Corporate Social Responsibility, Investor Sentiment, and Stock Returns

Abstract

In this study, we show that corporate social responsibility (CSR) increases volatility, since it creates noise in financial markets. Some outstanding studies related to the impact of investor sentiment state that companies with higher volatility exercise lower returns following high sentiment periods. Using environmental, social, and governance (ESG) research data, we sort a large number of US firms into high, medium, and low groups along with their social and environmental scores. We then predict the return of the high average minus the low average with investor sentiment, which has the tendency to act based on cognitive biases rather than the information at hand. Investor sentiment is proxied by direct sentiment surveys and the Baker and Wurgler (2006) composite sentiment index. We find that companies with higher environment-focused CSR activities have lower subsequent returns following high sentiment periods. We capture this evidence also for social performance with the composite sentiment index. The study introduces new insight to corporate social responsibility literature and extends return predictability literature. It also contributes a behavioral view to CSR-company performance relations.