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Corporate Social Responsibility and Internal Control Effectiveness*
Young Sang Kim**
Northern Kentucky University
Yura Kim University of Seoul
Hyun-Dong Kim
Korea Advanced Institute of Science and Technology (KAIST)
Keywords: corporate social responsibility; internal control effectiveness; material
weakness; financial reporting quality
JEL: G34; M14
* This work was supported by the 2015 Research Fund of the University of Seoul.
** Corresponding author: Young Sang Kim, Professor of Finance, Department of Economics
and Finance, Haile/US Bank College of Business, Northern Kentucky University, Highland
Heights, KY 41099, Email: [email protected], Tel: 1-859-572-5160, Fax: 1-859-572-6177.
Corporate Social Responsibility and Internal Control Effectiveness
Abstract
This study empirically examines whether corporate social responsible firms exhibit more
effective internal control over financial reporting. Specifically, we investigate whether ethical
and socially responsible firms apply business practices to ensure financial transparency and
accountability for their stakeholders. Using various measures of corporate social responsibility
(CSR) and a battery of robust regression analysis over the period from 2004 to 2012, we find
that CSR firms are more likely to have effective internal control and less likely to have material
weakness under Section 404 of the Sarbanes-Oxley Act (SOX). Our results are robust to the
propensity matching of firm characteristics, considering various measures of CSR, and
adjusting for several endogenous problems.
Keywords: corporate social responsibility; internal control effectiveness; material
weakness; financial reporting quality
JEL: G34; M14
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1. Introduction
Corporate social responsibility (CSR) has become a new area of concern for the
wellbeing of society. Various stakeholders beyond shareholders and investors are increasingly
demanding that firms be responsible and accountable for their impact on society and the
environment as a whole. Investors consider the ethical conducts of the firms when they make
investment decisions2, while customers consider environmental and corporate social impacts
in their purchasing decisions. As stakeholders are becoming increasingly aware of CSR as
members of civil society, corporations are not only promoting the business accountability of
the entity itself, but are also ensuring that their business partners in the supply chain are
operating business in a socially responsible manner. In response to this increasing demand in
the society, corporate social responsibility or corporate sustainability are becoming very
important parts of the business agenda and are considered prominent features of business and
society.3
From an organizational perspective, CSR refers to business stewardship that benefits
the environment, society, and economy. To be socially responsible and sustainable, firms are
under increased pressure to maintain a high level of ethical standards and transparency in every
business practice (Jones, 1995; Mackey, Mackey, and Barney, 2007; Jo and Harjoto, 2011; Kim,
Park, and Wier, 2012). The key objective of CSR from a financial reporting point of view is to
2 In the 2015 Good Must Grow survey, 65% of consumers said that they would consider purchasing from socially
conscious firms, up from 60% in 2013. 3 For instance, according to “2012 Corporate/ESG/Sustainability/Responsibility Reporting: Does It Matter?,” an
analysis released by the Governance and Accountability Institute, 57% of S&P 500 index companies issued
corporate sustainability or responsibility reports, up from 20% the previous year. The percentage of S&P 500
index companies that report on sustainability or responsibility also increased, going from 72% to 75% and then
to 81% in 2013, 2014, and 2015 respectively (www.ga-institute.com).
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ensure that the firm’s control environment is compliant, effective, efficient, and sustainable,
and that its financial information is accurate and transparent.
As firms face increased pressure to act in socially responsible ways, they are also under
great public scrutiny to provide accurate and timely financial reporting. Sarbanes Oxley Act
(SOX, hereafter), signed into law on July 30, 2002, was designed to enhance financial reporting
quality so that potential stakeholders can stay fully apprised of the firm’s financial situation.
Under Section 404 of the SOX, companies are mandated to publish any “material” information
concerning the scope and adequacy of the structure and procedures of their internal control
over financial reporting. The Exchange Act, Rules 13a-15(f) and 15d-15(f) define internal
control over financial reporting as a “process designed by, or under the supervision of, the
issuer’s principal executive and principal financial officers, or persons performing similar
functions, and effected by the issuer’s board of directors, management and other personnel, to
provide reasonable assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally accepted accounting
principles and includes those policies and procedures.”
In this paper, we study whether CSR firms apply business practices to ensure financial
transparency and accountability in order to satisfy their stakeholders. Specifically, we examine
whether CSR firms exhibit effective internal control over financial reporting as measured by
material weakness disclosure over financial reporting under SOX Section 404.4 The evidence
4 Material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or
interim financial statements will not be prevented or detected in a timely way (Public Company Accounting
Oversight Board (PCAOB) Auditing Standard No. 2, 2004). The PCAOB Auditing Standard No. 5 replaces the
term “more than remote likelihood” with “reasonable possible” when defining internal control material weakness.
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concerning CSR motivation and impacts on firm performance and/or policy implications is far
from clear conclusion and the link between CSR and internal control over financial reporting
has not yet been examined extensively in the literature. Prior research reports on the ethical
aspect of CSR activities. For example, Kim et al. (2012) claim that socially responsible firms
constrain both accruals and real earnings management and thus deliver more transparent and
reliable financial information to their stakeholders. Their research is based on a theoretical
foundation posting that moral firms operate based on trust and cooperation with their
stakeholders, which prevents opportunism (Jones, 1995). Stakeholder theory suggests that
entities should be accountable to all of their stakeholders who can affect, or be affected by the
achievement of the objectives of the entities (Freeman, 1984). Using a sample of Spanish firms,
Gras-Gil, Manzano, and Fernandez (2016) report that more socially committed firms engage
in less earnings management, improving financial reporting quality. Overall, socially
responsible firms are not inclined to pursue short-term gain, but set the right corporate culture
and develop long term corporate-stakeholder relationships.
The contrary evidence finds that firms may be motivated to engage in CSR for
opportunistic reasons. The firm may use CSR as a medium with which to signal the market that
it is a good corporation (Mahoney, 2012). Entrenched managers may conduct in CSR practices
to burnish their reputation, in turn causing agency conflicts between the managers and
shareholders (Jensen and Meckling, 1976; Barnea and Rubin, 2005). Some firms engage in
CSR activities irresponsibly, and thus bring negative consequences to the stakeholders
including shareholders, employees, customers, and suppliers. For example, firms that engage
in excessive CSR spending are more likely to avoid taxes measured in terms of the likelihood
of engaging in tax sheltering and the extent of book-tax differences (Hoi, Wu, and Hao, 2013).
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To examine the impact of CSR on internal control over financial reporting effectiveness,
we utilize a firm’s corporate social ratings provided by MSCI ESG STATS (previously known
as “KLD”) to measure firms’ CSR activities and extract internal control effectiveness measures
from the Audit Analytics database. Our measure of internal control effectiveness over financial
reporting is material weakness disclosure under Section 404 of the SOX. As external auditors
influence the likelihood of internal control deficiencies (e.g., Zhang, Zhou, and Zhou, 2007),
we include external auditor-related variables. Using a large sample of U.S. firms over the period
of 2004-2012, we find that CSR firms are more likely to have effective internal control over
financial reporting. Specifically, CSR firms are less likely to have material weaknesses under
Section 404 of the SOX. Additionally, the likelihood of a multiple material weakness decreases
as firms are more active in their CSR.
The contributions of this article are twofold. First, to our knowledge, we are among the
first to document a robust negative relation between CSR and internal control weakness over
financial reporting. Our results show that higher CSR firms are less likely to report material
weakness, and exhibit more effective internal control over financial reporting. We employ
several measures of CSR and provide several robust tests including propensity matching and
two-stage regression with instrumental variables. Second, we shed light on how CSR extends
to corporate behavior and effective financial reporting. Although some studies explore the
association between CSR and earnings quality, their empirical results are inconsistent and do
not advance our understandings of internal control over financial reporting. In this paper, we
try to fill this gap between CSR and internal control effectiveness using a large sample of U.S.
firms and a battery of robust empirical tests.
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The rest of the paper is organized as follows. Section two reviews the relevant literature
and builds the hypothesis. Section three describes the data collection and research model, and
the empirical findings of the study are then provided in section four. Finally, section five
concludes the paper.
2. Literature Review and Hypothesis Development
2.1. Literature review
Research on various aspects of CSR has received considerable attention in the literature
and the media over the decades. One strand of CSR research shows that a firm actively engages
in CSR activities by being ethical and transparent and therefore, brings a positive outcome to
the organization and stakeholders. Others argue that a firm’s engagement in CSR activities may
be for self-benefit purposes and CSR is a marketing strategy of “hypocritical window dressing”
(Forbes, 2011).
Proponents of CSR believe that it is a form of corporate culture related to ethical
conduct and “doing business right” and that firms engage in CSR activities to benefit society
at large. Kreps (1990) claims that corporate culture is a shared belief or principles among
members of the organization and that “designing and maintenance of the culture is crucial to
efficient organization.” A good design and maintenance of corporate culture foster beneficial
transactions in the future. Additional evidence show that socially responsible firms have been
shown to be less likely to engage in myopic earnings management (Kim et al., 2012; Gras-Gil
et al., 2016) and tax avoiding activities (Lanis and Richardson, 2015). Some prior works
examine the relation between CSR activities and future firm performance. Based on social
responsibility ratings provided by Fortune magazine’s annual survey of corporate reputations,
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McGuire, Sundgren, and Schneeweis (1988) document that firms with high scores perform
better on stock-market based measures such as risk-adjusted return, alpha, and total return and
on accounting-based measures such as ROA, sales growth, asset growth, and operating income
growth. Likewise, Luo and Bhattacharya (2006) report that CSR activities increase market
value although the mediating effect of customer satisfaction. For a sample of Indian firms,
Mishra and Suar (2010) develop CSR score based on various CSR databases including KLD
database, GRI guidelines (Global Reporting Initiatives), and the SAI (Social Accountability
International). They find that CSR firms improve both their financial and non-financial
performance such as workplace relations and personnel development. Harjoto and Jo (2011)
find that firms with effective corporate governance engage in CSR activities to resolve conflicts
between managers and investing and non-investing stakeholders supporting their conflict-
resolution hypothesis of CSR engagement. Ultimately, a firm’s CSR engagement enhances
operational performance and increases firm value. Examining the relation between CSR and
insider trading, Gao, Lisic, and Zhang (2014) find empirical evidence that managers of “CSR-
conscious” firms are significantly less likely to be involved in insider trades than are those of
“non-CSR-conscious” firms. However, the finding that the managers of socially responsible
firms refrain from informed trading is stronger if the interests of the managers and of the firm
are more closely aligned.
Others argue that firms’ CSR is done for opportunistic reasons and that insiders such
as managers and large blockholders intend to build personal reputations as good corporate
citizens concerned for employees, society, and the environment, at the expense of other
stakeholders (Barnea and Rubin, 2005). They propose that the overinvestment problem can
occur and thus, that CSR initiatives hamper firm value and can be a source of conflicts among
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different stakeholders. Supporting the view that excessive CSR spending can bring negative
consequences for a firm and its stakeholders, Hoi, et al. (2013) find that excessive and
irresponsible engagement of CSR activities can lead firms to be involved in unethical business
practices to avoid taxes. The empirical finding by Preuss (2010) that even firms headquartered
in tax havens or Offshore Finance Centres (OFCs) claim that they are social responsible firms
seem to suggest that some firms are strategic with CSR activities and that their commitment is
for window dressing. In addition, CSR activities impact the cost of equity financing. Firms
with high CSR ratings pay lower cost of equity financing (El Ghoul, Guedhami, Kwok, and
Mishra, 2011) and also pay significantly less for bank loans (Gross and Roberts, 2011). In a
theoretical paper, Mackey et al. (2007) prove that firms decide to make an investment in
socially responsible activities in order to maximize their market value. They argue that firms
are willing to move back and forth from socially responsible to traditional profit maximizing
firms in order to maximize profits. Thus, the firm’s choice to remain socially responsible or not
is dependent on the value maximization theory. Supporting this view, a number of studies find
that incumbent managers may strategically use CSR as an entrenchment mechanism while
colluding with social and environmental activist (Cespa and Cestone, 2007) or non-
shareholding stakeholders (Surroca and Tribo, 2008).
Another strand of the literature on internal control effectiveness is growing and has
become of much interest in social studies. As a result of corporate financial scandals such as
Enron and WorldCom, SOX was implemented on July 30, 2002 to ensure the quality of
financial reporting and safeguard stakeholders. In particular, SOX 404 became effective on
November 15, 2004. Under the Section 404 of the SOX, managers need to assess the
effectiveness of the internal control over financial reporting followed by external auditors’
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attestation of that effectiveness. If any material weakness exists, auditors must issue an adverse
opinion on the effectiveness of internal control over financial reporting. (PCAOB Standard
No.2; Standard No. 5). In fact, Section 302 of the SOX became effective on August 29, 2002,
before SOX 404. Under Section 302, firms started to disclose information about their internal
controls on a quarterly basis. We focus on SOX 404 rather than SOX 302. While Section 302
as somewhat vague disclosure requirements concerning material weaknesses, Section 404
states clear rules for disclosure (Doyle, Ge, and McVay, 2007a). Moreover, Section requires
additional reports including the examination of independent auditors, making the examination
of a firm’s material weaknesses more careful and accurate (Rice and Weber, 2012).
Internal control research has examined what factors drive the effectiveness of internal
control. Various determinants of internal control effectiveness have been identified by a
growing body of recent literature. The earlier research confirms that internal control
effectiveness is closely related to various firm characteristics. Weak internal control firms are
smaller, have more operating segments, are more likely to have foreign currency transactions
and are less profitable (Bryan and Lilien, 2005; Ge and McVay, 2005; Doyle et al., 2007a).
Several studies also agree that firms with more effective corporate controls are less likely to
report internal control weaknesses. For example, independent audit committees, audit
committee with financial expertise, and a larger audit committees report fewer internal control
deficiencies (Ashbaugh-Skaife, Collins, and Kinney, 2007; Hoitash, Hoitash, and Bedard,
2009). Firms with more independent boards of directors are also less likely to disclose internal
control weakness (Li, Lim, and Wang, 2007). Furthermore, Rice and Weber (2012) investigate
various determinants of internal control reporting including both firm characteristics and
governance factors. They find that the possibility of disclosing existing material weaknesses is
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negatively related to external capital needs, non-audit fees, and the size of the audit firm,
whereas it is positively related to financial distress, prior material weaknesses, auditor change,
and management replacement. Our paper complements this line of research by adding CSR as
a new determinant of a firm’s internal control effectiveness.
Corporate governance is very closely related to the effectiveness of internal control.
Li, Sun, and Ettredge (2010) argue that CFOs’ professional qualifications affects internal
control strength and that firms with CFOs possessing financial expertise and experience are
less likely to have material weaknesses. Similarly, Krishnan and Visvanathan (2007) show that
a smaller proportion of audit committee members with financial expertise is related to more
internal control deficiencies. Lin, Wang, Chiou, and Huang (2014) create a CEO entrenchment
measure based on the principal component analysis of several CEO characteristics such as CEO
compensation structure, and CEO duality and find that more entrenched CEOs are related to a
lower quality of internal control.
Ample research explores how internal control strength affects a firm’s conduct of
business. Material weaknesses are related to lower quality estimated accruals (Doyle, Ge, and
McVay, 2007b). Ineffective internal control has a negative impact on the accuracy of
management forecast reports since managers provide guidance based on erroneous internal
reports (Feng, Li, and McVay 2009). Furthermore, Donelson, Ege, and McInnis (2016)
document that those material weaknesses are positively associated with the future revelation of
fraud. Their research is related to our paper in that it provides evidence linking internal controls
and corporate ethical behavior. Prior studies also investigate how internal control effectiveness
affects audit-related factors. For example, firms with a material weakness are significantly
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related to a higher audit fees (Raghunandan and Rama, 2006), and firms that pay high audit
fees tend to more frequently dismiss their auditors (Ettredge, Li, and Scholz, 2007).
2.2. Hypothesis development
Stakeholder theory argues that good firms maintain a positive relationship with their
stakeholders and involve in business practices to maximize long-term value (Donaldson and
Preston, 1995; Donaldson, 1999). The CSR process is related to the ethical and moral
dimensions of firm operations and is closely related to corporate culture of conducting business.
The concept of CSR extends beyond the traditional view posited by a Nobel prize-winning
economist, Milton Friedman that a firm uses its resources and engages in activities to increase
profits and also includes benefiting society. Based on stakeholder theory, socially responsible
firms aim to increase long-term profits, build stakeholder trust, and take responsibility for
society through transparent and ethical behaviors. Also managers engage in CSR in order to
resolve conflicts among stakeholders, with the ultimate aim of maximizing shareholders’
wealth (Jensen, 2001). Therefore, this view argues that CSR is adopted in order to promote
shareholders’ welfare. Both Kim et al. (2012) and Gras-Gil et al. (2016) report that more
socially committed firms constrain earnings management ensuring that their financial reporting
is accurate and transparent. In addition, Dhaliwal et al. (2012) find that CSR firms are
associated lower analyst forecast errors providing more value relevant information to investors.
Active engagement in CSR activities reduces financial risks to the firm (Ortizky and Benjamin,
2001) and creates shareholder value in acquisitions (Deng et al., 2013). If CSR firms operate
business at sustainable levels and seek to improve operating efficiency and the effectiveness of
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their internal control structure, then the firms expect to report fewer material weaknesses in
internal control. Overall, the strand of literature suggests that CSR firms that are moral and
their corporate culture and governance play a role in setting the right course of action for the
business. We therefore propose the following hypothesis:
Stakeholder Hypothesis: A firm actively engaged in corporate social responsibility
(CSR) is positively associated with the effectiveness of internal control over financial
reporting pursuant to Section 404 of the SOX.
Alternatively, according to signaling theory, firms voluntarily disclose information to
the capital market to attract investors and gain a favorable reputation (Verrecchia, 1983).
Corporations may choose to engage in and disclose CSR activities to send a signal to the market
that they are better than others (Mahoney, 2012) and obtain support from and inhibit the
consumption by ethically responsible consumers and investors (Shea, 2010). Firms may use a
“halo effect” to improve brand strength and financial performance (The Economist, June 27,
2015). Individuals such as top managers and firms may choose to engage in CSR activities
opportunistically in the pursuit of self-interested profits. For examples, the top managers
involve in CSR activities to build personal reputations as good corporate citizens at the expense
of other stakeholders (Barnea and Rubin, 2005). Overall, firms’ CSR actions may be a strategic
choice and the costs of engagement can exceed benefits. If firms’ CSR activities are mere
“window-dressing” exercises for managing their presented image in the market at the cost of
some stakeholders of the firm, then CSR activities may have no or a negative relation to the
internal control structure. We thus propose the following hypothesis:
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Signaling Hypothesis: A firm actively engaged in corporate social responsibility (CSR)
is negatively or insignificantly associated with the effectiveness of internal control over
financial reporting pursuant to Section 404 of the SOX.
3. Data and Research Design
3.1 Sample construction
Initially, we obtain our sample from Audit Analytics, which includes external auditor
information and internal control reports. We adopt SOX Section 404 Material Weakness to
measure the effectiveness of the internal control system. Section 404 has required accelerated
filers to report their material weakness since 2004. Non-accelerated filers have had to conform
to SOX Section 404 since 2008. A registrant must comply with all of the requirements to report
on internal control over financial reporting if it satisfies the definition of a “large accelerated
filer” or an “accelerated filer,” as defined in Exchange Act Rule 12b-2.
We utilize a firm’s corporate social ratings provided by MSCI ESG STATS (previously
known as KLD) to measure the firm’s CSR activities. Many practitioners and academics use
KLD data as a reliable measure of a firm’s CSR, and they are referenced in a number of articles
and papers. Sharfman (1996) provides a comprehensive review of the validity of KLD
measures. They evaluate firms’ CSR activities on seven dimensions - corporate governance,
community, diversity, employee relations, environment, human rights, product, and other
exclusionary screen categories (e.g., alcohol, gambling, tobacco and military) using financial
statements, media coverage, government documents, and peer-reviewed articles. For each firm,
the KLD evaluates strengths (positive indicators) and concerns (negative indicators) in seven
non-exclusionary dimensions and records only the concerns in exclusionary dimensions. For
each strength activities, KLD assigns a score if a firm acts socially responsibly. The firm
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receives one point if it is involved in an activity of social concern. The composite KLD score
is measured by calculating the differences between the strengths and the concerns in each
dimension. However, raw CSR scores may create problems since the number and composition
of CSR strengths and concerns vary over time. To address this problem, we compute an
adjusted CSR score which divides the strengths and concerns of each dimension by its relative
number of strength and concern indications (Deng, Kang, and Low, 2013). In this paper, we
use both raw and adjusted KLD scores as the main independent variables in the analyses.
We obtain financial accounting data from the Compustat database and consider only
firm-year observations with available financial variables in Compustat, audit information from
Audit Analytics, and CSR measures from MSCI ESG STATS (KLD) database. Due to the
different regulations and reporting standards involved, we exclude financial institutions (SIC
code from 6000 to 6999) and regulated firms (SIC code from 4900 to 4949) from our sample.
The sample selection procedure yields a final sample of 15,961 firm-year observations from
3,070 unique firms covering 2004 to 2012.
3.2 Research model
To examine the relation between CSR and thes effectiveness of a firm’s internal control
over financial reporting pursuant to Section 404 of SOX, we regress the effectiveness of
internal control measured by a dummy variable of material weakness disclosure (MW) as well
as the number of material weakness count (Count MW) on several CSR proxies along with
firm characteristics and external auditor characteristics as follows:
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)1(,00
1100
DummiesIndustryDummiesYear
sticsCharacteriAuditorsticsCharacteriFirmCSRMWn
kk
n
jj
)2(,00
1100
DummiesIndustryDummiesYear
sticsCharacteriAuditorsticsCharacteriFirmCSRMWCountn
kk
n
jj
where MW is an indicator variable equals to 1 if a firm reports material weakness in internal
control under SOX Section 404, and 0 otherwise. We estimate Equation (1) with a logistics
regression. We employ a Poisson regression to estimate Equation (2) wherein its dependents
variable, COUNT MW, is material weakness count under SOX Section 404. To measure CSR
activities, we construct several measures. First, we compute Raw CSR5 (Raw CSR7), a sum
of strengths minus sum of the concerns among five (seven dimensions) dimensions of CSR
activities in the MSCI ESG STATS (KLD) database. We also compute adjusted CSR scores.
(Adj. CSR5 and Adj. CSR7) We first compute adjusted total strength and adjusted total
concerns by dividing the strength and concern scores of each dimension by its respective
number of strengths and concerns activities and then by subtracting the adjusted total concern
scores from the adjusted total strength scores. Higher CSR measures indicate higher CSR
ratings.
We include various lagged control variables for firm-specific characteristics in all
analyses. We control for the size of the firm calculated as a natural logarithm of total assets
(Firm Size). ROA is return on assets and measures the financial profitability of the firm. To
control for the growth prospects of the firm we compute a percent change in sales in year t
from year t-1 (Sales Growth). Leverage is the ratio of total debts to total assets. We also control
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for the market-to-book equity ratio (Market-to-Book), measured as the market value of equity
which is the year-end stock price times the number of outstanding shares divided by the book
value of equity,
Internal control reports under SOX Section 404 are attested by external auditors who
play an important role in identifying internal control weaknesses (Hammersley, Myers, and
Shakespeare, 2008). We include several external auditor variables to control for the external
governance for internal control effectiveness.5 BIG4 is an indicator variable taking a value of
1 if a firm is audited by a Big 4 firm and 0 otherwise. Several studies find that firms audited by
Big 4 auditors are less likely to report material weaknesses (Ge and Mcvay, 2005; Hoitash et
al., 2009). We consider auditor changes (Auditor Turnover), which is expected to be associated
with MW disclosure (Ettredge, Heintz, Li, and Scholz, 2007; Zhang et al., 2007). In addition,
we expect that auditors’ industry expertise (Auditor Special) affects internal control
effectiveness as Zhang et al. (2007) report that audit committee industry expertise increases the
likelihood that the firm will be found to have internal control weakness. Finally, we consider
auditor tenure (Auditor Tenure) to capture the impact of auditors' tenure on audit quality, as in
prior research (Johnson, Khurana, and Reynolds, 2002; Ghosh and Moon, 2005).
4. Empirical Results
4.1. Descriptive statistics
Panel A of Table 1 shows the sample distribution of material weakness disclosure under
Section 404 of the SOX by year. About 4.8% (767 firms) of our sample firms (15,961 firms)
5 We initially considered an audit size, a natural logarithm of audit fees in the analysis but dropped the variable
from the analyses because of its high correlation with the firm (Firm Size).
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disclose material weakness over financial reporting. The number of firms reporting material
weakness in internal control decreases over time from 140 in 2004 to 51 in 2012. Panel B of
Table 1 reports the count of a multiple material weaknesses. Approximately 57% of our sample
consists of a single material weakness disclosure. Very few firms disclose more than five
material weaknesses.
[Insert Table 1 here]
Table 2 reports descriptive statistics for all variables. On average, 4.8% of firms reports
material weakness in internal control under SOX Section 404 and. The raw score of CSR
ratings has a mean value of -0.286 and -0.612 for five and seven non-exclusionary categories
(Raw CSR5 and Raw CSR7), respectively. For adjusted CSR ratings, the mean value is -0.131
for five dimensions and -0.186 for seven dimensions. A mean firm in the sample has total assets
of 6.99 (in log scale), a return-on-asset ratio of 3.2%, a sales growth rate of 14.7%, a leverage
ratio of 22.4%, and a market-to-book ratio of 2.939. A total of 88.5% firms are audited by Big
4 auditors, 28.3% firms are audited by a specialized auditor, and 4.1% of firms experience an
auditor turnover. The average number of audit years (Audit Tenure) is 11.4 and ranges from 5
to 15.
[Insert Table 2 here]
Table 3 presents the correlation coefficients for the main variables. Material weakness
disclosures are negatively correlated with the CSR characteristics of the firms identified by the
net scores of total CSR ratings. Material weakness firms are negatively (positively) correlated
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with the innate characteristics of firms such as firm size, return on assets, leverage, and market-
to-book ratio (sales growth). For external audit characteristics, material weakness disclosures
are positively (negatively) correlated with audit turnover and audit size (auditor tenure and
audit special).
Table 3 reports the Pearson correlation matrix of the variables used in the analyses. Our
dependent variable, material weakness (MW) and a count of material weakness (MW Count)
are negatively associated with CSR measures (Raw CSR5, Raw CSR7, Adj. CSR5, Adj. CSR7)
but Adj. CSR7 is insignificant.6 Larger firms are less likely to report material weakness while
higher leverage leads to more internal control problems. Firms disclosing material weaknesses
are positively correlated with auditor switch (Auditor Turnover), but they are negatively
correlated with auditor tenure (Auditor Tenure) and an indicator variable for an external auditor
with industry specialist (Auditor Special).
[Insert Table 3 here]
4.2. Multiple regression analysis
Panel A of Table 4 presents logit regression results for Equation (1). The first column
in Table 4 shows the regression estimates of total CSR scores on material weakness, an
indicator variable (MW). We find negative and significant results between CSR proxies and
MW in models (1) through (8). These results indicate that firms with high CSR ratings are less
6 Material weakness (MW) and a count of material weakness (MW Count) are positively correlated with CSR
strength scores, but negatively correlated with CSR concern scores. These variables are not included in the
correlation table due to space constraints.
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likely to report material weaknesses in internal control. We observe a similar result when we
control for external audit characteristics. The third row shows the marginal effects of estimates
on material weakness. Similar to the first column, we find a negative and significant relation
between Adjusted CSR measures and MW, indicating that firms with higher CSR scores are
less likely to report material weakness in internal control.
Table 4 Panel B presents Poisson regression results for Equation (2). We show the
regression estimates of various CSR scores on the number of material weakness (Count MW).
We find a negative and significant relation between CSR and Number MW at the 1%
significance level. These results indicate that CSR firms experience a fewer material weakness
disclosures in internal control. We observe similar results even after we control for external
audit characteristics. Overall, our results indicate that firms with higher CSR scores experience
less material weakness in internal control.7
[Insert Table 4 here]
To examine the endogeneity problem, we run several robustness tests. Table 5 reports
empirical results of propensity score matching analysis. We construct a propensity score
matched sample as a control group. For every firm that reports material weakness over financial
reporting in internal control, we identify a matching firm based on firm size, ROA, the same
2-digit industry and same fiscal year. We re-estimate our research models using 1,534 firm-
year observations consisting of 767 MW observations and 768 matching control samples. In
7 We perform the same analysis using material weaknesses for two consecutive years and find empirical results
similar to those seen in Table 4.
19
Panel A, we provide a mean difference of our four main CSR proxies. For all four CSR
measures (Raw CSR5, Raw CSR7, Adj. CSR5, and Adj. CSR7), we find a significant
difference in means between treated and control groups at the 1% significance level. Panel B
of Table 5 reports the estimated coefficients for Equation (1), which confirm that our finding
is similar to the overall sample analysis reported in Table 4. As firms engage in more CSR
actions, they are less likely to disclose material weakness. Panel C of Table 5 reports that the
coefficients of all CSR measures show the significance at the 1% levels. These results suggest
that firms are likely to report a fewer material weaknesses under SOX Section 404.
[Insert Table 5 here]
We perform an additional analysis by decomposing the total CSR scores into strengths
and concerns. We show the results in Table 6. Panel A presents the logit regression estimates
of the decomposed CSR scores on material weakness. We find a significant and positive
coefficient on the concern scores (Concerns5, Concerns7, and Adj. Concerns7) in models (1)
to (4) and in models (7) and (8). In model (5) and (6), the concern scores are not statistically
significant but strength scores (Adj. Strenght5) are negative and significant. This indicates that
the higher the KLD strength score, the less likely the firms are to report material weakness in
internal control. It also indicates that the higher the KLD concerns score, the more likely the
firms report material weakness in internal control. Panel B presents the Poisson regression
estimates of the decomposed CSR scores on the number of material weakness. We find a
significant and negative coefficient on the strengths measures and a significant and positive
coefficient on the concerns scores except in model (6). Overall, the results indicate that the
higher the KLD strength score, the fewer material weaknesses in internal control the firms
20
report. It also indicates that the higher the KLD concerns score, the more material weaknesses
in internal control the firms report.
[Insert Table 6 here]
Following the literature (e.g., Kim et al., 2012), we construct additional CSR score
measures for each of the five or seven categories (dimensions): community (CSR-Com.),
corporate governance (CSR-Gov.), diversity (CSR-Div.), employee relations (CSR-Emp.),
environment (CSR-Env.), human rights (CSR-Hum.), and product (CSR-Pro.). Then, we
examine the relation between the CSR score of each dimension and material weakness in
internal control. We re-estimate the logit regression of Equation (1) using both the raw and
adjusted scores for each category by measuring total strength minus total concerns. As shown
in Table 7, the coefficients on CSR-Gov., CSR-Emp., and CSR-Hum. are negative and
significant at (p<0.1, <0.01, and <0.05, respectively). The coefficients on CSR-Com., CSR-
Div, CSR-Env., and CSR-Pro. are statistically insignificant. These results indicate that CSR in
corporate governance, employee relations, and human rights have a significant effect in
reducing material weakness in internal control, while CSR in community, diversity,
environment, and product are less likely to be related to internal control effectiveness over
financial reporting. In untabulated results, we find that multiple material weakness disclosure
(Count MW) is associated with the governance, diversity, employee relations, and human rights
aspects of CSR activities.
[Insert Table 7 here]
4.3. Additional robustness tests
21
We conduct several supplemental tests to examine the sensitivity of our results. Most
importantly, we acknowledge that some omitted variables correlated with a firm’s CSR actions
may also affect the firm’s internal control quality. It is challenging to control for the potential
impact of omitted variables and find perfect instruments for solving endogeneity concerns. In
examining the determinants of a firm’s CSR engagement, Harjoto and Jo (2011) consider a
firm’s attempt to measure product quality through advertising spending, CEO characteristics,
industry competition, and governance variables such as management entrenchment measures,
board structure, institutional ownership, and analyst following. We use a product market
competition measure, a Herfindahl--Hirschman index (HHI) based on a firm’s annual sales
using the 2-digit SIC code industry classification, as the instrument for CSR scores in the
analyses. A high HHI value indicates high concentration or less market competition. Finding a
good instrument variable is not easy. To test whether product market competition (HHI) serves
as a good instrument variable in our sample, we check the correlation between product market
competition (HHI) and our CSR measures, and between product market competition (HHI) and
material weakness (MW). The instrument used in the analysis may be an appropriate choice
since the instrument is highly correlated with our CSR measures at the 1% significance levels
and has low and insignificant correlation with the dependent variable (MW) as presented in
Table 3. Table 8 shows that the coefficients of HHI in the first stage are negative and significant
indicating that industry competition positively affects CSR engagements. The results from the
second-stage support our earlier findings that a firm’s CSR engagement is related to internal
control effectiveness. The coefficients of the CSR measures in column (2), (4), (6), and (8) are
negative and significant at the 5% level.
[Insert Table 8 here]
22
The literature finds that board structure is related to internal control weakness
disclosures. The board plays a monitoring role and remediates material weakness (Li et al.,
2007; Goh, 2009). Similarly, Hoitash et al. (2009) develop a composite score to measure board
strength and find that the likelihood of reporting material weakness is lower for firms with
higher board strength. CEO characteristics are also associated with internal control quality. Lin
et al. (2014) find that younger CEOs and longer CEO tenure are associated with weaker internal
control quality, but find insignificant results for CEO gender. We consider board and CEO
characteristics in the analysis and report the results in Table 9.
We consider a natural logarithm of the number of board members (Board Size), a
percent of independent board members (Board Indep.), and percent of female board members
(Female Director) to control for board characteristics, and age of CEO (CEO Age), tenure
period of CEO (CEO Tenure), and a female CEO indicator (Female CEO) to control for CEO
characteristics. We include board and CEO variables but exclude externa auditor variables in
columns (1), (3), (5), and (7). In columns (2), (4), (6), and (8) include all available variables.
Some CSR proxies are not statistically insignificant after we control for board and CEO
characteristics (Raw CSR5 in column (1) and Adj. CSR5 in Column (6), but the overall
coefficients of the CSR proxies are negative and significant. We find that the coefficients of
female directors are positive and significant. The findings on the role of female board members
on internal control quality are mixed. Chen, Eshleman, and Soileau (2016) report that female
board members reduce the likelihood of material weakness disclosures. In opposite Parker, Dao,
Huang, and Yan (2016) argue that females examine internal control problems more thoroughly
and are more likely to report internal control problems. Lin et al, (2014) find an insignificant
influence of female board members on internal control quality. This finding may indicate that
23
CSR firms maintain effective internal controls and are less likely to disclose material
weaknesses over financial reporting.
[Insert Table 9 here]
Further, we restrict our sample to firms that reported material weakness in internal
control, resulting in a sample of 767 observations. In untabulated results, we find a negative
and significant relation between CSR proxies and multiple numbers of material weaknesses
(Count MW), similar to the results shown in Table 4 Panel B. These results indicate that CSR
firms experience fewer material weakness disclosures among the firms that report material
weakness in internal control. These results are not affected when we control for external audit.
Some studies suggest that the KLD’s corporate governance has distinct construct that
is different from the other dimensions and thus eliminate corporate governance when
measuring CSR scores (Kim et al, 2012; Cui, Jo, and Li, 2015). Thus, as a robustness check,
we run Equation (1) and (2) excluding the corporate governance category (CSR-Gov.) and
compute both raw and adjusted scores with the remaining dimensions. The results are not
tabulated for the brevity, but we find that the CSR measures excluding the corporate
governance dimension (Raw CSR6 and Adj. CSR6) still display statistically significant results.
5. Conclusion
Our study seeks to understand the effect of CSR on the strength of internal control over
financial reporting quality. Specifically, we investigate whether ethical and socially responsible
firms apply business practices to ensure financial transparency and accountability for their
24
various stakeholders. Empirically, we examine the impact of a firm’s CSR engagement on
material weakness disclosures under Section 404 of the SOX. Firms with effective governance
firms engage in socially responsible activities maximize stakeholders’ value by resolving
conflicts between managers and investing and non-investing stakeholders (Jo and Harjoto,
2012). However, CSR activities can be value destroying when a frim strategically initiates CSR
activities at the expense of stakeholders and for the private benefit of reputational gain in the
market. Then, overinvestment problemw can occur (Barnea and Rubin, 2010). Our empirical
evidence appears to favor the ethical view. We find that higher CSR activities lead to better
internal control effectiveness over financial reporting. In particular, an increase in CSR reduces
the likelihood of material weakness significantly. The propensity matching analysis and 2SLS
methodology also reveal that our conclusion is unlikely to be confounded by endogeneity.
Combining two crucial areas of the literature-CSR and internal control- our study offers
interesting evidence that contributes to the debate on the costs and benefits of CSR. Our results
should be of particular interest to a broad range of parties including shareholder activists, CSR
activists, and regulators, as well as all public shareholders
25
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Appendix A. Variable definitions
Variable Descriptions
Dependent Variable:
MW An indicator variable equal to 1 if a firm reports material
weaknesses in internal control under SOX Section 404, and 0
otherwise
MW Count
Number of material weaknesses in internal control under SOX
Section 404
Corporate social responsibility:
Raw CSR5 Net score of CSR ratings, measured as total strengths minus
total concerns for 5 dimensions of CSR; community, diversity,
employee relations, environment, and product
Raw CSR7 Net score of CSR ratings, measured as total strengths minus
total concerns for 7 dimensions of CSR; community, corporate
governance, diversity, employee relations, environment,
human rights, and product
Adj. CSR5 Adjusted score of CSR ratings; strengths and concerns of each
of the 5 dimensions (community, diversity, employee
relations, environment, and product) is divided by its
respective number of strengths and concerns and the sum of
adjusted total strength is subtracted by the sum of the adjusted
total concern scores
Adj. CSR7 Adjusted score of CSR ratings; strengths and concerns of each
of the 7 dimensions (community, corporate governance,
diversity, employee relations, environment, human rights, and
product) is divided by its respective number of strengths and
concerns and the sum of adjusted total strength is subtracted
by the sum of the adjusted total concern scores
CSR-Gov. Net score of CSR ratings, measured as total strengths minus
total concerns in corporate governance category
CSR-com. Net score of CSR ratings, measured as total strengths minus
total concerns in community category
CSR-Div. Net score of CSR ratings, measured as total strengths minus
total concerns in diversity category
CSR-Emp. Net score of CSR ratings, measured as total strengths minus
total concerns in employee relations category
CSR-Env. Net score of CSR ratings, measured as total strengths minus
total concerns in environment category
CSR-Hum. Net score of CSR ratings, measured as total strengths minus
total concerns in human rights category
CSR-Pro. Net score of CSR ratings, measured as total strengths minus
total concerns in product category
Strengths5 Total strengths of KLD's 5 dimensions of CSR activities
(community, diversity, employee relations, environment, and
product)
30
Concerns5 Total concerns of KLD's 5 dimensions of CSR activities
(community, diversity, employee relations, environment, and
product)
Strengths7 Total strengths of KLD's 7 dimensions of CSR activities
(community, corporate governance, diversity, employee
relations, environment, human rights, and product)
Adj. Concerns7 Total concerns of KLD's 7 dimensions of CSR activities
(community, corporate governance, diversity, employee
relations, environment, human rights, and product)
Adj. Strengths5 A sum of strengths of 5 dimensions (community, diversity,
employee relations, environment, and product) where each
strength score is divided by its respective number of strengths
Adj. Concerns5 A sum of concerns of 5 dimensions (community, diversity,
employee relations, environment, and product) where each
concern score is divided by its respective number of concerns
Adj. Strengths7 A sum of strengths of 7 dimensions (community, corporate
governance, diversity, employee relations, environment,
human rights, and product)where each strength score is
divided by its respective number of strengths
Adj. Concerns7 A sum of concerns of 7 dimensions (community, corporate
governance, diversity, employee relations, environment,
human rights, and product) where each concern score is
divided by its respective number of concerns
External auditor characteristics:
Big4 An indicator variable equals to 1 if a firm is audited by a Big 4,
firm and 0 otherwise
Auditor Turnover An indicator variable if there is an auditor turnover, and 0
otherwise
Auditor Tenure A natural logarithm of tje number of years an auditor has
audited a firm
Auditor Special A dummy variable equal to 1 if a firm is audited by a specialized
auditor. An auditor is a specialist if it has tje largest share of
clients' total assets in the industry (2-digt SIC code)
Firm characteristics:
Firm Size The log of total assets
ROA Return on assets
Leverage Total debt divided by total assets
Market-to-Book Borrower’s market-to-book ratio of assets
Tangibility Property, plant, and equipment scaled by total assets
31
Table 1. Sample distribution by Year
Panel A: Distribution of material weakness by year
MW
Year No Yes Total
2004 1,044 140 1,184
2005 1,598 173 1,771
2006 1,649 127 1,776
2007 1,672 102 1,774
2008 1,846 48 1,894
2009 1,893 41 1,934
2010 1,946 42 1,988
2011 1,937 43 1,980
2012 1,609 51 1,660
Total 15,194 767 15,961
Panel B: Number of material weakness by year
Year 1 2 3 4 5 > 5 Total
2004 76 23 19 4 6 12 140
2005 91 40 15 8 7 12 173
2006 76 27 6 7 3 8 127
2007 58 22 7 3 7 5 102
2008 27 12 5 0 3 1 48
2009 22 9 2 3 1 4 41
2010 21 13 4 2 1 1 42
2011 32 7 2 1 1 0 43
2012 32 10 5 2 2 0 51
Total 435 163 65 30 31 42 767
32
Table 2. Descriptive statistics
This table presents distributional statistics for variables used in our analysis. Panel A presents 25th
percentile, medians, means, 75th percentile, standard deviations, and number of observations of
dependent variables. Panel B and C provide descriptive statistics of CSR measures and a variety of
firm and external auditor characteristics. Appendix A provides the definition of all variables.
Panel A: Internal control measures
Variable Mean Median P25 P75 SD N
MW 0.048 0 0 0 0.214 15961
MW Count 0.102 0 0 0 0.660 15961
Panel B: CSR measures
Variable Mean Median P25 P75 SD N
Raw CSR5 -0.286 -1 -2 0 2.288 15961
Raw CSR7 -0.612 -1 -2 0 2.491 15961
Adj. CSR5 -0.131 -0.185 -0.367 0 0.419 15961
Adj. CSR7 -0.186 -0.2 -0.5 0 0.498 15961
Strengths5 1.210 0 0 1 2.302 15961
Strengths7 1.369 1 0 2 2.462 15961
Adj. Strengths5 0.190 0 0 0.2 0.383 15961
Adj. Strengths7 0.236 0.111 0 0.268 0.467 15961
Concerns5 1.483 1 0 2 1.489 15961
Concerns7 1.935 2 1 3 1.741 15961
Adj. Concerns5 0.320 0.25 0 0.5 0.331 15961
Adj. Concerns7 0.422 0.367 0.167 0.533 0.401 15961
Panel C: Firm and auditor characteristics
Variable Mean Median P25 P75 SD N
Firm Size 6.990 6.877 5.849 7.979 1.536 15961
ROA 0.032 0.051 0.008 0.097 0.147 15961
Sales Growth 0.147 0.090 -0.002 0.214 0.354 15961
Leverage 0.224 0.184 0.014 0.348 0.218 15961
Market-to-Book 2.939 2.178 1.390 3.580 3.919 15961
Big4 0.885 1 1 1 0.319 15961
Auditor Turnover 0.041 0 0 0 0.198 15961
Auditor Tenure 11.418 9 5 15 7.935 15961
Auditor Special 0.283 0 0 1 0.451 15961
33
Table 3. Correlation
This table reports the Pearson correlation coefficients among variables for the sample. All variable definitions are defined in Appendix A. *, **, *** indicate statistical
significance at the 10%, 5%, and 1% levels, respectively.
Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
(1) MW 1
(2) MW Count 0.686*** 1
(3) Raw CSR7 -0.023*** -0.024*** 1
(4) Raw CSR5 -0.030*** -0.027*** 0.949*** 1
(5) Adj. CSR7 -0.010 -0.012 0.947*** 0.868*** 1
(6) Adj. CSR5 -0.018** -0.016** 0.907*** 0.941*** 0.925*** 1
(7) Firm Size -0.089*** -0.057*** 0.179*** 0.279*** 0.121*** 0.199*** 1
(8) ROA -0.045*** -0.048*** 0.064*** 0.081*** 0.0499*** 0.066*** 0.237*** 1
(9) Sales Growth 0.017** 0.016** -0.023*** -0.041*** -0.022*** -0.037*** -0.096*** 0.019** 1
(10) Leverage -0.019** -0.002 -0.043*** -0.034*** -0.038*** -0.033*** 0.319*** -0.128*** -0.012 1
(11) Market-to-Book -0.007 -0.004 0.073*** 0.076*** 0.058*** 0.065*** -0.061*** 0.040*** 0.120*** -0.099*** 1
(12) Big4 -0.053*** -0.03*** 0.066*** 0.112*** 0.061*** 0.104*** 0.278*** 0.017** -0.052*** 0.073* 0.024*** 1
(13) Auditor Turnover 0.091*** 0.053*** -0.027*** -0.042*** -0.02** -0.035*** -0.080*** -0.0270** 0.043*** -0.005 -0.004 -0.141*** 1
(14) Auditor Tenure -0.077*** -0.054*** 0.134*** 0.179*** 0.103*** 0.142*** 0.308*** 0.076*** -0.132*** -0.001 -0.024*** 0.231*** -0.234*** 1
(15) Auditor Special -0.022*** -0.008 0.027*** 0.046*** 0.016** 0.029*** 0.143*** 0.008 -0.002 0.025*** 0.015* 0.222*** -0.047*** 0.065*** 1
(16) HHI 0.004 0.006 -0.061*** -0.055*** -0.063*** -0.063*** 0.112*** 0.083*** -0.052*** 0.025*** -0.021*** 0.010 0.001 0.025*** 0.025*** 1
34
Table 4.
Panel A: Corporate social responsibility and internal control weakness
This table reports the results of logistic regression and Poisson regression to examine whether a firm’s CSR activities
are related to material weaknesses under Section 404 of the SOX. The dependent variable is a dummy variable
taking a value of 1 if a firm reports a material weakness and, 0 otherwise in Panel A and is a count of material
weakness disclosures of a firm (MW Count) in Panel B. Raw CSR5 and Raw CSR7 represent raw scores of the 5 or
7 different dimensions of CSR activities, respectively. Adj. CSR5 and Adj. CSR7 are computed by dividing the
strengths and concerns of each of the 5 or 7 dimensions by its respective number of strengths and concerns and
subtracting the sum of adjusted total concern scores from the adjusted total strength scores. Firm Size is a natural
logarithm of total assets. ROA is return on assets. Sales Growth is a change in sales in year t from year t-1. Leverage
is a ratio of total debts to total assets. In this test, we consider five proxies for audit quality. BIG4 is an indicator
variable equals 1 if a firm is audited by a Big 4 audit firm and 0 otherwise. Auditor Turnover is an indicator variable
if there is an auditor turnover and 0 otherwise. Auditor Special is a dummy variable that is equal to 1 if a firm is
audited by a specialized auditor. An auditor is a specialist if it has the largest share of clients' total assets in the
industry (2-digt SIC code). For each independent variable, we report the coefficient estimate in row 1, z-stat in row
2, and marginal effect in italics in row 3.The marginal effect is the percent change in the conditional probability of
a material weakness report of a firm for a 1 % change in a continuous variable holding all other variables at their
means. For the dummy variable, marginal effect is the percent change in the conditional probability of a material
weakness report of a firm as the dummy variable switches from 0 to 1. Standard errors are robust to
heteroscedasticity and clustered at the firm level. *, **, *** indicate statistical significance at the 10%, 5%, and 1%
levels, respectively.
Dependent var. = MW
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Raw CSR5 -0.069*** -0.060**
(-2.639) (-2.286)
-0.002 -0.002
Raw CSR7 -0.088*** -0.083***
(-3.538) (-3.340)
-0.003 -0.003
Adj. CSR5 -0.298** -0.239*
(-2.292) (-1.824)
-0.010 -0.008
Adj. CSR7 -0.373*** -0.344***
(-3.157) (-2.876)
-0.012 -0.011
Firm Size -0.289*** -0.217*** -0.302*** -0.228*** -0.298*** -0.226*** -0.309*** -0.235***
(-6.972) (-5.198) (-7.449) (-5.531) (-7.353) (-5.499) (-7.751) (-5.772)
-0.010 -0.007 -0.010 -0.007 -0.010 -0.007 -0.010 -0.008 ROA -1.271*** -1.326*** -1.255*** -1.312*** -1.264*** -1.320*** -1.251*** -1.308***
(-4.843) (-5.124) (-4.788) (-5.079) (-4.825) (-5.107) (-4.782) (-5.070)
-0.043 -0.043 -0.042 -0.042 -0.043 -0.043 -0.042 -0.042
Sales Growth 0.019 -0.029 0.024 -0.024 0.021 -0.028 0.025 -0.024
(0.178) (-0.274) (0.223) (-0.225) (0.194) (-0.263) (0.228) (-0.225)
0.001 -0.001 0.001 -0.001 0.001 -0.001 0.001 -0.001
Leverage 0.378* 0.313 0.373 0.305 0.392* 0.328 0.388* 0.321
(1.654) (1.361) (1.625) (1.323) (1.721) (1.426) (1.699) (1.396)
0.013 0.010 0.012 0.010 0.013 0.011 0.013 0.010
Market-to-
Book
-0.022** -0.021** -0.022** -0.021** -0.022** -0.022** -0.022** -0.022**
(-2.283) (-2.175) (-2.274) (-2.147) (-2.327) (-2.222) (-2.327) (-2.203)
-0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001
35
Big4 -0.291** -0.298** -0.288** -0.290**
(-2.192) (-2.237) (-2.164) (-2.180)
-0.010 -0.011 -0.010 -0.010
Auditor
Turnover
0.802*** 0.805*** 0.801*** 0.805***
(5.964) (5.978) (5.965) (5.987)
0.037 0.037 0.037 0.037
Auditor Tenure -0.023*** -0.022*** -0.023*** -0.023***
(-2.952) (-2.914) (-2.988) (-2.950)
-0.001 -0.001 -0.001 -0.001
Auditor Special -0.036 -0.039 -0.036 -0.038
(-0.338) (-0.368) (-0.339) (-0.363)
-0.001 -0.001 -0.001 -0.001
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant -0.636** -0.664** -0.557* -0.600** -0.600** -0.625** -0.534* -0.577**
(-2.163) (-2.283) (-1.927) (-2.104) (-2.053) (-2.156) (-1.860) (-2.037)
Observations 15,961 15,961 15,961 15,961 15,961 15,961 15,961 15,961
Log likelihood -2830 -2789 -2826 -2784 -2832 -2790 -2829 -2787
Chi2 395.3 533.7 398.9 542.5 395.9 530.7 398 536.9
36
Table 4.
Panel B. Corporate social responsibility and internal control weakness: Number of material weakness
Dependent var. = MW Count
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Raw CSR5 -0.069*** -0.060**
(-2.639) (-2.286)
Raw CSR7 -0.088*** -0.083***
(-3.538) (-3.340)
Adj. CSR5 -0.298** -0.239*
(-2.292) (-1.824)
Adj. CSR7 -0.373*** -0.344***
(-3.157) (-2.876)
Firm Size -0.289*** -0.217*** -0.302*** -0.228*** -0.298*** -0.226*** -0.309*** -0.235***
(-6.972) (-5.198) (-7.449) (-5.531) (-7.353) (-5.499) (-7.751) (-5.772)
ROA -1.271*** -1.326*** -1.255*** -1.312*** -1.264*** -1.320*** -1.251*** -1.308***
(-4.843) (-5.124) (-4.788) (-5.079) (-4.825) (-5.107) (-4.782) (-5.070)
Sales Growth 0.019 -0.029 0.024 -0.024 0.021 -0.028 0.025 -0.024
(0.178) (-0.274) (0.223) (-0.225) (0.194) (-0.263) (0.228) (-0.225)
Leverage 0.378* 0.313 0.373 0.305 0.392* 0.328 0.388* 0.321
(1.654) (1.361) (1.625) (1.323) (1.721) (1.426) (1.699) (1.396)
Market-to-Book -0.022** -0.021** -0.022** -0.021** -0.022** -0.022** -0.022** -0.022**
(-2.283) (-2.175) (-2.274) (-2.147) (-2.327) (-2.222) (-2.327) (-2.203)
Big4 -0.291** -0.298** -0.288** -0.290**
(-2.192) (-2.237) (-2.164) (-2.180)
Auditor Turnover 0.802*** 0.805*** 0.801*** 0.805***
(5.964) (5.978) (5.965) (5.987)
Auditor Tenure -0.023*** -0.022*** -0.023*** -0.023***
(-2.952) (-2.914) (-2.988) (-2.950)
Auditor Special -0.036 -0.039 -0.036 -0.038
(-0.338) (-0.368) (-0.339) (-0.363)
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant -0.636** -0.664** -0.557* -0.600** -0.600** -0.625** -0.534* -0.577**
(-2.163) (-2.283) (-1.927) (-2.104) (-2.053) (-2.156) (-1.860) (-2.037)
Observations 15,961 15,961 15,961 15,961 15,961 15,961 15,961 15,961
Log likelihood -2830 -2789 -2826 -2784 -2832 -2790 -2829 -2787
Chi2 395.3 533.7 398.9 542.5 395.9 530.7 398 536.9
37
Table 5. Corporate social responsibility and internal control weakness: Propensity score matched analysis
This table reports the results of univariate comparison and regressions using a propensity score matching procedure
to examine the effects of a firm’s CSR activities on the likelihood of material weaknesses disclosures under Section
404 of the SOX. The dependent variable is a dummy variable taking a value of 1 if a frim reports a material weakness
and, 0 otherwise in Panel A and is a count of material weakness disclosures of a firm (MW Count) in Panel B. Raw
CSR5 and Raw CSR7 represent raw scores of the 5 or 7 different dimensions of CSR activities, respectively. Adj.
CSR5 and Adj. CSR7 are computed by dividing the strengths and concerns of each of the 5 or 7 dimensions by its
respective number of strengths and concerns and subtracting a sum of the adjusted total concern scores from adjusted
total strength scores. Firm Size is a natural logarithm of total assets. ROA is return on assets. Sales Growth is the
change in sales in year t from year t-1. Leverage is a ratio of total debts to total assets. In this test, we consider five
proxies for audit quality. BIG4 is an indicator variable equal 1 if a firm is audited by a Big 4 audit firm, and 0
otherwise. Auditor Turnover is an indicator variable if there is an auditor turnover and 0 otherwise. Auditor Special
is a dummy variable equal to 1 if a firm is audited by a specialized auditor. An auditor is a specialist if it has the
largest share of clients' total assets in the industry (2-digt SIC code). For each independent variable, we report the
coefficient estimate in row 1, z-stat in row 2, and marginal effect in italics in row 3.The marginal effect is the percent
change in the conditional probability of a material weakness report of a firm for a 1 % change in a continuous
variable holding all other variables at their means. For the dummy variable, marginal effect is the percent change in
the conditional probability of a material weakness report of a firm as the dummy variable switches from 0 to 1.
Standard errors are robust to heteroscedasticity and clustered at the firm level. *, **, *** indicate statistical
significance at the 10%, 5%, and 1% levels, respectively.
Panel A: Univariate comparison of CSR scores between treated and control sample firms
VARIABLES Treated Control Mean Difference T-stat.
Raw CSR5 -0.596 -0.357 -0.239 -2.58***
Raw CSR7 -0.870 -0.536 -0.334 -3.37***
Adj. CSR5 -0.163 -0.114 -0.049 -3.04***
Adj. CSR7 -0.208 -0.142 -0.066 -3.56***
Panel B: Multivariate test: CSR and material weakness
Dependent var. = MW
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Raw CSR5 -0.097*** -0.095***
(-2.676) (-2.583)
-0.024 -0.024
Raw CSR7 -0.113*** -0.115***
(-3.336) (-3.355)
-0.028 -0.029
Adj. CSR5 -0.627*** -0.602***
(-2.948) (-2.792)
-0.157 -0.150
Adj. CSR7 -0.647*** -0.653***
(-3.426) (-3.387)
-0.162 -0.163
Firm Size -0.028 0.032 -0.053 0.010 -0.037 0.021 -0.069 -0.006
(-0.510) (0.549) (-0.983) (0.187) (-0.676) (0.378) (-1.278) (-0.105)
-0.007 0.008 -0.013 0.003 -0.009 0.005 -0.017 -0.001
ROA -0.578 -0.731* -0.552 -0.710* -0.561 -0.713* -0.531 -0.688*
(-1.473) (-1.841) (-1.407) (-1.786) (-1.433) (-1.800) (-1.354) (-1.733)
-0.144 -0.183* -0.138 -0.178 -0.140 -0.178 -0.133 -0.172
Sales Growth -0.126 -0.171 -0.118 -0.165 -0.124 -0.169 -0.118 -0.165
38
(-0.864) (-1.155) (-0.808) (-1.112) (-0.856) (-1.142) (-0.807) (-1.112)
-0.032 -0.043 -0.030 -0.041 -0.031 -0.042 -0.029 -0.041
Leverage 0.356 0.294 0.365 0.298 0.366 0.305 0.390 0.323
(1.095) (0.906) (1.115) (0.913) (1.127) (0.940) (1.193) (0.990)
0.089 0.074 0.091 0.075 0.091 0.076 0.097 0.081
Market-to-Book -0.023 -0.022 -0.023 -0.022 -0.023 -0.022 -0.024 -0.023
(-1.505) (-1.439) (-1.511) (-1.446) (-1.545) (-1.476) (-1.561) (-1.494)
-0.006 -0.005 -0.006 -0.005 -0.006 -0.006 -0.006 -0.006
Big4 -0.191 -0.217 -0.175 -0.200
(-1.024) (-1.160) (-0.938) (-1.073)
-0.048 -0.054 -0.044 -0.050
Auditor Turnover 0.421** 0.419** 0.415** 0.412**
(2.032) (2.012) (2.008) (1.986)
0.104 0.104 0.103 0.102
Auditor Tenure -0.011 -0.012 -0.011 -0.012
(-1.250) (-1.280) (-1.242) (-1.326)
-0.003 -0.003 -0.003 -0.003
Auditor Special -0.147 -0.146 -0.154 -0.154
(-1.038) (-1.028) (-1.088) (-1.087)
-0.037 -0.036 -0.039 -0.039
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant 0.419 0.314 0.566 0.461 0.437 0.331 0.642 0.535
(1.027) (0.746) (1.428) (1.127) (1.080) (0.791) (1.629) (1.312)
Observations 1,534 1,534 1,534 1,534 1,534 1,534 1,534 1,534
Log likelihood -1021 -1014 -1019 -1011 -1020 -1013 -1018 -1010
Chi2 68.22 82.62 72.01 87.88 69.65 83.44 72.43 87.51
39
Panel C: Multivariate test: CSR and number of material weakness
Dependent var. = MW Count
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Raw CSR5 -0.092*** -0.089***
(-3.96) (-3.81)
Raw CSR7 -0.106*** -0.106***
(-4.21) (-4.13)
Adj. CSR5 -0.509*** -0.492***
(-3.62) (-3.47)
Adj. CSR7 -0.545*** -0.542***
(-4.02) (-3.95)
Firm Size 0.027 0.051 0.001 0.027 0.016 0.040 -0.012 0.014
(0.40) (0.83) (0.01) (0.46) (0.24) (0.66) (-0.19) (0.24)
ROA -0.942*** -0.980*** -0.913*** -0.953*** -0.918*** -0.957*** -0.885*** -0.926***
(-2.73) (-2.96) (-2.70) (-2.93) (-2.68) (-2.91) (-2.65) (-2.89)
Sales Growth 0.055 0.033 0.062 0.039 0.056 0.035 0.062 0.039
(0.37) (0.23) (0.42) (0.28) (0.38) (0.24) (0.42) (0.28)
Leverage 0.349 0.320 0.354 0.323 0.360 0.331 0.373 0.341
(1.19) (1.15) (1.24) (1.19) (1.25) (1.21) (1.32) (1.28)
Market-to-Book -0.010 -0.010 -0.010 -0.010 -0.011 -0.010 -0.011 -0.011
(-0.97) (-0.94) (-1.03) (-0.99) (-1.04) (-1.01) (-1.11) (-1.07)
Big4 -0.083 -0.103 -0.071 -0.089
(-0.57) (-0.71) (-0.49) (-0.61)
Auditor Turnover 0.022 0.020 0.016 0.013
(0.16) (0.15) (0.12) (0.10)
Auditor Tenure -0.009 -0.010 -0.010 -0.010
(-0.77) (-0.79) (-0.79) (-0.84)
Auditor Special -0.015 -0.015 -0.021 -0.021
(-0.12) (-0.12) (-0.16) (-0.16)
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant 0.205 0.213 0.361 0.370 0.249 0.254 0.429 0.434
(0.65) (0.69) (1.17) (1.23) (0.81) (0.84) (1.42) (1.47)
Observations 1,534 1,534 1,534 1,534 1,534 1,534 1,534 1,534
Chi2 68.31 84.55 70.41 91.66 66.11 80.71 68.28 87.69
Log likelihood -2493 -2488 -2483 -2478 -2494 -2490 -2486 -2481
40
Table 6.
Panel A. Strengths and concerns of corporate social responsibility and internal control weakness
This table reports the results of logistic regression and Poisson regression to examine whether a firm’s CSR activities are
related to material weaknesses under Section 404 of the SOX. The dependent variable is a dummy variable taking a value
of 1 if a frim reports a material weakness and, 0 otherwise in Panel A and is the count of material weakness disclosures of
a firm (MW Count) in Panel B. Strenght5 and Strength7 represent the sum of the 5 or 7 different dimensions of CSR
strengths scores, respectively and Concerns5 and Concerns7 represent a sum of the 5 or 7 different dimensions of CSR
concerns scores, respectively. Adj. Strengths5, Adj. Strength7, Adj. Concerns5, and Adj. Concerns7 are computed by
adding the strengths and concerns of each of the 5 or 7 dimensions after dividing each score by its respective number of
strengths and concerns. Appendix A provides the definition of all the variables. For each independent variable, we report
the coefficient estimate in row 1, z-stat in row 2, and marginal effect in italics in row 3.The marginal effect is the percent
change in the conditional probability of a material weakness report of a firm for a 1 % change in a continuous variable
holding all other variables at their means. For the dummy variable, marginal effect is the percent change in the conditional
probability of a material weakness report of a firm as the dummy variable switches from 0 to 1. Standard errors are robust
to heteroscedasticity and clustered at the firm level. *, **, *** indicate statistical significance at the 10%, 5%, and 1%
levels, respectively.
Dependent var. = MW
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Strengths5 -0.049* -0.043
(-1.678) (-1.480)
-0.002* -0.001
Concerns5 0.098*** 0.085**
0.003*** 0.003**
(2.936) (2.505)
Strengths7 -0.037 -0.036
(-1.433) (-1.359)
-0.001 -0.001
Concerns7 0.144*** 0.136***
(5.038) (4.700)
0.005*** 0.004***
Adj. Strengths5 -0.394** -0.353*
(-2.035) (-1.810)
-0.013** -0.011*
Adj. Concerns5 0.231 0.157
(1.427) (0.960)
0.008 0.005
Adj. Strengths7 -0.244 -0.237
(-1.605) (-1.531)
-0.008 -0.008
Adj. Concerns7 0.468*** 0.423***
(3.469) (3.089)
0.016*** 0.014***
Firm Size -0.306*** -0.232*** -0.350*** -0.273*** -0.287*** -0.213*** -0.329*** -0.252***
(-8.260) (-5.943) (-9.391) (-6.952) (-7.749) (-5.447) (-8.935) (-6.463)
-0.010*** -0.008*** -0.012*** -0.009*** -0.010*** -0.007*** -0.011*** -0.008***
ROA -1.247*** -1.306*** -1.193*** -1.256*** -1.278*** -1.337*** -1.228*** -1.289***
(-5.008) (-5.227) (-4.803) (-5.034) (-5.130) (-5.345) (-4.939) (-5.164)
-0.042*** -0.042*** -0.040*** -0.040*** -0.043*** -0.043*** -0.041*** -0.042***
Sales Growth 0.021 -0.027 0.028 -0.018 0.020 -0.030 0.026 -0.022
(0.202) (-0.262) (0.269) (-0.175) (0.190) (-0.288) (0.252) (-0.211)
0.001 -0.001 0.001 -0.001 0.001 -0.001 0.001 -0.001
Leverage 0.397** 0.330 0.426** 0.358* 0.380* 0.312 0.414** 0.343*
41
(1.996) (1.635) (2.146) (1.779) (1.906) (1.547) (2.081) (1.702)
0.013** 0.011 0.014** 0.011* 0.013* 0.010 0.014** 0.011*
Market-to-Book -0.022** -0.022** -0.023** -0.022** -0.022** -0.021** -0.023** -0.022**
(-2.343) (-2.246) (-2.435) (-2.323) (-2.303) (-2.206) (-2.397) (-2.282)
-0.001** -0.001** -0.001** -0.001** -0.001** -0.001** -0.001** -0.001**
Big4 -0.284** -0.277** -0.295*** -0.281**
(-2.557) (-2.499) (-2.655) (-2.533)
-0.010** -0.010** -0.011** -0.010**
Auditor
Turnover
0.800*** 0.799*** 0.803*** 0.803***
(6.022) (6.005) (6.055) (6.046)
0.037*** 0.037*** 0.037*** 0.037***
Auditor Tenure -0.023*** -0.023*** -0.023*** -0.023***
(-3.590) (-3.592) (-3.565) (-3.598)
-0.001*** -0.001*** -0.001*** -0.001***
Auditor Special -0.039 -0.048 -0.033 -0.042
(-0.425) (-0.523) (-0.361) (-0.454)
-0.001 -0.002 -0.001 -0.001
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant -0.560** -0.604** -0.343 -0.408 -0.647** -0.678*** -0.458* -0.518**
(-2.189) (-2.339) (-1.356) (-1.600) (-2.532) (-2.629) (-1.838) (-2.064)
Observations 15,961 15,961 15,961 15,961 15,961 15,961 15,961 15,961
Log likelihood -2829 -2788 -2822 -2781 -2832 -2790 -2828 -2787
Chi2 494 576.4 508.1 590.2 489.6 572.8 496.5 579.3
42
Panel B. Strength and weakness of corporate social responsibility and internal control weakness: Number of
material weakness
Dependent var. = MW Count
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Strengths5 -0.114*** -0.107***
(-5.28) (-4.97)
Concerns5 0.102*** 0.089***
(4.68) (4.06)
Strengths7 -0.087*** -0.084***
(-4.62) (-4.44)
Concerns7 0.166*** 0.158***
(9.06) (8.53)
Adj. Strengths5 -0.827*** -0.781***
(-5.65) (-5.32)
Adj. Concerns5 0.211** 0.143
(1.96) (1.32)
Adj. Strengths7 -0.494*** -0.478***
(-4.48) (-4.30)
Adj. Concerns7 0.581*** 0.536***
(6.68) (6.10)
Firm Size -0.213*** -0.150*** -0.274*** -0.209*** -0.193*** -0.130*** -0.259*** -0.193***
(-8.82) (-5.92) (-11.32) (-8.17) (-8.00) (-5.13) (-10.78) (-7.60)
ROA -1.678*** -1.710*** -1.582*** -1.621*** -1.724*** -1.753*** -1.624*** -1.660***
(-11.03) (-11.34) (-10.45) (-10.79) (-11.30) (-11.60) (-10.70) (-11.02)
Sales Growth 0.102 0.064 0.108* 0.073 0.101 0.061 0.108* 0.071
(1.60) (1.01) (1.70) (1.15) (1.59) (0.97) (1.71) (1.13)
Leverage 0.496*** 0.449*** 0.526*** 0.476*** 0.487*** 0.439*** 0.527*** 0.476***
(4.00) (3.59) (4.26) (3.83) (3.92) (3.50) (4.27) (3.82)
Market-to-Book -0.016*** -0.016*** -0.017*** -0.017*** -0.016*** -0.016*** -0.017*** -0.017***
(-2.76) (-2.78) (-2.95) (-2.97) (-2.73) (-2.74) (-2.94) (-2.94)
Big4 -0.251*** -0.242*** -0.263*** -0.242***
(-3.44) (-3.32) (-3.60) (-3.31)
Auditor Turnover 0.528*** 0.522*** 0.534*** 0.529***
(6.10) (6.03) (6.17) (6.11)
Auditor Tenure -0.024*** -0.025*** -0.024*** -0.025***
(-5.76) (-5.82) (-5.72) (-5.85)
Auditor Special 0.049 0.035 0.055 0.041
(0.82) (0.60) (0.93) (0.70)
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant -0.230 -0.229 0.080 0.057 -0.312* -0.299* -0.010 -0.029
(-1.39) (-1.38) (0.49) (0.35) (-1.89) (-1.80) (-0.06) (-0.18)
Observations 15,961 15,961 15,961 15,961 15,961 15,961 15,961 15,961
chi2 1219 1345 1260 1384 1210 1338 1227 1354
43
Table 7. Corporate social responsibility and internal control weakness: By individual CSR dimensions
This table reports the results of logistic regression and Poisson regression to examine whether a firm’s CSR activities
are related to material weaknesses under Section 404 of the SOX. The dependent variable is a dummy variable
taking a value of 1 if a firm reports a material weakness and, 0 otherwise in Panel A and is the count of material
weakness disclosures of a firm (MW Count) in Panel B. Raw CSR scores for each dimension (community,
corporate governance, diversity, employee relations, environment, human rights, and products) is are
computed by subtracting its concern score from its respective strength score. Appendix A provides the definition of
all the variables. For each independent variable, we report the coefficient estimate in row 1, z-stat in row 2, and
marginal effect in italics in row 3.The marginal effect is the percent change in the conditional probability of a
material weakness report of a firm for a 1 % change in a continuous variable holding all other variables at their
means. For a dummy variable, marginal effect is the percentage change in the conditional probability of a material
weakness report of a firm as the dummy variable switches from 0 to 1. Standard errors are robust to
heteroscedasticity and clustered at the firm level. *, **, *** indicate statistical significance at the 10%, 5%, and 1%
levels, respectively Dependent var. = MW
VARIABLES (1) (2) (3) (4) (5) (6) (7)
CSR-Com. -0.102
(-0.713)
-0.003
CSR-Gov. -0.246***
(-3.009)
-0.008
CSR-Div. 0.049
(1.089)
0.002
CSR-Emp. -
0.254***
(-4.777)
-0.008
CSR-Env. -0.095
(-1.311)
-0.003
CSR-Hum. -0.344**
(-2.075)
-0.011
CSR-Pro. -0.148
(-1.365)
-0.005
Firm Size -0.231*** -0.276*** -0.248*** -
0.224***
-0.234*** -0.243*** -0.247***
(-5.584) (-6.780) (-5.817) (-5.493) (-5.754) (-5.972) (-5.997)
-0.008 -0.009 -0.008 -0.007 -0.008 -0.008 -0.008
ROA -1.327*** -1.288*** -1.320*** -
1.286***
-1.329*** -1.317*** -1.324***
(-5.120) (-4.974) (-5.087) (-4.975) (-5.118) (-5.081) (-5.120)
-0.043 -0.041 -0.043 -0.041 -0.043 -0.043 -0.043
Sales Growth -0.030 -0.014 -0.028 -0.030 -0.028 -0.031 -0.025
(-0.279) (-0.131) (-0.265) (-0.283) (-0.267) (-0.289) (-0.238)
-0.001 -0.000 -0.001 -0.001 -0.001 -0.001 -0.001
Leverage 0.346 0.352 0.369 0.304 0.350 0.373 0.349
(1.500) (1.532) (1.596) (1.312) (1.520) (1.619) (1.520)
44
0.011 0.011 0.012 0.010 0.011 0.012 0.011
Market-to-Book -0.022** -0.023** -0.023** -0.022** -0.022** -0.023** -0.023**
(-2.284) (-2.322) (-2.368) (-2.241) (-2.290) (-2.330) (-2.304)
-0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001
Big4 -0.296** -0.323** -0.297** -0.299** -0.295** -0.291** -0.285**
(-2.234) (-2.434) (-2.232) (-2.245) (-2.225) (-2.192) (-2.145)
-0.011 -0.012 -0.011 -0.011 -0.011 -0.011 -0.010
Auditor Turnover 0.800*** 0.808*** 0.798*** 0.798*** 0.800*** 0.803*** 0.800***
(5.957) (5.987) (5.942) (5.907) (5.954) (5.968) (5.959)
0.037 0.037 0.037 0.037 0.037 0.037 0.037
Auditor Tenure -0.023*** -0.024*** -0.024*** -
0.023***
-0.023*** -0.024*** -0.023***
(-3.064) (-3.081) (-3.139) (-2.974) (-3.075) (-3.115) (-3.058)
-0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001
Auditor Special -0.033 -0.038 -0.034 -0.035 -0.035 -0.035 -0.039
(-0.313) (-0.359) (-0.327) (-0.336) (-0.328) (-0.333) (-0.366)
-0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001
Year dummy Yes Yes Yes Yes Yes Yes Yes
Ind. dummy Yes Yes Yes Yes Yes Yes Yes
Constant -0.549* -0.232 -0.423 -0.614** -0.530* -0.489* -0.469*
(-1.925) (-0.843) (-1.430) (-2.191) (-1.895) (-1.753) (-1.690)
Observations 15,961 15,961 15,961 15,961 15,961 15,961 15,961
Log likelihood -2792 -2784 -2791 -2779 -2791 -2791 -2791
Chi2 517.6 531.1 525.4 545.4 521.8 519.4 516.5
45
Table 8. Corporate social responsibility and internal control weakness: Two stage regressions
This table provides the results of two-stage least square (2SLS) regressions of CSR activities on the likelihood of
material weaknesses disclosures under Section 404 of the SOX We use a product market competition measure, the
Herfindahl--Hirschman index (HHI) based a firm’s annual sales using 2-digit SIC code industry classification, as
the instrument for CSR scores in the analyses. The dependent variable is a dummy variable taking a value of 1 if a
firm reports a material weakness and, 0 otherwise. Appendix A provides the definition of all the variables. For each
independent variable, we report the coefficient estimate in row 1, z-stat in row 2, and marginal effect in italics in
row 3.The marginal effect is the percent change in the conditional probability of a material weakness report of a
firm for a 1 % change in a continuous variable holding all other variables at their means. For the dummy variable,
marginal effect is the percentage change in the conditional probability of a material weakness report of a firm as the
dummy variable switches from 0 to 1. Standard errors are robust to heteroscedasticity and clustered at the firm level.
*, **, *** indicate statistical significance at the 10%, 5%, and 1% levels, respectively.
1st Stage 2nd Stage 1st Stage 2nd Stage 1st Stage 2nd Stage 1st Stage 2nd Stage
VARIABLES Raw
CSR5
MW Raw
CSR7
MW Adj.
CSR5
MW Adj.
CSR7
MW
(1) (2) (3) (4) (5) (6) (7) (8)
Raw CSR5 -0.153**
(-2.047)
Raw CSR7 -0.150**
(-2.125)
Adj. CSR5 -0.805**
(-1.994)
Adj. CSR7 -0.750**
(-2.069)
Firm Size 0.453*** -0.032 0.324*** -0.053* 0.057*** -0.053* 0.042*** -0.066**
(33.888) (-0.776) (21.565) (-1.663) (22.750) (-1.690) (13.970) (-2.552)
ROA -0.153 -0.311*** 0.043 -0.279*** 0.008 -0.280*** 0.031 -0.259**
(-1.241) (-2.909) (0.308) (-2.597) (0.339) (-2.609) (1.112) (-2.389)
Sales Growth -0.103** 0.005 -0.060 0.012 -0.024*** 0.001 -0.018 0.006
(-2.106) (0.114) (-1.085) (0.277) (-2.594) (0.014) (-1.642) (0.141)
Leverage -1.292*** -0.179 -1.108*** -0.147 -0.179*** -0.129 -0.165*** -0.108
(-15.131) (-1.384) (-11.560) (-1.263) (-11.159) (-1.150) (-8.478) (-1.044)
Market-to-
Book
0.049*** 0.000 0.049*** 0.000 0.008*** -0.001 0.008*** -0.001
(11.233) (0.066) (9.909) (0.025) (9.105) (-0.156) (7.613) (-0.216)
Big4 0.117** -0.027 0.000 -0.044 0.049*** -0.006 0.027** -0.024
(2.022) (-0.519) (0.007) (-0.876) (4.497) (-0.101) (2.068) (-0.462)
Auditor
Turnover
0.054 0.439*** 0.095 0.441*** 0.008 0.434*** 0.021 0.438***
(0.607) (6.394) (0.952) (6.431) (0.457) (6.271) (1.027) (6.323)
Auditor Tenure 0.025*** -0.009** 0.024*** -0.009** 0.004*** -0.009*** 0.004*** -0.009***
(10.509) (-2.377) (9.111) (-2.441) (8.452) (-2.698) (7.203) (-2.673)
Auditor Special -0.014 -0.017 -0.014 -0.017 -0.009 -0.022 -0.009 -0.021
(-0.360) (-0.422) (-0.320) (-0.423) (-1.255) (-0.553) (-0.990) (-0.534)
HHI -1.690*** -1.742*** -0.309*** -0.330***
(-11.446) (-10.512) (-11.128) (-9.821)
Constant -3.474*** -1.299*** -2.833*** -1.181*** -0.556*** -1.218*** -0.495*** -1.130***
(-38.608) (-5.355) (-28.048) (-6.456) (-32.888) (-5.863) (-24.159) (-7.117)
Observations 15,961 15,961 15,961 15,961 15,961 15,961 15,961 15,961
Chi2 283.2 283.2 292.2 292.2 286.8 286.8 299.5 299.5
46
Table 9. Corporate social responsibility and internal control weakness: Characteristics of the board of
directors and CEO
This table reports the results of a logistic regression to examine whether a firm’s CSR activities are related to material
weaknesses under Section 404 of the SOX including board and CEO characteristics in the analyses. The dependent
variable (MW) is a dummy variable taking a value of 1 if a firm reports a material weakness and, 0 otherwise. The
Appendix A provides the definition of all variables. A natural logarithm of a number of board members (Board Size),
a percent of independent board members (Board Indep.), and percent of female board members (Female Director)
are included to control for board characteristics, and age of CEO (CEO Age), tenure period of CEO (CEO Tenure),
and a female CEO indicator (Female CEO) are used to control for CEO characteristics. For each independent
variable, we report the coefficient estimate in row 1, z-stat in row 2, and marginal effect in italics in row3.The
marginal effect is the percent change in the conditional probability of a material weakness report of a firm for a 1 %
change in a continuous variable holding all other variables at their means. For the dummy variable, marginal effect
is the percentage change in the conditional probability of a material weakness report of a as the dummy variable
switches from 0 to 1. Standard errors are robust to heteroscedasticity and clustered at the firm level. *, **, ***
indicate statistical significance at the 10%, 5%, and 1% levels, respectively.
Dependent var. = MW
VARIABLES (1) (2) (3) (4) (5) (6) (7) (8)
Raw CSR5 -0.078* -0.071
(-1.773) (-1.597)
-0.001 -0.001
Raw CSR7 -0.118*** -0.114***
(-2.862) (-2.743)
-0.002 -0.002
Adj. CSR5 -0.457* -0.397
(-1.792) (-1.545)
-0.008 -0.007
Adj. CSR7 -0.578*** -0.544**
(-2.590) (-2.428)
-0.010 -0.009
Firm Size -0.328*** -0.282*** -0.357*** -0.310*** -0.342*** -0.294*** -0.374*** -0.325***
(-4.148) (-3.515) (-4.476) (-3.825) (-4.334) (-3.678) (-4.635) (-3.971)
-0.006 -0.005 -0.006 -0.005 -0.006 -0.005 -0.007 -0.006
ROA -3.933*** -3.960*** -3.902*** -3.933*** -3.933*** -3.965*** -3.908*** -3.949***
(-5.332) (-5.261) (-5.255) (-5.186) (-5.332) (-5.269) (-5.273) (-5.219)
-0.072 -0.070 -0.070 -0.068 -0.072 -0.070 -0.070 -0.069
Sales Growth 0.047 -0.004 0.054 0.007 0.055 0.004 0.062 0.016
(0.138) (-0.013) (0.157) (0.021) (0.161) (0.012) (0.180) (0.046)
0.001 -0.000 0.001 0.000 0.001 0.000 0.001 0.000
Leverage -0.483 -0.513 -0.516 -0.552 -0.471 -0.498 -0.486 -0.518
(-0.916) (-0.961) (-0.979) (-1.034) (-0.894) (-0.935) (-0.922) (-0.972)
-0.009 -0.009 -0.009 -0.009 -0.009 -0.009 -0.009 -0.009
Market-to-
Book
-0.098*** -0.101*** -0.098*** -0.101*** -0.097*** -0.101*** -0.097*** -0.101***
(-3.491) (-3.571) (-3.484) (-3.554) (-3.488) (-3.569) (-3.499) (-3.565)
-0.002 -0.002 -0.002 -0.002 -0.002 -0.002 -0.002 -0.002
Big4 -0.351 -0.354 -0.348 -0.353
(-1.179) (-1.188) (-1.168) (-1.186)
-0.007 -0.007 -0.007 -0.007
Auditor
Turnover
0.801*** 0.793*** 0.796*** 0.788***
(2.635) (2.608) (2.616) (2.591)
0.021 0.020 0.021* 0.020
47
Auditor Tenure -0.017 -0.017 -0.017 -0.017
(-1.538) (-1.551) (-1.530) (-1.544)
-0.000 -0.000 -0.000 -0.000
Audit Special -0.195 -0.192 -0.197 -0.196
(-1.087) (-1.069) (-1.100) (-1.092)
-0.003 -0.003 -0.003 -0.003
Board Size 0.061 0.125 0.082 0.150 0.069 0.131 0.085 0.154
(0.149) (0.305) (0.202) (0.367) (0.169) (0.319) (0.210) (0.376)
0.001 0.002 0.001 0.003 0.001 0.002 0.002 0.003
Board Indep. -0.001 -0.000 -0.002 -0.001 -0.001 -0.000 -0.002 -0.001
(-0.214) (-0.048) (-0.311) (-0.135) (-0.219) (-0.052) (-0.322) (-0.146)
-0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000
Female
Director
0.023*** 0.024*** 0.025*** 0.027*** 0.023*** 0.024*** 0.023*** 0.025***
(2.599) (2.762) (2.862) (3.052) (2.585) (2.730) (2.719) (2.900)
-0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000
CEO Age -0.028** -0.027** -0.029** -0.028** -0.028** -0.027** -0.029** -0.028**
(-2.402) (-2.305) (-2.449) (-2.340) (-2.408) (-2.310) (-2.448) (-2.342)
-0.001 -0.000 -0.001 -0.000 -0.001 -0.000 -0.001 -0.000
CEO Tenure 0.011 0.010 0.012 0.011 0.011 0.010 0.012 0.011
(1.070) (0.905) (1.190) (1.027) (1.072) (0.906) (1.178) (1.014)
0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Female CEO 0.237 0.216 0.253 0.232 0.226 0.206 0.234 0.214
(0.898) (0.812) (0.955) (0.869) (0.858) (0.772) (0.887) (0.804)
0.005 0.004 0.005 0.004 0.005 0.004 0.005 0.004
Year dummy Yes Yes Yes Yes Yes Yes Yes Yes
Ind. Dummy Yes Yes Yes Yes Yes Yes Yes Yes
Constant 1.801* 1.779* 1.942* 1.897* 1.861* 1.837* 2.038* 1.987*
(1.689) (1.650) (1.824) (1.764) (1.751) (1.708) (1.916) (1.850)
Observations 5,427 5,427 5,427 5,427 5,427 5,427 5,427 5,427
Log likelihood -718.8 -709.5 -716.2 -706.9 -718.8 -709.6 -717 -707.8
Chi2 242.5 261.1 247.7 266.3 242.5 260.9 246 264.5