How do Normative and Compliant CSR Affect the
Earnings Quality of Japanese Firms?*
ZHAOYAN GU

KEIICHI KUBOTAHITOSHI TAKEHARA†

CUHK Business School,
CHINESE UNIVERSITY OF HONG KONG

Graduate School ofStrategic Management,
CHUO UNIVERSITY

Graduate School ofBusiness and Finance,
WASEDA UNIVERSITY

ABSTRACTThis study investigates the empirical relation between the corporate social performance(CSP) and earnings quality of public firms in Japan. To investigate this query, we adopt
several measures, including accruals-based earnings management (AEM) measures andreal activities-based earnings management (REM) measures. In general, thecomprehensive measurement of the CSP of Japanese firms is positively associated withearnings quality, suggesting that corporate social responsibility (CSR) activities may
improve the earnings quality of Japanese firms. However, a more detailed investigation
using CSP dimensional indices reveals a number of in-depth findings. First, before
controlling for financial performance, normative CSR is more strongly associated with
the AEM measures, whereas compliant CSR is more strongly associated with the REM
measures. Second, after controlling for financial performance in the regression analysis,
the regression slopes of the compliant CSR dimensions are no longer statisticallysignificant, implying the existence of a spurious correlation between compliant CSR
and earnings quality. Finally, the slopes of the normative CSR dimensions remain
significant even after controlling for financial performance. Overall, these results
indicate that the managers of firms that show high normative CSR values tend to avoid
adopting AEM and REM measures and that those firms that are conscious of CSR are
more likely to gain investor confidence.

*

Acknowledgements: The authors appreciate the helpful comments and suggestions received from Masahiro Enomoto(editor), Megumi Suto and anonymous referee. All remaining errors are of our own.
†
Corresponding Author. Address: Graduate School of Business and Finance, Waseda University, 1-6-1 Nishiwaseda,
Shinjyuku-ku, Tokyo, 169-8050, Japan. Phone: +81-35286-8419, E-mail: takehara@waseda.jp.
Received July 20, 2016; accepted October 13, 2017; available online November 22, 2017 (Advance publications by J-STAGE)
DOI: 10.11640/tjar.7.2017.01
Copyright©2017 Research Institute for Economics & Business Administration – Kobe University.

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The Japanese Accounting Review, 7 (2017), 1-22

JEL Classification: M41, M14
Keywords: Earnings Quality, Corporate Social Responsibilities, Normative CSR,
Compliant CSR

1. Introduction
While earnings quality is a financial measure used to report a firm’s financial performance toinvestors and other outside stakeholders, corporate social responsibility (CSR) is a businessapproach that aims to deliver a range of economic, social, and environmental benefits to all
stakeholders. Since Kim et al. (2012), several studies have investigated the relation between CSR
awareness and earnings quality. However, most previous studies have used U.S. data, and therefore,
less is known about the relation between earnings quality and CSR in Japan.
Earnings quality is considered to be useful for both investors and firms making long-term
strategic decisions (Schipper and Vincent, 2003; Francis et al., 2008). For example, earnings
quality rises when there is less fluctuation in earnings series (Trueman and Titman, 1988).
Earnings management, which may be detrimental to the attainment of earnings quality, is usuallyconducted by the extensive use of accounting accruals (Healy and Wahlen, 1999). The magnitudeof accruals, particularly abnormal accruals, can serve to highlight a lack of earnings quality.1
Earnings management has also been labeled real activities-based earnings management (REM) by
Roychowdhury (2006), Cohen et al. (2008), and Cohen and Zarowin (2010).2 However, REM
behavior may amplify earnings variability (Ronen and Yaari, 2008). Indeed, Jensen et al. (2004)
emphasized that firms ought to seek long-run goals instead of satisfying short-term objectives(e.g., quarterly profits) in order to satisfy analysts’ expectations. Firms that pursue long-term goals
tend to pay attention to CSR and sustainability, with the aim of building corporate reputation in
the long run.
In this study, we use the five CSP dimensions developed by Suto and Takehara (2016): (1)employee relations, (2) environmental preservation, (3) social contributions, (4) firm security andproduct safety, and (5) internal governance and risk management. Suto and Takehara (2016)
constructed these CSP indices on the basis of a stakeholder management approach, with each
CSP dimension corresponding to an important group of stakeholders. However, by imposing
similar criteria to those proposed by Harjoto and Jo (2015), we reclassify these five CSP
dimensions into two groupings, namely normative CSR and compliant CSR.
We contribute to the ongoing debate on the relation between CSR and earnings quality inthe following two ways. First, we examine the relation between comprehensive CSR and earnings
quality to confirm the robustness of the results presented by Kim et al. (2012), using Japanese data.
Second, we examine the extent to which the two types of CSR defined in Harjoto and Jo (2015),
namely normative and compliant CSR, affect the earnings quality of Japanese firms differently.
Considering the financial constraints on these firms, we anticipate that the positive association
between normative CSR and earnings quality is more robust compared with that between

1

In Japanese firms, the existence of these so-called accruals effects has been confirmed by Chung et al. (2004) andKubota et al. (2010), which reverse within several months of the end of the fiscal year.
2
The effects of real earnings management have been explored by Mande et al. (2000), Herrmann et al. (2003), Pan(2009), and Guo et al. (2012) in different contexts from that in the present study.

Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

3compliant CSR and earnings quality. In fact, we find that normative CSR improves the earnings
quality of Japanese firms even after controlling for financial performance, whereas compliant CSR
is not significantly associated with earnings quality. Our finding is crucial because the firm cansignal earnings quality to investors only through the normative CSR channel.
The remainder of the paper is organized as follows. We review related studies in Section 2
and develop the research hypotheses in Section 3. In Section 4, we explain the CSP dimensional
indices, several earnings quality measures, and the other financial variables used in this study. The
two-stage portfolio formation approach and regression models employed are also described. In
Section 5, we present the results of the correlation analyses and of the portfolio formation
approach. In Section 6, we report the results of the regression analyses. Finally, we conclude in
Section 7.

2. Earnings Quality and CSR
Suto and Takehara (2016) constructed CSP dimensional indices from the results of a survey
conducted by Toyo Keizai Inc. By using these indices, they examined the relation between CSP
and financial performance and found that CSR activities reduce firms’ financial risk. Ajward andTakehara (2014) showed that higher CSP alleviates financial constraints in firms, while Aoi et al.
(2015) compared the performance of Japanese public family and non-family firms based on these
CSP indices and concluded that the social performance of family firms is worse than that of
non-family firms in Japan.
On the relation between CSP and earnings quality, Kim et al. (2012) found that socially
responsible firms are less likely to manage earnings through discretionary accruals, to manipulate
real operating activities, or to be the subject of SEC investigations. Yip et al. (2011) showed thatearnings management and CSR reporting are related, finding that this relation is complementaryin the oil and gas industry, while it is substitutive in the food industry. McDermott (2011)
analyzed the relationship between the KLD score (based on Kinder–Lydenberg–Domini CSRdata) and financial reporting quality as well as investment behavior, emphasizing the role ofprivate benefits for firm managers. Outside the United States, Scholtens and Kang (2013)
reported that Asian firms with relatively high CSR engage in less earnings management.3
In this study, we reclassify the five dimensions of CSR in Suto and Takehara (2016) into
normative CSR and compliant CSR. Harjoto and Jo (2015) defined compliant CSR as CSR
actions required (or desired) by law, whereas normative CSR actions are voluntary (ordiscretionary), with firms only taking such actions to provide the means for human subsistence orenhance quality of life (Ulrich, 2008). Further, Harjoto and Jo (2015) showed the different
impacts of compliant CSR and normative CSR on analysts’ forecast dispersion, stock return
volatility, and the cost of capital. Hence, these two distinct types of CSR actions are expected toaffect earnings quality differently. Figure 1 illustrates the scope of our research, showing that inaddition to examining the overall relation between CSP and earnings quality (H1), we investigate
the differential impacts of normative and compliant CSR actions on accruals-based earnings
management (AEM) measures and real activities-based earnings management (REM) measures(H2 and H3).

3

Their sample is limited to only 16 firms in Japan.

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The Japanese Accounting Review, 7 (2017), 1-22

FIGURE 1. RELATION BETWEEN CSP AND EARNINGS QUALITYCSR Actions

H1

Earnings Quality

Normative CSR

AEM

Employee Relations

Absolute Value ofAbnormal Accruals

Environment
Preservation

H2

Variability ofEarnings

SocialContribution

Income Smoothing

Abnormal CFO

Security of the Firm
and Products Safety
Internal Governanceand Risk Management
Compliant CSR

Abnormal Production

H3

Abnormal R&D
Expenditure

REM

3. Hypothesis Development
As discussed in Kim et al. (2012), managers have an incentive to be trustworthy and ethicalin their businesses. Thus, those firms/managers more conscious about social responsibility tend to
be more honest to all types of stakeholders and avoid unethical conduct. As a result, they sustain
the credibility of stakeholders by continuing CSR actions. In this case, a comprehensive CSP
score, which is an imperfect signal of the degree of the social consciousness of managers, ispositively correlated with earnings quality measures. In other words, those firms that endeavor tomaintain integrity do not manage their earnings in order to deceive their stakeholders. Thus, H1
is proposed as follows:4
H1: A composite measure of CSP is positively associated with earnings quality.
Next, we consider the interrelations among normative CSR, compliant CSR, AEM, andREM. Because stakeholders are less informed about normative CSR actions, the degree of
information asymmetry is larger in normative CSR dimensions. By contrast, stakeholders find it
relatively easy to access the private information of managers because the evaluation items in

4

H1 is identical to the “transparent financial reporting hypothesis” presented in Kim et al. (2012). Thus, we confirm
the robustness of their results by using Japanese data.

Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

5compliant CSR actions are binding (or nonbinding) targets required by law. For this reason,stakeholders tend to find it rather difficult to assess the true implementation status of normative
CSR actions. Then, the measure of normative CSR constructed based on a balanced analysis isconsidered to be valuable. Indeed, such a normative CSR measure serves as a strong signal frommanagers to stakeholders and reduces the degree of information asymmetry. Therefore, themanagers of firms with high normative CSR scores are honest and ethical (i.e., they do not
manage earnings), although their social consciousness is unknown to stakeholders. H2 is thus
proposed as follows:
H2: The accounting earnings of firms with higher normative CSR are less managed by both AEM
and REM strategies.
However, the relation between compliant CSR and earnings quality is more complicated.
Since both binding and nonbinding actions are included in compliant CSR activities, there exists
a large dispersion of compliant CSR among firms. For example, many Japanese firms have
ISO9001 certification, while others do not.5 Although ISO standards including ISO9000s arevoluntary, the implementation of ISO standards shifts substantial costs to firms. Furthermore,ongoing capital expenditure on CSR activities is required to maintain ISO certification. For thisreason, those firms with inferior financial performance might be unable to afford to implement
ISO9001. The same holds for many other compliant CSR activities. Even if compliant CSR
activities are demanded by the regulations, financially constrained firms will have a spending limit
and will reduce (or delay) spending on such CSR activities. On the contrary, financiallyunconstrained firms will spend more money on compliant CSR activities.
Hence, although we can observe a positive correlation between compliant CSR actions andearnings quality measures, compliant CSR may not always enhance earnings quality. Moreprecisely, we expect both normative and compliant CSR to enhance the quality of accounting
earnings. However, some proportion of the positive effects of compliant CSR on earnings quality
can be explained by the financial performance of firms. Therefore, in the empirical analyses, we
control for the financial performance of firms, using return on assets (ROA), to investigate thisrelation. H3 is proposed as follows:
H3: After controlling for the financial performance of firms, compliant CSR is less associated withearnings quality compared with normative CSR.

4. Data and Methodology
4.1. Earnings Quality Measures
Our primary observation period is for the nine fiscal years from 2007 to 2015 for which the
CSP dimensional indices constructed by Suto and Takehara (2016) are available. However, to beable to compute the necessary statistics from accounting data, we go back an additional five years.
Financial statement and stock price data were extracted from the Nikkei NEEDS Databasepublished by Nikkei Digital Media, Inc.
5

ISO9001, a document released by the International Organization for Standardization (ISO), specifies the requirements
for a quality management system. The latest version is ISO9001:2015 (see https://www.iso.org/standard/62085.html).

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The Japanese Accounting Review, 7 (2017), 1-22

In this study, we define total accruals (ACC) as the difference between earnings before
extraordinary items (EBEI) and cash-flow from operations (CFO). First, we compute EBEI fromthe corresponding items on the income statement and obtain CFO directly from the cash-flowstatement. Because EBEI is equal to (CFO + ACC) by definition, accruals in this study arecomputed as EBEI – CFO.
We decompose total accruals into normal and abnormal components by using the modified
Jones model (1) proposed by Dechow et al. (1995). We then estimate the following
cross-sectional regression equation separately by each industry for each sample year:
ACC j ,t
TA j ,t 1

  0  1

ADJREV j ,t
PPE j ,t
1
 1
 2
  j ,t .
TA j ,t 1
TA j ,t 1
TA j ,t 1(1)where ΔADJREV is the difference between changes in sales and accounts receivables, PPE isproperty, plant, and equipment measured at net book value, and νj,t is a residual term.
The fitted values from the OLS estimation are used to construct the normal accruals (NAC)
components, and their residual terms are used as abnormal accruals (ABNAC). These abnormal
accruals components represent firm-specific accrual components in excess of industry averages.
In addition to the absolute value of abnormal accruals (|ABNAC|), we use two othermeasures of accounting figures-based earnings quality measures: variability and smoothness. The
variability of earnings (EBEISD) in this study is defined as the standard deviation of earnings
before extraordinary items (EBEI) over the past five years. The smoothness measure is a ratio of
the standard deviation of EBEI to the standard deviation of CFO.
As for our REM measures, we follow the method employed by Roychowdhury (2006);
moreover, the data construction method is almost identical. First, by conducting cross-sectional
regressions for every industry and year, we compute abnormal cash-flows from operations(ABNCFO), which are defined as a residual term from the following regression model:
CFO j ,t
TA j ,t 1

  0  1

SLS j ,t
SLS j ,t
1
 1
 2
  j ,t .
TA j ,t 1
TA j ,t 1
TA j ,t 1(2)

We also compute two additional REM measures, namely abnormal production (ABNPROD)
and abnormal R&D expenditures (ABNEXP), by employing regression models (3) and (4)proposed by Roychowdhury (2006).6 Roychowdhury (2006) hypothesized that ABNPROD issignificantly positive and ABNEXP is significantly negative when a firm increases its earnings byadopting REM strategies.
PROD j ,tTA j ,t 1

6

  0  1

SLS j ,t1
SLS t 1
SLS t
 1
 2
 3
  j ,t .
TA j ,t 1
TA j ,t 1
TA j ,t 1
TA j ,t 1(3)

By using equations (2) and (3) of Roychowdhury (2006), we computed two additional REM measures: abnormal costof goods sold and abnormal inventory growth. However, the Pearson correlation between abnormal production(ABNPROD) and abnormal cost of goods sold in our pooled sample was high at 0.916. Thus, we decided not to use
these two measures and focus instead on ABNPROD.

Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

DISEXP j ,tTA j ,t 1

  0  1

SLS t 11
 1
  j ,t .
TA j ,t 1
TA j ,t 1

7(4)

4.2 CSP Dimensional Indices
A stakeholder-focused approach to corporate governance emphasizes that CSR activities canbe linked to different stakeholders (e.g., employees, the environment, communities, customers,
suppliers) and that firms are required to choose the appropriate architecture of internal
governance and adopt strategies under the existing regulatory framework. Given these stakeholder
relationships, Suto and Takehara (2016) defined the following five CSP dimensions: 1) employee
relations, 2) environmental preservation, 3) social contributions, 4) firm security and productsafety, and 5) internal governance and risk management.7
The first dimension, employee relations (EMP), which includes workplace conditions, canenhance employee quality and motivation (Turban and Greening, 1997). Appropriate working
hours and wages, minority employment, job stability, safe working conditions, and skills
development are all related to the employee relations variable. The second dimension,
environmental preservation (ENV), is a pillar of CSP in a society that is increasingly concernedwith climate change. The third dimension, social contributions (SC), is related to a firm’s policy
for and response to social demands. Good relationships and coordination with the surrounding
community can reduce the costs associated with local conflicts, attract human resources, andenhance corporate reputation. On the contrary, negative relationships with the surrounding
community can narrow business perspectives and increase the costs and risks associated withbusiness operations. These three dimensions, namely EMP, ENV, and SC, are classified as
normative CSR. Hence, they serve as a signal to stakeholders about the social consciousness offirms/managers.
The fourth dimension, firm security and product safety (SS), is related to the quality of afirm’s products and the sustainability of its business. Therefore, it provides competitive advantage
in the long term by affecting a firm’s relationships with its customers. The fifth dimension,internal governance and risk management (IG), is related to the quality of disclosure, compliance,internal auditing, and self-disciplining that a firm demonstrates. These last two dimensions areclassified as compliant CSR. Finally, Suto and Takehara (2016) also defined a composite CSP(CSP) measure as a comprehensive index of the above five dimensions (EMP, ENV, SC, SS, IG).
We use this comprehensive measure of CSP to test H1.8

4.3. Portfolio Formation Method and Regression Model
Suto and Takehara (2016) pointed out the statistically significant relation between social
performance and financial performance in Japan. In that case, we expect that firms with lower
profitability and/or firms that face tighter financial constraints to have an incentive to increase
their cash-flows. Thus, they manage their earnings by using REM strategies. To avoid misleading

7

These CSP dimensional indices have been used in several empirical studies of Japanese data (e.g., Ajward andTakehara, 2014; Aoi et al., 2015).
8
Harjoto and Jo (2015) reclassified 80 ratings items (in seven qualitative areas) when they constructed their normativeand legal CSR measures. In a similar way, we reclassified the five CSR dimensions in Suto and Takehara (2016) into
the normative and compliance dimensions.

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The Japanese Accounting Review, 7 (2017), 1-22

interpretations from the results of the univariate correlation analysis, we adopt the two-stage
sequential portfolio formation method in this study.
To control for the correlation between financial performance, measured by ROA, andearnings quality, we first rank sample firms based on their ROA and construct ROA-ranked
quintile portfolios at the end of September for each year of the study period. Second, each ofthese five ROA-ranked quintile portfolios are subdivided into five groups based on theirdimensional CSP scores. As a result, we obtain 25(=5×5) ROA- and CSP-ranked portfolios.
Since the five CSP-ranked quintile portfolios in the same ROA quintile are almost at the same
ROA level, we are able to investigate the CSP–earnings quality relation after eliminating theeffects of ROA on earnings quality.
In addition to the two-stage portfolio formation, we also conduct multivariate cross-sectional
regression analysis, using the following control and instrumental variables: Natural logarithm of total assets (in million Japanese yen) (lnTA);
 ROA, which we must control for when testing H3;
 Leverage ratios, computed as non-current liabilities over total assets (LEV); Sales growth rates of the past five years (SLSG) (Lakonishok et al., 1994)
 Firm age, defined as number of years from foundation date (AGE); Dummy variable that equals 1 if the firm is not listed on the Tokyo Stock ExchangeFirst Section (NOTSE1); and Lagged one-year value of composite CSP (CSPB).
Note that lnTA, LEV, and SLSG are measures of financial constraints, financial stability, andfuture growth, respectively, whereas NOTSE1, AGE, and CSPB are used as instrumental variablesin the two-stage regression analysis.9 The two-stage least squares regression model is given as
follows:
EQ j ,t     1CSPj ,t   2 ROA j ,t   3 LEV j ,t   4 SLSG j ,t
4

8

i 1

i 1

   i SizeDummyi , j ,t    i YearDummyi  2006, j ,t   j ,t .

(5)

In model (5), the dependent variable EQj,t is one of six earnings quality measures, while CSPj,tis the composite CSP measure or one of the CSP dimensional indices.10

4.4. Sample and Descriptive Statistics
Table 1 reports the number of sample firms for which the CSP dimensional indices andaccounting figures between 2007 and 2015 were available. We report the number of observations
at the aggregated sector level, where the sector classification schemes are based on Kubota andTakehara (2007).
The first to ninth rows report the number of sample firms in each sector for each year. On

910These instrumental variables were selected with reference to Schreck (2011), Suto and Takehara (2016), and others.
We conducted Wu-Hausman’s test and Sargan’s over-identification test before conducting the two-stage leastsquares regression. The test statistics are available from the authors upon request. In addition, the standard errors
were corrected by applying the one-way (Year) cluster-robust method developed by Petersen (2009).

Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

9

TABLE 1. NUMBER OF SAMPLE FIRMS

2007
2008
2009
2010
2011
2012
2013
2014
2015
TSE1
TSE2
Others
Total

Consumption Goods
117
121
122
128
130
135
149
154
153
167
31
7
199

Investment
Goods
192
208
218
223
226
235
254
279
290
291
49
21
348

Services
79
89
90
96
117
123
135
136
142
140
31
27
174

Transportation
17
16
15
16
19
20
22
23
24
26
2
2
29

Utility
10
11
11
13
11
11
11
11
10
13
0
0
13

Real
Estate
10
15
12
14
15
15
16
16
17
20
0
1
21

All
Sectors
425
460
468
490
518
539
587
619
636
657
113
58
784

Notes: Number of sample firms at the end of September of each year (2007–2015) and numberof firms listed on the Tokyo Stock Exchange’s First Section (TSE1), Second Section (TSE2),
and all other stock exchanges in Japan (Others) are reported. Number of firms in the mostupper right four columns is with non-duplicated counting, and a single firm appears a
maximum of four times in our sample period. The total firm-years are 4,742.

average, we have more than 500 firm observations every year, with the largest number in theinvestment goods and consumption goods and services industries. The 10th to 12th rows list the
number of firms belonging to each section of the Tokyo Stock Exchange and the other stock
exchanges in Japan. The final row denotes the total number of firms. The majority of our sample
comes from the Tokyo Stock Exchange First Section. By adding the number of firms in 2007–2015 at the bottom of the table, we have 4,742 firm-year observations and 784 firm samples.
Table 2 reports the descriptive statistics of the variables used in the subsequent analyses. The
median and mean of the absolute value of abnormal accruals (|ABNAC|) are 1.979% and 2.776%
with a standard deviation of 2.648%. Variability (EBEISD) has a median value of 1.493% and amean value of 1.991%. Smoothness has a median value of 0.531 and a mean value of 0.648.
For the REM measures, the median and mean of abnormal cash-flows from operations(ABNCFO) are 0.168% and 0.130%, respectively. The median of abnormal production(ABNPROD) is positive at 0.771%, while the mean is -1.045%, suggesting a negative skew. Finally,in the case of abnormal R&D expenditures (ABNEXP), the median is -0.909% and the mean is
1.050%.
Next, the means of the CSR scores of CSP, EMP, ENV, SC, SS, and IG are 0.529, 0.326,
0.305, 0.212, 0.226, and 0.145, respectively. Note that in Suto and Takehara (2016) all the CSP
dimensional indices are normalized so that they approximately obey a standard normal
distribution, and thus we find that our sample belongs to the group of firms with somewhat

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The Japanese Accounting Review, 7 (2017), 1-22

TABLE 2. DESCRIPTIVE STATISTICS|ABNAC|EBEISD
Smoothness
ABNCFOABNPRODABNEXP
CSP
EMP
ENV
SC
SS
IG
lnTA
ROA
LEV
SLSG
AGE

1st Qu.
0.935
0.880
0.319
-2.471-5.156-4.641-0.576-0.455-0.342-0.496-0.223-0.337
10.6700.884
6.702-5.16556.490Median
1.979
1.493
0.531
0.168
0.711
-0.909
0.751
0.517
0.342
0.292
0.638
0.254
11.6002.206
14.4801.498
65.250

Mean
2.776
1.991
0.648
0.130
-1.045
1.050
0.529
0.326
0.305
0.212
0.226
0.145
11.7202.499
17.5101.174
66.740

3rd Qu.
3.750
2.572
0.836
2.539
5.751
3.934
1.829
1.273
0.954
0.962
1.050
1.037
12.7304.309
25.0807.415
78.100

S.D.
2.648
1.629
0.479
4.578
11.93510.706
1.592
1.250
0.863
1.053
1.234
1.313
1.469
4.228
13.767
15.59321.400Notes: The definitions of the variables are summarized in the Appendix.

above-average CSP scores.11 Finally, for the control variables, the means are 11.720 (log in
million Japanese yen) for firm size, 2.499% for ROA, 17.510% for leverage, and 1.174% for sales
growth. The mean firm age is 66 years, suggesting that relatively long-living firms responded to
the CSR questionnaire survey.

5. Results from the Portfolio Formation Method
5.1. Correlation Analysis Results
Before interpreting the results of the two-stage portfolio formation analysis, we check thesimple correlation among the variables. Panel A of Table 3 presents the Spearman rankcorrelations among the measures of earnings quality, while Panel B shows the correlations
between the measures of earnings quality and CSP indices. The lower numbers in each cell are
the p-values. Panel A shows that the correlation between the absolute value of abnormal accruals
and earnings variability (EBEISD) is 0.129 (p<0.01), while that between the variability andsmoothness measures is 0.694 (p<0.01). This finding suggests that Japanese firms tend to smooth
their earnings by using accounting accruals. Of the REM measures, ABNCFO is negatively(positively) correlated with ABNPROD (ABNEXP), while the Spearman correlation between
ABNPROD and ABNEXP is very low at -0.849.
Next, we detect the relationships between the REM and AEM measures. The third column

11

Because we need to compute the time series of accounting measures by using five years of data before our testing
period, new firms are not included in our sample, which may create some bias.

Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

11

TABLE 3 SPEARMAN CORRELATION MATRIX
Panel A. Correlation among Earnings Quality Measures|ABNAC|p-value
EBEISDp-value
Smoothness
p-value
ABNCFOp-value
ABNPROD
p-value|ABNAC|
1.000

EBEISD
0.129
0.000
1.000

Smoothness-0.106
0.000
0.694
0.000
1.000

ABNCFO
0.007
0.644
0.069
0.000
0.046
0.002
1.000

ABNPROD-0.0150.312-0.0870.000-0.0700.000-0.3080.000
1.000

ABNEXP
0.018
0.219
0.075
0.000
0.084
0.000
0.089
0.000
-0.8490.000

Panel B. Correlation between Earnings Management Measures and CSP/Control Variables|ABNAC|p-value
EBEISDp-value
Smoothness
p-value
ABNCFOp-value
ABNPROD
p-value
ABNEXPp-value

CSP EMP ENV
SC
SS
IG
lnTA
ROA
LEV
AGE SLSG-0.046 -0.071 -0.063 -0.054 -0.026 -0.003 -0.121 -0.006 -0.108 -0.133 -0.050
0.001 0.000 0.000 0.000 0.072 0.839 0.000 0.695 0.000 0.000 0.001-0.049 -0.063 -0.093 -0.060 -0.003 -0.029 -0.136 0.084 -0.030 -0.115 0.017
0.001 0.000 0.000 0.000 0.848 0.046 0.000 0.000 0.042 0.000 0.252
0.052 0.056 0.028 0.032 0.039 -0.034 0.049 -0.001 0.118 0.071 0.003
0.000 0.000 0.052 0.028 0.008 0.018 0.001 0.963 0.000 0.000 0.855
0.094 0.054 0.032 0.078 0.094 0.043 0.068 0.359 -0.124 -0.113 0.055
0.000 0.000 0.027 0.000 0.000 0.003 0.000 0.000 0.000 0.000 0.000-0.123 -0.065 -0.040 -0.093 -0.135 -0.058 -0.032 -0.261 0.119 0.054 -0.012
0.000 0.000 0.006 0.000 0.000 0.000 0.027 0.000 0.000 0.000 0.412
0.117 0.064 0.053 0.083 0.138 0.045 0.016 0.055 -0.022 -0.019 -0.027
0.000 0.000 0.000 0.000 0.000 0.002 0.280 0.000 0.122 0.183 0.065

Notes: The definitions of the variables are summarized in the Appendix.

from the right shows that ABNCFO is positively correlated with |ABNAC| with an estimatedcorrelation of 0.007 as well as with EBEISD with an estimated correlation of 0.069, which seems
to be reasonable. ABNPROD is negatively correlated with EBEISD and smoothness, and
ABNEXP is positively related with EBEISD and smoothness. These results indicate that these
two types of earnings quality measures, AEM and REM, affect the attainment of CSR in
different ways.
Panel B reports the correlations of these earnings quality measures with the other variables.
|ABNAC| is negatively correlated with CSP with a coefficient of -0.046 and the variability
measure (EBEISD) is negatively correlated with CSP with a coefficient of -0.049, which implies
that both lower abnormal accruals and lower variability enhance composite CSP, suggesting that

12

The Japanese Accounting Review, 7 (2017), 1-22

earnings quality is positively related to CSP.
We also find that the correlations of |ABNAC| with employee relations (EMP) and withenvironmental preservation (ENV) are significant (-0.071 and -0.063, respectively), whichsuggests that firms with lower abnormal accruals pay more attention to these CSP dimensions. As
for earnings variability, its correlation with ENV is negative and significant at -0.093. In otherwords, the more firms are concerned about protecting the environment, the lower are theirearnings variations.
For the REM measures, we find that ABNCFO and ABNEXP are positively related to CSP
and that ABNPROD is negatively correlated to CSP (p<0.01). These results show that realcash-flow effects influence the level of CSP (Kanodia, 2006). Specifically, lower abnormal
expenditures and higher abnormal cash-flows can enhance CSP, as can lower abnormal
production costs.
For each CSP dimension, all REM measures are significantly related to SS (firm security andproduct safety) and IG (internal governance and risk management) as shown in the fifth and sixth
columns from the left. Compliant CSR and ROA are more strongly associated with the REM
measures. The Spearman correlation between ROA and ABNCFO is high at 0.359 and thatbetween ROA and ABNPROD is -0.261. Although the correlation analysis reported in Table 3 isjust a preliminary one, the findings demonstrate the need for an alternative analysis that controls
for ROA.

5.2. Results from the Two-Stage Portfolio Formation
Table 4 shows the results obtained by employing the two-stage portfolio formation method.
In the first stage, we constructed ROA-ranked quintile portfolios, each of which was subdivided
into five CSP-ranked groups in the second stage. Table 4 shows the averages of the ROA, CSP,
and earnings quality measures of the highest and lowest CSP portfolios. We also conducted
Student t-tests under the null hypothesis of no difference between the highest and lowest CSP
portfolios. Panels A to F of Table 4 highlight the U-shaped pattern between the ROA and AEM
measures, while the REM measures are a monotonically decreasing function of ROA. We
interpret the U-shaped pattern between ROA and smoothness and that between ROA andEBEISD as evidence that firms use accounting accruals to smooth earnings. By contrast, they use
REM strategies to increase earnings.
Panel A shows the relations among the ROA, composite CSP, and earnings quality measures.
In most cases, the AEM measures of the lowest CSP portfolios are higher than those of thehighest CSP portfolios. For the REM measures, ABNCFO and ABNEXP (ABNPROD) arehigher in the higher (lower) CSP portfolios. Overall, the results in Panel A support H1,
confirming that comprehensive CSP is positively associated with earnings quality.
Panels B to D show the relation between normative CSR and earnings quality. For EMP(employee relations, Panel B) and ENV (environmental preservation, Panel C), the differences in
the AEM measures between the high EMP (or ENV) portfolios and low EMP (or ENV)
portfolios are statistically significant in many cases. By contrast, the differences in the REM
measures are significant only in ROA3 to ROA5. This finding suggests that when ROA issufficiently high as in the ROA1 and ROA2 portfolios, firms have insufficient incentives toincrease their cash-flows. As a result, EMP and ENV are not associated with REM in these high
ROA portfolios. This finding lends support to H2, namely that the earnings of firms withsuperior normative CSR are less managed.

ROA2
High
Low
3.729
3.762
2.501 -1.711 ***
2.510
3.002 *
1.903
1.938
0.669
0.542 **
1.740
0.326 ***
-5.869 -0.007 ***4.836 -0.697 ***
ROA2
High
Low
3.760
3.705
1.873 -1.430 ***2.368
2.910 ***
1.720
1.831
0.609
0.523 *
0.848
0.171
-2.707 -0.280
2.302 -0.052
ROA2
High
Low
3.628
3.774
1.456 -0.849 ***2.420
3.235 ***
1.857
1.898
0.675
0.579 *
1.379
0.698
-5.271 -3.133
4.771
2.709

Panel A. Composite CSP
ROA1 (Highest ROA)ROA Quintile
High
Low
ROA
7.572
7.933
CSP
2.491 -1.895 ***|ABNAC|
3.151
3.206
EBEISD
2.366
2.930 *
Smoothness
0.743
0.697
ABNCFO
3.141
3.299
ABNPROD-9.774 -8.469
ABNEXP
5.992
4.067 *

Panel B. Employee Relations
ROA1 (Highest ROA)ROA Quintile
High
Low
ROA
7.431
7.979
EMP
1.853 -1.641 ***|ABNAC|
2.616
3.170 *EBEISD
2.151
3.146 ***
Smoothness
0.766
0.708
ABNCFO
2.558
2.720
ABNPROD-8.841 -7.633
ABNEXP
5.780
3.860

Panel C. Environment
ROA1 (Highest ROA)ROA Quintile
High
Low
ROA
7.529
8.511 *
ENV
1.310 -0.994 ***|ABNAC|
2.905
3.467 **EBEISD
2.360
3.089 **
Smoothness
0.767
0.640 **ABNCFO
2.797
3.288
ABNPROD-9.074 -10.336
ABNEXP
5.593
5.453

ROA3 (Midium ROA)
High
Low
2.196
2.174
1.483 -0.824 ***2.528
3.232 **
1.554
1.919 *
0.603
0.612
0.178 -0.799 *-2.0352.536 ***
2.714 -1.141 ***ROA3 (Midium ROA)
High
Low
2.153
2.202
1.810 -1.594 ***2.253
3.195 ***
1.471
1.896 **
0.671
0.534 ***
-0.097 -0.676-1.3452.893 **
1.879 -1.654 **ROA3 (Midium ROA)
High
Low
2.211
2.180
2.434 -1.891 ***
2.871
3.178
1.652
1.908
0.619
0.604
0.344 -0.619 *-2.1633.451 ***
2.521 -2.180 ***

ROA4
High
Low
1.059
1.048
1.512 -0.896 ***
2.306
2.579
1.326
1.717 **
0.530
0.610
-0.284 -1.289 **0.041
2.161 **
0.918 -0.689 *

ROA4
High
Low
1.002
1.005
1.816 -1.536 ***1.992
2.886 ***
1.270
1.648 **
0.611
0.584
-0.782 -1.552
1.022
2.886
-0.072 -1.104

ROA4
High
Low
0.999
0.988
2.453 -1.851 ***2.054
2.708 **
1.488
1.707 *
0.609
0.605
-0.384 -1.587 **-0.4033.035 ***
1.085 -1.487 **ROA5 (Lowest ROA)High
Low
-2.392 -2.449
1.582 -0.922 ***
2.989
3.643
2.127
2.655
0.786
0.724
-1.001 -2.191 **-0.974
0.216
2.726
2.702
(continued on next page)

ROA5 (Lowest ROA)High
Low
-2.043 -2.797
1.796 -1.650 ***
2.829
3.445
2.120
2.937 *
0.709
0.778
-1.853 -2.204
0.790
1.402
1.554
1.419

ROA5 (Lowest ROA)
High
Low
-2.313 -2.406
2.539 -1.998 ***
2.818
3.358
2.223
2.653
0.789
0.711
-1.015 -1.814-1.118
0.708
2.947
1.801

TABLE 4. DIFFERENCES IN EARNINGS QUALITY BETWEEN HIGH AND LOW CSP FIRMS
Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?
13

ROA2
High
Low
3.686
3.670
1.282 -1.604 ***
2.797
2.789
1.998
1.820
0.627
0.520 **
1.507
0.203 ***
-6.3800.607 ***
5.710 -1.288 ***
ROA2
High
Low
3.697
3.666
1.464 -1.483 ***
3.074
2.602
1.736
1.696
0.622
0.544
1.033
0.505
-2.574 -0.755
1.576
0.140

E. Security and Safety
ROA1 (Highest ROA)ROA Quintile
High
Low
ROA
7.495
8.336
SS
1.305 -1.761 ***|ABNAC|
3.006
3.202
EBEISD
2.544
2.964 **
Smoothness
0.701
0.692
ABNCFO
3.539
3.393
ABNPROD-10.338 -7.840 **ABNEXP
5.785
3.583 *

F. Int. Gov. and Risk Mng.
ROA1 (Highest ROA)ROA Quintile
High
Low
ROA
7.348
7.762
IG
1.527 -1.710 ***|ABNAC|
3.046
3.159
EBEISD
2.182
2.712 **
Smoothness
0.586
0.734 **ABNCFO
3.177
3.069
ABNPROD-10.097 -7.014 **ABNEXP
5.341
3.868

ROA3 (Midium ROA)
High
Low
2.202
2.170
1.485 -1.876 ***
3.062
2.881
1.589
1.630
0.559
0.549
0.442 -0.635 **-0.266
3.255 ***
0.823 -1.727 **ROA3 (Midium ROA)
High
Low
2.183
2.200
1.235 -1.863 ***
2.937
3.083
1.704
1.645
0.599
0.551
-0.292 -0.982-0.9084.125 ***
1.415 -2.780 ***ROA3 (Midium ROA)
High
Low
2.181
2.189
1.535 -1.319 ***2.708
3.248 **
1.537
1.841
0.623
0.615
0.422 -0.860 ***-1.1273.508 ***
1.691 -2.017 ***Note: The definitions of the variables are summarized in the Appendix.

ROA2
High
Low
3.659
3.747
1.550 -1.275 ***
2.645
3.119
1.737
1.782
0.649
0.525 **
1.283
0.300 **
-3.5500.476 ***
2.810 -0.974 ***D. Social Contributions
ROA1 (Highest ROA)ROA Quintile
High
Low
ROA
7.841
7.876
SC
1.602 -1.329 ***|ABNAC|
3.091
3.094
EBEISD
2.253
2.788 **
Smoothness
0.711
0.739
ABNCFO
3.122
3.231
ABNPROD-9.574 -7.805
ABNEXP
5.449
3.167 *TABLE 4. (continued)

ROA4
High
Low
0.958
1.015
1.498 -1.702 ***
2.392
2.332
1.528
1.558
0.547
0.619
-0.456 -0.793
0.570
2.503 **
0.183 -1.539 *

ROA4
High
Low
1.071
1.030
1.248 -1.611 ***
2.386
2.775
1.704
1.562
0.596
0.593
-0.272 -1.583 ***0.233
3.578 ***
1.194 -2.135 ***

ROA4
High
Low
1.024
0.983
1.584 -1.292 ***2.120
2.688 *
1.507
1.681
0.620
0.638
-0.258 -1.087
0.418
3.986 ***
0.201 -2.325 ***ROA5 (Lowest ROA)High
Low
-2.145 -2.435
1.477 -1.827 ***
2.962
3.066
2.268
2.398
0.739
0.755
-1.664 -1.978
0.395
0.509
1.578
1.760

ROA5 (Lowest ROA)
High
Low
-2.220 -2.175
1.256 -1.699 ***
2.832
2.889
2.372
2.582
0.768
0.742
-1.467 -2.054
1.352
2.023
0.782
0.861

ROA5 (Lowest ROA)High
Low
-2.084 -2.189
1.645 -1.310 ***
2.887
3.104
2.142
2.362
0.739
0.758
-1.026 -2.136 **-0.3101.368 *
2.177
1.362

14
The Japanese Accounting Review, 7 (2017), 1-22

Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

15

However, the tendency we find in EMP and ENV is not observed in SC (social
contributions). The correlations between SC and the AEM measures are unclear, while thosebetween SC and the REM measures are very strong. These trends between SC and the earnings
quality measures are thus similar to those between compliant CSR and earnings quality. In Panel
E for SS (firm security and product safety) and Panel F for IG (internal governance and risk
management), the differences in the REM measures between high SS/IG and low SS/IG
portfolios are statistically significant in most cases. This finding implies that although firms are
not coerced to invest in philanthropic activities, many large Japanese companies may feelpressured to do so. Furthermore, investors understand firms’ social contributions and expenditure
because they are simple metrics. In that sense, social contributions are close to compliant CSR in
Japan. Hence, we find a strong association between compliant CSR and REM measures, thereby
rejecting H3. However, in the two-stage portfolio formation method, we only controlled for the
ROA of the firms, which means that we should not form a conclusion on H3 at this stage.

6. Regression Analysis Results
CSP, as the independent variable in the regression equations, may be correlated with the error
terms because of the presence of endogeneity (Wooldridge, 2010). If this were the case, themanagement decisions revealed in their earnings management behavior may actually determine
the level of the CSR of their firms instead.12 Because we do not know a priori whether firms withhigher earnings quality are more socially conscious, firms with higher CSP may pay attention toearnings quality or firms with stronger internal control, higher reliability of accounting numbers,
and higher accountability may attain a higher level of CSP emanating from their management
decisions. To address these concerns, we employ a two-stage least squares regression, with thefollowing three instrumental variables introduced into the first-stage regression: one-year lagged
CSP, firm age, and NOTSE1. Table 5 reports the results from the cross-sectional regressions forseveral measures of earnings quality regressed on the alternative CSP measures and the control
variables.
In the composite CSP result shown in Panel A, we find that the estimated regression
coefficient for |ABNAC| is -0.044 (p>0.1). Thus, |ABNAC| is negatively correlated withcomposite CSP even after controlling for financial attributes, although this negative correlation is
not statistically significant. The coefficient for EBEISD is -0.052 (p<0.05). As for the REM
measures, ABNPROD has negative and significant coefficients (p<0.01), whereas ABNCFO andABNEXP have positive and significant coefficients (p<0.1 and p<0.01, respectively). These resultsreconfirm the previous results for the various earnings quality measures, thereby supporting H1.
Panel B shows the results for employee relations (EMP). The coefficient for |ABNAC| has an
estimate of -0.160 (p<0.01). Further, the slopes for EBEISD, ABNPROD, and ABNEXP are-0.165, -0.842, and 0.878, respectively (p<0.01).
For environmental preservation (ENV) in Panel C, the coefficients for |ABNAC| and
EBEISD have slopes of -0.245 (p<0.05) and -0.128 (p<0.01), respectively, implying that the lower
the ENV score, the lower is earnings quality. On the contrary, the REM measures offer weaker
explanatory power for this CSP dimension, perhaps because they are more related to firms’ disclosure
12

Francis et al. (2008) discussed two causality channels, namely governance to earnings quality and earnings quality to
governance.

16

The Japanese Accounting Review, 7 (2017), 1-22

TABLE 5. REGRESSING EARNINGS QUALITY ON CSP
Panel A. Composite CSP|ABNAC|Intercept
2.981 ***
t-value
13.436CSP-0.044t-value-0.669-0.040 *ROA
t-value-1.770LEV-0.012 ***t-value-2.886SLSG-0.002t-value-0.906
0.044
Adjusted R2

EBEISD
1.837 ***
14.609-0.052 **-1.988-0.001-0.016
0.002
0.947
0.007
1.289
0.073

Smoothness
0.637 ***
14.3650.003
0.197-0.006-0.7510.004 ***
5.768
0.001
0.332
0.058

ABNCFO-0.282-0.9920.186 *
1.684
0.413 ***
10.744-0.014 **-1.981-0.008 **-2.4350.155

ABNPROD
1.573 *
1.685
-1.183 ***-4.490-0.773 ***-7.366-0.003-0.1750.067 ***
2.983
0.104

ABNEXP-2.098 *-1.7081.260 ***
3.799
0.226 ***
2.667
0.041 **
2.134
-0.032-1.5990.050

Panel B. Employee Relations|ABNAC|Intercept
3.063 ***
t-value
18.345EMP-0.160 ***t-value-3.622-0.039 *ROA
t-value-1.790LEV-0.011 ***t-value-2.880SLSG-0.003t-value-1.082
0.045
Adjusted R2

EBEISD
1.907 ***
13.827-0.165 ***-10.662
0.000
0.005
0.003
1.270
0.007
1.159
0.081

Smoothness
0.651 ***
13.219-0.007-0.480-0.006-0.7450.004 ***
5.794
0.001
0.299
0.056

ABNCFO-0.006-0.0310.135
1.002
0.413 ***
10.663-0.015 **-2.190-0.008 ***-2.7050.152

ABNPROD-0.198-0.188-0.842 ***-3.390-0.768 ***-7.1180.006
0.285
0.068 ***
2.847
0.092

ABNEXP-0.191-0.1590.878 ***
2.682
0.220 **
2.558
0.031 *
1.664
-0.034-1.594
0.037

Panel C. Environment|ABNAC|Intercept
3.179 ***
t-value
15.145ENV-0.245 **t-value-2.079-0.043 *ROA
t-value-1.920LEV-0.013 ***t-value-2.979SLSG-0.002t-value-0.7850.047
Adjusted R2

EBEISD1.873 ***
12.143-0.128 ***-3.307-0.002-0.071
0.002
0.839
0.008
1.315
0.073

Smoothness
0.640 ***
13.8300.003
0.139-0.006-0.7550.004 ***
5.718
0.001
0.329
0.058

ABNCFO-0.035-0.1730.151
1.107
0.415 ***
10.656-0.015 **-2.132-0.009 ***-2.6880.150

ABNPRODABNEXP-0.456-0.500-0.389-0.372-0.584
1.077 *
-1.2731.958-0.780 ***0.239 ***
-7.1272.691
0.002
0.037 *
0.077
1.950
0.073 ***
-0.039 *2.864-1.7150.086
0.031(continued on next page)Gu, Kubota and Takehara: How do Normative and Compliant CSR Affect the Earnings Quality of Japanese Firms?

17

TABLE 5. (continued)
Panel D. Social Contribution|ABNAC|Intercept
3.011 ***
t-value
15.072-0.104SCt-value-0.987-0.040 *ROA
t-value-1.775-0.012 ***LEVt-value-2.936SLSG-0.003t-value-0.9750.043
Adjusted R2

EBEISD1.732 ***
14.887-0.013-0.2990.000-0.014
0.003
1.056
0.008
1.344
0.071

Smoothness
0.669 ***
16.063-0.020-0.824-0.006-0.7570.004 ***
5.723
0.001
0.275
0.055

ABNCFO
0.047
0.214
0.081
0.499
0.413 ***
10.721-0.015 **-2.171-0.009 **-2.5740.151

ABNPROD
0.290
0.306-1.134 *-1.666-0.774 ***-7.4470.000
0.017
0.068 ***
2.756
0.096

ABNEXP-0.910-0.821
1.345 **
2.046
0.227 ***
2.739
0.037 **
2.043
-0.033-1.5100.042

Panel E. Security and Safety|ABNAC|Intercept
2.864 ***
t-value
16.086SS
0.013
t-value
0.105-0.040 *ROA
t-value-1.768LEV-0.012 ***t-value-2.757SLSG-0.002t-value-0.8400.044
Adjusted R2

EBEISD1.788 ***
12.824-0.068 **-2.2980.000-0.004
0.002
0.938
0.007
1.265
0.072

Smoothness
0.674 ***
15.057-0.029-1.487-0.006-0.7270.004 ***
5.611
0.000
0.215
0.053

ABNCFO-0.084-0.4810.220
1.559
0.412 ***
10.698-0.014 **-2.034-0.008 *-1.9500.156

ABNPROD-0.332-0.407-0.792-1.029-0.768 ***-7.3900.000
0.015
0.068 ***
2.796
0.096

ABNEXP-0.216-0.2240.980
1.245
0.220 ***
2.727
0.038 **
2.077
-0.033-1.515
0.042

Panel F. Int. Gov. and Risk Mng.
|ABNAC|EBEISDIntercept
2.907 ***
1.730 ***
t-value
17.49912.432
IG-0.037-0.018t-value-0.335-0.423-0.040 *0.000
ROA
t-value-1.750-0.011
LEV-0.012 ***0.003
t-value-2.7021.014
SLSG-0.0020.008
t-value-0.952
1.324
0.043
0.071
Adjusted R2

Smoothness
0.668 ***
15.490-0.031-1.340-0.006-0.7330.004 ***
5.327
0.000
0.213
0.053

ABNCFO
0.239 *
1.847
-0.108-1.1310.413 ***
10.669-0.016 **-2.258-0.010 ***-3.1690.148

ABNPROD-1.165 *-1.651-0.014-0.020-0.771 ***-7.3240.004
0.197
0.073 ***
2.739
0.085

ABNEXP
0.757
0.931
0.089
0.134
0.223 ***
2.705
0.034 *
1.921
-0.039-1.6070.028

Notes: The dependent variables are the various measures of accounting quality and the definitionsof all the variables are explained in the Appendix. *, **, and *** correspond to significance levelsof 10%, 5%, and 1%, respectively, where standard errors are corrected by using the two-way
cluster error correction method.

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The Japanese Accounting Review, 7 (2017), 1-22

decisions to outside stakeholders including current stockholders. Overall, these findings support
H2, namely that the earnings of firms with superior normative CSR are less managed by pursuing
AEM and REM strategies.
For social contributions (SC) in Panel D, the slope coefficients of ABNPROD and ABNEXP
have slopes of -1.134 (p<0.1) and 1.345 (p<0.05), respectively. This means that the lower the SC
score, the less earnings are managed by real activities-based strategies. By contrast, there is no
significant correlation between SC and AEM. Recall that SC is strongly correlated with the REM
measures and is close to compliant CSR in Table 4. By integrating the results in Tables 4 and 5,
SC in Japan may fall into an intermediate category between normative CSR and compliant CSR.
For the compliant CSR dimensions (SS, IG), the coefficients reported in Panels E and F are
not statistically significant in all cases. Indeed, although we find a significant relation between
compliant CSR and the AEM measures in Table 4, when we control for the firm size effects(lnMV), financial credibility (LEV), future growth (SLSG), and the year effects in addition tofinancial performance (ROA), we cannot find any clear relation between compliant CSR andearnings quality. In sum, these observations support H3.

7. Conclusion
In this study, we investigated the empirical relation between CSP and the earnings quality of
public firms in Japan, using data for the nine fiscal years from 2007 to 2015. Overall, we foundthat CSP is negatively associated with both the AEM and REM measures, suggesting that CSR
activities may improve the earnings quality of Japanese firms. However, a more detailed
investigation using five CSP dimensional indices reveals the different effects of normative andcompliant CSR on earnings quality. Before controlling for financial performance, we showed that
normative CSR is more strongly associated with the AEM measures, whereas compliant CSR is
more strongly associated with the REM measures. However, after controlling for financial
performance in the pooled regression analysis, the regression slopes for the compliant CSR
dimensions are no longer statistically significant. This finding suggests that a large part of thepositive association between compliant CSR and earnings quality can be explained by financial
performance. By contrast, the slopes of the normative CSR scores remain statistically significant
even after controlling for financial performance. Overall, the presented results indicate that the
managers of firms that have normative CSR values tend to avoid adopting AEM and REM
measures and that those firms that are conscious about social responsibility are more likely to gain
investor confidence through their CSR actions. Thus, the normative CSR scores analyzed in thisstudy provide supplementary signals to investors when they are evaluating the earnings quality ofJapanese firms.

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APPENDIX: LIST OF THE ABBREVIATIONS USED IN THE TABLES|ABNAC|EBEISD
Smoothness

Accruals based Earnnings Management Measures
Absolute value of abnormal accruals computed based on the modified Jones model.
Past five years Standard Deviation (SD) of Earnings Before Extraordinary Items(EBSI).
Measure of income smoothing defined as EBEISD/(Standarad Deviation of
CFO).

Real Activities Based Earnings Management Measures
ABNCFO Abnormal Cash-Flows from Operations.
ABNPROD Abnormal Production Costs.
ABNEXP Abnormal R&D Expenditures.

CSP
EMP
ENV
SC
SS
IG

Corporate Social Perfomance Measures
Composite measure of Corporate Social Performance.
Employee Relations (Normative CSR dimension).
Environment Preservations (Normative CSR dimension).
Social Contributions (Normative CSR dimension).
Security of the Firm and Products Safety (Compliant CSR dimansion).
Internal Governance and Risk Management (Compliant CSR dimension).

lnTA
ROA
LEV
SLSG
AGE

Control- and Instrumental Variables
Natual logarithm of total assets of the firm.
Return on Assets.
Financial leverage dedined as non-current liabilities to total assets.
Growth rate of sales revenue.
Number of years from foundation of the firm.