The interaction effect of leverage CSR Performance on the cost of Equity

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This paper has been initiated with the purpose of investigating the interaction effect of leverage and CSR performance on the cost of equity. Traditionally, leverage has been explained in relation to the pecking order or tradeoff theories. However, this paper uses the interesting idea that has been proposed by Ross (1977), which argued that leverage can be used to signal information to the outside investors, therefore, increasing the firm’s perceived value. Accordingly, leverage and CSR performance would have some common characteristics in relation to signaling theory. Therefore, the findings of this study would expand the body of knowledge beyond its current state. Using a sample of 2564 firms, the findings suggest; (1) a significant negative relationship between CSR performance and the cost of equity, (2) a significant positive relationship between leverage and the cost of equity, and (3) an insignificant relationship between the interaction effect and the cost of equity. Furthermore, the findings concerning leverage indicate a contrary perspective to the one proposed by Ross (1977) which can be further investigated in relation to the risk of bankruptcy, whereas, the insignificance of the interaction effect can be explained in relation to the separation of the risk sources. The findings of the study are relevant to those who are interested in CSR dynamics and its interaction with other sources that affect the risk perception, such as; managers, investors, and financial consultants. Keywords: Corporate Social Responsibility (CSR), leverage, signaling theory, cost of equity, information asymmetry, risk.
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