Financial reporting quality and investment in corporate social responsibility

This study investigates the role of financial reporting quality in disciplining managers' investments in corporate social responsibility (CSR). While agency problems are endemic to all investment decisions, with respect to investment in CSR, the moral hazard problem that results in over-investment is likely exacerbated as CSR provides certain private benefits to managers that would not be expected from a typical investment. Consistent with higher-quality financial reporting reducing over-investment in CSR, I document a negative association between financial reporting quality and investment in CSR for firms operating in settings with higher likelihood of over-investment. Further, I show that there is a positive relation between investment in CSR and future profitability for firms with high-quality financial reporting whereas there is a negative relation between investment in CSR and future profitability for firms with low-quality financial reporting. Overall, these results suggest that higher-quality financial reporting improves CSR investment efficiency by mitigating moral hazard, resulting in an investment in CSR that benefits shareholders by improving future financial performance.