Media exposure on corporate social irresponsibility and firm performance

Highlights

• CSI events trigger significant and negative cumulative abnormal returns.

• CSI events have negative impact on the firm's long-term operating performance.

• CSI events have negative impact on the firm's reputation and non-operating expenditures.

• The number of CSI reports is positively correlated with stock price crash risk.

• Media can serve as an external corporate governance mechanism.

Abstract

This study investigates the impact of media exposure of corporate social irresponsibility (CSI) events on firm performances. Using unique data from an emerging market, we find that CSI events trigger significant and negative cumulative abnormal returns (CARs). Negative CARs are more profound for environment and safety issues as well as illegal violations. The existence of CSI events has negative impact on the subject firm's long-term operating and financial performances due to reputation damage and extra costs for regulatory compliance and rebuilding reputation. Furthermore, the number of CSI reports is negatively associated with firm performance and positively correlated with stock price crash risk. The negative effect is more profound for CSI events reported by the media than those self-reported by subject firms due to regulations. Our findings support the conjecture that media can serve as an external corporate governance mechanism, especially in emerging markets where well established governance structure is not yet available.

Introduction

Several studies show that media play an important role as an external corporate governance mechanism of firms in the emerging markets because of their relatively weak legal and institutional environment. For example, Dyck et al. (2008) study the impact of media coverage on corporate governance by focusing on Russia in the period 1999–2002. They find that coverage in the Anglo-American press increases the probability that a potential corporate governance violation, such as share dilution or shareholder disenfranchisement, is reversed. Additionally, Kouwenberg and Phunnarungsi (2013) show that listed firms in Thailand experience large negative abnormal returns when they violate the information disclosure rules. The result is especially strong for firms that have low past violation records and low governance scores. The existing evidence suggests that media exposures play a role in the governance mechanism. However, our understanding of this effect is limited given that the focus has been on very specific governance disputes.

From a broader view of the corporate governance, firms in emerging economies may commit violations of substantive social irresponsibility (i.e. egregious environmental protection problem). Since the severity of social irresponsibility is quite diverse, it is not clear whether the press has a similar governance effect on the various magnitudes of violations (Miller, 2006).¹ Furthermore, while prior studies (e.g., Becker, 1968; Schuler and Cording, 2006) attempt to construct the link between corporate social performance and corporate financial performance, there is a lack of empirical studies that examine the relation between the existence and recurrence of CSI news exposed by the media and firm performance.

Using the event study methodology, we investigate the effects of media coverage on firms' stock market performances after reports of a wide range of socially irresponsible violations at different levels of severity, ranging from severe social irresponsibility (i.e. food safety problems) to minor violations (i.e. a delay in financial reporting). We further examine whether the occurrence and frequency of media coverage affect short-term and long-run operating performances of subject firms. In addition, we investigate whether media coverages of CSI events have any effect on the stock price crash risk.

We find that CSI events reported by media lead to significant and negative CARs. Of the four types of CSI behaviors that we investigate, the environment and safety issues and other illegal violations show stronger results than issues related to the labor relations and information disclosure. These results support our hypothesis that the negative impact of CSI events on firms' stock performance depends on the severity of social irresponsibility. Compared with firms that have no CSI events, firms that have at least one CSI news have significantly inferior long-term operating and financial performances. We also show that the frequency of CSI exposures by media is negatively associated with the subject firm's long-run operating performance, likely due to impaired reputation and extra expenses related to regulatory compliance and rebuilding reputation. Lastly, the number of CSI events exposed by media is positively related to the stock price crash risk. In other words, the poor long-run performance becomes more severe when the number of CSI events released by media increases. This result supports another hypothesis that the negative effect of CSI events on firm performance will magnify if the subject firm has more irresponsible behaviors. It seems that media can act as an external governance mechanism by punishing firms with CSI behaviors not only in the short term through negative CARs but also in the long run through poor operating performance and high stock price crash risk.

This study contributes to the literature in several ways. First, using a wide range of socially irresponsible violations, we help clarify whether the nature of violations itself determines the effectiveness of media as an external governance mechanism (Gillan, 2006). Prior studies indicate that media can influence corporate governance through negative characterization of violations by increasing the reputational cost and financial risk (Becker, 1968; Dyck et al., 2008; Kölbel et al., 2017). That is, the more negative the corporate governance violations are, the more effective the media is in influencing corporate behavior, performance, and risk. If a firm's violation is minor and no significant impact on the firm's reputation or performance is expected, the corporate governance role of media would be limited. By testing the effects of the press coverage for different types of CSI on firm performances, this study sheds light on whether media can work as an effective external governance mechanism. With this approach, we extend the scope of the role of media from common firm-level governance issues to a broader corporate social responsibility context.

Second, we show that the existence of CSI events can have severe negative impact on the subject firm's long-term operating and financial performances, compared to firms without CSI incidents. Moreover, we demonstrate to what extent the media coverage can develop its functionality as a corporate governance mechanism. Media can trigger a reaction from the subject firm not only through the adversity of the irresponsibility but also from the probability that a given irresponsible action is known to the audience and thus carries a reputational cost (Becker, 1968). However, the frequency of media coverage on firm performances is largely ignored in the literature. We fill this gap by examining whether the governance effect of media would magnify when a firm commits substantive violations and when the press reports them multiple times. These results not only stress the importance of media as an external governance mechanism but also remind firms of maintaining their reputation by not engaging in any CSI behavior.

Third, this study adds to the literature by showing that the negative impact of CSI events on the firms' long-term performances could be a result of the harmed corporate reputation and increased expenditures. A recent study by Sharpe and Hanson (2021) indicates that firms' sales are negatively affected during the year of a CSI event and then gradually recover following the event. We further show that the number of CSI events have adverse effects on the firm's institutional holdings and employee turnover. The perspectives toward an organization's reputation from the internal (e.g. employees) and external (e.g. institutional investors) are mostly overlooked by the literature since many studies have overly focused on the financial performances (Chun, 2005; Winkleman, 1999). More importantly, we find that the recurrence of CSI events are negatively associated with non-operating income. In other words, more CSI events may incur extra expenditure or investment to comply with regulatory requirements, leading to higher non-operating expenses and thus lower non-operating income. All of the above can dampen firms' long-term operating and financial performances.

Fourth, this research contributes to the corporate social responsibility literature by studying the effect of media coverage of corporate social irresponsibility on firms' stock returns. Prior studies mostly use annual observations from the Kinder, Lydenberg, Domini Research & Analytics (KLD) Social Ratings Database or Bloomberg's ESG scores to test the relationship between the social responsibility index and abnormal returns (e.g., Becchetti et al., 2012; Buchanan et al., 2018; Feng et al., 2018; Hoi et al., 2013; Price and Sun, 2017). Due to the nature of the KLD database and ESG scores, there may be lags between incidences of corporate social responsibility and the observed reactions from the market. We obtain unique data from the Taiwan Economic Journal (TEJ) database that offers detailed daily data for each negative/irresponsible behavior from 1999 to 2017. With this database, we can directly observe the reactions from the stock market after media release news about violations of the codes of social responsibility.

This paper proceeds as follows. We first review related papers in the literature and then develop our hypotheses, discuss the methodology and data, and present our empirical results. Finally, we conclude with implications and suggestions for future studies.