Responsible Investment

Ethical concerns likely to spur high-quality financial reporting

September 4, 2012
Image ‘Louvre piramid’ by Dino Quinzani (CC BY-SA 2.0)

In this 2012 study, Yongtae Kim (Santa Clara University), and Myung Seok Park and Benson Wier (both from Virginia Commonwealth University) examine whether socially responsible firms — in accordance with criteria established by Kinder et al. (2006)[1] — behave differently from other firms in their financial reporting. Specifically, the researchers question whether companies that show corporate social responsibility (CSR) also behave responsibly in their earnings management, by delivering more transparent and reliable financial information to investors in comparison to firms that do not meet these social criteria.

Kim, Park and Wier use three different proxies for earnings management: discretionary accruals, real activities manipulation, and the incidence of Accounting and Auditing Enforcement Releases (AAERs). Their results “hold after we control for alternative determinants of earnings management and CSR and potential substitution between accrual-based earnings management and real activities manipulation. Our results are also robust to the use of DSI400 designation as an alternative proxy for CSR, the use of full control samples, various measures of financial performance, and controls for several other potential confounding factors. The results are also robust to the use of an alternative measure of accruals quality.”

“To isolate the effect of ethical motivation from two other CSR incentives -reputation concern and financial performance, which could also drive a negative relation between CSR and earnings management — the authors control for reputation and financial performance in a multivariate analysis.” Their results are consistent with the transparent financial reporting hypothesis, which maintains that a managers’ incentives to be honest, trustworthy, and ethical lead to CSR activities. Their findings “suggest that ethical concerns are likely to drive managers to produce high-quality financial reports.”

In conclusion, the authors write, “We consider our findings with regard to financial transparency a first step in a stream that examines issues such as ethics and reputation as factors affecting corporate financial reporting. Further, CSR firms seem to consider the long-term view, which begs the empirical question of CSR firms’ longer-term corporate financial performance.”

References

  1. Kinder, Lyndenberg, and Domini. “Getting Started with KLD Stats and KLD’s Ratings Definitions.KLD Research & Analytics, Inc. (2006)

This article may be reproduced according to our terms of use with attribution (and link, if online) to www.tias.edu. To be cited as: “Ethical concerns likely to spur high-quality financial reporting”, Lloyd Kurtz, and Ingrid Ramaan, www.tias.edu, September 4, 2012.

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Is Earnings Quality Associated with CSR
Research Paper

Author(s)

Ingrid Ramaan
Administrative Editor FSinsight

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