Do Negative Corporate Social Responsibility Events Signal Financial Misreporting? — Empirical Finding from Taiwan

Abstract

This study examines whether negative corporate social responsibility events (NCSRs) signal potential firm misreporting and pending financial reporting restatements. Without formal opinions on the effectiveness of internal controls over financial reporting in Taiwan, we hypothesize NCSRs can represent and/or signal a firm’s internal control weakness, which may in turn result in poor financial reporting. Note that the concern with controlling owners expropriating wealth through ineffective internal controls is given important weight by investors and regulators. We further examine whether the signaling function of NCSRs is more pronounced in contexts with a serious agency problem, such as is found in the high divergence of control and cash flow rights case (denoted as high excess control rights) in Taiwan. Empirical results indicate that, as conjectured, incidence of NCSRs is positively associated with the likelihood of reporting restatements. Further evidence reveals that this result is particularly pronounced in the high divergence of control and cash-flow rights subsample test. We demonstrate several diagnostic tests and show the results are robust in various specifications.