Corporate Governance Quality and CSR Disclosures

Transcription

1 J Bus Ethics DOI /s Corporate Governance Quality and CSR Disclosures MuiChing Carina Chan John Watson David Woodliff Received: 24 January 2013 / Accepted: 2 September 2013 Ó Springer Science+Business Media Dordrecht 2013 Abstract Given the increasing importance attached to both corporate social responsibility (CSR) and corporate governance, this study investigates the association between these two complimentary mechanisms used by companies to enhance relations with stakeholders. Consistent with both legitimacy and stakeholder theory and controlling for industry profile, firm size, stockholder power/dispersion, creditor power/leverage, and economic performance, our analysis of the annual reports for a sample of 222 listed companies suggests that firms providing more CSR information: have better corporate governance ratings; are larger; belong to higher profile industries; and are more highly leveraged. Our findings support the limited prior research suggesting a link between corporate governance quality and CSR disclosure in company annual reports and suggest that, rather than mandating specific disclosures, regulators might be better served focussing on corporate governance quality as a way of increasing CSR disclosures. Keywords Corporate governance CSR disclosure Stakeholder theory Legitimacy theory Introduction Corporate scandals such as Enron (Clarke 2005), various stock market collapses, and the negative publicity around senior executive remuneration have increased society s expectations in relation to companies environmental, social and ethical responsibilities (Money and Schepers M. C. Chan J. Watson (&) D. Woodliff Accounting & Finance, The University of Western Australia, 35 Stirling Highway, Crawley, WA 6009, Australia John.Watson@uwa.edu.au 2007, p. 2). Further, Holder-Webb et al. (2009) point to the significant increase in funds invested in socially responsible investments and, undoubtedly, this has also caused companies to pay more attention to their corporate social responsibility (CSR) activities. 1 Such developments have, in turn, led to a growing body of research in the related areas of CSR and corporate governance. However, to date, there has been limited research that attempts to merge these two streams of inquiry (Michelon and Parbonetti 2012). The increased focus on CSR appears to be driven by two key factors, namely, a moral responsibility, and business interests (Adams and Zutshi 2004). Apart from earning a return for stockholders, it has been suggested that companies have a broader moral responsibility to their environment, workforce, and local communities. As companies expand and become more international they are likely to have a growing impact on the social and ecological environment of both local and international communities and there is a growing expectation that companies should be accountable to various stakeholder groups for all such impacts. In response to such expectations, a growing number of regulators globally are reviewing the governance arrangements of corporations to ensure that corporate practices are aligned with broader societal interests (Ioannou and Serafeim 2011, p. 2). This has led to a broadening of the dimensions companies need to cover to maintain their license to operate (Kolk and Pinkse 2010, p. 17). For example, a survey conducted to identify the desirability and feasibility of a CSR standard found that consumers expect firms to meet high health and safety, 1 It should be noted that in recent times the term sustainability is used by some commentators instead of social responsibility. However, to be consistent with the majority of the literature, and because we feel the term social responsibility is wider in scope than sustainability, we use the term CSR throughout this article.

2 M. C. Chan et al. worker, human rights, consumer protection, and environmental standards, regardless of where their operations are located (Smith 2002, p. 42). Further, Gibson and O Donovan (2007, p. 944) argue that, based on recommendations by the Corporate Governance Council of the Australian Stock Exchange (ASX), it is clear that good governance is now closely linked to the concept of CSR and accountability and that one way to demonstrate CSR is to increase annual report disclosures. It has also been suggested that paying attention to CSR activities is good for business. For example, Adams and Zutshi (2004) argue that being a good corporate citizen (acting morally responsibly) can assist companies to attract and retain the most talented people and this, inevitably, has to be good for business. Further, the production of social and environmental reports can help in the development of better internal control systems and decision-making processes; with resulting cost-savings from continuous improvements. Similarly, de Villiers et al. (2011, p. 1639) point to the link between a firm s environmental and financial performance noting that, given this link, details concerning a firm s environmental performance will be of interest to investors. This argument is supported by Ticor Limited, a mining company, which stated (in its annual report) that [e]nvironmental improvement programs continued to return benefits to Ticor South Africa s business and reputation (Ticor Limited Annual Report 2004, p. 22). Similarly, the growing demand from markets, regulators and civil society is a key motivation behind the development of an integrated reporting framework that reflects the commercial, social and environmental context within which organizations operate (International Integrated Reporting Committee 2011, p. 2). In summary, demonstrating it acts in a socially and environmentally responsible manner can provide a company with four major benefits: improved corporate image and relations with stakeholders; better recruitment and retention of employees; improved internal decision-making and cost-savings; and improved financial returns (Adams and Zutshi 2004). As a result, the past two decades have seen a rapid increase in the amount of CSR disclosure in company annual reports and this has been associated with an increase in social and environmental disclosure research (Mitchell and Hill 2009). A key assumption behind such research is that the amount of CSR disclosure provided by a company signifies the importance the company attaches to such matters (Krippendoff 1980; Gray et al. 1995; Deegan and Rankin 1996; Neu et al. 1998). Further, Aerts and Cormier (2009, p. 2) argue that environmental legitimacy is significantly and positively affected by the extent and quality of annual report environmental disclosures. Within the CSR literature, an area of consistent interest in recent times has been the association between the amount of disclosure and various corporate characteristics, such as firm size; profitability; and industry classification (see, for example, Cowen et al. 1987; Patten 1991; Roberts 1992; Hackston and Milne 1996; Purushothaman et al. 2000). As noted by Adams et al. (1998), the first step to improving the quantity and quality of CSR disclosure is to study the firm characteristics associated with CSR disclosure. One important firm characteristic where there has been limited research to date, however, is the relationship between CSR disclosure and corporate governance quality. As noted by Money and Schepers (2007, p. 5) there is little existing knowledge from a corporate perspective as to the extent of alignment between corporate governance and CSR. Further, studies that have sought to examine such a relationship have typically used either: an indirect proxy for corporate governance (for example, country of origin is used as an indicator of likely corporate governance differences by van der Laan Smith et al. 2005); a limited number of corporate governance attributes (for example, board composition, multiple directorships, and type of shareholders/stockholders are used as corporate governance variables by Haniffa and Cooke 2005); or a single corporate governance attribute (for example, the proportion of independent non-executive directors is used by Faisal et al. 2012, as a proxy for better corporate governance). A notable exception is the recent study by de Villiers et al. (2011) which examined a broad range of attributes related to the Board s monitoring role (for example, board independence) and its resource provision role (for example, board size). However, to the best of our knowledge (as discussed in more detail later) this is the first CSR study to use an overall corporate governance quality measure provided by an external party independent of the researchers (WHK Horwath 2005, Corporate governance report). Therefore, our study makes two important contributions to the literature. First, we add to the limited existing research by examining the association between corporate governance quality (controlling for various other firm characteristics) and the amount of CSR disclosure provided in company annual reports. Second, we use an overall corporate governance quality measure provided by an external party independent of the researchers (WHK Horwath 2005). Our findings, consistent with Michelon and Parbonetti (2012), suggest that corporate governance quality is an important internal contextual factor (Adams 2002) that is positively associated with CSR activities and disclosure. The remainder of this article is organized as follows. In the next section we review the literature that provides the theoretical background to the hypothesis tested in this study. This is followed by a research methods section incorporating a description of the CSR disclosure model

3 Corporate Governance Quality and CSR Disclosures examined, how the dependent and independent/control variables are measured, and the sample selection process. We then provide, and discuss, the results of our analysis and conclude with the study s limitations and some suggestions for future research. Theory Development In examining various CSR issues, prior studies have drawn on a number of theoretical frameworks, for example, agency theory, institutional theory, legitimacy theory, political economy of accounting theory, resource dependence theory, and stakeholder theory (Hackston and Milne 1996). As such, there does not appear to be a universally accepted theoretical framework of corporate social accounting (Hackston and Milne 1996, p. 78). However, there does seem to be a consensus in the literature that the various theories referred to above, rather than being distinct, are better viewed as complimentary or overlapping theories (Gray et al. 1995; Cormier and Magnan 1999; Holder-Webb et al. 2009; Reverte 2009; Chen and Roberts 2010). Given that legitimacy theory and stakeholder theory appear to have been the most widely used theories in examining CSR disclosures, each of these theories will be briefly reviewed in the following sub-sections. It should be noted that whilst legitimacy theory considers interactions with society as a whole stakeholder theory focuses on how an organization interacts with particular stakeholders (Deegan and Blomquist 2006, p. 350). Legitimacy Theory A number of CSR disclosure studies have used legitimacy theory as their conceptual framework (see, for example, Cormier and Gordon 2001; Deegan2002; O Donovan2002; Haniffa and Cooke 2005). Central to organizational legitimacy is the notion of a social contract. An organization exists and can use community resources when society considers that the organization is legitimate (Holder-Webb et al. 2009). If society deems that an organization is not operating in a legitimate manner, then society will react by threatening the organization s contract to continue its operations by, for example, consumers boycotting the products of the business; factor suppliers boycotting the supply of labor and reducing financial capital to the business; and stakeholders lobbying government for increased taxes, fines or laws to prohibit those activities of the business which do not conform to the expectations of the community. Legitimacy theory relies on the assumption that managers will adopt strategies to demonstrate to society that the organization is attempting to comply with society s expectations. As societal values change over time, organizations have to continuously demonstrate that their operations are legitimate and that they are good corporate citizens. Where managers perceive their organization s operations are not commensurate with its social contract then, according to legitimacy theory, remedial strategies are predicted. Since the theory is based on perceptions, for any remedial strategies implemented by management to have an effect on external parties they must be accompanied by disclosure. That is, information is necessary to change perceptions (Hooghiemstra 2000; Deegan 2002; Adams and Zutshi 2004). Remedial action that is not publicized will not be effective in changing perceptions (Hooghiemstra 2000; Cormier and Gordon 2001; Holder- Webb et al. 2009). This highlights the strategic importance and power of CSR disclosures made in company annual reports (Deegan 2002). Hence, legitimacy theory provides a potentially useful theoretical framework to evaluate the relationship between various firm characteristics and CSR disclosure. However, it should be noted that disclosures prompted by an organization s desire to increase its legitimacy are likely to be limited to good news (Deegan and Rankin 1996; Milne et al. 2009). Stakeholder Theory Ansoff (1965) used stakeholder theory to define the objectives of the organization, with one of the major objectives being to balance the conflicting demands of the firm s various stakeholders. Pfeffer and Salancik (1978) argue that organizations must rely on external stakeholders to provide resource support and, in turn, these stakeholders might demand certain actions from organizations. Similarly, Freeman (1984) and Ullmann (1985) discuss the significant role played by managers in assessing the importance of balancing and meeting the conflicting demands of various stakeholder groups to achieve the objectives of the firm. Clarkson (1995) notes that without the continuing support of its primary stakeholders an organization would have difficulty in surviving as a going concern. More generally, it has been argued that the longterm survival and success of an organization requires the support of all its stakeholders (van der Laan Smith et al. 2005, p. 126). Therefore, it is the dependence of the organization on external stakeholders for resources that gives these stakeholders power over the organization and the organization s behavior. Freeman (1999) argues that strategic stakeholder management suggests that effective organizations will pay attention to all stakeholder relationships that can affect, or can be affected by, the achievement of the firm s objectives. Stakeholder management is basically pragmatic in its concept and application. Therefore, the effective firm will manage all the stakeholder relationships that are important

4 M. C. Chan et al. to it. This suggests that stakeholder demands will be addressed if the resources they control are critical to a firm s continued operation and success. A strategic plan for managing stakeholder relationships might involve developing a firm s reputation as socially responsible through performing and disclosing CSR activities; particularly if, as suggested by de Villiers et al. (2011, p. 1639), there is a positive relationship between strong environmental performance and shareholder wealth. If CSR activities are viewed as part of a firm s strategic management plan for meeting stakeholder demands, it is reasonable to expect a positive relationship between stakeholder power and CSR performance/disclosure (Roberts 1992). Hence, stakeholder theory also provides a potentially useful theoretical framework for examining the relationship between various firm characteristics and CSR disclosure. Corporate Governance Quality To maximize stockholder value, a company s Board of Directors has to gain an understanding of the environmental and social consequences of the company s actions and ensure the company is responsive to the views of those with whom it comes into contact (Association of Chartered Certified Accountants 2005). As noted earlier, companies can be viewed as operating under a social contract whereby they are permitted to draw on community resources to produce goods and services but have no inherent rights to those resources. Further, there is an expectation that the benefits to society from companies using these resources should exceed their cost (Mathews 1993). As noted by Kolk and Pinkse (2010, p. 17), companies need to be both profitable and ethical, and that the dimensions to be covered for a license to operate have broadened such that there is a growing overlap between corporate governance and CSR. The Board sets the operating objectives and strategies for the company within its social contract and, thereby, ensures the company s continuing ability to draw on community resources to produce goods and services. It follows, therefore, that companies with good corporate governance should be better corporate citizens and more socially and environmentally responsible than companies with poor corporate governance. This, in turn, suggests there should be a strong positive association between corporate governance quality and the voluntary provision of CSR information. This proposition was supported by Eng and Mak (2003) in terms of total voluntary disclosures and by van der Laan Smith et al. (2005) and Haniffa and Cooke (2005) with respect to CSR voluntary disclosures. Further, as noted by de Villiers et al. (2011, p. 1639): Given the positive relationship between strong environmental performance and shareholder wealth, as well as other nonfinancial advantages, adherence to sound environmental practices should constitute an important objective for boards of directors. Therefore, based on both legitimacy and stakeholder theory (and the limited prior evidence) this study will examine the following hypothesis: Hypothesis 1 There is a positive association between corporate governance quality and the voluntary provision of CSR information in company annual reports. In testing this hypothesis, we control for the following variables that prior research indicates are also likely to be associated with CSR disclosures. Firm Size Aerts and Cormier (2009, p. 10) note that firm size has been shown to be an antecedent of legitimacy and there have been several studies suggesting that company size is positively associated with CSR activities (see, for example, Cowen et al. 1987; Patten 1991; Hackston and Milne 1996; Purushothaman et al. 2000; Haniffa and Cooke 2005). These studies note that larger companies tend to receive more attention from the general public and, therefore, are under greater pressure to provide CSR information. As the general public becomes more aware of the potential adverse impacts associated with corporate development, legitimacy pressures will force businesses to respond to various social and environmental issues considered to be the consequences of their activities (Tinker and Niemark 1987). Preston and Post (1975) note that these social and environmental issues of concern to society can, after due consideration, become the subject of new laws. Given business can be constrained by impending legislative pressure, firms have an incentive to get involved in the policy process, and this particularly applies to larger companies because, as noted by Watts and Zimmerman (1986), larger companies are more visible to the public and are, therefore, more likely to attract the attention of government regulatory bodies. Similarly, Branco and Rodrigues (2008, p. 688) suggest that larger companies, on average, are more diversified across geographical and product markets and, because of their greater visibility, will consider social responsibility activities and disclosure as a way of enhancing corporate reputation. Further, larger companies are likely to have more (current and potential) stockholders interested in CSR activities (than smaller companies), and the management of larger companies are more likely to use formal communication channels, such as annual reports, to relate the results of their CSR activities to interested parties (Cowen et al. 1987). Hence, to avoid regulation and reduce political costs, larger companies are more likely (than smaller companies) to provide voluntary CSR disclosures in their annual reports (Adams et al. 1998).

5 Corporate Governance Quality and CSR Disclosures Industry Profile Prior research suggests that the extent of public pressure companies face with respect to their legitimacy in operating within the boundaries and values of society varies across different types of industries. Legitimacy theory predicts that, because they have greater incentives to project a good corporate image, firms operating in high profile (sensitive) industries are likely to disclose more extensive CSR information than firms operating in low profile (less sensitive) industries. For example, Dierkes and Preston (1977) suggest that companies whose economic activities modify the environment, such as the extractive industries, are more likely to disclose information about their environmental impact than companies in other industries. In support of this proposition, Deegan and Gordon (1996) found that companies operating in industries of concern to environmental groups (for example, uranium mining, chemicals, coal, and timber products) use environmental disclosures to legitimize their operations. Parker (1986) also notes that CSR disclosure can act to pre-empt impending legislative pressure and as a counter to possible government intervention. Given firms in high profile industries are under greater pressure to demonstrate their legitimacy they can be expected to provide more extensive CSR information as a way of projecting a responsible social image and maintaining their competitive advantage (Itami 1987; Hall 1993). Stockholder Power/Dispersion Due to information asymmetry, as ownership dispersion in a corporation increases conflicts of interest between management and stockholders are more likely to arise. Voluntary reporting and disclosure can act to reduce the information asymmetry that exists between management and stockholders and can, therefore, assist in reducing agency conflicts (Jensen and Meckling 1976). Further, Keim (1978) argues that as the distribution of ownership of a corporation becomes more dispersed, the demands placed on the corporation by stockholders become broader. Disperse corporate ownership, especially by investors concerned with corporate social activities (for example, socially responsible mutual funds, church and civic pension plans, and ethical investors), heightens pressure for management to disclose socially responsible activities (Ullmann 1985). As noted by Cormier and Magnan (1999, p. 430), it is more efficient for management of widely held firms to disclose environmental information directly than for individual investors to collect it themselves. Therefore, it is reasonable to expect that the more disperse a firm s ownership structure the more CSR information will be disclosed. Creditor Power/Leverage Companies require financial resources for their continuing operations and creditors are an important source of such resources (Pfeffer and Salancik 1978; Roberts 1992). Further, stakeholder analysis used in prior research to explain corporate decisions concerning financial policies has concluded that capital structure decisions are part of an overall corporate stakeholder strategy and that creditors are important stakeholders whose influence should be managed (Cornell and Shapiro 1987; Barton et al. 1989). Given that significant creditors are important stakeholders it is reasonable to expect that their expectations concerning a firm s CSR activities will receive attention from corporate managers (Mitchell et al. 1997). For example, in its annual report, the Commonwealth Bank of Australia stated that [t]he Bank and its controlled entities are not subject to any particular or significant environmental regulation under a law of the Commonwealth or of a State or Territory, but can incur environmental liabilities as a lender. The Bank has developed credit policies to ensure this is managed appropriately (Commonwealth Bank of Australia 2004, p. 44). Similar statements can be found in the annual reports of other major banks. It seems, therefore, that when a bank re-possesses land (because a borrower has defaulted on a loan) the bank becomes responsible for any environmental problems (liabilities) associated with that land. Since banks can incur environmental liabilities as lenders, it follows that banks will want to ensure the companies they lend to manage their social and environmental responsibilities appropriately. This supports the view that significant creditors are likely to be interested in the CSR activities (and particularly the environmental performance) of the companies to whom they provide credit. Therefore, according to stakeholder theory, the more a company relies on external funding the more its management would be expected to respond to creditor expectations concerning the firm s CSR activities (Roberts 1992). Economic Performance According to stakeholder theory, the economic performance of a company affects management s decision to disclose CSR information. Theorists who accept this perspective cite profitability as a factor that allows (or perhaps compels) management to undertake, and to reveal to stockholders, more extensive CSR programs (Cowen et al. 1987). Alternatively, Orlitzky et al. (2003) argue that CSR activities give rise to improved corporate financial performance rather than good performance allowing (or compelling) CSR activities. Further, it has been suggested that in periods of low profitability economic demands are likely to take priority over discretionary CSR expenditures and,

6 M. C. Chan et al. therefore, low levels of profitability are likely to be associated with reduced CSR activities (Ullmann 1985; Roberts 1992). Cormier and Magnan (1999, p. 430) also note that for firms in poor financial condition, the disclosure of additional information about their environmental obligations or commitments is unlikely to enhance their reputation among creditors and suppliers. Thus, stakeholder theory predicts a positive association between economic performance and CSR disclosure. Research Method We employ the following CSR disclosure model to examine our hypothesis that there is a positive association between corporate governance quality and the voluntary provision of CSR information. DISC k ¼ b 0 þ b 1 CG k þ b 2 SIZE k þ b 3 IND k þ b 4 SHP k þ b 5 CP k þ b 6 EP k þ e k ð1þ where DISC is the amount of CSR information disclosed for firm k, CG is corporate governance quality, SIZE is company size, IND is industry profile, SHP is stockholder power/dispersion, CP is creditors power/leverage, EP is economic performance, and e is a normally distributed random error term The proxies used to represent the dependent, independent, and control variables in Eq. (1) are discussed in the following sub-sections. The companies selected to test this model were taken from the top 300 companies traded on the ASX in the year 2004, as obtained from the December 2004 issue of the personal investor magazine. A copy of the 2004 annual report for these companies was obtained by either downloading it from the company s website, or by phoning or writing to the company. Sixty-five of these companies did not have a Horwath corporate governance ranking (Horwath 2005) and were, therefore, excluded from the sample. 2 A further 13 companies were excluded for a variety of reasons, such as the accounts were in a foreign currency; or the company had been taken over. This left a final sample of 222 company annual reports for analysis. Measurement of the Dependent Variable CSR disclosure has been defined in a number of different ways (Mathews 1997). In this study, CSR disclosure is 2 The Horwath corporate governance report (Horwath 2005) only ranks the top 250 companies listed on the ASX and there was not an exact match between the Horwath (2005) corporate governance rankings and the top 250 companies as listed in the December 2004 issue of the personal investor magazine. defined as the information provided in a company s annual report relating to its activities, programs and application of resources deemed to affect both the public in general and particular stakeholder groups. These disclosures extend beyond traditional financial accounting information and typically include details pertaining to the environment, energy usage, employees, products, community services, and fair business practices (Ernst and Ernst 1978). This study used company annual reports as the sole source of CSR disclosure information for several reasons. First, there have been a number of prior CSR studies that have adopted this approach and we wanted to be consistent with those studies. Second, company annual reports are the only form of corporate disclosure that is provided on a regular basis (Buhr 1998) and easily accessible to researchers (Unerman 2000). Third, the information in company annual reports is widely recognized as having a high degree of credibility (Tilt 1994; Neu et al. 1998; Unerman 2000). Fourth, annual reports are considered by various user groups to be a major source of information about a company s CSR performance (see studies by Harte and Owen 1991; Epstein and Freedman 1994; Tilt 1994; Deegan and Rankin 1997; O Donovan 2002). Fifth, as noted by van der Laan Smith et al. (2005, p. 136), the use of the annual report as a method of communication with stakeholders is also consistent with the principles of stakeholder theory. Sixth, Gibson and O Donovan (2007, p. 944) note that, in 2003, the Corporate Governance Council of the ASX recommended that one way to demonstrate good governance was to use the annual report to disclose information to all legitimate stakeholders. Seventh, based on in-depth interviews with UK corporate managers, Spence (2009) reports that the most cited target audience for social and environmental reporting was investors and given that the annual report is typically the primary, if not the sole, source of information for most investors this provides further justification for basing our study on the information provided in company annual reports. Finally, in terms of the extent and quality of CSR disclosures, Hooks and van Staden (2011) found a high degree of correlation across a range of reporting media, including annual reports; standalone reports; and the internet. A review of the literature reveals three primary methods that might be considered for assessing the amount of CSR disclosure, namely, measurement in terms of words (Zeghal and Ahmed 1990; Deegan and Gordon 1996; Neu et al. 1998), measurement in terms of sentences (Ingram and Frazier 1980; Hackston and Milne 1996; Tsang 1998; Milne and Adler 1999), and measurement in terms of proportions of a page (Cowen et al. 1987; Patten 1991). Hackston and Milne (1996) are critical of adopting a measure based on the number of words, describing it as an ambiguous measure. The number of words can also be problematic as individual words do not convey any

7 Corporate Governance Quality and CSR Disclosures meaning without a sentence to provide the context (Hackston and Milne 1996; Milne and Adler 1999). Ingram and Frazier (1980, p. 617) used sentences as their unit of analysis since a sentence is easily identified, is less subject to interjudge variations than phrases, classes and themes, and has been evaluated as an appropriate unit in previous research. Using the proportion of a page devoted to CSR disclosure has also been criticized because of the subjectivity involved in the measurement process and because print sizes, column sizes and page sizes can differ from one annual report to another. Some authors also question how one would treat blank parts of a page (Gray et al. 1995). Using sentences overcomes the problems associated with having to allocate portions of a page and removes the need to account for, or to standardize, the number of words (Hackston and Milne 1996). As noted by Milne and Adler (1999, p. 243) [c]oding words or areas of a page (e.g., tenths or 100ths) as a basis to derive measures of social and environmental disclosures adds unnecessary unreliability. An argument against measuring CSR disclosure in terms of the number of sentences is that this will result in any non-narrative CSR disclosures (such as photographs or charts) being ignored. Any unit of measurement that cannot take account of graphs, charts, or photographs will omit from the CSR study these potentially powerful and highly effective methods of communication (Beattie and Jones 1997). It could even be argued that photographs are sometimes a more powerful tool in providing CSR disclosures than narrative disclosures, particularly for stakeholders who just flick through the annual report, looking at the pictures and possibly reading the chairman s report. As one of the main assumptions behind the use of quantitative content analysis as an empirical research tool is that volume of disclosure signifies importance (Krippendoff 1980; Gray et al. 1995; Deegan and Rankin 1996; Neu et al. 1998), it seems inconsistent to omit counting the volume of disclosure allocated to photographs, tables, graphs, or charts. While this contention is no doubt true, photographs, tables, graphs, or charts are highly subjective (Wilmshurst and Frost 2000, p. 17) making it difficult to meaningfully combine them with sentences and, consequently, we elected not to include them. This is acknowledged as a potential weakness of the study. Therefore, for the purposes of this study, CSR disclosure sentences are used as the unit of measurement; with disclosure being measured as a continuous variable represented by the number of CSR sentences in a company s annual report. 3 3 Note that Patten (1991) employed a dichotomous measure for his CSR disclosure variable, while Roberts (1992) employed three levels to measure disclosure, namely 0 = poor; 1 = good; and 2 = excellent. It should also be noted that some authors have distinguished between voluntary and mandatory disclosures (see, for example, Gray et al. 1995) while others have chosen not to make this distinction (see, for example, Patten 1991). Hackston and Milne (1996) argue that such a distinction is not helpful when the amount of mandatory disclosure is very low. In Australia, so little CSR disclosure is mandated by legislation that no distinction is made between voluntary and mandated CSR disclosure for the purposes of this article. 4 Finally, it is important to acknowledge that our focus was on the quantity, and not the quality, of CSR disclosures contained in company annual reports. As noted by Hooks and van Staden (2011), to evaluate the quality of disclosures would add a further dimension to the assessment of CSR disclosures and would add further subjectivity to the content analysis. Hooks and van Staden (2011, p. 210) also report that companies that had better quality environmental reporting also had more environmental reporting and this lends credibility to determining levels of environmental reporting by means of extent measures. CSR Measuring Instrument and Content Analysis Content analysis was defined by Abbot and Monsen (1979, p. 504) as a technique for gathering data that consists of codifying qualitative information in anecdotal and literary form, into categories in order to derive quantitative scales of varying levels of complexity. Krippendoff (1980, p. 21) further stated that content analysis is a research technique for making replicable and valid inferences from data according to their context. To enable content analysis to be performed in a replicable manner on the company annual report data collected for this study, a CSR measuring instrument was developed (from pilot tests on a sample of company annual reports) to record CSR disclosures across seven themes (the six identified by Ernst and Ernst (1978) and a general theme). A number of rounds of pilot testing were performed by one author and checked by another. Based on the pilot tests, modifications were made to the CSR measuring instrument. These pilot-testing rounds produced increasingly convergent views as to the number of sub-themes that should be recorded for each major disclosure theme and facilitated a consistent counting of the number of sentences under each of the seven disclosure themes/sub-themes. Having reached an 4 The only mandatory CSR disclosure required by Australian Corporations Law relates to the directors report where the directors must state if the entity s operations are subject to any particular and significant environmental regulation under a law of the Commonwealth or of a State or Territory and, if so, details of the entity s performance in relation to those environmental regulations must be provided.

8 M. C. Chan et al. acceptable level of agreement based on the pilot tests, one of the authors then completed the content analysis for the full sample of annual reports. The final CSR measuring instrument used to collect the data for this study is presented in Appendix A. Measurement of Corporate Governance Quality and the Five Control Variables Corporate Governance Quality As summarized in Table 1, corporate governance quality is assessed using the WHK Horwath (2005) Corporate governance report which ranks Australian companies from best to worst on the basis of their performance in six key corporate governance areas: board of directors; audit committee; remuneration committee; nomination committee; external auditor independence; and code of conduct and other policy disclosures. Although the weighting attached to these various characteristics is not known, a major advantage of using this corporate governance quality measure (as noted earlier) is the fact that it is independently determined. Based on the WHK Horwath (2005) Corporate governance report our sample companies were ranked from 1 (having the lowest corporate governance ranking) to 222 (having the highest corporate governance ranking). As a robustness test, a dichotomous measure of corporate governance quality was also examined by dividing the total sample into two categories: those with a corporate governance ranking above/below the median. The Five Control Variables The five control variables included in the analysis (as summarized in Table 1) are firm size, industry profile, stockholder power/dispersion, creditor power/leverage, and economic performance. Firm size (from personal investor, Aegis Equities Research 2004) is measured in terms of the firm s market capitalization ranking from 1 (being the smallest) to 222 (being the biggest). Industry profile is measured using a scale from 1 to 3; where 1 = low profile, 2 = medium profile, and 3 = high profile. Consistent with Brammer and Pavelin (2006), low profile firms were those classified by the ASX as being in the financials sector (and included: banks; diversified financial resources; insurance; real estate investment trusts; and real estate management and development). Consistent with Brammer and Pavelin (2006) and Patten (1991), high profile firms were those classified as being in the materials sector (and included: chemicals; construction materials; containers and packaging; metals and mining; and paper and forest products). All other firms were classified as medium profile and included firms in the following sectors: energy; industrials; consumer discretionary; consumer staple; health care; information technology; telecommunication services; and utilities. Stockholder power/dispersion is measured as the percentage of ordinary shares not owned by the 20 largest stockholders. Creditor power/leverage is measured by total liabilities as a percentage of the book value of equity. Finally, economic performance is measured by return on the book value of equity (ROE). For the purposes of robustness testing, we also used a variety of alternative measures for the control variables. For example, total asset was used as an alternative size measure and long-term liabilities as a percentage of equity was used as an alternative measure of creditor power/ leverage. As these alternative measures did not improve the study s findings the results from using them are not reported. Results Table 2 provides the descriptive statistics for the dependent, independent, and control variables (except for the Table 1 Description of independent and control variables Variable name (expected sign) Measurement Data source Corporate governance ranking (?) WHK Horwath corporate governance ranking from 1 (worst) to 222 (best) Firm size (?) Market capitalization ranking from 1 (smallest) to 222 (biggest) Industry profile (?) Industry profile: 1 = low profile, 2 = medium profile, 3 = high profile Stockholder power/dispersion (?) % of ordinary shares not owned by the 20 largest stockholders WHK Horwath 2005 corporate governance report (Horwath 2005) ASX top 300 companies from personal investor (Aegis Equities Research 2004) ASX industry sector classifications 2004 Annual reports Creditor power/leverage (?) Total liabilities as a percentage of the book 2004 Annual reports value of equity Economic performance (?) Return on the book value of equity 2004 Annual reports

9 Corporate Governance Quality and CSR Disclosures Table 2 Descriptive statistics for continuous variables Mean SD Min Max Skewness Kurtosis Total CSR disclosure Ln total CSR disclosure Stockholder power Creditor power Ln creditor power Economic performance Table 3 Pearson and Spearman rank correlation coefficients for the continuous independent variables *** p \ 0.01, two tailed; ** p \ 0.05, two tailed; and * p \ 0.10, two tailed Variables CG SIZE IND SHP LnCP EP Pearson correlation coefficients CG SIZE 0.445*** IND SHP 0.223*** *** LnCP *** *** EP * * Spearman rank correlation coefficients CG SIZE 0.445*** IND SHP 0.246*** *** LnCP * 0.263*** * EP * categorical and rank variables). Note that CSR disclosure and creditor power have been transformed by their natural logarithm due to non-normality in the data (based on the Kolmogorov Smirnov Z test). However, economic performance (which was also not normally distributed) was not transformed because taking the natural logarithm of this variable did not improve the model as it resulted in many cases with negative values having to be removed. It should also be noted that multi-collinearity between the variables did not appear to be a problem for the following reasons. First, as can be seen from Table 3, the highest correlation (Pearson or Spearman rank) between any of the independent/control variables was only Second, the standardized residuals from the OLS regression analysis appeared to be normally distributed (Kolmogorov Smirnov Z = 0.539; p = 0.934). Third, the highest VIF value was only 1.41 (Wu and Tu 2007). Finally, the highest condition index value was only As can be seen from Table 2, the mean number of CSR disclosure sentences was 39, with a minimum of zero and a maximum of 322. Of the 222 companies in the study, only three had no CSR disclosure sentences, with the remaining 5 As a rule of thumb, a condition index exceeding 30 indicates strong multicollinearity (Gujarati 2003). 219 companies providing from 1 to 322 disclosure sentences. In terms of the individual disclosure themes (not reported) the environment and human resources disclosure themes had the highest percentage of disclosing companies at 89 and 77 %, respectively; while only 1 % of companies disclosed information concerning fair business practices. Table 4 reports the SPSS results for the multivariate analysis of our CSR model using linear regression. In support of our hypothesis, the results indicate that total CSR disclosure is significantly positively associated with corporate governance quality and this finding also applies (at p \ 0.10) to four of the seven disclosure themes (environment, energy, human resources, and products). In terms of the control variables, as expected, total CSR disclosure is significantly positively associated with firm size, industry profile, and creditor power/leverage (with firm size and industry profile also being significant for the majority of the disclosure themes). However, the results show no significant association between the level of total CSR disclosure and either stockholder power/dispersion or economic performance (and, again, this finding is largely consistent across the various disclosure themes). Using various alternative proxies for the independent and control variables did not improve our results and, therefore, the findings for these alternative proxies are not presented.

10 M. C. Chan et al. Table 4 Regression results for total CSR disclosure and the seven disclosure themes Independent/control variables Total Seven disclosure themes CSR General Environment Energy Human Products Community Fair business disclosure resources practice t t t t t t t t Corporate governance 3.44*** ** 1.59* 3.37*** 1.95** Firm size 2.56*** 3.83*** 4.04*** 2.45** 2.73*** *** 0.34 Industry profile 8.04*** 5.52*** 9.46*** 1.94** 5.20*** 1.38* 2.41** 0.64 Stockholder power ** Ln creditor power 3.19*** *** Economic performance ** -2.44** Constant *** -4.50*** -2.41** -1.91** F Prob. (F) Adjusted R N In all regressions, the natural logarithm of CSR disclosure has been used to minimize the effects of non-normality in the data *** p \ 0.01, two tailed; ** p \ 0.05, two tailed; and * p \ 0.10, two tailed Discussion Our findings are consistent with the view that companies with good corporate governance are likely to be more socially and environmentally responsible than those with poor corporate governance. This result is in keeping with van der Laan Smith et al. (2005, p. 130) who found that stakeholders in countries with a communitarian (stakeholder) orientated corporate governance system (Denmark and Norway) have more power and legitimacy than in countries with a contractarian (shareholder) influenced corporate governance system (US). Our results also support Haniffa and Cooke (2005), who found a positive relationship between the level of CSR disclosure provided in a company s annual report and the number of directorships held by the Chair of its Board. At a more general level, our results are consistent with Eng and Mak (2003) who found that corporate governance variables associated with ownership structure and board composition affect the disclosure of non-mandatory strategic, non-financial and financial information. Our results also suggest that the reason a number of prior studies have failed to find a significant association between corporate governance quality and CSR disclosures might be due to the limited measures of corporate governance quality used by those previous studies (see, for example, Faisal et al. 2012). In summary, our findings suggest that promoting high quality corporate governance practices is likely to impact positively on the provision of voluntary CSR disclosures, thereby reducing the imperative to mandate such disclosures. In terms of our control variables, the significant positive association between CSR disclosure and firm size supports earlier studies by Cormier and Magnan (1999) in Canada, Haniffa and Cooke (2005) in Malaysia, Hackston and Milne (1996) in New Zealand, Purushothaman et al. (2000) in Singapore, and Cowen et al. (1987) and Patten (1991) in the US. However, Roberts (1992) found firm size was not significantly associated with CSR disclosure in the US after including a number of other variables (such as leverage; return on equity; and industry classification). Similarly, a significant positive association between CSR disclosure and industry profile was also recorded by Patten (1991) and Roberts (1992) in the US, Cormier and Magnan (1999) in Canada, and Hackston and Milne (1996) in New Zealand. However, Cowen et al. (1987) found that (from 10 industries) only the chemical industry was positively related to CSR disclosure in the US, and Purushothaman et al. (2000) reported that industry classification was not significant in Singapore. Our finding of a significant positive association between CSR disclosure and leverage (creditor power) supports the earlier findings of Roberts (1992), who reported a positive association between creditor influences and CSR disclosure in the US, and Purushothaman et al. (2000), who reported a positive association between leverage and CSR disclosure in Singapore. Our findings with respect to the two control variables that appeared not to be associated with CSR disclosure (stockholder power/dispersion and economic performance) are also largely consistent with the results of previous

11 Corporate Governance Quality and CSR Disclosures studies. For example, Roberts (1992) also failed to find an association between CSR disclosure and stockholder power/dispersion. Similarly, there was no association between CSR disclosure and economic performance found in the studies by Cowen et al. (1987) and Patten (1991) for the US, Hackston and Milne (1996) for New Zealand, and Purushothaman et al. (2000) for Singapore. However, Roberts (1992) did report a positive association between economic performance and CSR disclosure in his US study and the same applies to the Canadian study by Cormier and Magnan (1999) and the Malaysian study by Haniffa and Cooke (2005). Conclusions, Limitations, and Suggestions for Further Research The purpose of this article was to examine the association between corporate governance quality and CSR disclosure, controlling for firm size, industry profile, stockholder power/dispersion, creditor power/leverage, and economic performance. A major strength of this study is its use of an independent ranking of the overall corporate governance quality of Australian-listed companies provided by WHK Horwath (2005). Prior studies have typically only examined a limited number of corporate governance attributes. Consistent with our hypothesis, the analysis of 2004 annual report data for 222 listed Australian companies indicates CSR disclosure is significantly positively associated with good corporate governance. This finding supports earlier research by van der Laan Smith et al. (2005) who compared the CSR disclosure practices of a sample of US and Norwegian/Danish companies and Haniffa and Cooke (2005) who investigated the relationship between CSR disclosure and several corporate governance variables for a sample of Malaysian corporations. Consistent with much of the previous literature, three of the control variables included in this study were also found to be positively associated with CSR disclosure, namely, firm size, industry profile, and creditor power/leverage. However, for the two remaining control variables (stockholder power/dispersion and economic performance) no significant association with CSR disclosure was found; a finding that is also consistent with much of the previous literature. It is hoped that the findings from this study will contribute to both the CSR and corporate governance literature and will be of interest to researchers, investors, politicians, and regulators. For example, Australian politicians are currently paying a great deal of attention to global warming and climate change and are in the process of developing a carbon emissions trading scheme. The findings from this study should provide some useful insights to regulators/policy makers who may be considering the introduction of legislation to mandate annual report disclosures in this area. In particular, our findings suggests that (rather than mandating specific disclosures) regulators would be better served focussing on corporate governance quality as a way of increasing both CSR activities and their disclosure in company annual reports. Similarly, the International Integrated Reporting Committee (2011, p.2) is in the process of trying to develop an integrated reporting framework to guide organizations on communicating the broad set of information needed by investors and other stakeholders to assess the organization s long-term prospects. The discussion paper prepared by the International Integrated Reporting Committee (2011, p. 3) proposes that the initial focus of an integrated reporting framework should be on reporting by larger companies and on the needs of their investors. Our results indicating a positive association between firm size and voluntary CSR disclosures would support such an approach. In terms of limitations, it should be noted that our study only examined 2004 annual report disclosures of Australian-listed companies and, as such, may not be generalizable across other periods and countries. For this reason, further analysis of CSR disclosures in later years and other countries would be a useful extension to this study to determine if our findings are consistent over time and across geographical boundaries. Similarly, we only examine CSR disclosures contained in company annual reports and, therefore, future research could usefully examine other sources of CSR information (such as company websites). As acknowledged earlier, our study also ignored CSR disclosures in the form of photographs, tables, graphs, or charts because they are highly subjective (Wilmshurst and Frost 2000, p. 17) making it difficult to meaningfully combine them with sentences. We also note that our corporate governance variable simply ranks the companies in our sample from best to worst; that is, we do not have any absolute measure of a company s corporate governance quality. Finally, it is important to acknowledge that our adjusted R 2 indicates that only 35 % of the variation in the level of CSR disclosure between the companies in our sample can be explained by the independent and control variables we examined. Clearly content analysis can only take us so far in our search to better understand the key drivers of CSR disclosure in company annual reports. Therefore, although the level of explained variance in our study compares favorably with prior studies (for example, Branco and Rodrigues 2008, were only able to explain 33.5 % of the variance in their study of social responsibility disclosure for a sample of Portuguese firms), future qualitative research (for example, detailed case study analysis) is likely to be needed to shed further light on the factors that motivate the disclosure of CSR information in company