We examine the effect of corporate social responsibility (CSR) on the cost of equity capital for a large sample of US firms. Using several approaches to estimate firms’ ex ante cost of equity, we find that firms with better CSR scores exhibit cheaper equity financing. In particular, our findings suggest that investment in improving responsible employee relations, environmental policies, and product strategies contributes substantially to reducing firms’ cost of equity. Our results also show that participation in two “sin” industries, namely, tobacco and nuclear power, increases firms’ cost of equity. These findings support arguments in the literature that firms with socially responsible practices have higher valuation and lower risk.

/pdf/does-corporate-social-responsibility-affect-the-cost-of-1l8602mes2.pdf

Does Corporate Social Responsibility Affect the Cost of Capital

The corporate information environment develops endogenously as a consequence of information asymmetries and agency problems between investors, entrepreneurs, and managers. We provide a framework for analyzing the three main decisions that shape the corporate information environment in a capital markets setting: (1) managers’ voluntary reporting and disclosure decisions, (2) reporting and disclosures mandated by regulators, and (3) reporting decisions by third-party intermediaries (analysts). We review current research on disclosure regulation, information intermediaries, and the determinants and economic consequences of corporate disclosure and financial reporting decisions. We conclude that in the last ten years, research has generated a number of useful insights. Despite this progress, we call for researchers to consider interdependencies between the various decisions that shape the corporate information environment and highlight changes in the economic financial environment that raise new and interesting issues for researchers to address.

The Financial Reporting Environment: Review of the Recent Literature

The financial reporting environment: Review of the recent literature

https://www.econ.kyoto-u.ac.jp/~hujii/myweb/GradSchool%202013%20AccA%20Barth%202001.pdf

The relevance of the value relevance literature for financial accounting standard setting: another view $

The theory of the growth of the firm

Recent literature has used analysts' earnings forecasts, which are known to be optimistic, to estimate implied expected rates of return, yielding upwardly biased estimates. We estimate that the bias, computed as the difference between the estimates of the implied expected rate of return based on analysts' earnings forecasts and estimates based on current earnings realizations, is 2.84%. The importance of this bias is illustrated by the fact that several extant studies estimate an equity premium in the vicinity of 3%, which would be eliminated by the removal of the bias. We illustrate the point that cross-sample differences in the bias may lead to the erroneous conclusion that cost of capital differs across these samples by showing that analysts' optimism, and hence, bias in the implied estimates of the expected rate of return, differs with firm size and with analysts' recommendation. As an important aside, we show that the bias in a value-weighted estimate of the implied equity premium is 1.60% and that the unbiased value-weighted estimate of this premium is 4.43%.

/pdf/effect-of-analysts-optimism-on-estimates-of-the-expected-4z8yx22wcr.pdf

Effect of Analysts' Optimism on Estimates of the Expected Rate of Return Implied by Earnings Forecasts

The nature of the data we usually encounter in market-based accounting research is such that the results of the regression of market capitalization on financial statement data are driven by a relatively small subset of the very largest firms in the sample. We refer to this overwhelming influence of the largest firms as the "scale effect". Firms with large price per share (and large "per share" accounting variables) have a similar effect. This effect is more than heteroscedasticity. It arises due to the non-linearity in the relation between market capitalization (price per share) and the financial statement variables.

Scale and Scale Effects in Market-Based Accounting Research

The nature of the data we usually encounter in market-based accounting research is such that the results of the regressions of market capitalization on financial statement variables (referred to ‘price-levels’ regressions) are driven by a relatively small subset of the very largest firms in the sample. We refer to this overwhelming influence of the largest firms as the ‘scale effect’. This effect is more than heteroscedasticity. It arises due to the non-linearity in the relation between market capitalization and the financial statement variables. We present the case that scale is market capitalization rather than a correlated omitted variable. Since scale is market capitalization, we advocate its use as a deflator in a regression estimated using weighted least squares. This regression overcomes the scale effect and the resultant regression residuals are more economically meaningful. Christie's (1987) depiction of scale is the same as ours but he advocates the use of the returns regression specification in order to avoid scale effects. We agree that returns regressions should be used unless the research question calls for a price-levels regression.

Scale and the Scale Effect in Market‐based Accounting Research

Strategy theory suggests that firms can impede mean reversion of economic rents by employing competitive efforts, thereby impacting profitability, forecasting, and valuation. We use realized operating performance to establish which competitive effort proxies effectively protect rents. The inclusion of competitive advantage proxies improves future accounting return forecasts and several efforts generalize across industries including power over suppliers and the credible threat of expected retaliation (Porter, 1980). Traditional barriers-to-entry proxies (product differentiation, innovation, and capital requirements) do not result in higher profitability once risk- and industry-adjusted. Finally, competitive efforts are not fully impounded into stock price, resulting in abnormal future returns.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2002395_code106918.pdf?abstractid=1012856&mirid=1&type=2

Which Competitive Efforts Lead to Future Abnormal Economic Rents? Using Accounting Ratios to Assess Competitive Advantage

Strategy theory suggests that firms can impede mean reversion of economic rents by employing competitive efforts, thereby impacting profitability, forecasting, and valuation. We use realized operating performance to establish which competitive effort proxies effectively protect rents. The inclusion of competitive advantage proxies improves future accounting return forecasts and several efforts generalize across industries including power over suppliers and the credible threat of expected retaliation (Porter, 1980). Traditional barriers-to-entry proxies (product differentiation, innovation, and capital requirements) do not result in higher profitability once risk- and industry-adjusted. Finally, competitive efforts are not fully impounded into stock price, resulting in abnormal future returns.

Gregory A. Sommers

Papers

Effect of Analysts' Optimism on Estimates of the Expected Rate of Return Implied by Earnings Forecasts

Scale and Scale Effects in Market-Based Accounting Research

Scale and the Scale Effect in Market‐based Accounting Research

Which Competitive Efforts Lead to Future Abnormal Economic Rents? Using Accounting Ratios to Assess Competitive Advantage

Which Competitive Efforts Lead to Future Abnormal Economic Rents? Using Accounting Ratios to Assess Competitive Advantage