Received: 13 January 2022 Accepted: 11 March 2022

DOI: 10.1002/jcaf.22550

RESEARCH ARTICLE

The effect of short selling on corporate social responsibility:

Evidence from a quasi-experiment

Yongtao Hong1 Wei Wei2 Alex Young3

1 College
of Business, North Dakota State
University, Fargo, North Dakota, USA
2 Price College of Business, University of
Oklahoma, Norman, Oklahoma, USA
3 Frank G. Zarb School of Business,
Hofstra University, Hempstead, New
York, USA
Correspondence
Alex Young, Frank G. Zarb School of
Business, Hofstra University, Hempstead,
New York, USA
Email: alex.young@hofstra.edu
Abstract
Stakeholder demands have been viewed as constraints on the organization,
as well as opportunities that can benefit the firm. To distinguish between
these views, we use a natural experiment to study how relaxing constraints on
short selling affects corporate social responsibility (CSR). With a difference-in-
differences design, we find that relaxing short selling constraints has a positive
impact on CSR investment. Furthermore, we find that the increase in CSR varies
with measures of overvaluation and financial constraints, is mainly attributable
to the strategic subset of CSR rather than the social subset, and is driven by
a decrease in CSR concerns. Our result is consistent with the view that CSR
can benefit the firm through an insurance effect: firms increase CSR as protec-
tion from bad news becoming more readily incorporated into stock prices from
greater short selling.

KEYWORDS
corporate social performance, deregulation, stakeholder interests

1 INTRODUCTION The Securities Exchange Act of 1934 restricted short sell-

From 1999 to 2008, the percentage of the world’s 250 largest
firms by revenue that report on corporate social responsi-
bility (hereafter CSR) increased from 35% to 83% (KPMG,
2017). Numerous business cases have been advanced to
explain why firms engage in CSR. For example, CSR
may reduce costs and risks to the firm, confer competi-
tive advantage over the firm’s industry rivals, build value
through improvements in firm reputation and legitimacy,
or help connect various stakeholder interests. While these
rationales are not necessarily mutually exclusive, one point
of contrast is whether stakeholder demands are viewed as
constraints on the organization, or as opportunities for the
benefit of the firm (Kurucz et al., 2008). In this paper, we
attempt to further our understanding of when these two
stakeholder views can be distinguished by examining how
a specific type of financial deregulation, relaxing short sell-
ing constraints, affects CSR.
ing in a declining market: short sales were allowed above
the last trading price (“tick” test), or at the last trading
price if higher than the most recent trade at another price
(“zero-plus tick” test) (Securities and Exchange Commis-
sion, 2007). Nevertheless, short selling accounted for at
least 12% of overall 2000–2004 NYSE trading volume and
more than 31% of 2005 Nasdaq share volume (Boehmer
et al., 2008, Diether et al., 2008). Thus, it is important to
study how management responds to changes in short sell-
ing regulation.
Finance and management theory suggests several
hypotheses regarding CSR. First, without short selling,
security demand might come from investors who are
badly informed or overoptimistic, leading to overinvest-
ment (Gilchrist et al., 2005; Miller, 1977). CSR is an example
of a second-order investment because discretionary ethi-
cal activities come after economic and legal responsibilities
have been fulfilled (Waddock & Graves, 1997). Hence, it is

J Corp Account Finance. 2022;33:79–87. wileyonlinelibrary.com/journal/jcaf © 2022 Wiley Periodicals LLC. 79


80
possible that relaxing short selling constraints may reduce
CSR.
Second, reducing constraints on short selling can facil-
itate the incorporation of bad news into stock prices
(Gilchrist et al., 2005). By generating moral capital or good-
will that protects firms during negative events, CSR can
have an insurance effect on a firm’s reputation (Godfrey
et al., 2009). Thus, it is possible that relaxing short selling
constraints may increase CSR.
To answer how reducing short selling constraints affects
CSR, we use a natural experiment. On September 7, 2004,
the Securities and Exchange Commission (SEC) ordered
the review of existing short selling constraints (Regulation
SHO). 968 pilot or “treatment” firms from the Russell 3000
Index were randomly selected to trade without the tick or
zero-plus tick tests, while the remaining non-pilot or “con-
trol” firms continued trading with the tests (Securities and
Exchange Commission, 2004). Reg SHO began on May 2,
2005; and short-sale frequency increased significantly for
NYSE-listed stocks (Diether et al., 2009). Thus, the SEC
exogenously decreased equity market regulation.
We measure CSR with data from MSCI ESG KLD STATS,
where MSCI analysts rate firms across a variety of cate-
gories (e.g. employee relations, product safety, etc.) Using a
difference-in-differences design, we find that CSR ratings
of pilot firms increase significantly compared to the rat-
ings of non-pilot firms. The increase is robust to including
control variables, industry fixed effects, and shortening the
window length. Hence, pilot firms are improving CSR to
attenuate the negative effects of bad news that are poten-
tially facilitated by short selling.
We conduct several additional analyses. First, we show
that the main result varies with a priori measures of over-
valuation and financial constraints. Second, we find that
the increase in CSR is concentrated in the “strategic” sub-
set of CSR that relates more clearly to competitive strat-
egy such as reputation building, as opposed to the “social”
subset of CSR which involves a concern for social issues
(Waldman et al., 2006). Third, the overall increase in CSR
appears to be driven by a decrease in CSR concerns more
than an increase in CSR strengths.
Lastly, since the increase in CSR is driven by a
decrease in CSR concerns, an alternative explanation of
the observed improvement in CSR could be that instead
of devoting resources to CSR attributes to maximize eco-
nomic benefits, firms are decreasing concerns to reduce
media exposure and avoid the attention of short sellers.
Using hand-collected data, we find no significant differ-
ence between pilot and non-pilot firms’ newspaper expo-
sure. To the contrary, on average, the pilot firms have
slightly more news exposure than the non-pilot firms.
Our study makes the following contributions. First, we
contribute to the growing literature on the drivers of CSR.
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HONG et al.
Historically, the CSR literature has primarily focused on
the consequences of CSR, especially on firm value (Mar-
golis & Walsh, 2003). Yet it is important to understand the
drivers of CSR (Bansal & Roth, 2000), and recent stud-
ies have begun to provide more evidence on what affects
CSR (e.g., product market competition (Flammer, 2014)
and labor unemployment risk (Flammer & Luo, 2017)).
Our paper joins these studies by demonstrating that finan-
cial deregulation can increase CSR.
Second, we provide additional evidence on the effect of
relaxing short selling constraints. Prior studies have inves-
tigated the effect of Regulation SHO mainly on accounting
and financial economics outcomes, including for example
voluntary disclosure (Li & Zhang, 2015), earnings manage-
ment (Fang et al., 2016), accounting conservatism (Young,
2016), and audit fees (Hope et al., 2017). Our study con-
tributes to this literature by showing that short selling
deregulation can affect a broader set of stakeholders.
Third, Jia et al. (2020) also study the effect of Reg SHO on
CSR. We extend their findings by we exploring whether the
increase in CSR varies with a priori measures of overvalu-
ation and financial constraints; whether our main result is
concentrated in the “strategic” subset of CSR that relates
more clearly to competitive strategy such as reputation
building, or the “social” subset of CSR which involves
a concern for social issues (Waldman et al., 2006); and
whether firms decrease concerns to reduce media exposure
and avoid the attention of short sellers.
The remainder of this paper is organized as follows. Sec-
tion 2 develops the hypotheses. Section 3 describes the data
and research design. Sections 4 and 5 present the main and
supplementary results. Section 6 summarizes our findings
and concludes the paper.
2 HYPOTHESIS DEVELOPMENT
CSR has multiple definitions (Carroll, 1999). We follow
the stakeholders-based definition of CSR, which refers to
a firm’s discretionary multidimensional (economic, ethi-
cal, environmental, social, and political) activities directed
toward the firm’s stakeholders (investors, communities,
customers, employees, regulators, and suppliers) (Carroll,
1979, 1999; Hong & Young, 2021; Malik, 2015).
Understanding the motives for CSR is important for
several reasons, such as predicting socially responsible
behavior and revealing the mechanisms that foster socially
responsible organizations (Bansal & Roth, 2000). Despite
this importance, the literature has historically focused on
the consequences of CSR (Attig et al., 2016; Flammer &
Luo, 2017; Margolis & Walsh, 2003). To extend our under-
standing of what drives CSR, we start with two contrasting
perspectives: whether stakeholder demands are potential

HONG et al.
threats to the organization that can be mitigated by attain-
ing a threshold level of social performance, or whether
strategically orienting and directing resources toward per-
ceived stakeholder demands will build firm competitive
advantage (Kurucz et al., 2008).
To distinguish between these two views, we investi-
gate the effect of relaxing short selling constraints on
CSR. Without short selling, demand for a particular secu-
rity might come from badly informed or overoptimistic
investors (Miller, 1977). This can lower the cost of capital,
leading to overinvestment (Gilchrist et al., 2005).
With short selling, the cost of capital may increase and
discourage managers from making further investments
(Gilchrist et al., 2005). Moreover, seller-initiated specula-
tion can decrease the informativeness of stock prices, lead-
ing firms to pass on investment opportunities (Goldstein
& Guembel, 2008). Indeed, Grullon et al. (2015) find that
relaxing short selling constraints decreases capital expen-
ditures. CSR is a second-order investment complementing
capital expenditures because ethical responsibilities come
after economic and legal responsibilities have been ful-
filled (Carroll, 1979). Thus, relaxing short selling restric-
tions may also decrease investment in CSR.
On the other hand, reducing short selling constraints
can facilitate the incorporation of bad news into stock
prices (Gilchrist et al., 2005). Consistent with this, a NYSE
Euronext survey of 438 Chief Executive, Chief Financial,
and Investor Relations Officers found that 60% of the par-
ticipants (and 73% of the CEOs) believed short selling is
harmful to their company’s stock and shareholders (Opin-
ion Research Corporation, 2008).
Godfrey et al. (2009) show that CSR activities can have
an insurance effect on firm reputation as CSR generates
moral capital that protects firms during negative events.
Since short selling can affect the negative tails of stock
returns, protection from such downside risks becomes
more important as firms are more exposed to short selling.
Hence, as short selling constraints are relaxed, it is possible
that CSR may increase as an insurance mechanism against
negative events.
Thus, differing perspectives on CSR generate different
predictions for how relaxing short selling constraints may
affect CSR, and we state our main hypothesis as follows:
H1,a : Relaxing short selling constraints increases CSR.
H1,b : Relaxing short selling constraints decreases CSR.
3 RESEARCH DESIGN
3.1 Measuring CSR
We measure CSR using MSCI ESG KLD STATS (here-
after STATS). STATS is an annual data set of analyst-rated
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81
performance indicators for both strengths and concerns
on the following dimensions: community, corporate gov-
ernance, diversity, employee relations, the environment,
human rights, and product characteristics. We define CSR
as the sum of total strengths minus the sum of total
concerns across these performance dimensions (Chatterji
et al., 2009; Khan et al., 2016; Waddock & Graves, 1997),
standardized to mean 0 and variance 1 for ease of inter-
pretation. We will also examine strengths and concerns
separately in additional analysis because Mattingly and
Berman (2006) recommend against combining strengths
and concerns.
We use STATS for several reasons. First, they are widely
used in the CSR literature and are consistently measured
(Huang & Watson, 2015; Malik, 2015). Second, STATS data
reasonably capture the aspect of “social responsiveness”
in CSR (Mattingly & Berman, 2006), where social respon-
siveness refers to how well firms respond to stakeholder
demands (Carroll, 1979; Kang, 2013). Lastly, STATS data
cover the Russell 1000 and Russell 2000, which together
form the Russell 3000, from 2003 onward (Attig et al., 2016;
Flammer & Luo, 2017). Thus, the data are consistent with
the stakeholders-based definition of CSR used in this paper
(Carroll, 1999; Malik, 2015) and match the composition and
time frame of the Reg SHO natural experiment.
We do not use RepRisk and Sustainalytics because their
coverage begins in 2007 and 2009, respectively. Similarly,
we do not use Thomson Reuters ESG (formerly Asset4)
because it includes only a subset of the Russell 3000
beginning after 2011. Hence, these databases cannot mea-
sure CSR before Reg SHO began on May 2, 2005. While
no measure of CSR is perfect (Chatterji et al., 2016), any
measurement error in CSR from STATS will be absorbed
in the disturbance term of the regression because CSR is a
dependent variable in our paper (Greene, 2008).
3.2 Methodology
We estimate the following equation with OLS:
𝑦𝑖,𝑡 = 𝛼0 + 𝛼1 Post𝑖,𝑡 + 𝛼2 Treat𝑖 + 𝛼3 Post𝑖,𝑡 × Treat𝑖 + 𝜀𝑖,𝑡
(1)
where
∙ yi,t is an outcome variable.
∙ Posti,t is an indicator equal to 1 if the observation is
between January 1, 2005 and December 31, 2007; and 0
if between January 1, 2001 and December 31, 2003 (Fang
et al., 2016).
∙ Treati is an indicator equal to 1 if firm i was in the Reg
SHO pilot and 0 in the non-pilot.
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82 HONG et al.

Equation (1) is a difference-in-differences (DD) design TA B L E 1 Pilot and non-pilot firm differences
where the coefficient of interest is α3 . Intuitively, we sub- (1)
tract the before and after Reg SHO change in CSR of the Pilot Non-Pilot Difference Std. Error
non-pilot firms (first difference) from the change of the LEV 0.30 0.35 0.05 0.05
pilot firms (second difference). The two differences address ROA 0.03 0.03 0.00 0.01
that CSR may be changing over time regardless of Reg MTB 3.58 3.38 −0.20 0.29
SHO, and that permanent differences may exist between Size 6.85 6.88 0.02 0.09
the pilot and non-pilot firms. Thus, under the assump- Analysts 11.89 12.10 0.20 0.53
tion that the change in CSR of the non-pilot firms rep-
IO 0.69 0.70 0.01 0.01
resents the counterfactual of what the change in CSR of
CSR −0.34 −0.29 0.05 0.10
the pilot firms would have been had they not been part
Observations 1423
of Reg SHO – the so-called “common trends assumption”
(Angrist & Pischke, 2009) – α3 is the causal estimate of how The table presents the averages of the variables by pilot (Reg SHO treatment)
and non-pilot (control) status, the difference between the group averages, and
reducing constraints on short selling affects the change
the standard error of the difference. LEV is leverage, ROA is return on assets,
in CSR. MTB is the market-to-book ratio, Analysts is the number of analysts covering
Since the SEC randomly partitioned the Russell 3000 a firm, and IO is total institutional ownership. All observations are from fiscal
into pilot and non-pilot groups (Diether et al., 2009), year 2003 prior to the announcement of Reg SHO.
* p < 0.1, ** p < 0.05, *** p < 0.01.
including additional control variables in Equation (1)
should not meaningfully affect the estimate of α3 but could
reduce the error variance (Roberts & Whited, 2013). There- 4.2 Identifying assumption: Common
fore, we also include the following: trends

∙ Leverage The key identifying assumption is “common trends”: the

∙ Return on Assets change in outcomes of the non-pilot firms is what would
∙ Market-to-Book Ratio have happened to the pilot firms had they not been treated
∙ Size (Angrist & Pischke, 2009). While this assumption cannot
∙ Analyst coverage be directly tested (Pearl, 2009), we indirectly examine it in
∙ Institutional ownership Table 2 by treating the Reg SHO pre-period as the pseudo-
“post” period and comparing it to a pseudo-“pre” period
(January 1, 1998 to December 31, 2000) with the Table 1
These variables are defined in Appendix A, winsorized
variables as “outcomes.” Except for leverage, the coeffi-
at the 1st and 99th percentiles, and measured in year t − 1
cients on “Before × Treat” are insignificant from zero.
because covariates included as controls must be unaffected
Given multiple dependent variables, some coefficients
by the treatment (Roberts & Whited, 2013). Standard errors
may be significantly non-zero by chance. Therefore, we
are clustered by firm.
jointly estimate Table 2 with Seemingly Unrelated Regres-
sion (SUR) to test the null hypothesis that the “Before ×
Treat” coefficients are all zero. The χ2 -statistic is 9.28 (p =
4 RESULTS 0.23), and hence we fail to reject that the pre-trend differ-
ences in these variables are jointly zero such that the com-
4.1 Descriptive statistics mon trends assumption appears plausible.

Table 1 presents the pilot and non-pilot averages of

leverage, return on assets, the market-to-book ratio, size,
analyst coverage, institutional ownership, and CSR. The
variables are measured as of fiscal year 2003 prior to
the announcement of Reg SHO. The differences in these
variables between treatment and control firms are both
economically and statistically insignificant, which is
consistent with the pilot firms being randomly selected
from the Russell 3000 Index and also mitigates concerns
that the DD design overly relies on the functional form
assumption (Roberts & Whited, 2013).
4.3 Main result
Table 3 presents the results of estimating Equation (1) with
OLS:
CSR𝑖,𝑡 = 𝛼0 + 𝛼1 Post𝑖,𝑡 + 𝛼2 Treat𝑖 + 𝛼3 Post𝑖,𝑡 × Treat𝑖 + 𝜀𝑖,𝑡
In column 1, the coefficient on “Post” is negative, con-
sistent with the overall downward trend in CSR from 2004
to 2010 (Attig et al., 2016). Under the common trends
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HONG et al. 83

TA B L E 2 Identifying assumption: Pre-trends

(1) (2) (3) (4) (5) (6) (7)
LEV ROA MTB Size Analysts IO Rated
Before 0.04 0.06*** −1.26*** 0.15*** 0.66*** 0.09*** 0.31***
(0.03) (0.02) (0.20) (0.02) (0.17) (0.00) (0.01)
Treat 0.05 0.01 0.63 *
−0.06 0.19 0.01 0.02
(0.06) (0.04) (0.36) (0.09) (0.51) (0.01) (0.02)
Before × Treat −0.13** −0.00 −0.40 0.01 −0.29 −0.01 0.02
(0.07) (0.03) (0.36) (0.04) (0.30) (0.01) (0.02)
Constant 0.47*** −0.06*** 4.24*** 6.61*** 11.04*** 0.55*** 0.21***
(0.03) (0.02) (0.19) (0.05) (0.27) (0.01) (0.01)
Observations 7736 7736 7736 7736 7736 7736 7736
The table presents the results from estimating the following equation with OLS. The dependent variables are leverage, return on assets, the market-to-book ratio,
the number of analysts covering a firm, total institutional ownership, and whether the firm was rated by MSCI. Beforei,t is an indicator variable equal to 1 if the
firm-year observation is between January 1, 2001 and December 31, 2003; and 0 if it is between January 1, 1998 and December 31, 2000 (these are pseudo-event
dates set before Reg SHO). Treati is an indicator variable equal to 1 if firm i was part of the Reg SHO pilot program and 0 if it was not. Standard errors are clustered
by firm. The χ2 statistic with 7 degrees of freedom for the null hypothesis that the Before Treat coefficients are jointly zero is 9.28 (p = 0.23).
yi,t = α0 + α1 Beforei,t + α2 Treati + α3 Beforei,t × Treati + εi,t
* p < 0.1, ** p < 0.05, *** p < 0.01. Standard errors in parentheses.

T A B L E 3 The effect of relaxing short selling constraints on the assumption, the negative coefficient on “Post” reflects the
change in CSR counterfactual: what the decrease in CSR for the pilot firms
(1) (2) (3) (4) would have been if these firms were not in the pilot.
CSR CSR CSR CSR The positive coefficient on “Post × Treat” reflects how
Post −0.27*** −0.22*** 0.20*** the pilot firms deviated from the trend, which is the effect
(0.03) (0.03) (0.03) of Reg SHO: relaxing short selling constraints increased
Treat −0.05 −0.06 −0.05 −0.05
CSR by one-tenth of a standard deviation for the pilot firms
compared to the non-pilot firms. Since the coefficient on
(0.05) (0.05) (0.05) (0.05)
“Post” is negative and of larger magnitude than the coeffi-
Post × Treat 0.10 **
0.11 **
0.10 **
cient on “Post × Treat,” more specifically Reg SHO appears
(0.05) (0.05) (0.05)
to have caused a smaller decrease in CSR for the pilot firms
Post 2 −0.20***
compared to the non-pilot firms; proportionally, the aver-
(0.03) age change in the CSR rating for the pilot firms is about
Post 2 × Treat 0.09** 63% of the change for the non-pilot firms (95% confidence
(0.04) interval of [32%, 94%]).
Constant 0.23 ***
0.23 ***
−0.57 0.14*** Column 2 controls for lagged leverage, return-on-assets,
(0.03 (0.05) (0.56) (0.04) the market-to-book ratio, size, analyst coverage, and insti-
Controls No Yes Yes Yes tutional ownership; while column 3 additionally includes
Industry Fixed Effects No No Yes Yes industry fixed effects (three-digit SIC). The results are
Observations 6633 6633 6633 4845 qualitatively unchanged: CSR increased by slightly more
than one-tenth of a standard deviation.
The table presents the results from estimating the following equation with
OLS. The dependent variable is standardized CSR strengths minus concerns We have used a 3-year pre- and post-window, ending
from MSCI. Posti,t (Post 2) is an indicator variable equal to 1 if the firm-year on December 31, 2007. However, the SEC voted to remove
observation is between January 1, 2005 (January 1, 2006) and December 31, existing short-sale price tests as of July 6, 2007 (Diether
2007; and 0 if it is between January 1, 2001 (January 1, 2002) and December 31,
et al., 2009). To examine the sensitivity of the results to win-
2003 (after and before Reg SHO, respectively). Treati is an indicator variable
equal to 1 if firm i was part of the Reg SHO pilot program and 0 if it was not.
dow length, we shorten the window to 2 years, ending on
xi,t 1 includes lagged leverage, return-on-assets, the market-to-book ratio, size, December 31, 2006. Column 4 shows that CSR increased by
analyst coverage, and total institutional ownership as control variables. Indus- slightly less than one-tenth of a standard deviation. Hence,
try fixed effects are at the three-digit SIC level. Standard errors are clustered the increase in CSR is not driven by observations with fiscal
by firm.
CSRi,t = α0 + α1 Posti,t + α2 Treati + α3 Posti,t × Treati + x′i,t−1 β + εi,t
year ends after July 6, 2007. Overall, the results in Table 3
* p < 0.1, ** p < 0.05, *** p < 0.01. Standard errors in parentheses. consistently show that relaxing short selling constraints
increased CSR.
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84 HONG et al.

TA B L E 4 Cross-sectional variation in the market-to-book ratio ferent from zero at conventional levels among firms that
and size had a low market-to-book ratio. This appears to be consis-
(1) (2) (3) (4) tent with the overvaluation hypothesis, where the Reg SHO
CSR CSR CSR CSR effect should be stronger on firms that were more likely to
Low MTB High MTB Small Large be overvalued ex-ante.
Post −0.30*** −0.16*** −0.30*** −0.13*** The effect could also be stronger on smaller firms if they
(0.04) (0.04) (0.03) (0.05)
are more financially constrained and thus more sensitive
to Reg SHO (Li & Zhang, 2015). Columns 3 and 4 of Table 4
Treat −0.03 −0.07 −0.09* −0.09
show how the main result varies with size. Pilot and non-
(0.08) (0.07) (0.05) (0.07)
pilot firms are ranked by the median on size as of fiscal year
Post × Treat (0.08) 0.13** 0.10** 0.10
2003.
(0.07) (0.07) (0.05) (0.08)
In column 3, the coefficient on “Post × Treat” is positive
Constant 0.47*** 0.10* 0.20*** 0.22 and significant at the 5% level among small; while in col-
(0.07) (0.06) (0.05) (0.15) umn 4, the coefficient is positive but not significantly dif-
Controls Yes Yes Yes Yes ferent from zero at conventional levels among large firms.
Observations 3094 3487 3130 3746 The main result is positive for both small firms and large
The table presents the results from estimating the following equation with firms, but is more precisely estimated among small firms
OLS. Column 1 (2) includes only those observations that were ranked below compared to large firms, which is consistent with smaller
(above) the median in the market-to-book ratio as of fiscal year 2003. Col- firms being more sensitive to Reg SHO due to financial
umn 3 (4) includes only those observations that were ranked below (above)
constraints.
the median in size (natural logarithm of total assets) as of fiscal year 2003.
The dependent variable is standardized CSR strengths minus concerns from
MSCI. Posti,t is an indicator variable equal to 1 if the firm-year observation lies
between January 1, 2005 and December 31, 2007; and 0 if it falls between Jan- 5.2 Strategic and social CSR
uary 1, 2001 and December 31, 2003 (after and before Reg SHO, respectively).
Treati is an indicator variable equal to 1 if firm i was part of the Reg SHO pilot
program and 0 if it was not. xi,t 1 includes lagged leverage, return-on-assets, the Our main result is that relaxing short selling constraints
market-to-book ratio, size, analyst coverage, and total institutional ownership increases CSR as an instrumental response to bad news
as control variables. Standard errors are clustered by firm. being more easily incorporated in stock prices, consistent
CSRi,t = α0 + α1 Posti,t + α2 Treati + α3 Posti,t × Treati + x′i,t−1 β + εi,t.
with stakeholder demands being viewed as opportunities
* p < 0.1, ** p < 0.05, *** p < 0.01. Standard errors in parentheses.
for the benefit of the firm (Kurucz et al., 2008). Wald-
man et al. (2006) argue that the environment, product
5 ADDITIONAL ANALYSIS characteristics, and employee relations capture the “strate-
gic” aspects of CSR that contribute to a firm’s competitive
5.1 Subsamples by size and advantage against industry peers. In contrast, the commu-
market-to-book nity and diversity dimensions of CSR are more related to a
concern for “social” issues. That is, the main result should
The effect of Reg SHO could be stronger on pilot firms with be concentrated in “strategic” CSR rather than “social”
higher market-to-book ratios. A high market-to-book ratio CSR.
is a commonly used proxy for overvaluation; and under the Column 1 of Table 5 shows that the strategic subset of
overvaluation hypothesis, the effect should be stronger on CSR increased by about one-eighth of a standard deviation.
firms that were more likely to be overvalued (Grullon et al., Column 2 shows that the change in the social subset of CSR
2015). Specifically, overvalued firms may be more sensitive is economically and statistically insignificant. Thus, the
to bad news becoming more readily incorporated into stock main result that relaxing short selling constraints increases
prices from relaxing short selling constraints. Therefore, CSR is primarily concentrated in the aspects of CSR that
we may observe a stronger response in CSR from these contribute to a firm’s competitive advantage against its
firms to protect them from downside risks via the insur- peers.
ance effect. Columns 1 and 2 of Table 4 show how the main
result varies with the market-to-book ratio. Pilot and non-
pilot firms are ranked on the ratio as of fiscal year 2003 and 5.3 Separating strengths and concerns
whether they are below or above the median.
In column 2, we find that the coefficient on “Post × Mattingly and Berman (2006) caution against combining
Treat” is positive and significant at the 5% level among strengths and concerns from STATS because positive and
firms that had a high market-to-book ratio; while in col- negative social action may be independent constructs.
umn 1, the coefficient is positive but not significantly dif- In columns 3 and 4 of Table 5, we analyze strengths and
 10970053, 2022, 3, Downloaded from https://onlinelibrary.wiley.com/doi/10.1002/jcaf.22550 by li bai - National University Of Singapore Nus Libraries , Wiley Online Library on [26/04/2024]. See the Terms and Conditions (https://onlinelibrary.wiley.com/terms-and-conditions) on Wiley Online Library for rules of use; OA articles are governed by the applicable Creative Commons License
HONG et al. 85

TA B L E 5 Additional tests (Kurucz et al., 2008). Within these cases, one point of con-
(1) (2) (3) (4) trast is whether stakeholder demands are viewed as con-
Strat. CSR Soc. CSR CSR Str CSR Con straints on the organization, or as opportunities for the
Post −0.25*** −0.01 0.18*** 0.51*** benefit of the firm (Kurucz et al., 2008). In this paper, we
(0.03) (0.03) (0.03) (0.03)
investigate how relaxing short selling constraints, a type
of financial deregulation, affects CSR to provide additional
Treat −0.03 −0.06 −0.04 0.03
evidence on when these two views of stakeholder demands
(0.06) (0.05) (0.05) (0.05)
can be distinguished.
Post × Treat 0.12** 0.04 0.03 −0.10**
From financial economics theory, short selling can serve
(0.06) (0.04) (0.04) (0.04)
an important market role: without short selling, informa-
Constant 0.26 ***
−0.27 ***
−0.71 ***
−1.17*** tion is only partially revealed in stock prices, as the demand
(0.05) (0.04) (0.04) (0.05) for a particular stock might come from a small group of
Controls Yes Yes Yes Yes investors who may be badly informed or hold overopti-
Observations 6633 6633 6633 6633 mistic expectations (Miller, 1977). Since relaxing short sell-
The table presents the results from estimating the following equation with ing constraints can correct overvaluation and overinvest-
OLS. The dependent variables are strengths minus concerns from the strate- ment, if CSR is viewed as a second-order investment to
gic subset of CSR, strengths minus concerns from the social subset of CSR, and mitigate potential threats to the organization’s viability,
the separate strengths and concerns of CSR; all from MSCI and all standard-
then relaxing short selling constraints could decrease CSR.
ized. Posti,t is an indicator variable equal to 1 if the firm-year observation lies
between January 1, 2005 and December 31, 2007; and 0 if it falls between Jan- Alternatively, since reducing short selling constraints can
uary 1, 2001 and December 31, 2003 (after and before Reg SHO, respectively). facilitate the incorporation of bad news into stock prices, to
Treati is an indicator variable equal to 1 if firm i was part of the Reg SHO pilot the extent that CSR can have an insurance effect on a firm’s
program and 0 if it was not. xi,t 1 includes lagged leverage, return-on-assets, the
reputation by generating goodwill that protects firms dur-
market-to-book ratio, size, analyst coverage, and total institutional ownership
as control variables. Standard errors are clustered by firm. ing negative events (Godfrey et al., 2009), then relaxing
yi,t = α0 + α1 Posti,t + α2 Treati + α3 Posti,t × Treati + x′i,t−1 β + εi,t. short selling constraints could increase CSR.
* p < 0.1, ** p < 0.05, *** p < 0.01. Standard errors in parentheses. We measure an exogenous relaxation of short selling
constraints using Regulation SHO as a natural experiment.
With a difference-in-differences design, we find that relax-
concerns separately. Column 3 shows that the change in ing short selling constraints increases CSR. The increase
CSR strengths is economically and statistically insignifi- is primarily driven by a decrease in CSR concerns. Our
cant. finding suggests that in this context of financial deregu-
In contrast, column 4 shows that CSR concerns lation, stakeholder demands can benefit the firm through
decreased by one-tenth of a standard deviation. Therefore, an insurance effect: firms increase CSR as protection from
our main result is driven by a decrease in concerns. This is bad news becoming more readily incorporated into stock
consistent with investment in CSR acting as an insurance prices from greater short selling.
policy for firm reputation (Godfrey et al., 2009): as firms In addition, our finding also highlights the importance
become more exposed to short selling, firms try to limit of interdisciplinary research. Based on financial economics
their exposure to downside risk by reducing CSR concerns. theory, a fairly straightforward hypothesis is that relax-
An alternative explanation could be that instead of ing short selling constraints will decrease CSR: reducing
devoting resources to CSR for its economic benefits, firms the constraints will reduce overinvestment, and CSR is
decreased concerns to reduce media exposure and avoid a second-order investment. However, by combining both
attention from short sellers. In untabulated results, we financial economics and organizational theory, we see that
hand-collect data on news articles and find no significant stakeholder demands can be relevant even when they may
difference between pilot and non-pilot firms’ newspaper initially not appear to be, such as in the setting of financial
exposure. To the contrary, the pilot firms have slightly deregulation.
more news exposure than the non-pilot firms. Thus, it does Our paper used a natural experiment by the Securities
not appear that firms were decreasing concerns to reduce and Exchange Commission that pertained to stocks in the
media exposure. United States. An interesting avenue for future research
could be to investigate other events as natural experiments
to study the effect of short selling constraints on CSR or
6 CONCLUSION other firm outcomes. For example, there is variation in
the degree of short selling constraints across countries,
Several business cases have been developed by organi- and results from the United States may not generalize
zational theorists to articulate why firms conduct CSR internationally.

86
AC K N OW L E D G E M E N T S
We thank the Editor, Damir Tokic; Douglas Cummings;
Sunny Li Sun; conference participants at the 2017 AAA
Annual Meeting (San Diego); seminar participants at the
University of North Carolina Wilmington and Hofstra Uni-
versity for helpful comments; and Harrison Hong for shar-
ing data. All remaining errors are ours.
ORCID
Yongtao Hong https://orcid.org/0000-0003-2424-3923
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https://doi.org/10.1002/jcaf.22550

AU T H O R B I O G R A P H I E S

Yongtao Hong is an associate professor of accounting

at North Dakota State University.

Wei Wei is an assistant professor of finance at the

University of Oklahoma.

Alex Young is an assistant professor of accounting at

Hofstra University.

APPENDIX A: DEFINITIONS AND SOURCES OF DATA

Variable Definition Source

Leverage (LEV) Long-term liabilities plus short-term liabilities, divided by market value of equity Compustat
(DLTT + DLC)/(PRCCF × CSHO)
Return on Assets Income before taxes divided by lagged total assets (IB/ATt−1 ) Compustat
(ROA)
Market to Book Ratio Market value of equity divided by book value of equity (PRCCF × CSHO)/(CEQ) Compustat
(MTB)
Size The natural logarithm of total assets (log(AT)) Compustat
Analysts The number of analysts issuing a 1-year-ahead EPS forecast IBES
Corporate Social The sum of strengths for community, corporate governance, diversity, employee MSCI
Responsibility relations, the environment, human rights, and product characteristics; minus the
(CSR) sum of the corresponding concerns
Strategic CSR The sum of strengths for employee relations, environment, and product MSCI
characteristics; minus the corresponding concerns
Social CSR The sum of strengths for community and diversity, minus the corresponding MSCI
concerns
Rated An indicator variable that equals 1 if the firm was rated by MSCI, 0 otherwise MSCI
Institutional The yearly average of quarterly total (13f) institutional ownership Thomson
Ownership (IO) Reuters