Measuring CSR

To measure social performance, we utilize the KLD STAT database, currently owned by MSCI. KLD STAT, which stands for Kinder, Lydenberg, and Domini Statistical Tool for Analyzing Trends in Social & Environmental Performance, is an independent ESG ratings service founded in 1988 that employs their own research staff with industry and issue specialties. The database’s coverage started with the S&P 500 and the DS400 indices, however it has subsequently expanded to include the Broad Market Social Index as well as the 3000 largest US publicly traded

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companies by market capitalization. KLD STAT compiles its ratings every year at calendar year- end by examining public documents such as annual reports, company websites, CSR reports, and government agencies. They also monitor media sources to follow developing issues.

We use KLD STAT due to its established reliability and widespread use in ESG research. The database is “widely accepted by practitioners and academics as an objective measure of corporate social responsibility” (Goss and Roberts, 2011), while Jiao (2010) describes it as “one of the best data sources for corporate social performance to date.”

The ratings can be divided into two chief categories: qualitative issue areas and controversial business issues. Qualitative issue areas are organized by the separate CSR dimensions, including product characteristics, human rights, environment, employee relations, diversity, community, and corporate governance. Each dimension comes with a unique set of strengths and concerns, whereby KLD administers a binary rating. A “1” is given if a firm exhibits a particular strength or concern, and a “0” otherwise. Controversial business issues include alcohol, gambling, tobacco, firearms, military, and nuclear power. These issues come with a unique set of concerns, but not strengths. Consistent with prior literature, we exclude the controversial business issues in our analysis due to its inherent differences from the qualitative issue areas. Similarly, we also exclude the corporate governance dimension as our definition of CSR does not include conflicts of interest between shareholders and managers.

Various methods based on prior literature are used to measure CSR. The first method, in being consistent with traditional measures using KLD, uses the net aggregate value by taking the total number of indicated strengths and subtracting the total number of indicated concerns for each company for every year (El Ghoul et al., 2011; Kim et al., 2012). This proxy, hereafter referred to as CSR_net, provides a comprehensive, single-value measure of social performance for each firm- year observation.

However, the use of aggregate measures may confound the effects of individual dimensions that are not equally important or relevant (Bouslah et al., 2013). Hence, the next method is to compute the disaggregate values of social performance by keeping separate all of the different

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CSR dimensions. We do so by computing the number of indicated strengths minus the number of indicated concerns within each dimension.

Other methods for measuring CSR exist within the literature. Mattingly and Berman (2006) advise that KLD strengths and concerns are empirically and conceptually distinct concepts and that they do not measure opposite sides of a common underlying construct. Strike et al. (2006) similarly argue that positive and negative social actions are not simply the reverse reflections of each other such that both deserve their own separate examination. Their study finds that firms are commonly involved in both socially responsible as well as reprehensible activities. Bouslah et al. (2013) find that CSR strengths share unique associations to idiosyncratic risk compared to concerns. The prior evidence suggests that net measures that combine both strengths and concerns may result in a loss of important information. Thus we repeat the analyses while keeping separate all KLD strengths and concerns. We follow Oikonomou et al. (2012) and Bouslah et al. (2013) in computing the appropriate scores. For each dimension, we compute the strength score as the total number of indicated strengths divided by the total number of possible strengths, yielding a proportional value. An aggregate strength score is also computed by taking the average of all dimensional strength scores. We follow the same process for concerns.

It is important to note that due to its binary nature, KLD follows a cardinal system. Ratings only indicate whether firms meet predetermined criteria, and give no information on the degree of their strengths or concerns or on the actual dollar expenditure invested in such actions. This comes with important implications in terms of analysis and interpretation. A firm with a rating of “4” does not necessarily mean it engages in twice as much CSR activities as does a firm with a rating of “2”. In the context of regression analysis, a positive and significant loading on a proxy for CSR indicates only the association between the dependent variable and KLD’s particular rating system. One may interpret this to mean that further investments toward CSR will relate to an increase in the dependent variable only in the measure that KLD observes such actions and awards additional points. It does not account for the amount of corporate resources dedicated to CSR or whether such activities are profitable. We recognize and acknowledge the limitations of the CSR dataset in order to avoid drawing flawed or inaccurate conclusions. Nevertheless, we proceed with KLD due to its

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strong reputation for reliability and accuracy as well as its prevalence throughout academic research.