Corporate Social Responsibility and Shareholder’s Value: An Event Study Analysis

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ATLANTA
Corporate Social Responsibility and
Shareholder’s Value: An Event Study Analysis

Leonardo Becchetti, Rocco Ciciretti, and Iftekhar Hasan

Working Paper 2007-6
April 2007
FEDERAL RESERVE BANK
WORKING PAPER SERIES

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FEDERAL RESERVE BANK of ATLANTA WORKING PAPER SERIES
Corporate Social Responsibility and
Shareholder’s Value: An Event Study Analysis

Leonardo Becchetti, Rocco Ciciretti, and Iftekhar Hasan

Working Paper 2007-6
April 2007

Abstract: Corporate social responsibility (CSR) is increasingly a core component of corporate strategy in
the global economy. In recent years its importance has become even greater, primarily because of the
financial scandals, investors’ losses, and reputational damage to listed companies. While corporations are
busy adopting and enhancing CSR practices, there is (beyond very few notable exceptions) no established
empirical research on CSR’s impact and relevance in the capital market. This paper investigates this issue
by tracing the market reaction to corporate entry and exit from the Domini 400 Social Index, recognized as
a CSR benchmark, between 1990 and 2004. The paper highlights two main findings: a significant upward
trend in absolute value abnormal returns, irrespective of the type of event (for example, addition or
deletion from the index), and a significant negative effect on abnormal returns after exit announcements
from the Domini index. The latter effect persists even after controlling for concurring financial distress
shocks and stock market seasonality.

JEL classification: G14, D21, L21

Key words: corporate social responsibility, event study


The authors thank Tiziana Croce for valuable research assistance. The views expressed here are the authors’ and not
necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’
responsibility.

Please address questions regarding content to Leonardo Becchetti, Department of Economics, University of Roma Tor Vergata,
Via Columbia, 2, 00133 Rome, Italy, 39 06 72595706, 39 06 2020500 (fax), becchetti@economia.uniroma2.it; Rocco Ciciretti,
Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8873, 404-
498-8810 (fax), rocco.ciciretti@atl.frb.org; or Iftekhar Hasan, Lally School of Management, Rensselaer Polytechnic Institute,
110 8th Street, Troy, NY 12180-3590, 518-276-2525, 518-276-8661 (fax), hasan@rpi.edu.

Federal Reserve Bank of Atlanta working papers, including revised versions, are available on the Atlanta Fed’s Web site at
www.frbatlanta.org. Click “Publications” and then “Working Papers.” Use the WebScriber Service (at www.frbatlanta.org) to
receive e-mail notifications about new papers.

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1. Introduction
The recent financial scandals - e.g., Enron, Parmalat, Worldcom etc. - globally have forced the
corporate executives to give more attention to a broader strategy beyond the focused view of
stockholders’ wealth maximization. A general understanding is that the reputation of the company and
the welfare of different stakeholders are crucial to both stockholders wealth maximization and long-term
survival. Tirole (2001) argues that the concept of stakeholder value recognizes that corporate activity may
create negative externalities which need to be counterbalanced, either by institutional rules or by
corporations themselves. In such scenario, the ultimate value of shareholders’ wealth may be linked to the
“maximizing the sum of various stakeholder surpluses.” The studies by Geczy, Stambaugh and Levin
(2005) and Bauer, Koedijk and Otten (2006) reveal that the investors are equally interested in such
initiatives as documented by the increased flow of funds in the industry of ethically managed mutual
funds. Contemporary reports show that one out of nine dollars invested in the market funds are invested
in so called “socially responsible” investment portfolios.2 Similar trends are revealed in Europe where, in
recent years, the number of socially screened mutual funds has nearly doubled mainly in United
Kingdom, Sweden, France, and Belgium. None of these studies and reports however focuses on the
investors’ perception or on the potential reaction in the capital market associated with such socially
responsible actions/non-actions undertaken by the corporate actions. This paper attempts to void the gap
in the literature by investigating the potential link between CSR initiatives and the change in market value
or price movements of companies following/rejecting the CSR activities. We do so by investigating one
of the most renowned stock market indexes of social responsibility, the Domini 400 Social Index,3 while

2 See, Report on Socially Responsible Investing Trends in the United States, 2003 and Cerulli Associate’s European
SRI Reports respectively for further details.
3 The Domini 400 Social Index SM is a market capitalization-weighted common stock index. It monitors the
performance of 400 US corporations that pass multiple, broad-based social screens. The Index consists of
approximately 250 companies included in the Standard & Poor's 500 Index, approximately 100 additional large
companies not included in the S&P 500 but providing industry representation, and approximately 50 additional
companies with particularly strong social characteristics. Inclusion in the index is based on the SR screening of
Kinder, Lydenberg and Domini Research & Analytics, Inc. (KLD), the leading research group in providing ratings
of corporate social performance to investors. KLD screens around 3,000 firms accounting for 98% of total market
value of US public equities (Barnea-Rubin, 2005) . The screening approach is in two steps. In the first step a group
of firms is excluded if their activity is for a significant share in controversial industries (alcohol, tobacco, or
gambling; companies that derive more than 2% of gross revenues from the production of military weapons; and
electric utilities that own interests in nuclear power plants or derive electricity from nuclear power plants in which

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tracking and evaluating the impact of a series of events - of inclusion and deletion from the index – on in
the financial market.4 We posit that investors do track these socially responsible companies and the
indices and any substantial deviation or change announcement in the index are reflected in the abnormal
return of these firms in the capital market. Employing an event study analysis during the 1990-2004 era
we measure the financial investors’ perception and expectation and test about the net effect of entry/exit
from the CSR index thus provide evidence on the CSR-corporate performance nexus. Our evidence
portrays a significant upward trend in absolute value abnormal returns of the sample events, irrespective
of changes (addition or deletion) in the index. Importantly, we also find a significant negative effect on
abnormal returns after the exit announcements from the Domini index. This negative relationship
continues to persist even after controlling for concurring financial distress shocks and stock market
seasonality.
The rest of the paper is organized as follows. In the second section, we briefly summarize key the
theoretical and empirical literature. In the third section, we report data, methodology and results. In this
section we also perform a series of robustness checks on our findings with nonparametric tests, abnormal
returns based on alternative estimation models and exclusion of deletion rationales related to financial
distress shocks. The final section concludes the paper.

2. CSR and corporate performance: the state of art
Stock market prices should reflect the fundamental expected value of the stock, i.e. the discounted
sum of the expected dividends accruing to the owners of shares. When investors are rational and fully
informed, expected values are instantaneously revised upon news’ arrivals if the announcement refers to
an event affecting one or more factors determining the fundamental value of the stock (expected future
cash flows, interest rates, risk premia, stock betas, etc.). In this perspective the impact of events such as

they have an interest). From the remaining group of firms a subset of SR firms is selected according to a series of
qualitative indicators (community relations, product quality, workforce diversity, employee relations, environment,
human rights, non-US operations, and product safety and use). The definition of the Domini CSR criteria is
obviously questionable and open to debate. At the moment Domini information represents one of the most reliable
sources on CSR and is therefore the reference for our econometric analysis.
4 Entries or exits from the index are announced by the Domini the same day in which the event occurs. Hence, news
and event timing coincide.

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entries or exits from the Domini index should be predicted based on a theoretical framework which
evaluates the impact of the event itself on the different components of the formula of the fundamental
value of the stock.
A crucial issue to consider when formulating our hypothesis on the effects of the announcement
of an event related to the CSR choice is therefore the investigation of the nexus between corporate social
responsibility and corporate performance and, more specifically, in our case, the specific criterion of
corporate performance represented by shareholder’s value.
Kinder, Lydenberg and Domini Research & Analytics, Inc. (KLD) divide CSR criteria analyzed
for inclusion in the Domini 400 index into eight broad categories (see Appendix A): i) community; ii)
corporate governance; iii) diversity; iv) employee relations; v) environment; vi) human rights; vii)
product quality; viii) controversial business issues. For each of them, the Domini index identifies
strengths and weaknesses and indicates a series of corporate actions falling under one of the two
categories.
Overall, we find that most of the strengths and weaknesses in each of the eight domains are cost
increasing, with the notable exception of the product quality section and of rules limiting managerial
compensation (in the employee relations section). Hence, we may be led to conclude that most of the SR
criteria (see in particular those in the employee relations, environment, community and human right
sections) involve a shift of focus from the maximization of shareholders’ value to the satisfaction of the
interests of a broader set of stakeholders (shareholders but also local communities, workers, domestic and
foreign subcontractors)5.
On the other side, we must nonetheless consider that the CSR choice may have positive effects on
market value by enhancing workers productivity, especially when it involves wage and non wage benefits
for firm employees. The productivity enhancing effect of such benefits is widely analyzed by the
efficiency wage literature (Yellen, 1984) in shirking (Stiglitz-Shapiro, 1984) and gift exchange models
(Akerlof, 1982). Furthermore, the importance of intrinsic motivations in productivity, and the availability

5 For a reference on the most famous positions in the historical debate evaluating causes and consequences of CSR
see Friedman (1962) and Freeman (1984), while on the methodological problems arising when pursuing the goal of
maximization of multiple stakeholders interests see Jensen (1986) and Tirole (2001).

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of workers to accept lower wages (and even voluntary work) when intrinsic motivations6 are strong,
suggests that the latter are partial substitutes for pecuniary transfers. Intrinsic motivations are therefore a
channel through which corporate social responsibility, by fostering alignment between corporate goals
and workers’ motivations, may reduce costs and increase productivity.
Another “value increasing” argument is set forth by Freeman (1984) who considers that CSR may
be an optimal choice to minimize transaction costs and potential conflicts with stakeholders.7 In this
perspective, CSR may be seen as an effective tool for improving firm reputation and reducing the risk of
remaining victims of consumers’ activism and legal actions.
The nexus between CSR and corporate performance is therefore complex and its complexity is
confirmed by the empirical literature in the field which does not provide clear cut results.
In favor of a positive link are those studies showing that: i) costs of having a high level of CSR
are more than compensated by benefits in employee morale and productivity (Soloman and Hansen,
1985); ii) CSR is positively associated with financial performance (Pava and Krausz, 1996 and Preston
and O’Bannon, 1997); iii) positive synergies exist between corporate performance and good stakeholders
relationships (Stanwick and Stanwick, 1998; Verschoor, 1998); iv) change in CSR is positively associated
with growth in sales and returns on sales are positively associated with CSR for three financial periods
(Ruf et al., 2001). Consider that many of these papers find evidence of a positive effect on economic and
not on financial performance (with the exception of Pava and Krausz, 1996 and Preston and O’Bannon,
1997). Hence, the corporate SR choice may be beneficial in terms of net sales or value added per worker,
but not necessarily in terms of shareholder’s value.
On the negative side, we have contributions of Preston and O’Bannon (1997) Freedman and Jaggi
(1982), Ingram and Frazier (1983) and Waddock and Graves (1997).
Inconclusive results are those of McWilliams and Siegel (2001) Anderson and Frankle (1980),
Freedman and Jaggi (1986) and Aupperle, Caroll and Hatfield (1985). The limit common to most of these

6 On the relationship between workers’ intrinsic motivation and productivity see Ryan et al. (1991), Frey and
Oberholzer-Gee (1997) and Kreps (1997).
7 By summing up information from various sources it is possible to calculate that, only in the year 2005, the top
corporations in the US paid around 9 billion dollar settlements to avoid court judgement when sued by investors for
financial scandals (www.endgame.org/corpfines3.html).

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papers is in the adoption of estimation techniques which do not take into account problems of
endogeneity and stationarity of time series and panel data.
A more recent vintage of papers refines significantly the empirical methodology and presents
interesting findings. Among them, Barnea and Rubin (2005) show that the decision to invest in CSR is
negatively related to insiders’ ownership and interpret this finding in the light of an overinvestment
hypothesis. CSR is good for shareholders’ value up to a given level, but insiders may have an interest to
overinvest in it to improve their reputation and they are more likely to do so when their ownership share
is lower.
Two recent papers highlight the increasing diffusion of ethically managed funds and provide
theoretical framework and empirical analyses of their relative performance. Bauer, Koedijk and Otten
(2002) compare active strategies of ethical and traditional investment funds finding mixed results (not
univocal prevalence of one over the other), but observing a learning process which gradually improves
the performance of ethical investment fund managers. Geczy, Stambaugh and Levin (2003) calculate the
cost of imposing socially responsible investment constraints in terms of risk adjusted returns and show
how they depend on the share of SR investment, on views about asset pricing models (SR funds are less
able to offer exposure to size and value factors than to the standard one CAPM factor) and on stock
managers ability.
By considering the above mentioned theoretical and empirical considerations we expect different,
and potentially conflicting, effects of addition and deletion from the Domini index. If the shift of focus
hypothesis holds (and the cost increasing dominate over the cost decreasing effects), we should expect a
negative (positive) abnormal return in case of an addition (deletion) announcement. If, on the other hand,
we consider the growing volume of financial assets intermediated by socially responsible funds (and we
take into account that a relevant part of them follows the passive strategy of tracking a SR index) we
would expect the opposite effect of a negative (positive) abnormal return in case of a deletion (addition)
announcement, with such effect becoming stronger in the more recent years when the role of SR funds
has become more significant.


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As already observed, one of the main limits of all the above mentioned analyses based on balance
sheet data is the difficulty of controlling for endogeneity. In the CSR-corporate performance relationship
the problem is particularly severe as it is important to discern, for instance, in case of positive
relationship, whether the move to CSR is an autonomous driver of improvement in corporate performance
or, quite to the opposite, high cash flow and better performing firms are more likely to choose CSR, due
to their higher cash flow availability. A second, almost insurmountable, limit is that balance sheet based
analyses on the CSR-corporate performance nexus do not provide a risk adjusted measure of
performance.
The two advantages of investigating the impact of CSR on corporate performance in financial
markets are that, by calculating abnormal returns at the announcement date, i) we pick up the expected net
effect of entry into/exit from CSR – and hence we separate the effect of change in CSR on corporate
performance from the reverse causality effect - and ii) we may calculate it net of measurable risk factors.
Of course, as it is well known, an event study analysis may present problems such as the
sensitivity to waves of market optimism or pessimism and the restrictive assumption that stock market
reaction arises from rational fully informed investors taking their choices on the basis of the maximization
of their expected wealth. For the first point, an analysis in which events are scattered over a long time
spell (13 years) and a robustness check in which dummies for stock market seasonality are included in the
estimate of the determinants of abnormal returns should avoid this problem. On the second point we will
see that, when interpreting our findings, the case of SR investing is exactly one in which the hypothesis of
investors choosing only on the basis of the maximization of their expected wealth may not apply. SR
investors may in fact decide to sell a stock not because it is not going to be profitable, but because it does
not comply anymore to CSR standards.
Finally, in our event study analysis an observational equivalence issue related to the endogeneity
problem in the relationship between CSR and corporate performance may still persist if exit from the
Domini Index coincides with a financial distress shock. In such case the rationale of the observed
negative abnormal returns would not be the exit from the Index as both events would be jointly
determined by the concurring financial distress shock. To rule out this possibility we perform a robustness

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check by carefully examining the rationales for exclusion from the Domini 400 index and by excluding
from the analysis those likely to be related to financial distress.

3. Empirical findings
3.1 Empirical findings from the market model
We create a sample of 327 events of entries or exits from the Domini 400 Social Index
concerning 278 firms (27 firms register a double event of entry and exit from the index in the sample
period).
The Domini corporate screening identifies strengths and weakness for each of the following eight
broad categories: i) community; ii) corporate governance; iii) diversity; iv) employee relations; v)
environment; vi) human rights; vii) product quality; viii) controversial business issues, (for details on the
Domini criteria see Appendix A, for details on chronology and motivation of entries and exists see
Appendix B). When the stock does not pass anymore the qualitative screening process (described in
footnote 5) the stock is excluded from the index.
By looking at reasons for deletion we find that the most frequent one is lack of financial and
social representation (12 cases), followed by South Africa (6 cases), product concerns (6 cases),
bankruptcy (5 cases), military (3 cases). On the entry side we find, among CSR strengths which motivate
the event, diversity (85 times), employee (76), environment (40) and community (26).
We eliminate from the sample for obvious reasons deletions determined by mergers and
acquisitions, changes of ticker, changes of name and going private decisions.
It is important to consider that the index, by construction, has to maintain a constant number of
constituents. It is therefore evident that, while deletion is directly related to the information on the breach
of the SR criteria, addition is possible only after a deletion.8 As a consequence, while deletion is always
directly related to the breach of the Domini SR criteria, there may be lags between compliance of such
criteria and addition to the index. For this reason, in case of addition, our event study is more likely to

8 This creates an additional problem in balance sheet analyses on the impact of CSR on corporate performance based
on Domini affiliation since some of the (control sample) non Domini firms may possess all requirements needed to
pass the Domini screen, but are not included in the index until a constituent is excluded.

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isolate the effect that inclusion in the index may generate on passive buy-and-hold strategies of ethically
responsible investment funds.
To calculate abnormal returns we use the market model under the following specification
R − R = α + β (R − R ) + ε






(1)
t
f
0
o
m
f
t
where R is the one-day compounded return, R
t
f is the riskfree rate proxied by the one month
yield of the US Treasury Bill and (Rm-Rf) is the excess return of the stock market index. The advantage of
this simple model is that its coefficients are generally always statistically significant and therefore the
calculated abnormal returns are highly reliable. More sophisticated models (multi factor models, models
which include day of the week effects, etc.) do not share this advantage and scarcely improve goodness of
fit with respect to the former. (Brown-Warner, 1985, Campbell et al., 1997).
To estimate the market model we use an eight month window but we perform a robustness check
to control whether our results are confirmed with a different (2 month) window.
The first hypothesis we test here is whether the impact of announcements of addition and deletion
from the Domini index has risen over time. The rationale is that financial markets should be increasingly
sensitive to CSR news for several reasons: i) the interest of investors is becoming higher over time; ii) the
expected effects are higher since investors perceive the increased interdependence between CSR and
corporate performance or anticipate the higher reaction of concerned investors/consumers to the event; iii)
the volume of funds intermediated by “ethical funds” with active or passive strategies on the Domini
index has grown over time.
The estimated model is
CAR = α + α
+ ε






(2)
0
1Trendyear
t
i
where the dependent variable is the absolute (event window) CAR of the i-th stock for which an
event of entry or exit from the Domini occurred and Trendyear is a linear trend variable.
Since informational spillovers may occur before the announcement date we calculate abnormal
returns in the following different intervals - AR(0), CAR(-1,0) -, with 0 being the event date.

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