The impact of corporate social responsibility on corporate risk from a legal origin view and internationalization process

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The impact of corporate social responsibility on corporate risk

from a legal origin view and internationalization process

Abstract

The focus of this paper is to investigate how internationalization and legal origin can influence the relationship between corporate social responsibility (CSR) and

corporate risk. Specifically, multinational corporations vs domestic firms and common law vs civil law countries (legal origin) are compared. The research is conducted using a panel data of 36,135 firm-year observations for a sample period of 2002 through 2016. The findings suggest that firms that engage more in CSR

practices will have lower corporate risk. Furthermore, the findings support previous literature that the negative relationship between CSR and the firm risk is different as result of legal origin. As for internationalization, no significant result was found.

Name: Mizsharry Martis Student number: S2810441

Study Program: MSc International Financial Management Faculty: Faculty of Economics and Business

University: University of Groningen Supervisor: Dr. H. Gonenc

January 10, 2020

1 Table of Contents

1. Introduction ...2

2. Literature review ...4

2.1 Theories on corporate social responsibility and corporate risk ...4

2.1.1 Corporate social responsibility, firm risk and level of internationalization ...6

2.1.2 Corporate social responsibility, firm risk and legal origin ...7

3. Methodology ...9

3.1 Data and Variables definition ...9

3.1.1 Sample selection ...9 3.1.2 Dependent variable ...9 3.1.3 Independent variable ...9 3.1.4 Control variables ... 10 3.2 Regression model ... 11 3.3 Descriptive statistics ... 12 4. Results ... 16 4.1 Multivariate analysis... 16 4.2 Endogeneity control ... 22 5. Conclusion ... 24

5.1 Limitations and future research ... 25

6. References ... 26

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1.

Introduction

Corporate social responsibility (CSR) is an increasingly important subject as it plays a key role in business life and there is a vast amount of literature that inspects the reasons for CSR engagement and its influences on financial performance (Cai & He, 2014; Jo et al. 2014; Cai, Jo, & Cui, 2016). Due to this growing importance and emphasis on CSR, it is believed that investigating the CSR-firm risk association will provide information on the role that CSR plays in the risk management decision making of businesses, specifically the decisions that relate to environmental and social choices of the organization.

There are some institutional investors that show an inclination to invest in companies that practice particular socially responsible activities and a key reason to engage in CSR is the willingness to conform with environmental regulation and legislation (Walker et al., 2008). Regardless of the great focus on CSR in the literature, researchers have not arrived at an agreement on the importance or financial worth of engaging in CSR activities (Cai, Jo, & Pan, 2012). Worldwide, an increasing number of companies have been taking serious efforts integrating CSR into different aspects of their businesses (Jo & Harjoto, 2011). The

considerable grow of CSR practices has stimulated research on the relationship between CSR and performance. So far, this kind of research has mixed findings regarding the CSR effect (Jiao, 2010). As there are many reasons for companies to behave socially responsible, there are also consequences of not engaging in CSR such as reputational damage and legal

sanctions (Alder & Gooch, 2013). According to Klein & Dawar (2004) corporations use CSR engagement as insurance policy against risks and detrimental events, therefore the socially responsible behavior of firms can help minimize the risks of a harmful event (e.g. natural disasters, cyberattacks). Due to the advanced communication technology firms are more susceptible to media exposure, thus avoiding negative behavior has become more important.

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behave socially responsible and this perception increases the financial risk of a firm (McGuire, Sundgren and Schneeweis, 1988). Furthermore, prior study by Aupperle et al. (1985) showed that investors might forecast a cost rise in firms that behave socially

irresponsible, which can be the result of government fines. Although the previous studies look at the link between CSR and firm risk, none of them examine the effects of multinationals on the CSR-firm risk link. They neither investigate the CSR variation on firm risk across

countries from a legal origin perspective, so this paper aims to fill in this gap.

The main idea of this research is therefore to investigate if engaging in CSR reduces the amount of risk a firm faces. By investigating if the risk-reduction hypothesis, engaging in CSR practices to look good and hereby achieving long-term CSR-strategies that can ultimately decrease corporate risk, is the explicit motivation for firms to behave socially responsible. Additionally, the association will be analyzed to see if it is different for

multinationals and if it is different for countries with opposite legal origin. This leads to the following research questions:

- What effect does Corporate Social Responsibility has on Corporate Risk? - Does the impact of CSR on firm risk differs for multinationals?

- Does the impact of CSR on firm risk differs depending on the legal origin of countries?

Answering these questions can allow managers and other shareholders to understand the influence of CSR practices on their businesses, both domestic firms and multinationals. It will also enlarge managers view by providing information on the effect of legal system on CSR and business-risk that can be considered when making strategic planning.

For the analysis of this paper a panel data of 36,135 firm-year observations during 2002 to 2016 was used. The results state that firms with more CSR engagements will enjoy lower firm risk. Moreover, legal origin plays an important role in the relationship between CSR and firm risk, while internationalization does not affect this association. The results contribute to the literature of CSR and firm risk by using a large global sample and they highlight the

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relationship. The methodology will be discussed next, followed by the results. Finally, the research is concluded in the final section.

2.

Literature review

This section will contain background literature and theoretical arguments on the relationship between CSR and firm risk. Then the effect of internationalization and legal origin on this relationship will be discussed with their corresponding hypothesis.

2.1 Theories on corporate social responsibility and corporate risk

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According to Weber et al. (2008), risk reduction and risk management is one of the benefits of CSR. They introduce five main benefits from engaging in CSR on risk, which are direct financial effects, market effects, effects on businesses and production processes, effects on learning and organizational development, and non-market effects. The financial effects are in line with the research of Jo and Na (2012), which imply that engaging in CSR will have an effect on the accessibility of the financial markets and the growth in profit, resulting in a lower level of firm risk. The market effects are for example customer retention, meaning that the loyalty of customers is increased due to CSR practices, which will therefore contribute to a less volatile demand. The effects on business and production processes include lower production costs and less defaults contributing to a lower risk level. The effects on learning and organizational are for example the increased employee motivation resulting in fewer problems on the work floor and increased productivity. The non-market effects include the lower stakeholder resistance towards production facilities (Weber et al., 2008). Cornell and Shapiro (1987) also states that firms who have a higher CSR performance may have lower total risk, since they are less sensitive to external events.

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cost of a firm. Feldman et al. (1997) study shows that firms adopting a more environmentally pro-active posture experience a significant reduction in perceived riskiness to investors. With a higher level of non-diversifiable risk, low CSR firms will face higher cost of equity capital. Looking at the arguments mentioned above the next hypothesis is formulated:

Hypothesis 1: There is a negative relationship between corporate social responsibility and corporate risk.

2.1.1 Corporate social responsibility, firm risk and level of internationalization Early literature on the multinational corporation (MNC) posits a diversification benefit for MNCs, leading to lower levels of risk and to subsequently higher levels of debt, because they possess cash flows in imperfectly correlated markets. Initial research by Hughes, Logue, and Sweeny (1975) finds evidence consistent with the diversification benefit. However, there was also found that firm risk is positively related to internationalization, suggesting an increase in systematic risk with internationalization due to greater exchange rate risk (Bartov, Bodnar & Kaul, 1996 and Reeb, Kwok & Baek, 1998). An implication is that firm risk is increasing in corporate internationalization. This is consistent with the real behavior of firms as in practice, a high discount rate is asked for the evaluation of international investments as they have great uncertainty. Kwok and Reeb (2000) argue that when firms from more stable economies make international investments, it tends to increase their risk and leads to a reduction in debt usage. Similarly, Reeb et al. (1998) hypothesize that MNCs may have increased risk from a variety of risk factors (such as exchange rate risk, political risk, agency issues, asymmetric

information) hereby counterbalancing the diversification benefit.

Furthermore, it has been found that internationalization of firms has a positive relationship with CSR (Attig, Boubakri, El Ghoul, & Guedhami, 2016). Hitt et al. (2007) describes firm internationalization as “the process through which a firm expands the sales of its goods or services across the borders of global regions and countries into different geographic locations or markets”. On one hand, the internationalization process of firms can be used as a strategy to expand the competitive advantage of corporations (Nachum & Zaheer, 2005). This strategy can also be used to enhance the firm value by improving economies of scale and scope,

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This pressure that comes from stakeholders in a diverse environment instigates MNCs to engage in more CSR practices to demonstrate their receptivity to different stakeholders and to take harmless strategic decisions (Brammer et al., 2009). Multinationals that increase their CSR performance can achieve more economies of scope and can also protect their reputation, as they are frequently accused of being socially irresponsible (Kang, 2013). Most studies show evidence of a significant positive association between CSR and internationalization (Brammer et al., 2009; Kang, 2013; Attig et al., 2016), but the study of Simerly & Li (2000) found an insignificant relation.

So, as firms engage in the internationalization process they might have to deal with more risk, like litigation risk. Firms can decrease the perceived risk related to foreign expansion and improve their reputation as being socially responsible by engaging in more CSR practices. This raise in CSR practice can be an indication of the commitment of multinationals to the foreign market, thereby easing communication concerns (Zahra et al., 2000; Attig et al.,2016). The level of trust from stakeholders in the believe that firms behave socially responsible has an effect on their involvement with the firms and as mentioned before, adopting an

environmentally friendly attitude can considerably decrease a firms perceived risk(Feldman et al., 1997; Brammer et al., 2009).

Lastly, in the study of Cai et al., (2016) they control for the impact that multinationals might have on the relation between CSR and firm risk. In their results it showed to be significant at 1%level. This indicates that MNCs might moderate the relation between CSR and firm risk. Based on the arguments mentioned above, the following hypothesis is formulated:

Hypothesis 2: The negative relationship between CSR and firm risk is different for MNCs.

2.1.2 Corporate social responsibility, firm risk and legal origin

Kitzmueller and Shimshack (2012) state that corporate social responsibility is commonly used to describe stakeholder- oriented behavior. This brings up the question of why firms want to prove that they have altruistic characteristics rather than focusing only on profit maximization and why in some countries, firms tend to engage in CSR more, compared to firms in other countries. As mentioned above on one hand a frequently used justification is that

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beliefs do not explain the cross-country deviation in CSR, as they mostly investigate CSR associations for one country.

According to the law and finance theory, the legal system of a country influences its economic growth (Ciobanu, 2015). Additionally, legal system is categorized as a cause of economic development, as it has a crucial impact on the way that financial development in a country is promoted or stalled. So, the financial system of a country varies across countries legal origin (Graff, 2008). Theory differentiates between two main legal systems, the common law tradition and the codified civil law tradition. Civil law is originated from Roman law and uses different statutes and codes to control situations, particularly economical situations. Civil law contains different family of laws such as French, German and Scandinavian civil law. Common law is originated from England and includes laws modeled on the English law; there law is created by judges that are in charge to make decisions based on prior judicial decisions. Common law is completely independent from executive and legislative powers (La Porta et al., 1998; Ciobanu, 2015).

Most countries legal system is based on common law where they tend to provide better investor protection, than those countries which their legal system is based on civil law (La porta et al. 1997). Hail and Leuz (2006a), states that how a country-level legal protection of investors affect firms' valuations are still unclear. Legal protection can moderate the risk premium asked by investors. However, the existence of the relationship among legal

protection and the corporate risk is not obvious. It depends on the extent to which differences in legal protection leads to measurable differences in diversifiable or non-diversifiable risk across countries. Firms in countries with a common legal origin, tend to engage in CSR activities more often than those with civil legal origin (civil law). Based on this the following hypothesis is formulated:

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3.

Methodology

In this section the methods of the study will be presented. First, the data collection and sample construction are discussed. Then the dependent, independent and control variables are

explained, followed by the regression models. Lastly, the descriptive statistics for the regression variables are reported.

3.1 Data and Variables definition

3.1.1 Sample selection

In order to examine the relation between CSR and risk, data must be collected for both variables. The data collected for the analysis was from different sources. The CSR scores were gathered from Thomson Reuters ASSET4 database. The information for firm risk was collected from Thomson Reuters DataStream database. The focus of this paper is on legal origin and hence, the data was collected for different countries, representing common law and civil law. The civil law countries portray the family of laws (French, German and

Scandinavian) within civil law. Appendix A provides the legal origin data for all the countries that were used. Once all financial firms (SIC codes 6000-6799) were excluded as they have more leverage than firms in other industries, the sample consisted of 37,867 firm-year observation over the period of 2002-2016. The other industries were included in the sample and were classified by using SIC codes. Moreover, the dataset was ‘winsorized’ at the top and bottom 1% level in order to control for outliers. After exclusion of missing data, the sample consisted of 36,135 firm-year observations for the period 2002 through 2016.

3.1.2 Dependent variable

According to the modern portfolio theory, only systematic risk is important in asset pricing (Markowitz, 1952). The dependent variable in this paper is corporate risk. Therefore, to find out if there is a link between CSR and firm risk, CSR was regressed on the systematic risk. The CAPM (Capital Asset Pricing Model) has been used as a risk measurement where the beta coefficient represents the amount of market risk (Jo and Na, 2012). The CAPM was chosen as it is one of the most famous and frequently used asset pricing models (Cai, Jo, & Cui, 2016).

3.1.3 Independent variable

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acronym for environmental, social and governance, the three pillars mostly used as proxy for CSR. As mentioned above, the scores were collected from ASSET4 database within Thomson Reuters. The ESG information is based on more than 250 key performance indicators and more than 750 data points. CSR in this paper is the average of the environmental score and the social score. The environmental pillar measures the impact a firm has on its environment. The social pillar measures the capacity a firm has to gain trust and loyalty with its

community. The governance pillar has been left out as the definition in this paper does not include agency problems among shareholders and insides, thus it is assumed that all the firms have good governance.

Most other papers use MSCI’s ESG database, formerly known as KLD STATS or develop their own CSR rating instead of the ASSET4 database, it has a wide range of CSR ratings. The key difference between them is that KLD STATS has more subcategories than ASSET4. Nonetheless, the latter has worldwide information whereas the former is restricted to firms from United States. For this investigation international data is needed for the regression analysis, hence ASSET4 was used and also for its easy access.

3.1.4 Control variables

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for as it was not included in the definition of CSR, the WGI index1 is used, which is an

average of 6 governance score. Lastly, LEV is the leverage and is computed as long-term debt divided by total assets. This is expected to correlate positively as higher leverage tends to lead to higher risks.

Furthermore, degree of internationalization will be measured with foreign sales ratio, that is calculated as foreign sales divided by total sales and will be converted in a dummy variable (FSR), 1 for multinational corporations (MNC) and 0 for domestic firms. As for legal origin, it will be measured with a dummy variable (DLO), 1 for civil law and 0 for otherwise. Following the previous studies (e.g. El Ghoul et al., 2011; Salama et al., 2011; Cai et al., 2016), the predicted signs for these controls are the following: SIZE (-), MTB (-),CAPXR(+), OCF(-), AGR(+), GOV(-) and LEV (+).

3.2 Regression model

Respectively, the dependent variable and independent variable are firm risk and corporate social responsibility. To catch industry differences and year differences that might influence the relation between risk and CSR, industry and year dummies are included in the model (El Ghoul et al., 2011; Salama et al., 2011; Dhaliwal et al., 2014; Cai et al., 2016). As industry categories can have influence on CSR practices the industry dummy is used, whereas the year dummy controls for year specific events.

To examine the relationship between CSR and Risk, the following equations will be checked.

𝐹𝑖𝑟𝑚 𝑟𝑖𝑠𝑘

𝑖, 𝑡

= 𝛼 + 𝛽

1

𝐶𝑆𝑅

𝑖, 𝑡 − 1

+ 𝛽

2

𝐹𝑆𝑅𝑑𝑢𝑚𝑚𝑦

𝑖, 𝑡

+ 𝛽

3

𝑆𝐼𝑍𝐸

𝑖, 𝑡 − 1

+

𝛽

4

𝑀𝑇𝐵

𝑖, 𝑡 − 1

+ 𝛽

5

𝐶𝐴𝑃𝑋𝑅

𝑖, 𝑡 − 1

+ 𝛽

6

𝑂𝐶𝐹

𝑖, 𝑡 − 1

+ 𝛽

7

𝐴𝐺𝑅

𝑖, 𝑡 − 1

+ 𝛽

8

𝐺𝑂𝑉

𝑖, 𝑡 − 1

+

𝛽

9

𝐿𝐸𝑉

𝑖, 𝑡 − 1

+ 𝛽

10

𝐷𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦

𝑖, 𝑡

+ 𝛽

11

𝐷𝑌𝑒𝑎𝑟

𝑖, 𝑡

+ 𝜀

𝑖, 𝑡 (1)

𝐹𝑖𝑟𝑚 𝑟𝑖𝑠𝑘

𝑖, 𝑡

= 𝛼 + 𝛽

1

𝐶𝑆𝑅

𝑖, 𝑡 − 1

+ 𝛽

2

𝐷𝐿𝑂𝑑𝑢𝑚𝑚𝑦

𝑖, 𝑡

+ 𝛽

3

𝑆𝐼𝑍𝐸

𝑖, 𝑡 − 1

+

𝛽

4

𝑀𝑇𝐵

𝑖, 𝑡 − 1

+ 𝛽

5

𝐶𝐴𝑃𝑋𝑅

𝑖, 𝑡 − 1

+ 𝛽

6

𝑂𝐶𝐹

𝑖, 𝑡 − 1

+ 𝛽

7

𝐴𝐺𝑅

𝑖, 𝑡 − 1

+ 𝛽

8

𝐺𝑂𝑉

𝑖, 𝑡 − 1

+

𝛽

9

𝐿𝐸𝑉

𝑖, 𝑡 − 1

+ 𝛽

10

𝐷𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦

𝑖, 𝑡

+ 𝛽

11

𝐷𝑌𝑒𝑎𝑟

𝑖, 𝑡

+ 𝜀

𝑖, 𝑡 (2)

12

𝐹𝑖𝑟𝑚 𝑟𝑖𝑠𝑘

𝑖, 𝑡

= 𝛼 + 𝛽

1

𝐶𝑆𝑅

𝑖, 𝑡 − 1

+ 𝛽

2

𝐶𝑆𝑅 ∗ 𝐹𝑆𝑅

𝑖, 𝑡

+ 𝛽

3

𝑆𝐼𝑍𝐸

𝑖, 𝑡 − 1

+

𝛽

4

𝑀𝑇𝐵

𝑖, 𝑡 − 1

+ 𝛽

5

𝐶𝐴𝑃𝑋𝑅

𝑖, 𝑡 − 1

+ 𝛽

6

𝑂𝐶𝐹

𝑖, 𝑡 − 1

+ 𝛽

7

𝐴𝐺𝑅

𝑖, 𝑡 − 1

+ 𝛽

8

𝐺𝑂𝑉

𝑖, 𝑡 − 1

+

𝛽

9

𝐿𝐸𝑉

𝑖, 𝑡 − 1

+ 𝛽

10

𝐹𝑆𝑅𝑑𝑢𝑚𝑚𝑦

𝑖, 𝑡

+ 𝛽

11

𝐷𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦

𝑖, 𝑡

+ 𝛽

12

𝐷𝑌𝑒𝑎𝑟

𝑖, 𝑡

+ 𝜀

𝑖, 𝑡 (3)

𝐹𝑖𝑟𝑚 𝑟𝑖𝑠𝑘

𝑖, 𝑡

= 𝛼 + 𝛽

1

𝐶𝑆𝑅

𝑖, 𝑡 − 1

+ 𝛽

2

𝐶𝑆𝑅 ∗ 𝐷𝐿𝑂

𝑖, 𝑡

+ 𝛽

3

𝑆𝐼𝑍𝐸

𝑖, 𝑡 − 1

+

𝛽

4

𝑀𝑇𝐵

𝑖, 𝑡 − 1

+ 𝛽

5

𝐶𝐴𝑃𝑋𝑅

𝑖, 𝑡 − 1

+ 𝛽

6

𝑂𝐶𝐹

𝑖, 𝑡 − 1

+ 𝛽

7

𝐴𝐺𝑅

𝑖, 𝑡 − 1

+ 𝛽

8

𝐺𝑂𝑉

𝑖, 𝑡 − 1

+

𝛽

9

𝐿𝐸𝑉

𝑖, 𝑡 − 1

+ 𝛽

10

𝐷𝐿𝑂𝑑𝑢𝑚𝑚𝑦

𝑖, 𝑡

+ 𝛽

11

𝐷𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦

𝑖, 𝑡

+ 𝛽

12

𝐷𝑌𝑒𝑎𝑟

𝑖, 𝑡

+ 𝜀

𝑖, 𝑡 (4)

Where, CSR is the average of the environmental and social scores for firm i in year t-1 ; CSR*FSR represents the interaction effect between CSR and firm internationalization; CSR*DLO is the interaction effect between CSR and legal origin of countries; SIZE, MTB, CAPXR, OCF, AGR, GOV and LEV are the control variables described above for firm i in year t-1 ; DIndustry and DYear are the dummy variables to control for industry and year effects and ε is the error term. All the explanatory variables are lagged with 1 year, to control for endogeneity.

Regression models were estimated in order to test the developed hypotheses. Model 1 and model 2 tests the first hypothesis whether there is a negative relationship between CSR and risk. Model 1 test it by including the internationalization dummy variable and model 2 includes the legal origin dummy variable. Models 3 and 4 include an interaction effect with CSR, which is the test variable in this study. The interaction effect between CSR and

internationalization is included in model 3 to test the second hypothesis whether the negative impact of CSR on risk is different for multinationals. The third hypothesis is checked with model 4 by including the interaction effect between CSR and legal origin to examine whether the negative impact of CSR on risk is different for countries with different legal origins. All the models are tested using the ordinary least squares (OLS) method, with fixed effects, which is the generally used method.

3.3 Descriptive statistics

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of the CSR scores, a maximum of 98.095 and a minimum of 6.26, this explains that there are some firms that have higher CSR performance compared to others. For all the other variables it can be seen that the mean and medians are quite close to each other and there is no large difference between the minimum and maximum of the variables.

Panel B reports the correlation matrix between the response variable and its main explanatory variable and the control variables. Capital expenditure, asset growth and leverage show the expected positive relation to the dependent variable. Market-to-book ratio and operating cash flow also show the expected negative relation to the dependent variable. The predicted sign for size was negative, however the results shows a positive correlation to beta. This is also the case for the variable Gov. Additionally, the table shows that there is no problem with

multicollinearity. The highest correlation is of 0.486 between the variables CSR and size, but it is not high enough to suggest a multicollinearity problem. This positive association proves that large organizations invest more in CSR, this is consistent with the study of Hasseldine et al. (2005). There is only a -0.04 correlation between CSR and Beta.

Furthermore, table 2 provides descriptive statistics for the regression variables based on legal origin. The beta mean is higher in the common law countries (1.037) compared to the civil law countries (0.940), the standard deviation is also higher. In addition, the CSR mean is 60.497 in civil law countries and is 47.177 in common law countries, showing that firms in civil law countries display better CSR performance. These results are supported in the study by Dhaliwal et al. (2014) that reports how firms in stakeholder-oriented countries are

significantly more likely to engage in CSR practices.

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Finally, table 4 presents the descriptive statistics by year for the variables Beta and CSR. The year that has the highest number of observations (3356) is 2016, which also has the highest beta mean of 1.055. Whereas year 2002 has the lowest number of observation (715) and it also has the lowest mean beta of 0.873. This is also the case for the mean of CSR, where in 2016 has the highest mean of 57.965 and 2002 has the lowest mean of 49.971.

Table 1

Descriptive data for regression variables.

N Mean Median St. Dev. Min Max

Panel A. Descriptive statistics for all variables. Firm characteristics Beta 36.135 1.000 0.964 0.368 0.000 2.219 CSR 36.135 52.279 52.125 29.556 6.260 98.095 FSR 36.135 0.709 1.000 0.454 0.000 1.000 Size 36.135 15.330 15.311 1.479 9.492 19.979 Market-to-book CAPXR OCF Asset growth Governance 36.135 36.135 36.135 36.135 36.135 1.857 0.056 0.101 -0.135 1.201 1.437 0.041 0.094 -0.015 1.277 1.316 0.055 0.110 0.676 0.519 0.591 0.000 -0.466 -0.999 -0.947 9.124 0.361 0.512 2.878 1.970 Leverage 36.135 0.363 0.355 0.245 0.000 1.000 Country characteristic Legal Origin 36.135 0.383 0.000 0.486 0.000 1.000

Beta CSR Size Mtb Capxr Ocf Agr Gov

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This table presents descriptive statistics of the regression variables for the 36,135 firm-year

observations between 2002 and 2016. Panel A shows the mean, median, standard deviation, minimum and maximum of each variable. Panel B provides the correlation matrix for the main variables. Table 2

Descriptive statistics by legal origin.

Full Sample Common Law Civil Law

N Mean St. Dev. N Mean St. Dev. N Mean St. Dev. Firm characteristics Beta 36135 1.000 0.368 22293 1.037 0.400 13842 0.940 0.301 CSR 36135 52.279 29.556 22293 47.177 28.179 13842 60.497 29.871 FSR 36135 0.709 0.454 22293 0.681 0.466 13842 0.755 0.430 Size 36135 15.330 1.479 22293 15.090 1.514 13842 15.717 1.334 MTB CAPXR OCF Asset grow Governance 36135 36135 36135 36135 36135 1.857 0.056 0.101 -0.135 1.201 1.316 0.055 0.110 0.676 0.519 22293 22293 22293 22293 22293 2.011 0.060 0.103 0.077 1.295 1.403 0.061 0.123 0.603 0.385 13842 13842 13842 13842 13842 1.609 0.051 0.098 -0.476 1.049 1.119 0.042 0.085 0.647 0.653 Leverage 36135 0.363 0.245 22293 0.359 0.251 13842 0.369 0.234 Country characteristics Legal Origin 36135 0.383 0.486 22293 0.000 0.000 13842 1.000 0.000 This table presents descriptive statistics of the regression variables according to legal origin. Common law countries have 22,293 while civil law countries have 13,842 firm-year observations between 2002 and 2016.

Table 3

Descriptive statistics by industry.

Industry N Beta - Mean Beta - St. Dev. CSR - Mean CSR - St. Dev. Agriculture, Forestry & Fishing 169 0.846 0.301 41.407 25.144

Mining 3950 1.250 0.459 40.608 26.756 Construction 1521 1.079 0.360 49.266 29.978 Manufacturing 15767 1.017 0.352 59.807 29.167 Infrastructure (TCEGS) 6053 0.856 0.309 54.973 28.753 Wholesale Trade 1086 0.963 0.316 46.024 26.595 Retail Trade 2759 0.900 0.302 47.318 28.995 Services 4830 0.966 0.335 39.442 26.335 Total 36135 1.000 0.368 52.279 29.556

This table presents descriptive statistics of the regression variables for the 36,135 firm-year

16 Table 4

Descriptive statistics by year.

Year N Beta - Mean Beta - St. Dev. CSR - Mean CSR - St. Dev.

2002 715 0.873 0.442 49.971 28.813 2003 739 0.902 0.428 50.218 29.317 2004 1359 0.979 0.372 50.084 28.385 2005 1696 1.002 0.304 50.343 28.346 2006 1718 1.039 0.392 50.551 28.491 2007 1861 0.953 0.302 51.881 28.974 2008 2233 0.959 0.315 52.300 29.517 2009 2586 0.994 0.409 51.999 29.887 2010 3091 1.022 0.332 51.696 29.941 2011 3184 1.044 0.346 51.809 29.950 2012 3260 1.039 0.415 52.047 29.894 2013 3339 0.983 0.343 52.191 29.955 2014 3405 0.994 0.388 52.351 29.829 2015 3383 0.954 0.323 51.581 29.971 2016 3566 1.055 0.403 57.965 28.664 All 36135 1.000 0.368 52.279 29.556

This table presents descriptive statistics of the regression variables Beta and CSR for the 36,135 firm-year observations classified by firm-year for the period of 2002 through 2016.

4.

Results

Even though there is a lot of research on corporate social responsibility, there is not enough information over the impact of CSR performance on corporate risk, as discussed in the introduction. The purpose of this paper is to fill the gap in literature by investigating the connection between risk and the CSR practices of firms, with perspectives of legal origin and internationalization. The legal origin view includes civil law and common law countries, where the internationalization process deals with domestic versus multinationals. The next section will contain the multivariate regression. Followed by an endogeneity control test.

4.1 Multivariate analysis

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In general, the results show evidence of a negative relationship between corporate social responsibility and the firm risk. The overall CSR score (CSR_ES) is used as the test variable in models 1&2, while individual scores of CSR are used in models 3&4. Model 1 in table 5 inspects the influence of CSR on firm risk while controlling for internationalization (Panel A), legal origin (Panel B), year and industry fixed effects. The results suggest a negative

coefficient for CSR_ES, that is statistically significant when controlling for legal origin and internationalization. These results are consistent with the basic regression by Salama et al. (2011), Jo & Na (2012) and Cai et al., (2016), who also found a negative and statistically significant coefficient for CSR. For further analysis the firm-specific control variables (size, market-to-book, capital expenditure, operating cash flow, asset growth, governance and leverage) are included in model 2. The results in Panel A show quite a low negative

coefficient for CSR_ES, which is statistically significant at 1% level for internationalization. This is also the case for the CSR_ES coefficient from the legal origin perspective (Panel B), and it has a similar negative effect compared to the CSR_ES in Panel A. Additionally, both the FSRdummy and the legal origin dummy are significant at 1%level in the main relation. According to these findings it might be said that internationalization and legal origin play an equal role on the influence that CSR has on corporate risk.

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The regression outcomes in table 5 provides evidence in support of hypothesis 1 that there is a negative relationship between corporate social responsibility and corporate risk. This evidence is shown in model 2.

Table 5

Corporate social responsibility and firm risk. CSR_ES (1) CSR_ES (2) CSR_E (3) CSR_S (4) Panel A. Regressions results with internationalization dummy variable.

CSR -.0007*** (-9.361) -.0014*** (-18.194) -.0010*** (-13.730) -.0014*** (-20.021) Size .0349*** (20.415) .0313*** (18.350) .0347*** (20.701) MTB .0145*** (8.347) .0141*** (8.089) .0150*** (8.654) CAPXR .6822*** (16.776) .6864*** (16.836) .6703*** (16.504) OCF -.3377*** (-16.552) -.3444*** (-16.848) -.3312*** (-16.245) AGR .0330*** (10.349) .0293*** (9.195) .0366*** (11.446) GOV .0050 (1.206) .0068 (1.643) .0012 (.291) Leverage .0500*** (5.632) .0508*** (5.712) .0501*** (5.644) FSRdummy .0706*** (14.543) .0679*** (14.092) .0628*** (13.043) .0687*** (14.285) Intercept .8171*** (27.891) .2948*** (7.722) .3319*** (8.672) .3048*** (8.051)

Year effects Yes Yes Yes Yes

Industry effects Yes Yes Yes Yes

N 31522 31522 31522 31522

Adj. R2 0.1085 0.1383 0.1344 0.1402

Panel B. Regressions results with legal origin dummy variable.

19

Year effects Yes Yes Yes Yes

Industry effects Yes Yes Yes Yes

N 31522 31522 31522 31522

Adj. R2 _{0.1135 0.1416 0.1389 0.1438}

This table presents the results from the regression of the firm risk on the CSR scores over the period 2003-2016, as the variables were lagged by 1 year. The firm risk is measured by Beta and CSR is the average of the ES scores. Models 1 and 2 use the overall CSR score (CSR_ES) for the whole sample period. Models 3 and 4 reports the regressing of Beta on individual scores of the CSR_ES, namely, the environmental score (CSR_E) and the social score (CSR_S). Panel A presents the regression results with the dummy variable for

internationalization, while Panel B presents the results with the dummy variable for legal origin. Year and industry effects are included; robust t-statistics are reported within the parentheses.

*** Statistical significance at the 1% level.

Table 6 contains the regression of corporate risk on CSR proxies from an internationalization perspective by using the interaction effect between CSR and foreign sales ratio dummy (CSR*FSRdummy). In the first model the overall CSR score (CSR_ES) is used, while in the other models the individual scores of CSR are used. The first model contains the regression where the relationship of CSR and firm risk is inspected including the interaction effect and the firm-specific control variables. The results show a negative coefficient for CSR_ES that is statistically significant at 1% level and a statistically insignificant and positive coefficient for the interaction effect of CSR*FSRdummy. This result suggests that when domestic firms engage in CSR practices they will be able to reduce their corporate risk. However, for multinationals, the effect of CSR practices on risk is less negative relative to domestic firms, and the difference in the effect of CSR on firm risk between domestic and multinationals is not statistically different in model 1 and 3, but it is significant for environmental performance. This is consistent with the findings of Reeb, Kwok and Baek, (1998).

The remaining models 2 and 3 inspect the individual scores on corporate risk, including the interaction effect. Specifically, the environmental score (CSR_E) and the social score (CSR_S) are examined. The results display a negative coefficient for all the individual CSR scores and both scores are statistically significant at 1% level. Furthermore, the CSR* FSRdummy variable is statistically insignificant for the social score. However, the

20

The legal origin perspective of the relationship between corporate social responsibility and firm risk is presented in table 7. This correlation is observed by including the interaction effect between CSR and legal origin (CSR*DLO) in the model. The overall CSR score (CSR_ES) is used in models 1–3, whereas in models 4–5 the individual scores of CSR are used. The first regression (model 1) examines the effect of CSR on firm risk including the interaction effect and the firm-specific control variables. The results indicate a statistically significant negative coefficient for CSR_ES and a significant positive coefficient for

CSR*DLO, both are significant at 1% level. This suggests that the effect of corporate social responsibility on firm risk remains significantly negative and that the difference in the effect of CSR on firm risk between civil and common law countries is statistically different. To further explore the difference, the effect is presented in model 2 for civil law countries and model 3 for common law countries. The findings report that the effect is significantly positive for civil law countries at 5% level, meaning that civil law countries has a positive effect on CSR and by engaging in CSR practices they are able to reduce firm risk. Although there is a significantly negative effect for common law countries at 1% level, they are still able to reduce the firm risk through CSR performance. The reported results support the findings found in the research of Dhaliwal et al. (2014), where the negative relationship between CSR disclosure and corporate risk is strong for countries that are stakeholder oriented, which are civil law countries.

Furthermore, what is remarkable is that when studying the difference, the control variable GOV becomes statistically significant for civil law countries and common law countries, at 5%level and 1%level respectively. This indicates that the degree of corporate governance affects the firm risk when isolating firms in civil law countries and common law countries. Thus, it seems like firms in civil law countries that show better CSR performance will be able to significantly lower their firm risk. Additionally, firms in common law countries that engage in CSR practices will also be able to reduce their corporate risk.

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Finally, the findings in table 7 provide support for hypothesis 3, where the negative relationship between CSR and the firm risk is different for countries with different legal origin. Hence in general, the significantly negative effect is stronger for firms in civil law countries. According to the stakeholder perspective, firms with high CSR performance will be able to enhance their stakeholder relations, thereby bettering their financial performance. In this case the improved performance relates to lower firm risk, so, firms in civil law countries that engage into CSR practices can ultimately reduce their firm risks.

Table 6

Internationalization perspective of corporate social responsibility and firm risk. CSR_ES (1) CSR_E (2) CSR_S (3) CSR -.0015*** (-12.794) -.0012*** (-10.919) -.0013*** (-12.547) CSR*FSRdummy .0002 (1.133) .0003** (2.277) -.0002 (-1.288) Size .0348*** (20.245) .0310*** (18.136) .0349*** (20.722) MTB .0145*** (8.315) .0141*** (8.069) .0151*** (8.698) CAPXR .6807*** (16.730) .6828*** (16.735) .6713*** (16.527) OCF -.3372*** (-16.522) -.3436*** (-16.808) -.3317*** (-16.269) AGR .0331*** (10.379) .0295*** (9.256) .0365*** (11.418) GOV .0047 (1.123) .0064 (1.528) .0016 (0.391) Leverage .0499*** (5.619) .0508*** (5.703) .0502*** (5.662) FSRdummy .0608*** (7.647) .0500*** (6.773) .0763*** (9.991) Intercept .3019*** (7.804) .3443*** (8.907) .2966*** (7.724)

Year effects Yes Yes Yes

Industry effects Yes Yes Yes

N 31522 31522 31522

Adj. R2 .1383 .1345 .1402

This table presents the results from the regression of firm risk on the CSR scores from the internationalization perspective over the period 2003-2016, as the variables were lagged by 1 year. The firm risk is measured by Beta and CSR is the average of the ES scores. Model 1 use the overall CSR score (CSR_ES) for the whole sample period, whereas models 2 and 3 reports the regressing of Beta on individual CSR scores, namely, the environmental score (CSR_E) and the social score (CSR_S). Year and industry effects are included; robust t-statistics are reported within the parentheses.

22 Table 7

Legal origin perspective of corporate social responsibility and firm risk. CSR_ES (1) CSR_Civil (2) CSR_Common (3) CSR_E (4) CSR_S (5) CSR -.0014*** (-15.022) -.0005* (-1.855) -.0010*** (-3.617) -.0009*** (-10.769) -.0015*** (-16.947) CSR*DLO .0010*** (7.777) .0006** (2.269) -.0009*** (-3.469) .0009*** (7.407) .0009*** (7.039) Size .0369*** (21.665) .0207*** (8.386) .0485*** (21.296) .0329*** (19.427) .0379*** (22.692) MTB .0120*** (6.919) .0077*** (2.657) .0120*** (4.441) .0118*** (6.771) .0124*** (7.101) CAPXR .6199*** (15.295) .3757*** (5.712) .6600*** (12.725) .6241*** (15.371) .6136*** (15.161) OCF -.3234*** (-15.901) -.1751*** (-4.575) -.3651*** (-14.733) -.3303*** (-16.222) -.3172*** (-15.604) AGR .0137*** (4.068) -.0485*** (-11.625) .0751*** (14.497) .0115*** (3.426) .0157*** (4.641) GOV -.0040 (-.959) .0157*** (3.512) -.0751*** (-9.365) -.0042 (-1.001) -.0054 (-1.290) Leverage .0459*** (5.189) .1516*** (11.864) .0031 (0.259) .0465*** (5.246) .0460*** (5.202) Legal origin -.1425*** (-15.643) -.1388*** (-15.829) -.1344*** (-15.571) Intercept .3507*** (9.181) .3587*** (6.506) .3103 (6.100) .3905*** (10.196) .3425*** (9.046)

Year effects Yes Yes Yes Yes Yes

Industry effects Yes Yes Yes Yes Yes

N 31522 12330 19192 31522 31522

Adj. R2 .1432 .1079 .1574 .1404 .1451

This table presents the results from the regression of firm risk on the CSR scores from a legal origin perspective over the period 2003-2016, as the variables were lagged by 1 year. The firm risk is measured by Beta and CSR is the average of the ES scores. Model 1 use the overall CSR score (CSR_ES) for the whole sample period, whereas models 4 and 5 reports the regressing of firm risk on individual CSR scores, namely, the environmental score (CSR_E) and the social score (CSR_S). Model 2 uses the overall CSR score, but with an interaction for civil law countries and model 3 shows the interaction effect for common law countries. Year and industry effects are included; robust t-statistics are reported within the parentheses.

*** Statistical significance at the 1% level ** Statistical significance at the 5% level * Statistical significance at the 10% level.

4.2 Endogeneity control

In this subsection, following Cai et al. (2016), I run a test to deal with the problem of

endogeneity due to reverse causality and omitted variables. Specifically, the dynamic system GMM model is used to show that the negative association among CSR and firm risk is not defined by the simultaneity of omitted variables.

23

dynamic panel system it allows me to estimate the relation between CSR and risk, while including previous firm risk levels to take care of the dynamic aspects of the relationship between CSR and risk. So, to alleviate the issue that risk in the past period affects the CSR practice in the current period an extra explanatory variable is included in the models (1-4), specifically a lagged beta. However, in the GMM model the other explanatory variables were not lagged, only the additional one was lagged by 1 year. The results are presented in table 8 and it shows that there is hardly any difference in the results for this test and the previous findings.

Table 8

Dynamic panel system GMM regressions. GMM (1) GMM (2) GMM (3) GMM (4) CSR -.0007*** (-10.897) -.0005*** (-8.387) -.0008*** (-7.072) -.0007*** (-9.813) FSRdummy .0246*** (6.608) .0188*** (2.844) DLO -.0308*** (-8.803) -.0635*** (-8.777) CSR*FSRdummy .0001 (1.059) CSR*DLO .0006*** (5.158) Size .0126*** (9.730) .0135*** (10.466) .0125*** (9.656) .0136*** (10.536) MTB .0047*** (3.346) .0037*** (2.644) .0046*** (3.316) .0036*** (2.585) CAPXR .3245*** (9.987) .3075*** (9.486) .3233*** (9.943) .2982*** (9.192) OCF -.1203*** (-7.334) -.1155*** (-7.050) -.1196*** (-7.282) -.1126*** (-6.869) AGR .0218*** (8.496) .0145*** (5.348) .0219*** (8.533) .0139*** (5.115) GOV -.0011 (-.343) -.0026 (-.811) -.0014 (-.438) -.0051 (-1.581) Leverage .0345*** (5.105) .0330*** (4.881) .0344*** (5.089) .0328*** (4.853) Lag(beta) .6487*** (148.644) .6468*** (147.891) .6486*** (148.606) .6459*** (147.605) Intercept .0997*** (3.428) .1093*** (3.758) .1054*** (3.563) .1224*** (4.196)

Year effects Yes Yes Yes Yes

Industry effects Yes Yes Yes Yes

N 31522 31522 31522 31522

Adj. R2 _{.4915 .4920 .4915 .4924}

This table presents the robustness results for the findings reported in table 5-7 over the period 2003-2016, and it has 31,522 firm-year observations. The generalized method of moments was used for model 1-4, to examine endogeneity. The GMM models include a lagged beta as an independent variable, year and industry fixed effects. Moreover, GMM (3) and GMM (4) contains the findings for the interaction effect between CSR and

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5.

Conclusion

This paper investigates the effect of corporate social responsibility on the firm’s risk with an eye on internationalization and legal origin perspective. It enlarges the literature by examining the relationship regarding the internationalization process and for firms not only in the United States or United Kingdom, but worldwide with a focus on legal origin between civil law and common law countries. This research used a sample of 36,135 firm-year observations for the period 2002 through 2016, besides controlling for firm-specific characteristics (size, market-to-book, capital expenditure, operating cash flow, asset growth, governance and leverage) as well as year and industry fixed effects. Generally, the findings suggest that lower corporate risk is related with firms that engage in CSR practices and provides support for the first hypothesis.

From the internationalization perspective, the results show that multinationals tend to have high firm risk, which is consistent with the results of Reeb et al., (1998) and Cai et al., (2016). Furthermore, when looking at the effect of multinationals on CSR performance the results are insignificant, unless the environmental score is used. This suggest that the difference between multinationals and domestic firms on CSR-firm risk relation is small enough that it is not important in general. The small difference may be that multinationals invest more in environmental practices compared to social practices.

The findings for the legal origin perspective show that the negative influence of corporate social responsibility on firm risk in general is stronger for civil law countries. The data presents a significant positive effect on CSR for civil law countries, indicating that firms in civil law countries invest more in CSR and with better CSR performance they will be able to reduce their corporate risk. Statistics show that firms in civil law countries have higher CSR performance on average than firms in common law countries. This means that the relationship between CSR and firm risk significantly differs as a result of legal origin, consistent with the third hypothesis. This difference seems to be that firms in civil law country need high CSR performance in order to lower their firm risk, whereas for firms in common law countries with low CSR performance they are also able to lower their risk.

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and other stakeholders to understand the influence that CSR practices can have on their businesses, so they can take it into account for risk management strategies. Additionally, the comprehension of firm risk level is important for evaluating projects and determining the cost of capital.

5.1 Limitations and future research

Finally, this research has certain limitations. The proxy used for corporate social

responsibility only included the environmental and social score, as it was assumed that there is no agency problem between managers and shareholders, this is rarely the case, so it is possible that the variable is not accurately measured. Furthermore, beta was used to measure firm risk but, there is an aggregate number of studies proposing that idiosyncratic risk matters, thereby showing evidence in contrast to the classic asset pricing theory (e.g., Goyal and Santa-Clara 2003; Fu 2009; Cai, Jo, & Cui, 2016). This suggests that total risk would be a better measure of firm risk than beta as it contains firm-specific idiosyncratic risk and market risk. Lastly, the foreign sales ratio was converted into a dummy variable, thereby inhibiting some information. Maybe looking at the degree of internationalization can provide more information for the difference between multinationals and domestic firms.

The following topics might be interesting for future research. This research can be extended by looking if there is a difference for multinationals as a result of legal origin and as

mentioned above look at the degree of internationalization. It would also be interesting to examine the different categories of CSR regarding risk, the strengths and concerns.

26

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7.

Appendix

Table A Legal origin

Country N Legal Origin

Australia 2359 Common Law

Austria 146 Civil Law

Belgium 230 Civil Law

Brazil 488 Civil Law

Canada 2334 Common Law

Chile 139 Civil Law

China 540 Civil Law

Colombia 42 Civil Law

Czech Republic 26 Civil Law

Denmark 257 Civil Law

Egypt 54 Civil Law

Finland 323 Civil Law

France 1067 Civil Law

Germany 913 Civil Law

Greece 173 Civil Law

Hong Kong 1228 Common Law

India 507 Common Law

Indonesia 185 Civil Law

Ireland 138 Common Law

Israel 91 Common Law

Italy 389 Civil Law

Japan 4326 Civil Law

Korea 560 Civil Law

Luxembourg 35 Civil Law

Malaysia 280 Common Law

Mexico 205 Civil Law

Netherlands 373 Civil Law

New Zealand 174 Common Law

Norway 285 Civil Law

Peru 13 Civil Law

Philippines 101 Civil Law

Poland 126 Civil Law

Portugal 107 Civil Law

Russian 250 Civil Law

Singapore 428 Common Law

South Africa 584 Common Law

Spain 455 Civil Law

Sweden 533 Civil Law

Switzerland 608 Civil Law

Taiwan, China 765 Civil Law

Thailand 161 Common Law

Turkey 128 Civil Law

32

United States 10605 Common Law