OF THE TOP 100 MCG I - OIDA IJSD Journal

THE EFFECT OF BOARD AND OWNERSHIP STRUCTURE ON ENVIRONMENTAL REPORTING: A CASE OF THE TOP 100 MCG INDEX COMPANIES Wan Mohammad Taufik Bin Wan Abdullah a, Sharifah Binti Buniamin b, Mohd Hisyam Bin Mohd Ghazali c a, b, c

Department of Accounting, College of Business Management and Accounting, Universiti Tenaga Nasional, Malaysia. b Corresponding author: [email protected]

©Ontario International Development Agency ISSN: 1923-6654 (print) ISSN 1923-6662 (online). Available at http://www.ssrn.com/link/OIDA-Intl-Journal-Sustainable-Dev.html

Abstract: CSR-Based Corporate Governance examines ways in which the concept of corporate governance has widened to incorporate stakeholder concerns as well as shareholder accountability. This study examines the association between environmental reporting practice and board size, board independence, institutional ownership and foreign ownership. Data is obtained using content analysis on the annual report of the Top 100 public listed companies in Malaysia Corporate Governance Index (MCGI) 2009. The environmental reporting is based on environmental information disclose in separate environmental section. Overall finding shows that 21 companies reported some form of environmental information in separate environmental section in annual report. Furthermore, it is revealed that there is a significant relationship between the foreign ownership and the environmental reporting practice. This to a certain extent supports the contention of agency theory. Keywords: Board structure, environmental reporting, Malaysia Corporate Governance Index (MCGI) 2009, ownership structure. INTRODUCTION

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ast studies have demonstrated a growing number of companies that are voluntarily disclosing their environmental initiatives and activities, either as stand-alone corporate reports or as specific sections on environmental or sustainability

within corporate annual reports [1]. The volume of environmental information reported has also increased consistent with the increase in the number of legislations passed to protect and sustain environment [2]. Past studies have also reported the level on environmental information disclosure based either on quality, quantity or type of the reporting [3] and [4]. The motivation of this study derives from the literature which suggests the three factors that influence corporate social reporting, namely corporate characteristics, general contextual factors and the internal context which include the corporate governance structure [5]. The growing interest and the rise in prominence of corporate environmental and social reporting for achieving corporate accountability, is in step with the new governance regulation model [6]. This situation also has been closely linked to the recognition that good corporate governance (CG) requires consideration of the impact a corporation has on the wider community and the environment [7]. This scenario attracts researchers to study the association between Corporate Responsibility (CR) (which ER is part of CR) and CG practices [8] and [9]. Considering the lacking from the literature, the objectives of this study are twofold. First, to determine the environmental reporting practice of the Top 100 MCGI companies. Second, to investigate the relationship between the ownership and board

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Abdullah et al. / OIDA International Journal of Sustainable Development 04: 07 (2012)

structure with environmental reporting of top 100 MCGI companies. The MCGI is interesting and ideal to study for a number of motivational reasons. The primary reason is Minority Shareholder Watchdog Group (MSWG) established MCGI which listed the top 100 companies that had made the set criteria of selection such as conformances, performance and best practices including the quality of the disclosures. This index which is reviewed on a yearly basis contains the top 100 public listed companies based on the final corporate governance score. The final corporate governance ratings are determined by the main adjudicating committee based on certain sets parameters. MSWG believes that governance best practices will lead to long-term sustainable financial performance. Good governance creates an open and transparent system, which will improve communications, decision making and ultimately benefit shareholders and stakeholders as a whole [10]. The organization of this paper is as follows. The following section discusses literature review on environmental reporting, board and ownership structure and subsequently research hypotheses are developed. The next section describes the research methodology and is followed by a section on discussion of findings. Conclusion, limitations and future research are discussed in the final section. LITERATURE REVIEW DEVELOPMENT

AND

HYPOTHESES

The study is based on the proposition of agency theory, the theoretical framework most often used by researchers to understand the relationship between the board characteristics and firm value [11]. It involves a contract under which the principal engages another party, called agent, to perform some services on their behalf, where some power of decision making are delegated to the agent [12]. In corporate world, principal is the shareholders which are the owners of the company, whereas the management of the company represents the agent. Nevertheless, there is also contemporary advocate of extending agency theory to include other stakeholders embracing public at large, termed stakeholder-agency theory [13] which calls for companies to be more socially and environmentally responsible. According to [14], agency problem may arise as the agent fails to act in the best interest of principal and the effect may be reflected in the company’s share price. As parties internal to the organization, management has the upper hand over the shareholders pertaining to access to information. Therefore, agency theory suggests for voluntary disclosure as a means to mitigate the divergent interests between shareholders and the corporate managers. In addition, to safeguard the interests of

shareholders, board of directors is appointed through the election in the annual general meeting. Thus, the role of the board of directors is imperative to counter ‘managerial opportunistic’ behavior, which include taking action for their own personal interests at the expense of the shareholders interests [15]. In this sense, corporate governance framework in which board of directors is a part serves as an effective tool in meeting the expectations and needs of the shareholders which we term as the “accountability to the shareholders”. Institutional Ownership There are numerous studies on the relationship between corporate social performance, environmental reporting and institutional ownerships in developed markets. [16] examines the impact of corporate social responsibilities disclosure on financial performance and institutional investors, using four years panel data for a sample of Canadian companies. These companies exhibit no significant impact of companies’ composite social measures on the number of institutions investing in a companies’ stock. [17] studied the pattern of institutional investors in the UK and its relationship with socially responsible behavior of companies. They concluded that institutional investors will choose to place their investments in companies that have good social achievement and avoid investing in companies that have poor corporate social responsibilities performance as reported in the report. Previous studies found the existence of a positive and neutral relationship between corporate social responsibilities performance and institutional investors. Institutional investors in Malaysia are dominated by several large institutions, such as the Employees provident Fund (EPF), Lembaga Tabung Haji (Pilgrimage Management and Fund Board), and Permodalan Nasional Berhad (Malaysia’s biggest fund management agency), and have significant influence in corporate governance. Due to the magnitude of the assets controlled by institutional investors, it is a challenge for public listed companies (PLCs) to attract these investors who are interested in looking for new investment opportunities in Malaysian PLCs that have good CSR practices. In the academic literature, it is found that although the number of studies on CSR is high, an empirical examination on the relationship between environmental reporting and institutional investors in the Malaysian context is limited. [18] found that there are positive and significant relationships between corporate social responsibility disclosure and institutional investors. This result suggests that Malaysian PLCs are able to attract and maintain their institutional investors while they engage in social and environmental activities. According to [19],


institutional investor abstains from monitoring in order to avoid conflicts of interest. This may resulted on little influence on management decision as in decision to disclose any information related to environment. Thus, the first hypothesis is as follows: H1 There is a significant relationship between institutional ownership and environmental reporting Foreign Ownership Company with foreign ownership would disclose more information so that they can compete effectively in market [20]. They found that foreign ownership had a significant relationship with voluntary disclosure. This is consistent with the finding by [21] which pointed out that there is a positive association between foreign ownership and the extent of voluntary disclosure. To the extent that corporate governance will contrain corporate managers and / or controlling shareholders from expropriating other investors by monitoring and fostering an environment of greater transparency [22] and [23] foreign investors are more likely to be more dependent on effective corporate governance structures. The rationale for this postulate is that foreign investors are minority shareholders [24] and face higher risks of being expropriated by corporate managers and/ or controlling shareholders. Effective corporate governance should reduce foreign investors’ risks and increase their confidence and willingness to invest in particular listed companies. Additionally, they should help to ensure that minority shareholders receive reliable information about the performance of their investment is not expropriated by the management [25]. Therefore, on balance, there is a reason to expect a relationship between foreign investor share ownership and environmental reporting. However study by [26] did not find any significant relationship between foreign ownership and discretionary accruals. With support to agency theory in which the separation between ownership and control imply, the agency conflict would aroused. The agency conflict can be mitigated by involving shareholders in monitoring and controlling activities such as environmental commitment. Therefore, manager is expected to report more information in annual report including environmental information. The hypothesis is thus; There is a significant relationship between H2 foreign ownership and environmental reporting Board Size According to [27] board size has various implication for the board functioning. A smaller board is manageable and more often, it plays a role as controlling function whereas a larger board may not be able to function effectively as the board leaving

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the management relatively free. Even though larger board is unmanageable, it maybe valuable for the breadth of services as it would add diversity of experience of the boards [28]. Apart from that, larger board provides better environmental links and more expertise [29]. Thus board size is significant attribute that affect the board function. Published studies that linked board size and voluntary disclosure (including environmental information) are rather lacking. Besides [30], which found no significant association between the number of board members and the tendency for companies to report on the environment, and [31], which found a similar result for voluntary disclosure (in which environmental information is a part of it), other studies are almost untraceable. Thus, we hypothesise that: H3 There is a significant relationship between board size and environmental reporting. Board Independence The state of “independence” is met when a director inter alia is neither holding significant ownership nor holding any executive position in the company [32]. Independence according to Malaysian Code of Corporate Governance (MCCG) means the board should consist of members who are independence of both of the management and the significant shareholder. The MCCG has emphasized that the key for the good corporate governance is through the well balanced of director’s composition. A well balanced of composition refers to the composition that should not be controlled by a particular group of people that could compromise its independence in its conduct [33]. Therefore, the Codes stressed that at least 1/3 of the board should be non-executive who are independent. Non executive directors are defined as directors who are not affiliated with the management. Thus the extent of a board’s independence is measured by the number of non executive directors to the number of directors on board. It is expected that since these independent directors are supposed to represent the interests of other stakeholders, they will have more influence on environmental reporting [21]. Furthermore, since the involvement in social activities may enhance one’s prestige and honour in society, they will be more interested in satisfying the social responsibility of the firm. Research by [21] found that the composition of non-executive directors (i.e. independent) is significantly and positively related to corporate social disclosure. There are studies that found a significant positive association include [34], [31], and [35]. On the other hand, [36], [37] and [38] found a negative association. Thus, our hypothesis is as follows: There is a significant relationship between H4 board independence and environmental reporting

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Table 1: Measurement of Independent Variables No 1

Independent variables Foreign ownership

2

Institutional Ownership

3 4

Board size Board independence

Measurement Percentage of shareholding held by foreign investors at the end of the financial year Percentage of shares owned or controlled by institutional shareholders at the end of the financial year Number of board members (n) Number of independent non-executive directors divided by total number of directors on board (%)

Table 2: Reporting and Non-reporting Companies Environmental Section

Industry

Total

Low environmental sensitive

No 29

Yes 5

34

High environmental sensitive

50

16

66

Total

79

21

100

Table 3: Descriptive Analysis Variable Inst_ownership Foreign_ownership No_board Board_Ind

Min 0 0 5 30

Max 82.24 67.31 13 83

Mean 14.7295 13.9226 8.48 48.02

Skewness 1.955 1.611 .380 .546

Kurtosis 3.537 2.116 -.322 -.156

Std. Dev. 18.5569 15.7704 1.982 11.804

Table 4: Spearman Correlation Variables Env_sect OwnInst OwnForeign Bsize BInd Industry Σasset

Env_sect OwnInst 1.000 .192 .192 1.000 -.249* -.166 .083 .113 .001 .013 .111 -.116 .183 .324** * Significance at 0.05 level

OwnForeign Bsize BInd -.249* .083 .001 -.166 .113 .013 1.000 -.072 -.117 -.072 1.000 -.271** -.117 -.271** 1.000 -.171 .009 -.162 .159 .250* .019 ** Significance at 0.01 level

Industry .111 -.116 -.171 .009 -.162 1.000 -.133

Σasset .183 .324** .159 .250* .019 -.133 1.000


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Table 5: Results of Logistic Regression Variables Bsize BInd OwnInst OwnForeign Industry Σasset Constant

Coefficient 1.085 .995 1.008 .935 .648 1.000 .331

RESEARCH METHODOLOGY Data Collection The Top 100 MCG Index companies are examined because they are rated as the top 100 public limited companies (PLCs) in terms of corporate governance practices which include international best practices codes. Hence, these companies enable us to test the relationship of ownership and board structure on environmental reporting practice in the event of good corporate governance practices. The Malaysian Corporate Governance Index (MCGI) is the first of its kind in Malaysia which is introduced to measure the corporate governance levels in Malaysian public listed firms. The companies are screened and measured based on their conformance, performance and practice. Therefore the index will ensure that companies not only comply with standards and regulation, but also present fair, transparent and good financial performance [10]. Most of the previous study assessed environmental disclosures from corporate annual report. Annual report is used since it is the main document prepared by companies [39]. Annual report is also used as a main communication tool including environmental information which enables all stakeholders to obtain financial and non-financial information [40]. In Malaysia, annual reports of listed companies are the most accessible source of information [41] and consistent source which are of a relatively homogenous format and comparable [42]. In this study, the annual report for the year 2008 is used as the first MCGI was announced in 2009.

S.E. .149 .024 .013 .032 .661 .000 1.954

Environmental reporting is determined by the existence of a separate environmental section in the annual report. According to [43] disclosure in a separate section reflects the importance of the issue to the companies and facilitates the interested users to navigate the report. Despite that, more often than not,

Sig. .583 .834 .519 .036 .512 .752 .572

such information although reported extensively is integrated with other information in locations such as health, safety and environmental section, sustainability section, community involvement section and even in the operations review section. Therefore, consistent with [44] we treat only the “sections with at least one page of environmental information [or one-third of the section whichever is higher]” (emphasis added) as having a separate environmental section. Ownership and Board Structure Table 1 presents the summary on measurement of each independent variable. Data Analysis The logistic regression analysis is used to test the interrelationship between the four independent variables and the environmental disclosure. The assumptions underlying regression model are tested for multicollinearity based on the correlation matrix. Multicollinearity problem exists when the coefficient correlation between two variables is greater than 0.80 [45]. All these analyses are performed using SPSS 18.0 for Windows software. The basic logistic regression model is as follows: Log [P/1-P] = β0 + β3Fown + β4Iown + β1Bsize + β2Bind where P

1-P

Variables measurement Environmental Reporting

Wald .302 .044 .416 4.410 .431 .100 .319

= the probabilities that companies disclose environmental information in the annual report =the probabilities that companies do not disclose environmental information in the annual report

β0

= intercept

Fown

= Foreign ownership

Iown

= Institutional ownership

Bsize

= Board size

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Bind


= Board independence

FINDINGS AND DISCUSSIONS Descriptive Analysis Table 2 presents the findings on the number of reporting and non reporting companies. There are only 21 companies which reported environmental information in separate environmental section in the annual report year 2008. Companies are divided into two: high environmentally sensitive and low environmentally sensitive. This involves reviewing the works of previous researchers (see for example, [46] and also a report issued by the Department of Environment, Malaysia [47]. Thus, companies regarded as highly environmentally sensitive are involved in the following operations – mining, chemicals, transportation, oil and gas, wood and timber, utilities, agriculture, construction and properties, and manufacturing. For diversified companies, they are classified as highly environmentally sensitive if 51 percent of their revenue is derived from these nine operations [48]. It shows that 16 companies in high environmentally sensitive industry disclosed environmental information in separate section. The descriptive statistics of the number of environmental section and the continuous independent variables are depicted in Table 3. It is found that, on average, the sample companies have eight members in their board of directors, which 48% of them are independent from the management and having significant ownership. Additionally, the institutional and foreign ownership show the average of 15% and 14% respectively. Table 4 presents the result of the Spearman’s correlation analysis. The result shows that environmental section has significantly negative relationship with foreign ownership. However, none of the associations are having coefficient correlation of greater than 0.80, a situation which indicates no serious multicollinearity problem exists [45]. Logistic Regression analysis Normality test is not necessary for regression logistic since the test can be run even though the data is not normally distributed [49]. For data goodness of fit, Hosmer Lemeshow test is used to determine any significant difference between predicted value and the model. According to [45], the insignificant value of chi square shows that the model is significantly different with the data tested. Based on Hosmer Lemeshow test, chi square value for this data is insignificant (3.208). This result is also supported by a classification accuracy rate of 79%. Result of the logistic regression is presented in Table 5. The reported pseudo- R2, namely Cox and Snell R2 and

Nagelkerke R2 are 0.096 and 0.150 respectively. These results show that the model is significant and qualify for further assessment. The result shows that only foreign ownership has a significant positive relationship with the environmental reporting (p = 0.036). This indicates that the larger the foreign ownership in the company, the higher the tendency for companies to report on the separate environment section in annual report. The possible explanation is that, companies which involved with foreign ownership has brought about rising expectations among users and pressures for more disclosure financial and non financial (including Environmental info) which would provide the shareholders a valuable information The result is consistent with [20] who found a significant relationship between foreign ownership and the extent of voluntary disclosure. They suggest that company with foreign ownership would be an effective corporate governance mechanism which will materialize to improve the voluntary disclosure. They revealed that company with more foreign ownership disclosed higher voluntary information. In addition, [50] reported that foreign ownership can be seen as an effective governance tool that could monitor the company from non-value activities. On the other hand, insignificant relationships are found for the remaining variables, namely board size, board independence, and institutional ownership. The result for board size is consistent with [30] which found no significant association between the number of board members and the tendency for companies to report on the environment. Although larger board size leads to disclose not only more environmental information in the annual reports but also of higher quality [51], the fact that this information is voluntary in nature and the idea is new to Malaysian companies, it does not feel the necessity to report in a separate section. [27] claimed that larger boards may not be able to function effectively as the board leaves the management relatively free. Additionally, another possible explanation is that the number of reporting companies that provided environmental information in separate section in annual reports is only 21%. Therefore, it may influence the result on the association between corporate governance and the extent of environmental reporting. The result for board independence is consistent with the finding of [34]. A possible explanation is that although non-executive directors are presumed to be independent, in fact they may not be, and are therefore, not effective as monitors [38] and/or to contribute to environmental reporting. In fact, as suggested by [52], independence may be divided into independence of mind and independence of appearance. Thus, although the board members


appear to be independent, state of mind may be affected by influences that compromise one’s professional judgment and skepticism, integrity and objectivity. However, [20] found a positive significant relationship between board independence and voluntary reporting. Institutional ownership seems not to have significant influence on the company’s decision to engage in environmental reporting. The institutional control may not have the ability to expropriate from the corporate and may be less concerned about disclosure [53]. Furthermore, the fact that environmental reporting is a voluntary initiative, companies do not feel the pressure to do so. This however contradicts with this study’s earlier prediction which suggests that institutional ownership will influence the tendency of environmental reporting. Meanwhile, there is shown that company size and industry sensitivity is insignificantly associated with ER. Consistent with [54], who found no relationship between company size and the level of Corporate Social and Environmental Disclosure. Contradict with [43] who found that larger company becomes more visible and accountable to the public and therefore, more accountable with respect to environmental issues. In that case, larger company will disclose more environmental issue to decrease public pressure. In particular, size appears to be an important variable, and there is also strong evidence that that companies that are environmentally sensitive have to provide higher volume of environmental information in annual reports [43] and [55]. This mix result may be explained due to the variation in sample use, nation culture and differences in social and political contexts. CONCLUSION This study examines the association between environmental reporting practice and ownership and board structure. Data is obtained using content analysis on the annual report of the Top 100 Malaysia Corporate Governance Index (MCGI) companies in 2009. The environmental reporting is based on environmental information disclose in separate environmental section. The study found that 21 MCGI companies reported some form of environmental information in separate environmental section in annual report. Furthermore, it is revealed that there is a significant relationship between foreign ownership and the environmental reporting practice. However the institutional ownership is not statistically significant in explaining the environmental reporting practice in annual report. The non-significance of institutional ownership perhaps signals that further investigation should be held to identify different characteristic and classify them accordingly. For board structure, both variables

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(board size and board independence) showed insignificant relationship with environmental reporting practice. In concluding this study, it needs to be highlighted that reporting in annual report should not be regarded as a complete measure of company involvement in environmental or even social commitment. This is due to other medium of communication for its environment or social commitment such as via company newsletter, separate environmental bulletin, websites and newspapers. Thus, it would be an opportunity for future study to examine multiple medium of environmental reporting. Another important limitation of this study is the measurement of the ownership structure which is only based on institutional and foreign ownership. It would be interesting for future study to investigate on management and government ownership as a common business structure attributes in Malaysia. This study would contribute to the literature by providing evidence on the environmental reporting practices among company with good corporate governance practices. It may further provide new insights into agency issues to the Malaysian corporate environment. REFERENCES [1] Gray, R., Kouhy, R. and Lavers, S. (1995). Corporate social and environmental reporting: A review of the literature and a longitudinal study of UK disclosure. Accounting, Auditing and Accountability Journal, 8 (2): 47-77. [2] Romlah, J. (2006). The Environmental Reporting Practice of “Environmentally Problematic Companies” in Malaysia. The International Journal of Accounting, Governance & Society 1: 37- 47. [3] Deegan C. and Rankin. M. (1997). The Environment Reporting Expectations Gap: Australian Evidence. ANSA Symposium, Pert Australia, 4-5 April. [4] Teoh, H. Y., Pin, W. T., Joo, T. T. and Lng, Y. Y. (1998). Environmental disclosure – financial link: Further evidence from industrial perspectives> Asian – Pacific interdisplinary. Research on Accounting, The Osaka City University Media center, August 4-6. [5] Adams, C. A. and Kuasirikun, N. (2000). A comparative analysis of corporate reporting on ethical issues by UK and German chemical and pharmaceutical companies. The European Accounting Review; 9(1): 53-79. [6] Hess, D. (2007). Social reporting and new governance regulation: The prospects of achieving corporate accountability through transparency. Business Ethics Quarterly, 17 (3): forthcoming.

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