There is mixed evidence on whether the marginal dollar spent on corporate social responsibility is due to agency problems. We propose an approach by modeling how the 2003 dividend tax cut, which increased after-tax insider ownership and better aligned managerial and shareholder interests, affected the marginal dollar spent on firm responsibility. We confirm key predictions of our agency model: following the tax cut, moderate insider-ownership firms experience larger declines in their responsibility ratings and increases in their valuations relative to other firms. We also confirm another implication regarding managerial misalignment using a regression-discontinuity design of close votes on shareholder-governance proposals.

Credit ratings of corporations are biased, but the forces driving this bias are unclear. We argue it would be difficult for rating agencies to issue high grades for a firm’s debt when there are a lot of objective equity analyst reports about the firm’s earnings that are informative about its default. We find that an exogenous drop in analyst coverage leads to greater optimism-bias in ratings, especially for firms with little bond analyst coverage and those that are close to default. This coverage-induced shock leads to less informative ratings about future defaults and downgrades and more subsequent bond security mispricings.