observations, and the post-SOX sample contains 1,645 firms and 8,702 firm-year observations. 4.2 Measurement of Variables CSR Ratings 4 This used to be called KLD STATS. We use interchangeably ESG STATS and KLD STATS.
19 The MSCI ESG STATS (Statistical Tool for Analyzing Trends in Social and Environmental Performance) 5 is an annual data set of environmental, social, and governance (ESG) ratings for publicly traded companies conducted by MSCI ESG Research. The MSCI ESG STATS ratings model includes over 50 ESG indicators in seven ESG categories for the three topic areas: Seven ESG categories • Environment • Social: o Community o Human Rights o Employee Relations o Diversity o Customers • Governance 6 The spread of companies covered by STATS in 2010 is the largest 3,000 United States companies as defined by market capitalization. The STATS product incorporates a binary representation of ESG ratings: “if a company does satisfy the criteria established for a rating, this is indicated with a ‘1.’ If a company does not meet the criteria established for a rating, this is indicated with a ‘0.’ If an ESG indicator has not been researched for a particular company, this is indicated by ‘NR’ (Not rated).” 7 Each of the seven ESG categories has “strength” and “concern” variables; when a company meets the criteria for “concern” variables this is transformed into a “- 1.” For analysis in this study we aggregate the ratings into total strengths and sum the concerns over the seven ESG categories. We follow common practice in the academic literature, of adding 5 MSCI ESG Research builds on the expertise and achievements of sustainability pioneers KLD, Innovest, and IRRC acquired via MSCI’s acquisition of RiskMetrics. 6 We remove out this corporate governance scores in the KLD data because we analyze corporate governance as an endogenous variable, one of the key factors we are considering, in the model. We use this KLD rating of governance as a proxy for corporate governance variable in our model. 7 We excerpt the description of the rating system from MSCI ESG STATS User Guide & ESG Ratings Definition, MSCI ESG Research (2011).
20 the concerns to the strengths in order to arrive at a single net total score (i.e., Kim, Park, and Wier, 2012; Griffin and Mahon, 1997; Johnson and Greening, 1999; Waddock and Graves, 1997). Discretionary Accruals We estimate discretionary accruals as earnings management proxy variables by utilizing the annual cross-sectional industry regression with the modified Jones model based on DeFond and Subramanyam (1998) and Kothari, Leone, and Wasley (2005). The equation to measure discretionary accruals is as follows: !" !" ! !" ! ! = ࠵? ! + ࠵? ! ! ! !" ! ! + ࠵? ! ∆ !" ! !" ! ∆ !" ! !" ! !" ! ! + ࠵? ! !! ! !" ! !" ! ! + ࠵? ! !"# ! !" ! ! ! !" ! ! + ࠵? !" , (2) where TA it is total accruals for a firm i at year t, ∆ REV it is the change in net revenues for firm i at year t, ∆ REC it is the change in net receivables for firm i at year t, PPE it is gross property, plant, and equipment for firm i at year t, IBEI it is income before extraordinary items for firm i at year t, and A it-1 is total assets for firm i at year t-1. Total accurals ( TA it ) are calculated by deducting cash flow from operating activities (CFO it ) from income before extraordinary items (IBEIT it ). We obtain all items in the equations from the Compustat database. The residuals from the modified
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