Do Institutions Influence Corporate Behavior? An Analysis of Corporate Social Responsibility

Chuan-Yang Hwang (Nanyang Technological University)

Sheridan Titman (university of Texas)

Ying Wang (Nanyang Technological University)

Motivations

• There is a growing interest in institutional investors’ abilities to evaluate and influence corporations. (Bushee 1998; Hatzell and Starks 2003; Chen, Harford and Li 2007; Michaely and Vincent 2012)

• Few papers investigate whether the preferences of institutions affect corporate choices and firm value.

• We focus on the institutions’ preference of Corporate Social Responsible (CSR) policy.

Motivations

Why focus on CSR?

• The idea that institutions should consider CSR in their investment choices has gained considerable tractions recently.

• 3.74 Trillions in assets (11.3% of total investment assets) were managed using Socially Responsible Investing guide lines at the beginning of 2012.

• The effects of CSR on firm value has been controversial due to endogeniety of CSR: Firms may feel that they can afford the luxury of adopting strong CSR policies when their businesses are otherwise performing very well.

Motivations

Why focus on CSR?

• If we show that institution preference of CSR influences corporate policy and firm value. Viewing the change in institution preference of CSR as an exogenous shock, the causality relationship between CSR policy and firms value is more likely to run from Institutional preference CSR Policy firm value.

Research Issues

• We separate institutions into socially responsible institutions (SRI) and non-socially-responsible institutions (NSRI) based on a weighting of corporate social responsibility scores of their portfolio holdings.

• What are the impact on stock price, CSR policy as well as accounting performance (ROA), when a firm experiences significant increase in stock holdings from NSRIs (i.e., the preference of institutional investors becomes less favorable toward of CSR)?

• Would the impacts mentioned above depend on the existing level of CSR and firm performance?

• What if the preference of institutions fails to affect CSR policies as expected?

• Are we able to determine the causality between CSR and firm value?

• Who are NSRIs?

A Preview of the Main Findings• Stock returns next quarter is significantly and positively related

to the change of NSRI ownership this quarter

• The positive relation is stronger among larger firms, value firms and firms with higher CSR score, and it is strongest among high CSR and low ROA firms.

• Firms experiencing a large increase in NSRI owernship cut back CSR significantly in the future. This result is strongest among high CSR firms.

• Furthermore, such firms improve future performance (ROA), especially for high CSR and low ROA firms (i.e., firms whose ROA have been hurt by high CSR)

A Preview of the Main Findings

• There is a return reversal in stocks which have experienced a large increase of NSRI ownership but fail to cut back excessive CSR

• NSRIs are predominately the Type 4 institutions which include independent advisors and hedge funds.

• The positive return associated with the increase in NSRI ownership derives from these investors being NSRIs rather than from their legal types

Main Hypothesis

Excessive CSR Hypothesis

• Excessive CSR policies destroy firm values.

• A large increase in NSRI ownership signifies a more intense monitoring from NSRIs

• Investors respond positively in anticipation of the future cutback of CSR when a firm experience an significant increase of NSRI holdings.

Main Hypothesis

Predictions

• Relative to firms with little increase in NSRI ownership, firms experiencing a large increase cut back CSR significantly in the future, especially for high CSR firms;

• Such firms have a positive return in near term (next quarter) returns and long term future improvement in ROA, especially for high CSR and low ROA firms.

• There is return reversal when such firms fail to cut back excessive CSR as expected.

Data and Methodology

• Sample: all common stocks traded on NYSE, AMEX, and NASDAQ from 2003 to 2011

• Quarterly institutional holdings from Thomson Financial Stock return data from CRSP; Financial data from Compustat; Analyst coverage from I/B/E/S.

• CSR data is from KLD STATS database.

Data and Methodology

CSR Data• KLD covers strength and concern ratings for about 80 indicators within seven

qualitative issue areas including Community, Corporate Governance, Diversify, Employee Relations, Environment, Human Rights and Product.

• For each indicator and each year KLD assigns a value of one (1) if a strength exists in the particular issue and negative one (-1) if a concern exists.

• If the company does not have a strength or concern associated with the indicator, KLD assigns a value of zero (0).

• By adding up these positive and negative ones we get a measure of social responsibility for each of the areas for each firm in each year – positive KLD strength rating, negative KLD concern rating, and the total KLD rating

• Eg: PepsiCo got a point in the Diversity category because its CEO was a woman, while Coca-Cola received no points in this category because its CEO was a man.

Data and Methodology

NRSI Ownership Measures• Institutional investors’ Social Responsibility scores (SR)

• ADKLDj is the size-adjusted social responsible strength ratings for stock j in the previous year end.

• Each quarter, we sort institutional SR ratings into three groups. Institutions in the bottom group which have the lowest ratings are defined as NSRIs. The rest of the institutions are defined as SRIs.

• NSRIs (SRIs) are those institutions which are more likely to invest in firms with low (high) strength ratings.

• For each stock in each quarter, we measure the NSRI ownership as the number of shares held by NSRIs divided by the total number of shares outstanding.

NSRI ownership and next quarter return (Table 2)

Portfolio returns for NSRI and SRI (Table 3)

Alternative Hypothesis

Information Advantage Hypothesis

• NSRIs have superior information and buy the stocks of firms with good news which may or may not related to firms CSR policy.

Distinguish between Information Advantage and Excessive CSR Hypothesis

• Compare the predictive power of changes in the overall holdings of NSRI (DNSRIO) with changes in the number of institutions (DNUM_NSRI)

• If NSRIs have information advantage, the return predictive ability of change in NSRI ownership should be stronger in firms with greater information asymmetry, such as smaller firms and growth firms.

• Information advantage of institutions are larger in smaller and growth firms (Yan and Zhang, 2009; Baik, Kang and Kim, 2010)

Results are stronger in large firms and value firms, inconsistent with information hypothesis (Table 4)

Results are stronger in firms with high CSR, consistent with Excessive CSR hypothesis (Table 5)

Results are strongest in firms with high CSR and low ROA, consistent with Excessive CSR hypothesis (Table 6)

Are the Results Driven by the Type of Institutions?

• Hong and Kacperczyk (2009) show that mutual fund, hedge fund, independent investment advisors are more likely to hold sin stocks.

• Those institutions are more likely to be the NSRIs.

• Separate the institutions by the regulated types from Type 1 to Type 5 based on Brain Bushee classification

Holdings by Type X institutions (Table 7)

1. NSRIs account for about a quarter of the total institutional holdings (15.30% / 67.00%)

2. NSRIs account for about half of the Type 4 holdings (15.30% out of 31.35%)

3. While Type 4 institutions account for less than 50% of total institutional ownership (31.35% / 67%), they account for about 80% of the NSRIO (11.41% /

15.30%)

Holdings by Type 4 institutions and next quarter return (Table 8)

The Determinants of DNSRIO (Table 9)

High KLD dummy is equal to 1 if KLD is above median, otherwise it is 0;

NSRIs are more likely to target high KLD firms whose ROA has been hurt by

the excessive CSR policies.

The influence of NSRIs on Firms’ CSR

Each quarter, we independently sort all stocks • by ROA into two subsamples: High ROA (above median) and Low ROA (below

median),• by KLD into two groups: High (above median) and Low (below median), • by DNSRIO into two groups: high (top 30%) and non-high (bottom 70%). — We choose the top 30% cutoff for high DNSRIO since DNSRIO has to be

large enough to signify the advent of shareholder activism and the accompanying intense internal monitoring specified in our hypothesis.

Predictions: Firm in High KLD and High DNSRIO group should have the largest decrease in CSR scores.

Change of firm’s CSR (Table 10)

Change of firm’s CSR — Regressions(Table 11A)

Change of firm’s ROA — Regressions(Table 11B)

Return Reversal (Table 12)

Dummy Target is 1 if the stock in the high KLD

and high DNSRIO group, otherwise it is 0;

Dummy Failure in Model (1) and (2) is equal to

1 if the stock increases KLD in 2 years,

otherwise it is 0;

Dummy Failure in Model (3) and (4) is equal to

change of KLD in 2 years if the stock increases

KLD in 2 years, otherwise it is 0;

Conclusion

• Stock returns next quarter is significantly and positively related to the change of NSRI ownership this quarter

• The positive relation is stronger among larger firms, value firms and firms with higher CSR score, and it is strongest among high CSR and low ROA firms.

• Relative to firms with little increase in NSRI ownership, firms experiencing a large increase cut back CSR significantly in the future. This result is strongest among high CSR firms.

• The cutback in CSR improve firms future ROA and provide unambiguous evidence that excessive CSR policies destroy firm values.

• Seeing an increase in NSRI ownership , investor corrected expect the future cutback of CSR, especially for high CSR firms and stock price increase as a result. There is also a return reversal for such firms which fail to cut back CSR as expected.