Creditor Monitoring and Corporate Social Responsibility: Evidence from Covenant Violations

We examine whether and how creditor monitoring affects corporate social responsibility (CSR) activities through the observable event of debt covenant violations. Covenant violations shift the control rights to creditors, allowing creditors to strengthen monitoring on firm policies. Employing a quasi-regression discontinuity design, we document differential effects of creditor monitoring on various components of CSR activities: firms tend to reduce CSR activities related to employee and community welfare, while leaving activities largely intact on the components that can have long-term adverse reputational effects on the firm. We also find that the reduction in CSR activities occurs primarily in situations where managerial agency problems in CSR activities tend to be more severe. Our findings provide evidence that creditors play a role in shaping CSR.