DOI: 10.1111/1475-679X.12174 Journal of Accounting Research Vol. 55 No. 5 December 2017 Printed in U.S.A. Does Corporate Social Responsibility (CSR) Create Shareholder Value? Evidence from the Indian Companies Act 2013 H A R I O M M A N C H I R A J U∗ A N D S H I V A R A M R A J G O P A L† Received 6 October 2015; accepted 4 March 2017 ABSTRACT In 2013, a new law required Indian firms, which satisfy certain profitability, net worth, and size thresholds, to spend at least 2% of their net income on corporate social responsibility (CSR). We exploit this regulatory change to isolate the shareholder value implications of CSR activities. Using an event study approach coupled with a regression discontinuity design, we find that the law, on average, caused a 4.1% drop in the stock price of firms forced to spend money on CSR. However, firms that spend more on advertising are not negatively affected by the mandatory CSR rule. These results suggest that firms voluntarily choose CSR to maximize shareholder value. Therefore, ∗ Department of Accounting, Indian School of Business; † Roy Bernard Kester and T.W. Byrnes Professor of Accounting and Auditing, Columbia Business School. Accepted by Douglas Skinner. We thank an anonymous referee, Yakov Amihud, Bernie Black, Sanjay Kallapur, Simi Kedia, Yongtae Kim, Bill Kross, Stephanie Larocque (discussant), Suresh Radhakrishnan, Srini Rangan, Sri Sridharan, K.R.Subramanyam, Stephan Zeume (discussant), Hao Zhang, and workshop participants at 2015 MIT Asia Conference in Accounting, 2015 AAA conference and the Indian School of Business for helpful comments. We also thank Ranjan Nayak and Aadhaar Verma for providing excellent research assistance. Finally, we thank our respective schools for financial support. 1257 C , University of Chicago on behalf of the Accounting Research Center, 2017 Copyright 1258 H. MANCHIRAJU AND S. RAJGOPAL forcing a firm to spend on CSR is likely to be sub-optimal for the firm with a consequent negative impact on shareholder value. JEL codes: M14; M40; M41; M48 Keywords: CSR; shareholder value; Indian Companies Act 2013 1. Introduction Spending on certain forms of corporate social responsibility (CSR) is now mandatory in India.1 Clause 135 of the Companies Act (mandatory CSR rule, hereafter) passed by the Indian Parliament in 2013 requires a firm, which meets certain thresholds in any fiscal year, to spend 2% of its average net profits of the prior three years on CSR activities.2 A legislative mandate forcing corporations to spend funds on CSR activities is perhaps the first of its kind in the world. We exploit this unique setting to isolate the impact of CSR on shareholder value. There are two competing views on whether CSR affects shareholder value. The “shareholder expense” view, advocated most notably by Milton Friedman [1970], asserts that “the social responsibility of business is to increase its profits.” He goes on to argue that “if businessmen do have a social responsibility other than making maximum profits for stockholders, how are they to know what it is? Can self-selected private individuals decide what the social interest is?” Under Friedman’s framework, CSR activities of a firm are typically viewed as a manifestation of moral hazard toward the shareholder. The contrasting view, labeled here as the “stakeholder value maximization” view, following the “doing well by doing good” theory advanced in the management literature, argues that strategic CSR spending can increase firm value. The intuition is that a firm’s self-interested focus on stakeholders’ interests increases their willingness to support the firm’s operations in several ways (Kitzmueller and Shimshack [2012]). Existing empirical evidence on whether CSR creates shareholder value is inconclusive, partly because these studies are clouded by methodological concerns such as potential endogeneity, reverse causality, or omitted variable problems (Margolis, Elfenbein, and Walsh [2009]).3 The choice to conduct CSR is voluntary. Assuming firms spend their optimal level of 1 While the term CSR itself is not defined in the Indian Companies Act 2013, the Act does provide a list of activities that it considers to be CSR. We provide these details in section 3.1. 2 As per the mandatory CSR rule, if during any fiscal year a firm has either (1) a net worth of Indian Rupees (INR) 5,000 million (about U.S. $83 million) or more; (2) sales of INR 10,000 million (about U.S. $167 million) or more; or (3) a net profit of INR 50 million (about U.S. $0.83 million) or more, it is required to spend 2% of its average net profits of the last three years on CSR related activities. An exchange rate of 60INR = 1US$ is assumed for the conversion of INR to US$. 3 For reviews of the literature on CSR, see Griffin and Mahon [1997], Orlitzky and Benjamin [2001], Margolis and Walsh [2003], Orlitzky, Schmidt, and Rynes [2003], Margolis, Elfenbein, and Walsh [2009], and Kitzmueller and Shimshack [2012]. IMPACT OF CSR ON SHAREHOLDER VALUE 1259 CSR, on average, there ought to be no association between future firm performance and CSR in the cross-section (Himmelberg, Hubbard, and Palia [1999]). Hence, it is difficult to ascertain whether the observed associations between CSR and firm performance (i) are causal in nature; or (ii) are merely attributable to model misspecification due to the influence of unobserved firm level heterogeneity related to CSR (Himmelberg, Hubbard, and Palia [1999]). Second, as highlighted by Hong, Kubik, and Scheinkman [2012], reverse causality can drive the results as firms that are doing well, and are hence less financially constrained, are more likely to spend resources on CSR activities. Hence, firm performance could cause higher future CSR, as opposed to the other way around. Third, as Lys, Naughton, and Wang [2015] suggest, CSR could merely signal and not cause future profits. In sum, the correlation between CSR and firm value or firm performance, documented by earlier studies, albeit interesting, does not necessarily warrant a causal interpretation. To partially overcome these inferential problems, we exploit numerical thresholds specified in the mandatory CSR rule and employ a regression discontinuity design (RDD) to identify a potentially causal link between CSR and firm value.4 An RDD typically compares the outcomes just above and just below a discontinuous threshold, and attributes any differences in the outcome variable to the intervention that creates the discontinuity, assuming that but for the intervention, firms above and below the threshold are similar.5 Because the intervention is exogenously imposed, firms have no control as to whether they will receive the intervention or not. Hence, there is an equal probability that the firm might be assigned on either side of the threshold, thereby making RDD a close approximation of a randomized experiment near the threshold (Lee and Lemieux [2010]). However, an important limitation of RDD is that it captures treatment effects localized around the threshold and hence the results are not always generalizable to the entire population. In this paper, the discontinuity arises because, around the INR 50 million profit threshold exogenously determined by the mandatory CSR rule, a minor change in net income leads to a discrete change (i.e., a discontinuity) in the application of CSR rule. Such discontinuity classifies firms as AFFECTED (those who are required to comply with CSR rule) and UNAFFECTED (those who are not required to comply with CSR rule). Intuitively, there is no reason to expect systematic differences in a firm with a net income of INR 51 million and another with a net income of INR 49 million. Thus, any differences in the cumulative abnormal returns (CAR) around 4 Gow, Larcker, and Reiss [2016] document an increasing trend in the use of quasiexperimental methods to draw causal inference in accounting research and believe that papers using these methods are considered stronger research contributions. 5 See Imbens and Lemieux [2008], Lee and Lemieux [2010], and Robert and Whited [2012] for recent overviews on the RDD methodology and surveys of RDD applications in the economics and finance literature. 1260 H. MANCHIRAJU AND S. RAJGOPAL the significant CSR event dates (the outcome variable in our setting) for firms that are just above the threshold and have to comply with the CSR requirement and those that are just below the cutoff and did not have to comply, can be attributed to the CSR rule. Hence, our setting enables us to draw more reliable causal inferences on the impact of CSR on firm value. Ex ante, it is difficult to predict the impact of the mandatory CSR rule on shareholder value. In situations where firms’ CSR activities are not aligned with their shareholder’s interests (as suggested by Friedman [1970], Tirole [2001], Benabou and Tirole [2010], and Cheng, Hong, and Shue [2013]), the new mandatory CSR rule, via its increased reporting and governance requirements, will likely force firms to redirect their CSR spending to maximize firm value, leading thus to an increase in the shareholder value of firms affected by the rule. For instance, the increased scrutiny under mandatory CSR can force managers to cultivate relations with stakeholders that would pay off in the long run. However, if firms already conduct CSR to maximize their firm value before the law was passed, imposing binding legal constraints on their CSR choices will lead to declines in their shareholder values (Demsetz and Lehn [1985]). For example, if at equilibrium, a firm’s marginal benefits of CSR are lower than the marginal costs of CSR, then the firm will not spend on CSR. In such a case, requiring such a firm to spend 2% of its profits on CSR will only lead to a reduction of shareholder value. To test these predictions, we examine CAR of AFFECTED and UNAFFECTED firms around eight important event dates underlying the legislative passage of the mandatory CSR rule. Our main finding is that around these significant events, CAR for the AFFECTED firms is lower than the CAR for UNAFFECTED firms, suggesting an economically significant negative relation between CSR and shareholder value. We find that, on average, firms that are forced to spend money on CSR experience a 4.1% drop in the stock price around the eight events. Given that firms are required to spend 2% of their profits on CSR, to the extent CSR-related activities are negative NPV projects, the passage of this rule is likely to result in a 2% decline in shareholder value—corresponding directly to cash outflows of CSR activities. Although the 4.1% decline in shareholder value is not statistically different from 2%, interviews with CFOs of some of our sample firms suggest that the decline in shareholder value beyond 2% is plausible on account of factors such as the stock market’s perception of increased Governmental interference in business, increased compliance costs associated with reporting and monitoring CSR activities, and/or the diversion of scarce managerial time and effort to CSR activities that do not add to shareholder value.6 We then perform three cross-sectional analyses to identify conditions under which the mandatory CSR rule is likely to affect firm value differentially. 6 We hasten to add that we cannot empirically disentangle the impact of these conjectures on shareholder value. IMPACT OF CSR ON SHAREHOLDER VALUE 1261 These predictions are motivated by the “stakeholder value maximization” perspective of the management literature. Specifically, we examine whether the impact of CSR on shareholder value varies depending on the firm’s political connections, its advertisement spending, and its affiliation to a highly polluting industry. We find that the CAR for AFFECTED firms is less negative if such firms advertise. This is consistent with Servaes and Tamayo [2013] who argue that CSR and firm value are positively related for firms with high consumer awareness, as proxied by advertising expenditure. However, we find no consistent results for cross-sectional variation in stock price reactions to the mandatory CSR rule for AFFECTED and UNAFFECTED firms when we partition firms on political connectedness or on their membership in a polluting industry. We also examine whether the mandatory CSR rule impacts long-term value of the AFFECTED firms using Tobin’s Q as a measure of firm value. If investors consider CSR activities to be detrimental to firm value, then the Q of the affected firms should decline more, relative to that of unaffected firms, in the years when the likelihood of the passage of mandatory CSR rule increased. Consistent with our expectations, we find a greater decline in the Q of the AFFECTED firms in the years 2011 and 2013 relative to the Q of the benchmark UNAFFECTED firms. Overall, our results suggest that, on average, the mandatory CSR rule imposes significant net costs on firms that are required to comply with this regulation, leading to declines in shareholder value. We perform several additional tests to check the sensitivity of our results. First we test the basic assumption of RRD that firms should not be able to manipulate the rating variable and thereby select themselves in treatment and control groups (Lee and Lemieux [2010]). For this purpose, we examine the frequency distribution of firms around the thresholds and find no abnormal jumps. These results suggest that our RDD analysis is not affected by the possibility that potential treatment firms might have managed their profits/book value/sales to fall right below the cutoff to escape having to comply the law. Further, our results are robust to both nonparametric and parametric techniques of estimating the treatment effect. We make several contributions to the literature. First, our paper establishes a potentially causal link between CSR and firm value. Establishing causality between CSR and firm value is difficult due to potential confounding factors that may also contribute to a firm’s decision to engage in CSR. To overcome this hurdle, we use an RDD around regulatory change which forced certain firms to spend on CSR, as a mechanism to examine whether CSR indeed affects shareholder value. This research setting significantly mitigates endogeneity concerns and makes it more likely that changes in firm value around the event can be attributed to CSR. Second, we document a negative relation between mandatory CSR and shareholder value. Our finding suggests that if firms choose their CSR spending optimally before the law was imposed, there ought to be no relation between voluntary CSR and firm value. Forcing these firms to spend 1262 H. MANCHIRAJU AND S. RAJGOPAL on CSR therefore has a negative impact on shareholder value. A related implication of our paper is that studies that find an association between corporate outcomes (e.g., higher operating performance, lower cost of capital, or lower earnings management) and voluntary CSR spending need to grapple with the possibility that such associations are confounded by omitted variables, consistent with Himmelberg, Hubbard, and Palia [1999]. Third, a majority of prior studies consider voluntary CSR. To the best of our knowledge, we are the first to examine the impact of legislatively mandated CSR spending. Our results demonstrate that forcing firms to spend on CSR, on average, is likely to lead to negative consequences for shareholders. Finally, our study complements prior research that examines the effect of firm-specific characteristics on the relationship between CSR and shareholder value (e.g., Servaes and Tamayo [2013], Di Giuli and Kostovetsky [2014]). We show that firms with greater advertisement spending are less likely to be negatively affected by the mandatory CSR rule. Like any study that exploits a legislative change set in a particular institutional context, our paper also suffers from certain limitations relating to generalizability. It can be argued that the mandatory CSR activities prescribed by the Indian Companies Act 2013 are different in nature from the voluntary CSR seen in the rest of the world. Although the findings are relevant for India, it is unclear whether these findings can be applied to other parts of the world which have different economic and regulatory environments. We submit that, despite these generalizability limitations, the key findings of our paper have implications for efforts to encourage CSR in other economies. In particular, our study suggests that giving the firm flexibility to define what CSR means and letting it choose where it wants to direct its CSR spending is preferable from the shareholder’s perspective. 2. Related Literature and Hypotheses Does CSR affect firm value? The existing theoretical literature on this question can be categorized under two opposing views: (i) shareholder expense view; and (ii) stakeholder value maximization view. The shareholder expense view follows Milton Friedman’s [1970] assertion that “the social responsibility of business is to increase its profits.” Friedman argues that CSR involves managers spending shareholders’ money and “in effect imposing taxes, on one hand, and deciding how the tax proceeds shall be spent, on the other.” He considers CSR to be a drain on the firm’s valuable resources that should be utilized for shareholder value maximization. In contrast to the shareholder expense view, Freeman’s [1984] stakeholder theory argues that a firm should consider the interests of everyone who substantially affects (or is affected by) the welfare of the firm. Thus, social, environmental or ethical preferences of stakeholders can induce CSR activities (Baron [2001], McWilliams and Siegal [2001]). Such strategically motivated CSR activities can be profitable and the management IMPACT OF CSR ON SHAREHOLDER VALUE 1263 literature terms this thesis as “doing well by doing good.” 7 Following this stakeholder view, studies have documented that a high commitment to CSR activities is associated with attracting and retaining higher quality employees (Greening and Turban [2000]), improving the effectiveness of the marketing of products and services (Fombrun [2005]), increasing demand for products and services (Navarro [1988]), providing superior access to valuable resources (Cochran and Wood [1984]), generating moral capital or goodwill that tempers punitive actions by regulatory agencies during a negative event (i.e., an insurance effect) and thereby preserving or increasing firm value (Godfrey [2005]). The economics-based reasoning for profitable CSR is that these activities reduce transaction costs with stakeholders and provide net benefits to the firm. The theory of the firm, as advanced by Coase [1937] and expanded by Jensen and Meckling [1976], among others, views a firm as a nexus of contracts (both explicit and implicit) between shareholders and other stakeholders in which each group of stakeholders supplies the firm with critical resources. Firms that undertake CSR activities tend to develop a reputation for keeping their commitments associated with the implicit contracts. Consequently, stakeholders of these firms are more likely to contribute resources and effort to the firm and accept less favorable explicit contracts (compared to stakeholders of firms with no or low levels of CSR activities). The empirical evidence on the direct effect of CSR on firm value is mixed. Margolis, Elfenbein, and Walsh [2009], in their influential metaanalysis of roughly 167 studies, find that some studies document a positive effect when they regress firms’ financial performance (either accountingbased ROA or stock returns) on corporate goodness while others find a negative effect. The average effect across these studies is a small positive increase in firm performance. More recently, Dhaliwal, Li, Tsang, and Yang [2011] conclude that the voluntary disclosure of CSR activities (i) attracts institutional investors and analysts; and (ii) reduces the firm’s cost of capital. Servaes and Tamayo [2013] find that CSR activities and firm value are positively related for firms with high customer awareness. In contrast, Di Giuli and Kostovetsky [2014] find that Democrat-leaning firms are associated with more CSR activities than Republican-leaning firms, and increases in firms’ CSR ratings are associated with negative future stock returns and declines in ROA. This finding suggests that CSR activities that are motivated by the political affiliation of stakeholders come at the expense of firm value. While the discussion so far focuses on how voluntary CSR can be costly or beneficial to shareholders, we have to also consider the implications of mandatory CSR in India, as imposed by the Companies Act. There are several reasons why mandatory CSR activities and their disclosure may not benefit, and might even harm, shareholders. If Friedman’s view of CSR is 7 Benabou and Tirole [2010], Margolis, Elfenbein, and Walsh [2009], and Kitzmueller and Shimshack [2012] are some papers that review the literature on “doing well by doing good.” 1264 H. MANCHIRAJU AND S. RAJGOPAL indeed descriptively valid and firms optimally choose not to spend funds on CSR, imposing binding legal constraints on their CSR choices will lead to declines in their shareholder values. Once CSR spending and its reporting become mandatory, the Government could start prescribing how the CSR money should be spent, thereby limiting a firm’s flexibility in coming up with its CSR policies. Moreover, various interest groups may find it easier to lobby management to advance their environmental and social goals. Finally, mandatory CSR also comes with compliance obligations such as administrative costs associated with reporting information and the need for the board to monitor the firm’s CSR activities. While a new regulation could often impose net costs on shareholders, there can be circumstances where the regulation could be beneficial.8 In the pre-mandatory CSR period, managers potentially expend a sub-optimal level of CSR because of pressures to achieve short-term earnings targets. However, under mandatory CSR, managers may be nudged to cultivate relations with various stakeholders that might pay off in the long run. Moreover, managers’ CSR activities could reflect their own social preferences. Increased reporting and governance requirements imposed by the law might make firms redirect their CSR spending to maximize firm value. Finally, as discussed earlier, firms could use CSR activities to signal their commitment toward their implicit contracts. Mandatory CSR requires a firm to make its CSR policies more formalized and visible, which, in turn, could strengthen such a commitment. Hence, the terms of the firms’ explicit contracts could become more favorable to the firm. In summary, there are several ways in which CSR can either have a positive or negative impact on firm value. Based on this discussion our first hypothesis is: H1: The mandatory CSR rule affects shareholder value. We go on to hypothesize conditions under which mandatory CSR rule is likely to affect firm value differentially. Motivated by prior work on CSR, we consider whether the impact of CSR on shareholder value varies depending on the firm’s political connections, its advertisement spending, and its affiliation to a highly polluting industry. First, we consider the impact of a firm’s political connectedness on the relation between CSR and firm value. Faccio [2006] suggests that political connections can be of value to a firm in several ways including preferential treatment by government-owned enterprises (such as banks or raw material producers), lower taxation, preferential treatment in competition for government contracts, relaxed regulatory oversight of the company in 8 For example, Chhaochharia and Grinstein [2007] find that certain governance-related provisions of Sarbanes Oxley Act led to increase in firm value. Black and Khanna [2007] find that the governance reforms (Clause 49) introduced in India are associated with positive stock market reaction. Similarly, Black and Kim [2012] find that the 1999 Korean governance reforms also led to increase in firm value for the affected firms. IMPACT OF CSR ON SHAREHOLDER VALUE 1265 question, or stiffer regulatory oversight of its rivals. However, as pointed by Shleifer and Vishny [1994], politicians themselves will extract at least some of the rents generated by connections, and firm value will be enhanced only when the marginal benefits of the connections outweigh their marginal costs. CSR spending might constitute a potential mechanism via which a firm can satisfy the preferences of politicians and increase its ability to conduct business with the government and other entities with their political connections. Political connections assume greater importance in the context of India where government regulation is high, corruption is accepted as a ground reality, and enforcement mechanisms are unpredictable (Khanna and Palepu [2000]). Consequently, CSR activities can become an important part of corporate strategy to enhance these political ties. For example, in his inaugural Independence Day speech, the Prime Minister of India recently urged corporations to take up building toilets in schools as a priority under their CSR policies. Within four days, companies announced over INR 200 crore (US$ 33.33 million) of contributions to the government’s “Swachh Bharat” (Clean India) campaign.9 To the extent firms can use CSR as a mechanism to enhance their political ties, CSR can be valuable. Therefore, we hypothesize that: H2a: The negative (positive) effect of mandatory CSR rule on shareholder value is lower (higher) among firms that are politically connected. The marketing and management literature suggest that CSR activities of a firm can attract customers. Fisman, Heal, and Nair [2008], in their model, argue that consumers realize that only firms that care about product quality are willing to invest in CSR activities because purely profit-oriented firms (that can compromise on quality) find these investments to be “too expensive.” By engaging in CSR, firms are able to identify themselves as the ones selling better quality products. Further, socially responsible consumers (e.g., “green” consumers) are more likely to buy and some are even willing to pay more for products of CSR firms (Navarro [1998], Sen and Bhattacharya [2001]). Servaes and Tamayo [2013] find that CSR and firm value are positively related for firms with high consumer awareness, as proxied by advertising expenditure. They argue that a necessary condition for CSR to modify consumer behavior and hence affect firm value is consumer awareness of the firm’s CSR activities. Advertising expenditure increases the potential customers’ awareness of the firm, its products, and practices (including its CSR activities). This, in turn, is likely to increase the chances of a consumer identifying with the product, thereby enhancing revenue and eventually firm value. Following this logic, we hypothesize that: 9 http://timesofindia.indiatimes.com/india/Modis-Swachh-Bharat-call-gets-Rs-200-crorefrom-TCS-Bharti/articleshow/40384230.cms 1266 H. MANCHIRAJU AND S. RAJGOPAL H2b: The negative (positive) effect of mandatory CSR rule on shareholder value is lower (higher) among firms with high levels of advertisement expenditure. Finally, we investigate whether the negative effect associated with the mandatory CSR rule is relatively strong among firms in polluting industries. Once CSR becomes mandatory, environmental activist groups and local communities can pressure these firms to spend money on green technologies or environmental controls. While these investments can benefit the overall environment, they typically tend to yield limited firm-specific benefits. Hence, we hypothesize that: H2c: The negative (positive) effect of mandatory CSR rule on shareholder value is higher (lower) among firms that are in high polluting industries. 3. Research Design and Data 3.1 BACKGROUND OF THE COMPANIES ACT 2013 The Indian Companies Act, 2013 was enacted on August 29, 2013. This legislation attempts to overhaul a nearly 60-year-old Indian corporate law framework to bring it in line with global best practices. A unique feature of this Act is clause 135 (referred to as the CSR rule in this paper) which specifies that if in any given year, a firm has either (1) a net worth of Indian Rupees (INR) 5,000 million (about U.S. $83 million) or more; (2) sales of INR 10,000 million (about U.S. $167 million) or more; or (3) a net profit of INR 50 million (about U.S. $0.83 million), it is required to spend 2% of its average net profits of the last three years on CSR activities. For example, the rule implies that if in the year 2012, a firm that meets any of the three criteria has to spend 2% of profits averaged over the three years, 2010, 2011, and 2012. Similar to Iliev [2010], in the context of section 404 of the Sarbanes Oxley Act, these numerical thresholds help us disentangle the contribution of the CSR rule from other requirements of the Companies Act 2013 (e.g., enhanced corporate governance and disclosure norms, greater accountability of management and auditors; stricter enforcement, protection for minority shareholders, etc.) that apply to all listed firms, regardless of numerical cutoffs. The passage of Companies Act 2013 is a culmination of several years of effort. We focus on eight event dates that represent major milestones in the legislative passage of the Act. Figure 1 summarizes the timeline of events. These events are as follows: r Event # 1: The Companies Act was first introduced in the Lok Sabha (the lower house of the Indian parliament) on August 3, 2009 as the Companies Bill, 2009 (Bill, hereafter). The Bill in its original form had no clause on CSR. r Event # 2: The 2009 version of the Bill was referred to the Parliamentary Standing Committee on Finance, which submitted its report on IMPACT OF CSR ON SHAREHOLDER VALUE Event # 1 Aug 3, 2009 Event # 2 Aug 31, 2010 Event # 3 Feb 28, 2011 Event # 4 Dec 14, 2011 Introduction of the Company’s Bill 2009 in the Lok Sabha For the first time, Standing Committee on Finance inserts the notion of Mandatory CSR in its report Bowing to corporate pressure, the Ministry of Corporate Affairs announces that it is considering making CSR voluntary and not mandatory Government eventually goes ahead with the mandatory CSR and introduces a revised Company’s Bill in the Lok Sabha Event # 5 Jun 26, 2012 Standing Committee on Finance endorses the bill with no new changes relating to mandatory CSR 1267 Event # 6 Dec 18, 2012 Event # 7 Aug 8, 2013 Event # 1 Aug 29, 2013 The Companies Bill 2012, containing mandatory CSR clause, is passed in the Lok Sabha The Companies Bill 2012 is passed in the Rajya Sabha The President signs the bill and it is enacted FIG. 1.—Timeline of important events related to the passage of the mandatory CSR rule. August 31, 2010. The Finance Committee introduced the notion of mandatory CSR for the first time in its report dated August 31, 2010. Anecdotal evidence and reports in the popular press suggest that the Finance Committee, perhaps anticipating popular backlash that might result from a very progressive pro-business bill, inserted several new clauses to make the bill slightly more pro-development. The proposal mandating CSR spending was among these clauses and noted that: “every company having [(net worth of rupees 500 crore or more, or turnover of rupees 1000 crore or more)] or [a net profit of rupees 5 crore or more during a year] shall be required to formulate a CSR Policy to ensure that every year at least 2% of its average net profits during the three immediately preceding financial years shall be spent on CSR activities as may be approved and specified by the company.”10 r Event # 3: On account of protests from industry, the Ministry of Corporate Affairs announced on February 28, 2011 that it is considering making only the disclosure, as opposed to the actual spending, of CSR mandatory. The proposal for mandatory CSR attracted a lot of criticism from companies who argued that what they spend on community welfare, education, health, development, and environmental activism is for them to decide. Azim Premji, Chairman of Wipro Ltd., opposed mandatory CSR and argued that “my worry is the stipulation should not become a tax at a later stage ... Spending two per cent on CSR is a lot, especially for companies that are trying to scale up in these difficult times. It must not be imposed.” He also felt that a distinction should be made between personal philanthropy and CSR, which is a company activity.11 Murli Deora, the Minister of Corporate Affairs (the ministry 10 From a research design standpoint, as discussed later, it is important to note that these numerical cutoffs introduced on August 31, 2010, remained unchanged through various iterations of the bill until the bill became law. 11 http://businesstoday.intoday.in/story/azim-premji-aima-convention-corporate-socialresponsibility/1/198960.html 1268 r r r r r H. MANCHIRAJU AND S. RAJGOPAL that crafted the Companies Bill, 2009), also acknowledged that there was an argument as to whether the Government should mandate anything. Event # 4: The Ministry of Corporate Affairs eventually resisted pressure from corporate houses and went ahead with the mandatory CSR rule.12 Keeping in view the recommendations made by the Finance Committee, a revised Bill was prepared and the original Bill was withdrawn. The new Bill was introduced in the Lok Sabha on December 14, 2011. The Bill was again referred to the Finance Committee as certain new provisions, which had not been referred earlier to the committee, were included in this new Bill. Event # 5: The Finance Committee submitted its report on June 26, 2012. Event # 6: The Lok Sabha subsequently approved the Bill on December 18, 2012 and labeled it as the Companies Bill, 2012. Event # 7: The Companies Bill, 2012 was then considered and approved by the Rajya Sabha (the upper house of the Indian parliament) on August 8, 2013 as The Companies Bill, 2013. Event # 8: The Companies Bill, 2013 received the President’s assent on August 29, 2013 and has now become law. Under the hypothesis that CSR is value-destroying, we expect firms affected by the mandatory CSR rule to experience (i) negative stock market reactions on Event # 2, 4, 5, 6, 7, and 8 because each of these events is associated with an increased probability that the mandatory CSR rule will pass; and (ii) a positive stock market reaction on Event # 3 because it mitigates any possible harmful effects of the mandatory CSR rule by decreasing the probability that the legislation, in its proposed form, will pass. While the term “CSR” itself is not defined in the Act, Schedule VII of the Companies Act, quoted below, requires CSR activities of the firm to focus on at least one of the following areas: (i) eradicating extreme hunger and poverty; (ii) promotion of education; (iii) promoting gender equality and empowering women; (iv) reducing child mortality and improving maternal health; (v) combating HIV, AIDS, malaria and other diseases; (vi) ensuring environmental sustainability; (vii) employment-enhancing vocational skills; (viii) social business projects; (ix) contribution to the Prime Minister’s National Relief Fund or any other fund set up by the Central Government or the state governments for socioeconomic development, and relief and funds for the welfare of the scheduled castes, the scheduled tribes, other backward classes, minorities and women; and (x) such other matters as may be prescribed.13 12 Such resistance also suggests that reverse causality (from firm value to the implementation of the law) is highly unlikely. 13 Descriptive data on the magnitude and nature of CSR spending for one year, 2012, are presented in panels B and C of table 1. IMPACT OF CSR ON SHAREHOLDER VALUE 1269 The CSR rule also provides guidance on the enforcement mechanism needed to achieve the CSR goals. Specifically, it requires that a firm create a CSR committee consisting of three or more directors, at least one of which must be an independent director. The CSR committee is expected to devise, recommend, and monitor CSR activities, and the amounts spent on such activities. The new rule also requires that a firm must (i) publicly disclose an official policy on its CSR activities and document CSR activities implemented during the year in its annual report; and (ii) demonstrate a preference for local areas where they operate. While a company is not subject to liability for failing to spend on CSR, a company and its officers are subject to liability for not explaining such a failure in the annual report of the board of directors.14 Overall, the mandatory CSR rule of the Companies Act, 2013 is a unique regulation as it may be the first time in the world that a country has mandated expenditures for the public good, rather than simply tax companies or leave them to conduct CSR activities on their own. According to Ernst & Young, these provisions would generate over U.S. $2.5 billion of CSR spending annually. India is home to the largest concentration of poverty on the planet and can certainly benefit from this large inflow of funds to socially responsible activities. However, it is unclear whether such mandatory CSR improves or hurts shareholder value. 3.2 EVENT STUDY APPROACH AND ASSUMPTIONS To capture the effect of the CSR rule on firm value, we compare the CAR of AFFECTED firms to those of UNAFFECTED firms (controlling for other firm attributes that are likely to affect returns) around each of the eight key legislative events related with the passage of the Companies Act 2013, as outlined in section 3.1. On each event date, we classify a firm as AFFECTED or UNAFFECTED based on whether its profit/sales/book value for the most recent fiscal year end meets the thresholds mentioned in the CSR rule or not. For example, a firm whose profit equals INR 50 million for the fiscal year ended March 31, 2010 would be classified as AFFECTED when we consider the event date August 31, 2010. We measure abnormal returns by estimating the market model using 200 trading days of return data ending 11 days before the legislative event. The return on CNX 500 index is used as a proxy for market return.15 Daily abnormal stock returns are cumulated to obtain the CAR from day t−1 before the legislative event date to day t + 1 after the event date. 14 Failure to explain is punishable by a fine on the company of not less than INR 50,000 (about U.S. $833) and up to INR 25 lakhs (about U.S. $41,667). Further, officers who default on the reporting provision could be subject to up to three years in prison and/or fines of not less than INR 50,000 rupees (about U.S. $833) and as high as INR 5 lakh (about U.S. $8,333). 15 CNX 500 is a broad-based benchmark of the Indian capital market. It comprises of 500 firms that represents about 96% of the free float market capitalization of the stocks listed on National Stock Exchange of India (NSE). More details can be found at http://www.nseindia.com/products/content/equities/indices/cnx 500.htm 1270 H. MANCHIRAJU AND S. RAJGOPAL Before we proceed any further with the discussion of market reaction tests, we lay out certain crucial assumptions that we need to make to interpret these results. It is important to emphasize that we do not assume that the stock market has perfect foresight. Specifically, on any given event date, the stock market does not know (i) if and when the CSR law will eventually go in effect, and (ii) what the final form of the CSR law will look like when it is eventually passed. Hence, the events we examine represent the natural progression of a bill under the Indian parliamentary system. It is reasonable to assume that as we proceed along the time line of event dates (i) the probability of eventual passage of the law increases, and (ii) the probability of changes to the current version of the bill decreases. Therefore, the difference in the market reaction for the AFFECTED and UNAFFECTED firms on any event date captures the market’s assessment of the eventual passage of the law in its current form. We use such market reaction to proxy for the effect of CSR activity on firm value. It is important to note that our classification of firms into AFFECTED and UNAFFECTED does not induce any perfect foresight bias. As mentioned earlier, we classify a firm as AFFECTED or UNAFFECTED based on whether its profit/sales/book value for the most recent fiscal year end meets the thresholds mentioned in the CSR rule or not. However, it is not known whether that same company would continue to meet the profitability threshold at some point of time in future when the CSR rule is actually passed and is effective. We assume that the market considers the current level of profitability as an indicator of future profitability. Thus, we assume that firms that are classified as AFFECTED on a given event date before the passage of the law are also more likely to be classified as AFFECTED even after the passage of the law. This assumption is further strengthened by the fact that three firm characteristics (profitability, sales, and book value) are used to classify a firm as AFFECTED or UNAFFECTED. Because the numerical cutoffs related to these three firm characteristics represent either or conditions, it is unlikely that a firm classified as AFFECTED on a given event date will not be classified as AFFECTED in the future.16 16 These assumptions are reasonable because (i) the Companies Act with a CSR clause in it, even though introduced in 2010, eventually was passed in 2013; (ii) no changes were made in the threshold profit/sales/book value levels that would go in determining whether a firm will be affected by the CSR rule or not; and (iii) on average, about 83% of firms that we classify as AFFECTED in year t remain classified as AFFECTED in year t + 1. Similarly, 62% of firms that we classify as UNAFFECTED in year t remain classified as UNAFFECTED in year t + 1. In fact, with the benefit of hindsight, it can also be argued that the market fails to anticipate the time needed to shepherd the Indian Companies Act 2013 into law. For example, by reacting to Event 2 (figure 2b) as it did, the market is effectively acting as if the legislation will go into effect immediately. As it turns out, the legislation took another three years, by which time, whether a firm fell on one side of the cutoff in figure 2b is largely uncorrelated with whether the firm fell into the AFFECTED category in 2013. IMPACT OF CSR ON SHAREHOLDER VALUE 3.3 1271 BASIC SET UP OF A REGRESSION DISCONTINUITY DESIGN We combine the event study approach with a regression discontinuity design (RDD) to document the effect of CSR rule on firm value. The RDD technique was first introduced by Thistlethwaite and Campbell [1960] in a study that examined the impact of merit awards on future academic outcomes of students. In their setting, students with test scores, R, greater than or equal to a cutoff value c received an award, and those with scores below the cutoff did not receive an award. The process of granting merit awards generates a sharp discontinuity in the treatment variable (which is receiving the award, in this case) as a function of the rating variable (which is test score, in this case).17 More formally, the receipt of treatment is denoted by the dummy variable D ∈ {0, 1}, where D = 1 if R ࣙ c, and D = 0 if R < c. This framework assumes that individuals with scores just below the cutoff (who did not receive the award) are very much comparable to individuals with scores just above the cutoff (who did receive the award). Therefore, a discontinuous jump in Y at c can be attributed to the causal effect of the merit award because there is likely to be no reason, other than the merit award, for future academic outcomes, Y, to be a discontinuous function of the test score. The relationship between Y and R can therefore be estimated using the following regression model: Y = α + τ D + f (R) + ε, (1) where the term τ captures the effect of merit awards on future academic outcomes. The inferences drawn under an RDD approach are considered to be credible because the assignment of individuals in treatment and control groups is “as good as randomized” given that individuals cannot precisely control the assignment variable near the exogenously determined cutoff (Lee and Lemieux [2010]). Since the 1990s, the RDD technique has been used in a variety of economic contexts. Some recent applications of RDD in finance include: (i) Akey [2015] who estimates the value of a firm’s political connections by comparing the differences in abnormal stock returns of firms connected to candidates who just won/lost a close election; (ii) Flammer [2015] who estimates the effect of CSR on firm value by comparing the stock market reaction to firms whose CSR proposals pass/fail by a small margin of votes; (iii) Black and Kim [2006] who study Korean governance reforms, which apply to firms with assets greater than 2 trillion Korean Won, but not to smaller firms; and (iv) Iliev [2010] who studies the impact of section 404 of Sarbanes-Oxley, which applies to U.S. firms with $75M public float but not to the smaller firms. Our setting of the mandatory CSR rule nicely fits the RDD framework. The mandatory CSR rule imposes certain profitability/size cutoffs that 17 The rating variable is also referred to as forcing variable or the assignment variable in the literature. 1272 H. MANCHIRAJU AND S. RAJGOPAL classify firms as AFFECTED and UNAFFECTED. Assuming firms that are just above and below the cutoffs are fundamentally similar, unobservable firm characteristics are less likely to impact the relation between CSR and firm value. Further, there is no reason to believe that one group is more likely to undertake CSR activities than the other, thereby mitigating the concern that firms spending on CSR self-select themselves based on their private information about future profitability, as suggested by Lys, Naughton, and Wang [2015]. Therefore, any differences in the stock market reaction around key events related to the passage of mandatory CSR rule, as measured by CAR, for the two groups of firms (i.e., AFFECTED and UNAFFECTED) can thus be attributed to the mandatory CSR rule that creates the discontinuity. Our research setting differs from the basic RDD applications listed above, in that the mandatory CSR rule relies on more than one rating score to determine treatment status. A firm is affected by the mandatory CSR rule if during any fiscal year it has either (i) a net worth of Indian Rupees (INR) 5,000 million (about U.S. $83 million) or more; (ii) sales of INR 10,000 million (about U.S. $167 million) or more; or (iii) a net profit of INR 50 million (about U.S. $0.83 million) or more. Researchers label this special case of the RDD as multivariate RDD or MRDD. While there are several methods to estimate treatment effects under MRDD, we follow a binding-score regression discontinuity as described in Reardon and Robinson [2012].18 Specifically, we create a new rating variable M, defined as the minimum of the three individual rating scores based on profits, book value, and sales (where each score is first centered around its cutoff score), that perfectly determines the assignment. Continuing with the notation used in model (1), receipt of treatment is denoted by the dummy variable D {0, 1}, where D = 1 if M ࣙ c, and D = 0 if M < c. We then fit the following model: Y = α + τ D + f (M ) + ε. (2) As pointed out by Reardon and Robinson [2012], the binding-score regression discontinuity model is appealing because it is intuitively simple and it parsimoniously reframes the multidimensional vector of rating scores into a single dimension that alone determines treatment status, and hence ensures minimal loss of data in estimation. 3.4 DATA The data for our study are obtained primarily from Prowess, a database maintained by the Centre for Monitoring Indian Economy (CMIE). The Prowess database is widely used by scholars (e.g., Khanna and Palepu [2000], Bertrand, Mehta, and Mullainathan [2002], Gopalan, Nanda, and Seru [2007]) to conduct large sample studies on Indian firms. 18 Other methods to implement MRDD include response surface RD, frontier RD, fuzzy frontier RD, and distance-based RD. Please refer to Reardon and Robinson [2012] and Wong, Steiner, and Cook [2013] for more details. IMPACT OF CSR ON SHAREHOLDER VALUE 1273 Our full sample comprises of firms with nonmissing data on total assets, sales, net income, book value of equity, and market capitalization. We also require a firm to have stock return data around key event dates related to the passage of the Companies Act. These data restrictions yield a sample of 9,921 firm-year observations relating to 2,120 unique firms for the period 2009–2013. There are 5,889 firm year observations (59% of the sample) that are classified as AFFECTED and the remaining 4,032 firm-year observations (41% of sample) are classified as UNAFFECTED. Panel A of table 1 presents the industry-wise distribution of our sample. Business services, chemicals, construction, textile, and wholesale industries are heavily represented among the AFFECTED firms. To assess whether the nature of CSR spending voluntarily incurred by firms is consistent with the nature of CSR activities enumerated by the law, we hand-collect information on the magnitude and characteristics of CSR spending for just one year from the 2012 annual report or CSR reports of firms. In panels B and C of table 1, we describe amounts spent on CSR and the type of activities undertaken.19 Of the 1,237 AFFECTED firms for the year 2012, only 458 firms (37%) spend money on CSR activities. Panel B presents the descriptive statistics on the amount of CSR spent by the AFFECTED firms in the year 2012. The median amount spent on CSR is INR 3.02 million (approx. $50,333) which is roughly 0.37% of the average of last three years’ net income. The 75th percentile for CSR spending as a proportion of net income is 1.31%. Hence, before the passage of the CSR law, a majority of firms do not spend funds on CSR and those that do, spend well below the proposed 2% level. Panel C provides details on the type of CSR activity undertaken by these firms. The most common areas where firms focus their CSR spending are related to community welfare, education, environment, and health care. These areas of spending are mostly in line with the type of CSR activities listed in the mandatory CSR rule. To implement RDD, we focus on firms that are just below and just above the cutoff prescribed in the CSR rule. Specifically, we select firms whose binding score rating variable M (as defined in section 3.3) ranges between –0.50 and +0.50. Hereafter, we refer to this subsample as the RDD sample. The RDD sample comprises of 2,664 firm year observations from 2009 to 2013. Of these total observations 1,633 firm year observations (61% of the RDD sample) are classified as AFFECTED and the remaining 1,031 firm-year observations (39% of RDD sample) are classified as UNAFFECTED. Because the RDD analysis is conducted separately for each event date, and each year can have multiple events, the exact number of observations used in each test is different. 19 To be clear, we intend for the 2012 data on CSR magnitude and type of spending in panels B and C to be a completely descriptive analysis. We emphasize that we do not use these CSR magnitude data from 2012 to classify firms as treated and control firms throughout the paper. In particular, we do not use the 2012 magnitude of CSR spending in any of the regression analyses reported in the paper. 1274 H. MANCHIRAJU AND S. RAJGOPAL TABLE 1 Sample Description Panel A: Industry-wise distribution Industry UNAFFECTED AFFECTED TOTAL % 135 167 380 263 161 69 87 89 134 121 98 207 133 294 348 462 884 4,032 41% 337 306 415 491 475 177 153 166 236 276 154 295 322 328 205 214 1,339 5,889 59% 472 473 795 754 636 246 240 255 370 397 252 502 455 622 553 676 2,223 9,921 5% 5% 8% 8% 6% 2% 2% 3% 4% 4% 3% 5% 5% 6% 6% 7% 22% 100% Automobiles and Truck Banking Business Services Chemicals Construction Construction Material Consumer Goods Electrical Equipment Food Products Machinery Nonmetallic and Industries Pharmaceutical Production Steel Works etc. Textiles Trading Wholesale Other industries with < 2% frequency Total Panel B: Descriptive data on CSR spending N = 458 Mean Median SD P25 P75 CSR spending (INR million) CSR spending /average last three years profits (%) 49.30 1.22 3.02 0.37 200.89 2.31 0.53 0.07 14.39 1.27 Panel C: Descriptive data on CSR activity undertaken CSR activity Community welfare Education Environment Healthcare Rural development Women empowerment Children health Donations Disaster relief Sports Support for physically challenged N % 242 212 191 178 44 37 35 31 25 12 9 52.84% 46.29% 41.70% 38.86% 9.61% 8.08% 7.64% 6.77% 5.46% 2.62% 1.97% Our full sample consists of 9,221 firm year observations over the period 2009–2013. In panel A of this table, we present the industry-wise distribution of the sample. In panels B and C of this table, we provide descriptive statistics on amount spent on CSR, and the type of CSR activity undertaken by sample firms in the year 2012. Note that the data in panels B and C are descriptive in nature and are not used in any regression analysis reported in the paper. IMPACT OF CSR ON SHAREHOLDER VALUE 1275 4. Results 4.1 VERIFYING ASSUMPTIONS UNDERLYING RDD Consistent with the best practices recommended by Lee and Lemieux [2008], we begin by testing two crucial assumptions of RDD. The first assumption is that individuals cannot precisely manipulate the rating variable and hence cannot select themselves into the treatment and control groups. For example, if firms systematically manage earnings downwards to report earnings below INR 50 million to avoid compliance with the mandatory CSR rule, then inferences based on RDD would be invalid because the assignment of firms in the treatment and control groups is not as good as randomized. To examine this possibility, we graph the frequency of firms around the profits, book value, and sales cutoffs prescribed in the CSR rule for the year 2009 and the year 2013. In the year 2009, there was no information about the mandatory CSR rule, whereas in the year 2013, the guidelines for mandatory CSR were well known. Any abnormal jump (drop) in the frequency of firms just to the left (right) of the cutoff in the year 2013, relative to the year 2009, would suggest that firms deliberately manipulated their profits/book value of equity/sales to avoid potential compliance with the mandatory CSR rule. Figures 2a–2f show no such jumps or drops in the frequency of firms. Further, in our setting, three different cutoffs determine the assignment into the treatment group. Hence, the likelihood that a firm will simultaneously manipulate all the three different thresholds to avoid compliance with the mandatory CSR rules is relatively low. Another important aspect of RDD is that for this approach to work, all other factors that determine the dependent variable (CAR in our case) must also evolve smoothly with respect to the rating variable. If the other variables also show a discontinuity at the cutoff, then the estimated treatment effect of the intervention will be biased. In order to test the validity of this assumption, we compare the mean and median values of the various characteristics of AFFECTED and UNAFFECTED firms of the RDD sample. These results are documented in table 2. The construction of these variables is explained in appendix A. AFFECTED firms are typically larger and more profitable than the UNAFFECTED firms. This is to be expected because the cutoffs that divide firms as AFFECTED and UNAFFECTED firms are based on size and profitability. However, AFFECTED and UNAFFECTED firms are similar in terms of other firm characteristics that are likely to affect firm value such as leverage, sales growth, cash holdings, and board independence. AFFECTED firms are more likely to belong to a business group compared to UNAFFECTED firms. We adopt the Prowess database’s group classification to identify business group affiliation and government ownership. Although we do not have an explicit hypothesis related to group affiliation, that variable is important to control for in the Indian context, as done previously by Khanna and Palepu [2000], Bertrand, Mehta, and Mullainathan 1276 H. MANCHIRAJU AND S. RAJGOPAL (a) (b) Distribution of firms around INR 500 million profit cutoff on 08/29/2013 0 0 50 50 Frequency Frequency 100 100 150 150 Distribution of firms around INR 500 million profit cutoff on 08/03/2009 -50 0 50 Profit 100 150 -50 0 50 Profit (c) 100 150 (d) 60 Distribution of firms around INR 5,000 million book value cutoff on 08/29/2013 0 0 20 20 Frequency Frequency 40 40 60 Distribution of firms around INR 5,000 million book value cutoff on 08/03/2009 2000 3000 4000 5000 Book value 6000 7000 8000 2000 3000 4000 (e) 5000 Book value 6000 7000 8000 (f) 40 Distribution of firms around INR 10,000 million sales cutoff on 08/29/2013 0 0 10 10 Frequency 20 Frequency 20 30 30 40 Distribution of firms around INR 10,000 million sales cutoff on 08/03/2009 5000 7500 10000 Sales 12500 15000 5000 7500 10000 Sales 12500 15000 FIG. 2.—Did firms manipulate profits, book value, or sales to avoid mandatory CSR compliance? Graphs 2a and 2b (2c and 2d) plot the frequency distribution of firms around the INR50 million profit cutoff (INR5,000 million book value cutoff). Graphs 2e and 2f plot the frequency distribution of firms around the INR10,000 million sales cutoff. Firms with profit, book value, or sales above these cutoffs are required by law to spend funds on CSR. Graphs to the left (a, c, and e) are based on values on 08/03/2009, when the information about mandatory CSR rule was unknown. Graphs to the right (b, d, and f) are based on values on 08/29/2013 when the information about the mandatory CSR rule was fully known. [2002], Gopalan, Nanda, and Seru [2007], and other papers. AFFECTED firms spend more on advertising than UNAFFECTED firms. Further, AFFECTED firms are more politically connected than UNAFFECTED firms. We measure political connectedness using a dummy variable POLITICAL that equals one if the firm or the business group to which a firm belongs has made a contribution of INR 20,000 or more to a political party in India between 2005 and 2012, and zero otherwise. We obtain these data from the Median 1.4889 0.0236 1.8766 0.5074 0.0203 0.0039 0.0259 0.4615 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 Mean 3.0191 0.0245 2.4263 0.4828 0.0505 0.0805 0.0574 0.4709 0.1009 0.1649 0.0010 0.0126 0.0016 0.0155 0.4578 SD 4.3100 0.0635 1.7854 0.2281 0.0761 0.2487 0.0882 0.1177 0.3013 0.3713 0.0311 0.1116 0.0076 0.1237 0.4985 12.3165 0.0492 1.9229 0.4887 0.0569 0.0780 0.0653 0.4611 0.2394 0.3356 0.0031 0.0276 0.0043 0.0790 0.4770 Mean 8.6899 0.0413 1.4392 0.5089 0.0315 0.0026 0.0351 0.4545 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 Median SD 15.9263 0.0611 1.5815 0.2162 0.0714 0.1919 0.0848 0.1162 0.4269 0.4723 0.0553 0.1637 0.0132 0.2698 0.4996 AFFECTED (2) N = 1,633 [3] – [2] 7.2010∗∗∗ 0.0177∗∗∗ −0.4374∗∗∗ 0.0015 0.0113∗∗ −0.0013 0.0092 −0.0070 0.0000∗∗∗ 0.0000 0.0000 0.0000 0.0000∗∗∗ 0.0000∗∗∗ 0.0000 9.2973∗∗∗ 0.0247∗∗∗ −0.5034∗∗∗ 0.0059 0.0064∗∗ −0.0025 0.0079 −0.0098 0.1386∗∗∗ 0.1707∗∗∗ 0.0021 0.0149 0.0026∗∗∗ 0.0635∗∗∗ 0.0192 Difference in median [2] – [1] Difference in mean This table reports the mean, median, and standard deviation of various firm characteristics for the AFFECTED and UNAFFECTED firms for the RDD sample, which comprises of 2,664 firm year observations from 2009 to 2013. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between −0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. The significance of differences in means and medians are evaluated based on the t-test and Wilcoxon test, respectively (p-values for the t-statistics and Z-statistics are two-tailed). ∗∗∗ , ∗∗ and ∗ denote significance at 1%, 5%, and 10% level, respectively. ASSETS (INR, billions) ROA BM LEV CAPEX SGROWTH CASH BOARD INDPENDENCE BIG4 BG GOVT OWNED MNC AD POLITICAL POLLUTED UNAFFECTED (1) N = 1,031 TABLE 2 Descriptive Statistics for the RDD Sample IMPACT OF CSR ON SHAREHOLDER VALUE 1277 1278 H. MANCHIRAJU AND S. RAJGOPAL Web site of the Association of Democratic Reforms, a not-for-profit organization working in the area of electoral and political reforms in India.20 Finally, AFFECTED and UNAFFECTED firms have equal representation in industries identified by Ministry of Environment and Forests, Government of India as heavily polluting industries.21 The dummy variable POLLUTED captures these industries and is equal to one if a firm belongs to metallurgical, chemical, petrochemical, coal, thermal power, building materials, paper, brewing, pharmaceutical, fermentation, textiles, leather, or the mining industry, and zero otherwise. For these four variables we find no jumps in the covariates at the cutoffs.22 These results give us comfort to proceed with the RDD estimation. 4.2 UNIVARIATE RESULTS In table 3, we report median CAR for the AFFECTED and the UNAFFECTED firms in the RDD subsample, around the each of the eight key legislative events related to the passage of the Companies Act 2013, as outlined in section 3.1. There is no significant market reaction to Event # 1 on August 3, 2009, that is, when the Bill was introduced for the first time in the Lok Sabha (lower house of the Indian Parliament). This outcome is not surprising because the August 3, 2009 version of the Bill contained no clause related to CSR. The insignificant result (which is akin to a placebo test) mitigates the possibility that some unobserved firm characteristics drive the differences in CAR for the two sub-samples. 23 On August 31, 2010 (Event # 2), the Standing Committee on Finance presented its report with a mandatory CSR clause. We find a significant negative market reaction for the AFFECTED (−2.3%) firms but a slightly positive reaction for the UNAFFECTED firms (0.3%), consistent with the hypothesis that CSR is value-destroying. This event is important in the context of our study because it contained news related to only the CSR aspect of the Companies Act. As discussed in section 2, the Parliamentary Standing Committee on Finance vetted the initial version of the Companies Act and inserted a mandatory CSR clause. This new rule was a totally unexpected addition to the Act. For the first time profitability/size/net-worth cutoffs were prescribed to determine which firms will be affected by the mandatory CSR rule. These cutoffs eventually remained unchanged in the final version of the bill that was enacted. 20 http://adrindia.org/research-and-report/political-party-watch/combined-reports/2014 /corporates-made-87-total-donations-k 21 http://envfor.nic.in/legis/ucp/ucpsch8.html 22 These results and accompanying graphs are available upon request. 23 Note that we have used the numerical cutoffs prescribed in the second event date (August 31, 2010) to classify firms into AFFECTED and UNAFFECTED for stock returns related to the first event date (August 3, 2009). In one sense, this reflects hindsight bias. We prefer to interpret the null result related to returns on the first event date on August 3, 2009 as a placebo test. IMPACT OF CSR ON SHAREHOLDER VALUE 1279 TABLE 3 Market Reaction – Univariate Results Based on RDD Sample Event # 1 2 3 4 5 6 7 8 Date Aug 3, 2009 Aug 31, 2010 Feb 28, 2011 Dec 14, 2011 Jun 26, 2012 Dec 18, 2012 Aug 8, 2013 Aug 29, 2013 Median CAR for a firm around all eight events Predicted sign on AFFECTED firms (under the hypothesis that CSR UNAFFECTED is value-destroying) (1) Insignificant − + − − − − − − 0.003 0.003∗∗∗ −0.002 −0.001 0.002∗∗∗ 0.006∗∗∗ −0.005∗∗ −0.004 −0.003 AFFECTED Difference (2) (2) – (1) 0.001 −0.023∗∗∗ 0.004 −0.001 0.001∗ −0.016∗∗∗ −0.006 −0.003 −0.008∗ −0.001 −0.026∗∗∗ 0.006 0.000 −0.001 −0.021∗∗∗ −0.001 0.001 −0.005 This table reports median 3-day CAR around the key legislative events for the two subgroups of our sample, that is, UNAFFECTED, and AFFECTED firms in the RDD sample. We measure abnormal returns by estimating the market model using 200 trading days of return data ending 11 days before key legislative events related to the passage of the Companies Act 2013. The return on National Stock Exchange’s CNX 500 index is used as a proxy for the market return. Daily abnormal stock returns are cumulated to obtain the CAR from day t − 1 before the legislative event date to day t + 1 after the event date. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between −0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. The significance of median and the difference in median values for the two subgroups is tested using Wilcoxson test. ∗∗∗ , ∗∗ , and ∗ denote significance at 1%, 5%, and 10% level (two-tailed), respectively. For Event # 3, when the Ministry of Corporate Affairs announced that it is considering making only the disclosure of CSR and not the actual spending on CSR mandatory, we expect a positive market reaction for the AFFECTED firms because this event is likely to mitigate any possible negative effects of the mandatory CSR rule. However, we do not observe any significant market reaction. Events # 4–8 are associated with increased probability of the legislation passing. Therefore, we expect a negative market reaction for the AFFECTED firms under the hypothesis that CSR is value-destroying. However, we find a statistically significant negative reaction for the AFFECTED firms only for Event # 6 when the Lok Sabha (the lower house of the Indian Parliament) passed the Companies Act (–1.6%). The other events such as the re-introduction of the Bill in the Lok Sabha (Event# 4), submission of a revised report by the Parliamentary Standing Committee on Finance (Event # 5), the passage of this Bill in the Rajya Sabha, the upper house of the Indian Parliament (Event # 7), and Presidential assent to the Bill (Event# 8) 1280 H. MANCHIRAJU AND S. RAJGOPAL are all associated with a statistically insignificant market reaction for the AFFECTED firms. The median CAR for the AFFECTED firms across all these eight events is negative. Overall, these results provide initial evidence of a negative impact of CSR on shareholder value. 4.3 GRAPHICAL ANALYSIS Graphs provide a transparent way of showing how the treatment effect is identified in an RDD framework. For each of the eight event dates outlined previously, we separately plot the stock market reaction for firms in the RDD sample. Figures 3a–3h show a scatter plot that presents the stock market reaction on significant CSR events for AFFECTED and UNAFFECTED firms. On the X-axis is the binding score rating variable (M, in this case) which ranges from –0.50 to 0.50, with 0 being the cutoff point. On the Y axis is the three-day CAR around the event date. To enhance the visual impact of the graph, estimated CAR is superimposed on the plot, where CAR is estimated as a function of the rating variable M separately on both sides of the cutoff using local linear estimation, triangular kernel, and Imbens– Kalyanaraman [2012] bandwidth, using the following equation: CAR = α + τ AFFECTED + f (M ) + ε. (3) Because the only difference near the cutoff is that firms to the right of zero are AFFECTED by the mandatory CSR rule whereas firms to the left of zero are UNAFFECTED, any discontinuity in CAR at the cutoff can therefore be attributed to the mandatory CSR rule because it imposes the threshold and creates the discontinuity. We use the RD command in STATA, developed in Nichols [2007], to generate this graph. Figures 3a through 3h correspond to each of the event dates. For the sake of parsimony, we describe only three graphs. Graph 3a relates to the Event # 1 on August 3, 2009. There is no significant jump or drop at the cutoff point suggesting that the average CAR for the AFFECTED and UNAFFECTED firms on this date are statistically indistinguishable. Graph 3b relates to the Event # 2 on August 31, 2010. At the cutoff point, the fitted curve on the right is significantly lower that the fitted curve to the left. The only difference near the cutoff is that firms to the right of zero are AFFECTED by CSR rule whereas firms to the left of zero are UNAFFECTED. Hence, this discontinuous drop in the fitted curve (that captures firm value) at the threshold can be attributed to the mandatory CSR rule which imposes the cutoff and creates the discontinuity. Based on this graph 3b, we infer a negative relation between CSR and firm value. Using the same logic, we find a negative relation between CSR and firm value in Figure 3f that relates to the Event # 6 on December 18, 2012. However, all the remaining graphs suggest that the market reaction for the AFFECTED and UNAFFECTED firms on the remaining event dates are statistically indistinguishable. IMPACT OF CSR ON SHAREHOLDER VALUE (b) 3-day CAR around Event# 2 - 08/31/2010 -.5 0 .5 -.06 -.04 -.04 -.02 -.02 0 0 .02 .02 .04 .04 .06 .06 (a) 3-day CAR around Event# 1 - 08/03/2009 1281 -.5 0 (d) 3-day CAR around Event# 4 - 12/14/2011 -.5 0 .5 -.06 -.06 -.04 -.04 -.02 -.02 0 0 .02 .02 .04 .04 .06 .06 (c) 3-day CAR around Event# 3 - 02/28/2011 .5 -.5 0 (f) 3-day CAR around Event# 5 - 06/26/2012 3-day CAR around Event# 6 - 12/18/2012 .5 -.06 -.06 -.04 -.04 -.02 -.02 0 0 .02 .02 .04 .04 .06 .06 (e) -.5 0 .5 -.5 0 (h) 3-day CAR around Event# 7 - 08/28/2013 3-day CAR around Event# 8 - 08/29/2013 .5 -.06 -.04 -.04 -.02 -.02 0 0 .02 .02 .04 .04 .06 .06 (g) -.5 0 .5 -.5 0 .5 FIG. 3.—CAR around significant CSR events for the RDD sample. Figures 3a–3h show the market reaction for the AFFECTED and UNAFFECTED firms around events related to the passage of mandatory CSR rule for the RDD sample. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between −0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. The variable M is plotted on the X-axis. The vertical axis indicates 3-day CAR. The solid line plots predicted value of which is estimated as a linear function of M, estimated separately to the left and right of the cutoff point (M = 0). RD routine of STATA as described in Nichols (2017) is used to generate these graphs. 1282 H. MANCHIRAJU AND S. RAJGOPAL We ascertain the validity of these inferences by performing two robustness checks. First, as suggested by Lee and Lemieux [2010], if the true relation between the X and Y variables is nonlinear, then RDD using local linear estimations will induce a bias in favor of finding a treatment effect when there is none. To rule this possibility out, we assume the relationship between CAR and M is a third-order polynomial function and then superimpose the fitted CAR on the scatter plot. In estimating local polynomial regressions, the number of bins is determined using the approach outlined in Calonico, Cattaneo, and Titiunik [2014a]. Despite changes in the estimation techniques, the graphs for Event # 2 and Event # 6, that is, on August 31, 2010 and December 18, 2012, display a sudden drop in the fitted CAR at the cutoff point. Second, we rule out the possibility that certain extreme values of CAR are driving these results. A sharp discontinuity at the cutoff point is still seen in the graphs for these two event dates even after dropping the top and bottom 1% of the observations.24 The magnitude of the treatment effect τ , as reflected in these graphs, is summarized in table 4. Panel A documents the results following the same estimation techniques as used in the graphs, that is, RDD analysis using local linear estimation, triangular kernel, and Imbens–Kalyanaraman [2012] bandwidth. We use the RDROBUST command in STATA, developed in Calonico, Cattaneo, and Titiunik [2014b] to perform RDD estimations. We continue to find a significant negative market reaction around August 31, 2010, the date when the Parliamentary Standing Committee on Finance inserted a mandatory CSR clause in the Companies Act. The CAR for AFFECTED firms is 2.4% lower than the UNAFFECTED firms. Similarly, there is a significant negative market reaction around December 18, 2012, the date when the Lok Sabha (lower house of the Indian Parliament) passed the Companies Act. The CAR for AFFECTED firms is 1.6% lower than the UNAFFECTED firms. We do not find a statistically significant difference in the market reaction for AFFECTED and UNAFFECTED firms for other events. In the panel B of table 4, we also report results from estimating the RDD using third-order polynomial and optimal bandwidths as suggested in Calonico, Cattaneo, and Titiunik [2014a]. The results are similar to those documented in table 3. 4.4 PARAMETRIC ESTIMATION We expand the basic RDD framework to incorporate other factors that affect the stock market’s reaction and estimate the following regression equation: τ j EVEN T j ∗ AFFECTED + δM ∗ AFFECTED CAR = α + + n 24 We j βn M ∧n + i γi Ri + λk Contr ol j + ε. k do not tabulate these graphs in this paper, but these are available upon request. (4) 0.004 (0.239) 480 3 26 −0.001 (−0.070) 480 1 26 EVENT 1 08/03/2009 −0.026∗∗∗ (−3.326) 517 3 28 −0.024∗∗∗ (−4.499) 517 1 28 EVENT 2 08/31/2010 −0.001 (−0.138) 556 3 28 0.001 (0.182) 556 1 28 EVENT 3 02/28/2011 0.002 (0.193) 543 3 26 0.003 (0.496) 543 1 26 EVENT 4 12/14/2011 0.003 (0.301) 514 3 28 0.001 (0.095) 514 1 28 EVENT 5 06/26/2012 −0.019∗∗ (−1.936) 536 3 29 −0.016∗∗∗ (−2.735) 536 1 29 EVENT 6 12/18/2012 0.004 (0.345) 491 3 25 0.002 (0.235) 491 1 25 EVENT 7 08/08/2013 −0.007 (−0.646) 481 3 25 0.000 (0.004) 481 1 25 EVENT 8 08/29/2013 This table summarizes the difference in the market reaction for the AFFECTED and UNAFFECTED firms around events related to the passage of mandatory CSR rule for the RDD sample. The market reaction is measured as the 3-day CAR. We measure abnormal returns by estimating the market model using 200 trading days of return data ending 11 days before key legislative events related to the passage of the Companies Act 2013. The return on National Stock Exchange’s CNX 500 index is used as a proxy for the market return. Daily abnormal stock returns are cumulated to obtain the CAR from day t−1 before the legislative event date to day t + 1 after the event date. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between −0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. In panel A of the table the dependent variable CAR is estimated as a function of M, separately on the both sides of the cutoff (i.e., where M = 0) using local linear estimation, triangular kernel, and Imbens–Kalyanaraman (2012) bandwidth and the difference in estimated CAR for the two sides is documented here. This difference in CAR corresponds to the jump (or drop) in the fitted curve at the cutoff point as documented in figures 2(a)–2(g). In panel B, CAR is estimated as a function of M, using local third order polynomial estimation, triangular kernel as per Calonico, Cattaneo, and Titiunik (2014a). Operationally, RDROBUST routine of STATA as described Calonico, Cattaneo, and Titiunik (2014b) is used to generate these estimates. ∗∗∗ , ∗∗ , and ∗ denote significance at 1%, 5%, and 10% level (two-tailed), respectively. Coefficient z-statistics Observations Polynomial order Bins Panel B Coefficient z-statistics Observations Polynomial order Bins Panel A Dependent variable = CAR TABLE 4 Market Reaction – Summary of Graphical Analysis Using RDD IMPACT OF CSR ON SHAREHOLDER VALUE 1283 1284 H. MANCHIRAJU AND S. RAJGOPAL This pooled regression is estimated over all the event dates. The dependent variable CAR is the market reaction around the event dates, as previously described. Our coefficient of interest is τ j which captures the differential stock market reaction for the AFFECTED firms relative to the UNAFFECTED firms on a given event date. The overall differential market τ j . The β j coefficients reaction for the AFFECTED firms is measured by j in model (4) capture the nonlinearity in the relationship between CAR and the rating variable M constructed under the binding-score regression discontinuity design. The γ j coefficients capture the relationship between CAR and the three rating scores R based on profits, book value, and sales that separate the firms as AFFECTED and UNAFFECTED. The δ coefficient in model (4) captures the differential relationship between the binding score rating variable M and CAR in the AFFECTED firms. These terms are included in the model following standard RDD practices, as suggested in Lee and Lemieux [2008]. The regression model includes several control variables. Following Fama and French [1992], we include firm size and book-to-market ratio in the model and expect negative and positive coefficients on these variables, respectively. The mandatory CSR rule is a part of an overall Companies Act 2013. We control for three important provisions of this Act that relate to board independence and audit quality (proxied by a Big 4 auditor), and enhanced creditor rights (proxied by leverage). These regulatory requirements can either impose additional costs on firms or result in benefits due to better monitoring. Hence, we do not make any predictions about the expected sign of coefficients on these variables. We acknowledge that capturing all the provisions of the Companies Act that are value relevant is difficult and hence there are genuine concerns about omitted correlated variables. However, it is important to emphasize that except for the mandatory CSR rule, all the provisions of the Companies Act 2013 apply to all firms uniformly, regardless of whether they fall in the AFFECTED or UNAFFECTED categories. Hence, the differential stock price reactions for these three categories of firms can therefore be uniquely attributable to the mandatory CSR rule. We also include indicator variables in the model that capture whether a firm belongs to a business group, is foreign owned, or is Government owned. Finally, we include industry dummy variables to overcome the problem associated with cross-sectional correlations in the individual firm returns that will arise given that the event period is common to all firms in our sample. Event time dummies are also included to control for firm-invariant time-specific effects. Table 5 presents the results from estimating equation (4). Column (1) shows results from estimating a reduced form model without control variables, column (2) reports results from estimating the full model with control variables, and column (3) presents results from estimating the full model with control variables and firm fixed effects. Across the three EVENT 1 ∗ AFFECTED EVENT 2 ∗ AFFECTED EVENT 3 ∗ AFFECTED EVENT 4 ∗ AFFECTED EVENT 5 ∗ AFFECTED EVENT 6 ∗ AFFECTED EVENT 7 ∗ AFFECTED EVENT 8 ∗ AFFECTED M ∗ AFFECTED M M∗M M∗M∗M R1 R2 R3 SIZE BM LEV ROA CAPEX SGROWTH CASH BOARD INDPENDENCE BIG4 τ1 τ2 τ3 τ4 τ5 τ6 τ7 τ8 δ β1 β2 β3 γ1 γ2 γ3 λ1 λ2 λ3 λ4 λ5 λ6 λ7 λ8 λ9 coef 0.003 −0.022∗∗∗ 0.000 −0.003 −0.004∗∗ −0.016∗∗∗ 0.001 −0.000 −0.014 0.011 0.009 −0.028 0.000 0.000 0.001 (1) 1.591 −14.174 0.258 −1.571 −2.479 −9.597 0.539 −0.048 −0.515 0.623 0.422 −1.189 0.849 1.412 1.207 t-stat coef 0.002 −0.023∗∗∗ 0.001 −0.003 −0.004∗ −0.015∗∗∗ −0.000 −0.001 −0.005 0.004 0.002 −0.021 0.000 0.000 0.001 0.001 −0.000 −0.004 −0.002 −0.000 −0.001 −0.001 0.010∗∗∗ 0.000 (2) 0.984 −9.474 0.491 −1.090 −1.709 −6.275 −0.168 −0.272 −0.173 0.227 0.076 −0.741 0.671 0.364 1.013 0.762 −1.367 −1.440 −0.268 −0.051 −1.111 −0.141 5.459 0.071 t-stat Dependent Variable = CAR TABLE 5 Market Reaction –Parametric Estimation of RDD coef −0.000 −0.025∗∗∗ −0.004 −0.008 −0.006 −0.018∗∗∗ −0.004 −0.003 −0.061 0.039 0.063 −0.046 0.000 −0.001 −0.009∗∗∗ 0.004 −0.000 −0.000 −0.004 0.004 −0.001 −0.011 −0.007 0.011 (3) t-stat (Continued) −0.038 −5.301 −0.772 −1.508 −1.202 −3.494 −0.749 −0.571 −1.501 1.416 1.601 −0.878 0.470 −0.453 −2.625 0.785 −1.055 −0.005 −0.176 0.418 −0.506 −0.723 −0.586 1.207 IMPACT OF CSR ON SHAREHOLDER VALUE 1285 j =1 τ j = 2% F-stat (p-value) λ10 λ11 λ12 λ13 λ14 λ15 j τ j E V E N T j ∗ AF F E CT E D + δM ∗ AF F E CT E D + 9.73∗∗∗ (0.00) 2.66 (0.10) Yes No No 4,118 0.050 coef n βn M ∧n + i t-stat γi Ri + coef k λk Contr ol j + ε. Yes Yes No 3,807 0.068 0.003 −0.017∗∗∗ −0.003 −0.022 0.006 −0.001 4.72∗∗ (0.03) 1.36 (0.24) (2) 1.159 −3.474 −1.098 −0.560 1.428 −0.109 t-stat Dependent Variable = CAR 4.44∗∗ (0.03) 2.23 (0.13) Yes No Yes 3,807 0.354 0.509 0.183 0.002 0.030 t-stat −0.240 coef −0.002 (3) The dependent variable is the 3-day CAR. We measure abnormal returns by estimating the market model using 200 trading days of return data ending 11 days before key legislative events related to the passage of the Companies Act 2013. The return on National Stock Exchange’s CNX 500 index is used as a proxy for the market return. Daily abnormal stock returns are cumulated to obtain the CAR from day t – 1 before the legislative event date to day t + 1 after the event date. The estimation is restricted to the RDD sample. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between –0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. Control variables are defined in appendix A. The t-statistics are based on robust standard errors clustered at firm and event level. ∗∗∗ , ∗∗ , and ∗ denote significance at 1%, 5%, and 10% level (two-tailed), respectively. CAR = α + This table presents the results from estimating model (4) Event FE Industry FE Firm FE Observations R2 Test : 8 BG GOVT OWNED MNC AD POLITICAL POLLUTED 8 Test : j =1 τ j = 0 F-stat (p-value) (1) T A B L E 5—Continued 1286 H. MANCHIRAJU AND S. RAJGOPAL IMPACT OF CSR ON SHAREHOLDER VALUE 1287 columns, the coefficients τ2 , and τ6 are negative and statistically significant suggesting that AFFECTED firms experienced a negative stock market reaction when the Parliamentary Standing Committee on Finance inserted a mandatory CSR clause in the initial version of the Companies Act, and the Bill was passed in the Lok Sabha. In column (3), the βn coefficients are insignificant suggesting that there is no nonlinearity in the relationship between CAR and the binding score rating variable M. Further, the rating score M is also not differentially associated with CAR in the AFFECTED firms (compared to UNAFFECTED firms), as seen by the insignificant δ coefficient. The γ1 and γ2 coefficients are also insignificant indicating that the three individual rating scores R, based on profits and book value, which separate firms as AFFECTED and UNAFFECTED, are unrelated with CAR. However, the γ3 coefficient is significant and negative suggesting that the farther the firm is from the sales-based cutoff for the applicability of mandatory CSR rule, the more negative is the CAR. None of the control variables are significantly associated with CAR. This is to be expected because RDD assumes that the treatment and control firms are all but similar except for the intervention that creates the discontinuity. Collectively, our results suggest that the mandatory CSR rule has a negative impact on the shareholder value of the AFFECTED firms. In terms of economic significance of these results, overall, we find that the CAR for the AFFECTED firms is about 4.1% (as measured by τ j in column 1) lower j than the CAR for UNAFFECTED firms. Given that the mandatory CSR rule directs that a firm has to spend 2% of its profits on CSR, diverting 2% of profits away from the positive NPV projects of a firm should theoretically reduce the firm value by around 2%.25 The point estimate of τ j is not j statistically different from the theoretical prediction of a 2% reduction in firm value at conventional significance levels. However, 4.1% is certainly larger than 2%. Our interviews with Chief Financial Officers (CFOs) of certain Indian firms in the treatment sample reveal that in addition to the direct cash flow effects of mandatory CSR rule, the stock market reaction might potentially capture certain indirect costs such as (i) the diversion of scarce managerial time and effort to comply with regulation; (ii) the possibility of greater government intervention in determining where the CSR money should be spent; and (iii) the dilution of the benefits of strategic CSR spending by channeling funds from CSR aimed at recruiting talented employees to CSR that does not fetch benefits to the firm; and (iv) poten- 25 Tax deductibility of CSR expenses was unclear at the time when the mandatory CSR rule was being debated in the parliament (Chugh [2014]) http://archive. financialexpress.com/story-print/1231302. If this expense is not tax deductible then under the shareholder expense view of CSR, diverting 2% of profits away from the positive NPV projects of a firm should theoretically reduce the firm value by around 2%. If this expense is tax deductible then reduction in the firm value will be around 1.4% (assuming a 30% tax rate). 1288 H. MANCHIRAJU AND S. RAJGOPAL tial diversion of funds provisioned for CSR activities to a trust or foundation owned by promoters or insiders of the firm. 4.5 CROSS-SECTIONAL VARIATION Next, we focus on the cross-sectional variation in the market reaction to the mandatory CSR rule for the AFFECTED firms. Specifically, we examine three dimensions—political connectedness, consumer awareness, and environmental impact—hypothesized by prior work to affect the efficacy of CSR spending. To test these predictions, we expand model (3) and estimate the following specification: τ j EVENT j ∗ AFFECTED + μ j EVEN T j ∗ AFFECTED CAR = α + j ∗VARIATION + δM ∗ AFFECTED + + j n βn M ∧n + γi Ri i λk Contr ol j + ε. (5) k We estimate three different versions of this model where VARIATION refers to POLITICAL (political connectedness), HIAD (high advertisement intensity indicator variable), and POLLUTED (affiliation to a highly polluting industry), respectively. Other terms of the model are same as previously described for model (4). Results from estimating model (5) are tabulated in table 6. In column (1), we consider the impact of political connections of a firm. While the μ j coefficient is positive and significant on some event dates (especially, EVENT # 2 and EVENT # 6, consistent with our expectations), it is negative and significant on other event dates. These inconsistent signs make it difficult for us to draw meaningful inferences on the impact of political connections on the CSR-firm value relation. In column (2), we generally find positive μ j coefficients, suggesting that a firm’s advertisement spending mitigates the negative relation between CSR and shareholder value. Finally, in column (3), the signs on the μ j coefficients are not always consistent with our expectations. These mixed results make it difficult to establish variation in the CSR–shareholder value relation conditioned on affiliation to a highly polluting industry. For brevity, we do not report and discuss the coefficient estimates on control variables for this table. As a robustness test, we also perform this crosssectional analysis using the nonparametric RDD methodology adopted in table 4. Specifically, we estimate equation (3) on each event date for each subsample separately. These un-tabulated results are qualitatively similar to results shown in table 6. 4.6 ANALYSIS USING TOBIN’S Q AS A MEASURE OF FIRM VALUE While the previous sub-sections looked at the announcement period returns, in this section, we consider the effect of the mandatory CSR rule on EVENT 1 ∗ AFFECTED EVENT 2 ∗ AFFECTED EVENT 3 ∗ AFFECTED EVENT 4 ∗ AFFECTED EVENT 5 ∗ AFFECTED EVENT 6 ∗ AFFECTED EVENT 7 ∗ AFFECTED EVENT 8 ∗ AFFECTED EVENT 1 ∗ AFFECTED ∗ VARIATION EVENT 2 ∗ AFFECTED ∗ VARIATION EVENT 3 ∗ AFFECTED ∗ VARIATION EVENT 4 ∗ AFFECTED ∗ VARIATION EVENT 5 ∗ AFFECTED ∗ VARIATION EVENT 6 ∗ AFFECTED ∗ VARIATION EVENT 7 ∗ AFFECTED ∗ VARIATION EVENT 8 ∗ AFFECTED ∗ VARIATION M ∗ AFFECTED M M∗M M∗M∗M τ1 τ2 τ3 τ4 τ5 τ6 τ7 τ8 μ1 μ2 μ3 μ4 μ5 μ6 μ7 μ8 δ β1 β2 β3 0.003 −0.025∗∗∗ 0.001 −0.002 −0.003 −0.017∗∗∗ 0.001 −0.000 −0.015∗∗∗ 0.034∗∗∗ −0.003 −0.007 −0.011∗∗∗ 0.021∗∗∗ −0.014∗∗∗ −0.002 −0.006 0.004 0.002 −0.020 1.422 −10.810 0.618 −0.985 −1.559 −7.400 0.238 −0.212 −2.817 6.518 −0.555 −1.418 −2.632 4.815 −2.852 −0.404 −0.200 0.238 0.102 −0.733 tstat 0.002 −0.026∗∗∗ 0.002 −0.005∗∗ −0.004∗ −0.017∗∗∗ 0.001 −0.001 0.002∗∗ 0.006∗∗∗ −0.001 0.006∗∗∗ 0.000 0.004∗∗∗ −0.002∗∗∗ 0.000 −0.005 0.004 0.002 −0.020 coef 0.754 −11.416 0.790 −2.117 −1.716 −6.923 0.351 −0.237 2.189 4.597 −0.944 7.075 0.379 4.509 −2.763 0.168 −0.176 0.229 0.072 −0.744 tstat VARIATION = HIAD VARIATION = POLITICAL coef (2) (1) Dependent Variable = CAR TABLE 6 Market Reaction – Cross Sectional Analysis of the RDD Sample 0.004 −0.022∗∗∗ −0.000 −0.003 −0.001 −0.017∗∗∗ 0.000 −0.001 −0.004∗∗∗ −0.004∗∗∗ 0.003∗∗ 0.000 −0.006∗∗∗ 0.003∗∗∗ −0.001 −0.000 −0.004 0.004 0.001 −0.021 coef (Continued) 1.491 −8.225 −0.045 −0.995 −0.541 −6.141 0.059 −0.235 −4.281 −4.832 2.376 0.127 −6.204 2.896 −1.143 −0.078 −0.150 0.215 0.049 −0.774 tstat VARIATION = POLLUTED (3) IMPACT OF CSR ON SHAREHOLDER VALUE 1289 γ1 γ2 γ3 j τ j E V E N T j ∗ AF F E CT E D + j tstat 0.716 0.382 0.954 coef 3,807 0.071 4.58∗∗ (0.03) 0.000 0.000 0.001 Yes Yes Yes No tstat n βn M ∧n + 0.658 0.285 0.994 μ j E V E N T j ∗ AF F E CT E D ∗ V ARI AT I ON + δM ∗ AF F E CT E D + 3,807 0.080 0.00 (0.96) 0.000 0.000 0.001 Yes Yes Yes No coef VARIATION = HIAD VARIATION = POLITICAL i γi Ri + 3,807 0.070 1.25 (0.26) 0.000 0.000 0.001 Yes Yes Yes No coef k λk Contr ol j + ε 0.653 0.396 1.083 tstat VARIATION = POLLUTED (3) The dependent variable is the 3-day CAR. We measure abnormal returns by estimating the market model using 200 trading days of return data ending 11 days before key legislative events related to the passage of the Companies Act 2013. The return on National Stock Exchange’s CNX 500 index is used as a proxy for the market return. Daily abnormal stock returns are cumulated to obtain the CAR from day t – 1 before the legislative event date to day t + 1 after the event date. The estimation is restricted to the RDD sample. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between –0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. VARIATION is an indicator variable that refers to BG (business group affiliation), POLITICAL (political connectedness of a firm), HIAD (high advertisement spending indicator variable), and POLLUTED (affiliation to a highly polluting industry), in columns (1)–(4), respectively. The variables BG, POLITICAL, HIAD, and POLLUTED are based on beginning of the year values and hence are not tainted by hindsight bias. Control variables are defined in appendix A. The t-statistics are based on robust standard errors clustered at firm and event level. For brevity, coefficient estimates of the intercept, year dummies, and industry dummies are not reported. ∗∗∗ , ∗∗ , and ∗ denote significance at 1%, 5%, and 10% level (two-tailed), respectively. CAR = α + This table presents the results from estimating model (5) Observations R2 j =1 R1 R2 R3 Controls Event FE Industry FE Firm FE 8 Test : μ j = 0 F-stat (p-value) (2) Dependent Variable = CAR (1) T A B L E 6—Continued 1290 H. MANCHIRAJU AND S. RAJGOPAL IMPACT OF CSR ON SHAREHOLDER VALUE 1291 firm value in the longer run. Following prior research on firm value and governance (e.g., Ahern and Dittmar [2012], Black and Kim [2012]), we use Tobin’s Q as our main measure of firm value.26 , where Q is calculated as the sum of total assets and market value of equity less common book equity, divided by total assets. We consider natural logarithm of Q to address the skewness in the variable. We assess whether the mandatory CSR rule leads to a decline in value for the affected firms, right at the time when the rule was adopted. If investors consider CSR activities as detrimental to firm value, then the shareholder value of affected firms should decline, relative to that of unaffected firms, in the years when the likelihood of the passage of mandatory CSR rule increased, controlling for other factors that affect shareholder value. Table 7 presents results from our analysis of changes in Q. Panel A reports the univariate results and indicates that there was a significant decline in Q of AFFECTED firms in the years 2011 and 2013, compared to Q of UNAFFECTED firms. Panel B displays the results from the basic RDD analysis. Specifically, Ln(Q ) is estimated as a function of the rating variable M separately on both sides of the cutoff using local linear estimation, triangular kernel, and Imbens–Kalyanaraman [2012] bandwidth. We use RDROBUST com mand in STATA, developed in Calonico, Cattaneo, and Titiunik [2014b] to perform the RDD estimations. We find a statistically significant difference in Ln(Q ) for AFFECTED and UNAFFECTED firms in the year 2011 and 2013. Finally, in panel C of this table, we show results from estimating the following model: τ j YEAR j ∗ AFFECTED + δM ∗ AFFECTED Ln Q = α + + n j βn M ∧n + i γi Ri + λk Contr ol j + ε. (6) k In this model we control for firm-specific characteristics such as size, leverage, growth opportunities, profitability, liquidity, ownership structure, board independence, and the presence of Big 4 auditor, which are known to affect firm value. Column 1 shows the estimation results with industry fixed effects. Column 2 includes firm fixed effects. Across all these columns, the coefficients on the interaction terms YEAR2011∗AFFECTED and YEAR2013∗AFFECTED are negative and significant. These results are consistent with our CAR results where we found that the most important event dates in our study are in the fiscal year 2011 and 2013. Similar to previously documented results, the economic magnitude of these coefficients is much larger than expected. The sign on coefficient estimates for 26 We obtain qualitatively similar results if we use one-year market adjusted buy hold returns instead of Q ratio to measure the firm value in the longer run. These results are not tabulated in this paper but are available upon request. Coefficient z-statistics Observations Polynomial order Bins Dependent Variable = ࢞Ln(Q) 0.017 (0.303) 481 1 25 YEAR 2009 −0.078 0.227 −0.030 −0.001 −0.062 2009 2010 2011 2012 2013 Panel B: Basic RDD analysis Median Mean −0.033 0.203 −0.036 −0.010 −0.065 Year UNAFFECTED (1) Panel A: Univariate tests Mean −0.058 0.218 −0.074 0.025 −0.125 YEAR 2011 −0.100∗∗∗ (−2.729) 566 1 30 −0.027 (−0.870) 525 1 27 −0.025 0.015 −0.038∗∗ 0.036∗∗ −0.061∗∗∗ (2) – (1) 0.021 (0.554) 546 1 26 YEAR 2012 Difference in Mean YEAR 2010 −0.111 0.243 −0.128 0.042 −0.160 Median AFFECTED (2) ࢞ Ln(Q) TABLE 7 Changes in Tobin’s Q for the RDD Sample (Continued) −0.097∗∗∗ (−3.183) 546 1 29 YEAR 2013 −0.033 0.015 −0.098∗∗∗ 0.044∗∗ −0.098∗∗∗ (2) – (1) Difference in Median 1292 H. MANCHIRAJU AND S. RAJGOPAL YEAR 2010 ∗ AFFECTED YEAR 2011 ∗ AFFECTED YEAR 2012 ∗ AFFECTED YEAR 2013 ∗ AFFECTED M ∗ AFFECTED M M∗M M∗M∗M R1 R2 R3 ࢞SIZE ࢞LEV ࢞ROA ࢞CAPEX ࢞SGROWTH ࢞CASH ࢞BOARD INDPENDENCE BIG4 BG GOVT OWNED Panel C: RDD analysis with controls τ1 τ2 τ3 τ4 δ β1 β2 β3 γ1 γ2 γ3 λ1 λ2 λ3 λ4 λ5 λ6 λ7 λ8 λ9 λ10 −0.001 −0.062∗∗∗ 0.000 −0.072∗∗∗ −0.054 0.082 −0.039 −0.137 −0.000 −0.003 0.012 −0.073∗ 0.377∗∗∗ 0.062 −0.016 0.022 0.200∗∗ 0.061∗∗∗ 0.016 −0.012 −0.027 coef (1) T A B L E 7—Continued −0.036 −3.395 0.029 −4.093 −0.426 0.879 −0.224 −1.135 −0.053 −0.987 1.479 −1.669 9.990 0.375 −0.453 0.943 2.110 2.652 1.221 −1.130 −0.334 tstat −0.037 −0.115∗∗∗ 0.001 −0.081∗∗ 0.117 −0.074 −0.206 0.244 −0.001 −0.001 −0.004 −0.094∗∗∗ 0.341∗∗∗ 0.115 −0.019 0.014 0.210∗∗ 0.082 0.023 −0.091∗∗ coef Dependent Variable = ࢞Ln(Q) (2) (Continued) −1.170 −3.412 0.030 −2.191 0.351 −0.362 −0.632 0.632 −1.032 −0.053 −0.142 −2.975 4.418 1.008 −0.346 0.650 2.035 0.982 0.488 −2.151 tstat IMPACT OF CSR ON SHAREHOLDER VALUE 1293 j =1 8 τ j = 2% F-stat (p-value) λ11 λ12 λ13 λ14 coef 0.034 1.234∗ −0.006 0.067 4.40∗∗ (0.04) 3.19∗ (0.07) Yes Yes No 2,370 0.290 (1) 1.336 1.913 −0.331 0.823 tstat 5.09∗∗ (0.02) 4.25∗∗ (0.04) Yes No Yes 2,370 0.616 0.086 2.015 coef Dependent Variable = ࢞Ln(Q) (2) j τ j Y E AR j ∗ AF F E CT E D + δM ∗ AF F E CT E D + n βn M ∧n + i γi Ri + k λk Contr ol j + ε. tstat 0.515 1.397 Q is defined as book value of total assets plus market value of equity less book value of equity, divided by the book value of total assets. The estimation is restricted to the RDD sample. The RDD sample is constructed as follows. First, a binding score rating variable M is created which is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which perfectly determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sale above these cutoffs, the firm is then required to spend on CSR. Firms with the variable M ranging between –0.50 and 0.50 comprise our RDD sample, where firms with M > 0 are AFFECTED by the rule and firms with M < 0 are UNAFFECTED by the rule. Control variables are defined in appendix A and are measured at the end of the year. The significance of differences in means and medians reported in panel A are evaluated based on the t-test and Wilcoxon test, respectively (p-values for the t-statistics and Z-statistics are two-tailed). The t-statistics reported in panel B are based on robust standard clustered at firm and year levels. For brevity, coefficient estimates of the intercept, year dummies, and industry dummies are not reported. ∗∗∗ , ∗∗ , and ∗ denote significance at 1%, 5%, and 10% level (two-tailed), respectively. Ln(Q ) = α + Panel A reports changes in the mean and median values of ࢞Ln(Q) for UNAFFECTED and the AFFECTED firms. Panel B reports results of estimating model (6): Year FE Industry FE Firm FE Observations R2 Test : MNC ࢞AD POLITICAL POLLUTED 8 Test : j =1 τ j = 0 F-stat (p-value) Panel C: RDD analysis with controls T A B L E 7—Continued 1294 H. MANCHIRAJU AND S. RAJGOPAL IMPACT OF CSR ON SHAREHOLDER VALUE 1295 the firm-specific controls variables are consistent with prior research (e.g., Black and Kim [2012]). Specifically, we find that leverage and liquidity are positively associated with Q ratio, whereas firm size and business group affiliation (proxy for agency costs) are negatively associated with Q. Overall, the results of this section indicate that during the years 2011 and 2013, which coincide with a greater likelihood of the passage of the mandatory CSR rules, AFFECTED firms experienced a decline in Q, relative to UNAFFECTED firms. These results are robust to alternate measures of long-run firm value such as annual buy hold market adjusted stock returns. 4.7 ADDITIONAL TESTS AND ROBUSTNESS CHECKS In our additional analysis, we evaluate whether the impact of mandatory CSR rule on shareholder value varies depending on the financial reporting quality of a firm. It can be argued that official guidance related to the implementation of the mandatory CSR rule is still emerging and not fully finalized. For example, the Companies Act does not define CSR. Instead, the Act lays out a list of possible activities that would be considered CSR. Further, the mandatory CSR rule is a “comply or explain” rule. Hence firms might game the system and meet the requirements by changing their reporting techniques or by reclassifying existing activities as CSR activities. If that is the case, the market reaction for such misreporting firms is likely to be different from the market reaction for other firms. We classify firms with higher value of discretionary accruals (either signed or unsigned) calculated as per the modified Jones [1991] model and/or higher frequency of related party transactions (as suggested by Bertrand, Mehta, and Mullainathan [2002]) as the ones that are more likely to adjust their reporting techniques. Our un-tabulated results show that there is no crosssectional variation in the stock price reaction for the AFFECTED and UNAFFECTED firms conditioned on the level of discretionary accruals and/or frequency of related party transactions. Next, given the comply-or-explain nature of the law, we examine whether our results do indeed capture the “comply” part rather than the “explain” part of the law. The treatment studied in our setting is a mandatory requirement to invest in CSR to the tune of 2% of profits and, failing that, to explain noncompliance. Given the comply-or-explain nature of the law, we may have effectively documented the effect of having to explain why the firm does not comply. To address this possibility, we rely on data provided by INDIA CSR, a leading CSR news portal in India.27 The portal’s report titled India CSR outlook (2016) provides initial evidence on how the mandatory CSR rule has played out in practice among the 250 Indian firms based on market capitalization.28 The key findings of the report are that (i) on aggregate, the prescribed CSR spending for these firms was INR 71.43 billion (or US$ 1.19 billion), whereas these firms actually spent INR65.78 27 http://indiacsr.in/about-us/about-india-csr/ 28 http://indiacsr.in/wp-content/uploads/2016/09/CSR-Outlook-Report-2016-India.pdf 1296 H. MANCHIRAJU AND S. RAJGOPAL billion (or US$ 1.10 billion), suggesting that firms, by and large, complied with the regulation; and (ii) education and healthcare attracted the most CSR spending. These data suggest that the stock market’s perceptions about the negative consequences of mandatory CSR are justified in that firms were forced to spend 2% of their profits on social causes that are not closely related to the firms’ operating activities. We also conduct several robustness tests to assess the sensitivity of our results. In the event study/CAR-based analysis, we obtain similar results if we (i) use buy-and-hold returns for the event window instead of summing daily abnormal returns; (ii) use COSPI index and MSCI emerging market index instead of CNX500 index as the proxy for market returns while estimating the market model to calculate abnormal returns;29 (iii) use market adjusted returns to capture abnormal returns instead of using the market model; (iv) change the event window to (–5,+5), (–2,+2), or (0,+2) instead of (–1,+1) while calculating CAR; and (v) exclude outliers instead of winsorizing them at 1% and 99%. We also obtain similar results in table 7 if we estimate the regressions on a balanced panel where the same number of firms are present throughout the event period. 5. Conclusion This paper examines the effect of CSR activities on shareholder value. Our identification comes from a unique regulatory change in India that makes it mandatory for firms to spend 2% of their profits on CSR if their profits/book value/sales exceed certain thresholds. This research setting enables us to better isolate how stock market participants, in aggregate, view the average effect of mandatory CSR activities on shareholder value. We find that the CAR around key events leading to the passage of the mandatory CSR rule is negative for firms affected by this regulation. On average, the decline in the stock price of firms forced to spend money on CSR accumulated over the eight important event dates is about 4.1%. We also find that compared to firms unaffected by the mandatory rule, firms affected by the mandatory CSR rule experience a greater decline in Tobin’s q ratio in the years when the likelihood of the passage of mandatory CSR rule increased. Overall, our evidence suggests that mandatory CSR activities can impose social burdens on business activities at the expense of shareholders. Our findings also indicate that firms, left to their own devices, choose their optimal level of CSR spending designed to maximize their firm value. Hence, we suggest caution in drawing causal inferences from associations of corporate outcomes and CSR spending. While the findings of this study are specific to India, they are potentially relevant to the policy debate of other emerging economies which are 29 COSPI is the CMIE’s Overall Share Price Index (COSPI) that comprises of all the stocks in the CMIE universe. IMPACT OF CSR ON SHAREHOLDER VALUE 1297 experiencing unprecedented CSR initiatives by their regulators due to concerns related to unequal economic growth and environmental abuses. An important caveat of our study is that our analysis does not explore the social welfare implications of the mandatory CSR rule. Therefore, our study is not a verdict on regulatory reforms related to CSR, which is inherently a social welfare decision and involves numerous stakeholders, apart from shareholders. Whether mandatory CSR achieved its objective of social welfare is an important question we intend to study in future work. APPENDIX A Variable Definitions AFFECTED UNAFFECTED CAR Q SIZE BM LEV indicator variable that equals one if the firm’s binding score rating variable M > 0. The variable M is defined as the minimum of the three individual rating scores R1, R2, and R3, which are in turn defined as (Profit – 50)/50, (Book value – 5,000)/5,000, and (sales – 10,000)/10,000, and which determines whether a firm is affected by the mandatory CSR rule or not. Profit, book-value and sales for the most recent fiscal year end before any event date are considered to eliminate any perfect foresight bias. The INR 50 million profits, INR 5,000 million book value, and INR 10,000 sales are the three cutoffs specified in the mandatory CSR rule. If a firm has profit, book value, or sales above these cutoffs, the firm is then required to spend funds on CSR. indicator variable that equals one if the firm’s binding score rating variable M < 0. cumulative abnormal returns where we measure abnormal returns by estimating the market model using 200 trading days of return data ending 11 days before key legislative events related to the passage of the Companies Act 2013. The return on National Stock Exchange’s CNX 500 index is used as a proxy for the market return. Daily abnormal stock returns are cumulated to obtain the CAR from day t – 1 before the legislative event date to day t + 1 after the event date. (book value of total assets + market value of equity –common book equity)/ total assets natural log of the market value of equity (market value of equity = stock price at the end of fiscal year ∗ number of shares outstanding) ratio of book value of equity to the market value of equity at the end of the year long-term debt (including its current portion) divided by total assets at the end of year 1298 H. MANCHIRAJU AND S. RAJGOPAL SGROWTH ROA CAPEX CASH BG MNC GOVT OWNED BOARD INDPENDENCE BIG4 AD HIAD POLITICAL POLLUTED sales growth defined as (salest – salest –1 )/salest –1 income from continuing operations divided by the total assets at the end of year capital expenditure during the year/total assets at the end of year cash and marketable securities at the end of year/total assets at the end of year indicator variable that equals one if the firm belongs to a business group as defined by the Prowess database, and zero otherwise indicator variable that equals one if the firm is a subsidiary of multinational corporation, and zero otherwise indicator variable that equals one if the firm is owned by the central or a state Government, and zero otherwise number of independent directors on the board/total number of directors on the board indicator variable that equals one if the firm engages a Big 4 auditor, and zero otherwise advertisement expenses divided by the sales during the year indicator variable that equals one if advertisement spending AD is in the top quartile for the industry-year distribution, and zero otherwise indicator variable that equals one if the firm or the business group to which a firm belongs has made a contribution of INR20,000 or more to a political party in India between 2005 and 2012, and zero otherwise indicator variable that equals one if the firm belongs to an industry identified by Ministry of Environment and Forests, Government of India as heavily polluting industries, and zero otherwise REFERENCES AHERN, K. 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