Unpacking the drivers of earnings management in CSR firms: influence of investor risk perception

Abstract

The study examines the relationship between corporate social responsibility (CSR) and earnings management strategies (expense shifting and revenue shifting). Based on the sample of 41,100 Bombay Stock Exchange listed firm-years spanning over fourteen years (2009–2022), we find that CSR-oriented firms prefer revenue shifting over expense shifting for core earnings management, and this effect is more pronounced among government CSR firms (firms spending on government-related sectors). Our subsequent tests exhibit the differential impact of earnings management strategies on stock return, where investors are found to perceive expense shifting as riskier than revenue shifting, which in turn, is likely to incentivize CSR firms to prefer revenue shifting for core earnings management. Our findings alert auditors about suspected firms (CSR and government CSR firms) that inflate core earnings through shifting practices and highlight the market arbitrage opportunity (mispricing) for investors, where abnormal returns can be fetched by making a zero-investment strategy in expense and revenue shifter stocks. The study is among the pioneering attempts to document the substitution relationship between earnings management strategies in CSR firms and provide empirical evidence on the pricing impact of these strategies. Our findings are robust to the problem of endogeneity and self-selection bias.