Firm Misvaluation and Corporate Social Responsibility

This paper shows that firm misvaluation positively affects a firm’s corporate social responsibility (CSR) ratings. The positive effect is only significant when firms are relatively overvalued. Using mutual fund hypothetical outflow pressure, I establish causality from misvaluation to CSR performance. The channel tests show that the increased CSR is more likely to be caused by a direct catering channel instead of an external financing channel. The baseline result holds when I exclude observations with equity issurance or debt issurance during the previous three years. Contrary to the prediction of the external financing channel, the positive effect on CSR is more pronounced for firms with higher financial strength. Moreover, the effect is stronger when CSR sentiment is high and for firms with higher socially responsible investor ownership and higher long-term institutional investor ownership. Overall, the results reveal the incentives of managers to increase CSR activities in overvaluation to cater to investors who have a taste for better CSR performance.