How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

Abstract

This study investigates the empirical relation between the corporate social performance (CSP) and earnings quality of public firms in Japan. To investigate this query, we adopt several measures, including accruals-based earnings management (AEM) measures and real activities-based earnings management (REM) measures. In general, the comprehensive measurement of the CSP of Japanese firms is positively associated with earnings quality, suggesting that corporate social responsibility (CSR) activities may improve the earnings quality of Japanese firms. However, a more detailed investigation using CSP dimensional indices reveals a number of in-depth findings. First, before controlling for financial performance, normative CSR is more strongly associated with the AEM measures, whereas compliant CSR is more strongly associated with the REM measures. Second, after controlling for financial performance in the regression analysis, the regression slopes of the compliant CSR dimensions are no longer statistically significant, implying the existence of a spurious correlation between compliant CSR and earnings quality. Finally, the slopes of the normative CSR dimensions remain significant even after controlling for financial performance. Overall, these results indicate that the managers of firms that show high normative CSR values tend to avoid adopting AEM and REM measures and that those firms that are conscious of CSR are more likely to gain investor confidence.