Three Essays on Corporate Social Responsibility (CSR)

This dissertation presents three essays in financial economics with regards to corporate social responsibility and ratings. The first essay develops the first model for the CSR rating agency who has incentives to shirk while the rated firms have incentives to manipulate information through deceptive public relations (greenwash). Depending on the size of the socially responsible investor base and its composition, three possible regimes can be inferred from the model. The first one is where the rating agency is catering to mainly a large group of sophisticated SR investors who compensate the rating agency for the value of information. The second one is where the rating agency is catering to mainly a large group of trusting SR investors who compensate the rating agency for the value of institutional certification. In either of these two regimes, the weight of the large group of SR investors should generate higher market valuations for higher-rated firms that motivate firm managers to perform greenwashing. The third regime is where there are just too few SR investors to justify the effort to produce informative signals and to drive apart market valuations for rated firms. The second essay investigates the empirical predictions of the model described in the first essay. I challenge the conventional wisdom of commercial CSR ratings being informative in a first attempt to understand how this ratings market operates. Using a novel difference-in-difference identification strategy, I show ratings significantly decreased for firms targeted by a regulatory crackdown on informational manipulation that inflates ratings. I find that better environmental ratings predict worse future corporate behavior via a novel set of benchmarks (i.e. penalties, lawsuits, and media coverage) while neither environmental nor social ratings appear to offer incremental predictive value beyond size and other standard firm characteristics. Higher-rated firms are associated with higher market valuations relative to their lower-rated counterparts. My findings point to a world in which the ratings business is primarily catering to a large group of trusting investors who buy ratings not for the value of information but for the value of institutional certification. The third essay examines the ratings of a recently emerged rating agency competitor and find its ratings are of no better predictive quality. I introduce a novel set of measures, `corporate badness (CB) ratings', for corporate environmental and social performance. In contrast to the leading commercial ratings, worse CB ratings correctly predict more future corporate bad behavior out-of-sample. These CB ratings provide a way to study ratings disagreement, which can be used to disentangle greenwashing from the other information contained in the leading commercial CSR ratings.