ,t + 3 DISCN i ,t * HIPERFORM i ,t + 4 SIZEi ,t + 5 STDROE i ,t + 6 ACHEPS i ,t + 7 RDi ,t + 8 ROAi ,t + 9 CORRi ,t + i ,t

, and

(6)

DISPi ,t +1 = 0 + 1 DISCN i ,t + 2 HIPERFORM i ,t + 3 DISCN i ,t * HIPERFORM i ,t + 4 SIZEi ,t + 5 STDROEi ,t + 6 ACHEPS i ,t + 7 RDi ,t + 8 ROAi ,t + 9 CORRi ,t + i ,t

(7)

COVERAGEt+1 = COVERAGEt+1 - COVERAGEt where COVERAGE is the 12-month average of the number of analysts who issue annual earnings forecasts in I/B/E/S for the firm. FEt+1 = FEt+1 - FEt where FE is the absolute value of the 12-month average of analyst forecast errors defined as actual earnings minus mean forecast, deflated by stock price at the beginning of the fiscal year. DISPt+1 = DISPt+1 - DISPt where DISP is the 12-month average of the standard deviation of analysts forecasts, deflated by the stock price at the beginning of the fiscal year. STDROEt= STDROEt - STDROEt-1 where STDROE is the standard deviation of ROE (DATA18/DATA60) in the preceding 10-year period. INVPRICEt= INVPRICEt - INVPRICEt-1 where INVPRICE is the inverse of stock price (DATA199) at the beginning of the fiscal year. RETVARt= RETVARt - RETVARt-1 where RETVAR is the daily stock return variance estimated over the 200 days prior to the year end. RDt= RDt - RDt-1 where RD is the research and development expense (DATA46) deflated by total assets at the beginning of the fiscal year. CORRt= CORRt - CORRt-1 where CORR is the Pearson correlation coefficient between ROE and annual stock returns in the preceding 10-year period. All other variables are defined as before. We derive our control variables following prior literature. Firm size (SIZE) is included because larger firms have more potential brokerage or investment banking businesses for analysts brokerage houses (Bhushan, 1989). According to Bhushan (1989), Analysts are more likely to follow firms with higher return variability (STDROE and RETVAR) because the
30

expected trading benefits based on private information on these stocks are higher. Brennan and Hughes (1991) suggest that the inverse of stock prices (INVPRICE) can proxy for the brokerage commission rate, which in turn serves as an incentive for analysts to follow the firm. We add the research and development expense (RD) as a proxy for firms levels of information asymmetry (Aboody and Lev, 2000) because analysts have relatively stronger incentives to follow firms with higher levels of information asymmetry (Barth et al., 2001). The earnings-return correlation (CORR) captures the difficulty in predicting a firms earnings and ROA controls for firms profitability. Finally, annual change in EPS (ACHEPS) controls for the magnitude of the forthcoming earnings information (Ali et al., 2007). Empirical results are reported in Table 6. Panel A shows the descriptive statistics of the three main variables in the year following the CSR disclosure. Disclosing firms are covered by more analysts (COVERAGE: 26.19 for disclosers vs. 15.13 for non-disclosers; t-value=31.01) and the analysts issue more accurate forecasts compared with non-disclosing firms (FE: 0.159 for disclosers vs. 0.209 for non-disclosers; t-value= -5.15). However, there is no significant difference between the two groups of firms in terms of forecast dispersion. In terms of changes from year t to year t + 1, only the change in forecast errors (FE) is significantly different between the two groups. In particular, disclosing firms observe their analysts increasing forecast accuracy after they issue CSR reports (-0.166 for disclosers vs. 0.159 for non-disclosers; t-value=-3.04). Multivariate regression results for Equations (5) to (7) are reported in Panels B to D, respectively. Consistent with the analyses earlier, to examine the role of relative CSR performance, we run the regressions within each tercile of the CSR performance scores. Column I of Panel B shows that firms with the highest performance scores (column I) demonstrate the most significant positive association between CSR reporting and analyst
31

coverage (DISCN: coef.=0.40; t-vale=2.77). In the middle group, the relation becomes weaker (coef.=0.582; t-value=1.69). In the low group, the coefficient on DISCN is no longer significant at conventional levels. Similar results are found for analyst forecast errors. Panel C demonstrates that in the high and middle groups of CSR performance (coef.=-0.259 and t-value=-8.01 for the high group and coef.=-0.42 and t-value=-1.94 for the middle group), CSR disclosure is negatively associated with analyst forecast errors. However, this effect is not significant in the low performance group. Results for forecast dispersion in Panel D also display similar pattern. Only in the high CSR performance group (coef.=-0.022 and t-stat=-3.44), we observe a significantly negative association between CSR disclosure and forecast dispersion. To sum up the results in this subsection, voluntary CSR disclosure is associated with more analyst coverage, improved forecast accuracy and lower forecast dispersion, consistent with our conjecture that CSR reporting helps reduce information asymmetry between managers and shareholders and also among shareholders. This evidence supports our reasoning that CSR disclosure can reduce the cost of equity capital through reducing estimation risk in the market. Further, consistent with our earlier finding that the cost of equity capital benefit is only manifested among firms with relatively superior CSR performance, the effects of CSR reporting on analyst coverage, analyst forecast accuracy, and forecast dispersion are only significant when the firm has relatively high CSR performance.

6. CSR Reporting and Equity Issuance As discussed earlier, an important purpose for firms to reduce the cost of equity capital is to seek additional equity capital in the future. If the above results reflect mangers motivation for voluntarily producing stand-alone CSR reports, we should observe ex post more actual equity
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issuances after CSR disclosure. We run the following regressions to empirically test this conjecture:

SEOi ,t +T = 0 + 1 DISCN i ,t + 2 MBi ,t + 3 LNSALES i ,t + 4 ROAi ,t + 5 LEVi ,t + 6CASH i ,t + 7 FIN i ,t + 8 PAYOUTi ,t + 9 CAPITALi ,t + 10 RDi ,t + 11 LNDISPi ,t + i ,t

(8)

ISSUE $i ,t +T = 0 + 1 DISCN i ,t + 2 MBi ,t + 3 LNSALES i ,t + 4 ROAi ,t + 5 LEVi ,t + 6 CASH i ,t + 7 FIN i ,t + 8 PAYOUTi ,t + 9 CAPITALi ,t + 10 RDi ,t + 11 LNDISPi ,t + i ,t

(9)

where T = 1 or 2 denotes one or two years following the disclosure. SEOt+1 (SEOt+2) equals one if the firm has seasoned equity offering one (two) year(s) following the CSR report. ISSUE$t+1 (ISSUE$t+2) is the total dollar amount in billions raised in a firms seasoned equity offering one (two) year(s) following the CSR report. Information on SEOs is obtained from SDC (Security Data Corporation). LNSALES is the natural logarithm of total sales (DATA12). CASH is total cash to asset ratio, defined as cash and short-term investments (DATA1) divided by total asset. PAYOUT is defined as cash dividend (DATA21) relative to total assets. CAPITAL equals capital expenditures (DATA128) scaled by total assets. RD is research and development expenses (DATA46) scaled by total assets. LNDISP is forecast dispersion in year t measured as the logarithm of the standard deviation of analyst estimates of year t earnings divided by the consensus forecast for year t earnings. Logistic regression Equation (8) assesses whether firms CSR reporting is related to the likelihood of future equity issuances through SEOs. Regression Equation (9) further examines whether CSR reporting is associated with the amount of capital raised, among firms conducting SEOs. Following prior studies, we control for various other potential factors affecting firms equity

33

issuance decisions. Stein (1995) suggests that firms may choose the time when their stocks are overvalued to issue equity. Moreover, growth firms have larger need of capital. Hence we include the market-to-book ratio (MB). The research and development expenses (RD) and capital expenditures are included as additional proxies for firms growth opportunities. The likelihood of equity issuance may depend on the extent of financial constraints firms face. Moreover, firms may follow the pecking order in their choice of financing options. Specifically, they may rely preferentially on internal reserves and debt financing before issuing equity (Myers, 1984; Myers and Majluf, 1984). As such, we include profitability (ROA), cash flow (CASH), payout ratio (PAYOUT), and leverage (LEV) to capture the financial constraint, internally generated funds, and debt capacity. We control for analyst forecast dispersion (LNDISP) as a proxy for the agreement between the management and investors, because Dittmar and Thakor (2007) propose that firms are more likely to issue equity when the agreement is high. Lastly, we control for firm size (LNSALES) and the financing activities already conducted (FIN) in the current year. Results are presented in Table 7. Further supporting our conjecture that firms voluntarily release CSR reports to improve transparency and reduce the cost of equity capital, Panel A shows that firms are more likely to seek equity capital through SEOs in the two years following the disclosure. The coefficients on DISCN are all significant at conventional levels. According to the coefficient estimate for DISCN in Column I (coef. = 0.388; p-value = 0.027), the odds of disclosing firms to issue equity is 47.4% higher than non-disclosing firms. After controlling for more variables in column II, that odds difference increases to 63%. In Column III, disclosing firms odds is 91.7% higher than non-disclosing firms to issue equity in the second year after CSR reporting. Adding additional control variables in Column IV increases the odds difference to 96.8%. Panel B of Table 7 reveals that holding other things constant, disclosing firms not only are
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more likely to issue equity, they also raise a significantly larger amount. The difference ranges from US$ 107 million to US$ 195 million, depending on which year following the CSR reporting the firm conducts the SEO and the model specifications. Using DISC and DISCI to replace DISCN produces similar results.

7. Summary and Conclusions In this paper we examine a potential benefit associated with the rapidly increasing voluntary reporting of social responsibility activities by U.S. firms, a reduction in the cost of equity capital. We attempt to provide empirical answers to several closely related questions: (1) Does a potential reduction in the cost of equity capital motivate firms to produce CSR reports? (2) Does CSR disclosure actually lead to a lower cost of equity capital? (3) If the answer to question (2) is yes, what are the underlying mechanisms linking CSR disclosure to a lower cost of equity capital? and finally, (4) Do disclosing firms exploit the benefit of a reduction in the cost of equity capital by subsequently issuing equities? We find that past cost of equity capital is positively associated with firms likelihood of releasing CSR reports. However, only those firms with CSR performance superior to their industry peers enjoy a reduction in the cost of equity capital after they issue the CSR reports. Dedicated institutional investors are attracted to firms with superior CSR performance. CSR reporting also increases analyst coverage, reduces forecast errors, and lowers forecast dispersion for superior CSR performers. Lastly, CSR reporting firms appear to exploit this benefit of a reduction in the cost of equity capital. They are more likely than non-disclosing firms to conduct SEOs to raise capital in the two years following the disclosure. Moreover, among firms conducting SEOs, those producing CSR reports raise a significantly larger amount of equity capital than non-reporting firms.
35

This study adds to the voluntary disclosure literature. We expand the traditional research on voluntary disclosure to a broader dimension beyond the narrowly-focused financial disclosure. Our analyses enhance our understanding of the rationales and incentives behind the recent trend of voluntary CSR disclosure. These results have important implications for companies, regulators, and investors.

36

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Appendix 1 List of Sample Firms with Stand-alone CSR Reports in Year 2007
Company Name
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 Kimberly-Clark Corporation Xerox Corporation The Boeing Company Herman Miller Inc TECO Energy Inc Herman Miller Inc Pinnacle West Capital Corporation ConocoPhillips Office Depot Staples Inc Weyerhaeuser Company National Grid USA Intel Corporation Starbucks Corporation Mattel Inc Southern Copper Corporation PG&E PPL Corporation Procter & Gamble Inc Pepsico Inc Dell Inc The Timberland Company GAP Inc Xcel Energy Inc Southern Copper Corporation Cummins Inc United Parcel Service of America Inc Green Mountain Power Corporation CBS Corporation Smithfield Foods Inc Wisconsin Public Services Corporation General Electric Company Bristol-Myers Squibb Company Pfizer Inc Cisco Systems Inc Wisconsin Energy Corporation General Motors Corporation Nike Inc Citigroup Inc Hewlett-Packard Company

Publish Month
Apr Nov Jan Apr Apr Nov May Oct Sep Aug Jun Oct May Mar Jan Sep Jun Oct Nov Dec Jul Aug Aug Jun Jun Feb Aug Nov July Jul May Jun Nov Sep Nov Nov May May July Mar

No. of Pages
53 64 66 67 67 68 70 72 73 76 76 76 77 77 80 82 82 84 85 87 88 90 91 91 93 98 104 107 108 110 112 114 120 120 121 124 135 163 163 188

External Assurance (Yes =1, No=0)

0 0 0 0 0 0 0 1 1 0 0 1 1 1 1 1 0 0 0 0 0 0 1 0 1 0 0 0 0 0 0 0 1 1 0 0 0 1 0 1

If a firm discloses multiple CSR reports in one year, we add up the number of pages of each report and show the total number of pages.

42

Appendix 2 CSR Categories and Performance Scores by Industries

Industries Mining/Construction Food Textiles/Print/Publish Chemicals Pharmaceuticals Extractive Manf: Rubber/glass/etc Manf: Metal Manf: Machinery Manf: Electrical Eqpt Manf: Transport Eqpt Manf: Instruments Manf: Misc Computers Transportation Utilities Retail: Wholesale Retail: Misc Retail: Restaurant Financial Insurance/RealEstate Services Mean Corporate Total Community Diversity Governance Strength 0.769 2.227 1.586 2.122 1.504 1.200 1.280 1.169 1.129 1.355 1.879 1.385 1.361 1.589 1.211 1.847 0.722 1.421 1.206 1.521 0.518 0.792 1.382 0.149 0.340 0.155 0.257 0.163 0.148 0.144 0.068 0.118 0.143 0.128 0.107 0.151 0.117 0.113 0.185 0.019 0.158 0.084 0.330 0.037 0.027 0.162 0.143 0.269 0.137 0.154 0.147 0.176 0.148 0.139 0.140 0.142 0.193 0.207 0.218 0.193 0.143 0.177 0.116 0.150 0.136 0.272 0.150 0.150 0.174 0.186 1.081 0.657 0.678 0.735 0.199 0.369 0.200 0.279 0.438 0.604 0.543 0.460 0.733 0.593 0.696 0.309 0.795 0.682 0.648 0.254 0.472 0.572 Employee Relations 0.160 0.383 0.288 0.527 0.278 0.421 0.397 0.424 0.237 0.330 0.545 0.227 0.294 0.359 0.265 0.336 0.118 0.203 0.215 0.207 0.073 0.103 0.273 Environment 0.091 0.164 0.218 0.458 0.113 0.232 0.125 0.255 0.193 0.149 0.302 0.180 0.059 0.096 0.037 0.448 0.073 0.056 0.075 0.008 0.001 0.018 0.125 Human Rights 0.026 0.024 0.002 0.000 0.000 0.002 0.016 0.000 0.002 0.007 0.000 0.001 0.008 0.000 0.001 0.001 0.000 0.009 0.000 0.004 0.000 0.000 0.003 Product 0.017 0.026 0.145 0.079 0.077 0.021 0.093 0.080 0.148 0.151 0.121 0.121 0.193 0.094 0.072 0.003 0.092 0.064 0.014 0.058 0.001 0.030 0.072

This table provides a brief summary for the seven categories included in KLD Research & Analytics database used to rate firms CSR performance. Within each of these seven categories, KLD defines a set of potential strengths and assigns a value of one if the strength exists and a zero otherwise. The statistics provided in this table are the mean performance scores (non-industry-adjusted raw performance scores) for each industry. The seven categories and the potential strengths for each category are summarized below.
Community Corporate Governance Diversity Employee Relations Environment Human Rights Product (1) Charitable Giving, (2) Innovative Giving, (3) Non-U.S. Charitable Giving, (4) Support for Education, (5) Support for Housing, (6) Volunteer Programs, and (7) Other Strengths (1) Compensation, (2) Ownership, (3) Political Accountability, (4) Transparency, and (5) Other Strengths (1) Board of Directors, (2) CEO, (3) Employment of the Disabled, (4) Promotion, (5) Women & Minority Contracting, (6) Work/Life Benefits, (7) Gay & Lesbian Policies, and (8) Other Strengths (1) Health and Safety, (2) Retirement Benefits, (3) Union Relations, (4) Cash Profit Sharing, (5) Employee Involvement, and (6) Other Strengths (1) Beneficial Products & Services, (2) Clean Energy, (3) Pollution Prevention, (4) Recycling, and (5) Other Strengths (1) Labor Rights, (2) Relations with Indigenous Peoples, and (3) Other Strengths (1) Benefits the Economically Disadvantaged, (2) Quality, (3) R&D/Innovation, and (4) Other Strengths

43

Table 1 Sampling Process

Number of Sampling Step Total number of CSR reports during 1993-2008 Less: Number of CSR reports issued in 2008 Total number of CSR reports during 1993-2007 Less: Repetitive reports by the same firm in the same year Total number of firm-year observations with CSR disclosure (if firms issue CSR reports more than once per year, we only count it once) Less: Firm-years without KLD performance scores Total number of firm-year observations with both stand-alone CSR disclosure and KLD performance scores Less: Firm-years with missing variables in main analyses Final CSR reporting sample: Number of firm-year observations Number of unique firms 679 196 observations 1,416 143 1,273 198

1,075 167 908 229

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Table 2 Sample Industry Distribution

Panel A: Distribution by industries No. of firm-years with CSR reports 25 40 36 67 62 66 15 19 15 17 25 27 3 86 23 98 6 16 13 6 0 9 5 679 No. of unique firms issuing stand-alone CSR reports 7 14 14 13 13 16 3 3 6 5 8 7 2 22 10 26 4 9 3 4 0 5 2 196

Industries

% of obs.

% of firms

1 2 3 4 5 6 7 8 9

Mining/Construction Food Textiles/Print/Publish Chemicals Pharmaceuticals Extractive Manf: Rubber/glass/etc Manf: Metal Manf: Machinery

3.68 5.89 5.30 9.87 9.13 9.72 2.21 2.80 2.21 2.50 3.68 3.98 0.44 12.67 3.39 14.43 0.88 2.36 1.91 0.88 0.00 1.33 0.74 100.00

3.57 7.14 7.14 6.63 6.63 8.16 1.53 1.53 3.06 2.55 4.08 3.57 1.02 11.22 5.10 13.27 2.04 4.59 1.53 2.04 0.00 2.55 1.02 100.00

10 Manf: Electrical Eqpt 11 Manf: Transport Eqpt 12 Manf: Instruments 13 Manf: Misc 14 Computers 15 Transportation 16 Utilities 17 Retail: Wholesale 18 Retail: Misc 19 Retail: Restaurant 20 Financial 21 Insurance/RealEstate 22 Services 23 Others Total

45

Table 2 contd

Panel B: Distribution by years Years 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Total No. of Firms with CSR Reports 2 8 10 17 21 20 27 22 57 58 59 81 95 102 100 679 % of Firms 0.29 1.18 1.47 2.50 3.09 2.95 3.98 3.24 8.39 8.54 8.69 11.93 13.99 15.02 14.73 100.00

46

Table 3 Determinants of CSR Disclosure

Panel A: Descriptive statistics Full Sample
COC t-1 PERFORM t-1 HICONCERN t-1 SIZE t-1 LITIGATION t-1 ROA t-1 COMPETITION t-1 FIN t-1 TOBINQ t-1 LEV t-1 GLOBAL t-1 LIQUIDITY t-1 CIG t-1 ABS_EM t-1 0.118 -0.062 0.390 7.125 0.206 0.028 -0.059 -0.007 2.177 0.228 0.197 1.670 0.512 0.048

Firms with DISCN=1

0.113 3.621 0.779 9.570 0.224 0.057 -0.054 -0.033 2.068 0.254 0.493 1.339 0.699 0.031

Firms with DISCN=0

0.119 -0.281 0.367 6.981 0.205 0.026 -0.060 -0.005 2.184 0.226 0.180 1.690 0.501 0.049

t-value (difference)
-1.42 32.23 26.35 57.19 1.44 8.24 2.88 -5.77 -2.09 4.14 24.51 -7.43 13.06 -14.95

Panel B: Cost of equity capital in the pre-CSR disclosure year and CSR disclosure (Logistic Regression)
I DISCN t Variables COC t-1 PERFORM t-1 HICONCERN t-1 SIZE t-1 LITIGATION t-1 ROA t-1 COMPETITION t-1 FIN t-1 TOBINQ t-1 LEV t-1 GLOBAL t-1 LIQUIDITY t-1 CIG t-1 ABS_EM t-1 Year Dummies Industry Dummies Pseudo R-Square Likelihood Ratio N (dep. var. =1) N Pred. Sign + + + + ? + + ? + + + Coeff. 1.894 0.345 0.318 1.040 2.145 Prob. 0.008 0.000 0.014 0.000 0.057 II DISC t Coeff. 1.131 0.383 0.427 1.054 0.127 2.133 Prob. 0.054 0.000 0.001 0.000 0.051 III DISCI t Coeff. 3.325 0.177 0.843 0.936 3.317 Prob. 0.062 0.012 0.014 0.000 0.251 IV ASSURANCE t Coeff. 3.591 1.143 0.384 0.876 1.351 4.684 0.647 Prob. 0.045 0.001 0.186 0.000 0.216 0.072 V HIPAGE t Coeff. 1.925 0.281 0.609 0.750 0.524 1.623 Prob. 0.004 0.000 0.001 0.000 0.226 0.231

-0.100 0.766

0.698 -0.052 0.942

-5.130 0.000 -5.385 0.000 -4.395 0.170

0.858 -0.900 0.692

-0.309 0.640 -0.095 0.884 -0.435 0.805 -0.309 0.815 -1.399 0.103 -0.293 0.000 -0.337 0.000 -0.201 0.208 -0.170 0.151 -0.203 0.010 0.812 0.292 0.032 0.074 0.029 0.807 0.644 0.302 0.122 0.151 0.019 0.327 0.526 0.014 0.400 0.645 -0.885 0.392 0.964 0.235 0.690 0.086 2.179 1.517 0.012 0.019 -0.120 0.507 0.725 0.033 0.843

-0.091 0.119

-0.098 0.085 -0.209 0.204 -0.359 0.026 -0.085 0.303 0.510 -1.575 0.469 Yes Yes 0.4477 641.64 301 10,556

-0.831 0.599 -1.667 0.282 -1.325 0.754 Yes Yes 0.4751 1,897.29 563 10,556 Yes Yes 0.5495 2,731.92 679 10,556 Yes Yes 0.3400 234.10 196 10,556

Yes Yes 0.4399 554.63 117 10,556

47

Table 3 Contd

Panel C: Change of cost of equity capital in the pre-CSR disclosure year and CSR disclosure (Logistic Regressions)
DISCN t Variables COC t-1 PERFORM t-1 HICONCERN t-1 SIZE t-1 LITIGATION t-1 ROA t-1 COMPETITION t-1 FIN t-1 TOBINQ t-1 LEV t-1 GLOBAL t-1 LIQUIDITY t-1 CIG t-1 ABS_EM t-1 Year Dummies Industry Dummies Pseudo R-Square Likelihood Ratio N (dep. var. =1) N Pred. Sign + + + + ? + + ? + + + Coeff. 1.551 0.428 0.871 0.715 0.812 0.089 -2.196 -1.192 -0.167 0.483 -0.037 0.029 0.122 -1.385 Yes Yes 0.4609 528.54 175 3,279 Prob. 0.079 0.000 0.001 0.000 0.173 0.946 0.482 0.351 0.115 0.554 0.884 0.776 0.639 0.646 Coeff. 1.539 0.463 0.872 0.778 0.866 0.222 -2.017 -0.921 -0.227 0.350 0.044 0.031 0.258 -2.161 Yes Yes 0.5371 758.92 238 3,279 DISC t Prob. 0.084 0.000 0.001 0.000 0.154 0.872 0.522 0.465 0.032 0.669 0.855 0.762 0.292 0.470

Dependent variables: DISCt is an indicator variable that equals one if the firm discloses stand-alone CSR reports in year t, and zero otherwise. DISCNt takes the value of one if the concerned firm issued CSR reports in year t, but not in year t+1, even though it might resume reporting in year t+2 or after, and zero otherwise. DISCIt is an indicator variable that equals one if it is the earliest reporting year of a firm (initiating year), and 0 otherwise. ASSURANCEt is an indicator variable that equals one if the firm employs an independent third party for the external assurance/auditing of its CSR disclosure, and zero otherwise. HIPAGEt is a dummy variable that equals one if the number of pages of the firm's CSR reports is higher than the mean number of pages of its industry, and zero otherwise. Independent variables: COCt-1 is the implied cost of equity capital in year t-1 estimated as the mean of three different models: (1) Gebhardt et al. (2001) model, (2) Claus and Thomas (2001) model, and (3) price-earnings growth (PEG) ratio model suggested by Easton (2004). COC t-1 is the change of the implied cost of equity capital from year t-2 to year t-1. PERFORM t-1 is the measure of corporate social responsibility (CSR) performance defined as the industry-adjusted total CSR strength scores from the seven CSR rating categories obtained from KLD Research & Analytics Database. HICONCERN t-1 is a dummy variable that equals one if the firms total CSR concern score is higher than the industry median, and zero otherwise. SIZE t-1 is the natural logarithm of the market value of equity (DATA25*DATA199) at the beginning of each year. LITIGATION t-1 is an indicator variable that equals one if the firm operates in a high-litigation industry (SIC codes of 2833-2836, 3570-3577, 3600-3674, 5200-5961, and 7370), and zero otherwise. ROA t-1 is total return on assets measured as the ratio of income before extraordinary items (DATA18) and total assets (DATA6) at the beginning of each year. COMPETITION t-1 is proxied by Herfindahl-Hirschman Index multiplies by (-1) which is calculated by summing the squares of the individual company market shares based on total shares of the 50 largest companies in an industry or all the company in the industry, whichever is lower. FIN t-1 is the amount of debt or equity capital raised by the firm during the concerned year scaled by total assets of that year. It is measured as the sale of common stock and preferred shares minus the purchase of common stock and preferred shares (DATA108-DATA115) plus long term debt issuance minus the long term debt reduction (DATA111-DATA114). TOBINQ t-1 is Tobin's Q defined as market value of common equity (DATA 25*DATA 199) plus book value of preferred stocks (DATA 10),

48

book value of long term debt (DATA 9) and current liability (DATA 5) divided by book value of total asset. LEV t-1 is leverage ratio, defined as the ratio of total debt (DATA 9+DATA 34) divided by total assets. GLOBAL t-1 is an indicator variable that equals one if the firm reports foreign income, and zero otherwise. LIQUIDITYt-1 is the ratio of the number of shares traded in year t-1 to the total shares outstanding at the end of year t-1. CIG t-1 is a dummy variable that equals one if the firm issues earnings forecast in year t-1, and zero otherwise. ABS(EM) t-1 is the absolute value of abnormal accruals estimated based on Modified-Jones model. All continuous variables are winsorized at the 1% and 99% level.

49

Table 4 Post-CSR Disclosure Cost of Equity Capital

Panel A: Post-CSR disclosure cost of equity capital (Dependent variable = %COC t+1)
I Variables DISCN t HIPERFORM t DISCN t* HIPERFORM t SIZE t BETA t LEV t MB t LTG t LNDISP t Year Dummies Industry Dummies Adjusted R-Square N 3.700 0.966 -5.559 -17.427 -0.199 -0.065 Yes Yes 0.1084 8,332 5.78 2.51 -2.87 -2.30 -2.16 -0.46 Coeff. -0.438 t stat. -0.72 Coeff. 1.386 0.205 -2.623 3.674 0.659 -5.311 -15.124 -0.144 -0.105 Yes Yes 0.1470 8,332 DISCN t 1.18 0.73 -1.98 6.27 1.89 -3.01 -2.18 -1.70 -0.82 3.710 0.454 -6.159 -4.736 -0.222 -0.233 Yes Yes 0.1350 8,332 5.25 1.09 -3.01 -0.53 -2.60 -1.93 0.329 0.49 II t stat. Coeff. III t stat. Coeff. 1.717 0.171 -2.513 3.683 0.599 -4.659 -17.059 -0.152 -0.099 Yes Yes 0.1416 8,332 DISC t 1.40 0.61 -1.95 6.24 1.77 -2.62 -2.49 -1.79 -0.77 IV t stat.

Panel B: Post-CSR disclosure cost of equity capital conditional on firm's CSR Performance (Dependent variable = %COC t+1)
I Variables DISCN t SIZE t BETA t LEV t MB t LTG t LNDISP t Year Dummies Industry Dummies Adjusted R-Square N Coeff. -1.682 3.376 0.759 -4.276 -17.668 -0.183 -0.064 Yes Yes 0.0929 2,750 t stat. -2.02 5.05 1.96 -2.11 -2.23 -1.88 -0.43 Coeff. -0.429 3.411 0.802 -4.418 -17.225 -0.193 -0.073 Yes Yes 0.0882 2,832 Top 33% PERFORM II t stat. -0.62 5.12 2.08 -2.18 -2.19 -1.99 -0.49 Coeff. 0.194 3.365 1.003 -4.727 -16.408 -0.210 -0.098 Yes Yes 0.0892 2,750 Middle 34% PERFORM III t stat. 0.25 5.04 2.58 -2.33 -2.08 -2.18 -0.65 Lowest 33% PERFORM

%COCt+1 is the change of cost of equity capital in percentage from year t to year t+1. DISCt is an indicator variable that equals one if the firm discloses stand-alone CSR reports in year t, and zero otherwise. DISCNt takes the value of one if the concerned firm issued CSR reports in year t, but not in year t+1, even though it might resume reporting in year t+2 or after, and zero otherwise. HIPERFORMt is an indicator variable that equals one if the firms total CSR strength score, namely, PERFORM, is higher than the industry median (in other words, if the firms is classified as a high CSR performer in its industry), and zero otherwise. SIZE t is the natural logarithm of the market value of equity (DATA25*DATA199) at the beginning of each year. BETA t is the change of beta from year t-1 to year t and BETA is estimated from the market model using daily CRSP stock returns data. LEV t is the change of leverage from year t-1 to year t and LEV is leverage ratio, defined as the ratio of total debt (DATA9+DATA34) divided by total assets. MBt is the change of market-to-book ratio from year t-1 to year t defined as market

50

value of equity (DATA25*DATA199) divided by book value of equity (DATA60). LTGt is the change of long-term growth rate where LTG is measured as the difference between the mean two-year-ahead analyst consensus EPS forecast and the mean one-year-ahead analyst consensus EPS forecast divided by the mean one-year-ahead analyst consensus EPS forecast; and LNDISP t is the change in analyst forecast dispersion from year t-1 to year t, and LNDISP is measured as the log of the standard deviation of analyst estimates of year t earnings divided by the consensus forecast for year t earnings. Analyst forecast data are obtained from IBES. All continuous variables are winsorized at the 1% and 99% level to control for outliers. All t-statistics are corrected using the Huber-White procedure.

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Table 5 Post-CSR Disclosure and Institutional Investors

Panel A: Summary statistics Full Sample DED t+1 TRA t+1 QIX1 t+1 DED t+1 TRA t+1 QIX t+1 11.85 15.26 30.02 -0.55 -0.45 1.02 Firms with DISCN=1 10.27 15.34 31.17 -0.48 -1.28 0.74 Firms with DISCN =0 11.94 15.25 29.95 -0.56 -0.40 1.04 t-value (difference) -1.62 0.10 1.44 0.11 -1.26 -0.43

Panel B: Post-CSR disclosure institutional investors holdings DED t+1 QIX t+1 Variables Coeff. t stat. Coeff. t stat. DISCN t 0.399 1.64 0.054 0.17 HIPERFORM t DISCN t * HIPERFORM t DED t-1 QIX t-1 TRA t-1 MRET t TVOL t-1 MV t BETA t-1 IRISK t-1 LEV t DP t EP t MB t SGR t RATE t SHRS t Year Dummies Industry Dummies Adjusted R-Square N -0.085 0.083 -0.029 -1.20 0.29 -6.97 -0.032 0.050 0.039 -0.003 -0.003 0.017 -0.521 3.409 0.397 -0.010 -0.001 0.030 0.371 Yes Yes 0.5062 6,670 0.65 0.78 -0.02 -0.03 0.14 -1.03 0.89 1.00 -0.79 -0.58 1.75 2.05 -0.105 0.033 0.025 -0.007 0.057 -0.928 11.909 0.154 0.011 0.002 0.038 -0.109 Yes Yes 0.6918 6,670 -6.74 -1.05 0.49 0.14 -0.05 0.37 -1.40 2.38 0.29 0.65 0.87 1.68 -0.47 -0.114 -0.126 -1.23 -0.34

TRA t+1 Coeff. t stat. -0.001 0.00 0.093 -0.077 1.31 -0.27

-0.060 -0.007 0.069 -0.152 -0.080 -0.102 0.305 6.917 -0.365 0.026 0.000 0.024 -0.295 Yes Yes 0.6385 6,670

-15.54 -0.09 1.30 -1.10 -0.82 -0.86 0.60 1.77 -0.90 1.95 -0.18 1.42 -1.64

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Table 5 contd

Panel C: Post-CSR disclosure institutional investors holdings conditional on firm's CSR performance DED t+1 DED t+1 DED t+1 Variables Coeff. t stat. Coeff. t stat. Coeff. t stat. Top 33% PERFORM Middle 34% PERFROM Lowest 33% PERFORM DISCN t 0.350 2.62 0.303 1.19 0.346 0.79 DED t-1 -0.020 -2.77 -0.029 -5.35 -0.060 -6.19 MRET t -0.007 -0.05 0.142 1.39 -0.116 -0.69 TVOL t-1 0.005 0.06 0.030 0.46 0.119 1.06 MV t 0.079 0.35 -0.146 -0.76 0.124 0.43 BETA t-1 -0.271 -1.84 0.104 0.76 0.331 1.49 IRISK t-1 0.200 1.13 -0.057 -0.36 -0.451 -1.63 LEV t 0.457 0.57 -0.234 -0.33 -0.839 -0.80 DP t 7.264 1.19 -6.341 -1.27 25.083 2.75 EP t -0.858 -1.37 0.787 1.42 1.010 1.15 MB t -0.012 -0.69 -0.039 -1.86 0.030 1.02 SGR t -0.002 -0.73 0.000 0.16 0.001 0.44 RATE t 0.034 1.34 0.011 0.44 -0.008 -0.21 SHRS t 0.650 2.44 0.291 1.13 0.073 0.18 Year Dummies Yes Yes Yes Industry Dummies Yes Yes Yes Adjusted R-Square 0.5845 0.5108 0.5190 N 2,200 2,270 2,200
DED t+1, QIXt+1, and TRAt+1 are the percentage of ownership holding by dedicated, quasi-indexer, and transient institutional investors relative to total shares outstanding in year t+1. DED t+1, QIX t+1, and TRA t+1 are changes in percentage of ownership from year t to year t+1. DISCN takes the value of one if the concerned firm issued CSR reports in year t, but not in year t+1, even though it might resume reporting in year t+2 or after, and zero otherwise. HIPERFORMt is an indicator variable that equals one if the firms total CSR strength score, namely, PERFORM, is higher than the industry median (in other words, if the firms is classified as a high CSR performer in its industry), and zero otherwise. MRETt = MRETt - MRETt-1; MRET is the market-adjusted buy-and-hold stock return measured over a given year with a minimum of 125 observations. TVOL t+1 is the average monthly trading volume relative to total shares outstanding measured over the concerned year. MVt= MV t - MVt-1; MV is the log of the market value of equity (DATA25*DATA 199). BETAt-1 is the market-model beta calculated from daily stock returns measured over a given year with minimum of 125 observations. IRISKt-1 is the log of the standard deviation of market-model residuals calculated from daily stock return over a year with minimum of 125 observations. LEVt is the change of leverage from year t-1 to year t and LEV is leverage ratio, defined as the ratio of total debt (DATA9+DATA34) divided by total assets. DPt = DPt - DPt-1; DP is the ratio of dividend (DATA21) to market value of equity. EPt = EPt - EPt-1; EP is the ratio of income before extraordinary items (DATA 18) to market value of equity. MBt = MBt - MBt-1; MB is market-to-book value of equity defined as market value of equity (DATA25*DATA199) divided by book value of equity (DATA60). SGRt = SGRt SGRt-1; SGR is percentage change in annual sales (DATA 12). RATEt = RATEt - RATEt-1; RATE is the S&P stock rating (9=A+, 8=A, 7=A-; 6=B+; 5=B; 4=B-; 3=C; 2=D; 1=not rated). SHRSt = SHRSt - SHRSt-1; SHRS is the log of shares outstanding. All continuous variables are winsorized at the 1% and 99% level to control for outliers. All t-statistics are corrected using the Huber-White procedure.

53

Table 6 Post-CSR Disclosure and Analyst Forecast

Panel A: Summary statistics
Full Sample COVERAGE t+1 FE t+1 DISP t+1 COVERAGE t+1 FE t+1 DISP t+1 15.828 0.202 0.197 -1.220 0.000 0.006 Firms with DISCN=1 26.190 0.159 0.193 -1.257 -0.166 -0.001 Firms with DISCN=0 15.127 0.209 0.197 -1.218 0.159 0.007 t-value (difference) 31.01 -5.15 -0.49 0.28 -3.04 -1.32

Panel B: Post-CSR disclosure analyst coverage (Dependent variable = COVERAGE t+1)

Variables INTERCEPT DISCN t SIZE t STDROE t INVPRICE t RETVAR t RD t ROA t CORR t Adjusted R-Square N I Coeff. t stat. Top 33% PERFORM -1.163 0.400 0.063 -0.516 1.982 0.037 1.905 1.796 -0.005 0.0490 4,887 -18.38 2.77 0.38 -1.13 1.61 1.41 1.22 3.93 -0.65 II III Coeff. t stat. Coeff. t stat. Middle 34% PERFORM Lowest 33% PERFORM -0.768 -10.54 0.582 1.69 0.408 2.33 0.281 0.74 1.434 1.44 0.105 3.20 1.437 0.81 0.598 1.69 -0.011 -1.37 0.0690 5,035 -1.769 0.654 1.004 1.527 5.592 0.283 -2.556 2.187 -0.018 0.0382 4,887 -22.07 1.52 4.19 2.41 1.94 6.70 -1.17 1.73 -1.76

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Table 6 contd

Panel C: Post-CSR disclosure analyst forecast errors (Dependent variable = FE t+1)

I Variables Coeff. t stat. Coeff. II t stat. Coeff. III t stat.

Top 33% PERFORM INTERCEPT DISCN t SIZE t STDROE t ACHEPS t RD t ROA t CORR t Adjusted R-Square N 0.756 -0.259 -0.293 -0.251 -0.321 -0.266 -0.170 -0.003 0.0316 4,242 44.33 -8.01 -6.84 -1.79 -2.29 -0.73 -0.83 -0.97

Middle 34% PERFORM 1.535 -0.420 -0.399 1.195 0.958 -0.079 -1.142 0.006 0.0138 4,370 24.90 -1.94 -2.90 2.86 1.51 -0.05 -2.23 0.69

Lowest 33% PERFORM 1.357 -0.260 -0.789 0.311 -0.255 -1.949 -0.778 -0.002 0.0302 4,242 27.31 -1.29 -6.80 0.94 -0.56 -2.09 -1.95 -0.22

Panel D: Post-CSR disclosure analyst forecast dispersion (Dependent variable = DISP t+1)
I Variables INTERCEPT DISCN t SIZE t STDROE t ACHEPS t RD t ROA t CORR t Adjusted R-Square N Coeff. t stat. Top 33% PERFORM 0.015 4.40 -0.022 -3.44 -0.017 -2.04 -0.125 -3.77 -0.408 -13.78 0.667 4.84 -0.196 -4.14 0.001 1.93 0.0837 4,527 II Coeff. t stat. Middle 34% PERFORM -0.002 -0.83 -0.008 -1.07 -0.002 -0.56 -0.020 -1.50 -0.010 -0.89 0.180 2.51 -0.007 -0.34 -0.001 -0.18 0.0130 4,665 III Coeff. t stat. Lowest 33% PERFORM 0.001 0.30 0.034 1.41 -0.032 -3.46 0.049 1.50 -0.109 -3.63 -0.181 -1.26 -0.034 -0.75 0.001 1.02 0.0150 4,527

COVERAGEt+1 = COVERAGEt+1 - COVERAGEt; COVERAGE is the 12-month average of the number of analysts who issued annual earnings forecasts in IBES for the concern firm. FEt+1 = FEt+1 - FEt; FE is the absolute value of the 12-month average of analyst forecast errors defined as actual earnings minus mean forecast, deflated by stock price at the beginning of the fiscal year. DISPt+1 = DISPt+1 - DISPt; DISP is the 12-month average of the stand deviation of analysts forecasts, deflated by the stock price at the beginning of fiscal year. DISCN takes the value of one if the concerned firm issued CSR reports in year t, but not in year t+1, even though it might resume reporting in year t+2 or after, and zero otherwise. SIZEt= SIZEt - SIZEt-1; SIZE is the natural logarithm of the market value of equity (DATA25*DATA199) at the beginning of each year. STDROEt= STDROEt STDROEt-1; STDROE is the standard deviation of ROE (#18/#60) in the preceding 10-year period. INVPRICEt= INVPRICEt INVPRICEt-1; INVPRICE is the inverse of stock price (DATA199) at the beginning of the fiscal year. RETVARt= RETVARt RETVARt-1; RETVAR is the daily stock return variance estimated over the 200 days prior to the year end. RDt= RDt - RDt-1; RD is the research and development expense (DATA46) deflated by total assets at the beginning of the fiscal year. ROAt= ROAt ROAt-1; ROA is earnings before extraordinary item divided by total assets. CORRt= CORRt - CORRt-1; CORR is the Pearson correlation between ROE and annual stock return in the preceding 10-year period. All continuous variables are winsorized at the 1% and 99% level to control for outliers. All t-statistics are corrected using the Huber-White procedure.

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Table 7 Post-CSR Disclosure and Seasoned Equity Offering

Panel A: Logistic model estimates for the determinants of SEO post-CSR disclosure
I SEO t+1 Variables Intercept DISCN t MB t LNSALES t ROA t LEV t CASH t FIN t PAYOUT t CAPITAL t RD t LNDISP t Pseudo R-Square Likelihood Ratio N (dep.var. =1) N 0.0759 508.50 1,101 17,792 Coef. -1.885 0.388 0.012 -0.223 -1.113 2.324 Prob. 0.000 0.027 0.097 0.000 0.000 0.000 II SEO t+1 Coef. -1.635 0.489 0.024 -0.244 -1.470 2.603 -0.980 2.134 1.238 0.864 -1.974 0.050 Prob. 0.000 0.009 0.010 0.000 0.001 0.000 0.000 0.000 0.105 0.000 0.025 0.702 0.0574 283.38 674 17,792 III SEO t+2 Coef. -2.852 0.651 0.001 -0.146 -1.613 2.188 Prob. 0.000 0.001 0.906 0.000 0.000 0.000 IV SEO t+2 Coef. -2.718 0.677 0.013 -0.156 -2.043 2.494 -0.599 1.308 0.532 0.754 -2.638 -0.125 Prob. 0.000 0.001 0.253 0.000 0.000 0.000 0.092 0.000 0.446 0.001 0.019 0.466

0.1096 571.05 885 13,013

0.0746 278.68 517 13,013

Panel B: OLS estimates for the total dollar amount issued in SEO after CSR disclosure
I ISSUE$ t+1 Variables Intercept DISCNt MB t LNSALES t ROA t LEV t CASH t FIN t PAYOUT t CAPITAL t RD t LNDISP t Adjusted R-Square N 0.2809 1,101 Coef. -0.232 0.171 0.010 0.065 -0.094 0.040 t stat. -8.19 4.71 6.30 15.83 -1.73 1.49 II ISSUE$ t+1 Coef. -0.398 0.107 0.010 0.076 0.258 0.111 0.115 0.060 0.216 0.101 0.387 0.075 0.3150 885 56 t stat. -10.05 2.91 5.10 15.34 3.01 3.34 2.20 1.56 3.07 3.48 2.49 3.03 0.2937 674 III ISSUE$ t+2 Coef. -0.188 0.195 0.012 0.061 -0.050 0.006 t stat. -5.00 4.84 5.25 11.66 -0.67 0.15 IV ISSUE$ t+2 Coef. -0.345 0.138 0.012 0.071 0.241 0.090 0.088 0.054 0.039 0.056 0.427 0.098 0.3103 517 t stat. -6.00 3.17 4.50 10.55 1.90 1.87 1.14 0.93 0.15 1.36 1.81 2.91

SEOt+1 (SEOt+2) equals one if the firm has seasoned equity offering in one (two) year(s) after it issues CSR reports, an zero otherwise. DISCNt takes the value of one if the concerned firm issued CSR reports in year t, but not in year t+1, even though it might resume reporting in year t+2 or after, and zero otherwise. ISSUE$t+1 (ISSUE$t+2) is the total dollar amount in billions issued by a firms seasoned equity offering in one (two) year(s) after it issues its CSR reports obtained from SDC. MBt is market-to-book value of equity defined as market value of equity (DATA25*DATA199) divided by book value of equity (DATA60). LNSALESt is the natural logarithm of total sales (DATA12). LEVt is leverage ratio, defined as the ratio of total debt (DATA9 + DATA34) divided by total assets. CASHt is total cash to asset ratio, defined as cash and short-term investments (DATA1) divided by total asset. FINt is the amount of debt or equity capital raised by the firm during the concerned year scaled by total assets of that year. It is measured as the sale of common stock and preferred shares minus the purchase of common stock and preferred shares (DATA108 - DATA115) plus long term debt issuance minus the long term debt reduction (DATA111-DATA114). PAYOUTt is defined as cash dividend (DATA21) relative to total assets. CAPITALt equals capital expenditures (DATA128) scaled by total assets. RDt is research and development expenses (DATA46) scaled by total assets. LNDISPt is forecast dispersion in year t measured as the log of the standard deviation of analyst estimates of year t earnings divided by the consensus forecast for year t earnings. All continuous variables are winsorized at the 1% and 99% level to control for outliers.

57