Is CSR performance related to disclosure tone in earnings announcements?

Yu Lu (Business School, Beijing Technology and Business University – Fucheng Road Campus, Beijing, China)
Steven Cahan (Department of Accounting and Finance, University of Auckland, Auckland, New Zealand)
Diandian Ma (Graduate School of Management, University of Auckland, Auckland, New Zealand)

Accounting Research Journal

ISSN: 1030-9616

Article publication date: 1 July 2019

Abstract

Purpose

This study aims to examine whether the disclosure tone in earnings announcements is related to a firm’s corporate social responsibility (CSR) performance.

Design/methodology/approach

Considering the lower likelihood of earnings management conducted by CSR-conscious firms, and the significant market impact of the tone of disclosure in the earnings announcements, the study investigates whether firms with good CSR performance attempt to influence investors’ judgements through “soft information” and, thus, produce earnings announcements with more positive tone. Specifically, it examines whether CSR performance is positively related to the optimistic disclosure tone in earnings announcements.

Findings

The study finds that more socially responsible firms exhibit a more optimistic tone in earnings announcements. The findings are robust to a variety of sensitivity tests and data from different years. Furthermore, the study finds that the positive association between CSR performance and disclosure tone in the earnings announcement is particularly apparent in the manufacturing industry.

Research limitations/implications

This study contributes to the literature in multiple ways.

Practical implications

These findings should assist regulators in better understanding the verbal components in earnings announcements.

Social implications

It is possible that firms might opportunistically engage in CSR activities to enhance their social image to exaggerate financial performance and influence investors’ 2019 decisions.

Originality/value

These results show that CSR performance is positively associated with the optimistic tone in earnings announcements. The findings are consistent with two alternative interpretations. First, even though CSR-conscious firms are unlikely to engage in earnings management, they may engage a more subtle form of impressions/tone management. Second, firms with better CSR performance may have better financial performance, and thus are more confident and optimistic, resulting in a more positive tone in their earnings announcements. As the study controls for financial performance and find a positive relation between CSR concerns and optimism in earnings announcements, it favors the previous explanation.

Keywords

Citation

Lu, Y., Cahan, S. and Ma, D. (2019), "Is CSR performance related to disclosure tone in earnings announcements?", Accounting Research Journal, Vol. 32 No. 2, pp. 129-147. https://doi.org/10.1108/ARJ-05-2016-0059

Publisher

:

Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited


1. Introduction

Corporate social responsibility (CSR) is becoming an increasingly important issue as managers recognize that financial performance is not the only metric of success in the business world. In accounting, a number of studies find that firms’ CSR performance and their communications related to corporate ethics and responsibility can evoke strong reactions among investors (Morsing and Schultz, 2006; Wanderley et al., 2008). In particular, in the wake of the major corporate scandals such as Enron and Worldcom, disclosures about socially responsible activities are increasingly associated with investor confidence, firm reputation and firm value (McBarnet, 2005).

Consistent with Mullainathan and Shleifer’s (2005) catering theory, Cahan et al. (2015) find that more socially responsible firms receive more favorable media coverage. Previous research also shows that ethically and socially responsible firms are less likely to conduct earnings management and, thus, produce more transparent and reliable financial information (Atkins, 2006; Kim et al., 2012). Given that CSR practice has a positive impact on a firm’s social image and that good CSR performance is associated with more reliable financial information, firms with good CSR performance might use their positive images to exaggerate non-financial information or to provide a camouflage for misconduct on the part of the manager or firm (Lang and Lundholm, 2001; Hemingway and Maclagan, 2004). Alternatively, CSR-conscious firms with good financial performance may simply have better future prospects, leading to greater optimism in their disclosures.

Recently, attention has also been paid to the non-numerical components – the “soft information” of earnings announcements. Tetlock et al. (2008) document that qualitative information – specifically, the negative words in firm-specific news stories – is captured in stock prices and can be used to predict firms’ accounting earnings and stock returns. Feldman et al. (2010) find that the market reacts strongly to changes in tone in the earnings announcements, after controlling for accruals and earnings surprises. Hales et al. (2011) investigate the effects of vivid language on investors’ judgements and find that disclosure tone has a significant influence on investor judgements. These studies suggest that disclosure tone conveys material information which cannot be captured by the numerical component in earnings announcements (Durnev and Mangen, 2011).

In this study, we investigate whether firms with good CSR performance is associated with earnings announcements that have a more positive tone. We find that CSR performance has a significant positive association with the disclosure tone in earnings announcements, which suggests that firms with good CSR performance generally deliver more optimistic earnings announcements. As we control for financial performance in our tests, our results suggest that firms with good CSR may not explicitly engage in earnings management (Kim et al., 2012), they may engage in a more subtle form of impressions management, i.e. adjusting the tone used in their disclosures. That is, if the manager’s optimism is inappropriate, investors may be potentially misled as to the current and future financial performance and firm value. Our results are robust to alternative proxies for CSR performance measurement and disclosure tone, and the use of data from a different year.

To enhance our analysis, we further investigate the association between the total CSR strengths (concerns) and the disclosure tone. The results show that both total strengths and concerns are positively correlated with the optimistic tone in the earnings announcements. The positive association between CSR strengths and the disclosure tone can be interpreted in a similar way as the main test results. However, the positive association between the CSR concerns and the positive tone in the earnings announcements suggests that firms with higher CSR concerns also disclose earnings announcements in a more positive tone. This latter finding is consistent with an opportunism interpretation and less consistent with better financial prospects driving our results since CSR concerns are likely to have a negative impact on financial performance. Our additional tests results also show that the association between CSR performance and a firm’s earnings announcement tone is particularly apparent in the manufacturing industry. Finally, the results are robust to using data from different years.

Our study contributes to the literature in multiple ways. Previous research suggests that separately, CSR performance and earnings announcement disclosure tone have strong impacts on investors (Rogers et al., 2011; Kim et al., 2012). However, earlier research has not explored whether CSR performance is related to the tone of earnings announcements. Thus, our study extends the growing literature on CSR issues by examining how CSR affects how firms communicate non-CSR related information to investors. Previous research shows that CSR firms provide more reliable financial information (Kim et al., 2012). However, influencing investors’ decisions is about more than just using “hard numbers”; the verbal component of earnings announcements can also significantly influence investor judgements (Hales et al., 2011). Motivated by extant research, our interest lies in the effect of CSR performance on the verbal component – the disclosure tone – in earnings announcements.

We also consider that our findings regarding the association between CSR performance and disclosure tone in earnings announcements to be important for investors and regulators. It is important to understand managers’ incentives for engaging in CSR activities (Moser and Martini, 2012). Our findings suggest that even though firms with good CSR performance may not engage in earnings management (Kim et al., 2012), they may engage in tone management.

This research proceeds as follows. Section 2 reviews the literature and develops the hypotheses. Section 3 discusses the research design including the sample selection, variable definitions and model construction. Section 4 presents the results, and Section 5 concludes.

2. Literature review and hypothesis development

A growing literature has documented that CSR activities and disclosures provide useful information to investors, and influence their decision-making and estimates of firm value (Dhaliwal et al., 2011; Dhaliwal et al., 2012; Di Giuli and Kostovetsky, 2014; Epstein-Reeves, 2010; Kim et al., 2012; Rennekamp, 2012; Shank et al., 2005). A substantial number of studies also explore the relation between firms’ earnings disclosures and the market’s reaction or firm valuation (Lang and Lundholm, 2001; Files et al., 2009; Henry, 2006, 2008; Hales et al., 2011; Lehavy et al., 2011; Tan et al., 2014; Tetlock et al., 2008). However, while it has been documented that both CSR performance and the tone of earnings announcements have a significant impact on investors and firm valuation, the association between CSR performance and earnings announcements disclosure tone remains unexplored.

Social responsibility is a significant “driving force” of increased ethical behavior (Linthicum et al., 2010). Ethical, political and integrative theories of CSR indicate that managers have an incentive to be ethical and to do right things in business processes (Phillips et al., 2003). Kim et al. (2012) find that CSR firms have higher quality accruals, and are less likely to be the subject of SEC investigations. They interpret their results as evidence that managers in good performing CSR firms are more ethical and, thus, are more likely to deliver high-quality accounting information to investors. Consistent with Kim et al. (2012), Cheng et al. (2014) also find that CSR performance is positively related to earning quality and corporate transparency. Further, other research indicates that CSR performance is positively related to corporate reputation (Linthicum et al., 2010), while negatively associated with information asymmetry (Cho et al., 2013) and tax aggressiveness (Lanis and Richardson, 2012). At the same time, good performing CSR firms also tend to have better financial performance (Dhaliwal et al., 2012; Griffin and Mahon, 1997; Waddock and Graves, 1997; Roman et al., 1999), lower cost of capital (Dhaliwal et al., 2011) and lower cost of bank loans (Goss and Roberts, 2011).

Alternatively, the demand for CSR activities can be driven by non-ethical concerns of managers (Fritzsche, 1991). Numerous studies (Fombrun and Shanley, 1990; Verschoor, 2005; Linthicum et al., 2010) point out that CSR activities send a positive signal about firm reputation, suggesting that CSR performance may be motivated by reputation building. For example, a stronger relation between CSR and media favorability for “sin” firms is documented by Cahan et al. (2015), which supports the view that firms use CSR performance to bolster the firm’s reputation and to create a more positive image.

A few studies investigate if managers use CSR opportunistically to maintain a good reputation, or to disguise other devious practices (Prior et al., 2008; Hemingway and Maclagan, 2004; Jensen and Meckling, 1976; Carroll, 1979). Agency theory suggests that managers may have incentives to increase their firm’s CSR, and disclose their firm’s performance in a more favorable manner to pursue their self-interest and disguise other unethical practices (McWilliams et al., 2006; Prior et al., 2008). Although Kim et al. (2012) find that CSR firms are less likely to manipulate “hard numbers,” their findings do not preclude the possibility that firms with a socially responsible image and reputation of providing transparent and reliable information can use “non-numeric” information to manage investors’ impressions.

It is well documented that the content, language and presentation of the earning announcement is mostly discretionary (Henry, 2008; Davis et al., 2012; Li, 2008). Earnings announcement language provides opportunities for managers to affect the market participants’ perceptions of the firm’s future performance (Davis et al., 2012). In a different context, Li (2008) analyses the association between annual report readability and firm performance and earnings persistence, and finds that annual reports of firms with lower earnings are harder to read, compared to the annual reports of firms with more persistent positive earnings. Li (2008) also claims that managers issue less readable disclosures to reduce the influence of poor results, and often portray the firm’ results overly favorable. Similarly, Zechman (2010) points out that managers with incentives to use off-balance sheet financing do not provide transparent disclosure about synthetic leases. Studies also corroborate that managers “hype” their stock by increasing discretionary and optimistic disclosure in the aim of reducing the cost of capital or influence short-term prices, especially before new stock issues (DuCharme et al., 2004; Lang and Lundholm, 2001).

Given the importance of disclosure tone, managers of good performing CSR firms may exploit their favorable image and use more optimistic language when announcing their earnings. However, whether they do is not obvious. First, previous research suggests good CSR firms are more ethical, and this ethicality may affect all of the firm’s decisions including the preparation of the earnings announcement. Ethical firms may refrain from tone management for the same reason they refrain from earnings management. Second, firms face strong constraints in terms of tone management. For example, Rogers et al. (2011) find that more optimistic language used in earnings announcements leads to more lawsuits. Higher litigation risk is found when managers are both unusually optimistic and engage in abnormal selling. Ethical firms may be even more sensitive to these constraints than less ethical firms. As a result, whether managers of good performing CSR engage in tone management is an empirical question.

Consequently, we propose the following hypothesis:

H1.

CSR performance is associated with optimistic disclosure tone in earnings announcements, controlling for the financial performance.

In testing H1, two caveats are in order. First, given that it has been well documented that managers’ earnings disclosure behaviors vary with firms’ financial performance it is possible that firms with good CSR performance have better financial performance, and that better financial performance leads to more optimistic earnings announcements. Our empirical strategy to address this concern is to control for financial performance measured by ROA. However, as ROA is only one measure of financial performance, we cannot completely rule out this competing hypothesis. Second, in this study, we do not test whether investors are misled by the optimism in the earnings announcement. In other words, if there is opportunism embedded in the earnings announcement, investors may be able to see through this and make adjustments when the optimism is excessive.

3. Research design

3.1 Sample selection

Our sample data comprises 1,848 stocks from 8 industrial groups listed on the New York Stock Exchange, the American Stock Exchange and the Nasdaq Stock Market. Data from the same jurisdiction ensures a common regulatory and market environment. The financial data is drawn from the COMPUSTAT, auditor data are collected from Audit Analytics and the annual earnings announcement of each company is hand-collected from their respective company websites.

The CSR data is obtained from the Kinder, Lynderberg, Domini Research and Analytics Inc. (KLD) database. KLD rates CSR performance on the basis of various attributes using a large variety of resources including financial statements, business press, academic journals and government reports. Since 2003, it has covered 3,000 of the largest companies and evaluates the environmental and social performances of firms along seven dimensions (KLD, 2006). For each dimension, KLD separately rates positive indicators (strengths) and negative indicators (concerns). We use KLD social performance rating scores as our measure of CSR performance[1].

Our main analysis uses CSR data from the year 2012, and the financial and auditor data from the year 2013, to avoid the econometric issue of stickiness of observations over multiple years. The one-year lag between the CSR data and the financial and auditor data is to ensure that CSR is measured prior to the earnings announcement so that the earnings announcement disclosure tone can capture the level of CSR performance at the time the earnings announcement is released[2].

Our data collection starts from the CSR included in the KLD database. The KLD database contains data on 2,016 firms in 2012. Of the 2,016 firms, we lose 57 after matching KLD database with COMPUSTAT and Audit Analytics databases and another 111 after matching with annual earnings announcements. Our final sample data consists of 1,848 observations. The collection process of data is presented in Table I.

3.2 Variables and empirical test models

3.2.1 Measurement of earnings announcement tone.

We compute the positive disclosure tone of the earnings announcement for every firm. The positive disclosure tone is defined as the extent to which managers describe the positive outcomes in a positive manner. We use content analysis, which counts the frequency of positive words from pre-specified word lists (Rogers et al., 2011). When pre-specified positive words appear more frequently in an earnings announcement, that earnings announcement delivers a more positive disclosure tone.

Previous research examines the verbal components of earnings announcements using computer-based textual analysis software. The dictionary approach uses mapping algorithms to read text and classify words or phrases which match with pre-specified rules generally agreed upon by readers (Li, 2010). This method minimizes manual errors such as overlooked words and replication issues raised by subjectivity in the manual coding process. We use Diction 7.0 to conduct our analysis.

Following Henry (2006), we choose 118 key positive words that show optimistic tone of the verbal components disclosed in the earnings announcements. The optimistic tone of an earnings announcement is calculated as the sum of positive components (e.g. praise, satisfaction and inspiration) minus the sum of negative components (e.g. blame, hardship and denial), scaled by the total word count of the earnings announcements and then multiplied by 10,000[3]. The deflation allows for comparison between earnings announcements of different lengths (Rogers et al., 2011). We label this measure Optimism. In the additional tests, we use two alternative measurements of the optimism tone in the earnings announcements, the positive tone (Rogers et al., 2011) and the net tone (Henry, 2008). The alternative measurements and results are discussed in the alternative analysis section.

3.2.2 Measurement of CSR.

KLD evaluates CSR in areas including corporate governance, community relations, diversity, employee relations, environment, human rights, product, alcohol, gambling, military contracting, nuclear power and tobacco. Following Kim et al. (2012), we construct a CSR score that includes community relations, diversity, employee relations, environment, human rights and product areas. Specifically, we compute a total CSR score for each firm by subtracting total concerns from the total strengths in these six areas for the year ended 2012 (Di Giuli and Kostovetsky, 2014). We label this measure CSR. Higher score indicates better CSR performance. In additional tests, we employ alternative proxies for CSR performance, and consider the association between the CSR performance in each area and the disclosure tone of earnings announcements.

3.2.3 Model.

To formally test our hypothesis, we use the model below:

(1) Optimism=β0+β1CSR +β2ROA+β3Leverage+β4BM+β5Size+β6Big4+β7CG+ε
where Optimism and CSR are defined above; and

ROA = the ratio of earnings before interest and tax to total assets;

Leverage = total liabilities divided by total assets;

BM = book value of equity divided by market value of equity;

Size = natural logarithm of the market value of equity;

Big 4 = a binary variable equals to one if the auditor is Deloitte, Ernst and Young, KPMG or PwC and 0 otherwise; and

CG = net score of KLD’s corporate governance rating.

Our control variables are selected on the basis of previous literature. As a firm’s financial performance significantly drives the disclosure tone in the earnings announcement, we include ROA to control the effect of firm’s financial performance on disclosure tone of the earnings announcement (Rogers et al., 2011). ROA is the most commonly used variable to measure firm performance (Davis et al., 2012). Including ROA helps control for the likelihood that firms with good CSR likely have better financial performance[4]. We also control for the firm’s leverage, as firms have incentives to reduce agency costs by creating a more positive social image. Firms with higher Leverage are likely to use positive words to improve their social image (Givoly et al., 2010; Davis and Tama-Sweet, 2012). However, firms with lower Leverage are also likely to be more optimistic as they have lower financial risk in general. Hence, we do not predict a sign and significance for the coefficient of Leverage. Following Davis and Tama-Sweet (2012) and Kim et al. (2012), we include BM as the proxy for growth options[5], Big4 for firms using one of the Big 4 auditors and Size to control for firm size. We also include CG, a net score of KLD’s corporate governance ratings in our regressions to capture its effect on the disclosure tone. Firms are likely to use more optimistic language about the prospects of firms due to their growth opportunities. However, previous studies also document that growth firms are more likely to have litigation risk and suggest that growth firms can reduce litigation risk by moderating the optimistic tone in disclosure (Kim et al., 2012). Given the mixture of aggressive and conservative disclosure behaviors owing to different considerations regarding a firm’s growth opportunities and litigation risk, we do not predict a sign for the coefficient of BM. Likewise we do not predict the sign and significance for the coefficients associated with Big4, Size and CG. Finally, we control industry effects to address potential bias resulting from using data across multiple industries (Givoly et al., 2010).

Incorporating these control variables into our models helps isolate the effects of firms’ CSR performance on the positive tone of earnings announcements that is driven by management discretion. In the model above, we expect the coefficient associated with CSR variable (β1) to be significantly positive.

4. Results

4.1. Descriptive statistics

Table II reports a summary descriptive statistics for all the variables in model (1). The sample size is 1,848. All continuous variables are winsorized at 1 and 99%. Table II shows the mean value of Optimism is 48.75. This mean value of optimistic tone is consistent with the level documented by Hildebrandt and Snyder (1981), Rutherford (2005) and Henry (2006). It suggests that on average, 30% of disclosed information in financial reports is positive.

The mean value of the CSR score is 0.82. This is consistent with Cho et al. (2013) who also report a positive score of CSR. The summary statistics for the control variables are consistent with prior research.

Table III reports Pearson correlations for variables in model (1). A correlation coefficient in bold indicates that the correlation is statistically significant at least at the 10 per cent level. With the highest correlation of −21.3 per cent between BM and Size, it is unlikely that multicollinearity is likely to be a significant concern in our study.

4.2 Results

Table IV reports the regression results generated by Model 1. The coefficient of CSR is positive and highly significant. The results support our hypothesis and suggest that CSR performance is positively associated with an optimistic disclosure tone in earnings announcements. It means that after controlling for financial performance, firms with good CSR performance disclose their earnings using more optimistic language. Although good CSR firms are less likely to manipulate the “hard numbers” (Kim et al., 2012), we find that CSR firms may influence investors’ perceptions by managing the verbal component of the earnings announcement. One interpretation is that managers may take advantage of investors’ trust that is associated with better CSR performance and influence them through “soft information” – the verbal component of earnings announcements. Another interpretation is that firms with good CSR performance have better financial performance and, thus, are more optimistic. We can only rule out this interpretation if ROA is an adequate proxy for financial performance[6].

Our results also show that ROA is positively related to the optimistic tone in earnings announcements. These results are consistent with previous studies, which show firms’ economic performance significantly affects a firm’s disclosure tone (Henry, 2008; Rogers et al., 2011; Miller, 2002; Davis et al., 2012). The coefficient on Leverage is positive but not significant. A well-performing firm has fewer concerns about their image for the creditors as creditors are more concerned when firms perform poorly (Guay, 2008). As more than 80 per cent of firms in our sample data have positive earnings, capital structure is not likely to create sufficient incentives for firms to make the tone in earnings announcements more positive. The coefficient associated with BM is positive but not significant. Size does not show any influence on the earnings tone, which is consistent with Rogers et al. (2011), who show that firm size is not a significant variable in determining the disclosure tone in earnings announcements[7].

5. Additional tests

5.1 Data from 2011

To test the robustness of the results presented in Table IV. We applied model (1) to data from 2011. Following the same method used for the main test, we hand-collect data for the optimistic tone in earnings announcements. We use CSR data from the year 2011, and the financial and auditor data from the year 2012. The one-year lag between the CSR data and the financial and auditor data ensures that CSR is measured prior to the earnings announcement.

Using 2011 data, we find a high (59 per cent) correlation between CSR and CG[8]. Because this creates a multicollinearity issue, we modify our measure of CSR and include the corporate governance score from KLD in computing the CSR measure for 2011. Therefore, the CSR variable for 2011 includes seven social rating categories: corporate governance, community, diversity, employee relations, environment, human rights and product, which is also widely used in prior studies (Cho et al., 2013)[9].

Table V presents the results generated by Model 1 using data from 2011. Consistent with our main results, the coefficient on CSR is positive and significant[10].

5.2 Analysis of strengths and concerns

KLD separately rates positive indicators (strengths) and negative indicators (concerns). Each domain of CSR strengths or CSR concerns may represent different constructs (Mattingly and Berman, 2006). Following Goss and Roberts (2011) and Kim et al. (2012), we disentangle the CSR strengths, Str and CSR concerns, Con, by examining the relationship between the disclosure tone in earnings announcements with CSR strength ratings and CSR concern ratings separately. Str is the sum of strengths in six CSR areas of rating and Con is the sum of concerns in six CSR areas of rating.

The results in Table VI show that both CSR strengths and CSR concerns are positively related to positive disclosure tone in earnings announcements using data from 2011 or 2012. The results indicate that the higher the CSR strengths (concerns) score, the more positive the tone in the earnings announcement. The positive association between CSR strengths and the disclosure tone can be interpreted in the similar manner as is for the main test results reported in Table IV. The positive association between the CSR concerns and the disclosure tone provides some support for an opportunism interpretation as firms with CSR concerns also use an optimistic tone. Said differently, as CSR concerns are likely related to lower financial performance, this finding is inconsistent with the view that financial performance is driving our main results.

Also as discussed in the previous section, firms with more CSR concerns would likely to be more positive in their earnings announcement. As earnings announcement tone provides opportunities for managers to affect investors’ perceptions of firm’s future performance (Davis et al., 2012), firms with more CSR concerns are more motivated to use optimistic language to create a positive image for its current and future performance to maintain or increase investor confidence or even to conceal its misconducts in various ways. Our results, reported in Table VI, indicate firms with more CSR concerns use more optimistic language in their earnings announcements. This finding should be of importance and interest to regulators and investors.

5.3 Industry

Wanderley et al. (2008) and Sweeney and Coughlan (2008) demonstrate that industry factors can have an impact on CSR and information disclosure. We also test if the relation between CSR performance and the disclosure tone in earnings announcements is clustered in certain industries. According to one-digit SIC code, our sample data spans eight industries, namely, mining, construction, manufacturing, transportation and public utilities, wholesale trade, retail trade, finance, insurance and real estate and services and public administration[11]. Table VII provides the results on an industry-by-industry basis. Panels A and B show the results using data from 2012 and 2011, respectively. The results show that in the manufacturing industry, CSR performance is positively related to positive disclosure tone in earnings announcements. The results are consistent with Cooke (1992), who shows that because the manufacturing industry is important to the whole economy, managers in those industries are highly motivated to disclose positive earnings and good news. The results are also consistent with Boutin-Dufresne and Savaria (2004) who conclude that the nature of business activities varies across industries.

6. Conclusion

Although previous studies find that CSR-conscious firms are less likely to conduct earnings management (the numeric component of earnings announcements), these studies do not preclude the possibility that they manage investors’ perspective of the firm’s performance via the non-numeric (i.e., verbal) component in the earnings disclosure. Our research examines the relationship between CSR performance and earnings announcement tone using the US data. Our results show that CSR performance is positively associated with the optimistic tone in earnings announcements. Our findings are consistent with two alternative interpretations. First, even though CSR-conscious firms are unlikely to engage in earnings management, they may engage a more subtle form of impressions management, i.e. tone management. Second, firms with better CSR performance may have better financial performance and are, thus, more confident and optimistic, resulting in a more positive tone in their earnings announcements. As we control for the financial performance (ROA) and find a positive relation between CSR concerns and optimism in earnings announcements, we favor the previous explanation. However, we acknowledge that the latter explanation cannot be completely ruled out. Another limitation relates to our finding that both CSR strength and

CSR concerns are positively related to disclosure tone. While we offer some possible explanations for this seemingly contradictory set of results in Section 5.2, we do not test these explanations empirically. We leave a more thorough examination of the separate effects of CSR strengths and CSR concerns on disclosure tone to future research.

We contribute to the literature by showing that CSR performance is associated with the disclosure tone in earnings announcements. Previous research shows that socially responsible firms are less likely to practice earnings management, thereby delivering more transparent and reliable financial information (Kim et al., 2012). Our findings show that socially responsible firms produce earnings announcements with more positive tone, which suggests that even those firms that are labelled in the literature as being more ethical (Kim et al., 2012) can act opportunistically. As a result, our findings should be of interest to investors and regulators as well as academics.

Data collection process

CSR from KLD database 2,016
Less observations missing from Compustat database 28
Less observations missing from Audit Analytics 29
Less earnings announcement 111
Initial sample 1,848
Notes:

Table I presents the data collection process. The KLD database contains data on 2,016 firms in 2012. Of the 2,016 firms, 57 were lost after matching KLD database with COMPUSTAT and Audit Analytics databases. Another 111 were lost after matching with annual earnings announcements. The final sample data consists of 1,848 observations

Sample descriptive statistics

Mean SD Minimum 25th percentile Median 75th percentile Maximum
Optimism 48.75 7.07 25.05 45.445 49.4 52.635 0.88
CSR 0.82 2.39 −4 −1 0 1 16
ROA 0.03 0.1 −0.58 0.01 0.04 0.07 0.25
Leverage 0.21 0.2 0 0.03 0.18 0.33 0.85
BM 0.45 0.31 −0.23 0.22 0.4 0.64 1.39
Size 7.79 1.41 5.47 6.73 7.6 8.63 11.84
PE 0.82 0.39 0 1 1 1 1
Big 4 0.9 0.3 0 1 1 1 1
CG 0.08 0.54 −3 0 0 0 2
Notes:

Table II reports summary descriptive statistics for all the variables in Model 1. Sample size is 1,848.Optimism is calculated as the sum of positive components (praise, satisfaction and inspiration) minus the sum of negative components (blame, hardship and denial), scaled by the total word count of the earnings announcements, then multiplied by 10,000; CSR is defined as total strengths minus total concerns in KLD’s six social rating categories: community, diversity, employee relations, environment, human rights and product; ROA is the ratio of earnings before interest and tax to total assets; Leverage is total liabilities divided by total assets; BM is book value of equity divided by market value of equity; Size is defined as natural logarithm of the market value of equity; Big 4 is a binary variable equals to one if the auditor is Deloitte, Ernst and Young, KPMG or PwC and 0 otherwise; CG is the net score of KLD’s corporate governance rating. All continuous variables are winsorized at 1and 99%

Pearson correlations for independent variables

CSR ROA Leverage BM Size Big 4
ROA 0.1143
Leverage 0.0457 0.1343
BM −0.0292 −0.0141 −0.0166
Size 0.0046 −0.0039 0.0449 0.213
Big 4 0.1133 0.05 0.0596 0.0045 −0.0065
CG 0.0695 0.0021 −0.0411 0.0345 0.0232 −0.0049
Notes:

Table III reports Pearson correlation for variables in Model 1. The variables are as previously defined. Italic text indicate significance at least 10% level

Results for Model 1 examining the effect of CSR on earnings announcement tone (2012)

Optimism tone
Variables Coefficients p-value
CSR 0.2568 0.000
ROA 11.9473 0.000
Leverage 0.4360 0.604
BM 0.1428 0.791
Size 0.1192 0.309
Big4 −0.0914 0.865
CG 0.4288 0.177
Constant 47.6171 0.000
Industry fixed-effects Yes
F value 7.18
Adjusted R2 0.045
N 1,848
Notes:

Table IV reports regression results for the effect of firm’s CSR performance on earnings announcement’s optimistic tone using data from 2012. The variables are as previously defined. Industry fixed-effects are included in the model

Results for Model 1 examining the effect of CSR on earnings announcement tone (2011)

Optimism tone
Variables Coefficients p-value
CSR 0.1472 0.003
ROA 12.1399 0.000
Leverage −0.0104 0.990
BM −0.0186 0.972
Size 0.1451 0.210
Big4 0.1735 0.745
Constant 44.2428 0.000
Industry fixed-effects Yes
F value 7.72
Adjusted R2 0.045
N 1,846
Notes:

Table V reports regression results for the effect of firm’s CSR performance on earnings announcement’s optimistic tone using data from 2011. The CSR variable for 2011 includes seven social rating categories: corporate governance, community, diversity, employee relations, environment, human rights and product. The other variables are as previously defined. Industry fixed-effects are included in the model

CSR strengths and concerns

Variables CSR strengths CSR concerns
Coefficients. p-value Coefficients p-value
Year 2012
CSR 0.2708 0.000 0.3307 0.056
ROA 11.7470 0.000 12.3749 0.000
Leverage 0.3920 0.640 0.2253 0.789
BM 0.1649 0.759 0.1215 0.822
Size 0.1164 0.321 0.1139 0.333
Big4 −0.1222 0.820 0.1008 0.851
CG 0.4926 0.122 0.4257 0.184
Constant 47.4971 0.000 47.4322 0.000
Industry fixed- effects Yes Yes
F value 7.46 6.42
Adjusted R2 0.047 0.039
N 1,848 1,848
Year 2011
CSR 0.1736 0.007 0.3292 0.007
ROA 11.9179 0.000 12.389 0.000
Leverage −0.0592 0.944 −0.0734 0.930
BM 0.0087 0.987 0.0237 0.964
Size 0.1463 0.205 0.0155 0.179
CG 0.3493 0.245 0.7298 0.004
Big4 0.0949 0.859 0.2615 0.663
Constant 48.068 0.000 47.9901 0.000
Industry fixed- effects Yes Yes
F value 7.77 7.76
Adjusted R2 0.049 0.049
N 1,846 1,846
Notes:

Table VI reports the regression results of for the effect of firms’ CSR strengths and concerns on the earnings announcement tone. CSR strengths is the sum of strengths in six CSR areas of rating, and CSR concerns is the sum of concerns in six CSR areas of rating. The six CSR areas include community, diversity, employee relations, environment, human rights and product. The other variables are as previously defined. Industry fixed-effects are included in the model

Industry

Mining Manufacturing Transportation Retail trade Finance Services
Year 2012
CSR 0.5998 (0.071) 0.3066 (0.002) 0.3617 (0.089) 0.1081 (0.704) 0.2744 (0.149) −1.1090 (0.551)
ROA 4.8235 (0.597) 8.3074 (0.000) 43.4268 (0.002) 29.8164 (0.000) 25.8913 (0.009) 17.2630 (0.000)
Leverage −12.3264 (0.007) 2.4622 (0.097) 5.6335 (0.105) 0.4951 (0.878) 3.9240 (0.036) −2.1551 (0.196)
BM −0.5526 (0.819) 0.1502 (0.864) −2.3468 (0.238) 1.0654 (0.582) −0.3766 (0.766) 1.0420 (0.425)
Size 0.4376 (0.461) 0.2857 (0.115) −0.3239 (0.430) 0.5379 (0.253) −0.2255 (0.400) 0.0904 (0.743)
Big4 −0.0514 (0.980) 0.0579 (0.948) 0.0310 (0.990) −3.2386 (0.186) −0.0376 (0.974) 0.6093 (0.656)
CG 1.4511 (0.159) 1.0272 (0.041) −2.3460 (0.127) −3.5185 (0.236) −0.1335 (0.849) 0.7570 (0.311)
Constant 45.5156 (0.000) 45.5020 (0.000) 49.7132 (0.000) 44.1502 (0.000) 49.0286 (0.000) 47.386 (0.000)
F value 2.77 6.20 2.30 2.78 1.98 4.08
Adjusted R2 0.1186 0.0508 0.0530 0.0895 0.0164 0.0704
N 93 681 164 128 413 286
Year 2011
CSR −0.7318 (0.102) 0.2116 (0.023) 0.2956 (0.218) 0.2817 (0.231) −0.0806 (0.639) −0.2184 (0.175)
ROA 6.5850 (0.527) 9.6395 (0.000) 39.0052 (0.011) 32.3170 (0.000) 22.8091 (0.013) 11.6607 (0.006)
Leverage −14.2585 (0.001) 0.8667 (0.552) 4.8637 (0.152) −1.3162 (0.676) 3.8868 (0.036) −1.9935 (0.253)
BM 0.8450 (0.727) 0.0215 (0.979) −1.9981 (0.289) −0.1697 (0.922) −0.5312 (0.673) 0.5500 (0.681)
Size 0.2934 (0.607) 0.2517 (0.153) −0.3878 (0.336) 0.8716 (0.056) −0.1437 (0.594) 0.1918 (0.496)
Big4 0.5587 (0.790) 0.0821 (0.925) −0.3627 (0.867) −1.0239 (0.690) 0.2368 (0.833) 1.8176 (0.193)
CG 11.6940 (0.020) 0.6305 (0.725) 0.0451 (0.990) −3.7759 (0.393) 8.6793 (0.016) 0.2230 (0.939)
Constant 32.3766 (0.000) 45.9062 (0.000) 51.1323 (0.000) 44.5088 (0.000) 38.7578 (0.000) 45.6832 (0.000)
F value 2.65 7.42 1.54 3.37 2.53 2.21
Adjusted R2 0.1129 0.0611 0.0214 0.1170 0.0250 0.0315
N 92 691 173 126 418 261
Notes:

Table VII reports the regression results of for the effect of firms’ CSR performance on the earnings announcement tone for different industries in the years 2012 and 2011. CSR is defined as total strengths minus total concerns in KLD’s six social rating categories: community, diversity, employee relations, environment, human rights and product. The other variables are as previously defined. P-values are in parentheses

Notes

1.

We use the KLD database because it is currently the most widely used and comprehensive information source for CSR research (Graves and Waddock, 1994; Turban and Greening, 1996; Waddock, 2003). Although the CSR measurement has been challenged by previous literature (Carroll, 1979; Graves and Waddock, 1994; Wokutch and McKinney, 1991) given the vague boundary and complexity of CSR, the KLD database has been deemed “the de facto research standard at this moment” and “the best currently available to scholars” (Waddock, 2003, pp. 369-371). Also given the difficulty in measuring multidimensional CSR performance, the KLD database contains both “strengths” and “concerns” measure for each CSR dimension issues, which effectively reflects the traits of both positive and negative CSR behaviors. Therefore, following previous studies (Kim et al., 2012; Giuli and Kostovetsky, 2014; Cahan et al., 2015), we conduct the same aggregation of the measures (e.g., strength scores minus concern scores) to create a CSR-item score.

2.

We also use data from 2011 to test the robustness of the results.

3.

We use Optimism as the dependent variable, because it considers both positive and negative components of an earnings announcement (Davis et al., 2012). Compared to Positive tone and Net tone, the alternative measurements of earnings announcement tone, Optimism is a better measurement.

4.

Considering that relationship between a firm’s financial performance and earnings announcement tone can potentially be nonlinear, we also run the test with ROA2 included in model 1. Our untabulated results show that CSR remains positively associated with the earnings announcement tone with a p-value of 0.003. However, we do not report the regression results because including ROA2 into Model 1 leads to multicollinearity issue as the correlation between ROA and ROA2 is -62.5% at 1% significance level. We also include ROE, defined as net profit after tax divided by total equity, into the regression instead of ROA, as a proxy for firm’s financial performance, and the results remain robust.

5.

Another potential proxy for future performance is ROAt+1. However considering ROAt+1 is the actual financial performance for year t+1 rather than a market expectation at time t, we include BM to proximate a firm’s growth prospects rather the ROAt+1.

6.

To test the robustness of our results, we consider two alternative proxies for optimistic tone of earnings announcements. First, following Henry (2006), we choose 118 key positive words that show positive tone of the verbal components disclosed in the earnings announcements. Following Rogers et al. (2011), we construct the first alternative measure of positive tone, the Positive tone. The positive tone of an earnings announcement is calculated as the total number of positive words divided by total number of words in the earnings announcement. Second, following Henry (2008), we construct the second alternative measure of positive tone by using Net tone. Net tone is calculated as positive words minus negative words. We have 93 key negative words which show negative tone in the verbal components disclosed in the earnings announcements. The untabulated results indicate that CSR performance is significantly positively associated with both Positive tone and Net tone, and thus confirm the results presented in Table IV. To examine whether our results are also robust to alternative measures of CSR scores, we calculate alternatives CSR1 and CSR2 to replace CSR as the dependent variables. CSR1 is measured as total strengths minus total concerns in KLD’s five social rating categories including community, diversity, employee relations, environment, and human rights (Chatterji et al., 2009). Following Kim et al. (2012), we exclude the KLD human rights category and compute CSR2 as total strengths minus total concerns in KLD’s four social rating categories including community, diversity, employee relations and environment. Out untabulated results show that both CSR1 and CSR2 are positively related to firms’ optimistic tone of earnings announcement.

7.

Because it has been well established within the literature that there is a positive association between CSR performance and a firm’s financial performance, and a positive association between a firm’s financial performance and earnings announcement tone, we conduct an additional test specifically to examine whether the positive association between CSR performance and disclosure tone is due to solely a firm’s financial performance. As our hand-collected data contain only earnings announcements that were disclosed after CSR performance was disclosed, the influence of CSR performance on the disclosure tone of earnings announcements can only be one-way, rather than reverse or two-way. Given this, we conduct a Sobel–Goodman mediation test to examine the proportion of the influence a firm’s CSR performance on a firm’s earnings announcement tone that is due to a firm’s financial performance. Our results show that the mediation effect of a firm’s financial performance is statistically significant with approximately 21.3% of the total effect of CSR performance on a firm’s earnings announcement tone being mediated. This in turn means that 78.7% of the total effect of CSR performance on a firm’s earnings announcement tone is not carried by a firm’s financial performance. The results confirm that CSR performance has an effect on the disclosure tone in earnings announcements after accounting for the influence of firm financial performance.

8.

We find it interesting that the correlation between CG and CSR varies between years; however, we do not focus on the correlation variations in this study.

9.

As the correlation between ROA and ROA2 is -61.9% at 1% significance level, we do not include ROA2 into the regression.

10.

To make the results comparable, we also conduct a test using the CSR measure that includes the CG component for 2012, and find the results are consistent.

11.

We do not test the relation between CSR performance and the disclosure tone in earnings announcements for the construction industry, with observations of 30 in 2012 (30 in 2011), and the wholesale trade industry, with observations of 53 in 2012 and (55 in 2011) owing to the small sample size.

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Corresponding author

Yu Lu can be contacted at: luyu@btbu.edu.cn