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  • 1. Issues in Social and Environmental AccountingVol. 1, No. 1 June 2007Pp. 149-159 The Link between Corporate Social Performance and Financial Performance: Evidence from Indonesian Companies Hasan Fauzi Faculty of Economics Sebelas Maret University, Indonesia Lois S. Mahoney Department of Accounting and Finance Eastern Michigan University, USA Azhar Abdul Rahman Faculty of Accountancy Universiti Utara Malaysia, MalaysiaAbstractThis study examines the relationship of corporate social performance (CSP) to corporate finan-cial performance (CFP) to determine if CSP is related to firm performance. Additionally, itexamines whether firm size or industry affects the relationships between CSR and CSP. Thisstudy advances the literature as it examines this relationship for companies in a developingcountry, Indonesia, along with examining the impact of moderating variables on this relation-ship. Two models were developed: the first model was derived using slack resource theory andthe second model was developed using the good management theory. Through the examinationof 383 firms, the result of the study failed to find a significant relationship between CSP andCFP in either model. Further analysis, using the slack resource theory, did find that companysize had a significant positive moderating effect on the relationship between CSP and CFP.Key Words: Corporate Social performance, financial performance, content analysis, stake-holder, good management theory, and slack resource theory.Hasan Fauzi is a Program Director of Master in Accounting and Director of Indonesian Center for Social and Environ-mental Accounting Research and Development (ICSEARD) at Faculty of Economics of Sebelas Maret University,email: hfauzi2003@indo.net.id. Lois S. Mahoney is Associate Professor at Department of Accounting and Finance atCollege of Business Eastern Michigan University, USA, email: lois.mahoney@emich.edu. Azhar Abdul Rahman isAssociate Prefessor at Faculty of Accountancy of University Utara Malaysia, email: Azhar258@e-web.uum.edu.my.The authors are very grateful to Rob H. Gray of St. Andrews University for his direction and helpful suggestion onliterature review and to Ainun Na’im of Gadjah Mada University as well as to three anonymous referees for commentson earlier draft of this paper.
  • 2. 150 H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159Introduction holders are only one of multiple stake- holder components that managementFriedman (1962/1970) in Griffin & should satisfy (Frederick et al., 1992).Mahon (1997) and Ruf et al., 2001) ar- In addition to investors, suppliers, labor,gues that the main responsibility of a and customers, they also need to con-company is to its shareholders and, sider people, community, governments,therefore, cost expenditures for social and all other stakeholders in makingresponsible activities are in violation of company decisions. The failure to con-management’s responsibility. Thus, such sider all these stakeholders could resultexpenditures by the company often lead in conflict to the corporation. As a re-to controversies by its shareholders. sult, it is expected that a company willThese controversies have led to a map- incur additional costs, such as environ-ping of views of a company, a concept mental and community contribution,going beyond Friedman’s view of share- resulting in impacts on corporate socialholders only. Two models explain the performance (CSP) and corporate finan-different views of the company: the in- cial performance (CFP).put-output model and the stakeholdermodel (Donaldson & Preston, 1995). Research examining the relationshipUnder the input-output model, a com- between CSP and CFP has producedpany is assumed to exist as a result of conflicting results, although a number ofthe contributions resulting from stock- the findings indicate a positive associa-holders, investors, suppliers, labor, and tion (see for examples: Worrell et al.,customers. The implication of this 1991; Preston & O’Bannon, 1997;model is that other parties (i.e. commu- Frooman, 1997; Roman et al., 1999; Or-nity, employees, government agencies, litzky & Benjamin, 2001; Murphy,specialty groups etc.) affecting or af- 2002; and Simpson & Kohers, 2002).fected by the company are not consid- Furthermore most of these findings wereered in the system or subsystem of the derived from the evidence coming fromcompany. Decisions made by the com- developed countries. The objectives ofpany will only consider those who are this paper are twofold: First, it adds topart of the system or subsystem. Thus, the literature on the relationship betweenunder the input-output model, the poten- CSP and CFP by using a model contain-tial exists for the company to encounter ing moderating variables and second, itconflict with these other groups not ac- provides valuable insights on this rela-commodated in the model through boy- tionship for developing countries, espe-cotts, lawsuits, and protests (Ruf et al., cially Indonesia. As a result, this re-2001). search will not only contribute to the debate on the link between CSP andUnder the stakeholder view, all parties CFP but also extend the literature byunder the input-output model are consid- examining the impact of different cul-ered in a company’s system or subsys- tures and systems on this relationship.tem along with all other groups in soci-ety affected by or affecting the com- Literature Review and Hypothesespany. Consequently, the decisions made Developmentby the firm should consider all parties orstakeholders. Under this view, share- The debate on the relationship between
  • 3. H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159 151CSP and CFP involves two important by the works of Orlitzky (2001), Or-issues: direction and causality of the re- litzky & Benjamin (2001), Ruf et al.lationship (Preston & O’Bannon, 1997). (2001), Konar & Cohen (2001), MurphyBased upon the literature review, the (2002), Simpson & Kohers (2002), Or-relationship between CSP and CFP litzky et al. (2003), and Mahoney &could be positive, neutral, and negative. Roberts (2007). Patten (2002) found aGriffin & Mahon (1997) reviewed 51 negative correlation. Researchers suchstudies discussing the relationship be- as McWilliams & Siegel (2000 andtween CSP and CFP from the 1970’s 2001) and Moore (2001) found incon-through the 1990’s. The Griffin & clusive results. Fauzi (2004) using con-Mahon’s study (1997) mapped the issue tent analysis of annual reports of compa-of direction of the relationship between nies listed on the New York Stock Ex-CSP and CFP for the periods. In the change for the period of 2004 also pro-1970s, there were 16 studies reviewed vided support for inconclusive results.with 12 of which had positive relation-ship. During the period of the 1980s and In addition to providing different results1990s, the positive direction of the rela- on the relationship direction from that oftionship accounted for 14 of 27 studies Griffin & Mahon (1997), Roman et al.and seven of the eight studies, respec- (1999) argued that errors existed in theirtively. Negative results were supported study resulting in erroneous conclusions.by only one study in the 1970s, 17 stud- For those findings, determined to beies in the 1980s, and 3 studies in the generalized erroneously by Griffin &1990s. Inconclusive findings were Mahon (1997), Roman et al. (1999) re-found by four studies in the 1970s, five classified findings from negative to posi-studies in the 1980s, and no finding in tive direction and from positive or nega-the 1990s. It should be noted that one or tive to inconclusive result. In summariz-more studies could have one or more ing the direction of relationship betweenfindings in the work of Griffin and CSP and CFP, Roman et al. (1999) re-Mahon (1997). moved research with problems of invalid measurement and replaced them withAs the study of Griffin & Mahon (1997) new studies for those supplanted by laterwas not all inclusive, there are additional studies. Roman et al. (1999) ended upstudies contributing to the direction of with a total of 46 studies comprising 51the association between CSP and CFP research results, 33 out of which arerelationship in the 1990s. During this positively correlated.period, positive direction of the relation-ship has been supported by Worrell et al. In a more recent work, Margolis &(1991), Preston & O’Bannon (1997), Walsh (2003) also mapped studies in-Waddock & Graves (1997), Frooman vestigating the relationship between CSP(1997), and Roman et al. (1999). Nega- and CFP. They followed the works oftive results are supported by Wright & Griffin & Mahon (1997) but used aFerris (1997). Furthermore, in the 2000s, wider time period (1972 – 2002) result-there are some researchers adding to the ing in analysis of 127 published studies.debate on the link between CSP and Of these studies, 70 studies (55%) re-CFP with different perspectives of meth- ported having a positive relationship,odology. Positive results were supported seven studies suggested a negative rela-
  • 4. 152 H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159tionship, 28 studies supported inconclu- CSP and CFP have led to ambiguity insive results, and 24 studies found the results in prior studies. Nevertheless,relationship went in both directions. problems may have emerged because theGray (2006), in his review of studies views did not take into account whetherinvestigating the relationship between some variables might have moderatedCSP and CFP, argued that results are the effect of CSP and CFP. As sug-inconclusive. This argument is also sup- gested by previous research, this studyported by Murray et al. (2006) in their examines the relationships between CSPcross section data analysis. However, and CFP by incorporating the followingusing a longitudinal data analysis, they suggested variables that may influencefound evidence to the contrary. Hill et the relationship: company size, and in-al. (2007) investigated the effect of cor- dustry type (Waddock & Graves, 1997;porate social responsibility on financial Griffin & Mahon, 1997 and 1999; Or-performance in terms of a market-based litzky, 2001; Ruf et al., 2001; Wagner,measure and found positive results in the 2001; Moore, 2001; Simpson & Kohers,long-term. 2002; Orlitzky et al., 2003; and Itkonen, 2003).The second issue that Griffin & Mahon(1997) raised is about the causality. In Prior research has not taken into accountan effort to meet the stakeholder’s ex- moderating variables. The presence of apectation, companies should try to im- moderating variable can often modifyprove their CSP, which often comes at the relationship between the independentthe expense of also trying to improve and dependent variables. According totheir CFP. The question that emerges is Waddock & Graves (1997) and Itkonenwhether a company is better off focusing (2003) company size is related to CSP,first on CSP or focusing first on CFP. as larger companies have been found toWaddock & Graves (1997) and Dean be more socially responsible than(1998) put forward two theories to an- smaller ones. These results are also sup-swer the question: slack resource theory ported by Orlitzky (2001) who alsoand good management theory. Under the found that the size of a company af-slack resource theory, a company should fected the relationship between CSP andfocus on its financial position, allowing CFP. According to Orlitzky (2001) andit to contribute to the CSP. Conducting Itkonen (2003), CSP is related to thegood social performance requires funds firm size since in the beginning, entre-that might result from the success of fi- preneurial strategies focus on the basicnancial performance. According to this economic survival and not on ethical andtheory, financial performance comes philanthropic responsibilities. As thefirst. A good management theory holds firm grows, these same firms began tothat social performance comes first. focus more on their CSP responsibility.Based on this theory, a company per- Based upon these arguments, it is ex-ceived by its stakeholders as having a pected that the size of a company will begood reputation will result in a stronger a moderating variable and will affect thefinancial position (through market relations between CSP and CFPmechanism). (Orlitzky, 2001 and Itkonen, 2003).Simplistic views of relationship between Researchers also suggest that industry
  • 5. H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159 153type should be taken into account when tion on CSP was collected from theanalyzing the relationship between CSP CAR, company social reports, CSP In-and CFP. As suggested by prior re- donesia, CSP news capital market direc-search, industry can affect the relation- tory, Jakarta stock exchange websites,ship between CSP and CFP (Waddock & other web sites and other electronicGraves, 1997; Griffin & Mahon, 1997; news. Information on all financial vari-Ruf et al., 2001; Moore, 2001; and ables, total assets and industry was col-Simpson & Kohers, 2002) and will also lected from the CARs. Consistent withbe treated as a moderating variable. prior literature, data on CSP and finan- cial performance have a one-year lagBased on the literature review, we exam- (Waddock & Graves, 1997).ine the following hypotheses:H1: The relationship between CSP andCFP in Indonesia is positive Measure of CSPH2: Company size affects the relation-ship between CSP and CFP in Indonesia CSP is measured and calculated throughH3: Industry type affects the relationship content analysis for each company fol-between CSP and CFP in Indonesia lowing the approaches of both by Kinder, Lydenberg Domini (KLD), an United States based independent ratingMethod company and by Michael Jantzi Re- search Associate (MJRA), an independ-Data and Sample Selection ent rating company in Canada. Both these companies measure several dimen-An initial sample of 407 companies was sions of the CSP to arrive at a totalselected from companies listed on the measure of CSP. These dimensions in-Jakarta Stock Exchange for the period of clude community issues, diversity in the2002 and 2003 that meet the following workplace, employee relations, environ-criteria: mental performance, international is-1. They represent types of industry sues, product and business practices, and (manufacturing and non- other variables concerning compensa- manufacturing) tion, confidentiality, and ownership in2. They have been registered on the other companies. Jakarta Stock Exchange for at least two years Both positive and negative social re-Missing Corporate Annual Reports sponsible information was collected(CAR) reduced the sample size by 24 through examining the CAR, companycompanies, resulting in a final sample of corporate social reports, along with ex-383 companies comprising 246 manu- amining information obtained from thefacturing and 137 non-manufacturing capital market directory, Jakarta stockcompanies. exchange websites, other web sites and other electronic news regarding the sam-The CAR for these companies was ob- pled companies. CSP for each companytained from the official web site of the was assessed on a scale of -2 to +2 forJakarta Stock Exchange, the companies’ each rating. A -2 rating for any dimen-web site, and other web sites. Informa- sion indicates major concern, -1 indi-
  • 6. 154 H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159cates a notable concern, 0 indicates no Result and Discussionnotable or major strength and concern,+1 indicates a notable strength and +2 Descriptive Statisticsindicates a major strength. A compositeCSP score was then calculated by sum- Table 1: Descriptive Statisticming the scores of each dimension foreach company. Variables N Mean SD CSP index 383 4.0 1.7Measure of CFP ROA (in %) 383 2.5 27.2 ROE (in %) 383 5.8 74.9Following the works of Waddock &Graves (1997) and Roman et al. (1999), Total Asset 383 3,862 14,34 (in Rp Bil- 9Return on Assets (ROA) and Return on lion)Equity (ROE) were used separately tomeasure a firm’s financial performance.ROA is defined as the ratio of net in- Table 1 shows the mean and standardcome after tax to total assets and ROE is deviation for the CSR composite score.defined as the ratio of net income after The mean was 4.0 with a standard devia-tax to outstanding shares. Information tion of 1.7. The sampled companieson ROA and ROE was collected from have a mean ROA and ROE of 2.5% andthe CAR. 5.8%, respectively, with standard devia- tions of 27.2% and 74.9%, respectively.Measure of Moderating Variables Company size, as measured by total as- sets is Rp 3,862 billion with a standardTwo moderating variables are used in deviation of Rp 14,349 billion.this study: size and industry. There arethree approaches used to measure com-pany size in literature: total assets Regression Analysis(Waddock & Graves, 1997; Simerly &Li, 2001; and Moore, 2001), the number Tables 2, 3, and 4 show the results ofof people employed (Simerly & Li, our regressions models used to examine2001) and annual sales of the firm the relationships between CSP and CFP.(Simerly & Li, 2001; Ruf et al., 2001; Table 2 shows the results of our regres-and Moore, 2001). This study uses the sion using CSP as the dependent vari-measure of total assets to measure com- able. Based upon the slack resource the-pany size as Waddock & Graves (1997) ory (Waddock & Graves, 1997) CSP isargues that total assets are the “money treated as a dependent variable, whilemachine” to generate sales and income. financial performance is treated as inde-Dummy variables are used to control for pendent variable and company size, in-performances that may vary by indus- dustry type and related interaction termstries. A variable of 1 was assigned to are treated as moderating variables. Ta-companies that were manufacturing and bles 3 and 4 show the results of our re-0 was assigned to non-manufacturing gressions using CFP as the dependentcompanies. variable, CSP as the independent vari- able and the interaction terms as moder-
  • 7. H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159 155ating variables. This model is consistent insignificant suggesting that the link be-with the good management theory tween CSP and CFP is inconclusive in(Waddock & Graves, 1997). nature. Additionally, no significant rela- tionship was found between the relation-Table 2 indicates that the relationship of ships of industry type and CSP. How-CSP and CFP, for both measures of fi- ever, the relationship between size andnancial performance (ROA and ROE), is CSP is significantly positive at p<.000 Table 2: Regression Analysis Using CSP as Dependent VariableIndependent, Control, and Mod- Coefficient Standard t-Value Prob erating Variables ErrorROA 0.113 0.016 0.443 0.658ROE 0.098 0.003 0.791 0.435Company Size 0.416 0.000 4.350 0.000Industry Type 0.039 0.177 0.774 0.439Interaction:ROA/Company Size 0.142 0.000 1.576 0.116ROA/Industry Type -0.116 0.017 -0.444 0.658ROE/Company Size -0.244 0.000 -0.788 0.075ROE/Industry Type -0.118 0.004 -0.845 0.398 Model SummaryAdjusted R Square 0.083F-Statistics 5.323Prob 0.000 Table 3: Regression Analysis Using ROA as Dependent VariableIndependent, Control, and Coefficient Standard t-Value ProbModerating Variables ErrorCSP 0.000 0.709 -0.001 0.999Interaction:CSP/Company Size 0.064 0.000 0.374 0.709CSP/Industry Type -0.001 1.130 0.008 0.994 Model SummaryAdjusted R Square 0.596F-Statistics 95.103Prob 0.000
  • 8. 156 H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159 Table 4: Regression Analysis Using ROE as Dependent VariableIndependent, Control, and Mod- Coefficient Standard t-Value Prob erating Variables ErrorCSP 0.014 1.950 0.323 0.747Interaction:CSP/Company Size -0.104 0.000 -0.608 0.544CSP/Industry Type 0.057 3.108 -0.637 0.525 Model SummaryAdjusted R Square 0.597F-Statistics 95.491Prob 0.000level and the interaction terms of size tions. Meanwhile, smaller companiesand ROE with CSP is marginally signifi- appear to have reluctance to invest incantly negatively at a p<.075 level. Us- CSP, possibly because they fear it willing the model derived from the slack negatively affect CFP. These findingsrecourse theory (Waddock and Graves, contribute to the overall research debate1997), the evidence indicated in table 2 on the relationship between CSP andprovided a reasonable basis to reject the CFP along with enriching our under-hypotheses 1 and 3 and supports hy- standing of this relationship for compa-pothesis 2. nies in developing countries.The good management theory (Waddockand Graves, 1997) formed the basis to Conclusion, Implication, and Limita-derive the regression model using CFP tionas a dependent variable. As shown intables 3 and 4, none of the independent, Previous studies on the relationship be-control or moderating variables are sig- tween CSP and CFP yield conflictingnificant. Hypothesis one is not sup- results; some are positive, negative, andported as we failed to find a significant neutral. All of the studies use some con-relationship between CSP and CFP. trol variables (total assets, number ofSimilarly, hypotheses 2 and 3 are not employees, financial risk, type of indus-supported as we also failed to find any try, and research and development ac-significant relationships between the tivities) in their models. Unlike previ-effect of company size or industry type ous studies, this study uses some of theon the relationship between CSP and variables as moderating variables: com-CFP. pany size and industry type to examine whether these variables can improve ourOur finding of a significant positive rela- understanding of the relationship be-tionship between CSP and company size tween CSP and financial performance.provide support for the slack theory, in-dicating that larger companies partici- The key findings of this study are as fol-pate in more socially responsible ac- lows:
  • 9. H. Fauzi, L. S. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 1 (2007) 149-159 1571. Using the model derived from the tion, all dimensions identified by MJRA slack resource theory, we find no could not be found in some company relationship between CSP and CFP, annual reports. A potential bias may though we did find that company also exist as the negative aspects of CSP size does affect the relationship of were often hard to obtain. CSP and CFP.2. Using the model derived from the good management theory, we found References no evidence supporting a relation- ship between CSP and CFP. Dean, L. K. (1997) “The Chicken and The Egg Revisited: Ties BetweenThese findings have important implica- Corporate Social Performance andtions for the Indonesian business sector the Financial Bottom Line”, Jour-and capital market regulators, like nal of Applied Psychology, Vol.Bapepam. Recently new laws have been 82.agreed upon by legislators of Indonesia Donaldson, T. & Preston L.E. (1995)to improve CSP. Article 77 of the law “The Stakeholder Theory of thenow obliges Indonesian companies to Corporation: Concept, Evidence,conduct CSP. Furthermore, it is ex- and Implication”, The Academy ofpected that the capital market regulator Management, Vol. 20, No. 1.(Bapepam) and Indonesian standard set- Frooman, J. (1997) “Socially Irresponsi-ter will include social and environmental ble and Illegal Behavior andperformance as mandatory disclosure. Shareholder Wealth”, Business &As it is becoming increasingly important Society, Vol. 3, pp. 221-249.for companies to integrate social and Fauzi, H. (2004) “Identifying and Ana-environmental concerns in their business lyzing the Level of Practices ofstrategies, it is important for managers Company’s Social Responsibilityof these companies to understand the in Improving Financial Perform-relationship between CSP and CFP. ance”, Journal of Business and Management, Vol. 4, No. 2.Future research may want to consider an Frederick, W. C., James, E. P. & Davis,alternative measure of CSP that includes K. (1992) Business and Society:more objective measures to perform Corporate Strategy, Public Pol-content analysis, such as survey ap- icy, and Ethics. McGraw-Hill In-proach as described by Igalens & Gond ternational Edition(2005). The relationship between CSP Gray, R. (2006) "Does sustainabilityand CFP may also be extended to in- reporting improve corporate be-clude a balanced scorecard in hopes that haviour?: Wrong question? Righta good theoretical framework can ex- time?", Accounting and Businessplain better the practice of company’s Research, International Account-CSP. ing Policy Forum, pp.65-88. Griffin, J.J., & Mahon, J.F. (1997) “TheLimitations to the study include judg- Corporate Social Performance andmental factors resulting from biases of Corporate Financial Performancethe reviewers performing the content Debate: Twenty-Five Years ofanalysis in determining CSP. In addi- Incomparable Research”, Business
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