Theory to Practice

CSR and market reactions to adverse events

Activities relating to Corporate Social Responsibility (CSR) (also known as (ESG)), enhance both the reputation and the value of companies, as previous research has shown. Ample investments in such activities enable companies to improve relations with shareholders and with stakeholders in general, building trust and generating a “reputational premium” which translates into an increased share value. Using these findings as a starting point, our study takes a closer look at the hypothesis that the reputational capital that comes with high levels of CSR cushions companies against the effects of unexpected adverse events. The theory holds that the negative market reaction which ensues is invariably alleviated for these firms, compared to their low-CSR counterparts, all other conditions being equal. But our research demonstrates that this is not always the case. In fact, market reaction is amplified, not attenuated, for companies that are perceived to have high CSR when the negative event in question reveals that this corporate social responsibility is actually fake, not genuine. The true intent instead is to conceal management’s opportunistic and/or negligent behavior (aka greenwashing), rather than to pursue a strategy to defend and strengthen the company’s competitive advantage. 

The study

Our research was based on a sample of 1,165 restatement announcements involving 815 companies listed on the US stock market in the twelve-year period from January 2005 to December 2016. In 1,022 cases, the reason behind the restatement was to correct inadvertent errors; in the remaining 143 instances, these errors were classified as fraudulent, i.e. intentional misstatements by management. A restatement is a revision of a company’s previously-released financial statement data due to a material error. Such an error might be a difference between the reported figure for a balance sheet item, how it is classified or presented, and the accurate number according to generally accepted accounting principles.
Our choice of restatements as the base events for this research was motivated by the following four considerations:

      This choice allowed us to test the hypothesis of risk mitigation associated with CSR activities, analyzing the intensity of the market reaction to negative events linked to opportunistic behaviors (fraud) or unintentional errors by management.
      Restatements are high-impact accounting procedures that capture the attention of market players, regulators, and researchers.
      These are unexpected events, a fact attenuating the potential problem that corporate decisions on CSR activities may be endogenic.
      Last, data on restatements are readily available and easy to use.
      The basis for our study is the hypothesis (corroborated by recent research) that the market’s (negative) reaction to a restatement announcement is attenuated for a high CSR company compared to a low CSR company. This is because investors see such an event as a one-off occurrence. What’s more, during the rectification process (which could last months if not years), they expect management to voluntarily provide any relevant financial information, and more importantly, to make every effort to complete the process promptly. However, when a restatement announcement implicates opportunistic behavior (fraud), shareholders and stakeholders will no longer trust the management of a company which they had erroneously perceived as having a high level of CSR. As a result, the reputational premium that was baked into the stock price disappears. It follows that high levels of CSR actually can both mitigate corporate risk when negative events occur, and amplify the negative market reaction when management engages in fraudulent behavior (misappropriations or intentional accounting violations). Our findings clearly show that when the restatement stems from an inadvertent error, in the three-day window following the announcement the drop in stock market value is inversely proportional to the company’s level of CSR. In contrast, when the restatement is due to fraud, the higher the company’s level of CSR, the more negative the stock price response because the market factors in the greenwashing effect. This leads to a reduction or elimination of the company’s reputational premium.

Conclusions and takeaways

Depending on the conduct of company management, the sign varies denoting the interaction between the company’s CSR level and the market’s response to a restatement announcement. Since the market expects the leaders of a high CSR company to fully comply with ethical and legal principles, a restatement announcement due to fraud is irrefutable proof that no such compliance exists. Trust in management subsequently collapses, triggering a more negative reaction from that market compared to what would occur for a low CSR company (all other conditions being equal) because the reputational premium component would no longer be calculated in the stock price. 


The bottom line is that investing in CSR activities can be a double-edged sword for management. While it is true that CSR can effectively mitigate risks and protect the value of the company when negative events occur, this happens only when corporate social responsibility is genuine. This means that management makes a concrete commitment to comply with fundamental ethical and legal principles. Vice versa, when management builds a fake image of high CSR for its stakeholders and investors, adopting greenwashing policies, negative events pull back the curtain on the underlying opportunistic behavior. In this case, we will see a negative reaction from the market that is amplified (not attenuated), and far more value will be destroyed compared to companies with low levels of CSR.