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RESEARCH BRIEF: Corporate Citizenship can mitigate Idiosyncratic Risk


Takeaway: For firms with low debt, an investment in corporate citizenship is an investment in insurance against risk.

Suggested Audience: Accountants, CFOs, standards setters, investor relations professionals

Corporate citizenship efforts can help insure firms against idiosyncratic risk—those risks that impact an individual firm (rather than an industry or the market as a whole). Idiosyncratic risk accounts for approximately 80 percent of total stock risk and security price fluctuations and investors set a lower cost of capital for firms with lower risk.

By lowering idiosyncratic risk, managers may be able to pursue a wider array of strategic opportunities, and more reliably hit performance targets—since a lower idiosyncratic risk is a predictor of lower variance of projected cash flows of firms [1]

Key findings:

  • Corporate citizenship can act as insurance against risks faced by individual firms.
  • Even when positive corporate citizenship does not increase shareholder value from higher returns, it can lower risks by strengthening shareholder “goodwill,” generating consumer loyalty, employee satisfaction, and good relations with suppliers, all of which may strengthen a firm against unexpected crises or pitfalls.
  • Conversely, negative corporate citizenship (actions that are socially detrimental) heightens a firm’s risks by weakening shareholder “goodwill.”
  • Firms are most likely to reduce risk via corporate citizenship initiatives when they have little debt.
    • Firms with high debt do not benefit as much from positive corporate citizenship.
  • Firms in volatile industries with fewer competitors were less likely to participate in corporate citizenship efforts.

If citing, please refer to original article: “Positive and Negative Corporate Social Responsibility, Financial Leverage, and Idiosyncratic Risk,” Saurabh Mishra and Sachin B. Modi; Journal of Business Ethics, October 2012

 


[1] Researchers looked at 192 publicly traded U.S. firms for the period 2000–2009 in the University of Chicago’s Center for Research in Security Prices (CRSP) database and COMPUSTAT databases, for a total of 1,728 firm-year observations

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