Perceptions of corporate social responsibility in the capital market

This study investigates how capital market participants such as investors and financial analysts perceive corporate social responsibility (CSR) as improving earnings quality. Managers use CSR as a signal of future financial improvement, which causes companies to invest in CSR in the current period. An expectation of future financial improvement leads to increase in the quality of earnings because it curtails the incentive to engage in earnings management. In addition, CSR is a signal to increase the reputation of the firm. If a firm values its reputation, managers of a CSR firm would refrain from earnings management to avoid damage to its reputation. We use a sample of Korean listed companies for the period 2002-2011 and a proxy for CSR involvement based on the Korea Economic Justice Institute index. When we use earnings response coefficients (ERCs) to measure investors’ perceptions of earnings quality, we find that ERCs are higher for firms with engagement in CSR activity. Further, when we use the predictive ability of past earnings in forecasting future earnings to measure analysts’ perceptions of earnings quality, we find that the predictive ability of past earnings is higher when firms engage in CSR. Our results provide evidence that capital market participants perceive CSR as a signal of improved earnings quality.