Does Being Shariah-Compliant or Socially Responsible Matter to the Financial Markets?

Driven by the evident lack of a market and cross-cultural perspective of the corporate social responsibility (CSR) – corporate performance relationship and the similarities between CSR and Shariah-compliance (SC), this study examines the relationship between a firm’s designation as a top CSR performer or SC and the market’s subsequent reaction as measured by its stock price informativeness, total and idiosyncratic risk, and firm-specific investor sentiment. Country effects are included to examine how markets outside the U.S. react towards CSR, and how non-Muslim markets react towards SC. Consistent with the information asymmetry argument, top CSR performers and, SC firms exhibit greater stock price informativeness due to increased voluntary disclosures. But top CSR performers that were also SC (SCCSR) exhibited a negative relationship suggesting information overload. Consistent with stakeholder theory, markets perceive top CSR performers (SC firms) to be less (more) risky. Market perception of firm risk is however country-dependent. Also, following the managerial opportunism argument, SC firms and top CSR performers have higher idiosyncratic risk. Unsurprisingly, SCCSR firms displayed lower idiosyncratic risk as they are the oldest and most reputable in their respective industries. Finally, consistent with the value-enhancement hypothesis, investors are generally positive towards top CSR firms. Investors too are positive towards SC firms but only in Europe and South Korea while SCCSR firms are only viewed favourably in Europe and South Korea, owing to the positive coefficients observed for each of these countries / regions. So, yes, being socially responsible or SC does matter to the financial markets, more so in certain countries. The findings contribute to existing literature in a few ways. First, this study is the only study that has examined the overlapping characteristics of CSR and SC empirically and in so doing, bridges the divide between the Western foundations of morality and ethics and the Islamic principles of social justice by integrating other disciplines including religion, ethics, ethnography, sociology, finance, strategic management, and economics. Second, prior CSR studies emphasized: 1) accounting-based performance measures; 2) American companies and, more importantly; 3) privileged information. This study fills the gap by exploring how a firm’s CSR/SC designation affects the wider market’s perception towards it. This study also explores how cultural differences may affect this relationship, something that has only been attempted twice. Also, this study uses information that is publicly available for free, as opposed to KLD ratings that are not publicly available and require a substantial fee for limited access thus failing to represent what the overall market knows about the company’s CSR/SC performance. Third, this study provides ample statistical evidence towards understanding how markets react to Shariah-compliance. Although previously attempted, the scope of prior studies has been so narrow as to render them insignificant. This study widens the scope significantly and bridges the gap in the application of generally accepted finance theory and Islamic finance. Finally, by drawing parallels between CSR and Shariah-compliance, the possibility of having a consistent approach in evaluating Shariah-compliance is now more likely which should encourage a greater adoption rate of Shariah-compliance, at least in the countries observed.