Issues in Social and Environmental AccountingVol. 1, No. 2 December 2007Pp 334-347 Institutional Ownership and Corporate Social Performance: Empirical Evidence from Indonesian Companies Hasan Fauzi Faculty of Economics Sebelas Maret University, Indonesia Lois Mahoney College of Business Eastern Michigan University, USA Azhar Abdul Rahman Faculty of Accountancy University Utara Malaysia, MalaysiaAbstractPrior research on the relationships of institutional ownership and corporate social responsibilityhas focused on North American (U.S. and Canada) and European companies. With the passageof Indonesian Law No. 40 in 2007, Indonesian companies are now obligated to conduct CSP.As these companies objected to the passage of this law, awareness of how CSP may benefitIndonesian companies in terms of its positive impact on institutional investors needs to be in-vestigated. Thus, this paper examines the relationships of IO and CSP for Indonesian compa-nies. Unfortunately, contrary to the results for North American and European companies, wefound no relationships between institutional ownership and corporate social responsibility forIndonesian companies. This finding suggests that most institutional investors do not includeCSP as part of their investment decisions.Keywords: Institutional ownership, Corporate social performance (CSP), corporate socialresponsibility (CSR), Indonesian companiesHasan Fauzi is Director of Indonesian Center for Social and Environmental Accounting Research and Development(ICSEARD) at Faculty of Economics of Sebelas Maret University, email: email@example.com. Lois Mahoney isAssociate Professor at Department of Accounting and Finance at College of Business Eastern Michigan University,USA, email: firstname.lastname@example.org. Azhar Abdul Rahman is Associate Prefessor at Faculty of Accountancy ofUniversity Utara Malaysia, email: Azhar258@e-web.uum.edu.my.
H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 335Introduction of its positive impact on institutional investors and profitability needs to beSince the inception of the triple bottom provided. Thus, this paper examines theline concept in 1990s (Elkington, 1998), relationships of IO and CSP for Indone-many investors consider corporate social sian companies.performance (CSP) an important compo-nent of their investment decisions.Many investors demand that the corpo- Theory and Research Questionrations they invest in have high levels ofCSP. Coffey & Fryxell (1991) found Corporate Social Performancethat corporations with high levels ofCSP are attractive to investors, espe- In an effort to meet all stakeholder ex-cially institutional investors. Consistent pectation, companies need to improvewith these findings, Waddock & Graves CSP while also improving financial per-(1994) found that institutional investors formance. Waddock & Graves (1994)and CSP are significantly positively re- put forward two theories to explain thelated. The growing dominance of insti- causality relationship between CSP andtutions in the capital market is reflective financial performance: slack resourceof the concentration and increasing theory and good management theory.wealth of these institutional investors Under slack resource theory, a com-(Brancato & Gaughan, 1991). As a re- pany’s improved financial performancesult, institutional investors’ decisions in may result in the availability of excessthe capital market would likely impact funds that can be used for CSP activities.companies stock values. Thus, compa- Thus, conducting CSP requires the usenies that are concerned about their finan- of funds obtained from the success ofcial performance should also be con- financial performance. According tocerned about maintaining high levels of this theory financial performance comesCSP. Hence, corporate social activities first. The good management theoryare becoming part of normal company holds that CSP come first. Based on thisoperations considerations. theory, a company perceived by its stakeholders as having a good CSP repu-Prior research on the relationships of tation will be more attractive in such ainstitutional ownership (IO) and CSP way that it will lead to improved finan-has focused on North American (U.S. cial performance through market mecha-and Canada) and European companies nism.(Mahoney & Roberts, 2007, Graves &Waddock, 1994 and Consolandy et al. Unlike financial performance indicators,2006). Indonesian Law No. 40, passed CSP is difficult to measure. As a result,in 2007, now obligates Indonesian com- previous research on the relationshippanies to conduct CSP. Indonesian between CSP and financial performancecompanies objected to the passage of have focused on using independent in-this law as they felt it would lead to de- dexes and self-reported information increase profitability and stated that that measuring CSP. Itkonen (2003, p.5)they were not ready to implement it. summarizes the different approaches ofTherefore awareness that CSP may CSP in the Table 1. These approachesbenefit Indonesian companies in terms include eight attributes of reputation
336 H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 Table 1 CSP Index MeasuresMeasure Dimensions Judges SourceFortune Eight attributes of reputation Financial analysts, Griffin & Mahon, senior executives and 1997 outside managersKLD Five attributes of CSP focusing External audiences Waddock & Graves, on key stakeholder relations, 1997 three on topics with which companies have recently ex- perienced external pressuresTRI Quantitative measures of com- No external judges Griffin & Mahon, panies’ environmental dis- needed, companies 1997 charges to water, air and land- themselves give the fills and disposal of hazardous data wasteCorporate Quantitative measure of com- No external judges Griffin & Mahon,Philan- panies philanthropy, how much needed, companies 1997thropy money spent in the charitable themselves give the activities dataBest Cor- Three-year average share- Social investment Murphy,2002porate Citi- holder return and six social research firmszen measures: company’s influ- ences on customers, employ- ees, community, environment, minorities and non-U.S. stake- holders(Fortune index), five aspects focusing on to investigate the pattern of environmentkey stakeholders and three pressure vari- disclosures, Thomas & Kenny (1997),ables (KLD Index), quantitative measure O’Donovan & Gibson (2000), and Cun-of environmental aspect (TRI measure), ningham (2002) developed environmentquantitative aspect of company philan- indexes calculated from environmentthropy (Corporate philanthropy meas- disclosure in CARs. Mangos andure), and return and six social measure O’Brien (2002) used the CSP indexon customer, employee, community, (environmental aspect included) in theirenvironment, minority, and non US attempt to relate this index to economicstakeholder (best corporate citizen). performance. Regarding the use andWhile these approaches may use similar role of CAR to evaluate the transparencymethods in arriving at a CSP values, of management as a good corporate gov-these values may differ due to the ernance principle, Beattie et al. (2002)evaluators’ perspective or bias. reported amount and quality of company disclosures based on the number of textBecause of the complexity in measuring units of certain thematic contained in theCSP and the lack of CSP indexes avail- CAR. Furthermore, Stanton and Stantonable, some researchers have used social (2002) examined the use of CAR’s indisclosures contained in Corporate An- studies that have been conducted by re-nual Report (CAR) as a proxy for CSP searchers from 1990 onward. In their(Waddock & Graves, 1997). In an effort work, they put forward perspectives
H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 337(political economy, legitimacy, account- leads investors to revise their percep-ability, and marketing), subject of analy- tions of the probability distributions ofsis, and focus used for each study con- future cost and revenues (Shane &ducted by the researchers. Iu & Clowes Spicer, 1983 and Mahoney and Robert,(2001) also supported the importance of 2007). Investors are assumed to con-evaluating narrative disclosure of ac- sider both risk and return and high levelscounting by using a method called tex- of CSP may reduce firm risk, thus pro-ture index, developed by Sydserff & viding an incentive for company manag-Weedman (1999). The texture index is a ers to invest in positive CSP activities.part of content analysis research meth- By choosing a similar socially responsi-odology originally developed in commu- ble company, an investor might achievenication science. the same return with less risk. Coffey & Fryxell (1991) found mixedInstitutional Ownership results in their study between IO and CSP. While they found no significantAccording to Pound (1988), institutional relationship between IO and charitableowners’ investments are so large that giving they did find a significant posi-they have less ability than individual tive relationship to a component of CSP;shareholders to move quickly in and out the number of women on a board of di-of investments without affecting share rectors. Graves & Waddock (1994) andprices. As a result, these institutional Mahoney and Robert (2007), using theinvestors have a strong interest not only KLD measures of CSP for a sample ofin the financial performance of the firm U.S. firms, found a significant positivein which they invest in, but also in the relationship between the number of in-strategies, activities, and other stake- stitutions owning shares and CSP. Thus,holders of the firm (Fortune, 1993; Gil- based upon the above arguments and theson & Kraakman, 1991; Holdderness & results of Graves & Waddock (1994)Sheena, 1988; Pound, 1992; Smith 1996; and Mahoney & Roberts (2007), we ex-Johnson & Greening, 1999 and Ma- pect that for Indonesian firms, CSP willhoney & Robert, 2007). Thus institu- be significantly positively related to thetional investors may see the long-term number of institutions owning its shares.benefits of a firm’s involvement in CSP(i.e.: maintaining product quality, beingresponsive to the natural environment, Research Methodcommunity and people they employ)(Turban and Greening, 1997). Data and Sample SelectionSpicer (1978) and Mahoney & Robert Data for this study was obtained from(2007) argue that institutional investors CARs for manufacturing and non manu-consider low CSP firms to be riskier in- facturing companies that were registeredvestment. This risk arises from the pos- on the Jakarta Stock Exchange (JSX)sibility of costly sanctions resulting from and issued an annual report (includingadverse legislative or regulatory actions, financial statements) in 2005. A total ofjudicial decisions, or consumer retalia- 339 companies were registered on thetion. The likelihood of such actions JSX. Of these companies, 325 issued
338 H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347CARs in 2005. One CAR was unread- pendix A and following the approach ofable, resulting in a final sample size of JRI, data from each CAR was assessed324 companies. Of these 324 compa- on a scale of zero to two for bothnies, 138 were manufacturing and 188 strength and weakness for each dimen-were non manufacturing. sion. A -2 rating for any dimension in- dicates major concern, -1 indicates a notable concern, 0 indicates no notableMeasures or major strength and concern, +1 indi- cates a notable strength and +2 indicatesCSP a major strength (Mahoney & Robert, 2007). The CSP index was then calcu-This study uses the approach of measur- lated by summing all dimensions scoresing CSP as developed by Jantzi Re- for each company. The ratings weresearch Inc. (JRI), (2008) by evaluating conducted by one researcher and veri-the CSR disclosures in Indonesian CARs fied by a second researcher. Any dis-for each of JRI’s dimensions to arrive at crepancies in ratings were resolved be-a CSP index. JRI is a research institu- tween agreements of the two research-tion that prepares and generates informa- ers.tion on CSP for Canadian firms and de-veloped and maintains the Canadian So- Institutional Ownershipcial Investment Database. This databaseis comparable to the KLD database de- Consistent with prior research (Mahoneyveloped by KLD Research & Analytics & Robert, 2007) IO was measured byfor U.S. companies. JRI has a long- the number of institutions owning sharesstanding research partnership with KLD in each company. This information waswhere they exchange research and have obtained from the Institutional Owner-collaborated on numerous research pro- ship in Indonesia Listed Companies Di-jects (JRI, 2008). For the purpose of rectory.measuring CSP, JRI prepared a guide-line of CSP measures containing the fol- Control Variableslowing dimensions: community and so-ciety, corporate governance, customers, Some difference in CSP may result fromemployees, environment, human rights financial performance, firm size and in-and controversial business activities. dustry and need to be controlled forEach of these dimensions has subsec- (Waddock & Graves, 1997, Mahoney &tions addressing areas such as reporting, Roberts, 2007). Consistent with priormanagement systems, programs and ini- research (Mahoney & Roberts 2007)tiatives, and other performance data ROE and ROA are used as a proxy for(JRI, 2008). (See Appendix A for fur- financial performances and total assetsther information on each of these dimen- as a proxy for firm size. Firm industry issions) JRI gives each of these dimen- represented by a dummy variable basedsions two ratings, one for strength and upon whether the company is a manu-one for weakness, on a scale of zero to facturing or non manufacturing com-two. pany.Using the guideline as indicated in Ap-
H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 333-347 339 Table 2 Means and Standard DeviationsVariables N Min Max Mean Std DevCSP 324 0 30 8.07 5.631IO 324 0 18 2.82 2.052ROE 324 -796.8 363.66 -3.24 74.853ROA 324 -431.67 93.65 0.919 27.506TA 324 8382 3E+008 5310086 21321240Industry 324 0 1 0.57 0.495Analytical Model company with the highest CSP score of 30 is PT. Holcim Indonesia. ElevenAnalytical model used to test the hy- companies had the lowest CSP score ofpotheses is a regression model: zero (such as Ades Waters and Pt. Alu- CSPi= β0 + β1IO + β2ROAi + mindo). β3ROIi + β4SIZEi + β5 INDUS- TRYi + e The data was tested for multicollinearity. The result of our tests indicated that noWhere: independent variables (ROE, ROA, total i: firm 1….. (number of sample assets, IO and industry) had tolerancefirms – 1) values less than 0.10, indicating that no β: regression coefficient correlation among independent variables CSP = Corporate Social Respon- exists. These results are supported bysibility the VIF values for each independent IO= Institutional ownership variable as they are all less than ten. ROA=Return on Assets Thus we concluded that no multicolin- ROI =Return on Investment earity exits among the independent vari- Size =Total Assets ables. Industry = 0 if, 1 otherwise Table 3 presents the results of our re- gression equation. This model is signifi-Findings and Discussion cant at p<.000 level, meaning that it can be used to predict the variability of CSPTable 2 presents the descriptive statistics resulting from the change in the IO.for the entire sample. The mean of IO is2.82 with a standard deviation of 2.052. As shown in Table 2, IO is not signifi-The company with the highest number cant (p<.0165) indicating that IO doesof institutional owners (18) is PT. Kawa- not impact on CSP. This finding is in-san Industri Jababeka and the companies consistent with prior research in Northwith the lowest number of institutional American companies, which provideowners (zero) are PT. Beton Manunggal, support of the relationship between IOPT. Intan Wijaya, and Jakarta Interna- and CSP. Graves and Waddock (1994)tional. The mean CSP score is 8.07 with and Mahoney and Robert (2007) usingthe standard deviation of 5.631. The samples from American companies and
340 H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 Table 3 Regression ResultDescrip- Sum of Square Degrees of Mean Square F Significancetion FreeRegression 1421 5 284.22 10.246 0.000Residual 8821 318 27.739Total 10242.22 323 Variable Coefficient Std of Err t-value Sig R2Constant 7.149 0.597 11.971 0.000 0.125IO 0.200 0.144 1.390 0.165ROE 0.009 0.004 2.265 0.024ROA 0.027 0.011 2.487 0.013TA 8.47 0.000 2.487 0.013Industry -0.148 0.598 -0.247 0.805Canadian companies, respectively, ship between both measures of financialfound a significant positive relationship performance and CSP. These findingsbetween IO on CSP. This current study support slack resource theory, indicatingis also not consistent with the study of that a good financial performance leadsConsolandy et al. (2006), where they to an increase in CSP.also found a positive relationship be-tween IO and CSP for European compa-nies. ConclusionA possible reason for the difference in Our research failed to find a significantthe relationship of CSP or CSP could be relationship between IO and CSP forthe way that Indonesian companies view Indonesian companies. The implicationCSP. For Indonesian companies, CSP is of the finding implies that the potentialalways thought of as to philanthropic actions of institutional investors can notactivities only. The activities to main- use as means to encourage CSP activi-tain their commitment to customers and ties in Indonesian companies. Further-suppliers for example is not commonly more, this finding would suggest thatview by Indonesian companies as being most institutional investors do not in-part of CSP. The differences of the clude CSP as part of their investmentviews may contribute to the different decisions.result. Additionally, Indonesian compa-nies by protesting that they are not ready A limitation of this study may be the useto apply CSP as required by Law 40, of only one year annual report comparedprovide support for Graves & Wad- to the previous studies including moredock’s (1994) slack resource theory. than one year. Future research may want to consider CSP over a period ofInteresting, though, our research does several years. The possibility of biasindicate a positive significant relation- also exists from researchers conducting
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H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 343 Appendix: Indicators used to assess the corporate social performance in Corporate Annual Reports (adopted from MJRA)DIMENSIONS INDICATOR AND MICRO LEVEL INDICATORSCOMMUNITY AND Public Reporting:SOCIETY -The company publicly reports on its community involvement Charitable Donations Program -Policy statement on community donations -Amount of cash donations -Cash donations as a percentage of pre-tax profit -Areas of focus -Program to support employee giving and volunteerism Communication Relation -Policy statement on engagement/consultation -Managerial structure and responsibility -Mechanism of community engagement/consultation -Benefit sharing agreement with local communities -Impact on or relation with local aboriginal communities Aboriginal Relation -Policy statement on aboriginal relation -Mechanisms of engagement/consultation -Benefits sharing agreements and joint ventures -Impact on / relations with local aboriginal communities Impact on Society -Policy statement on bribery and corruption -Involvement in bribery and corruption -Tax or trade -related controversies -Impact/initiatives related to marginalized groups -Other impact on societyCORPORATE Management SystemsGOVERNANCE -Statement of social responsibility principles or values -formal corporate governance principles -Code of business conduct -Management of ethical issues -Confidential proxy voting
344 H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 333-347 -Board committees -Board independence -Separate chairman and chief executive officer Other Governance Data- -Share structure -Compensation of highest-paid executive -Termination agreements -Governance controversies -Shareholder proposalsCUSTOMERS Impact on Customers -Policy statement on safety of product/service -Policy statement on the treatment of customers -systems/programs to ensure product safety or fair treatment of customers Impact on Customers -Safety of product/service -Treatment of customers/clients -Illegal/controversial business practices -Marketing practicesEMPLOYEES Employee Data -Total number of employees -Employee turnover -Change in employee total over last five years Reporting -The company publicly reports on employee issues Employee Programs and Benefits -Employee needs assessment/employee satisfaction surveys -Employee education and development -Work/life balance -Ownership program -Profit sharing program -Redeployment, retraining and/or outplacement services -Other programs/benefits
H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 345 Diversity -Policy on diversity/employment equity -Public reporting on diversity issues -Managerial structure and responsibility -Employee training and communication -Performance objectives and targets -Systems to track diversity data -Recruitment/retention/promotion programs -Maternity/parental benefits -Other diversity initiatives/benefits -Percentage of women on the board -Percentage of women among senior officers -Diversity controversies Health and Safety -Policy on occupational health and safety -Employee training and communication -Occupational health and safety programs -Employee wellness programs -Health and safety record Union Relations -Percent unionized -No. of strikes/lockouts in the last five years -Description of relations Other Employee Data -Employee controversiesENVIRONMENT Exposure to Environmental Issues -Potential environmental impacts Management Systems -Formal Environmental Management System -Environmental policy -Certification -Managerial structure and responsibility -Environmental aspects identified -Systems to measure and monitor environmental performance
346 H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 -Audits -Performance objectives and targets -Employee training and communication -Management review of EMS -Sourcing practices - Life -cycle analysis Public Reporting -Substantial environmental reporting -The companys environmental reporting Impact and Initiatives -Resource use (energy, material, water) -Pollution control -Land use, biodiversity and/or remediation -Other impact or initiatives Regulatory Compliance -Environmental penalties over the last five years -Number of convictions over the last five years -Incidents of non –compliance Other Environmental Data -Environmental liabilities -Total environmental expendituresHUMAN RIGHTS Exposure to Human Rights Issues -Exposure related to countries in which the company operates Management Systems -Human rights policy/code of conduct -Systems/programs to manage human rights issues Impact and Initiatives -Community engagement -Implication in the abuse of human rights
H. Fauzi, L. Mahoney, A. A. Rahman / Issues in Social and Environmental Accounting 2 (2007) 334-347 347CONTROVERSIAL AlcoholBUSINESS ACTIVITIES -Level of involvement (% of annual revenues) -Nature of involvement Gaming -Level of involvement(% of annual revenues) -Nature of involvement Genetic Engineering -Nature of involvement Tobacco -Level of involvement (% of annual revenues) -Nature of involvement Use of animal
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