Corporate social responsibility and access to capital for listed companies

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MSc Accountancy & Control, variant Accountancy Faculty of Economic and Business, University of Amsterdam

Master Thesis:

Corporate Social Responsibility and access to capital

for listed companies

Name: Angelina Chen Student number: 10001412 Supervisor: Dr. A. Sikalidis Date: 19 June 2015

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Statement of Originality

This document is written by student Angelina Chen who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources others than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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ABSTRACT

Purpose – This paper provides empirical evidence on the relationship between Corporate Social Responsibility (CSR) and access to capital. Access to capital is measured by assessing cost of equity and cost of debt. Specifically, this study investigates whether CSR lowers both cost of equity and cost of debt.

Research design and methodology – To investigate the relationship between CSR and access to capital empirical archival research is conducted with the use of data of S&P500 companies in the period 2003-2013.

Findings – The first hypothesis of this study investigates whether a relatively higher rating in Corporate Social Performance (CSP) leads to lower cost of equity. In contrast to the first hypothesis I do not find a negative and significant relationship between CSR and cost of equity. The second hypothesis tests whether a relatively higher rating in Corporate Social Performance (CSP) leads to lower cost of debt. Subsequently, I do find support for the second hypothesis. This study shows that CSR and the credit rating (therefore, cost of debt) are negatively and significantly associated. However, when conducting robustness analyses I do find support for both hypotheses.

Limitations – The limitations of this study are found in two areas. In this study the S&P500 is taken into account, however, other samples can have different results. S&P500 companies are mostly mature companies and therefore CSR can have a different affect than with other companies. Therefore, when conducting the same study with other companies, for example incumbents, the results might be different. Subsequently, the relationship between CSR and access to capital can be influenced by other factors besides this relationship itself, such as the ability of managers to manage their business. Therefore, the results of this study can be disturbed by other factors than CSR itself. Future research should take these limitations into account and control for this.

Originality – Research on CSR and access to capital is not an exception in existing accounting literature. However, prior literature has focused on either cost of equity or cost of debt. This study on contrary takes into account both cost of equity and cost of debt when assessing the relationship between CSR and access to capital. Subsequently, this study also looks the impact of R&D and advertising intensity on access to capital. This has been done in a limited fashion in prior literature.

Key words: Corporate Social Responsibility (CSR), cost of equity, cost of debt, agency theory, stakeholder engagement, ethics, financial performance, R&D intensity, advertising intensity.

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2.4.1. Cost of equity ... 18 2.4.2. Cost of debt ... 19 2.5 Hypotheses ... 20 3. RESEARCH METHODOLOGY ... 22 3.1 Sample selection ... 22 3.2 Variable measurement ... 23 3.2.1 Cost of equity ... 23 3.2.1.1 Control variables ... 24 3.2.2 Cost of debt ... 24 3.2.2.1 Control variables ... 25 3.3 Empirical models... 26

4. DESCRIPTIVE STATISTICS AND EMPIRICAL RESULTS ... 27

4.1 Descriptive statistics ... 27

4.2 Results cost of equity ... 30

4.2.1 Regression analysis ... 30

4.3 Results cost of debt ... 32

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5. ROBUSTNESS ANALYSES ... 34

5.1 R&D intensity and advertising intensity ... 34

5.2 Results Cost of Equity ... 35

5.3 Results Cost of Debt ... 37

5.4 Winsorization ... 39

5.4.1 Results Cost of equity ... 40

5.4.2 Results Cost of Debt ... 42

6. CONCLUSION ... 43

REFERENCES ... 46

APPENDIX A: VARIABLE DEFINITIONS AND DATA SOURCES (COST OF EQUITY) ... 50

APPENDIX B: VARIABLE DEFINITIONS AND DATA SOURCES (COST OF DEBT) .. 52

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LIST OF TABLES

Table 1: Descriptive statistics Table 2: Correlation matrix Table 3: CSR and Cost of Equity Table 4: CSR and Cost of Debt

Table 5: CSR and Cost of Equity including R&D and advertising intensity Table 6: CSR and Cost of Debt including R&D and advertising intensity Table 7: CSR and Cost of Equity winsorized

Table 8: CSR and Cost of Debt winsorized

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1. INTRODUCTION

The last years have shown an increase in the number of reports on Corporate Social Responsibility (CSR) around the world (Dhaliwal et al., 2012). The largest corporate sustainability initiative in the world, the United Nations Global Compact, shows that approximately 2000 companies have signed to the initiative in 2012. Although this is a decrease compared to the approximately 2500 companies who have signed a year earlier, CSR is still adopted by many companies (Global Corporate Sustainability Report, 2013)

There are several motives for companies to report on CSR. According to EY (2013) companies see improved reputation as the most valuable contribution of CSR. Kim et al. (2012) argue that socially responsible companies tend to engage less in earnings management. This is another motivation for investors to call for CSR reporting. Furthermore, many studies have shown a positive relationship between CSR and financial performance (Flammer, 2013; Lech, 2013). This implies that companies are more likely to engage in CSR reporting to increase their financial performance. However, other studies find a negative relationship (Friedman, 1970; Balabanis, 1988). CSR is seen as a burden for companies’ financial position due to the high costs. Nevertheless, currently still many companies engage in CSR and many still follow this lead.

Many studies have investigated the relationship between CSR and financial performance, however, fewer studies have focused on the relationship between CSR and access to capital. One could suggest that access to capital is, however, the main point of interest for investors. This is because all companies need to have access to capital in order to operate and progress. Therefore, it is interesting to investigate the relationship between CSR and access to capital. The objective of this study is to investigate whether the use of Corporate Social Responsibility (CSR) leads to better access to capital for listed companies.

In order for CSR to work there must be accountability for stakeholders (Cooper & Owen, 2007). With lack of stakeholder accountability companies can be free to decide whether or not to operate in a sustainable way. In that case there is no added value of CSR reports. Therefore, companies have to give accountability to stakeholders when they decide to issue CSR reports. Further, companies need to address information asymmetry issues as well. Due to the separation of ownership and management there is information asymmetry between these parties (Jensen & Meckling, 1976). In order to avoid additional costs and risks investors are more likely to increase the cost of capital. According to Dhaliwal et al. (2012) CSR might

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help to lower information asymmetry and therefore lower the cost of capital. CSR provides investors more information and thereby lowering risks. To compensate for this, investors are more likely to lower the cost of capital (Cheng et al., 2014).

Cost of capital consists of cost of equity and cost of debt. Thus, in order to assess the relationship between CSR and access to capital both cost of equity and cost of debt must be considered. Prior literature has investigated the relationship between CSR and cost of equity. Cheng et al. (2014) show that CSR lowers cost of equity due to the increased trust of investors towards companies which report on CSR. They provide evidence that CSR can be seen as added value regarding the ability to lower cost of equity. Following, Dhaliwal et al. (2011) find that investors are more likely to invest in more transparent companies. CSR can be seen as a tool for increased transparency and therefore it tends to lower the cost of equity. Besides lower cost of equity, prior literature also shows that CSR is able to lower cost of debt. Goss & Roberts (2011) provide evidence that CSR signals more trustworthiness towards investors. Therefore CSR lowers the cost of debt. Similar findings are found by Demiroglu & James (2010) and Attig et al. (2013). Demiroglu & James (2010) who find that CSR is related to fewer debt covenants resulting in lower cost of debt. Moreover, Attig et al. (2013) show that companies engaging in CSR have higher credit ratings, which results in lower cost of debt as well.

In the aforementioned paragraph I showed that prior literature assumes that CSR lowers both cost of equity and cost of debt. This will be examined more explicitly in this study. To determine whether companies’ CSR reporting is related to cost of capital, I employ a sample consisting of S&P500 companies between 2003 and 2013 to investigate this relationship. CSR is measured by using the total scores of companies on seven qualitative issues taken from the MSCI ESG database. Further, cost of equity is measured by using the PEG ratio of companies derived from the I/B/E/S database (Easton, 2004; Dhaliwal et al., 2011; El Ghoul et al., 2011). The price/earnings to growth (PEG) ratio is used to determine a stock's value while taking the company's earnings growth into account, whereby a lower PEG ratio indicates that companies’ stock is undervalued (Easton, 2004). Following Attig et al. (2013) the cost of debt is measured by using credit ratings as a proxy from the Compustat database.

The results of this study show that CSR does not lower the cost of equity. This is not consistent with prior literature (Dhaliwal et al., 2011; El Ghoul, 2011). This can be explained by the used sample, because the sample consists of companies which mostly engage in CSR reporting. CSR can therefore no longer been seen as a competitive advantage by investors 8

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(Cheng et al., 2014). Following, this study suggests that CSR does lower the cost of debt, consistent with prior literature (Attig et al., 2013). CSR is related with higher credit ratings, which results in lower cost of debt.

Subsequently, I assess the robustness of the results by conducting two robustness analyses. Firstly, I add both R&D intensity and advertising intensity to the models. McWilliams & Siegel (2000) suggest that excluding R&D is problematic, because previous literature links R&D to improvements in the long-run economic performance. As discussed before, financial performance is linked to access to capital. Therefore, R&D should be included in the models. Further, differentiation is also expected to be related with access to capital (Hull & Rothenberg, 2008). Advertising intensity serves as a proxy for differentiation and should therefore be included in the models. The results show that CSR and cost of equity are not negatively and significantly related. Also, both R&D and advertising intensity are not significantly associated with cost of equity either. With regard to cost of debt, CSR and cost of debt are negatively and significantly related. Further, R&D intensity is also negatively and significantly associated with cost of debt, which is consistent with prior literature (McWilliams & Siegel, 2000). However, advertising intensity is positively and significantly related to cost of debt, which contradicts previous findings (Hull & Rothenberg, 2008).

Secondly, the data are winsorized at the first and 99th percentiles of their distributions. It is shown that there are extreme values within the sample. This could influence the outcomes and therefore I assess the robustness of the results by winsorization. Subsequently, CSR is negatively and significantly related with both cost of equity and cost of debt. This is consistent with prior literature (Dhaliwal et al., 2011; Attig et al., 2013).

Furthermore, this study is mainly motivated by the lack of studies which have taken both cost of equity and cost of debt into account when assessing the relationship between CSR and cost of capital. Therefore this study contributes in two ways. Firstly, by investigating both cost of equity and cost of debt. Secondly, this study also takes R&D and advertising intensity into account. Prior literature has shown that these factors have a significant influence on cost of capital and should therefore be included (McWilliams & Siegel, 2000; Hull & Rothenberg, 2008).

The following parts of the study constitute five more sections. Section 2 discusses the related literature and develops the hypotheses. Section 3 describes the research method. Section 4 provides the descriptive statistics and the results. Section 5 describes the robustness analyses and the results. This study concludes in section 6.

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2. LITERATURE REVIEW AND HYPOTHESES

In this paragraph previous papers and theory will be discussed in order to be able to develop the hypotheses of this paper. Firstly, the concept of Corporate Social Responsibility (CSR) will be explained. Secondly, stakeholder engagement will be discussed in further detail. Thirdly, agency theory will be discussed. Fourthly, financial performance will be discussed. Fifthly, ethics regarding credit ratings will be discussed. Sixthly, there will be drawn upon the link between CSR and access to capital. Lastly, the hypotheses of this paper will be developed based on the discussed theory.

2.1 Corporate Social Responsibility (CSR)

There are many definitions of Corporate Social Responsibility (CSR) in existing literature. One of the most used definitions of CSR is the definition of Global Reporting Initiative (GRI):

“A firm’s accountability to internal and external stakeholders for organizational performance towards the goal of sustainable development.” (Stenzel, 2010)

According to Brundtland (1989) sustainable development means that development must meet the needs of present generations without compromising the ability of future generations to meet their own needs. This implies that companies should consider the needs from both current and future generations when operating and not solely focus on profitability of the company itself.

In order for both current and future generations to be assured that companies take into account their needs, these generations need to have accountability. Accountability also has many definitions. A general definition is the following: “the giving and demanding of reasons for conduct” (Robert & Scapens, 1985, p.447). A more precise definition is given by Gray (2001, p.11), who argues that accountability is identifying what one is responsible for and then providing information about that responsibility to those who have rights to that information. Both definitions show that there are in fact two dimensions in accountability, one is being held to account and the other is holding to account. The first dimension encounters that companies are being held to account for their actions by, for instance,

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consumers and investors. The second dimension, holding to account, regards consumers and investors monitoring companies. They want to be sure that these companies behave in the way they think is responsible and thereby taking into account their needs.

Thus, with the increasing concerns about the environmental and societal aspects of companies’ operations, companies are more and more expected to issue CSR reports (KPMG, 2013). Therefore, it is even more important nowadays for companies to gain legitimacy from society, especially from stakeholders, in order to operate. Legitimacy can be described as a condition or status which exists when an entity’s value system is congruent with the value system of the larger social system of which the entity is part (Deegan & Unerman, 2006). Companies need to gain a social license to operate, which is based on the notion of a ‘social contract’. The social contract is considered to consist of several components, some which are explicit and others implicit (Deegan, p. 253, 2014). The explicit components are the legal requirements a company is applicable to, which are clear and in written. However, the implicit components, which consist of non-legislated societal expectations, are not clear. This consists of the expectations stakeholders have. There are different expectations between stakeholder groups and even within stakeholder groups, which make it difficult to assess the exact expectations of stakeholders in general. Therefore, different managers will have different perceptions regarding societal expectations and react differently. When companies fail to comply, there will be societal sanctions. An example of this is customers boycotting the products of a company which is not complying with the social contract. Therefore, legitimacy is necessary nowadays for organizational survival. A possibility to gain this legitimacy from society is to issue CSR reports, whereby companies show that they indeed take into account the expectations of society. By doing this companies show that their value system is congruent with that of society and therefore they can keep operating.

2.1.1 Stakeholder engagement

As mentioned before, in order for CSR to work there must be accountability for stakeholders. If there is stakeholder accountability it means that stakeholders can truly hold companies into account for their operations (Cooper & Owen, 2007).With lack of stakeholder accountability companies can be free to decide whether or not they operate in a sustainable way. When companies do issue CSR reports it would not be valuable to stakeholders either. This is because they do not have the power to hold companies accountable for their actions.

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CSR is used by managers as a tool to win or retain the support of those stakeholders who have power over the company (Rinaldi et al., 2014). A stakeholder is described as any identifiable group or individual who can affect or is affected by the achievement of organization’s objectives. Examples of stakeholder groups are: investors, shareholders, suppliers and consumers. These groups all have different perspectives on what is deemed legitimate in their eyes. Companies have to choose to whom they reply. Deegan and Unerman (2006) make a distinction between ethical branch and managerial brand within stakeholder theory. The ethical branch argues that all stakeholders are equal and all stakeholders should be included in the dialogue with the company. However, the managerial branch argues that companies must attend to the expectations of the most important stakeholders.

This identification of the range of stakeholders to be taken into consideration will be dependent upon the motives for engaging in CSR (Rinaldi et al., 2014). Managers who are more morally concerned with the companies’ activities will choose to include all stakeholders. While managers who only care about the amount of power stakeholders have on the company will be more likely to engage with the most powerful stakeholders only.

If companies have decided to which stakeholders they want to be responsible and accountable for, the next step in stakeholder engagement is to identify their expectations (Rinaldi et al. 2014). To have stakeholder engagement a company must first identify what the social, environmental and economic expectations of stakeholders are. A company must know what the expectations of stakeholders are, because otherwise they cannot being held accountable for their operations. Secondly, companies have to identify what the company should be responsible and accountable for. This implies that companies have to consider their operations in order to decide for what accountability they provide to stakeholders. Lastly, companies must enable stakeholders to truly hold the company to account. If stakeholders cannot truly hold companies to account for their actions, there is no accountability for stakeholders. Without stakeholder accountability there cannot be stakeholder engagement. Therefore, in order to have stakeholder engagement, the company must make sure that they can be held to account by stakeholders.

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2.1.2 Agency theory

Next to stakeholder engagement, companies also need to take information asymmetry into account due to the separation of ownership and management. This can be explained using agency theory. This theory has two concepts: the principal and the agent. The principal is someone who has ultimate authority and the agent is anyone acting on behalf of the principal (Baiman, 1990). In this study the principal can be seen as the stakeholders of a particular company and the agents are the managers of these companies. The stakeholders in this study consist of shareholders and debt holders.

According to Baiman (1990) there is the notion that individuals act in their own interest. In this study this will be the manager of a particular company. Stakeholders are the owners of a company and therefore want to have profit maximization. However, because of the separation of ownership and management, there can be the case that managers do not act in the best interest of the owners, i.e. the stakeholders, but instead act in their own interest. This is called moral hazard. Managers have more information than stakeholders, because managers work within the company and can also influence information which outflows from the company (Scott, 2012, p.468). Due to this information asymmetry between the stakeholders and management, stakeholders react on this. Stakeholders know that managers might not act in the company’s best interest and ask compensation for this risk.

In the case of equity, shareholders take into account this risk by paying less for the shares than they initially would want to pay (Jensen & Meckling, 1976). By doing this, shareholders mitigate their risk of information asymmetry. Another option for shareholders is the use of board governance (Merchant & Van der Stede, 2012, p. 561). Shareholders can delegate authority to outside members to monitor executive board members. Shareholders will be represented in the board and have influence on the business to make sure that the company acts in their interest. In the case of debt, debt holders will ask for more interest than they initially would have asked in order to be compensated for this risk (Jensen & Meckling, 1976). By doing this, debtholders limit the bankruptcy costs. If a company goes bankrupt, the shareholders have a bigger part of their money back than if they would have asked for a lower interest rate. Debt holders could also put more debt covenants on the loan in order to discipline managers to act in their interest (Jensen & Meckling, 1976).

According to Dhaliwal et al. (2012) CSR leads to less information asymmetry. This is because the information environment is better when using CSR. Stakeholders are better

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aware of the environmental and societal impacts of companies’ operations and therefore there is less information asymmetry. CSR represents long-term aspects of companies’ operations due to the inclusion of environmental and societal impacts (European Commission, 2013). Thus, both equity holders and debt holders have more insurance with the adoption of CSR reports that companies will be able to operate in the future. With more insurance and lower information asymmetry stakeholders will be more likely to issue capital to companies and also be less strict in providing their capital. Therefore, CSR can been seen as a tool which lowers the information asymmetry between principal and agent.

2.2 Financial performance

In order to show the relationship between CSR and access to capital, financial performance has to be discussed firstly. Dhaliwal et al. (2012) show that CSR improves the information environment, which is measured by analyst forecast. This shows that with the use of CSR companies have a better ability to show useful information to society. They also show that over the last years there are more companies which adopt CSR. Similar trends are found by EY (2013), KPMG (2013) and Global Corporate Sustainability Report (2013). Due to the increasing concerns regarding societal and environmental aspects of companies’ operations, stakeholders are increasingly asking for companies to report on it. This can be done by providing CSR reports to society, which partly explains the increasing number of CSR reports (KPMG, 2013). However, Fernández-Kranz & Santaló (2010) argue that this increase can also be the result of competitors who produce CSR reports. In order to keep up with the competition companies will adopt CSR. Therefore, this can also be a reason for the increase in CSR as well. EY (2013) also shows that one of the biggest reasons for companies to adopt CSR is that this deems to improve their reputation. With improved reputation customers will be more likely to purchase their goods and this results in higher profits. In other words, companies report on CSR with the intention that CSR will higher their financial performance. Several studies show that CSR indeed leads to better financial performance (Flammer, 2013; Lech, 2013). Flammer (2013) sees CSR as a valuable resource for companies to survive in the long-run. However, CSR has decreasing marginal returns. First there is an increase in return due to the adoption of CSR, but after a while not anymore. This can be explained by the fact that stakeholders and companies do not have a difference anymore in their perceptions. Adding more CSR activities therefore will not give

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stakeholders the feeling that companies are better, because they are satisfied already. Flammer (2013) also looked at the industries. There is a difference in the effect CSR has on financial performance between the industries. Industries with higher degrees of institutional norms of CSR show a larger effect on financial performance. This can be explained due to the stakeholder expectations in these industries. These stakeholders put more emphasis on CSR and therefore there will be a larger effect when these companies adopt more CSR activities. Lech (2013) finds that there is a positive relationship between CSR and financial performance, but this is not significant. She argues that this could be because there is only a focus on the short term, while CSR most likely has more effects in the long-term. Besides that the author only focused on Polish firms, which could be a limitation as well.

However, other studies show a negative relation between CSR and financial performance (Friedman, 1970; Balabanis et al., 1998). Friedman (1970) argues that companies only have one social responsibility and that is to maximize profit. The adoption of CSR will result in costs for companies, which will lower their profit. Besides that Friedman (1970) does not see it as a responsibility a companies to act in a more sustainable way. After all, according to him they should only focus on profit maximization. However, he does mention that CSR could have a positive effect for companies in the long-run. Companies will be associated with better social and environmental manners, which could lead to more loyal customers. Balabanis et al. (1998) show that capital markets are rather indifferent on the extent companies adopt CSR. More important, they show that participants of the capital market react in a negative way on the degree of CSR of companies. This suggest that there is more than only CSR which reflects investors’ perceptions about financial performance of a company. Balabanis et al. (1998) also argue that there should be more scope on stakeholder engagement to investigate the relationship between CSR and financial performance more in depth.

Previous studies show different views on the question whether or not CSR leads to better financial performance (Friedman, 1970; Balabanis et al., 1998; Flammer, 2013; Lech, 2013). Regardless of what the answer on this will be, it is important for companies to have profitable activities for their existence. Companies therefore need to raise capital to be able to engage in activities. It is thus important to look at the accessibility of capital of companies. Also, in previous papers the authors took into account several aspects which should be considered as well when looking at the accessibility of capital for companies. For example, in the paper of Flammer (2013) industry effects are taken into account. Different industries have different effects on their financial performance. This can also have an effect on the ability to 15

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raise capital for companies in different industries. Therefore, when assessing the relationship between CSR and access to capital, the results on the relationship between CSR and financial performance should also be taken into account.

2.3 Ethics

Before access to capital will be discussed it is important to discuss the concept of ethics. According to Lewis & Unerman (1999) ethics is concerned with understanding what determines whether something is good or bad. They argue that CSR therefore can be considered to be grounded in ethics. Without the understanding of ethics managers would not know in what respects the impacts of their organization are regarded as good or bad.

Therefore, it is deemed important and essential that ethics is taken into account when discussing CSR. Besides this, investment decisions of both shareholders and debtholders are based on information they receive from companies and credit rating agencies. Before discussing this information there should be looked at the reliability and trustworthiness of this information. This is based on ethical grounds and therefore ethics should be assessed prior to assessing the relationship between CSR and access to capital.

Lewis & Unerman (1999) also show that there is an increase in ethical investments in the U.K. This indicates that investors are less likely to invest in companies which exploit the environment in order to make profits. This shows that investors are calling for more ethical companies for their investments. A similar result is shown by Choi & Pae (2011), who argue that there is a positive relationship between corporate commitment to business ethics and financial reporting quality. They argue that companies with a higher level of ethical commitment have lower earnings management. There is also more conservatism in their reporting and they are better able to predict future cash flows accurately compared to companies with lower level of ethical commitment.

On the other hand Duff & Einig (2014) discuss the ethical behavior of credit rating agencies. Credit rating agencies often have a close relationship with the companies they rate, however, credit rating companies should act in the interest of investors. Therefore there can be a conflict of interest. This involves the ethical decisions credit rating agencies have to make in order to fulfill their duty to serve the interest of investors. Scalet & Kelly (2012) have also investigated the ethics of the industry of credit rating agencies. They conclude as long as ethics of the industry is not in the right place, i.e. in line with the interests of

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investors, the ratings they provide are also not right. Based on Duff & Einig (2014) and Scalet & Kelly (2012) doubts regarding the trustworthiness of credit ratings can be made. Access to debt is partly based on these credit ratings. Therefore, there can be doubt about the reliability of information for investors. It is important to take ethics into account, because it shows that investment decisions of debtholders are based on information which could not be based on ethical grounds.

2.4 CSR and access to capital

As discussed in the prior paragraph investors providing debt and equity make investment decisions based on the available information. Ethics is involved in this process. According to Bharath et al. (2008) companies with poorer audit quality have more stringent price (i.e. interest) terms than companies who possess better audit quality. This implies that audit quality will lower the interest on debt for companies. When audit quality improves investors have more trust in a company. Auditors are independent and therefore add trust to investors’ perceptions of a company. When the audit quality improves, it means that investors can have more trust in the company due to the lower chance of material errors in the financial statements. This increased trust results in lower interest rates on debt for companies. Therefore, higher audit quality decreases cost of debt.

Besides this, Kim et al. (2012) investigate whether socially responsible firms, which report on CSR, behave differently compared to other firms in their financial reporting. They investigate this by looking at earnings management. They argue that when constraining earnings management in financial reporting, the financial statements will be more reliable and transparent. The authors find that socially responsible firms are not only less likely to manage earnings through discretionary accruals, but also are less likely to manipulate real operating activities and are less likely to be involved in SEC investigations. Therefore, they provide evidence that socially responsible firms produce higher quality financial reports. This implies that socially responsible firms can have better access to capital due to their high quality financial reports (Bharath et al., 2008; Kim et al., 2012).

Coles et al. (2006) find that the higher sensitivity to stock price volatility in the managerial compensation scheme is, the more likely managers will have the incentive to both invest in riskier assets and implement more aggressive debt policy. This is not good for both investors and debt holders. While managers benefit from the upside potential with minimum

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downside risk, investors do want risk in order to have high returns. However, investors do want that managers take their interests into account. After all, investors’ intention is to have a profitable investment. Besides that debt holders are risk-averse, because they have lower chance of getting their money back. In case of bankruptcy debtholders are one of the last in line to be repaid. To be compensated for the increased risk both investors and debt holders will ask for more insurance. Jensen & Meckling (1976) show that debt holders, for example, will add more debt covenant to their contracts. By doing this the debt holders have more insurance that they will get their money back. They also show that shareholders are more likely to pay less for the shares of a company in order to be compensated for the risks they face. CSR can limit this risk and therefore lower cost of capital. In other words, this shows that with the use of CSR companies have a better ability to show useful information to society, which can lead to lower cost of capital in return.

2.4.1. Cost of equity

Research indicates that companies which report on CSR have better access to new capital and also face fewer costs. By reporting on CSR companies show potential shareholders that they are competitive and lower-risk investments (Cheng et al., 2014). CSR shows that a company is acting in a sustainable way in both environmental and societal aspects. Therefore, stakeholders will have more trust in these companies. Because of this increased trust stakeholders will be more likely to invest in these companies. Cheng et al. (2014) therefore argue that the degree of CSR lowers the cost of equity capital for companies. This is also due to increased commitment and engagement with stakeholders on the basis of mutual trust and cooperation (Jones, 1995). When adopting CSR stakeholders have more trust in these companies. Stakeholders see that companies share common beliefs and therefore agency costs will reduce. This will again result in lower cost of capital. Another study by Dhaliwal et al. (2011) show that investors are more likely to invest in more transparent companies. A way to provide more transparency is to provide a CSR report next to the financial statements. Due to increased trust in these companies, investors are more likely to lower the cost of equity capital. Further, they also find that firms with CSR performance superior to that of their industry peers enjoy a reduction in the cost of equity.

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2.4.2. Cost of debt

Besides lower cost of equity due to increased CSR, previous studies also show that CSR can lead to lower cost of debt. Goss & Robert (2011) show that CSR statistically significant lowers 7 to 18 basis points on bank loans. This implies that banks see CSR as a signal of trustworthiness of a company and its business. Also, CSR concerns have impact on the bank loan. When there are more CSR concerns, a bank will ask higher interest due to the increased risk. Therefore, it is deemed that a higher degree of CSR will lead to lower cost of debt. Drucker & Puri (2009) have found that loans have additional and restrictive debt covenants, particularly when agency costs and information asymmetry are more severe. As shown before CSR lowers information asymmetry due to the increased transparency and trust (Cheng et al., 2014; Dhaliwal et al., 2011). Debt holders have lower risk with lending when companies adopt CSR and will be both more likely to lend and ask lower interest. Therefore it is deemed that CSR will lower the cost of debt.

Demiroglu & James (2010) find that riskier borrowers are more likely to obtain loans with tight covenants. This can be explained by the higher risk lenders face when providing a loan. When companies use CSR and show that their business is yet both socially and environmental responsible, lenders will be more likely to lower the number of covenants on debt. This will also result in lower cost of debt, because lenders do not have to write contract containing these covenants anymore, or at least to a smaller degree. Chava (2014) also finds that lenders charge lower interest rates on bank loans to companies that derive significant revenue from environmentally beneficial products. Companies can report on environmental aspects via CSR reports. Thus, this shows again that CSR leads to lower cost of debt.

Further, Attig et al. (2013) have investigated the impact of CSR on firms’ credit ratings. They show that there is a significant positive impact of CSR on firm credit rating. Companies with higher social performance are rewarded with higher credit ratings by rating agencies. CSR conveys important non-financial information which credit rating agencies use in their assessment of companies. This indicates that CSR has a positive effect on credit ratings. With better credit ratings companies are more able to have lower cost of debt due to increased trust in their operations (Goss & Roberts, 2011). Also, Attig et al. (2013) find that the CSR investments that matter most for companies’ credit rating are those that are socially desired, going beyond a company’s direct economic benefits, but directly related to a company’s primary stakeholders. This means that companies tend to engage in projects

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which provide social benefit. However, their goal is to achieve this with minimizing costs and the hope that it will result in reputational benefits to the company. Yet again, in order to reach this companies need to make sure they operate in the desired way of stakeholders. Thus, when companies operate in a way which is perceived socially desirable by stakeholders they will be able to receive higher credit ratings. This will eventually result in lower cost of debt.

However, on the other hand Menz (2010) does not find that socially responsible companies receive lower risk premium. One reason for this is that credit ratings matter more for bond investors than CSR ratings. Within credit ratings rating agencies mostly take into accounts several environmental and social issues already and therefore an extra CSR rating does not seem to add informational value to bondholders. In short, bond investors don’t see an added value in CSR and therefore there is no positive relationship found between CSR and lower cost of debt. Another explanation for this result is that CSR might still be ignored by many bond investors as a valuation factor. The bond investors might leave out CSR rating due to reduced diversification possibilities when including this. Menz (2010) shows that there is not a positive relationship between CSR and cost of debt. However, at the same time he does show that higher credit ratings do add value to cost of debt for companies. Yet, the relationship between CSR and cost of debt measured by credit ratings is not conclusive.

2.5 Hypotheses

In order to measure for CSR, this study uses Corporate Social Performance (CSP) as a measurement. CSP is a rating on the CSR activities of companies. Therefore, the higher CSP is, the more likely it is that companies engage in more CSR related activities. In order to measure for access to capital, this paper uses two measurements: cost of equity capital and cost of debt.

As discussed before previous research has shown that CSR lowers the cost of equity capital. This is because companies which engage in CSR are deemed as lower risk investments by shareholders (Cheng et al., 2014). CSR helps companies to be better engaged with their stakeholders and therefore this results in a negative relationship between CSR and cost of equity capital. This is based on stakeholder engagement (Rinaldi et al., 2014). Besides this Dhaliwal et al. (2011) also show that CSR results in more transparency which also contributes to lower cost of equity capital.

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H1: Ceteris paribus, a relatively higher rating in Corporate Social Performance (CSP) leads

to lower cost of equity capital.

Next to cost of equity capital this study also considers cost of debt. Cost of debt is measured by credit ratings following the study of Attig et al. (2013). Previous research by Goss & Roberts (2011) show that companies engaging in CSR receive lower cost of debt due to the signaling effect of CSR. CSR shows that these companies are more trustworthy and transparent than companies which opt not to engage in CSR. Besides this Drucker & Puri (2009) and Demiroglu & James (2010) find that CSR tends to lower the number of debt covenants imposed on loans to companies which engage in CSR. A reason for this is that there is less information asymmetry following agency theory.

Further, Attig et al. (2013) have investigated the impact of CSR on firms’ credit ratings. Companies with higher social performance are rewarded with higher credit ratings by rating agencies. Also, when companies operate in a way which is perceived socially desirable by stakeholders they will be able to receive higher credit ratings. This will eventually result in lower cost of debt.

However, on the other hand Menz (2010) does not find that socially responsible companies receive lower risk premium. One reason for this is that credit ratings matter more for bond investors than CSR ratings. Earlier studies thus show mixed evidence regarding the relationship between CSR and cost of debt measured by credit ratings. However, most studies show a negative relationship. Also, lately there is increasingly more reporting on CSR and shows added value (Dhaliwal et al., 2012; Kim et al., 2012). Therefore, this paper expects that this paper will show similar results as most previous studies, namely that companies which engage in CSR receive higher credit ratings and this will result in lower cost of debt for these companies.

H2: Ceteris paribus, a relatively higher rating in Corporate Social Performance (CSP) leads

to lower cost of debt.

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3. RESEARCH METHODOLOGY

3.1 Sample selection

The data is retrieved from MSCI ESG STATS (formerly KLD), Compustat, The Center for Research in Security Prices (CRSP) and Thomson Reuters' Institutional Brokers Estimates System (I/B/E/S). The database of MSCI ESG STATS is used to extract information on CSR. MSCI ESG provides ratings of Corporate Social Performance (CSP), which is a measure of CSR. MSCI ESG evaluates on several dimensions, including community, corporate governance, diversity, employee relations, environment, human rights, product, alcohol, firearms, gambling, military, nuclear power and tobacco. The last six dimensions, however, are exclusionary categories in constructing CSR scores. Following Dhaliwal et al. (2011) and Attig et al. (2013) these categories are not included in this study, because it is not expected that these categories will affect the ability of companies to raise capital.

Furthermore, data from Compustat is accessed to measure the cost of capital. Cost of equity and cost of debt are used to measure access to capital. Compustat provides financial statement data from which cost of capital can be derived. Also, Compustat provides credit rating data which is used in order to measure the cost of debt.

CRSP maintains the most comprehensive collection of security price, return, and volume data for the NYSE, AMEX and NADSAQ stock markets. CRSP is used for data regarding stock, which will be used in both cost of equity and cost of debt. Lastly the I/B/E/S database will also be used. I/B/E/S provides consensus and detail forecasts from security analysts, including earnings per share, revenue, cash flow, long-term growth projections and stock recommendations. This database is used to derive data regarding earnings per share (EPS).

The sample consists of S&P 500 firms from 2003-2013. The sample for cost equity started with 6352 Compustat observations. Merging with MSCI ESG STATS, CRSP and I/B/E/S this sample is reduced to 2141 observations. The sample for cost of debt started with 5163 Compustat observations regarding credit ratings. Merging with MSCI ESG STATS, CRSP and I/B/E/S this sample is reduced to 2298 observations.

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3.2 Variable measurement

3.2.1 Cost of equity

This study follows the model of Dhaliwal et al. (2011) to measure cost of equity. Earlier both Dhaliwal et al. (2011) and El Ghoul et al. (2011) have used several models to measure the cost of equity. However, on this part this study will follow Reverte (2012) and only measure cost of equity by using the PEG ratio instead of using multiple measures. Reverte (2012) shows that the PEG ratio method of Easton (2004) is reliable. Therefore, the PEG ratio method is used to measure the cost of equity. The PEG method derives the cost of equity from the following equation:

CC

i,t

=

�

𝑒𝑒𝑒𝑒𝑠𝑠𝑖𝑖,𝑡𝑡+1_𝑃𝑃−𝑒𝑒𝑒𝑒𝑠𝑠𝑖𝑖,𝑡𝑡

0,𝑖𝑖

(1)

Where epsi, t and epsi, t+1 represent analysts’ consensus forecast of earnings per share for firm i

for one-year ahead and two-year ahead, respectively. P0, i is the stock market price of firm i’s

shares at the forecast date (end of year t). All these variables are derived from I/B/E/S.

As mentioned before MSCI ESG measures CSR based on seven qualitative issues. MSCI ESG measures these issues by rating on concerns and strengths. Following Attig et al. (2013) this study calculates a score for each qualitative issue equal to the number of strengths minus the number of concerns. Then, the sum of the qualitative issues are summed up to obtain an overall CSR score (CSR_S). However, this study takes into account all seven qualitative issues MSCI ESG uses in contrast to Attig et al. (2013). Attig et al. (2013) have excluded corporate governance, because in their research there was no conflict of interest between insiders and shareholders. However, in this study there is a conflict of interest, namely that of shareholders and debtholders in contrast to the companies. Shareholders and debtholders have different preferences and companies have to take into account these preferences (Jensen & Meckling, 1976; Rinaldi et al., 2014). By doing this, companies have to make a choice by leaving one party unsatisfied. Therefore, it is deemed that there is a conflict of interest in this study and corporate governance should be included.

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3.2.1.1 Control variables

In order to isolate the effects of the CSR variables a number of variables is used to control for this. This is done by following the research of Dhaliwal et al. (2011). The following variables are used: BETA, which is measured by using the market model beta based on daily data from CRSP in order to control for systematic risk; MB, the market-to-book ratio and SIZE, which is based on a natural logarithm of fiscal year-end market value of equity. Both MB and SIZE are derived from Compustat. According to Fama & French (1992) expected returns have a negative effect on both market-to-book ratio and firm size. Therefore, these variables are included to control for these effects on cost of equity. Besides this, the debt ratio (LEV) is included because debt servicing plays a monitoring role and debt holders demand greater disclosure (Dhaliwal et al., 2011). LEV is derived from Compustat as well and is defined as the ratio of total debt divided by total assets. Furthermore, according to Dhaliwal et al. (2011) implied cost of equity is positively associated with long-term growth. Therefore, an empirical proxy of long-term growth rate based on I/B/E/S analyst EPS forecasts (LTG) is included. LTG measures the difference between the two-year-ahead consensus EPS forecast and the one-year-ahead consensus EPS divided by the one-year-ahead consensus. Lastly, Dhaliwal et al. (2011) include LNDISP as well. This is included to control for analyst forecast dispersion, because they show that this is negatively associated with cost of equity and therefore this is included in this study as well. This is calculated by using the natural logarithm of the standards deviation of analyst EPS forecasts divided by the consensus forecast.

3.2.2 Cost of debt

Following Attig et al. (2013) the cost of debt from companies is measured by credit ratings. Consistent with Attig et al. (2013) the measure of firm credit ratings (RATING) is specified by transforming the long-term credit ratings compiled by Standard & Poor’s (S&P) and reported in Compustat to an ordinal scale. Attig et al. (2013) have used values from 8 to 1, however, this study assigns values from 9 to 1. This is done, because in this study there are also firms which have a lower score than CC. I assign a value of 9 if a company has an S&P rating of AAA, 8 if AA, 7 if A, 6 if BBB, 5 if BB, 4 if B, 3 if CCC, 2 if CC and 1 if D.

The measurement of CSR scores will be done according to Attig et al. (2013) as is discussed before. This will be done the same way as is done with the cost of equity. By doing

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this the CSR scores of both models will be similar and therefore more comparable and reliable than it would be the case if two different measures are used.

3.2.2.1 Control variables

In order to isolate the effects of the CSR variables a number of variables is used to control for this. This is done following the research of Attig et al. (2013). However, BETA is measured by following the studies of Dhaliwal et al. (2011), El Ghoul et al. (2011) and Reverte (2012) similar to BETA in the cost of equity model, which is measured by using the market model beta based on daily data from CRSP in order to control for systematic risk. Furthermore, the following variables are used: SIZE, as a natural logarithm of total assets in millions of US dollars in order to control for firm risk; COVERAGE, the ratio of earnings before interest and taxes plus interest expense divided by interest expense; MARGIN, the ratio of cash flow from operating activities to sales. It is expected that both COVERAGE and MARGIN are positively associated with credit ratings. This means that a greater interest coverage and a higher operating margin reduces default risk and in turn enhances firm credit ratings (Attig et al., 2013). Following, LEVERAGE, the ratio of long-term debt to total assets. Leverage is a measure for default risk. The higher the chance of default is, the more likely investors are to increase the cost of debt (Sengupta, 1988). CAPINT, the ratio of property, plant, and equipment to total assets is included as well in order to control for creditors’ security. This measures the amount of assets that can be claimed by creditors in case of bankruptcy. Therefore, the higher CAPINT, the more likely cost of debt is lower for companies (Attig et al., 2013).

Lastly, two dummy variables are included as well. BIG4, an indicator variable set to 1 if the firm hires a Big 4 auditor, and 0 otherwise; and LOSS, an indicator variable set to 1 if net come before extraordinary items is negative in the current year, and 0 otherwise. According to Pittman & Fortin (2004) retaining a Big 6 auditor can reduce debt-monitoring costs by enhancing credibility of financial statements, which enables companies to borrow at lower cost. Therefore, it is expected that companies having a Big 4 auditor will be more likely to have lower cost of debt. Following, Jiang (2008) shows that credit ratings are decreased following a reported loss. This implies that losses have a negative effect on credit ratings and therefore increase the cost of debt. Beatty et al. (2008) also find that cost of debt increase due to reported losses. The number of debt covenants increase with reported losses

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and therefore results in higher cost of debt. Therefore, it is expected that losses have a negative effect on cost of debt.

3.3 Empirical models

The first regression tests for the relationship between CSR and cost of equity, whereby a negative relationship is expected. According to Cheng et al. (2014) CSR will lower cost of equity due to shareholders’ perceptiveness that companies which engage in CSR are lower risk investments. Also, by engaging in CSR companies are seen as more transparent and therefore the cost of equity will be lower (Dhaliwal, 2011). In order to measure cost of equity the PEG ratio is used. The PEG ratio is seen as a reliable measure for cost of equity (Reverte, 2012). Further, I control for systematic risk, firm size, market-to-book ratio, leverage, long-term growth and analyst forecast dispersion.The regression to test for hypothesis one can be specified as followed:

CCi,t = 𝛽𝛽₀+ 𝛽𝛽₁𝐶𝐶𝐶𝐶𝐶𝐶 _ 𝐶𝐶i,t + 𝛽𝛽₂𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵i,t + 𝛽𝛽₃𝐶𝐶𝑆𝑆𝑆𝑆𝐵𝐵i,t + 𝛽𝛽₄MBi,t + 𝛽𝛽₅LEVi,t + 𝛽𝛽₆LTGi,t

+ 𝛽𝛽7LNDISPi,t + 𝜀𝜀i,t

Following, an ordered probit model is used to investigate the relationship between CSR and cost of debt, whereby a positive relationship is expected. Goss & Robert (2011) show that CSR lowers cost of debt due to increased trustworthiness. Furthermore, Demiroglu & James (2010) find that riskier borrowers are more likely to obtain loans with tight covenants. CSR will lower the riskiness and therefore the cost of debt. The cost of debt will be measured by using credit ratings. According to Attig et al. (2013) higher credit ratings will result in lower cost of debt due to increased trust. CSR is often taken into account when rating companies and therefore it is expected that credit ratings will lower the cost of debt. Therefore, it is expected that there is a positive relationship between credit rating and cost of debt. Further, I control for systematic risk, firm size, interest coverage, operating margin, leverage and capital intensity. Following, BIG 4 and LOSS are included as dummy variables. The regression to test for hypothesis two can be specified as followed:

RATINGi,t = 𝛽𝛽₀+ 𝛽𝛽₁𝐶𝐶𝐶𝐶𝐶𝐶 _ 𝐶𝐶i,t + 𝛽𝛽₂𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵i,t + 𝛽𝛽₃𝐶𝐶𝑆𝑆𝑆𝑆𝐵𝐵i,t + 𝛽𝛽₄𝐶𝐶𝐶𝐶𝐶𝐶𝐵𝐵𝐶𝐶𝐵𝐵𝐶𝐶𝐵𝐵i,t +

𝛽𝛽5𝑀𝑀𝐵𝐵𝐶𝐶𝐶𝐶𝑆𝑆𝑀𝑀 i,t + 𝛽𝛽₆𝐿𝐿𝐵𝐵𝐶𝐶𝐵𝐵𝐶𝐶𝐵𝐵𝐶𝐶𝐵𝐵i,t + 𝛽𝛽₇𝐶𝐶𝐵𝐵𝐶𝐶𝑆𝑆𝑀𝑀𝐵𝐵i,t + 𝛽𝛽₈𝐵𝐵𝑆𝑆𝐶𝐶4i,,t + 𝛽𝛽₉ 𝐿𝐿𝐶𝐶𝐶𝐶𝐶𝐶 i,t + 𝜀𝜀i,t

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4. DESCRIPTIVE STATISTICS AND EMPIRICAL RESULTS

4.1 Descriptive statistics

Table 1 gives an overview of the descriptive statistics of cost of equity, cost of debt and control variables for the whole sample.

Table 1 Descriptive statistics

N Mean SD Median Min Max 10% 25% 75% 90%

CSR_S 3759 1,024 4,098 0,000 -11,000 19,000 -4,000 -2,000 3,000 7,000 SIZE 3759 9,572 1,433 9,470 4,094 14,697 7,877 8,561 10,417 11,437 LEVERAGE 3759 0,216 0,157 0,194 0,000 1,511 0,031 0,106 0,303 0,411 COVERAGE 3629 70,055 1693,492 7,238 -179,601 97932,000 1,000 3,142 15,584 34,215 BIG4 3724 0,995 0,071 1,000 0,000 1,000 1,000 1,000 1,000 1,000 MB 3759 2,792 18,026 2,314 -652,023 759,618 0,000 1,285 3,726 5,583 LOSS 2742 0,057 0,231 0,000 0,000 1,000 0,000 0,000 0,000 0,000 MARGIN 3759 0,067 2,529 0,118 -101,706 1,179 0,000 0,055 0,210 0,316 BETA 3398 0,172 36,118 0,113 -546,397 545,612 -27,539 -5,620 5,652 28,342 LTG 3397 0,172 2,161 0,107 -20,925 103,520 -0,231 -0,008 0,241 0,505 CC 2520 0,472 0,420 0,400 0,000 11,640 0,190 0,292 0,541 0,752 LNDISP 3623 -3,570 0,994 -3,728 -6,178 2,068 -4,669 -4,273 -2,996 -2,262 RNDINT 3152 -0,002 0,035 0,000 -1,212 0,000 0,000 0,000 0,000 0,000 INDAINT 3152 0,013 0,028 0,000 0,000 0,286 0,000 0,000 0,013 0,042 CAPINT 3759 0,270 0,249 0,182 0,000 0,940 0,009 0,068 0,444 0,664 LEV 3759 0,172 0,169 0,159 0,000 1,562 0,000 0,000 0,269 0,390 RATING 3318 6,366 0,915 6,000 2,000 9,000 5,000 6,000 7,000 7,000

The mean (standard deviation) of CSR_S is 1,024 (4,098). This shows that companies within the sample have an average CSR score of 1,024. This is low, because companies can score on 7 qualitative dimensions for their CSR scores. Subsequently, the median of CSR_S is 0,000. The mean of CSR_S is higher than the median. Therefore, the mean could be overestimated, because there are extreme high values. Besides this the standard deviation is relatively high compared to the range of CSR scores, which implies that there is much dispersion within the sample.

The mean (standard deviation) for cost of equity (CC) is slightly positive. The mean (standard deviation) is 0,472 (0,421). This is in line with Dhaliwal et al. (2011). The median of CC is 0,400. The median is lower than the mean, which provides some information that there are more extreme high values. Following, the mean (standard deviation) for cost of debt (RATING) is 6.366 (0,915), which is relatively high (low). This shows the companies within the sample have a high credit rating on average and credit ratings among the companies show

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few dispersion. Also, the median of RATING is 6,000. The median is lower than the mean, which gives indication that there are extreme high values within the used sample.

With regard to the control variables used in the models, mostly the medians are lower than the mean is. This provides some information that the used data contains more extreme high values. This means that there are some high outliers. However, the differences are mostly minor. Only the difference between mean and median of COVERAGE is proportional. The mean is 70,055 whilst the median is 7,238. This shows that within the variable COVERAGE there are many extreme high values.

Table two gives an overview of the correlations. Significant correlations are shown in the matrix. The matrix shows that CSR is significantly related to both cost of equity and cost of debt. CSR is negatively and significantly associated with cost of equity at 5% significance level, which is consistent with hypothesis 1. Following, CSR and RATING are positively and significantly associated at 0, 1% significance level, which is consistent with hypothesis 2.

The matrix shows that there are no high correlations between the variables. This provides some evidence that multicollinearity is not an issue in the models. In case of multicollinearity the coefficients of the models may change proportionally when there are small changed in the models or the data. Therefore, low multicollinearity in this study can be seen as positive.

Following, table two shows that a number of used variables are correlated with many variables. For example, the variables SIZE, LEVERAGE and LOSS are highly correlated with many variables. This indicates that these variables tend to affect other variables more. On the other side, other variables show few correlation. For example, BIG4 and COVERAGE are mostly not correlated. This gives some indication that these variables barely affect other variables.

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4.2 Results cost of equity

Following, I analyze the results of the regression analysis for cost of equity. Table 3 reports the results of the relationship between CSR and cost of equity.

4.2.1 Regression analysis

Table 3 1

CSR and Cost of Equity

CC Coefficient SD t-stat. p-value

CSR_S -0,001 0,001 -0,71 0,476 BETA -0,001 0,001 -0,28 0,778 SIZE -0,005 0,005 -1,10 0,270 MB 0,001 0,001 1,07 0,285 LEV 0,045 0,034 1,32 0,186 LTG 0,160*** 0,006 25,60 0,000 LNDISP 0,117*** 0,007 17,31 0,000 Constant 0,901*** 0,051 17,70 0,000 Observations 2141 R-squared 0,388 adj. R-squared 0,386 F-statistic 193,12 p(F) 0,000

Standard Errors in parentheses *** p<0,001, ** p<0,01, * p<0,05

Hypothesis 1 predicts that a relatively higher rating in CSP leads to lower cost of equity. The regression shows that CSR is not significantly associated with a change in future cost of equity. This is not consistent with the results of Dhaliwal et al. (2011) and El Ghoul et al. (2011). Dhaliwal et al. (2011) suggest that CSR disclosure per se is not significantly associated with change in companies’ future cost of capital. However, they find different

1_{This table represents results of regression analysis of cost of equity on CSR scores and a number of controls.}

*** indicates that the estimated coefficient is statistically significant at the 0,1 percent level.

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results when comparing companies with superior CSR performance relative to their industry peers. Companies which have a higher CSR score relative to industry peers face lower cost of equity. The overall conclusion of Dhaliwal et al. (2011) suggest that CSR-disclosing companies with superior CSR performance achieve a reduction in the cost of equity capital. Following, in this study 38, 6% of cost of equity is explained by CSR scores. However, this adjusted R-squared is higher than Dhaliwal et al. (2011) have found, 25,8% respectively, which implies that more can be explained between cost of equity and CSR scores in this study. Even though a higher percentage of cost of equity can be explained, the results are not significant. Therefore, this study shows that hypothesis 1 cannot be accepted.

This can be explained by the used sample. The sample consists of S&P500 companies, which mostly engage in CSR disclosure. Global Corporate Sustainability Report (2013) show the number of companies reporting on CSR are decreasing in the last years. This can either mean that investors do not value companies reporting on CSR and companies therefore report less on CSR. Another explanation can be that most large companies are already reporting on CSR and it is therefore no longer seen as a competitive advantage. Therefore, less companies are likely to start disclosing CSR reports.

However, the results show that there is a significant positive relationship between LTG and cost of equity. Following Dhaliwal et al. (2011) LTG is included to proxy for long-term growth rate. The results show that the higher the long-long-term growth rate is, the higher the cost of equity is. This is not consistent with Dhaliwal et al. (2011). It is expected that this relationship is negative, because with higher long-term growth rate there is more certainty for investors. Therefore, investors are more willing to lower the cost of equity for these companies. However, this study shows the opposite. This can be explained by conservatism of investors (Bushee, 1998). Inventors might be less willing to invest in companies which have above average long-term growth rate. This can imply that these companies operate in more volatile environments. Investors are risk averse and therefore might ask for more return i.e. higher cost of equity. Another explanation can be that investors focus more on short term (Bushee,1998).Therefore they might value information for short term decisions more than long-term due to less uncertainty.

Subsequently, there is a significant positive relationship between LNDISP and cost of equity. Following Dhaliwal et al. (2011) LNDISP is included to control for analyst forecast dispersion. Therefore, this study shows that more analyst forecast dispersion contributes to a higher cost of equity. This is consistent with the results of Dhaliwal et al. (2011). When there is more dispersion among analysts, it means there is no uniform forecast for a particular

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company. This means that investors have more risk when investing, because analysts themselves are not sure about, for example, the solvability of these companies. Therefore, LNDISP increases the cost of equity.

4.3 Results cost of debt

Following, I analyze the results of the regression analysis for cost of debt. Table 4 reports the results of the relationship between cost of debt and CSR.

4.3.1 Regression analysis

Table 4 2

CSR and Cost of Debt

RATING Coefficient SD z-stat. p-value

CSR_S 0,013* 0,005 2,42 0,016 BETA 0,001 0,001 1,21 0,226 SIZE 0,319*** 0,019 17,11 0,000 COVERAGE 0,001* 0,001 2,39 0,017 MARGIN 1,330*** 0,221 6,02 0,000 LEVERAGE -2,392*** 0,184 -13,03 0,000 CAPINT -0,684*** 0,113 -6,04 0,000 BIG4 -1,373 0,754 -1,82 0,068 LOSS -1,106*** 0,101 -10,93 0,000 Constant cut1 -2,673*** 0,815 Constant cut2 -2,510*** 0,801 Constant cut3 -1,345* 0,773 Constant cut4 -0,259 0,770

2_{This table represents results of regression analysis of cost of debt on CSR scores and a number of controls.}

***, ** and * indicate that the estimated coefficient is statistically significant at the 0,1, 1 and 5 percent level respectively.

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Constant cut5 1,263 0,770 Constant cut6 2,855*** 0,772 Constant cut7 3,768*** 0,775 Observations 2298 pseudo R2 0,142 Chi-statistic 850,64 p(Chi2-statistic) 0,000 Log Likelihood -2579,129

Standard Errors in parentheses *** p<0,001, ** p<0,01, * p<0,05

Hypothesis 2 predicts that a relatively higher rating in CSP leads to lower cost of debt. The regression shows that there is a significant positive relationship between CSR and credit rating. The higher the credit rating of a company is, the lower the cost of debt is expected to be. Therefore, this finding confirms hypothesis 2.This is consistent with Attig et al. (2013). However, this study reports a significant relationship at 5% significance level whereas Attig et al. (2013) use a 1% significance level. This result supports the view that CSR is able to lower the cost of debt. Capital providers value CSR and therefore lower the cost of debt for companies which have a higher CSR score.

Following, several control variables are included which have been used in previous research by Attig et al. (2013). Consistent with Attig et al. (2013) the estimated coefficient on SIZE is positively and significantly at 1 % significance level. This shows that larger companies are less likely to default. Therefore, capital providers are more likely to charge lower cost of debt to larger companies. Both COVERAGE and MARGIN are also positively and significantly related to companies’ credit rating. This is also consistent with Attig et al. (2013), however, COVERAGE is significant at 5% level whereas Attig et al. (2013) find a significant relationship at 1% level. This suggests that greater interest coverage and a higher operating margin lower default risk. Due to this lower risk credit ratings increase. Subsequently, LEVERAGE and LOSS are negative and significant at the 0, 1% level, consistent with Attig et al. (2013). This shows that non-market risk reduces credit ratings of companies. With regard to LEVERAGE this means that the more leveraged a company is, the more it is likely that credit ratings are lower compared to less leveraged companies. This can be explained by the increased risk companies have with more outstanding debt, i.e. more default risk. Likewise LOSS lowers credit ratings due to increased default risk.

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This study shows that CAPINT is negative and significant at 0, 1% significance level. This contradicts previous literature (Attig et al., 2013; Pittman & Fortin, 2004). With regard to CAPINT it is expected that this is positive, because in case of bankruptcy assets of companies can be sold to cover the debts (Attig et al. (2013). However, it can be the case that companies finance their assets with debts. This can influence credit worthiness in a negative way.

Lastly, this study shows that BIG4 is not significantly related with cost of debt. This contradicts prior literature. It is expected that Big 4 auditors provide higher audit quality and investors therefore value the presence of a Big 4 auditor over a non-Big 4 auditor (Pittman & Fortin, 2004; Francis & Yu, 2009). However, Lawrence et al. (2011) find that the effect of Big 4 auditors is insignificant with regard to audit quality. Their results suggest that the differences between audit quality is largely reflected by client characteristics and client size. Therefore, it can be the case that a Big 4 auditor is not valued by investors, which can explain the result of this study.

5. ROBUSTNESS ANALYSES

In this section I report results of additional analyses that assess the robustness of the results by adding R&D intensity and advertising intensity to the original empirical models. Subsequently, I also test the robustness of the results by winsorization. With winsorization, I set the extreme small and large observations equal to the values of less extreme small and large observations, respectively. The data are winsorized at the first and 99th percentiles of their distributions. In the previous sections it is shown that there are extreme values within the sample. This could influence the outcomes and therefore I assess the robustness of the results by winsorization.

5.1 R&D intensity and advertising intensity

By including both R&D intensity and advertising intensity the results will be more robust. McWilliams & Siegel (2000) suggest that excluding R&D in a model is problematic, because literature links investment in R&D to improvements in long-run economic performance. R&D is considered to be enhance knowledge, which results in product and process innovation. This again results in higher productivity for companies. As discussed before financial performance is linked to ability of companies to have access to capital. Therefore, 34

Corporate social responsibility and access to capital for listed companies

Master Thesis: