Does corporate social responsibility play a moderating role in trading silence prior to bad news earnings announcements?

• Published date: 01 July 2023
• Author: Atreya Chakraborty,Lucia Silva Gao,Sangwan Kim,Rongbing Liu
• Date: 01 July 2023
• DOI: http://doi.org/10.1002/jcaf.22625

Received:  December Accepted:  February 

DOI: ./jcaf.

RESEARCH ARTICLE

Does corporate social responsibility play a moderating role

in trading silence prior to bad news earnings

announcements?

Atreya Chakraborty1Lucia Silva Gao1Sangwan Kim1Rongbing Liu2

University of Massachusetts Boston,

Boston, USA

Framingham State University,

Framingham, USA

Correspondence

Sangwan Kim, University of

Massachusetts Boston, College of

Management,  Morrissey Blvd.,

Boston, MA , USA.

Email: sangwan.kim@umb.edu

Abstract

We examine whether corporate social responsibility (CSR) plays a role in mod-

erating trading silence prior to bad news earnings announcements. Unusually

low trading volume before the public release of negative earnings information

constrains price discovery. We find that unusually low trading volume prior

to earnings announcements is less pronounced for firms with a high level of

CSR activities. We also find that this effect is stronger before bad news earn-

ings announcements than good news earnings announcements. These findings

are robust to various alternative research design choices and to the endogeneity

concern between CSR and trading activity. Taken together, our study demon-

strates that CSR plays a moderating role in trading silence by improving firms’

pre-disclosure business and information environments.

KEYWORDS

corporate social responsibility, earnings announcements, short selling constraints, trading

silence

JEL CLASSIFICATION

G, M

1 INTRODUCTION

This paper examines whether corporate social responsi-

bility (CSR) plays a positive role in moderating trading

silence before bad news earnings announcements.Robust

trading activity enables price discovery by facilitating dis-

semination and market incorporation of new information.

Therefore, it is not surprising that trading silence, espe-

cially before the public release of negative information, can

cause mispricing (Akbas, ; Baruch et al., ). Does

a firm’s CSR strategy affect this potential mispricing by

reducing the severity of trading silence? This question is

the key focus of our paper.

One should expect CSR strategies to impact price dis-

covery. There is good evidence that credible signaling of a

firm’s CSR strategy requires making information on ethi-

cal, social, and environmental issues, often not mandated,

publicly available. As costly as these actions might seem,

they may be beneficial to the firm because evidence sug-

gests that credible CSR enhances intangible value (see,

e.g., Malik () for a recent review). Surprisingly, there

is little evidence on whether CSR stature also affects trad-

ing silence. This evidence is clearly very important for our

understanding of market activity prior to bad news earn-

ings announcements, which is particularly conducive to

mispricing. Our paper provides new empirical evidence

on this issue by documenting that CSR plays a moderat-

ing role in mitigating trading silence prior to the arrival

of negative earnings news. Given the role of trading vol-

ume in price discovery, our results point to a previously

282 ©  Wiley Periodicals LLC.J Corp Account Finance. ;:–.wileyonlinelibrary.com/journal/jcaf

CHAKRABORTY  .283

unexplored channel through which CSR can affect market

outcomes.

Two competing views exist about the association

between CSR and trading silence before the arrival of bad

news.Under the stakeholder view, the impact of CSR on

trading silence before bad news earnings announcements

can be explained by the enhanced reputation associated

with CSR engagement. As the relationship with vari-

ous firm stakeholders often involves unobservable and

implicit contracts (e.g., product quality and policy trans-

parency), CSR improves a firm’s reputation for honoring

its commitments. Consequently, companies with higher

CSR engagement are perceived as abiding by higher moral

standards and ethical behavior (Carroll, ; Jones, ;

McWilliams & Siegel, )andaremorelikelytoearn

the trust from investors and other stakeholders (Porter,

; Porter & Kramer, , ). Thus, the improve-

ment in trust and reputation serves as a mechanism

that moderates trading silence before bad news earnings

announcements. Additionally, firms with good reputa-

tion will tend to disclose more information to keep their

reputation capital (Cui et al., ;Joetal.,). As eth-

ical managers feel obligated to improve the information

environment(Fisman et al., ), CSR increases the trans-

parency of corporate disclosures and investor relations.

These arguments provide indirect channels through which

CSR moderates trading silence before bad news earnings

announcements.

In contrast to the stakeholder view of CSR, the agency

view,based on the agency theory introduced by Jensen and

Meckling (, p. ), postulates that agency costs have

implications for the “social responsibility” of business,

as managers may sacrifice corporate resources through

CSR programs to pursue personal benefits (Hemingway &

Maclagan, ). Under the agency view, as CSR increases

the opacity of information environment, we anticipate that

CSR exacerbates trading silence before bad news earnings

announcements. A priori, it is difficult to predict if the

stakeholder view will outweigh the agency view (or vice

versa) and hence we seek empirical evidence to settle this

issue.

We measure a firm’s CSR environments using the

classification scheme developed by KLD Research and

Analytics, currently known as MSCI ESG STATS, as in

prior research (Kim et al., ). Following Akbas (),

we calculate abnormal trading volume as the change in

trading activity before earnings announcements relative

to a control period for the same firm, reducing the effect

of time-invariant firm attributes on our inferences. In our

baseline tests, we document that the degree of unusu-

ally low trading volume is less pronounced for firms

with a high level of CSR before earnings announcements

containing both positive and negative earnings surprises.

In our primary hypothesis tests, we find that the associa-

tion between CSR and pre-announcement trading volume

is more pronounced when upcoming earnings announce-

ments contain negative information than positive informa-

tion. The effect of CSR on the silence of trading activity

before bad news earnings announcements is economically

significant; we find that a one-standard-deviation change

in the aggregate CSR score is associated with an increase

of .% of the pre-announcement trading silence. This

amount is economically meaningful as it accounts for

approximately .% of the average firm’s trading silence

in our sample.

To addressthe endog eneity betweenCSR and unusually

low trading volume before bad news announcements, we

conduct two robustness tests by employing () the instru-

mental variable estimation and () the propensity score

matching technique.Our inferences are robust to instru-

mental variable estimation and propensity score matching.

Additionally, we utilize several alternative measures of

CSR to address the concern that measurement issues drive

our findings. Our inferences do not change when we use ()

CSR rank measures and () various alternative CSR scores

excluding one individual CSR dimension at a time.

One limitation of our study is that we can only assert but

not prove that our empirical measure (i.e., trading silence)

captures short seller trading behavior and not some other

classes of investor behavior that explains the relation

between CSR and trading participation. Further, our trad-

ing volume measure is constrained by the firm-level data.

Like other market research, detailed data on buying and

selling behavior at the investorlevel would allow for a more

accurate measure of short selling constraints. Another

limitation is the potential effect of endogeneity. Though

we show that abnormally low trading volume before bad

news earnings announcements varies with our measures

of CSR using the instrumental variables and propensity

score matching techniques, we cannot conclude that trad-

ing silence varies because of CSR. Nevertheless, because

our CSR performance measure is associated with a lack of

trading in the pre-disclosure environment, knowledge of

the relationship we document can be useful for investors,

regulators, and other market participants.

In summary, this study makes two contributions to the

extant literature. First, we provide new evidence on the

positive role played by CSR in capital markets. This high-

lights the trading volume channel of CSR. The trading

behavior of informed investors, such as short sellers, is

a topic of critical importance to regulators, given their

primary policy objective of leveling the playing field

(Aguilar, ; Verrecchia, ).Our results that CSR

moderates unusually low trading activity caused by short

selling frictions also implies that the positive sentiment

that the firm gains through its CSR performance has the