Firms behaving badly? Investor reactions to corporate social irresponsibility

• Author: Vamsi K. Kanuri,Michelle Andrews,Reza Houston
• Date: 01 March 2020
• Published date: 01 March 2020
• DOI: http://doi.org/10.1111/basr.12193

Bus Soc Rev. 2020;125:41–70.

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41

wileyonlinelibrary.com/journal/basr

Received: 3 February 2020

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Accepted: 4 February 2020

DOI: 10.1111/basr.12193

ORIGINAL ARTICLE

Firms behaving badly? Investor reactions to

corporate social irresponsibility

Vamsi K.Kanuri1

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RezaHouston2

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MichelleAndrews3

© 2020 W. Michael Hoffman Center for Business Ethics at Bentley University. Published by Wiley Periodicals, Inc., 350 Main Street, Malden,

MA 02148, USA, and 9600 Garsington Road, Oxford OX4 2DQ, UK.

Vamsi K. Kanuri, Reza Houston and Michelle Andrews contributed equally.

1Mendoza College of Business, University

of Notre Dame, Notre Dame, IN, USA

2Ball State University, Muncie, IN, USA

3Goizueta Business School, Emory

University, Atlanta, GA, USA

Correspondence

Reza Houston, Ball State University,

Muncie, IN 47303, USA.

Email: rhouston@bsu.edu

Abstract

Corporate social irresponsibility (CSI) and other question-

able business incidents that appear to harm stakeholders fre-

quently afflict firms yet draw disparate investor reactions.

We address this disparity by investigating the association

between firm legal orientation and investor reactions to

CSI. We hypothesize the proportion of board members and

top management team (TMT) executives with law degrees

affects investor perceptions of firm foresight, and in turn,

their judgment of blame and consequent punishment. Based

on abnormal returns to 629 announcements of CSI and

308 publicly traded S&P 500 firms, we find that both too

small and too large a proportion of board of directors and

TMT members with law degrees lead investors to mete out

harsher punishment. This inverted u-shaped link is further

affected by firm size, firm risk, and industry competition.

Our investigation sheds light on the link between executive

education and financial performance in the context of CSI

and investor perceptions of foresight.

KEYWORDS

corporate social irresponsibility, event study, executive education,

investors, stock returns

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INTRODUCTION

In early 2009, aircraft manufacturer Boeing Co. announced plans to reduce its workforce by 4,500, rep-

resenting cuts of more than 5% (Gates, 2009). Weeks later, construction equipment maker Caterpillar

Inc. revealed plans to cut 20,000 workers, a slash equaling a tenth of its workforce (Goldman, 2009).

In the days following these announcements, Boeing incurred −3.8% cumulative abnormal returns

(CARs), while Caterpillar Inc. accumulated +1.9%. Varied investor reactions to reports of similar cor-

porate events are not limited to internal business concerns (events that occur within a firm), but man-

ifest for external environmental concerns (events that occur outside of a firm) as well. For instance,

revelations in 2008 that confectioner Hershey Co. allegedly violated environmental regulations drew

−1.2% CARs, yet news that automotive parts manufacturer Johnson Controls Inc. paid environmental

regulation fines yielded +4.8% CARs.

Why would reports of similar business concerns draw investor reactions that vary in both direction

and magnitude? Research on corporate social irresponsibility (CSI), defined as any business incident

that appears to harm the social good (Kang, Germann, & Grewal, 2016), suggests investor decisions

to punish afflicted firms are guided by their perceptions of blame (Strike, Gao, & Bansal, 2006). How

investors may develop these perceptions has yet to be explained. While studies have examined perfor-

mance implications of specific CSI events and the contextual factors that affect firm outcomes of CSI

(e.g., Godfrey, Merrill, & Hansen, 2009; Groening & Kanuri 2018; Hamilton, 1995; Kang et al., 2016;

Kashmiri, Nicol, & Hsu, 2017), internal organizational features such as the composition of a firm's

senior leadership that may govern how investors react to CSI has received limited scholarly attention.

Understanding how investors react to instances of CSI is critical to discerning the role shareholder

relationships play in stakeholder exchanges (Day & Fahey, 1988). In fact, because shareholder value

can be created through corporate social responsibility (Godfrey et al., 2009; Luo & Donthu, 2006),

in some instances such value can be destroyed through CSI. British Petroleum's Deepwater Horizon

oil spill in 2010 exemplifies a CSI incident that slashed shareholder value. Since a firm must manage

problems related to stakeholder relationships (Sen, Bhattacharya, & Korschun, 2006), firm perfor-

mance relies not only on maximizing shareholder value but also on maintaining and protecting it from

negative events.

To understand the drivers of investor reactions to CSI, we investigate an organizational feature that

may guide investor responses to afflicted firms.1

We propose that when assessing corporate culpa-

bility, investors will develop perceptions of blame (Lange & Washburn, 2012). This is because, after

reports of CSI break, the root causes are unlikely to immediately surface due to the complexity of

unraveling interactions between components, the noise of media speculations, and the reluctance of

firms to provide explanations (Bettis, 1983; Marcus & Goodman, 1991). To cope with their uncer-

tainty regarding the cause of the CSI, we contend that investors will rely on signals of the firm's ability

to have adequately prevented the event from occurring (Dutta, Biswas, & Grewal, 2007; Mazodier &

Rezaee, 2013; Xiong & Bharadwaj, 2013). A relevant and unbiased signal of a firm's ability to an-

ticipate CSI is how much influence key decision makers have on firm strategy (Greening & Johnson,

1997; Vaughan, 1983). For instance, the influence of IT and marketing personnel in top manage-

ment teams (TMTs) has been shown to help shield intra-industry firms from spillover effects of CSI

(Kashmiri et al., 2017). A key indicator of prevention may thus be the presence of strategic decision

makers who are trained to foresee the potential negative repercussions of firm decisions (Hambrick,

Misangyi, & Park, 2015; Sarpong & Maclean, 2014).

To determine whether firms had adequate foresight of the negative outcomes, we argue that in-

vestors pay particular attention to the proportion of board of directors (BOD) and TMTss members