Does Corporate Social Responsibility
Does Corporate Social Responsibility
Evidence from
Geographic Identification
Author(s): Pornsit Jiraporn, Napatsorn Jiraporn, Adisak Boeprasert and Kiyoung Chang
Source: Financial Management , FALL 2014, Vol. 43, No. 3 (FALL 2014), pp. 505-531
Published by: Wiley on behalf of the Financial Management Association International
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We show that a firm 's CSR policy is significantly influenced by the CSR policies of firms in the
same three-digit zip code, an effect possibly due to investor clienteles, local competition, and/or
social interactions. We then exploit the variation in CSR across the zip codes to estimate the effect
of CSR on credit ratings under the assumption that zip code assignments are exogenous. We find
that more socially responsible firms enjoy more favorable credit ratings. In particular, an increase
in CSR by one standard deviation improves the firm 's credit rating by as much as 4.5%.
We find that a firm's corporate social responsibility (CSR) policy is significantly influenced
by the CSR policies of firms in the same three-digit zip code, an effect possibly due to investor
clientele, local competition, and/or social interactions. We then exploit the variation in CSR across
the zip codes to estimate the effect of CSR on credit ratings under the assumption that zip code
assignments are exogenous. We find that more socially responsible firms enjoy more favorable
credit ratings. In particular, an increase in CSR by one standard deviation improves the firm's
credit rating by as much as 4.5%.
Although a tremendous volume of research has been conducted regarding the issue of corporate
social responsibility (CSR), its effects on corporations are still not completely understood. One
difficulty is identifying exogenous shocks to CSR policies. Due to market segmentation, investor
clientele, social interactions, and/or local competition, we hypothesize that firms located in close
proximity to one another will have similar CSR policies. Exploiting the variation in CSR policies
across geographic locations, we then estimate the effect of CSR on credit ratings since ratings
significantly influence the cost of debt for the firm. Firms with favorable credit ratings have better
access to capital markets and can borrow at a much lower cost. Additionally, strong credit ratings
also inspire investor confidence.
Our proximity measure is based on zip codes. The US Postal Service (USPS) allocates zip
codes based on efficiency in mail delivery. Zip code changes are also rare and usually reflect
changes in macroeconomic factors such as demographics and urban development. Thus, zip
code assignments are unlikely related to corporate policies or outcomes and can be considered
exogenous.
The idea of corporate isomorphism and peer pressure is hardly new. Corporations that invest
in CSR have strong incentives to publicize their CSR activities and make them as visible as they
* Pornsit Jiraporn is an Associate Professor of Finance in the School of Graduate Professional Studies at Pennsylvania
State University in Malvern, PA and a Visiting Associate Professor of Finance at The National Institute of Development
Administration (NIDA) and SASIN Graduate Institute of Business Administration (GIBA), Chulalongkorn University in
Bangkok, Thailand. Napatsorn Jiraporn is an Assistant Professor of Marketing at State University of New York (SUNY) at
Oswego in Oswego, NY. Ardisak Boeprasert is a PhD candidate at the National Institute of Development Administration
(NIDA), Bangkok, Thailand and The Petroleum Authority of Thailand in Bangkok, Thailand. Kiyoung Chang is an
Associate Professor of Finance at the University of South Florida-Sarasota-Manatee in Sarasota, FL 34243.
Financial Management • Fall 2014 • pages 505 - 531
C. Geographic Proxi
A
crucial hypothesis of
of a firm is influenced b
made in support this hy
investor clientele. A larg
and individual investors
Moskowitz, 1999; Grin
Massa and Simonov, 200
different preferences fo
severe, local investors
environmentally conscio
affected by the same loc
policies.
In addition, local competition is expected to be a critical factor. CSR is usually viewed positively
by investors. How investors view a firm's CSR policy may depend, in part, on the CSR policies of
neighboring firms. Investors may have a negative view of a firm if its CSR policy is much weaker
than those of the surrounding firms. For this reason, when formulating its CSR policy, a firm
must take into consideration the CSR policies of surrounding firms. Local competition to attract
investors forces the CSR policies of geographically proximate firms to be similar. Moreover,
social interaction and peer effects can be particularly important for corporate decision makers.
Managers who work in the same geographic area usually have opportunities to network and
build valuable relationships with their peers, exchanging ideas and learning from one another's
experience (Pirinsky and Wang, 2010). The social interactions and peer effects of the executives
in the same geographic area have the potential to make the CSR policies of neighboring firms
more similar.
2 Consistent with this notion, Pirinsky and Wang (2010) argue that the local preference of investors naturally creates a
clientele of investors from the same region, which could have an influence on major corporate policies. For example, a
company that is headquartered in Boston would have a disproportionately large number of (local) institutional investors
that could affect its corporate financial policies.
A. Sample Formation
4 Our sample includes 133 unique three-digit zip codes with at least five corporate headquarters. There are a total of
323 unique three-digit zip codes with at least one corporate headquarters in the United States (according to the data
from Compustat). Thus, our sample represents 41.20% of all of the three-digit zip codes with at least one corporate
headquarters. We also check the robustness of our results using two-digit zip codes and obtain similar results.
5 Although there are other alternative measures of CSR, KLD is the most widely accepted. Other CSR measures can be
found in Carroll (1991), Hansen and Wernerfelt (1989), and Waddock and Graves (1997).
C. Firm Location
The modern firm has fuzzy boundaries as its operations and management could encompass
numerous countries around the globe. The academic literature usually defines a firm's location
the location of its corporate headquarters. Corporate headquarters are usually close to corporat
core business activities. More importantly, corporate headquarters are the place where corpora
decision makers reside and are the center of information exchange between the firm and it
suppliers, service providers, and investors (Davis and Henderson, 2008; Pirinsky and Wang,
2010).
In this study, we follow the literature and define a firm's location by the location of its headquar-
ters. We identify the zip code of the headquarters location and classify firms as "geographically
proximate" if they are located in the same three-digit zip code. This method of geographic identi-
fication has several advantages. First, zip codes are easily identifiable and have clear boundaries,
facilitating geographic identification. Additionally, the zip code is determined by the US Postal
Service to maximize efficient mail delivery. Thus, it is unlikely related to corporate financial
characteristics. Moreover, zip code changes are rare. The US Postal Service does not modify zip
codes based on corporate performance.6 For these reasons, a geographic location based on a zip
code is likely exogenous.
D. Credit Ratings
We follow Klock, Mansi, and Maxwell (2005) and compute credit ratings using a conversion
process in which AAA-rated bonds are assigned a value of 22 and D-rated bonds are assigned a
value of 1. For example, a firm with an A+ rating from S&P would receive a score of 18. We
focus on the S&P credit ratings because Litov (2005) and Ashbaugh-Skaife et al. (2006) find that
the S&P ratings reflect the overall creditworthiness of the firm. Table I provides our credit rating
conversion.
E. Summary Statistics
Table II displays the descriptive statistics. A few observations are worth noting. The average
credit rating is 13.43, corresponding to BBB- . On average, the sample firms are profitable as
indicated by the average earnings before interest and taxes (EBIT) ratio of 0.09 of total assets.
The average leverage, calculated as total debt divided by total assets, is 0.30. R&D expenditures
and advertising spending average 0.03 and 0.01, respectively. The fixed assets ratio, computed as
6 Zip codes are occasionally reassigned based on demographics and mail delivery efficiency. For instance, when a rural
area becomes suburban, a new zip code is introduced. It is unlikely that corporate financial policies influence how the U.S.
Postal Service reallocates zip codes. In this sense, geographic identification based on zip codes is probably exogenous.
22 AAA
21 AA+
20 AA
19 AA-
18 A+
17 A
16 A-
15 BBB+
14 BBB
13 BBB-
12 BB+
11 BB
10 BB-
9 B+
8 B
7 B-
6 CCC+
5 CCC
4 CCC-
3 CC
2 C
1 D
Table
Credit ratin
R&D expend
assets. The f
industry (S
dummy is e
based on the
plant, property, and equipment divided by total assets, averages 0.09. About 10% of the sample
firms are regulated (i.e., they belong to either the financial or utility industries). Approximately
53% of the sample firms are included in the S&P 500 Index. The average CSR score is 0.22. This
slightly positive average CSR score indicates that, on average, there are more CSR strengths than
CSR concerns.
Table III reports the 10 most socially responsible areas and the 10 least socially responsible
areas. The area where firms have the highest average CSR score is the three-digit zip code 105
in West Chester, New York. The next most socially responsible areas are Hartford, Connecticut,
St. Paul, Minnesota, and New York, New York.
The rest of the top 10 most socially responsible areas are predominantly in the West (California
and Oregon) and the Midwest (Indiana). Alternatively, the area where firms are given the lowest
average CSR score is the three-digit zip code 727 for Fayetteville, Arkansas. The rest of the top
10 least socially responsible areas scatter across the country, covering states in different regions
including the East (Pennsylvania and Virginia), the Southeast (Florida and North Carolina), and
the Midwest (Kansas and Ohio).
G. Control Variables
Based on the literature, we control for a number of firm characteristics that have been
to influence CSR. We control for firm size by including the log of total assets. Large firm
to attract more attention and pressure to respond to stakeholders' demands (Burke et al.,
Large firms are expected to exhibit more social responsibility. We control for profitabili
7 We use contemporaneous variables in Table IV. To alleviate concerns regarding possible reverse causality, we also run
a regression where the average CSR score of the surrounding firms is lagged by one year. The result remains similar.
Furthermore, we investigate the impact of geography on CSR using the same method as Gao et al. (201 1). In particular,
we construct a location dummy variable for each three-digit zip code. We regress the CSR score on all of the control
variables, including the industry dummies and the location dummies. Then, we examine whether the location dummies
are jointly significant. The F-statistics are significant suggesting that geographic location does matter to CSR. The large
F-statistics allow us to reject the null hypothesis that geographic location bears no effect on CSR. It is important to note
that the industry dummies are also included and are jointly significant. Thus, the location effects are above and beyond
those explained by industry.
Table V. Regression
*** Significan
** Significant
* Significant
be negligib
weak.10
We also execute additional empirical tests to mitigate the concern for reverse causality. First,
we lag the average CSR score of the geographically close firms by one period (i.e., we regress
the CSR score of a given firm at time t on the average CSR score of the surrounding firms in
year t - 1). We continue to obtain consistent results. Moreover, we identify the first year when
each firm shows up in the sample. Then, we replace the average CSR score of the neighboring
firms in each year by the value in the earliest year. The logic is that the average CSR score in the
earliest year could not have resulted from the CSR score in any of the subsequent years, making
reverse causality unlikely. The regression result holds when we use the value in the earliest year.
These additional tests increase our confidence that an endogeneity bias due to reverse causality
is unlikely in our sample.
To gain further insight, we execute a fixed effects regression analysis. One critical adva
of the fixed effects analysis is that it only captures the variation over time. As such, it co
for the possible effects of unobservable firm characteristics that remain constant over
thereby minimizing the omitted variable bias. Table VI reports the results of the fixed ef
regressions. In Model 1, the average CSR score of the geographically close firms has a po
and significant coefficient. The result suggests that when the neighboring firms become m
socially responsible, firm i also increases its own CSR. In Model 3, we average the CSR scor
time for each firm. Thus, the regression in Model 3 captures only the cross-sectional varia
The coefficient of the average CSR score is positive and significant. When we only look
10 Another possible argument for reverse causality is that firms may choose a geographic location based on
other words, firms with high CSR choose to be located closer to other firms with high CSR. This is highly unli
Headquarter relocations are rare. It is implausible that firms change location in response to CSR. Furthermore, C
received much more attention recently. Thus, CSR has increased significantly over the years. Yet, firms still rarely
their headquarter locations. If reverse causality were valid, we would observe many more corporate relocations a
levels change over the years.
cross-sectional variation
random-effects regressi
In addition, we perform
changes in the CSR score
firms. An analysis based
The results are displayed
CSR score is positive and
improve their CSR over
the evidence from the f
Furthermore, it is conce
metropolitan area may b
firmsin a rural area. We
located in one of the larg
are reported in Model 2
Apparently, the location
urban and rural areas.12
11 We obtain the population data from the US Census Bureau. According to the 2010 Census, the 10 largest cities are New
York, Los Angeles, Chicago, Houston, Philadelphia, Phoenix, San Antonio, San Diego, Dallas, and San Jose.
12 We thank an anonymous referee for this suggestion.
Based on agency theory, this perspective argues that CSR investments constitute costly dive
sions of firm resources. CSR engagement represents an agency conflict between managers an
shareholders. Managers over invest in CSR and gain private benefits at the expense of sharehol
ers. Bernea and Rubin (2010) contend that overinvestments in CSR occur because the credit for
CSR initiatives accrues principally to the manager, while the cost is borne by the shareholders
Friedman and Fridman (1962) argue that firms should not be involved in philanthropy as share
holders can better engage in philanthropic activities on their own. Porter and Kramer (2006) al
make a similar argument that philanthropy should be left in the hands of individual shareholde
Thus, CSR initiatives represent an inefficient deployment of corporate resources that do no
create value for shareholders. To the extent that CSR activities constitute an agency cost or
wasteful diversion of resources, firm value is expected to decline, making both shareholders an
debtholders worse off. The overinvestment view suggests that recognizing the agency conflict
engendered by CSR activities, credit rating agencies assign lower credit ratings to firms wit
higher CSR.
C. Empirical Results
A crucial challenge in the empirical literature in CSR is the endogeneity bias, which prevent
researchers from drawing casual inferences. Firms with better CSR may enjoy better firm per
formance. At the same time, better performing firms can afford to invest more in CSR. Thus,
is unclear whether the direction of causality runs from CSR to firm performance or vice vers
One possible solution to the endogeneity problem is the instrumental variable (IV) technique.
The idea is to identify a variable that is highly correlated with CSR, yet does not influence firm
performance except through CSR. It is difficult to find such a variable as financial variables ten
to be correlated. Geographic location has been used as an instrumental variable in many prio
studies as it is fixed and more likely to be exogenous.
Previously, we have demonstrated robust evidence that the degree of CSR of a given firm
in a particular area is influenced by the CSR of geographically proximate firms. We exploit th
variation in CSR across the geographic locations and estimate the impact of CSR on credit ratin
In particular, we employ as our instrumental variable the average CSR score of the surroundin
firms in the same three-digit zip code. This variable should be a legitimate instrument for tw
reasons. First, this variable is clearly related to the CSR score of a given firm, as demonstrate
earlier. As such, it meets the relevance requirement for an instrumental variable. In addition,
plausibly meets the exclusion requirement; that is, it is not correlated with credit ratings. The U
Postal Service allocates zip codes exclusively based on efficiency in postal delivery, not corpora
financial policies or outcomes. Thus, the variation in CSR across zip codes is likely exogenous
The two-stage least squares (2SLS) results are presented in Table VIII. Model 1 is the first stag
regression, where we estimate the CSR score using the average CSR score of the surrounding
firms. We include all of the control variables, as well as the year and industry dummies. As
expected, the average CSR score of the geographically close firms carries a positive and significa
coefficient.13 Model 2 is the second stage regression, where we take the instrumented value of
13 To ensure the strength of our instrumental variable, we compute the Anderson canonical correlation LM statistic
under-identification, as well as the Craig-Donald Wald F-statistic for weak identification. These two statistics examin
whether the relationship between the instrumental variable and the instruments is sufficiently strong to justify infere
from the results. We find that the two statistics are highly significant. Thus, our instrumental variable does not suff
from the weak instrument problem.
14 We also use the average CSR score of the surrounding firms in the same two-digit, instead of three-digit, zip code and
obtain consistent results.
15 To determine the economic significance, we multiply the standard deviation of the CSR score by the coefficient (2.672
X 0.228 = 0.609). Thus, an increase in CSR by one standard deviation improves the firm's credit rating by 0.609 or about
4.5% of the average credit rating (0.609/13.42 = 0.045).
16 Gao et al. (2011) report that leverage of firms located in close proximity exhibits similarity. This finding may be
relevant to our study as leverage and financial risk are taken into account by credit rating agencies. To explore this issue,
we run a regression similar to those in Table VII, but include, as an additional control variable, the average leverage of
firms located in the same three-digit zip code. The result remains consistent.
The risk mitigation view argues that firms engage in CSR activities to build up moral capital
thereby mitigating the adverse effects of negative events. There are two implications of the risk
mitigation view. First, if CSR activities are associated with lower risk, then the effect of CSR
on credit ratings should be positive. Our results support this notion indicating that more socially
responsible firms enjoy more favorable credit ratings. In addition, if CSR reduces risk, then the
effect should be attributed more to CSR concerns, rather than CSR strengths. To examine this
second implication, we execute additional analysis as follows. We separate the CSR score into
strengths and concerns, instead of combining them into one aggregate CSR score. Then, we
perform a regression analysis for the strengths and the concerns separately. The regression results
are found in Table X. The evidence corroborates our hypothesis. In particular, the strengths carry
an insignificant coefficient, while the concerns exhibit a significantly negative coefficient. The
effects of the strengths and the concerns are indeed asymmetric. This is consistent with the notion
that companies invest in CSR primarily to reduce their risk exposure. The risk mitigation view is
corroborated.
VI. Conclud
Due
to market s
firm is likely to
own CSR policy.
firms located in
even after contro
R&D spending, a
firm' CSR is inf
exploit the varia
two-stage least s
credit ratings. Ou
that more sociall
Appendix
Additional Robustness Tests
A. Expanded Sample
We execute further robustness checks. First, in our sample selection process, we lost a su
number of firms due to missing data regarding R&D and advertising expenditures. It is we
in the literature in empirical finance that these two variables are missing for a large
firms in Compustat. One common solution to this problem is to assume that R&D and a
expenditures are zero when the data are missing. This assumption has been used in ma
studies that significantly deal with these two variables. When we apply this assumptio
No.
study, the sample size increases from 2,5 1 6 to 4,726. The results based on the expanded sample are
shown in Table A2. Model 1 is the first-stage regression where the CSR score is the dependent
variable. The average CSR score of the neighboring firms exhibits a positive and significant
coefficient, confirming the results based on the smaller original sample. Model 2 is the second-
stage model. The dependent variable is credit ratings. The CSR score instrumented from the first
stage shows a significantly positive coefficient. Thus, the results based on the expanded sample
reinforce the conclusion that firms with higher CSR enjoy better credit ratings.
Please note that we do not use the expanded sample as our primary sample as the assumption of
zero R&D and advertising expenditures when the data are missing is made simply to address the
sample size problem in empirical research and, as such, is not based on an economic rationale.
Just because a firm does not report its R&D and advertising expenditures does not necessarily
mean that it does not spend anything on R&D and advertising. As a result, we do not believe that
the results based on this assumption are as reliable as those from our original example (which,
although smaller, contains actual data on R&D and advertising). In any event, the results are
remarkably consistent, regardless of which sample is used.
Our requirement that each zip code has at least five headquarters may seem a bit arbitrary.
We impose this minimum requirement to avoid any mechanical relationship when the number of
firms in each zip code is too low. For robustness, we change the minimum requirement to three
and seven firms. The alternative tests produce consistent results. The minimum number of firms
in each zip code does not materially affect the conclusion.
C. Exclusionary Screens
Please recall that there are six other CSR categories that KLD uses only as exclusionary screens.
These CSR components are not included in the calculation of the CSR score. These categories
are alcohol, firearms, gambling, military, nuclear power, and tobacco. For these CSR categories,
KLD reports only the concerns and not the strengths, while for the other seven categories included
in the CSR score, both the strengths and the concerns are reported. Thus, it is quite evident that
the six exclusionary screens are not meant to be interpreted the same way as the other seven
categories. For the sake of completeness, we construct an index based on these six exclusionary
screens by summing the concerns in these six categories. Then, we run a regression with this index
as an independent variable. The coefficient of the total exclusionary concerns is not significant. It
does not appear that credit ratings agencies take these exclusionary CSR categories into account
when assigning credit ratings. The result confirms our assumption that these six exclusionary
screens should not be interpreted the same way as the other seven CSR categories.
Model
D. CSR Components
Additionally, certain financial institutions are only allowed to hold investment-grade secur
Thus, the difference between investment-grade and noninvestment-grade ratings is much
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