Forecasting price delay and future stock returns: The role of corporate social responsibility

• Date: 01 July 2019
• Author: Yujing Gong,I‐Ming Jiang,Kung‐Cheng Ho,Chia‐Chun Lo,Andreas Karathanasopoulos
• Published date: 01 July 2019
• DOI: http://doi.org/10.1002/for.2600

SPECIAL ISSUE ARTICLE

Forecasting price delay and future stock returns: The role of

corporate social responsibility

Yujing Gong

1

| Kung‐Cheng Ho

2

| Chia‐Chun Lo

3,4

| Andreas Karathanasopoulos

5

|

I‐Ming Jiang

6

1

Wenlan School of Business, Zhongnan

University of Economics and Law,

Wuhan, China

2

School of Finance, Zhongnan University

of Economics and Law, Wuhan, China

3

Risk Management and Insurance

Department, Georgia State University,

Atlanta, Georgia

4

Prince Mohammad Bin Salman College

(MBSC), King Abdullah Economic City,

Kingdom of Saudi Arabia

5

Dubai Business School, University of

Dubai, Dubai, UAE

6

Faculty of Digital Finance, College of

Management, Yuan Ze University,

Taoyuan, Taiwan

Correspondence

I‐Ming Jiang, Faculty of Digital Finance,

College of Management, Yuan Ze

University, Taoyuan, Taiwan.

Email: jiangfinance@saturn.yzu.edu.tw

Funding information

Ministry of Science and Technology of

Taiwan, Grant/Award Number: MOST

106‐2632‐H‐155‐001; Fundamental

Research Funds for the Central Universi-

ties, Grant/Award Numbers:

2722019JCG021, 2722019PY036 and

2722019PY034; Zhongnan University of

Economics and Law, Grant/Award Num-

bers: 71803196, 71801226 and 71771217

Abstract

This paper investigates the role of corporate social responsibility (CSR) perfor-

mance in forecasting companys' stock prices and future returns. The forecast-

ing analysis identifies a negative association between CSR performance and

proxies of price delay. The negative CSR–delay association is weak for state‐

owned enterprises (SOEs) because of their politically oriented motivation of

CSR activities, but significantly strong for non‐SOEs. Furthermore, we find that

forecasting delayed firms is expected to have higher future returns. In particu-

lar, the returns premium is most attributable to the CSR component of delay,

compared with the non‐CSR component. Taken together, these results suggest

that CSR performance plays a positive role in enhancing stock price efficiency,

and a potential explanation is that CSR performance can be considered as addi-

tional information for equity predictions.

KEYWORDS

China, CSR, expectedreturns, forecasting price delay

1|INTRODUCTION

According to the efficient market hypothesis (EMH), stock

prices react to new information quickly and completely in

a frictionless financial market. However, a substantial

number of studies document empirical evidence of various

types of market frictions, such as incomplete information

(Merton, 1987), information asymmetry (Jones & Slezak,

1999; Wood, 1991), and short‐sale constraints (Miller,

1977), which potentially induce a delayed adjustment of

stock prices to new information (Hou & Moskowitz,

2005). Because the Chinese stock market is still an emerg-

ing market, improving its market efficiency and reducing

its market frictions are essential. In addition to rapid eco-

nomic development, the Chinese government has recog-

nized the concern of how to balance economic growth

Received: 9 October 2017 Revised: 30 September 2018 Accepted: 9 April 2019

DOI: 10.1002/for.2600

354 © 2019 John Wiley & Sons, Ltd. Journal of Forecasting. 2019;38:354–373.wileyonlinelibrary.com/journal/for

and the development of social responsibilities. Previous

studies suggest that corporate social responsibility (CSR)

activities raise a firm's reputation, prompting it to build a

more transparent information environment (Aguilera,

Rupp, Williams, & Ganapathi, 2007; Cai, Jo, & Pan, 2011;

Cui, Jo, & Na, 2016; Greening & Turban, 2000; Turban &

Greening, 1997). Hence, our first research question is

whether the performance of CSR activities is a valuable

information factor for investors that could enhance stock

price efficiency.

As Hou and Moskowitz (2005) suggest, stock price

delay is a response to market‐wide information that ade-

quately captures market frictions. Therefore, in our study,

we investigate the effectiveness of the Chinese capital

market by measuring stock price delay. Hou and

Moskowitz (2005) further argue that stock price delay is

mainly attributable to low recognition of firms by inves-

tors, which indicates that firms with greater stock price

delay require higher returns compensations. Based on

the liquidity theory, Lin, Singh, Sun, and Yu (2014) docu-

ment that the delay premium is due to the systematic

liquidity risk. CSR reports provide additional information

to outside investors about firms' future cash flows (Cho,

Lee, & Pfeiffer, 2013; Cui et al., 2016). Firms with poor

CSR performance are likely to be less recognized and illi-

quidity. Therefore, our second research question is

whether the CSR component of delay is associated with

higher future stock returns.

We measure the stock price delay by its delayed

response to market‐wide or firm‐specific news (Hou &

Moskowitz, 2005). We obtain the CSR performance data

of the Chinese listed firms from the Rankins CSR Ratings

(RKS) database, which draw from 153 measures over four

dimensions of CSR from 2009 to 2015. Consistent with

our prediction, we find that poor CSR performance fore-

casts strong price delay in response to information when

investor attention variables and illiquidity are controlled.

However, the negative association is significantly strong

for non‐state‐owned enterprises (non‐SOEs) but weak for

SOEs because of the political orientation of their CSR activ-

ities (W. Li & Zhang, 2010). As previous studies suggest,

firms' engagement in their social responsibility perfor-

mance is an endogenous concern (Cui et al., 2016; Ioannou

& Serafeim, 2015; Jo & Harjoto, 2011, 2012). Following the

method applied by Cui et al. (2016), we use the instrumen-

tal variable (IV) approach to alleviate the endogeneity and

observe that the negative association is sustained.

Furthermore, we investigate whether the CSR compo-

nent of delay predicts higher future returns. Previous lit-

erature suggest that nonfinancial reports can reduce

information asymmetry, which may predict future

returns (Brockhoff, 1984; Christodoulakis & Mamatzakis,

2008; Heilemann, 2002; Sheng & Thevenot, 2015). Our

research design allows us to separate the returns pre-

mium of delay into CSR‐associated component, which is

measured as the fitted value of delay explained by CSR,

and non‐CSR‐associated components. We find that both

total delay and the CSR component are associated with

higher future returns. Specifically, the CSR component

of delay explains almost 80% of the returns premium.

This result suggests that more delayed firms are compen-

sated by higher future returns, especially firms engaging

in fewer CSR activities. In addition, we also examine

whether CSR‐associated component of delay is able to

forecast future returns out of sample. Our results provide

strong support for the view that the CSR‐associated com-

ponent improves forecast accuracy of future returns.

Our paper makes a threefold contribution to the liter-

ature. First, this is the first paper to examine how CSR

performance influences stock price efficiency in the Chi-

nese stock market. It highlights the role of CSR activities

in the price information process. Second, the sizeable

number of public listed SOEs in China enables us to sep-

arately investigate the impacts of CSR performance on

stock price delay for SOEs and non‐SOEs. Our findings

on the association between CSR performance and stock

price delay are also relevant for other emerging countries

with SOEs. Third, we investigate how each component of

price delay forecasts future stock returns. Our results sug-

gest that firms with poor social performance are expected

to experience strong price delay and have great returns

premium in the future.

The rest of this paper is organized as follows. In

Section 2, we present the development of the Chinese

stock market and its CSR background. In Section 3,

we address the relevant literature and develop our

hypotheses. In Section 4, we discuss data collection

and methodologies. In Section 5, we present the results.

We conclude and explain the implications of the study

in Section 6.

2|CHINESE STOCK MARKET

The Chinese stock market was established in the early

1990s. Currently, the Shanghai (SHSE) and Shenzhen

(SZSE) stock exchanges list stocks in four boards: the

Shanghai main board, the Shenzhen main board, the

Shenzhen small and medium enterprises board, and the

Shenzhen ChiNext board. The split‐share structure is a

unique feature of the Chinese stock market that allows

public listed firms to have both tradable shares and

nontradable shares owned by the state or legal persons.

On April 30, 2005, the Chinese Securities Regulatory

Commission announced the split‐share reform, which is

intended to ensure that all shares of public listed firms

GONG ET AL.355