Corporate Governance and CSR Disclosure - Bahauddin Zakariya ...

Pakistan Journal of Social Sciences (PJSS) Vol. 36, No. 1 (2016), pp. 225-238

Corporate Governance and CSR Disclosure: Evidence from a Developing Country Waris Ali, PhD Assistant Professor Department of Business Administration Bahauddin Zakariya University, Multan, Sahiwal Campus [email protected]

Moeed Ahmad Sandhu, PhD Assistant Professor Department of Business Administration Bahauddin Zakariya University, Multan, Sahiwal Campus [email protected]

Javed Iqbal Lecturer Department of Business Administration Bahauddin Zakariya University, Multan, Sahiwal Campus [email protected]

Muhammad Sajid Tufail Lecturer Department of Business Administration Bahauddin Zakariya University, Multan, Sahiwal Campus [email protected]

Abstract This study aims to enhance our understanding about the role of corporate governance in driving CSR disclosure agenda in a developing country, Pakistan. This research used a content analysis method to codify the reported information in the annual reports into CSR disclosure theme and used regression analysis technique to determine the relationship between characteristics of corporate governance and CSR disclosure, while controlling for company characteristics. Multiple directorships of a chairman, non-executive directors on board, and non-executive directors in the audit committee were used as proxies of corporate governance and the number of sentences disclosed was used to measure the extent of CSR disclosure. We have found that only one corporate governance characteristic i.e. multiple directorships of a chairman has significant positive relationship with CSR disclosure while other corporate governance characteristics such as independence of corporate board and presence of non-executive directors in the audit committee have non-significant relationship. The results are suggesting that corporate governance mechanism plays a limited role in driving the CSR reporting agenda in Pakistan. Keywords: Corporate Governance, CSR Disclosure, Developing Country, Corporate Characteristics

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Pakistan Journal of Social Sciences Vol. 36, No. 1

I. Introduction Corporate governance and corporate social responsibility (CSR hereafter) reporting have established themselves as independently researched areas and a little effort has so far been made to create the link between them (Khan et al., 2013). It has been found that CSR disclosure is associated with the values, the norms, and the choices of those who are involved in corporate decision making and the mechanisms of corporate governance (Haniffa and Cooke, 2005; Khan et al., 2013; Gibbins et al., 1990). The research in this area has predominantly found the positive association of corporate governance mechanisms such as board independence and multiple directorship of a chairman with CSR performance (Johnshon and Greening, 1999; Harjoto, 2011). Also there are some empirical studies which suggest that both corporate governance and CSR positively influence market value of a firm (Beltratti, 2005). The adoption of corporate governance is sometime made to gain corporate legitimacy (Biggart, 1991; Hamilton and Biggart, 1988). Literature has also suggested that to calm down the concerns threating the organizational legitimacy has been the main driver of such disclosures (Chen et al., 2008; Deegan et al., 2002; Rahaman et al., 2004). Therefore a strong relationship can be envisaged between corporate governance and CSR disclosure. It has been argued, in a cross country study, that the presence of effective law and order institutions and the prevalence of low level of corruption in a country are determinants of corporate governance legitimacy (Judge et al., 2008). The similar point was argued by Uddin and Choudhury (2008) that primitive societies characterized by corruptions, political interference and family dominance are not conducive for westernstyled corporate governance models. Despite this, western-styled corporate governance models were adopted by my developing countries due to the pressure from external aid agencies and the effectiveness of these models has been questioned (see Mukherjee-Reed 2002; West 2006; Reed 2002; Siddiqui 2010). Therefore the influence of corporate governance mechanism on CSR disclosure may be different in developing countries. The researchers have already argued that there is a paucity of research examining the relationship between corporate governance and CSR disclosure in the context of developing economies (Khan et al., 2013). This is perhaps the valid reason for conducting this study in the context of a developing country i.e. Pakistan. Pakistan is characterized by high political involvement (Cohen, 2002) and high level of corruption 1 (Transparency International, 2014). Pakistan has adopted a code of corporate governance since 2002. In this study, we examine the impact of corporate governance on CSR disclosure in the context of Pakistan. Like many other countries, Pakistan has adopted the western style of corporate governance since 2002. This governance model requires companies to have independent board, separation of chairman and CEO, and provision of audit committees etc. In the more recent times, the Securities and Exchange Commission of Pakistan has further strengthened the corporate governance mechanisms in 2012. Given the results of corporate governance studies on other developing countries such as Bangladesh (see Sobhan and Werner 2003), the effectiveness of corporate governance mechanisms in Pakistan can be doubted. Pakistan, thus presents an interesting case to examine the relationship between corporate governance and CSR Disclosure. The motivations for conducting this study are manifold. Firstly, it presents much needed up-to-date evidence on the state of CSR disclosure on a developing country. 1

Pakistan score 26 out of 100 (Transparency International, 2014)

Waris Ali, Moeed Ahmad Sandhu, Javed Iqbal, Muhmmad Sajid Tufail

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Secondly, a little research has examined the link between corporate governance and CSR disclosure in the context of developing countries (Khan et al., 2013). Thirdly, previous studies in the developing countries relied on one window of observations (i.e. one year data) when examining the determinants of CSR disclosure. Thus reliance on one window of observations may lead towards biased conclusions therefore this research incorporates longitudinal data to establish the link between corporate governance and CSR disclosure. This paper has been structured as follows: The next section discusses the theoretical framework of this study and followed by a section which presents literature review and associated hypotheses. Succeeding sections describe the methodology and data analysis results of this research. The penultimate section presents the conclusion and the last section highlights the limitations and the future research areas.

II. Theoretical Framework Several studies have pointed that the acceptance of western styled corporate governance in developing economies was encouraged by governments’ efforts to gain legitimacy with external parties such as foreign governments and foreign aid agencies (Reed 2002; Mukherjee- Reed 2002; Siddiqui 2010). The legitimacy theory has frequently been used to explain the motivations of CSR disclosure (Hannifa & Cooke, 2005; Islam & Deegan, 2008; Khan et al., 2013). This theory is based on the notion of ‘social contract’, which requires the organization to perform within the norms and values set by the society (Gray et al., 1996; Khan et al., 2013). In essence, an organization gains support of stakeholders in so far as the corporation benefits or does not harm the society. According to this theory, organizations attempt to be seen as operating within the norms and values of the society. In other words, organizations attempt to ensure that their activities and practices are perceived as legitimate by the external stakeholders. Legitimacy is defined as generalized assumption that the activities of an organization are proper, desirable, or appropriate within the socially constructed system of norms, values, and beliefs of the society in which the firm is operating (Perrow, 1970). Although it is the discretion of a firm to restrain itself with in the institutional norms and the failure to conform the critical institutional norms may threaten its legitimacy and consequently its survival (DiMaggio & Powell, 1983; Oliver, 1991). Therefore, an organization tries its actions and activities to be congruent with the norms and values of its society or stakeholders (Lindblom, 1994; Dowling & Pfeffer, 1975; Khan et al., 2013). It has been argued that any disparity between corporate activities and the norms and values of the society results in legitimacy gap (Sethi, 1979). The substantial legitimacy gap will result in loss of an organizational legitimacy. In such situations, a corporation may adopt different public disclosure strategies for its survival (Dowling and Pfeffer, 1975; Lindblom, 1994). In CSR disclosure literature, authors have depicted that companies have adopted various social disclosure strategies to reduce legitimacy gap and to mitigate legitimacy threats (Patten, 1991; Deegan et al., 2002; Chen et al., 2008). Legitimacy theory implies that it is the top level management who recognizes the legitimacy gap and carries out necessary social practices and their disclosure to express their accountability to the relevant stakeholders. Thus corporate governance mechanism particularly the internal corporate governance is likely to pay an important role in the reduction of legitimacy gap through lengthy corporate social disclosures.

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III. Literature Review and Development of Hypotheses Corporate governance is an internal factor (Amran & Haniffa, 2011), and is defined as “the system by which companies are directed and controlled” (Cadbury 2000, cited in Jo & Harjoto, 2012; Haniffa & Cooke, 2005). Companies are usually controlled/ managed by the corporate board. Companies are sometime managed/ controlled by adopting additional mechanisms/systems such as independence of a corporate board, separation of a chairman and CEO, and independence of audit committee etc. (Khan et al., 2013). The Chairman is the administrative head of a firm, and the Chairman’s responsibility is to ensure the smooth running of the firm’s operations according to the policy guidelines of the board. Having multiple directorship indicates that the Chairman has been exposed to multiple firms. It is possible that a Chairman who has multiple directorships may learn issues of concerns from the other companies on whose board he/she sits. Previous studies have showed a significant relationship between a chairman having multiple directorships and CSR disclosure (Haniffa & Cooke, 2005; Jo & Harjoto, 2012). Jo and Harjoto (2012) conducted a study in US, and found a positive relationship between a chairman with multiple directorships and product quality dimension of social performance. Another study was conducted in Malaysia and found a significant relationship between CSR disclosure and firm’s board being led by a chairman with multiple directorships (Haniffa & Cooke, 2005). Relating this to a Pakistani context, the corporate governance code introduced in Pakistan allows directors to have a maximum of ten directorships (Code of Corporate Governance, 2002). This provides an opportunity for the company directors to learn practices (by interacting with other company directors) from the other companies. Thus it can be expected that companies whose chairman has multiple directorships may disclose more CSR information. H1: multiple directorship of a company’s chairman has a significant positive relationship with CSR disclosure (quantity and quality) and its dimensions The corporate governance code which was introduced in 2002 in Pakistan also requires companies to have at least 25% non-executive directors on their board and have at least one non-executive director (preferably the chairman) in the audit committee (Code of Corporate Governance, 2002). Non-executive directors not only protect the interests of shareholders but also those of other stakeholders (Haniffa & Cooke, 2005). According to Jensen and Meckling (1976) non-executive directors are necessary to stop executives’ opportunistic behaviour by controlling and monitoring their actions. Moreover, non-executive directors benefit the firm by developing links with the external environment (Haniffa & Cooke, 2002). There is a possibility that non-executive directors may influence the executives to disclose CSR information in order to manage a company’s links and to achieve normative status in the institutional environment. Previous studies have not shown a consistent relationship between non-executive directors on a board and CSR disclosure (Prado-Lorenzo et al., 2009; Haniffa & Cooke, 2005; Jo & Harjoto, 2012). Prado-Lorenzo et al. (2009) conducted a study in Spain and found that the presence of non-executive directors on the board positively influenced companies’ CSR disclosure. Jo and Harjoto (2012) conducted a study in US and found a positive relationship between external company directors and two dimensions of corporate social performance (i.e. human resource and product disclosure). Contrary to the above, Haniffa and Cooke (2005) conducted a study to check the effect of culture and


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corporate governance on corporate social reporting and found a significant negative relationship between having non-executive directors on a board and corporate social reporting. Thus, based on the empirical evidence, the direction of the relationship cannot be determined. H2: the proportion of non-executive directors on a board has a significant relationship with CSR disclosure (quantity and quality) and its dimensions H3: the proportion of non-executive directors in an audit committee has a significant relationship with CSR disclosure (quantity and quality) and its dimensions Figure 1: Theoretical Model Control Variable Company Size Company Profitability Industry, Year Dummy

Corporate Governance Multiple directorships of a chairman Non-executive directors on board Non-executive directors in the audit committee

CSR Disclosure (Extent)

Figure 1 shows the theoretical model of this research and examines the impact of several corporate governance variables such as: multiple directorships of a chairman, non-executive directors on board, and non-executive directors in the audit committee on the extent of CSR disclosure; and controls for some corporate characteristics such as: company size, company profitability, industry, and year.

IV. Methodology This research used a content analysis research method to codify the reported information in the annual reports into CSR disclosure theme. The CSR disclosure instrument was developed based on previous studies such as: Hackston and Milne (1996), Haniffa and Cooke (2005), Vuontisjarvi (2006), Branco and Rodrigues (2008), and GRI 3.1 (2011); and later on updated based on the disclosures in the sampled companies’ annual reports. In finale, CSR disclosure includes disclosures in five dimensions: 1) environment, 2) human resource, 3) products and consumers, 4) community involvement, and 5) general disclosure. This research used the following regression model to analyze the data with the help of SPSS software.

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Disclosureit = α1 + β1 CMDit+ β2 NEDBit+ β3 NEDACit + β4CSit + β5 CPit+ β6 ES1it+ + β7Year dummy+ εit CSRDQnit = CSR disclosure quantity (extent) of ith company at time t CMDit = Multiple directorships of a chairman of ith company at time t NEDBit = Non-executives directors on board of ith company at time t NEDACit = Non-executives directors in the audit committee of ith company at time t CSit = Company size of ith company at time t CPit = Company profitability of ith company at time t ES1it = Environmental sensitivity of ith company at time t β1, β2……….β17 are regression coefficients to be estimated εit = Error term of ith company at time t i = 1,2, …. …. … 120 and t = 2008 and 2011 The measurement of the dependent and independent variables is mentioned in the following table. Table 1: Measurement of Variables Variables

Measurement

CSR disclosure score

Was calculated by counting the sentences reported about CSR issues Used a dummy variable in which a chairman with multiple directorships was graded one and zero otherwise Is measured by calculating the proportion of non-executive directors in the total directors Used a dummy variable in which one was given to a company having 50% and more non-executive directors in the audit committee and zero otherwise Used total assets as a proxy of a firm’s size Accounting based measure (i.e. Return on Assets) was used to measure a company’s profitability Is a dummy variable and used the following coding scheme 1 1- If a company is operating in an industry with a SIC code 06XX, 10XX, 12XX, 13XX, 17XX, 19XX, 20XX,21XX, 22XX, 23XX, 24XX, 27XX, 29XX, 35Xx, 41XX, 51XX, 49XX, and 50XX 0 0- if a company is not operating in an industry having above SIC codes

Multiple directorships of a chairman Non-executives directors on board Non-executives directors in the audit committee Company size Company profitability Environmental sensitivity

V. Research Results Table 2 provides the results of a descriptive analysis of all the variables used in this study. The sampled companies used an average of 44 sentences to describe their CSR related activities. In addition to this, 35% of the sampled companies are operating in environmentally sensitive industries. The companies included in the sample are large in size (average total asset = PKR 30,582,678 thousands) and their average profitability is 3.29% of total assets (return on assets = 3.29%). As far as the governance structure is concerned, there is a high presence of non-executive directors on the general board (65% on average) and on the audit committee (87% on average). Moreover, 54% of the sampled companies’ chairmen have more than two directorships (see Table 2).

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Table 2: Descriptive Statistics for the independent and dependent variables Variables

Minimum Maximum

CSR disclosure (extent)- CSRD Profitability (ROA)

00

672

44.03

Std. Deviation 73.90

Mean

-45.25%

44.25%

3.29%

10.27%

.21%

100.00%

60.49%

29.52%

Institutional Ownership-IS

Creditors (Lenders) .00% 967.77% 68.39% Non-executive directors on Board12.50% 100.00% 64.87% NEDB Company Size (,000)-CS 11263.00 1153480100 30582678.42 %NEDAC

.33

1.00

87% %age

.00

1.00

15%

.00

1.00

54%

Dummy Variables Multinational Subsidiary-MNSs Chairman with multiple directorshipsCMD

78.87% 23.60% 1.0399E8 .17

The assumptions of the regression analysis model (i.e. the extent of CSR disclosure) and its results are now discussed. To check the linearity assumption, the standardized predicted values are plotted against the studentized residuals, as suggested by Hair et al. (2010), and the resultant plot (see Figure 2a) does not exhibit any non-linear pattern, which ensures that the overall model is linear. Moreover, partial regression plots are developed to assess whether each independent variable has a linear relationship in the regression variate to ensure its best representation in the regression model. The partial regression plots have shown that each variable in the model has a linear relationship with the dependent variable. The residuals are also considered normally distributed (see Figure 2b) because all of the values fall along the diagonal with no substantial departure. The residuals plot shows that the residuals are equally dispersed below and above the central line. It shows evidence of homoscedasticity of the residuals (see Figure 2a). To check Multicollinearity among the independent variables, various measures e.g. correlations, tolerance value, and variance inflation factor (VIF), as suggested by Hair et al., (2010), were calculated. The results showed that multicollinearity among the independent variables is not an issue because the tolerance and VIF value of each independent variable is substantially below the threshold level 2 (see Table 4). Moreover, the correlation matrix has also showed the evidence of absence of perfect multi-collinearity problem as the highest correlation between any two independent variables is - 0.291 (see Table 3). Table 4 provides multivariate pooled regression analysis results on CSR disclosure (extent). The regression model is significant at 0.1% (F statistics = 10.476; p-value =0.000) and has explanatory power (adjusted R2) of 22%. The result shows that the CSR disclosure is principally driven by company size (Sβ3=0. .266, p-value=.000), followed 2

The threshold level of tolerance is 0.10 and VIF is 10 (see Hair et al., 2010). If VIF value is greater than 10 or tolerance values is less than 0.10 that it is considered harmful collinearity (Hair et al., 2010; Kennedy, 2008; Neter et al., 1983 cited in Haniffa and Cooke, 2005). 3 Standardised beta (Sβ) coefficient eliminates problems of different units of measurement of independent variables and this reflects relative impact of independent variable on dependent variable. It is an objective measure of importance of variable (i.e. independent) that can be directly compared (Hair et al., 2010).

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by environmental sensitivity (Sβ=0.238, p-value=0.000), profitability of the company (Sβ=0.171, p-value=0.004) and Chairman with multiple directorships (Sβ=0.129, pvalue=0.034). Figure 2: CSR Disclosure (Quantity) – Regression analysis assumptions

Figure a: Analysis of standardized Residuals

Figure b: Normal Probability Plot: Standardized Residuals

Figure c: Residual histogram The results have shown a significant positive relationship of chairman with multiple directorships with the extent of CSR disclosure (see Table 4). This result is consistent with Haniffa and Cooke (2005) who have shown a significant positive association between chairman with multiple directorships and the extent of CSR disclosure in Malaysia. This indicates that the experience of a chairman gained by sitting on different boards of companies influences the corporate CSR disclosure. The similar has been argued by Haniffa and Cooke (2005) that disclosure is sometime made on the desire of chairman based on his experience of events in other companies in which he acts as a director to ensure congruency between corporate acts and societal concerns.

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Table 3: Pearson correlation matrix Variables YD ES

YD 1

ES 0.004 1

NEDB

NEDB 0.076 0.028

NROA -0.003 -0.129

NCS 0.008 -0.142

CMD -0.03 -0.228

NEDAC -0.103 0.064

1

0.001

0.012

-0.032

-0.291

1

0.028

0.005

0.031

1

-0.151

-0.065

1

-0.065

NROA NCS CMD NEDAC

1

YD: Year Dummy; ES: Environmental Sensitivity; NEDB: Non-Executive Directors on Board; NROA: Normal Score of Company Profitability (ROA) using Van der Waerden's Formula by Year; NCS: Normal Score of Company Size using Van der Waerden's Formula by Year; CMD: Multiple directorships of a Chairman; NEDAC: Non-Executive Directors in Audit Committee

Table 4: Determinants of the extent of CSR disclosure Variables

Unstandardized Standardized Coefficients Coefficients Std. B Beta Error

Non-Executive .188 Directors on Board Multiple directorship of .233 a Chairman NED in Audit -.131 Committee Environmental .452 Sensitivity Normal Score of ROA .160 Normal Score of .247 Company Size Year Dummy .000 (Constant) -.349

t

Sig.

Collinearity Statistics Tolerance

VIF

.119

.096

1.589

.113

.909

1.100

.109

.129

2.136

.034

.907

1.103

.112

-.071

-1.168 .244

.894

1.118

.116

.238

3.908

.000

.898

1.113

.054

.171

2.939

.004

.981

1.019

.055

.266

4.479

.000

.940

1.064

.104 .130

.000

.003 .998 -2.676 .008

.986

1.014

Dependent Variable: Normal Score of Total CSR Disclosure Quantity using Van der Waerden's Formula by Year

In addition to the above, the non-executive directors on board and non-executive directors in the audit committee have a non-significant relationship with the CSR disclosure. Thus the evidence does not provide support for the hypothesis (H2 and H3). One of the reasons for this result could be a lack of awareness of the non-executive directors on the board about CSR related issues. It is also possible that these nonexecutive directors may not be experiencing any pressures from stakeholders regarding the disclosure of CSR information. The results showed a significant positive relationship (t=1.76, p-value=0.076) between company size and the extent of CSR disclosure. This result is consistent with the existing disclosure studies, particularly Haniffa and Cooke (2005), Amran and Devi (2008), and Mahadeo et al. (2011), who have found a significant positive relationship between company size and the extent of CSR disclosure. The result suggests that large

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companies with a high social visibility in Pakistan appear to favor CSR disclosure. The results have also shown a significant positive relationship (t=1.79, p-value=0.074) between profitability (i.e. return on assets) and the extent of CSR disclosure. This result is consistent with Haniffa and Cooke (2005) in which company profitability has a significant positive relationship with the extent of CSR disclosure. Table 4 also shows a significant positive relationship of an industry’s environmental sensitivity with the extent of CSR disclosure (t= 1.73, p-value=0.084). This result is consistent with the existing studies, particularly Newson and Deegan (2002), who have shown that high profile companies (i.e. those doing business in chemical, raw material extraction, wood and paper and forestry) are disclosing significantly more CSR information than those in low profile industries.

VI. Conclusion This paper investigates the relationship between corporate governance mechanisms and the extent of CSR disclosure in an Asian economy, Pakistan by controlling for firm specific factors. In line with the previous studies, this research has also adopted a content analysis research method to calculate CSR disclosure score and used multiple regression analysis technique to examine the relationship between corporate governance and CSR disclosure variables. We have found that only one corporate governance characteristic i.e. multiple directorships of a chairman has significant positive relationship with CSR disclosure while other corporate governance characteristics such as independence of corporate board and presence of non-executive directors in the audit committee have non-significant relationship. One of the reasons for this result could be a lack of awareness of the non-executive directors on the board about CSR related issues. It is also possible that these non-executive directors may not be experiencing any pressures from stakeholders regarding the disclosure of CSR information. Thus corporate governance mechanism plays a limited role in driving the CSR reporting agenda in Pakistan. The result showed that three control variables: environmental sensitivity, company profitability, and company size have significant positive influence on CSR disclosure. This result is consistent with the studies conducted in other developing such as: Bangladesh and Malaysia (Haniffa & Cooke, 2005; Amran & Devi, 2008; Mahadeo et al., 2011; Khan et al., 2013).

VII. Limitations and Future Research The findings of this research are subject to some limitations. The results of this study relied on annual reports disclosure. Authors especially Wanderley et al. (2008) and Van Staden and Hooks (2007) have contended that internet is an important medium to disclose CSR information and many companies have used this source to make CSR disclosure. Thus relying only on one source of disclosure may undermine CSR disclosure. Therefore future research should also examine internet sources of CSR information while examining corporate CSR disclosure. This research studied large listed companies of Pakistan and therefore the results of this study cannot be generalized to other non-listed companies. Therefore, for the better understanding of CSR disclosure, future research should focus on non-listed companies.


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This research incorporated only a few indicators of corporate governance, due to non-availability of data, while investigating the relationship between corporate governance and CSR disclosure. Therefore, the incorporation of several measures may enhance the validity of this research.

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