[Sponsored Article] The effect of mandatory CSR disclosure on firm profitability and social externalities: Evidence from China CHEN, Yi-Chun | HUNG, Mingy i | WANG, Yongxiang Journal of Accounting and Economics 65 (2018) A study on the mandatory reporting of corporate social responsibility (CSR) activities in China has found that companies’ profitability declined after the rule came into effect, but so did pollution, providing a benefit to society. The study by Yi-Chun Chen, Mingyi Hung and Yongxiang Wang focused on a requirement introduced in 2008 for the Shanghai Stock Exchanges Corporate Governance Index and the Shenzhen Stock Exchanges 100 Index. Targeted firms were required to submit CSR reports, which made performance more visible to government watchdogs, NGOS and other stakeholders, who now had a tool to pressure firms into increasing CSR activities. The authors looked at the performance of these firms before and after the disclosure rule came into effect (from 2006 to 2011) and compared them with firms that were not required to file CSR reports, and they found that reporting firms experienced decreases in both return on assets and return on equity after disclosure. “Mandatory CSR reporting firms experienced a decrease in sales revenue and an increase in operating costs and impairment charges subsequent to the mandate. We interpret this as evidence that firms responded by shutting down some production facilities and increasing their pollution control and labor force,” they said. “Firms would have undertaken such activity before the mandate if it were beneficial to performance, so we find that the increase in CSR activity comes at a cost to performance.” There are variations in the effect, though, according to the characteristics of the firms. Firms with greater government control invested more in CSR activities, especially staff protection and public relations, and firms in the most polluting industries spent more on environmental protection. The authors interpreted this as showing political and social considerations were the primary drivers of CSR spending, not economic considerations. Moreover, state-owned enterprises (SOEs) seemed to be the main driver for the overall decrease in firm performance following the CSR mandate because non-SOEs did not experience this drop. SOEs are subject to agency problems due to potential conflicts between the government as controlling shareholder and minority shareholders, and between SOE managers and shareholders (the managers may pursue private political benefits and are not subject to market competition). Pollution levels were also affected by these factors. Following the 2008 mandate, cities with the highest proportion of firms subject to the mandatory CSR disclosure experienced the greatest reduction in both the amount of industrial wastewater discharges and sulfur dioxide emissions, which fell 28 percent and 24 percent respectively from 2006-2011. However, the improvements were not so evident in cities with a high concentration of SOEs affected by mandatory CSR disclosure. “The findings indicate that the observed decrease in firm performance subsequent to the CSR disclosure mandate is driven primarily by SOEs, but the observed decrease in pollution is driven primarily by non-SOEs. This is consistent with the notion that the agency problems of SOEs lead to greater but less efficient CSR spending that depresses any potential social benefit that could arise from the spending increases,” the authors said. In general, the authors showed that mandatory CSR disclosure changed firm behavior and generated positive externalities to society at the expense of shareholders. “While we acknowledge that mandated disclosure may have different effects across institutional environments, we interpret our results as support for the notion that the stakeholder pressure associated with disclosure regulation can cause a firm to take action,” the authors said. However, the less efficient spending that can result from agency conflicts between politicians / SOE managers and minority shareholders can attenuate that positive social impact.