Goss, Allen. "Corporate Social Responsibility and Financial Distress." Working Paper, Ryerson School of Management, Toronto, 2007.
This study examines the possibility that corporate social responsibility may serve as a proxy for management skill. Noting that financial distress ('the inability of the firm to meet its obligations to debt holders) is regarded by some experts (e.g., Altman) as a sign of management shortcomings, the author comments that "there should be a negative and monotonic relationship between CSR scores and financial distress."
The study reviews 1,295 U.S. non-financial firms for the 1991-2003 time period. Working from established models of the probability of corporate distress, the study tests whether the addition of an overall social score derived from KLD data can improve their predictive power. This is accomplished via three separate analyses:
Univariate analysis: This demonstrates that "there is a statistically and economically significant difference in the likelihood of default in the next period between the firms in the top quartile (5.05%) and the bottom quartile (11.1%)." Key financial metrics, such as liquidity, operating income/total assets, and retained earnings/total assets are higher for strong CSR performers than for weak ones.
Multivariate analysis: The dependent variable is distance to default (DD) - a calculation of the probability of future default. "After controlling for the accepted accounting and market based determinants of distress, there remains an almost monotonic negative relationship between KLD scores and the probability of distress...the signs are consistent with the interpretation that good firms are less likely to experience financial distress..." This finding was statistically significant at the 1% level.
The author notes that the issue of causality is not addressed by the preceding analysis - "the correlation documented here might ... be explained by healthy firms being those with the luxury to invest in CSR." A Granger causality analysis is undertaken to disentangle these issues, but fails to "provide any support for normative arguments in favor of CSR."
LK comment: This study received an Honorable Mention in the 2007 Moskowitz Prize competition