Corporate Social Responsibility and Earnings Quality: International Evidence

Abstract

In this paper, we investigate whether the corporate social responsibility (CSR) orientation of a firm affects its reporting incentives, in terms of the trade-off between real earnings management (REM) and accrual-based earnings management (AEM). Furthermore, relying on previous literature on the relationship between legal enforcement and the trade-off between AEM and REM, we consider whether the CSR orientation plays a moderating role in this relationship. We base our study on a sample of 5,863 firm-year observations for 1,141 unique firms, covering 24 different countries over the period 2003–2009. We find that CSR-oriented firms are less likely to engage in REM than in AEM. Moreover, we document that in strong legal enforcement countries, incentives to use REM instead of AEM are significantly lower in companies with a high CSR orientation than in companies with a low CSR orientation. These findings are consistent with the expectation that CSR-oriented companies are less likely to engage in the more costly but harder to detect earnings management strategy, i.e. the strategy that alters the underlying real operations of the company (REM). We provide additional evidence for our arguments that CSR-oriented firms are more likely to give up REM than AEM because of its detrimental value on future performance. All together our evidence suggests that CSR orientation acts as a constraint for REM and in doing so it contributes to the creation of value for all stakeholders.