Corporate social responsibility and firm financial risk reduction: On the moderating role of the legal

environment

Mohammed Benlemlih and Isabelle Girerd-Potin

Abstract

Approaching the institutional environment through its regulative component, we distinguish

between shareholder-oriented and stakeholder-oriented countries. Identifying first this classification

with the distinction between common law versus civil law countries and using a large sample of
5,716 firm-year observations that represents 1,169 individual firms in 25 countries between 2001
and 2011, we show that Corporate Social Responsibility (CSR) significantly reduces firms’
idiosyncratic risk in civil law countries but not in common law countries. Using then a more direct
classification based on shareholder and employee protection scores, our findings suggest that CSR
negatively affects firms’ idiosyncratic and systematic risks only in less shareholder-oriented and more
stakeholder-oriented countries, respectively. These findings are similar in the different components
of CSR with two notable exceptions: a high score in corporate governance reduces firm risk only in
common law countries, and community involvement increases idiosyncratic risk in more shareholder-
oriented and less stakeholder-oriented countries, respectively. Taken together, our results strongly
support the view that the relationship between CSR and financial risk is moderated by the
institutional context of the firm.

1 INTRODUCTION

In recent decades, growing attention has been paid to CSR in both academic literature and the
business world. CSR is often seen as a strategic response to pressure from stakeholders who may be
adversely affected by company practices (Jackson & Apostolakou, 2010). The Volkswagen scandal,
which resulted in the company losing one third of its market capitalization four trading days after the
scandal broke on September 18, 2015, reveals the increasing attention from policymakers, investors,
and social and environmental activists towards companies’ CSR strategies. In September 2015, social
rating agencies like Vigeo downgraded Volkswagen’s scores. But in its press release, Vigeo highlights
the fact that, before the scandal, Volkswagen was positioned below the performance of its peers in
the automobile-manufacturing sector. The social scores already included Volkswagen’s middling CSR
performance and related risks. This example may help us understand why recent studies have shown
a negative link between CSR and financial risk. Two theoretical arguments related to the stakeholder
theory and information asymmetry suggest that CSR is the cause of risk reduction. Attention to
stakeholders and abundant disclosed information reduce firm risk. Our empirical study first shows
that CSR is negatively associated with firm financial risk and it is socially responsible (SR) behavior
that causes risk reduction. On these foundations we can go further and explore whether and how
differences in institutional environments influence the perception of, and link between, CSR and
financial risk. Studies on CSR have revealed a significant variation in CSR involvement, not only across
firms and industries but also across countries. The institutional framework of a country seems to
affect firms’ CSR scores (e.g., Ioannou & Serafeim, 2012) and moderate the relation between CSR and
firm value (e.g., El Ghoul, Guedhami, & Yongtae, 2015). However, relatively few studies have
investigated whether and how different institutional environments could influence the perception of
CSR activities, and, consequently, their impact on firm actions and outcomes. Our study contributes
to this line of research by investigating whether a firm’s institutional context moderates the link
between CSR and financial risk.

Institutions may be defined as the rules and norms that guide how individuals, organizations and
markets interact with each other (North, 1990; Scott, 1995). Aguilera and Jackson (2003) emphasize
that most researchers contrast two dichotomous models of Anglo-American and Continental
European corporate governance: ‘The Anglo-American model is also labeled the outsider, common
law, market-oriented, shareholder-centered, or liberal model, and the Continental model labeled the
insider, civil law, blockholder, bank-oriented, stakeholder-centered, coordinated, or “Rhineland”
model. We refer to this dichotomy to define two categories of countries: shareholder-oriented
countries and stakeholder-oriented countries.

Our intuition is that the relation between financial risk and CSR commitment is dependent on the
way individuals and the country’s rules consider and protect shareholders on the one hand, and non-
financial stakeholders on the other. Individuals in shareholder-oriented countries are expected to
have a low sensitivity to firms’ SR behaviors: employees are not attracted by SR firms, and consumers
do not use the SR criterion in their purchases. As a result, there is no advantage to a firm increasing
its SR involvement since it would not expect more fidelity, stability or reputation. The effects of SR
commitment could be a higher cost, a waste of a firm’s resources, and a deviation from the
maximization of shareholders’ wealth goal. With regard to the relation between CSR and financial
risk, we thus expect a null or a slightly positive relation, because the firm may face more costs
without any compensation. The profile of stakeholder-oriented countries is the opposite –
employees show a greater loyalty to SR firms, consumers use SR criteria in their purchase choices and
they are more patient in the case of unwanted events etc. SR involvement is well perceived and is
likely to increase a firm’s value through good reputation, high employee loyalty, and consumer
confidence in product quality. In these countries, a significant negative relation is expected between
SR commitment and financial risk.

One practical question to solve is the separation between the two kinds of countries. By referring to
the three dimensions in the institutional environment, namely regulative, normative, and cognitive
dimensions (Scott, 1995), we focus in this study on the regulative environment. Our choice is mainly
motivated by the results of Liang and Renneboog (2016), who empirically show that the legal
foundation is the most fundamental source of CSR. We therefore rely on legal aspects and we begin
with the traditional distinction based on legal origins. As emphasized by LaPorta, Lopez-de-Silanes,
Shleifer, and Vishny (LLSV, 1998), scholars identify two broad legal traditions: civil law and common

law.

However, one might argue that there is no perfect match between common law/civil law countries
on the one hand and shareholder-oriented/stakeholder-oriented countries on the other. To improve
the classification of countries, we next focus on the rules concerning the two major production
inputs, labor, and capital. For this purpose, we choose to classify countries according to their
shareholder protection level (based on La Porta, Lopez-de-Silanes, & Shleifer, 2008) and the
strictness of employment protection (based on the OECD indicators of employment protection).

Using financial risk measures coming from portfolio theory, we examine the link between CSR and
financial risk measured by systematic and idiosyncratic risks. Should we expect lower systematic and
idiosyncratic risks for SR firms?
Systematic risk is related to the sensitivity to market movements or more generally to common risk
factors on the market. Even if SR firms are likely to attenuate the impact of economic conditions, the
SR impact is probably more prominent on the idiosyncratic risk. Idiosyncratic risk reflects the risk
associated with firm-specific strategies after we account for the market-wide variation. First, this
specific risk can hide a SR common factor ignored by traditional risk–return models. Second, SR firms
can avoid strong changes in stock value following negative events, thanks to long term investors,
loyal employees and customers, in other words thanks to a moral capital (Godfrey, 2005) that acts as
insurance. As a result, the impact of SR behavior is assumed to be stronger on idiosyncratic risk.

Based on the Vigeo database and using 5,716 firm-year observations representing 1,169 individual
firms in 25 countries between 2001 and 2011, we show that the overall CSR involvement slightly
reduces firms’ idiosyncratic risk only in civil law countries. From the individual components of CSR
analysis, our findings suggest that firms that adopt favorable human rights practices, and maintain a
good relationship with their employees, suppliers, and customers, benefit from a reduction of
idiosyncratic risk only if they are implemented in civil law countries. Corporate governance
involvement is the only dimension that appears to matter and reduce firms’ exposure to financial risk
in common law countries. Law and regulation in common law countries are more shareholder-
oriented, and companies are likely to act in the best interest of their shareholders. Good corporate
governance practices are consequently well perceived in common law countries and lead to
increasing firms’ value by reducing financial risk (systematic and idiosyncratic risks) and the cost of
capital.

In the same vein, we show that the overall CSR score is negatively and significantly related to
systematic and idiosyncratic risks only in countries with low shareholder protection or alternatively
countries with high stakeholder protection. These results are consistent with the view that in more
stakeholder-oriented countries (less shareholder-oriented countries, respectively), expectations to
act in favor of all stakeholders are high. CSR activities are well perceived, highly priced by the market
and lead to reducing firms’ financial risk. Additional results from the individual components of CSR
strongly support this view – human rights, human resources, and business behavior dimensions are
also associated with low firm financial risk only in countries with low shareholder protection and
countries with high stakeholder protection, respectively.

The rest of this paper is structured as follows: Section 2 presents the theoretical background as well
as the hypothesis development; Section 3 introduces the data and the methodology; Section 4
discusses the main results and tests their validity via robustness checks; and finally, Section 5
concludes.

2 PREVIOUS LITERATURE, THEORETICAL BACKGROUND AND MAIN HYPOTHESES:

Our work builds on two literatures. On the one hand, we extend studies that examine the relation
between CSR and financial risk; on the other, we expand research that investigates how different
types of institutions may influence the development and diffusion of CSR practices.

2.1 CSR and financial risk in the literature

Through a meta-analysis, Orlitzky and Benjamin (2001) reconsider papers that address the link
between social performance and financial risk in the US between 1978 and 1995. The authors
support the existence of a negative relationship between these two variables and conclude that CSR
practices are relevant for firms and are associated with low financial risk. More recent studies
analyze the relation between CSR and financial risk as measured by the traditional risk–return
models. A wide body of this literature focuses on the idiosyncratic risk as the main measure of
financial risk bearing in mind that the formation of well-diversified portfolios is impossible in practice
(Jo & Na, 2012), and that the idiosyncratic risk is the single largest impediment to market efficiency
by deterring arbitrage activity (Duan, Hu, & McLean, 2010). These studies’ findings are ambiguous
and do not provide clear evidence of the negative relation between CSR and idiosyncratic risk. While
some affirm that CSR reduces firm idiosyncratic risk through positive reputation, high employee
loyalty and strong customer trust (e.g., Bouslah, Kryzanowski, & M’Zali, 2013; Boutin-Dufresne &
Savaria, 2004; Lee & Faff, 2009; Luo & Bhattacharya, 2009; Mishra & Modi, 2013), others document
no significant relation between CSR and idiosyncratic risk (e.g., Humphrey, Lee, & Shen, 2012; Kim,
2010).

Jo and Na (2012), Luo and Bhattacharya (2009), and Oikonomou, Brooks, and Pavelin (2012) explore
the relation between CSR and systematic risk in the American market. Jo and Na (2012) use the MSCI
ESG Stats database between 1991 and 2010 and show that a firm’s overall CSR engagement alleviates
the systematic risk and the sensitivities to market fluctuations in controversial industries in the US.
Similarly, Luo and Bhattacharya (2009) document a negative relation between CSR and systematic
risk for Fortune’s MAC firms in the years 2002 and 2003. Oikonomou et al. (2012) analyze the
relationship between CSR and systematic risk between 1992 and 2009 using a sample of companies
from the S&P 500. They show that the individual KLD strength components are negatively but
insignificantly related to systematic risk while three out of five of the individual social concerns
(community, employment, and environment) are positively and significantly associated with
systematic risk. Salama, Anderson and Toms (2011) predominantly focus on environmental
responsibility in the UK market between 1994 and 2006 and document a negative association
between firms’ environmental performance and systematic risk. Finally, Gregory, Whittaker, and Yan
(2016) show on a sample of US firms rated by KLD that SR firms have a higher value. Even if the
valuation effect is attributable mainly to greater earnings persistence, the market betas are slightly
lower on high SR stocks.

Existing literature on the relation between CSR and financial risk is not limited to conventional
measures of risk. For example, Goss (2009) argues that CSR is a significant determinant of distress
probability and shows a negative relation between firms’ CSR involvement and the probability of
default on a sample of US firms rated by KLD over the period 1991 to 2003. Bauer, Derwall, and Hann
(2009)4 focus their analysis on employee relations – a component of CSR – and show that the quality
of employee relations is a strong determinant of bond investors’ decisions. Similar results have been
shown in the work of Verwijmeren and Derwall (2010): firms with high employee relations
performance have better credit ratings and low debt–assets ratios. In sum, previous literature
documents a slight negative relationship between CSR and different measures of financial risk,
namely stock volatility, idiosyncratic risk, systematic risk and credit risk. The literature has little to
say, however, about the outcomes of CSR in different institutional contexts, and thus the extent to
which firms’ institutional environment affects the relation between CSR and firms’ financial risk.

2.2 CSR and firms’ institutional context in the literature

Most of the previous literature considers CSR as a firm’s voluntary initiative, and relates it to the
firm’s financial and operational performance (Liang & Renneboog, 2016). However, a firm’s CSR
practices are far from being unaffected by a country-level institutional framework. Ioannou and
Serafeim (2012) empirically examine the link between national-level institutions and firms’ CSR
practices. Using a sample of firms from 42 countries spanning seven years,

and an annual composite CSR index for each firm based on social and environmental metrics, the
authors document a huge cross-country variation in CSR ratings and stakeholders’ practices. They
argue that the political system, the labor and education system, and the cultural system are the most
important national business system categories of institutions that impact CSR. Similarly, Jackson and
Apostolakou (2010) use data obtained from SAM (an independent asset management company in
Zurich) that represent firms in 16 western European countries, and find that firms from the Anglo-
Saxon countries score higher on most dimensions of CSR than firms in the more coordinated market
economies in Continental Europe. These findings are in harmony with the new institutionalism, which
sees institutions as creating a variety of coercive, normative and mimetic pressures on firms to adopt
particular structures or practices to enhance their legitimacy (DiMaggio & Powell, 1991). Chapple and
Moon (2005) analyze website reporting of CSR for seven Asian countries, and document a cross-
country CSR variation that could be explained by national factors. They also find that multinational
corporations adjust their CSR practices according to the specific national contexts in which they
operate. Finally, Maignan (2001) focuses on consumers’ understanding of CSR in France, Germany,
and the US, and concludes that nation-level institutions influence their perceptions significantly. For
example, in France and Germany, consumers pay less attention to firms’ economic responsibilities,
and tend to support firms with high CSR practices, unlike US consumers, who value highly economic
responsibilities. Maignan (2001) concludes that nation-level institutions are likely to affect firms’
involvement in CSR activities and resulting social performance through their impact on consumer
perceptions.

If the institutional context affects firms’ CSR involvement and stakeholders’ perceptions of CSR
activities, the outcomes from adopting a CSR strategy are also likely to be affected by the nation-level
institutions through the conditional effect of CSR practices on firms’ reputation, customers’
satisfaction, employees’ loyalty, and suppliers’ solidarity. Very few studies have considered this issue.
El Ghoul et al. (2015) show that the institutional framework of a country moderates the relation
between CSR and firm value. Hoepner, Oikonomou, Scholtens, and Schröder (2016), looking into 470
loan agreements in 28 different countries, find that higher country sustainability is associated with
lower costs of bank loans. And finally, Breuer, Rosenbach, and Salzmann (2016) examine the effects
of CSR on the cost of equity under different levels of investor protection. The authors conclude that,
in countries where investor protection is strong, the cost of equity capital is negatively associated
with the level of CSR investment. To the best of our knowledge, no cross-country study has
investigated the effect of a firm’s CSR activities on its financial risk. In this paper we fill this gap in the
literature and examine how the legal environment moderates the relation between CSR and financial
risk.

2.3 CSR and firms’ financial risk: Theoretical background and hypotheses

Three main arguments theoretically justify the association between CSR and financial risk. Two
arguments, involving the stakeholder theory and information asymmetry, are in line with CSR
generating a lower financial risk. The third one, based on the risk management theory, presents
social performance as a result of a risk reduction policy. The first argument relies on stakeholder
theory. Social responsibility and stakeholder theory go hand in hand. In stakeholder theory, attention
is paid to all groups that can affect or be affected by a firm. Freeman (1984) suggests that managers
should balance the interests of shareholders, employees, customers, and the community to ensure
the survival and success of the organization. Indeed, businesses have significant interest in increasing
their social performance and meeting stakeholders’ expectations so as to preserve and develop the
company’s reputation. A good reputation due to better stakeholder relations is thus considered an
intangible asset impacting the value of the firm (Little& Little, 2000) and producing potential tangible
benefits (Fombrun, 1996). From the resource-based perspective developed by Barney (1991), a
positive reputation reflects a psychological contract between a firm and its stakeholders, creating an
intangible asset enhancing firm performance. The impact of reputation on financial performance is
mainly due to insulation from negative financial performance (Luo & Bhattacharya, 2009). Firms that
improve their reputation by increasing their social performance benefit from a low likelihood of legal
actions resulting in financial penalties, less strict regulatory controls, a high degree of employee
loyalty, and strong customer trust. Furthermore, as indicated by Godfrey (2005), CSR initiatives
generate moral capital, creating relational wealth in different forms among all firm stakeholders (e.g.,
employee satisfaction as a result of a good working environment, legitimacy and credibility in the
community). The moral capital provided by CSR acts as insurance, protecting relational wealth
against loss by reducing negative stakeholder assessments and the overall severity of sanctions
against the firm.

Second, CSR practices reduce the information asymmetry, which is likely to affect financial risk.
Indeed, from an information quality point of view, Pastor and Veronesi (2003, 2009) show through a
theoretical model that uncertainty about profitability increases the idiosyncratic return volatility.
More precisely, an improvement in the quality of information about firm profitability leads to low
information asymmetry and low idiosyncratic volatility. This is consistent with O’Hara (2003) and
Rajgopal and Venkatachalam (2011), who claim that by improving the disclosures and the quality of
reporting, firms mitigate the information asymmetries about their performance and reduce their
stock price volatility. From a CSR perspective, several studies demonstrate that information
asymmetry is likely to be more severe in low CSR firms (e.g., Cho, Lee, & Pfeiffer Jr., 2013). Kim, Park,
and Wier (2012) support this idea and provide evidence that firms with high CSR scores are less likely
to manipulate their real operating activities or to manage their earnings. Furthermore, the authors
emphasize that high CSR firm managers shun earnings management and produce more transparent
financial reporting because they want to project and communicate a positive image to all the
stakeholders (Dhaliwal, Li, Tsang,&Yang, 2011). This reduction of information asymmetry provides
additional evidence in support of the role that CSR can play in reducing stock price volatility. For
example, Benlemlih, Shaukat, Qiu, and Trojanowski (2016) confirm this view by showing that firms
that disclose additional environmental and social information are associated with low total and
idiosyncratic risks. From a risk management perspective, Kytle and Ruggie (2005) emphasize that the
main objectives of a risk management system are to address uncertainty in the marketplace, create
controls that minimize or eliminate disruption, loss or damage to business operations, and reduce
the impact of unwanted events on the business. Implementation of a risk management system leads
to making choices that prove to be socially responsible. For example, to avoid the risk of paying
pollution-related penalties, the firm will act in favor of the environment, which will result in less strict
regulatory controls, a high level of customer trust and a better understanding, by the community, of
the difficulties faced by firms, especially in times of financial crisis (Lahrech, 2011). Thus, improving
environmental risk management reduces the probability of an environmental crisis that could
negatively affect a firm’s expected cash flows. This is consistent with the idea of Sharfman and
Fernando (2008) who argue that a reduction in emissions and pollution, and the mitigation of
litigation risk, may enhance financial performance and/or reduce financial risk. The authors explain
that when potential litigations are reduced, cash flows are more stable and the firm’s resources can
be dedicated to strategic decisions and investments that contribute to reducing the financial risk
perceived by the market. In sum, it is expected that CSR helps maintain stable relations with
governments and the financial community, including shareholders. CSR also helps firms build
customer loyalty, gain employee support in times of financial instability and reduce information
asymmetry among all firms’ stakeholders. This undoubtedly reduces a company’s risk of facing
financial penalties and lawsuits. In practice, companies with better social ratings are expected to
have less financial risk than companies with poor social ratings. As regards the part of the risk that is
most affected, we claim it is the idiosyncratic risk for two reasons. First, if CSR can be analyzed as a
common risk factor, it will not be included in a traditional risk-return model like the CAPM or the
Fama–French model and will be improperly included in the idiosyncratic risk. Second, if CSR, thanks
to stakeholders’ benevolent and patient behavior, is a way to reduce random shocks occurring to the
firm, it will result in a lower idiosyncratic risk. The importance of systematic risk is obvious for a
portfolio manager who cannot avoid bearing this risk. However, he is also concerned by idiosyncratic
risk that may include a non-diversifiable common SR risk factor or that cannot be eliminated because
of the impossibility of a perfect diversification.

H1: CSR reduces firm financial risk, and the impact is stronger on idiosyncratic risk.

2.4 The role of the institutional framework in the relation between CSR and firms’ financial risk

From an international perspective, and by studying the association between ‘national institutions’
and social performance, Ioannou and Serafeim (2012) reveal a huge cross-country variation in CSR
ratings and actual stakeholders’ practices. Liang and Renneboog (2016) empirically show that legal
origins are more fundamental sources of CSR than political institutions and firms’ performance. The
English common law fosters CSR and sustainability the least, whereas companies under civil law
origin are likely to be more socially responsible. In common law countries, laws and regulations
effectively protect shareholders’ interest, which reinforces the shareholder primacy model, and
questions the incentives for companies to address the interests of any other stakeholder. Therefore,
stakeholder well-being would only be achieved by the maximization of the shareholders’ value and
the development of the capital market. CSR activities and stakeholders’ consideration are likely to be
perceived as a waste of a company’s resources and CSR involvement in common law culture is
expected to have no effect on (or to positively affect) firms’ financial risk. In contrast to this common
law view of social value,Matten and Moon (2008) argue that civil law traditions are believed to be
more stakeholder-oriented in defining company law. Allen, Carletti, and Marquez (2009) and Liang
and Renneboog (2016) highlight the example of German companies that are legally required to
consider stakeholders’ interests through the co-determination system that allows employees to have
an equal number of seats as shareholders on the supervisory board. Therefore, in civil law countries,
the higher the demand for CSR activities, the higher the increase in market value for a firm that
improves its CSR practices (Mackey, Mackey, & Barney, 2007).

Overall, the discussion on the legal origins of CSR emphasizes the existence of two major country
orientations. On the one hand, “shareholder-oriented countries” are those that protect and consider
shareholders most and grant less interest to other stakeholders. In such countries, regulators
intervene extensively in the interest of shareholders, and individuals support the notion that the
maximization of a firm’s value is the main objective of a firm. CSR practices in favor of employees,
customers and suppliers are not very well perceived by the community and are likely to increase
firms’ financial risk since the market in these countries considers such practices to be a waste of a
company’s resources. This is most likely the case in common law countries. In contrast to this first
category, in “stakeholder-oriented countries,” regulation takes into account the interest of all
company stakeholders and not only that of shareholders. The regulators tend to stimulate CSR
practices through an environment that protects human rights, improves the relations with human
resources, and protects customers, suppliers and other actors in the market. Social and
environmental practices are well perceived by all economic actors, and are likely to be priced by the
market and lead to low firm financial risk. This is most likely the case in civil law countries:

H2: The negative link between CSR commitment and firms’ financial risk is stronger in civil law than in
common law countries.
The common law versus civil law classification may not be as binary as that. Indeed, a country could
have a strong attitude that protects shareholders, but, at the same time, take into account other
stakeholders’ interests. For example, Deakin and Sarkar (2008) examine the correlations between
shareholder, creditor, and worker protection score changes in France, Germany, the UK, and the USA
over the period 1970–2005. They find a positive correlation between the three areas of law except
for the UK. Therefore, improving the protection of shareholders can be consistent with improving the
protection accorded to creditors and workers. From a company perspective, the primary factors of
production are capital (mainly represented by shareholders) and labor (mainly represented by
human resources). To further explore the institutional environment, we consider the level of
countries’ regulation in favor of these two categories (shareholders and human resources as the
main representation of financial and non-financial stakeholders). This choice of shareholders’ and
workers’ legal protection is in harmony with our first classification (common law versus civil law
countries); it refers to regulation implemented by countries to protect mainly shareholders and/or
other stakeholders, which is a good representation of the legal system of the country. As discussed
previously, we expect that CSR would have a negative effect on financial risk in countries where the
regulation tends to protect all firms’ non-financial stakeholders (assessed by the strictness of
employment protection) as compared to countries with more shareholders’ protection regulation.
This is consistent with our third hypothesis:

H3: The negative link between CSR commitment and firms’ financial risk is stronger in stakeholder-
oriented countries than in shareholder-oriented countries.

We further explore this link between CSR and financial risk by looking separately at each component
of CSR. We expect the negative relationship identified in H2 with the overall CSR score to be
maintained for each sub-score, except the corporate governance one. Indeed, this last dimension is
related to the way in which firms consider financial stakeholders, especially shareholders. We thus
expect that a good performance in corporate governance would reduce firm risk more strongly in
common law countries and shareholder-oriented countries than in civil law or stakeholder-oriented
countries. This is consistent with H4:

H4: Corporate governance is the only CSR domain for which the negative link with firms’ financial risk
is stronger in common law (respectively shareholder-oriented) countries than in civil law
(respectively stakeholder oriented) countries.

3 DATA AND METHODOLOGY

To establish the link between CSR and financial risk, our study uses the Vigeo ratings to measure
social responsibility. It also uses data provided by Thomson Reuters for financial variables. Systematic
and idiosyncratic risks are the main dependent variables, CSR score is considered to be the interest
variable and several firm characteristics are used as control variables. In our sample, we thus retain
observations with sufficient data to calculate those variables. The sample for this study consists of
5,716 firm-year observations representing 1,169 individual firms between 2001 and 2011. Table 1
indicates the number of firms located in the different countries covered by the Vigeo rating agency.
Countries such as the United Kingdom, the United States, and France are well represented and are,
therefore, more heavily considered in the sample presented in this paper (15.50%, 15.45%, and
14.77%, respectively).

3.1 CSR data

To measure a firm’s CSR commitment, we use data provided by the Vigeo rating agency. Vigeo is the
European leader in CSR ratings and their registered office is located in France. It has recently been
used by several researchers (e.g., Ferrell, Liang, & Renneboog, 2015; Girerd-Potin, Jimenez-Garces, &
Louvet, 2014; Liang & Renneboog, 2016; Quéré, Nouyrigat, & Baker, 2015) because of the reliability
of its data and the appliance of a check-the-box approach (Quéré et al., 2015) that consists in rating a
firm based on its compliance with the conventions, guidelines, and declarations of international
organizations such as the UN, ILO, and OECD. Vigeo rates firms from different countries as compared
to KLD stats, which focus on the American market.7 Although the methodologies used by the two
agencies are different, their dimensions are similar. For example, five KLD components – community,
corporate governance, human resources, environment, and human rights – are also assessed by
Vigeo. Despite this similarity, three main differences exist between KLD and Vigeo sub-ratings. First,
KLD presents a separate score for diversity while Vigeo integrates this dimension in the human rights
score. Second, KLD dimensions contain a sub-rating for product characteristics; this is integrated into
‘business behavior’ for Vigeo.8 Third, KLD provides scores for strengths and concerns in each of

TABLE 1 Sample breakdown by country

Country N % Country N %

Australia 139 2.43 Japan 744 13.02

Austria 74 1.29 Luxembourg 18 0.31

Belgium 80 1.40 New Zealand 10 0.17

Canada 91 1.59 Portugal 54 0.94

China 6 0.10 Singapore 30 0.52

Denmark 91 1.59 Spain 227 3.97

Finland 136 2.38 Sweden 225 3.94

France 844 14.77 Switzerland 190 3.32

Germany 370 6.47 The Netherlands 153 2.68

Greece 41 0.72 The United Kingdom 886 15.50

Hong Kong 79 1.38 The United States of America 883 15.45

Ireland 50 0.87

Italy 220 3.85 Total 5,716 100

the seven dimensions. Vigeo provides a rating for six fields: environment, corporate governance,
human rights, human resources, business behavior, and community involvement. In this paper, we
follow the methodology of Girerd-Potin et al. (2014) by calculating a global CSR rating representing
the average of the six Vigeo components. More importantly for our purpose, Vigeo uses a best-in-
class approach where firms are rated relative to their industry peers from both domestic and
international markets. The ratings are independent from the cross-country difference in jurisdiction,
regulation and the local CSR situation (Ferrell et al., 2015). This characteristic of Vigeo ratings ensures
that the CSR ratings data are not biased by country-specific institutions, which is critical for our study.

3.2 Country-level institutions

To classify countries according to their legal origins (common law versus civil law), we refer to LLSV
(1998), and create two dummy variables that take the value of one if the country is a common law
(civil law, respectively) one and 0 otherwise. We next build two interaction variables to capture the
effect of CSR scores on financial risk in common law (COMMONLAW*CSR) versus civil law (CIVIL
LAW*CSR) countries.

We also use a more direct classification based on the level of regulation in favor of shareholders and
stakeholders by focusing on regulation related to the primary factors of production, which are capital
(mainly represented by shareholders) and labor (mainly represented by human resources). Our
shareholders’ protection scores are based on LLSV (1998), La Porta et al. (2008) and Spamann (2010)
and the stakeholders’ protection scores are based on the strictness of employment protection from
the OECD indicators of employment protection. One might argue that these classifications are highly
related and that countries with high shareholders’ protection are the same as countries with low
stakeholders’ protection (as measured by human resources’ protection). The correlation coefficient
between these two scores partially confirms this intuition since they are strongly negatively
correlated with a correlation coefficient of −0.78. However, because the negative correlation is not
perfect, it seems relevant to keep both classifications. From these two indicators, we create two
dummy variables that take the value of 1 if the country is a shareholder-oriented (stakeholder-
oriented, respectively) one and 0 otherwise. As previously, we next build two interaction variables to
capture the effect of CSR scores on financial risk in these two institutional contexts.

3.3 Financial risk data

To study the relationship between CSR and financial risk, this paper uses different measures of
financial risk based on the variance and its components, namely systematic and idiosyncratic risks.
We use the market beta provided by the Fama–French three-factor model (1993)10 with an
estimation of the Fama–French model over a 36-month period. We also consider idiosyncratic risk as
measured by the standard deviation of the residuals from the Fama–French three factor model. The
model estimating the systematic and idiosyncratic risks in the multivariate approach is illustrated by
the following equation:

Rit − Rft = 𝛼i + 𝛽iM(RMt − Rft) + 𝛽isSMBt + 𝛽ihHMLt + 𝜀it, (1)

where Rit is the return of firm i for month t; the Rft represents the risk-free rate (based on a one-
month Euribor rate); (RMt − Rft) is the excess return on the market portfolio for month t; the SMBt is
the difference of returns between ‘small’ and ‘big’ market capitalization portfolios for month t; and
HMLt is the difference in returns between ‘high’ and ‘low’ book-to-market portfolios for month t.
Both SMBt and HMLt are calculated using the Fama–French three-factor model methodology. The 𝜀it
is the stochastic error term. To estimate the firm systematic risk (equal to the market beta) and firm
idiosyncratic risk (equal to the standard deviation of the error terms) for a given year, we use the
monthly excess returns over the last 36 months. This process is repeated 11 times for each firm in
order to estimate the value of systematic and idiosyncratic risks for each year of the sample.

3.4 Control variables

The control variables in our study are consistent with the work of Bouslah et al. (2013), Oikonomou
et al. (2012), and Salama et al. (2011) on the relationship between CSR and financial risk. They act as
controls for the different effects of firm characteristics on financial risk. Therefore, we measure firm
size (SIZE) by using the natural logarithm of market capitalization. A negative relationship is expected
between this measure and financial risk. Previous work (e.g., Alexandre & Thistle, 1999; Melicher,
Rush, & Winn, 1976) suggests that large firms are less exposed to financial risk since they have the
capacity to manage their risk, especially in times of high volatility. We use the book-to-market ratio
(BTM), which is equal to the book value of assets divided by the market value of assets, as a proxy for
investment opportunity. Several studies (e.g., Lewellen, 1999) highlight the issue that firms with
extremely poor growth perspectives are characterized by low share prices and high book-to-market
values. A number of analysts consider firms with extremely poor growth perspectives (high book-to-
market ratio) to be more exposed to stock volatility. A positive relationship is thus expected between
this study’s measures of financial risk and book-to-market ratio. We also control for capital gearing
(GEAR), measured by the total debt as a percentage of the total capital. Previous studies (e.g., Baxter,
1967; Hamada, 1972; Ben-Zion & Shalit, 1975) argue that a firm’s debt as a consequence of its capital
structure is highly correlated with its risk. The greater the amount of debt, the higher the firm’s
financial risk. Another variable widely used in such studies is the firm liquidity (LIQ). To control the
effect of liquidity, this study uses the current ratio defined as the total current assets to total current
liabilities (e.g., Abdelghany, 2005). Liquidity reveals whether the firm is able to meet its obligations in
the short term. The greater a company’s liquidity, the less it is exposed to financial risk. We also
control for firm profitability (REN), which is measured by earnings before interest and taxes as a
percentage of total capital. Investors are more confident in profitable firms’ future as they are more
likely to face adverse events. We expect profitability to be negatively related to financial risk.
Furthermore, we include country dummy variables to control for country fixed effects; we also
include industry dummy variables to control for industry fixed effects, since industrial components
can also influence a firm’s financial risk. The industry dummy variables are based on the one-digit
code of the Standard Industrial Classification (SIC).

Finally, in order to account for changing economic conditions, this study includes dummy variables
for each year of the sample period.

3.5 Methodology

Using a multivariate approach, we run regressions of financial risk (systematic and idiosyncratic risks)
on the interaction terms with the overall CSR score (as well as the interactions with the individual
components of CSR) and other control variables as defined below:

FRit = 𝛼 + 𝛽1 × ∗COMMON LAW∗CSRit + 𝛽2 × ∗CIVIL LAW∗CSRit + 𝛽3 × BTMit + 𝛽4 × GEARit + 𝛽5 ×

SIZEit + 𝛽6 × LIQit + 𝛽7 × RENit + Σ j 𝛽j × INDUSTRYDUMMYj + Σ k 𝛽k × COUNTRYDUMMYK + Σ L 𝛽L ×
YEARDUMMYL + 𝜀it

where FRit is the financial risk measured by systematic risk, or idiosyncratic risk; 𝛼 is the time
invariant intercept; and the 𝛽 are the slope coefficients of the respective factors. CSRit represents
social responsibility scores. It is successively measured by the overall CSR score (CSR_NET) and the
individual components of the Vigeo rating: community involvement (CIN), corporate governance
(CG), human resources (HR), environment (ENV), business behavior (BB), and human rights (HRTS);
BTMit is the book-to-market ratio; GEARit is the capital gearing; SIZEit is the logarithm of market
capitalization; LIQit is firm liquidity; RENit is firm profitability. All refer to firm i in year t, and 𝜀it is the
respective disturbance term.

This multivariate approach is based on annual data (at the end of each year in our sample). All the
regressions are run using panel data techniques with year, country, and industry fixed effects. To
validate the hypotheses, we expect 𝛽1 and 𝛽2 to be negative (for H1 on the direct link between CSR
and financial risk, there is only one coefficient 𝛽1 and we expect it to be negative) and 𝛽2 to be
stronger and highlight a higher significance level than 𝛽1 (for H2, the link is stronger in civil law than
in common law countries) except when CSR is considered to be a corporate governance rating (H4).
To validate H3, we replace civil law and common law countries with stakeholder- and shareholder-
oriented countries.
3.6 Descriptive statistics

Table 2 presents an overview of the descriptive statistics for the regression variables and CSR data.
Panel A reports the sample descriptive statistics regarding our two main risk measures. With regard
to the systematic risk, the average value in our sample is 0.91, while the median is around 0.87. In
terms of idiosyncratic risk, the descriptive statistics show that the average measure is 7.92% and the
median value is 7.31%. Panel B presents descriptive statistics for CSR measures. It shows that the
average for the individual components of CSR is between 1.93 for the smallest value and 1.99 for the
largest value. Panel C presents the descriptive statistics of the control variables. Finally, the overall
CSR score descriptive statistics by year are presented in panel D.

To explore the potential relationship between CSR and financial risk, Table 3 presents the Pearson
correlation coefficients. The overall CSR score is negatively related to systematic risk and
idiosyncratic risk. Furthermore, these two measures of risk are negatively associated with all the
individual components of the CSR score. Additionally, the measures of financial risk are highly related
to the explanatory variables with the expected relationships (except for systematic Risk with
gearing). Finally, the weak correlations between these explanatory variables indicate that our models
do not suffer from multicollinearity problems.

TABLE 2 Descriptive statistics for the regression variables and corporate social responsibility data

Variable Mean Min Q1 Median Q3 Max St. Dev. N

Panel A. Descriptive statistics for the dependent variables (financial risk variables)

SYSTEMATIC 0.91 −2.84 0.50 0.87 1.25 4.53 0.60 5,716

IDIOSYNCRATIC 7.92% 0.15% 5.73% 7.31% 9.24% 34.86% 0.04 5,716

Panel B. Descriptive statistics for the corporate social responsibility scores

CIN 1.96 0.00 1.00 2.00 3.00 4.00 0.96 5,716

BB 1.98 0.00 1.00 2.00 3.00 4.00 0.95 5,716

CG 1.93 0.00 1.00 2.00 3.00 4.00 0.96 5,716

HRTS 1.97 0.00 1.00 2.00 3.00 4.00 0.95 5,031

HR 1.98 0.00 1.00 2.00 3.00 4.00 0.95 5,716

ENV 1.99 0.00 1.00 2.00 3.00 4.00 0.96 5,716

CSR_NET 1.83 0.00 1.29 1.80 2.30 4.00 0.69 5,716

Panel C. Descriptive statistics for the control variables

BTM 0.72 0.08 0.51 0.72 0.91 2.68 0.29 5,716

LIQ 1.16 0.01 0.55 0.77 1.02 59.64 6.07 5,716

GEAR 0.80 −6.84 0.23 0.54 1.04 6.96 1.02 5,716

REN 0.15 −4.29 0.07 0.13 0.21 4.26 0.25 5,716

SIZE 22.36 14.46 21.55 22.36 23.16 26.47 1.32 5,716

Panel D. Descriptive statistics for the overall corporate social responsibility score
2001 1.52 0.12 1.20 1.45 1.88 2.55 0.48 152

2002 1.49 0.41 1.18 1.45 1.83 2.55 0.44 168

2003 1.46 0.41 1.14 1.45 1.75 3.15 0.48 236

2004 1.70 0.12 1.14 1.57 2.16 3.82 0.71 288

2005 1.88 0.12 1.24 1.88 2.46 3.47 0.74 315

2006 1.87 0.12 1.29 1.88 2.40 3.47 0.75 335

2007 1.87 0.12 1.29 1.83 2.46 3.64 0.73 389

2008 1.86 0.12 1.29 1.87 2.46 3.64 0.72 492

2009 1.89 0.00 1.33 1.88 2.40 4.00 0.68 1,051

2010 1.89 0.00 1.40 1.88 2.40 4.00 0.68 1,121

2011 1.87 0.00 1.29 1.80 2.40 4.00 0.69 1,169

4 RESULTS

4.1 Main results

4.1.1 The link between CSR and firms’ financial risk worldwide (without considering the legal context)

We argue in hypothesis 1 that the overall CSR score negatively affects firms’ financial risk worldwide.
We thus estimate our main regression and report the results in Table 4. With regard to the control
variables, we notice

TABLE 3 Pearson correlation coefficients between the variables

BETA IDIO CSR_NET HRTS ENV HR CIN CG BB BTM GEAR SIZE LIQ REN

BETA 1.00

IDIO 0.33 1.00

CSR_NET −0.04 −0.16 1.00

HRTS −0.01 −0.11 0.76 1.00

ENV −0.02 −0.11 0.76 0.51 1.00

HR −0.02 −0.14 0.77 0.61 0.59 1.00

CIN −0.01 −0.08 0.69 0.44 0.52 0.47 1.00

CG 0.00 −0.04 0.49 0.21 0.24 0.20 0.23 1.00

BB −0.01 −0.11 0.74 0.55 0.55 0.54 0.46 0.26 1.00

BTM 0.03 0.15 0.02 0.03 0.07 0.04 0.01 −0.07 0.02 1.00

GEAR −0.08 0.01 0.05 0.02 0.03 0.03 0.07 0.02 0.06 0.09 1.00

SIZE −0.06 −0.36 0.33 0.25 0.29 0.25 0.29 0.13 0.24 −0.35 −0.02 1.00

LIQ −0.13 −0.13 0.04 0.01 0.04 0.03 0.04 0.03 0.05 0.17 0.21 −0.02 1.00
REN 0.00 −0.16 0.00 −0.02 −0.01 −0.01 0.02 0.03 0.00 −0.31 −0.11 0.13 −0.07 1.00

This table shows the Pearson pairwise correlation coefficients between the variables for the 5,716
firm-year sample observations between 2001 and 2011. Definitions for all variables are presented in
Appendix A. The correlation coefficients in bold face are significant at least at the 5% level. The
dependent variables are the market beta (BETA) and idiosyncratic risk (IDIO). The CSR variables are
the overall CSR score (CSR_NET), human rights (HRTS), environment (ENV), human resources (HR),
community involvement (CIN), corporate governance (CG), and business behavior (BB). The control
variables are book-to-market ratio (BTM), gearing (GEAR), size (SIZE), liquidity (LIQ), and profitability
(REN).

TABLE 4 The relation between the overall CSR score and firms’ financial risk worldwide

Dependent variable Market beta Idiosyncratic risk

(1) (2)

INTERCEPT 1.456*** 0.283***

(4.99) (27.78)

CSR_NET −0.023** −0.001**

(−1.96) (−1.98)

BTM 0.170*** 0.001

(5.69) (0.72)

GEAR −0.013 0.002***

(−1.59) (2.82)

SIZE −0.008 −0.009***

(−1.11) (−19.88)

LIQ −0.126*** −0.006***

(−13.05) (−10.27)

REN −0.009 −0.012***

(−0.30) (−3.48)

INDUSTRY Yes Yes

COUNTRY Yes Yes

YEAR Yes Yes

R2 22.41 29.87

N 5,716 5,716

This table reports results from regressing systematic and idiosyncratic risks on the overall CSR score
and control variables over the 2001–11 period. The control variables are book-to-market ratio (BTM),
gearing (GEAR), size (SIZE), liquidity (LIQ), and profitability (REN). All the models include country,
industry and year fixed effects. For definitions of variables refer to Appendix A. T-statistics based on
robust and heteroskedasticity consistent standard errors are reported in parentheses.

* Statistical significance at the 10% level.

** Statistical significance at the 5%level.
*** Statistical significance at the 1%level.

significant coefficients consistent with our expectations for the book-to-market ratio and firm’s
liquidity. In line with our assumptions, a firm’s size and profitability are both negatively associated
with idiosyncratic risk. In terms of our variables of interest, models 1 and 2 show that the overall CSR
score negatively affects systematic and idiosyncratic risks (at the 5%significance level). This provides
evidence that the negative relationship between CSR and firms’ financial risk, shown to be significant
in some specific geographic areas, is also valid in an international context. However, our expectation
to detect a stronger impact on idiosyncratic risk than on systematic risk is not validated at this stage.
CSR has similar effects on market and idiosyncratic risk, with SR firms experiencing less volatility than
their industrial counterparts, both when shocks affect the market as a whole and the firm alone.

We are interested in the moderating effect of the legal context on the relation between CSR and firm
risk. However, the study of this moderating role is relevant only if the causality is from CSR to risk
reduction. If it is risk management that creates – as a byproduct – an SR firm behavior, we cannot
expect various perceptions of CSR in countries to impact firm risk reduction.

To investigate this issue, we address the question of whether high social performance precedes low
financial risk or vice versa. In other words, does good social performance cause a firm to become less
risky, or does a low level of financial risk lead to subsequent superior social performance? In fact,
when studying the relationship between CSR and financial risk, one might argue that low financial
risk helps increase social commitment. High stability is generally associated with good financial
performance, which may result in more resources being available for the pursuit of CSR goals.

To examine the direction of causation between firm financial risk and CSR measures, we use the
Granger causality test (Granger, 1969). Several studies have used the Granger causality test in the
context of CSR (e.g. Bird, Hall, Momentè, & Reggiani, 2007; Scholtens, 2008; Nelling &Webb, 2009;
Bouslah et al., 2013). According to Granger’s causality procedure, the variable X is said to Granger-
cause the variable Y if the past values of X are useful in predicting Y, given the past values of Y. If the
coefficients of the lags of the variable X are significantly different from zero, we conclude that X
‘Granger-causes’ Y. Similarly, the causation may occur from Y to X (Y ‘Granger-causes’ X) if past values
of Y contain information that helps predict X above and beyond the information contained in past
values of X. In order to test for Granger causation, we follow Scholtens (2008) and Bouslah et al.
(2013) by considering a vector autoregression (VAR) model with three lags:

⎧⎪⎪⎨⎪⎪⎩

FRit = 𝛼1 + 𝛼11FRit−1 + 𝛼12FRit−2 + 𝛼13FRit−3 + 𝛽11CSRit−1 + 𝛽12CSRit−2 +𝛽13CSRit−3 + 𝛾1Xit + 𝜀it,

CSRit = 𝛼2 + 𝛼21FRit−1 + 𝛼22FRit−2 + 𝛼23FRit−3 + 𝛽21CSRit−1 + 𝛽22CSRit−2 +𝛽23CSRit−3 + 𝛾2Xit +

𝜃it,

where FRit is the financial risk measure (systematic risk or idiosyncratic risk) of firm i in year t.
TheCSRit is theCSR score (measured by the overall CSR score as well as the individual components of
CSR, namely human rights, environment, human resources, community involvement, corporate
governance and business behavior) of firm i in year t. TheXit is the vector of the control variables as
defined above (the control variables used in the main analysis include time, industry and country
fixed effects). For each equation in the VAR, we test the null hypothesis that none of the other
endogenous variables Granger-cause the dependent variable in the same equation.

Table 5 reports the p-values of the Granger causation tests. Based on these results, the null
hypothesis that the overall CSR score does not Granger-cause financial risk at the 1%significance level
can be rejected (this is true for systematic and idiosyncratic risks). Therefore, we conclude that the
overall CSR score of a firm does Granger-cause its financial risk. Furthermore, neither of the two
measures of financial risk Granger-causes the overall CSR score. Consequently, there appears to be
unidirectional causality from the overall CSR score to the financial risk. Examining the individual
components of CSR, it appears that a similar relationship holds between human resources and
systematic and idiosyncratic risks, between community involvement and idiosyncratic risk, and
between corporate governance and business behavior and idiosyncratic risk. All the relationships are
statistically significant at the 5% level or better.

Overall, our results from the Granger causality tests show that information asymmetry and
stakeholder theory dominate risk management theory in explaining the link between CSR and
financial risk. They also confirm that the findings from the main analysis do not suffer from any
reverse causality issue.

4.1.2 The link between CSR and firms’ financial risk worldwide: on the role of the legal context

We argue in hypothesis 2 that the relationship between CSR and financial risk is more negative in civil
law than in common law countries (in stakeholder-oriented than in shareholder-oriented countries,
respectively). To examine how the strength of a country’s institutions affects the relation between
CSR and financial risk, we estimate equation (2) and present the results in Table 6. It appears from
this analysis that social involvement in common law countries does not lead to any risk reduction
perspective. The CSR coefficient in common law countries loads negatively but statistically
insignificantly in the two models (systematic and idiosyncratic risks), providing support for our
second hypothesis and suggesting that CSR is not associated with firms’ financial risk reduction in
those countries. In civil law countries, we notice that, only idiosyncratic risk is negatively and
significantly affected by the overall CSR score (model 2). We interpret this result as additional
support for our first and second hypotheses. In civil law countries, individuals expect high CSR
involvement from companies and tend to reward such practices with more loyalty (from customers),
high solidarity (from employees), and great support (from the community), which, in turn, leads to
more stability and helps the firm to attenuate its idiosyncratic risk.

We enlarge the framework of our analysis by studying the effect of common law versus civil law
classification on the relation between individual components of CSR and firms’ financial risk. It
appears from Table 7 that involvement in human rights, human resources, and business behavior has
a stronger effect on firms’ idiosyncratic risk in civil law than in common law countries. Indeed, there
is no significant relationship between these three individual components of CSR and idiosyncratic risk
in common law countries. This result is completely in harmony with our expectation from hypothesis
H2, that in common law countries, the regulation is shareholder oriented and aims to protect mainly
shareholders’ interests at the expense of other stakeholders. This explanation is also confirmed when
looking at the corporate governance score results. From panel E in Table 7, we empirically validate
hypothesis H4 and show that good corporate governance practices that benefit mainly financial
stakeholders are the only dimension priced in common law countries. Good corporate governance is
found to reduce systematic and idiosyncratic risks in common law countries, which reinforces the
view that in these countries, activities and regulations that are in line with shareholders’ interests are
well perceived by the market and lead to the improvement of a firm’s value.

TABLE 5 The relation between the overall CSR score and firms’ financial risk worldwide: Granger
causality tests between the measures of financial risk and the CSR scores

Systematic risk Idiosyncratic risk

(1) (2)

CSR_NET does not Granger-cause risk 0.01 0.00

Risk does not Granger-cause CSR_NET 0.17 0.27

HRTS does not Granger-cause risk 0.92 0.85

Risk does not Granger-cause HRTS 0.42 0.19

ENV does not Granger-cause risk 0.65 0.35

Risk does not Granger-cause ENV 0.80 0.74

HR does not Granger-cause risk 0.04 0.05

Risk does not Granger-cause HR 0.66 0.35

CIN does not Granger-cause risk 0.20 0.00

Risk does not Granger-cause CIN 0.49 0.26

CG does not Granger-cause risk 0.77 0.01

Risk does not Granger-cause CG 0.21 0.19

BB does not Granger-cause risk 0.46 0.04

Risk does not Granger-cause BB 0.43 0.19

This table presents the p-value of the Granger causality tests between the financial risk measures and
the CSR measures over the period 2001–11. The financial risk measures are systematic risk based on
the Fama–French three-factor model (column 1) and idiosyncratic risk calculated as the standard
deviation of the residuals derived from the Fama–French three-factor model (column 2). The CSR
measures are the overall CSR score (CSR_NET), human rights score (HRTS), environment score (ENV),
human resources score (HR), community involvement score (CIN), corporate governance score (CIN),
and business behavior score (BB). For definitions of variables refer to Appendix A. For each score, we
test whether the specific score does not Grangercause the measure of financial risk (line 1), and
whether the measure of financial risk does not Granger-cause the specific score (line 2). The Granger
causality tests are constructed from the estimated coefficients of the vector autoregression (VAR)
with three lags. For each equation in the VAR, we test the hypothesis that none of the other
endogenous variables Granger-cause the dependent variable in the same equation.

With respect to the legal foundation and in order to validate hypothesis H3, we use direct proxies for
shareholders’ versus stakeholders’ protection and explore the extent to which results from this
classification differ from the previous ones. Table 8 presents the results using the interactions
between the overall CSR rating and high versus low shareholders’ protection (models 1–2) and high
versus low stakeholders’ protection (models 3–4), respectively. Two main findings emerge from this
table. First, the coefficient of CSR for low shareholder protection countries loads negatively and
statistically significantly through the two measures of firms’ financial risk as opposed to the
coefficient of CSR for high shareholder protection countries that is never significant. This evidence
suggests that firms’ CSR involvement only reduces financial risk in countries with low shareholders’
protection. Second, the coefficient for CSR in stakeholder roriented countries loads negatively and
statistically significantly at the 5%level or better in models 3 and 4, suggesting that strong
stakeholder-supporting attitudes contribute to low financial risk in high stakeholders’ protection
countries, whereas in low stakeholder-oriented countries, where the CSR involvement does not have
any impact on financial risk, the coefficients load insignificantly. Taken together, the results from
Table 8 strongly support our prediction in hypothesisH3and confirm that the negative link between
CSR and financial risk is only valid in stakeholder-oriented countries as compared to shareholder-
oriented countries.

TABLE 6 The relation between the overall CSR score and firms’ financial risk worldwide: on the role of
the legal context (common law versus civil law countries)

Common law versus civil law

Dependent variable Market beta Idiosyncratic risk

(1) (2)

INTERCEPT 1.385*** 0.285***

(4.71) (27.66)

COMMONLAW*CSR −0.027 −0.001

(−1.56) (−0.83)

CIVIL LAW*CSR −0.015 −0.001*

(−1.03) (−1.75)

BTM 0.169*** 0.001

(5.66) (0.68)

GEAR −0.013 0.002***

(−1.60) (2.80)

SIZE −0.009 −0.009***

(−1.24) (−20.00)

LIQ −0.125*** −0.006***

(−13.03) (−10.28)

REN −0.009 −0.012***

(−0.31) (−3.48)
INDUSTRY Yes Yes

COUNTRY Yes Yes

YEAR Yes Yes

R2 22.40 29.89

N 5,716 5,716

This table reports results from regressing systematic and idiosyncratic risks on the overall CSR score
and control variables over the 2001–11 period for common law versus civil law countries. The control
variables are book-to-market ratio (BTM), gearing (GEAR), size (SIZE), liquidity (LIQ), and profitability
(REN). To capture the effect of the overall CSR score on firms’ risk in common law versus civil law
countries, we use interaction variables that are equal to the common law dummy times the overall
CSR score (COM_LAW*CSR) and the civil law dummy times the overall CSR score (CIV_LAW*CSR). The
classification of common law and civil law countries is based on LLSV (1998). All the models include
country, industry, and year fixed effects. For definitions of variables refer to Appendix A. T-statistics
based on robust and heteroskedasticity consistent standard errors are reported in parentheses. *
Statistical significance at the 10% level. ** Statistical significance at the 5% level. *** Statistical
significance at the 1% level.

In Table 9, we finally investigate whether our main findings from previous analysis hold when using
individual components of CSR. We focus on the effect of each individual dimension of CSR on
financial risk among countries classified first according to shareholders’ protection and second to
stakeholders’ protection. In panels A, C, and F, we find that the human rights, human resources, and
business behavior dimensions are associated with low firm financial risk only in countries with low
shareholders’ protection and countries with high stakeholders’ protection, respectively. All the
coefficients load negatively and statistically significantly through the two measures of financial risk
(systematic and idiosyncratic risks). The results from the community involvement score show similar
findings for systematic risk.

TABLE 7 The individual components of CSR and firms’ financial risk: The effect of the institutional
context (common law versus civil law countries)

Dependent variable Market beta Idiosyncratic risk

(1) (2)

Panel A. Human rights component

COMMONLAW*CSR −0.007 0.000

(−0.60) (−0.05)

CIVIL LAW*CSR −0.001 −0.001*

(−0.14) (−1.72)

R2 23.13 30.94

Panel B. Environment component

COMMONLAW*CSR 0.003 −0.001

(0.26) (−0.73)
CIVIL LAW*CSR −0.005 0.000

(−0.56) (−0.02)

R2 22.36 29.83

Panel C. Human resources component

COMMONLAW*CSR −0.041*** −0.001

(−3.51) (−1.37)

CIVIL LAW*CSR −0.020** −0.002***

(−2.08) (−3.85)

R2 22.56 30.01

Panel D. Community involvement component

COMMONLAW*CSR 0.009 0.002**

(0.75) (2.34)

CIVIL LAW*CSR −0.010 0.001*

(−0.98) (1.71)

R2 22.38 29.93

Panel E. Corporate governance component

COMMONLAW*CSR −0.045*** −0.003***

(−3.54) (−3.76)

CIVIL LAW*CSR 0.017 0.001

(1.46) (1.09)

R2 22.55 30.03

Panel F. Business behavior component

COMMONLAW*CSR −0.012 0.000

(−1.04) (−0.28)

CIVIL LAW*CSR −0.010 −0.001**

(−1.00) (−2.34)

R2 22.39 29.88

This table reports results from regressing systematic and idiosyncratic risks on the individual
components of CSR and control variables over the 2001–11 period for common law versus civil law
countries. To capture the effect of individual components of CSR on firms’ risk in common law versus
civil law countries, we use interaction variables that are equal to the common law dummy times a
specific individual component of CSR (COM_LAW*CSR) and the civil law dummy times a specific
individual component of CSR(CIV_LAW*CSR). The classification of common law and civil law countries
is based on LLSV (1998). The individual components of CSR are Human Rights (panel A), Environment
(panel B), Human Resources (panel C), Community Involvement (panel D), Corporate Governance
(panel E) and Business Behavior (panel F). Unreported control variables (for lack of space) used in all
the models are book-to-market ratio (BTM), gearing (GEAR), size (SIZE), liquidity (LIQ), and
profitability (REN). The models also include industry, country and year fixed effects. For definitions of
variables refer to Appendix A. T-statistics based on robust and heteroskedasticity consistent standard
errors are reported in parentheses. * Statistical significance at the 10% level. ** Statistical
significance at the 5%level. *** Statistical significance at the 1%level.

TABLE 8 Corporate social responsibility and firms’ financial risk: the effect of the institutional context
(shareholders’ protection and stakeholders’ protection)

Shareholders’ protection Stakeholders’ protection

Dependent variable Market beta Idiosyncratic risk Market beta Idiosyncratic risk

(1) (2) (3) (4)

INTERCEPT 1.688*** 0.283*** 1.262*** 0.280***

(8.36) (27.24) (4.31) (26.96)

HIGH_SH_PRO*CSR 0.005 −0.000

(0.53) (−0.26)

LOW_SH_PRO*CSR −0.032*** −0.002**

(−2.52) (−2.26)

HIGH_STA_PRO*CSR −0.045*** −0.002***

(−2.86) (−2.81)

LOW_STA_PRO*CSR −0.008 0.000

(−0.58) (0.20)

BTM 0.158*** 0.002 0.167*** 0.002

(5.21) (0.90) (5.50) (1.08)

GEAR −0.013 0.001*** −0.012 0.001**

(−1.50) (2.06) (−1.50) (2.04)

SIZE −0.008 −0.009*** −0.004 −0.009***

(−1.29) (−21.48) (−0.63) (−19.57)

LIQ −0.124*** −0.006*** −0.124*** −0.006***

(−12.38) (−9.46) (−12.41) (−9.46)

REN −0.008 −0.012*** −0.010 −0.011***

(−0.27) (−3.28) (−0.32) (−3.31)

INDUSTRY Yes Yes Yes Yes

COUNTRY Yes Yes Yes Yes

YEAR Yes Yes Yes Yes

R2 22.50 30.01 22.60 29.94

N 5,556 5,556 5,556 5,556

This table reports results from regressing systematic and idiosyncratic risks on the overall CSR score
and control variables over the 2001–11 period for countries according to their shareholders’
protection and stakeholders’ protection. The control variables are book-to-market ratio (BTM),
gearing (GEAR), size (SIZE), liquidity (LIQ), and profitability (REN). To investigate whether
shareholders’ protection and stakeholders’ protection affect the relationship between CSR and
financial risk, we include two interaction variables in each model. Models 1–2 include interaction
variables equal to the high shareholders’ protection dummy (for countries with shareholders’
protection score above the sample median) times the overall CSR score (HIGH_SH_PRO*CSR), and an
interaction variable equal to the low shareholders’ protection dummy (for countries with
shareholders’ protection score below the sample median) times the overall CSR score
(LOW_SH_PRO*CSR). Models 3–4 include interaction variables equal to the high stakeholders’
protection dummy (for countries with stakeholders’ protection score above the sample median)
times the overall CSR score (HIGH_STA_PRO*CSR), and an interaction variable equal to the low
stakeholders’ protection dummy (for countries with stakeholders’ protection score below the sample
median) times the overall CSR score (LOW_STA_PRO*CSR). Shareholders’ protection scores are based
on the scores of LLSV (1998); La Porta et al. (2008) and Spamann (2010). Stakeholders’ protection
scores are based on the OECD indicators on Employment Protection Legislation. All the models
include industry, country and year fixed effects. For definitions of variables refer to Appendix A. T-
statistics based on robust and heteroskedasticity consistent standard errors are reported in
parentheses. * Statistical significance at the 10% level. ** Statistical significance at the 5%level. ***
Statistical significance at the 1%level.

TABLE 9 The individual components of CSR and firms’ financial risk: The effect of the institutional
context (shareholders’ protection and stakeholders’ protection) Shareholders’ protection
Stakeholders’ protection

Dependent variable Market beta Idiosyncratic risk Market beta Idiosyncratic risk

(1) (2) (3) (4)

Panel A. Human rights component

HIGH_INST*CSR 0.010 0.000 −0.027** −0.002***

(1.02) (−0.44) (−2.42) (−2.94)

LOW_INST*CSR −0.029** −0.001* 0.010 0.001

(−2.29) (−1.72) (0.99) (1.44)

R2 23.23 30.94 23.32 31.16

Panel B. Environment Component

HIGH_INST*CSR 0.012 0.000 −0.011 −0.000

(1.29) (−0.71) (1.00) (−0.50)

LOW_INST*CSR −0.027** 0.000 0.001 0.000

(−2.16) (−0.15) (0.14) (0.09)

R2 22.46 29.83 22.41 29.95

Panel C. Human resources component

HIGH_INST*CSR −0.010 −0.001 −0.047*** −0.003***

(−1.10) (−1.56) (−4.17) (−4.50)

LOW_INST*CSR −0.057*** −0.003*** −0.018* −0.000

(−4.71) (−4.35) (−1.93) (−0.84)

R2 22.70 30.08 22.68 30.21

Panel D. Community involvement component

HIGH_INST*CSR 0.011 0.001*** −0.024** 0.000

(1.21) (2.53) (−2.06) (0.21)

LOW_INST*CSR −0.025** 0.001 0.008 0.002***

(−1.95) (1.23) (0.87) (3.82)

R2 22.45 29.91 22.48 30.14

Panel E. Corporate governance component

HIGH_INST*CSR −0.011 −0.002*** −0.007 0.003

(−1.06) (−3.85) (−0.53) (−0.25)

LOW_INST*CSR −0.009 0.001 −0.013 −0.001*

(−0.64) (1.23) (−1.27) (−1.93)

R2 22.38 29.9 22.42 29.99

Panel F. Business Behavior Component

HIGH_INST*CSR 0.002 0.000 −0.022** −0.002***

(0.23) (−0.82) (−1.96) (−2.80)

LOW_INST*CSR −0.030*** −0.001** −0.001 0.000

(−2.45) (−2.21) (−0.07) (0.17)

R2 22.46 29.89 22.46 30.05

(Continues)

BENLEMLIH AND GIRERD-POTIN 1157

TABLE 9 (Continued)
This table reports results from regressing systematic and idiosyncratic risks on the individual
components of CSR and control variables over the 2001–11 period for countries according to their
shareholders’ protection and stakeholders’ protection (proxies for the institutional context). To
investigate whether shareholders’ protection and stakeholders’ protection affect the relationship
between individual components of CSR and financial risk, we include two interaction variables in
each model. Models 1–2 include interaction variables equal to the high shareholders’ protection
dummy (for countries with shareholders’ protection score above the sample median) times a specific
individual component of CSR (HIGH_INST*CSR), and an interaction variable equal to the low
shareholders’ protection dummy (for countries with shareholders’ protection score below the
sample median) times a specific individual component of CSR (LOW_INST*CSR). Models 3–4 include
interaction variables equal to the stakeholders’ protection dummy (for countries with stakeholders’
protection score above the sample median) times a specific individual component of CSR
(HIGH_INST*CSR), and an interaction variable equal to the low stakeholders’ protection dummy (for
countries with stakeholders’ protection score below the sample median) times a specific individual
component of CSR (LOW_INST*CSR). Shareholders’ protection scores are based on the scores of LLSV
(1998), La Porta et al. (2008) and Spamann (2010). Stakeholders’ protection scores are based on the
OECD indicators on Employment Protection Legislation. The individual components of CSR are
Human Rights (panel A), Environment (panel B), Human Resources (panel C), Community
Involvement (panelD), Corporate Governance (panel E) and Business Behavior (panel F). Unreported
control variables (for lack of space) used in all the models are book-to-market ratio (BTM), gearing
(GEAR), size (SIZE), liquidity (LIQ), and profitability (REN). The models also include industry, country
and year fixed effects. For definitions of variables refer to Appendix A. T-statistics based on robust
and heteroskedasticity consistent standard errors are reported in parentheses. * Statistical
significance at the 10% level. ** Statistical significance at the 5%level. *** Statistical significance at
the 1%level.

They also show that in more shareholder-oriented countries (less stakeholder oriented, respectively),
practices in favor of community are not well perceived by the market and lead to an increase in
firms’ idiosyncratic risk. Furthermore, and as stated in hypothesis H4, corporate governance score
reflects some aspects of shareholders’ protection. It is expected that shareholder-oriented countries
highly value companies that do well in respect to governance issues. The empirical results from panel
E slightly support this expectation. Good corporate governance practices significantly reduce
idiosyncratic risk in high shareholders’ protection (model 2) and low stakeholders’ protection
countries (model 4).

Taken together, these results from the individual dimensions analysis are completely in harmony
with our third and fourth hypotheses. These findings also provide additional support for those from
the overall CSR score analysis, and from the common law versus civil law classification as well.

4.2 Robustness tests

The following section discusses the results from the robustness tests that confirm our findings from
the main analysis.

4.2.1 Alternative estimations and standard errors

In this section, we verify the robustness of our findings using alternative econometric specifications
and standard errors. These alternative estimations help ensure that our main inference does not
suffer from any cross-sectional or serial dependence. Table 10 reports the results from regressing the
measures of financial risk on the overall CSR score in countries according to their legal origins
(common law versus civil law), the protection of their shareholders (high shareholders’ protection
versus low shareholders’ protection) and the protection of their stakeholders (high stakeholders’

protection versus low stakeholders’ protection) using a Newey–West estimation procedure that
controls for heteroskedasticity and serial correlation among the residuals (Models 1–6), and a Fama–
MacBeth procedure that uses cross-sectional regressions (models 7–12). The estimated coefficients
on the interactions between the overall CSR score and the variables that represent the institutional
context in our study show similar results to those in the main analysis section, indicating that our
main evidence is unaffected by the use of different estimation methods.

4.2.2 Instrumental variables approach

Our main evidence suggesting that CSR affects financial risk only in specific institutional contexts may
be driven by endogeneity. First, country-level institutions may impact not only the effect of CSR but
also a firm’s involvement in CSR. Second, it is possible that omitted country-level factors that affect
both CSR and the institutional indices are driving our main results. To mitigate these concerns, we re-
estimate the regressions from our main analysis using instrumental variables estimation.

1158 BENLEMLIH AND GIRERD-POTIN

TABLE 10 Robustness tests: Alternative estimations and standards errors

Newey–West estimation Fama–MacBeth estimation

Dependent variable Common lawversus

civil law

Shareholders’

protection

Stakeholders’

protection

Common lawversus

civil law

Shareholders’

protection

Stakeholders’

protection

Beta Idiosy. Beta Idiosy. Beta Idiosy. Beta Idiosy. Beta Idiosy. Beta Idiosy.

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

INTERCEPT 1.507*** 0.312*** 1.502*** 0.319*** 1.434*** 0.311*** 3.481*** 0.330*** 3.450***
0.327*** 3.397*** 0.317***

(5.69) (17.73) (5.84) (18.84) (5.52) (17.82) (8.34) (11.70) (8.51) (12.91) (8.44) (13.37)

COM.LAW*CSR −0.025*** −0.001 −0.005 −0.003***

(−1.16) (−0.90) (−0.29) (−2.94)

CIVIL LAW*CSR −0.028 −0.003*** 0.001 −0.005**

(−1.52) (−2.45) (0.04) (−2.19)

HIGH_SH_PRO*CSR 0.008 0.000 0.015 0.000

(0.63) (0.12) (1.06) (0.65)

LOW_SH_PRO*CSR −0.028* −0.001** −0.005 −0.001*

(−1.70) (−2.38) (−0.29) (−1.77)

HIGH_STA_PRO*CSR −0.064*** −0.004*** −0.030*** −0.004***

(−3.23) (−3.54) (−2.71) (−4.63)

LOW_STA_PRO*CSR −0.006 0.000 0.012 0.001

(−0.35) (−0.22) (0.36) (0.39)

BTM 0.133*** 0.002 0.120*** 0.002 0.135*** 0.003 0.046 −0.011 0.041 −0.011 0.039 −0.011

(3.66) (0.83) (3.23) (0.79) (3.63) (1.23) (0.30) (−1.69) (0.26) (−1.59) (0.25) (−1.59)

GEAR −0.012 0.002** −0.012 0.001 −0.012 0.001 0.005 0.002** 0.012 0.001 0.009 0.001

(−1.17) (2.16) (−1.15) (1.53) (−1.09) (1.63) (0.33) (1.97) (0.79) (1.62) (0.59) (1.43)

(Continues)

BENLEMLIH AND GIRERD-POTIN 1159

TABLE 10 (Continued)

Newey–West estimation Fama–MacBeth estimation

Dependent variable Common law versus

civil law

Shareholders’

protection

Stakeholders’

protection

Common law versus

civil law

Shareholders’

protection

Stakeholders’

protection
Beta Idiosy. Beta Idiosy. Beta Idiosy. Beta Idiosy. Beta Idiosy. Beta Idiosy.

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

SIZE −0.004 −0.009*** −0.006 −0.010*** 0.001 −0.009*** −0.099*** −0.010*** −0.099***
−0.010*** −0.097*** −0.010***

(−0.40) (−13.46) (−0.69) (−15.12) (0.06) (−13.13) (−6.96) (−12.05) (−6.92) (−12.99) (−6.63) (−12.72)

LIQ −0.123*** −0.006*** −0.121*** −0.006*** −0.120*** −0.006*** −0.138*** −0.007***

−0.296** −0.022*** −0.136*** −0.006***

(−10.04) (−7.26) (−9.52) (−6.72) (−9.51) (−6.63) (−9.51) (−7.79) (−2.04) (−3.76) (−9.91) (−7.90)

REN −0.021 −0.014*** −0.019 −0.013*** −0.021 −0.013*** −0.293*** −0.022*** −0.139***
−0.006*** −0.294** −0.022***

(−0.59) (−3.15) (−0.53) (−3.06) (−0.57) (−3.01) (−2.03) (−3.81) (−10.43) (−7.43) (−1.99) (−3.73)

INDUSTRY Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

COUNTRY Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

YEAR Yes Yes Yes Yes Yes Yes No No No No No No

R2 25.46 30.18 25.55 30.36 25.58 30.40

N 5,716 5,716 5,556 5,556 5,556 5,556 5,716 5,716 5,556 5,556 5,556 5,556

This table reports results from using alternative estimations and standard errors to regress
systematic and idiosyncratic risks on the overall CSR score and control variables over the 2001–11
period for common law versus civil law countries, high shareholders’ protection and low
shareholders’ protection countries, and high stakeholders’ protection and low stakeholders’
protection countries. The control variables are book-to-market ratio (BTM), gearing (GEAR), size
(SIZE), liquidity (LIQ), and profitability (REN). To capture the effect of the overall CSR score on firms’
risk, we use two interaction variables equal to the common law dummy times the overall CSR score
(COM_LAW*CSR) and the civil law dummy times the overall CSR score (CIV_LAW*CSR) in models 1–2
and 7–8; two other interaction variables equal to the high shareholders’ protection dummy (for
countries with shareholders’ protection score above the sample median) times the overall CSR score
(HIGH_SH_PRO*CSR), and the low shareholders’ protection dummy (for countries with shareholders’
protection score below the sample median) times the overall CSR score (LOW_SH_PRO*CSR) in
models 3–4 and 9–10; and finally, two interaction variables equal to the high stakeholders’
protection dummy (for countries with stakeholders’ protection score above the sample median)
times the overall CSR score (HIGH_STA_PRO*CSR), and the low stakeholders’ protection dummy (for
countries with stakeholders’ protection score below the sample median) times the overall CSR score
(LOW_STA_PRO*CSR) in models 5–6 and 11–12. The classification of common law and civil law
countries is based on LLSV (1998); the Shareholders’ protection scores are based on the scores of
LLSV (1998), La Porta et al. (2008) and Spamann (2010); and the stakeholders’ protection scores are
based on the OECD indicators on Employment Protection Legislation. All the models include country,
industry and year fixed effects. For definitions of variables see Appendix A. The alternative
estimations and standard errors are Newey– West standard error correction (models 1–6) and Fama–
MacBeth standard errors (models 7–10). T-statistics from these two alternative estimations are
reported in parentheses. * Statistical significance at the 10% level. ** Statistical significance at the
5%level. *** Statistical significance at the 1%level.
TABLE 11 Robustness tests: 2 SLS regression

Common law versus civil law Shareholders’ protection Stakeholders’ protection

Dependent variable Market

beta

Idiosyncratic

risk

Market

beta

Idiosyncratic

risk

Market

beta

Idiosyncratic

risk

(1) (2) (3) (4) (5) (6)

INTERCEPT −1.914 −0.014 −3.107 −0.518*** −3.119 −0.518***

(−1.16) (−0.12) (−1.14) (−3.64) (−1.14) (−3.64)

COMMONLAW*CSR −0.809* −0.084**

(−1.85) (−2.25)

CIVIL LAW*CSR −0.897** −0.081**

(−2.06) (−2.56)

HIGH_SH_PRO*CSR −1.028 −0.211***

(−1.42) (−5.58)

LOW_SH_PRO*CSR −1.256* −0.216***

(−1.73) (−5.70)

HIGH_STA_PRO*CSR −1.223* −0.215***

(−1.68) (−5.68)

LOW_STA_PRO*CSR −1.165 −0.213***

(−1.60) (−5.63)

BTM 0.488*** 0.032*** 0.591** 0.081*** 0.612** 0.081***

(2.92) (2.65) (2.16) (5.68) (2.23) (5.70)

GEAR 0.025 0.005*** 0.036 0.011*** 0.039 0.011***

(1.19) (3.35) (1.09) (6.14) (1.18) (6.16)

SIZE 0.188* 0.010 0.254 0.040*** 0.266 0.041***

(1.86) (1.32) (1.51) (4.58) (1.57) (4.60)

LIQ −0.127*** −0.006*** −0.126*** −0.007*** −0.128*** −0.007***

(−13.09) (−10.67) (−12.84) (−10.74) (−13.03) (−10.80)

REN 0.029 −0.008** 0.047 −0.002 0.043 −0.002

(0.79) (−2.34) (1.06) (−0.64) (0.97) (−0.66)

INDUSTRY Yes Yes Yes Yes Yes Yes

COUNTRY Yes Yes Yes Yes Yes Yes

YEAR Yes Yes Yes Yes Yes Yes

R2 21.79 29.42 22.04 29.72 21.77 29.69

N 5,716 5,716 5,556 5,556 5,556 5,556

This table reports the results of the second stage from an instrumental variable estimation that
controls for the endogeneity of CSR when regressing systematic and idiosyncratic risks on the overall
CSR score and control variables over the 2001–11 period for common law versus civil law countries,
high shareholders’ protection versus low shareholders’ protection countries, and high stakeholders’
protection versus low stakeholders’ protection countries. The first-stage regressions (not reported to
save space) involve regressing the overall CSR score on all independent variables (book-to-market
ratio (BTM), gearing (GEAR), size (SIZE), liquidity (LIQ), and profitability (REN)), country, industry, and
year fixed effects, and the instrument – a dummy variable for whether the previous year’s earnings
are negative as in El Ghoul et al. (2011). Second-stage regression results that use the predicted values
of the CSR proxy from the first-stage regressions to calculate the interaction terms are reported. To
capture the effect of the overall CSR score on firms’ risk, we use two interaction variables equal to
the common law dummy times the predicted values of the overall CSR score (COM_LAW*CSR) and
the civil law dummy times the predicted values of the overall CSR score (CIV_LAW*CSR) in models 1–
2; two other interaction variables equal to the high shareholders’ protection dummy (for countries
with shareholders’ protection score above the sample median) times the predicted values of the
overall CSR score (HIGH_SH_PRO*CSR), and low shareholders’ protection dummy (for countries with
shareholders’ protection score below the sample median) times the predicted values of the overall
CSR score (LOW_SH_PRO*CSR) in models 3–4; and finally, two interaction variables equal to the high
stakeholders’ protection dummy (for countries with stakeholders’ protection score above the sample
median) times the predicted values of the overall CSR score (HIGH_STA_PRO*CSR), and the low
stakeholders’ protection dummy (for countries with stakeholders’ protection score below the sample
median) times the predicted values of the overall CSR score (LOW_STA_PRO*CSR) in models 5–6. The
classification of common law and civil law countries is based on LLSV (1998); the Shareholders’
protection scores are based on the scores of LLSV (1998), La Porta et al. (2008), and Spamann (2010);
and the stakeholders’ protection scores are based on the OECD indicators on Employment Protection
Legislation. All the models include country, industry and year fixed effects. For definitions of variables
see Appendix A. T-statistics based on robust and heteroskedasticity consistent standard errors are
reported in parentheses. * Statistical significance at the 10%level. ** Statistical significance at the
5%level. *** Statistical significance at the 1%level.

Following recent studies (e.g. Attig, El Ghoul, Guedhami, & Suh, 2013; Benlemlih, 2015; El Ghoul,
Guedhami, Kwok, & Mishra, 2011), we use as instrument a dummy variable that takes the value one
if the previous years’ earnings are negative and zero otherwise. When previous earnings are
negative, there are fewer resources to invest in CSR. This instrument is also likely to be exogenous to
the contemporaneous overall CSR score. In the first stage (untabulated to save space), we regress the
overall CSR score on the instrument, other determinants of CSR (BTM, GEAR, SIZE, LIQ, REN), year,
industry and country fixed effects. We then replace the CSR score in equation (2) with the fitted value
of CSR proxy (times the institutional variables) from the first-stage regression.
Table 11 reports the results using the predicted value of CSR proxy. We find that the coefficient of
CSR for civil law countries loads negatively and statistically significantly with idiosyncratic risk, the
coefficient of CSR for low shareholders’ protection is negative and statistically significant with
systematic and idiosyncratic risks (models 3–4), and the coefficient of CSR for high stakeholders’
protection is negative and statistically significant with systematic and idiosyncratic risks (models 5–6).

Taken together, the results using the predicted value of CSR score support our prediction from the
main analysis and confirm that our results do not suffer from any endogeneity issue.

4.2.3 Alternative measures of systematic and idiosyncratic risks

As highlighted in the methodology section, the main analysis of this study uses the Fama–French
three-factor model to calculate systematic and idiosyncratic risks. These two measures of financial
risk can also be obtained using other models such as the market model. We thus replace systematic
and idiosyncratic risks provided by the Fama–French three-factor model with systematic and
idiosyncratic risks estimated from the market model, and rerun all the regressions above. Our results
from this analysis show that, overall, the estimated coefficients present similar results to those in the
main analysis. These additional estimations provide evidence that our results are robust to
alternative measures of systematic and idiosyncratic risks.

5 CONCLUSIONS

This paper extends previous literature on the link between CSR and firms’ financial risk by exploring
the role those different institutional contexts play in such a relation. We first establish the existence
of a negative link between CSR and firm financial risk and, second, we confirm that the causality
direction is from SR behavior to financial risk. These results are consistent with information
asymmetry and stakeholder theories and discard risk management theory. With regard to the role of
the institutional context in CSR effects, we argue that the negative relation between CSR and firms’
financial risk is stronger in civil law than in common law countries. We posit in addition that, ceteris
paribus, the stronger the shareholder protection in a firm’s country, the less CSR reduces the firm’s
financial risk, and the stronger the stakeholder protection in a firm’s country, the more CSR reduces
risk. Using a sample of 5,716 firm-year observations covering the time period from 2001 to 2011 and
representing 1,169 individual firms in 25 countries, we show that the overall CSR involvement
reduces firms’ idiosyncratic risk only in civil law countries. Furthermore, the individual components of
CSR analysis show that firms that adopt favorable human rights practices, and maintain a good
relationship with their employees, suppliers, and customers, benefit from a decreased idiosyncratic
risk only if they are implemented in civil law countries. The corporate governance involvement is the
only dimension that appears to matter and reduce firms’ exposure to financial risk in common law
countries. We also use direct proxies for shareholders’ and stakeholders’ protection and investigate
whether our previous results from the common law versus civil law classification are confirmed. We
show that the overall CSR score is negatively and significantly related to firms’ financial risk as
measured by systematic and idiosyncratic risks only in countries with low shareholders’ protection
and high stakeholders’ protection, respectively. Additional results from the individual components of
CSR are in harmony with this result and strongly support this view: The human rights, human
resources, and business behavior dimensions are associated with low firms financial risk only in
countries with low shareholders’ protection and countries with high stakeholders’ protection,
respectively.

The economic significance of our results is not negligible. For example, a one standard deviation in
the overall CSR rating reduces systematic and idiosyncratic risks by 1.7% and 0.9%, respectively. As
regards the economic significance in relation to our classifications, we document that a one standard
deviation increase in the overall CSR score reduces systematic risk by 2.4% and idiosyncratic risk by
1.7% in high stakeholder-oriented countries, and by 3.4% and 1.7%, respectively, in low shareholder
protection countries.

The findings presented in this study have several potential implications for corporate managers: In
high stakeholder orientation countries, it would be beneficial for firms to improve their social
performance in the CSR components that have a significant impact on financial risk reduction,
especially human rights, human resources and business behavior. With regard to high shareholder
orientation countries, corporate managers are encouraged to care about corporate governance and
to control community involvement expenses. As for portfolio managers, the findings presented in
this study highlight the need to take into account firm social performance to assess financial risk,
crucial social components changing with countries. Indications are also given to reduce unavoidable
idiosyncratic risk and minimize portfolio risk. Our results on the role of the institutional context in
moderating the link between CSR and financial risk should be interpreted with caution. While we try
to address the endogeneity issue using several alternative approaches, unobserved factors that
shape the strength of country-level institutions may also affect the relationship between CSR and
financial risk. El Ghoul et al. (2015) suggest addressing this issue by examining whether the
relationship between CSR and financial risk changes after exogenous shocks induced by regulatory
changes. Future research may thus identify an exogenous shock in a specific country and re-examine
our inference from the main analysis.