csr, audit quality and firm performance during covid-19: an

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Munich Personal RePEc Archive CSR, audit quality and firm performance during COVID-19: an organizational legitimacy perspective Yadav, Sandeep and Srivastava, Jagriti Indian Institute of Management Kozhikode, Kerala, India, Indian Institute of Management Kozhikode, Kerala, India June 2021 Online at https://mpra.ub.uni-muenchen.de/108967/ MPRA Paper No. 108967, posted 04 Aug 2021 14:43 UTC

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Page 1: CSR, audit quality and firm performance during COVID-19: an

Munich Personal RePEc Archive

CSR, audit quality and firm performance

during COVID-19: an organizational

legitimacy perspective

Yadav, Sandeep and Srivastava, Jagriti

Indian Institute of Management Kozhikode, Kerala, India, Indian

Institute of Management Kozhikode, Kerala, India

June 2021

Online at https://mpra.ub.uni-muenchen.de/108967/

MPRA Paper No. 108967, posted 04 Aug 2021 14:43 UTC

Page 2: CSR, audit quality and firm performance during COVID-19: an

1

CSR, audit quality and firm performance during COVID-19: an organizational legitimacy

perspective

Abstract

Purpose - COVID-19 induced uncertainty in the firms’ business transactions, product-market

competition and financial market cause severe organizational legitimacy crisis. Using the

organizational legitimacy perspective, we study the relationship between corporate social

responsibility (CSR) activities, audit quality, and firm performance.

Design/methodology/approach – We use a quarterly panel of 89,185 firm observations (15,955

unique firms) from 131 countries from July 2018 to December 2020 for 10 quarters. We use a

Difference-in-Difference (DiD) method to estimate the effect of CSR activities and audit quality

on firm performance during the COVID-19 period.

Findings - We find a U-shaped relationship between CSR and firm performance. This relationship

is strengthened during COVID-19. In contrast, we find an inverted U-shaped relationship between

firm audit quality (audit fee) and firm performance. However, this relationship is weakened during

the pandemic.

Originality/value – Our study makes important contributions to theory and practice on

maintaining organizational legitimacy during the pandemic. During the crisis, managers need to

focus on strategies increasing firm value for the time period. This study shows that firms’ temporal

legitimacy gaining practices such as CSR activities and audit quality provides an opportunity to

increase firm value. Firm managers also need to identify the optimal level of CSR activities and

audit fees to balance the cost of agency and the benefits of legitimacy.

Keywords CSR, audit quality, COVID-19, firm performance, organizational legitimacy

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1. Introduction

COVID-19 led to unprecedented uncertainty in the economy (Altig et al., 2020). It resulted in a

global economic crisis and a sharp decline in stock markets worldwide (Szczygielski et al., 2021).

On one hand, social distancing norms and strict lockdowns were imposed to reduce the spread of

the virus (Caulkins et al., 2020). On the other hand, these stringent measures resulted in reduced

economic activity for the firms. Many firms followed a simple strategy of cutting down the

expenses and crouch it till the storm passes in response to the declining sales and uncertainty over

this period (Boissay et al., 2020). The pandemic has resulted in increased attention to corporate

social responsibility (CSR) activities (Bae et al., 2021). The firms are involved in creating and

increasing shareholder value by repeating their commitments to stakeholder interests. Any failure

in responding to such commitments would adversely impact the business environment for firms

(Manuel and Herron, 2020). Moreover, it can adversely impact investors' confidence that can result

in financial distress. Furthermore, given the high risk of distress during COVID-19, it is likely that

the firms violate the debt contracts (Albitar et al., 2020), and follow earning smoothing practices.

This increased demands in assurance for investors to increase their confidence through audit

quality (Arthur et al., 2015) as well as increased CSR activities. In light of the risk caused by the

pandemic, we study the impact of CSR activities and audit quality on firm performance during

COVID-19.

We integrate the institutional (DiMaggio & Powell, 1983; Scott, 1987) and strategic

(Ashforth and Gibbs, 1990; Suchman, 1995) theories of organizational legitimacy to propose a

theoretical model. First, we argue that up to an extent, the shareholders perceive CSR efforts as

firms’ conformity to societal norms at their cost. The firms merely engage in CSR practices to

show a certain level of compliance with social and environmental outcomes (Deegan, 2002;

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Waddock, 2004). We further argue that beyond an extent, the CSR decisions are based on an

organizational strategic legitimacy perspective rather than complying with institutional norms. The

rational firm managers take these extensive CSR decisions to increase form profit or increase the

firm value. Hence, we hypothesize a U-shaped relationship between CSR activities and firm

performance. Furthermore, the COVID-19 pandemic is a truly exogenous event that led to a high

level of uncertainty and an unprecedented stock market crash within a relatively short period. The

firms are under the spotlight due to the sudden increase in market participants and the increased

focus of government bodies on CSR activities during the pandemic. The firms with higher CSR

activities with limited financial and human resources during the pandemic are perceived more

legitimate and valued higher by shareholders. Hence, we hypothesize that the U-shaped

relationship between CSR activities and firm performance is strengthened during COVID-19.

Second, audit fees show the firms’ audit quality and audit cost. Firms use higher audit fees

as a strategic instrument to reflect audit quality by using specialized audit staff and more audit

hours (O’Sullivan and Diacon, 2002), and signals that firms have hired big auditors with more

skill, expertise, and experience. This enhances the legitimacy of a firm's disclosure and reporting

to increase firm value. Further, we argue that audit fees beyond a level may negatively influence

firm value. As per auditing pricing theory and literature on abnormally high audit fees, a very high

audit fee reflects firm business risks (Asthana & Boone, 2012; Choi et al., 2010). A very high audit

fee also shows agency relationship between firm’s managers and auditing firm, which, in turn,

reduces auditor independence. Hence, we hypothesize an inverted U-shaped relationship between

audit quality (or audit fee) and firm performance. Prior literature suggests that economic crises

negatively impact firm accounting management and reporting practices (Huizinga and Laeven,

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2012, 2012; Peterson and Arun, 2018). This makes the role of firm audit efforts more important

and weakens the inverted U-shaped relationship between audit quality, and firm performance.

In this study, we use a quarterly panel of 89,185 firm observations (15,955 unique firms)

from 131 countries from July 2018 to December 2020 for 10 quarters. We use a Difference-in-

Difference (DiD) method to estimate the effect of CSR activities and audit quality on firm

performance during the COVID-19 period. Our findings support the U-shaped relationship

between CSR activities and firm performance. This relationship is strengthened during COVID-

19. In contrast, we find an inverted U-shaped relationship between firm audit quality (audit fee)

and firm performance. This relationship is weakened during COVID-19.

We make a significant contribution to the theory and practice of maintaining organizational

legitimacy during the pandemic. First, we add to the strategic legitimacy perspective by showing

that firms can adopt strategies like CSR activities and high audit quality to gain legitimacy and

increase firm value during the COVID-19 period. Second, we add to mixed literature on the

relationship between CSR activities and firm performance. We show that the relationship between

CSR activities and firm performance is non-linear. Third, we contribute to the literature on the

relationship between audit quality and firm performance. Our findings show that up to an extent

audit fees improve firm performance by increasing high-quality disclosure and reducing

information between the firm and shareholders. A very higher level of audit fee indicates high firm

risk, an agency relationship between firm and auditors, and compromise auditors independence.

This reduces firm legitimacy and subsequently firm value.

2. Theory and hypotheses development

2.1 Organizational legitimacy perspective

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Extant literature has used institutional theory (DiMaggio & Powell, 1983; Scott, 1987), and

strategic theories (Ashforth and Gibbs, 1990; Suchman, 1995) to explain an organization's

legitimacy management. Institutional theory predicts organizational legitimacy as an outcome of

following widely maintained firm characteristics and normative assumptions of institutions

(DiMaggio and Powell, 1983; Scott, 1987). Under the logic of institutional legitimacy firms have

limited capability to manage the institutional legitimacy (Suchman, 1995), because firms follow

"a continuous and often unconscious adaptation process in which the organization reacts to

external expectations" (Palazzo and Scherer, 2006). In contrast, the strategic approach assumes

that organizational legitimacy treat is directly influenced and managed by firms (Ashforth and

Gibbs, 1990) as an operational resource (Suchman, 1995). Firms get institutional support by

instrumentally deploying and manipulating the redolent symbols (Suchman, 1995). The current

COVID-19 pandemic situation as a worldwide crisis provides firms with the opportunity to

purposively maintain organizational legitimacy. Firms take purposive legitimization actions based

on managerial calculations (Ashforth and Gibbs, 1990).

The COVID-19 pandemic context may cause stakeholders to reject firm practices such as

lower level of CSR practices and audit quality, if they perceive these practices as merely

reputational gaining stunts to increase firms value. In the current COVID-19 pandemic context,

firms deliberately communicate their rational argument about specific practices to gain legitimacy.

Based on the above discussed theoretical argument, we examine whether firms' practices of high

CSR activities and audit quality increase firms' legitimacy to gain organizational value during the

COVID-19 pandemic.

2.2 CSR and firm performance

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Firms are always under pressure to maximize shareholders' wealth as well as stakeholder's welfare.

Firms’ concern for institutional legitimacy forces to adopt CSR practices (Bansal and Clelland,

2004; Berrone and Gomez-Mejia, 2009) to improve firm reputation and access to resources

(Christmann and Taylor, 2001). Existing literature is not able to resolve the relationship between

CSR activities and firm performance. Some of the studies find CSR as a value-enhancing activity

for the firm (e.g., Cao et al., 2019; Dai et al., 2020; Deng et al., 2013; Flammer, 2015, 2020; Gao

et al., 2020), while other studies document that it CSR activities can reduce the firm value or even

not related to firm value (e.g., Bénabou & Tirole, 2010; Cheng et al., 2014; Di Giuli &

Kostovetsky, 2014; Masulis & Reza, 2015). The conflict resolution view suggests that CSR

activities enhance firm reputation and value by resolving the conflicts between managers and non-

investing firm stakeholders (Jo and Harjoto, 2011; Servaes and Tamayo, 2013). The

overinvestment view suggests that CSR practices are costly to shareholders and managers as agent

overinvestment shareholders money to gain corporate reputation (e.g., Brammer et al., 2006;

Crisóstomo et al., 2011; Harjoto & Jo, 2015; Hillman & Keim, 2001; Jo & Harjoto, 2011; Nelling

& Webb, 2009). These studies mostly assume a linear relationship between CSR activities and

firm performance. We argue that this relationship varies with the level of firm CSR activities and

have different implication in the crisis such as COVID-19.

We use institutional legitimacy and organizational legitimacy perspective to establish a

non-linear relationship between CSR initiatives and firm performance. The current debate on the

relation between CSR activities and firm strategies to enhance value is based on organizational

legitimacy which does not adequately define the boundaries in globalized societies (Palazzo and

Scherer, 2006). The conceptual basis of these arguments is based on getting societal acceptance

with minimum required efforts (Deegan, 2002; Waddock, 2004). In line with agency arguments in

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the existing literature (Masulis and Reza, 2015), we argue that shareholders perceive these initial

lower CSR efforts as firm conformity to societal norms at their cost. The managers take these

decisions to enhance the firm's reputation rather than increasing firm value. The firms merely

engage in CSR practices to show a certain level of compliance with social and environmental

outcomes. Shareholders see these compliance activities as costly affairs. We argue that up to an

extent firm CSR activities cost shareholders and reduce firm value.

We further argue that after an extent firm manager CSR decisions are based on

organizational strategic legitimacy perspective rather than complying with institutional norms. The

rational managers' CSR decisions are based on the assumption that firms have strategic capabilities

to influence and manipulate stakeholders to gain pragmatic legitimacy. The firms seek new forms

of legitimacy rather than doing taken for granted social and environmentally friendly activities

(Palazzo and Scherer, 2006). These firms at higher CSR levels even introduce the new domains

which are traditionally considered state actors responsibilities (Matten and Crane, 2005; Palazzo

and Scherer, 2006). The rational firm manager takes these extensive CSR decisions to increase

firm profit or increase the firm value. Based on this discussion, we argue that up to an extent CSR

activities reduce firms' value but managers' rational decisions of CSR after a level are focused on

increasing firm value or performance. Hence, we hypothesize:

H1a. Firm-level of CSR activities have a U-shaped relationship with firm performance.

COVID-19 pandemic has challenged the corporate practices and assumptions related to

CSR activities. Business is seen both as a source as well as an active actor to mitigate societal risk

during the crisis (Crane and Matten, 2020). Firms are taking heterogeneous responses to the

COVID-19 crisis. For example, Costco helping employees by increasing the hourly rate by $2,

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Vodafone helping the customer by providing unlimited mobile data, L'Or ́al supporting suppliers

by accelerating payments, and LVMH producing hand sanitisers for general community support

(Bae et al., 2021). In contrast, firms like Marriott International laying off the workforce and

jeoparding the employee healthcare benefits in the needing hours (Bae et al., 2021). This evidence

shows that firms follow different approaches to gain legitimacy and survive during COVID-19.

COVID-19 pandemic is a truly exogenous event that led to a high level of uncertainty and

an unprecedented stock market crash within a relatively short period. This exogenous shock results

from a public health crisis rather than an economic crisis. The subsequent lockdown to protect

public health caused the stock market crash in the affected regions (Albuquerque et al., 2020).

This sudden unexpected shock challenged firms' ability to respond on short notice. Firms are under

the spotlight due to the sudden increase in market participants and government bodies focus on

CSR activities during the pandemic. We argue that firm initial CSR stunts to overcome legitimacy

barriers increase agency cost and reduce shareholders returns (Buchanan et al., 2018). The firm

with higher CSR activities with limited financial and human resources during a pandemic is

perceived more legitimate and valued higher by shareholders. Firms with higher CSR efforts also

attract socially responsible investors(SRIs). SRIs are more resilient to COVID-19 shock compared

to other investors (Albuquerque et al., 2020). SRIs are also less sensitive to short-term firm

performance losses (Bollen, 2007; Renneboog et al., 2011), and hold stable firm value during

COVID-19. Therefore, we hypothesize:

H1b. The U-shaped relationship between CSR activities and firm performance is strengthened

during COVID-19.

2.3 Audit quality and firm performance

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The Enron bankruptcy in 2001 and Arthur Andersen collapsed in 2002 questioned the auditing

quality of firms. The role of external auditors becomes important in a public firm with separation

of ownership and control (Francis, 2004). In this study, we focus on the audit fee as a measure of

audit quality effort by firms. The relationship between audit fee and firm performance is also

puzzled. The audit fee reflects both the cost of auditing and audit quality. Some studies find that

higher audit fees improve firm performance as it is considered as a signal of audit quality (Bell et

al., 2008; Martinez and da Jesus Moraes, 2014; Stanley, 2011). Others find that higher audit fees

is a signal of firm risk and it reduces firm performance (Moutinho et al., 2012). We propose a

contextual non-linear relationship between audit fees and firm performance.

Firms' actual audit fees consist of normal fees and abnormal fees due to the idiosyncratic

relationship between firm and auditor. Normal audit fee reflects auditors effort (Choi et al., 2008,

2009; Simunic, 1980), but above a level, normal audit fee also reflects auditor-client specific

relations (Higgs and Skantz, 2006). Audit fees as a proxy of audit quality reflect more audit efforts

in a closely regulated market with the limited opportunity of earning rents (Hoitash, 2011;

Kanagaretnam et al., 2011; Yuniarti, 2011). Audit fee shows audit process efforts with specialized

staff and more audit hours (O’Sullivan and Diacon, 2002). Higher audit fees also signal that firms

have hired big auditors with more skill, expertise, and experience. This enhances the legitimacy of

a firm's disclosure and reporting to increase firm value.

Further, we argue that audit fees beyond a level may negatively influence firm value. As

per auditing pricing theory and literature on abnormally high audit fees (Asthana & Boone, 2012;

Choi et al., 2010) a very high audit fee reflects firm business risk. Abnormally high audit fee

indicates financial reporting problems (Hribar et al., 2014), and reduce firm performance (Picconi

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and Reynolds, 2013; Stanley, 2011). A very high audit fee also shows agency relationship between

firm manager and auditing firm and reduce auditor independence. A very high audit fee benefits

are surpassed by the cost of substandard reporting due to idiosyncratic relationships. A very high

audit fee also shows agency relationship between firm manager and auditing firm and reduce

auditor independence. This reduces firm auditing process legitimacy and subsequently reduces

firm value. Therefore, we hypothesize:

H2a. Audit fee has an inverted U-shaped relationship with firm performance.

The firms’ performance is negatively impacted by COVID-19 due to high uncertainty in

financial and economic conditions, supply and demand shock due to lockdown imposed by various

country governments (Ozili and Arun, 2020). Prior literature suggests that economic crises

negatively impact firm accounting management and reporting practices (Huizinga and Laeven,

2012, 2012; Peterson and Arun, 2018). Firms engage in malpractices of miscommunicating with

shareholders to gain legitimacy during the crisis. Firms follow earnings smoothing practices

(Peterson and Arun, 2018), and distort financial reporting during the crises (Huizinga and Laeven,

2012). This makes the role of audit quality more important and firms with higher audit fees are

perceived to be more legitimate. We argue that during the COVID-19 crisis the firm with lower

audit fees is perceived less legitimate compared to firms with high audit fees. Therefore, we

hypothesize:

H2b. The inverted U-shaped relationship between audit fee and firm performance is weakened

during COVID-19.

3. Data and methodology

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3.1 Analytical method

We use a DiD method to examine the proposed hypotheses (Goodman-Bacon and Marcus, 2020).

We employ the following equation in our study: Yj,t = β0 + β1Xj ∗ COVID − 19t + Zj,t−1 + Countryc,q + γi,q + εj + ϵj,t where Y represents Tobin’s Q as a measure of firm performance. Our main independent variables

are Xj* COVID-19 where X equals CSR activities score and audit quality of the firm along with

their squared terms. COVID-19 was declared as a pandemic by World Health Organisation in

March 2020. We refer to April 2020- December 2020 as the post-COVID-19 period. Accordingly,

COVID-19 equals 1 for the post-pandemic declaration period and 0 otherwise. Z represents a

vector of firm-level control variables which includes size, sales growth, liquidity, leverage,

profitability, and age (log age) of the firm. Country represents a vector of country-specific control

variables that includes export GDP per capita and GDP growth. We winsorize all these variables

at the 1st and 95th percentile to remove possible outliers in the sample. We take the lagged value

by one-quarter of all the variables to control for the potential endogeneity concerns. The primary

independent variables (CSR activities and audit quality) are available annually, we use one year

lag of these variables for respective quarters.

γi,q represents industry-quarter fixed effects to control for any time-variant industry-

specific variations. εj represents firm-fixed effects that control for any firm-specific heterogeneity.

As an alternative measure, we also include country-quarter interactive fixed effects. This dummy

controls for any time-variant country-specific changes. These interactive fixed-effects help in

controlling any unobserved heterogeneity in the market performance of the firms (Gormley and

Matsa, 2014). These fixed effects also minimize the issues related to omitted variables and

endogeneity.

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3.2 Data description

We employ a quarterly panel of 89,185 firm-quarter observations (15,955 unique firms) from 131

countries from July 2018 to December 2020 for 10 quarters. We use the Refinitiv Eikon database

for obtaining all the firm-level variables used in our study. Country-level variables are obtained

from the world bank database. The dependent variable of our study is firm performance, which is

being measured by Tobin's Q. It is defined as the ratio of the sum of equity and total liability to

the total assets of the firm. Tobin’s Q is used as a market-based performance measure of the firm

(Kao et al., 2018; Ting, 2021).

Our main independent variables are CSR activities and the audit quality of the firm. CSR

activities are measured using the ESG score of the firm. Here, the ESG score is based on the firm's

environmental (impact on living and non-living natural systems), social (capacity to generate

loyalty and trust) and governance pillar (activities to act in the best interest of shareholders) (Ding

et al., 2016). The higher the ESG score of the firm, the higher the firm is involved in CSR activities.

The other independent variable, audit quality, is measured using the logarithm of audit fees paid

by a firm (Saeed et al., 2020). It is used as a proxy for demand for high-quality audits.

We control for various firm-level variables. Firm size is measured using the logarithm of

total assets. Sales growth is defined as the change in sales. We use the quick ratio of the firm as a

proxy for liquidity in our sample. Leverage is measured as the ratio of debt to equity. Profitability

equals the return on assets (ROA) and age equals the logarithm of the age of the firm in years.

Table I describes the measurement or variables with appropriate references and data sources.

---------------------------------------------

Insert Table I about here

---------------------------------------------

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4. Results

Table II shows the summary statistics of the key variables used in our study. The mean value of

Tobin's Q per cent is 99.57 which shows that most of the firms in our sample have the market

value that reflects the recorded assets of the firm. The minimum value of Audit quality is 7.91 and

the maximum value is 15.19 which shows that firms are paying both low and high audit fees in the

sample. The average size of firms in our sample is 11.84. ESG score of firms included in the

sample has a high standard deviation of 20.17. Our sample is dominated by firms with low

liquidity as the 75th percentile value of the Quick ratio is 2.22 and the maximum value is 8.75. The

average profitability of firms is -0.13. The average change in the age of the firms is 2.82. Export

GDP has a high standard deviation of 26.07. GDP growth of countries included in the sample

ranges from 0.15 to 7.02. Table III shows the correlation matrix of the variables used in the study.

---------------------------------------------

Insert Table II and Table III about here

---------------------------------------------

Table IV shows regression results of CSR activities impact on firm performance. Model-1

is the null model with all the control variables. Model-2 shows that CSR activities have a

significant negative ( = -0.019 , p-value < 0.05) effect on firm performance and squared term of

CSR activities has a significant positive ( = 0.001 , p-value <0.05 ) effect on firm performance.

This supports our hypothesis 1a, which predicts a U-shaped relationship between CSR activities

and firm performance. The results of Model-3 show that interaction between CSR activities and

COVID-19 has significant positive ( = -0.017, p-value < 0.05) impact on firm performance.

Model-3 also shows that the interaction between the squared term of CSR activities and COVID-

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19 has a significant negative ( = 0.001, p-value <0.05) impact on firm performance. These results

support our hypothesis 1b, which predicts the positive moderating effect of COVID-19 on the

relationship between CSR activities and firm performance.

---------------------------------------------

Insert Table IV about here

---------------------------------------------

Table V shows regression results of audit quality impact on firm performance. The results

in Model-1 show that audit quality has a significant positive ( = 0.212, p-value <0.05 ) impact on

firm performance, and squared of audit quality has a significant negative ( = -0.009 , p-value <

0.05) impact on firm performance. This supports our hypothesis 2a, which predicts an inverted U-

shaped relationship between audit quality and firm performance. The results of Model-2 show that

the interaction between audit quality and COVID-19 has a significant negative ( = -0.251, p-value

< 0.10) impact on firm performance. Model-2 also shows that the interaction between the squared

term of audit quality and COVID-19 have a significant positive ( = 0.011, p-value < 0.10) impact

on firm performance. These results support our hypothesis 1b, which predicts the negative

moderating effect of COVID-19 on the relationship between CSR activities and firm performance.

---------------------------------------------

Insert Table V about here

---------------------------------------------

5. Discussion

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This study shows that firms use CSR activities and audit quality as a resource of legitimacy. These

strategies have become more important during the COVID-19 crisis. Prior studies on the

relationship between CSR activities and firm performance during COVID-19 show mixed

evidence. Some of the studies find a positive impact of firm CSR orientation on a stock return

during COVID-19, while others reported no significant impact (Bae et al., 2021; Demers et al.,

2021). These studies are limited to firm stock return during the COVID-19 period only and assume

a linear relationship between CSR activities and firm value. Our study provides evidence that CSR

activities and firm value do not have a linear relationship. We find that CSR activities have a U-

shaped relationship with firm market-based performance. The initial level of firms’ CSR activities

efforts is the effort to confirm with institutional norms and cost the shareholder. Beyond a level,

the CSR activities are undertaken by the firms’ managers to gain strategic legitimacy and improve

firms’ performance. Firms showing higher commitment to CSR activities with limited financial

and human resources during COVID-19 are perceived more legitimate by the shareholders. The

COVID-19 crisis strengthens the relationship between CSR activities and firm performance.

Audit quality measured using audit fee shows firm effort to produce quality reports and

communication to stakeholders with lower malpractices. We find that up to a level audit fee reflects

firm auditing efforts of hiring experienced, qualified, and reputed auditors and improves firm

performance. Audit fee beyond a level reflects an idiosyncratic firm-auditor relationship with

compromised audit quality and shows high firm risk. We find support for an inverted U-shaped

relationship between audit quality and firm performance. Furthermore, given the high risk of

distress during COVID-19, it is likely that the firms violate the debt contracts (Albitar et al., 2020),

and follow earning smoothing practices. This demands increased assurance for investors to

increase their confidence through audit quality (Arthur et al., 2015). Our results show that an

Page 17: CSR, audit quality and firm performance during COVID-19: an

16

inverted U-shaped relationship between audit quality and firm performance is weakened during

COVID-19. This shows that during a crisis high audit efforts are valued more compared to lower

audit efforts.

5.1 Theoretical and managerial implications

First, we add to the strategic legitimacy perspective by showing that firms can adopt strategies like

CSR activities and high audit quality to gain legitimacy and increase firm value during a crisis

such as the COVID-19 pandemic. Second, we add to mixed literature on the relationship between

CSR activities and firm performance. We show that the relationship between CSR activities and

firm performance is non-linear. Beyond an optimal level, the CSR decisions are focused on

increasing firm strategic capabilities to influence and manipulate stakeholders to gain pragmatic

legitimacy (Suchman, 1995). Third, we contribute to the literature on the relationship between

audit quality and firm performance. Our findings show that up to an extent audit fees improve firm

performance by increasing high-quality disclosure and reducing information between the firm and

shareholders. A very higher level of audit fee indicates high firm risk, an agency relationship

between firm and auditors, and compromise auditors independence. This reduces firm legitimacy

and subsequently firm value.

Finally, we suggest managers focus on firm temporal strategies to overcome the challenges

from the COVID-19 pandemic (Shi and Prescott, 2012). The manager needs to shift their focus

from cost to time orientation. During the crisis, managers need to focus on strategies increasing

firm value for the time period. This study shows that firm temporal legitimacy gaining practices

such as CSR activities and audit quality provides an opportunity to increase firm value. The firm

Page 18: CSR, audit quality and firm performance during COVID-19: an

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manager also needs to identify the optimal level of CSR activities and audit fees to balance the

cost of agency and the benefits of legitimacy.

This study is limited to CSR activities and audit quality as legitimacy maintaining strategies

during COVID-19. Future studies can explore other strategies such as earnings management and

corporate investment decisions. Future studies can extend this study by taking institutional context

as a moderating factor on the relationship between CSR activities, audit quality, and firm

performance. The country-specific formal institution's development and informal institutions may

significantly vary our findings.

6. Conclusion

We use a quarterly panel of 89,185 firm-quarter observations from 131 countries to estimate the

impact of CSR activities and audit quality on firm performance during the COVID-19 period. We

find a U-shaped relationship between CSR activities and firm performance during COVID-19. The

higher CSR activities are undertaken by the firms’ managers to gain strategic legitimacy and

improve firms’ performance. In contrast, we find an inverted U-shaped relationship between firm

audit quality and firm performance after the declaration of COVID-19 as the pandemic. The high

audit efforts are valued more compared to lower audit efforts during the COVID-19 period. Our

study makes significant contributions to theory and practice on maintaining organizational

legitimacy during the pandemic. The managers need to focus on strategies increasing firm value

during the crisis period.

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Table I. Variable definitions and data sources Variable Description Data Source Reference

Tobin’s Q Equals ratio of the sum of equity and total liability to total assets of the firm

Refinitiv Eikon Kao et al., (2018)

CSR Equals the ESG score of a company based on the environmental(E), social(S), and governance(G) scores in the previous year

Refinitiv Eikon Ding et al. (2016)

Audit Quality Equals logarithm of audit fees paid by a firm in the previous year

Refinitiv Eikon Saeed et al. (2020)

Size Equals the logarithm of total assets of the firm

Refinitiv Eikon Saeed et al. (2020)

Sales growth Equals the change in sales of the firm

Refinitiv Eikon Ding et al. (2016)

Liquidity Equals quick ratio of the firm Refinitiv Eikon Boodoo, (2016)

Leverage Equals debt-to-equity ratio of the firm

Refinitiv Eikon Suto & Takehara, (2017)

Profitability Equals return on assets of the firm Refinitiv Eikon Saeed et al. (2020)

Log age Equals the logarithm of the age of the firm in years

Refinitiv Eikon Saeidi et al. (2015)

Export GDP Equals ratio of export to GDP of a country

World Bank Maksimovic, (2001)

GDP growth Equals growth in GDP of a country relative to the previous year

World Bank Maksimovic, (2001)

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Table II. Summary statistics of key variables used in the study

Variable N Mean SD Min P25 P50 P75 Max

Tobin’s Q 255444 99.57 3.32 69.78 100.00 100.00 100.00 100.00

Audit Quality 165794 12.32 1.56 7.91 10.42 11.40 12.28 13.33

Audit Quality2 165794 154.32 38.09 62.56 108.52 130.05 150.68 177.66

CSR 49530 42.06 20.18 5.22 16.40 25.51 40.30 58.09

CSR2 49530 2176.23 1813.99 27.26 268.87 650.51 1624.44 3374.63

COVID-19 437580 0.30 0.46 0.00 0.00 0.00 0.00 1.00

Size 230861 11.85 2.51 4.36 8.60 10.26 12.00 13.64

Sales growth 183999 0.04 0.40 -0.99 -0.39 -0.14 0.00 0.16

Liquidity 222927 1.94 2.18 0.00 0.24 0.63 1.17 2.22

Leverage 230031 0.36 1.49 -10.13 0.00 0.00 0.23 0.82

Profitability 211662 -0.14 0.70 -5.89 -0.17 -0.02 0.00 0.02

Log age 348886 2.82 0.83 0.00 1.79 2.48 2.94 3.40

Export GDP 418080 33.52 26.07 10.12 12.17 18.41 21.21 38.44

GDP growth 435678 3.42 2.13 0.15 0.73 1.93 2.93 5.56 Notes: The description of all the variables in given in Table I. N represents the number of observations. Min and Max represent the minimum and maximum observations respectively. SD and P denote standard deviation and percentile respectively.

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Table III. Correlation table

Variables 1 2 3 4 5 6 7 8 9 10 11 12

1 Tobin's Q 1

2 Audit quality -0.12*** 1

3 CSR -0.17*** 0.38*** 1

4 COVID-19 0.01 0.02* 0.03*** 1

5 Size -0.15*** 0.46*** 0.51*** -0.03*** 1

6 Sales growth 0.01 -0.04*** -0.04*** -0.02** -0.03*** 1

7 Liquidity 0.04*** -0.21*** -0.27*** 0.05*** -0.42*** 0.06*** 1

8 Leverage -0.02* 0.01 0.02 0.03 0.10*** -0.01 -0.06*** 1

9 Profitability -0.04*** 0.09*** 0.17*** -0.11*** 0.35*** 0.07*** -0.21*** 0.03*** 1

10 Log age 0.04*** 0.01 0.14*** -0.03*** 0.09*** -0.01 -0.06*** 0.03*** 0.13*** 1

11 Export GDP -0.04*** -0.13*** 0.24*** -0.02 0.14*** -0.02* -0.11*** 0.02*** 0.06*** -0.04*** 1

12 GDP growth -0.01 -0.22*** -0.14*** -0.17*** 0.10*** 0.02* -0.03*** 0.01 0.06*** 0.01 0.01 1

Notes: *, **, *** represent significance level at 10%, 5% and 1% respectively.

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Table IV. Regression results of CSR and firm performance Variables (1) (2) (3) (4) (5) (6)

CSR -0.019** -0.008 -0.017** -0.006

(0.008) (0.008) (0.007) (0.008)

CSR2 0.001** 0.001 0.001* 0.001

(0.000) (0.000) (0.000) (0.000)

COVID-19 0.219** 0.205**

(0.088) (0.087)

CSR x COVID-19 -0.017** -0.016**

(0.007) (0.007)

CSR2 x COVID-19 0.001** 0.002**

(0.000) (0.000)

Size 0.001 0.020 0.053*** 0.003 0.023 0.055***

(0.007) (0.017) (0.019) (0.007) (0.018) (0.019)

Sales growth -0.007* -0.018 -0.016 -0.006 -0.015 -0.015

(0.004) (0.016) (0.015) (0.004) (0.016) (0.016)

Liquidity -0.001 -0.014 -0.014 -0.001 -0.014 -0.015

(0.002) (0.010) (0.011) (0.002) (0.010) (0.011)

Leverage 0.002 0.006 0.004 0.002 0.006 0.004

(0.002) (0.005) (0.005) (0.002) (0.005) (0.005)

Profitability -0.063 -0.616** -0.619** -0.063 -0.625** -0.628**

(0.072) (0.299) (0.299) (0.072) (0.301) (0.300)

Log Age 0.026 0.173 0.199 0.022 0.163 0.189

(0.144) (0.448) (0.457) (0.127) (0.416) (0.423)

Export GDP 0.000 0.003 -0.001

(0.002) (0.023) (0.023) GDP growth 0.002 0.022 0.026

(0.004) (0.044) (0.044) Constant 99.782*** 99.025*** 98.394*** 99.786*** 99.075*** 98.359***

(0.373) (1.153) (1.315) (0.342) (1.123) (1.283)

Observations 89,185 19,922 19,922 94,371 20,292 20,292

Industry-Quarter fixed effects Yes Yes Yes Yes Yes Yes

Country-Quarter fixed effects No No No Yes Yes Yes

R-squared 0.001 0.003 0.008 0.003 0.008 0.013

N 15,955 2,986 2,986 16,112 3,008 3,008 Notes: The description of all the variables in given in Table I. The dependent variable in all the models is the percentage of Tobin’s Q. Standard errors are clustered at firm level. Model (1) -(3) show the results with country-level variables and model (4)-(6) show the results with Country-quarter fixed effects. The standard errors are reported in parentheses. *, **, *** represent significance level at 10%, 5% and 1% respectively.

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Table V. Regression results of Audit Quality and firm performance

Variables (1) (2) (3) (4)

Audit Quality 0.212** 0.326** 0.184* 0.302**

(0.108) (0.133) (0.095) (0.121)

Audit Quality2 -0.009** -0.014** -0.008** -0.013**

(0.005) (0.006) (0.004) (0.005)

COVID-19 1.474 1.387

(0.897) (0.845)

Audit Quality x COVID-19 -0.251* -0.237*

(0.152) (0.143)

Audit Quality2 x COVID-19 0.011* 0.010*

(0.006) (0.006)

Size -0.010 -0.004 -0.011 -0.004

(0.013) (0.010) (0.012) (0.009)

Sales growth -0.005 -0.005 -0.004 -0.004

(0.004) (0.004) (0.004) (0.004)

Liquidity -0.007** -0.008** -0.007** -0.008**

(0.003) (0.004) (0.003) (0.003)

Leverage 0.001 0.001 0.001 0.001

(0.003) (0.003) (0.003) (0.003)

Profitability -0.030 -0.028 -0.030 -0.029

(0.019) (0.018) (0.019) (0.018)

Log Age 0.106 0.085 0.097 0.070

(0.272) (0.268) (0.226) (0.221)

Export GDP 0.014 0.012

(0.011) (0.012) GDP growth -0.003 0.001

(0.007) (0.007) Constant 98.210*** 97.551*** 98.716*** 97.991***

(0.907) (1.041) (0.809) (0.990)

Observations 46,183 46,183 50,236 50,236

Industry-Quarter fixed effects Yes Yes Yes Yes

Country-Quarter fixed effects No No Yes Yes

R-squared 0.001 0.002 0.006 0.007

N 8,754 8,754 9,180 9,180 Notes: The description of all the variables is given in Table I. The dependent variable in all the models is the percentage of Tobin's Q. Standard errors are clustered at the firm level. Model (1) -(2) show the results with country-level variables and model (3)-(4) show the results with Country-quarter fixed effects. The standard errors are reported in parentheses. *, **, *** represent significance level at 10%, 5% and 1% respectively.