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This is the authors’ final peer reviewed (post print) version of the item published as: Muttakin,MB, Khan,A and Azim,MI 2015, Corporate social responsibility disclosures and earnings quality: Are they a reflection of managers’ opportunistic behavior?, Managerial Auditing Journal, vol. 30, no. 3, pp. 277-298. Available from Deakin Research Online: http://hdl.handle.net/10536/DRO/DU:30072074 Reproduced with the kind permission of the copyright owner Copyright: 2015, Emerald
Corporate social responsibility disclosures and earnings quality
Are they a reflection of managers’ opportunistic behavior?
Mohammad Badrul Muttakin and Arifur Khan
School of Accounting, Economics and Finance, Deakin University, Melbourne, Australia, and
Mohammad I. Azim
Department of Accounting, Swinburne University of Technology, Melbourne, Australia
Abstract Purpose – This paper aims to explore the relationship between corporate social responsibility (CSR)
disclosures and earnings quality proxied by earnings accruals. Specifically, we examine whether CSR
disclosures are context‐specific, that is, whether companies dominated by powerful stakeholders are
obliged to behave in a responsible manner to constrain earnings management, thereby reporting
higher‐quality earnings to investors.
Design/methodology/approach – This paper explores the relationship between CSR disclosures and
earnings quality proxied by earnings accruals. Specifically, we examine whether CSR disclosures are
context‐specific, that is, whether companies dominated by powerful stakeholders are obliged to
behave in a responsible manner to constrain earnings management, thereby reporting higher‐quality
earnings to investors. Findings – Results show that managers in an emerging economy manage
earnings when they provide more CSR disclosures. Such earnings management is achieved through
income increasing discretionary accruals. Furthermore, companies from export‐oriented industries
dominated by powerful stakeholders (international buyers) disclosing more CSR activities, provide
transparent financial reports through constraining earnings management.
Originality/value – The findings of this study are significant for both investors and policymakers.
Investors should not take for granted that firms engage in CSR activities, behave ethically and
provide transparent financial reports. As we document that firms might manipulate earnings
through discretionary accruals and provide less transparent financial reports to shareholders, the
credibility of firms’ CSR policies should be assessed with caution. Policies directing at promoting
socially responsible practices instead of motivating the desired behaviour, may provide managers
with additional incentives to utilise CSR for opportunistic behaviour. Thus, policymakers need to be
cautious about this opportunistic behaviour and enhance monitoring to enforce social compliance.
Possibly, some guidelines can be introduced to confirm that CSR disclosures are based on actual
practice and not just a “green wash” statement to deceive stakeholders.
Keywords Corporate social responsibility, Discretionary accruals, Opportunistic behaviour, Earnings
quality, emerging economy
Paper type Research paper
1. Introduction Every company should engage in socially responsible activities for the benefit of their stakeholders.
A growing number of companies are considering social issues while developing their business
strategies (Hillman and Keim, 2001; Dentchev, 2004; McWilliams and Siegel, 2000). It has been
shown that companies engaging in socially responsible activities are more transparent and have
lower risk of manipulations in reported earnings (Kim et al., 2012).
Companies have an implied social contract with stakeholders including shareholders, investors,
employees, etc. Therefore, it is their responsibility to conduct business on the basis of trust and
ethics (Gray et al., 1987). Firms implementing corporate social responsibility (CSR) attempt to meet
the expectations of stakeholders and implement the social contract. Thus, it is contended that a firm
which behaves socially and cares about its stakeholders will report transparent financial information
and present an authentic picture of the overall financial position of the company (Salewski and
Zulch, 2012). An alternative argument is that the agency problem can motivate managers to link CSR
to their opportunistic behaviour (Prior et al., 2008). In particular, firms involved in CSR might try to
hide the impact of corporate misconduct. Managers of such firms may report more CSR activities, so
that their opportunistic behaviour is over‐shadowed by the CSR disclosures. In other words, it is
possible that firms with more CSR disclosures will manipulate information and report poor‐quality
earnings, thereby resulting in less transparent information. Therefore, the relation between CSR
disclosures and the transparency of financial reporting, i.e. earnings quality, becomes an empirical
issue.
Previous studies document mixed results regarding the association between CSR and transparent
financial reporting (see, for example, Kim et al. 2012; Chih et al., 2008; Prior et al., 2008). Empirical
evidence shows that firms that are more committed to CSR provide more extensive financial
disclosures and engage less in earnings management (Chih et al., 2008). In contrast, some
researchers argue that managers may strategically use CSR to disguise their opportunistic
behaviours. Promoting CSR activities can help a manager secure his/her job by avoiding close
scrutiny by stakeholder activists (Cespa and Cestone, 2007). Prior et al. (2008) argue that managers
who pursue private benefits by distorting earnings information will be able to entrench themselves
by engaging in CSR. Accordingly, Prior et al. (2008) document a positive association between the
level of earnings management and CSR engagement. Chih et al. (2008) also report a high level of
earnings aggressiveness in socially responsible firms.
CSR in relation to earnings quality has been examined by several researchers, and most recently by
Chih et al. (2008), Yip et al. (2011), Kim et al. (2012) and Scholtens and Kang (2013). Most of the
prior studies have been carried out in a developed‐countries context. For example, Yip et al. (2011)
using US data, found that the relationship between CSR reporting and earnings management is
affected by the political environment; Kim et al. (2012) used the Domini 400 Social Index and found
that socially responsible firms appear to reduce earnings manipulations, as compared to non‐CSR
firms. Very few researchers incorporate data from emerging economies. Two notable papers in this
regard are Chih et al. (2008) and Scholtens and Kang (2013). Chih et al. (2008) examine 46 countries
some of which are emerging economics; and Scholtens and Kang (2013) examine the relationship
between CSR and earning management and between investors’ protection and earnings
management using a sample which includes ten Asian countries some of which are emerging
economies.
The contribution of this research is that it examines whether CSR disclosures and earnings quality
are a reflection of managers’ opportunistic behaviours. We investigate an emerging market,
Bangladesh, where the capital market is less developed (World Bank, 2009); there is poor
enforcement and monitoring (Siddiqui, 2010); the economy heavily depends on export‐oriented
industries (Islam and Deegan, 2008); and a powerful stakeholder group (i.e. international buyers)
play a significant role in the CSR disclosures (Belal and Owen, 2007; Islam and Deegan, 2008; Khan et
al., 2013). Furthermore, O’Neill et al. (2005) include Bangladesh in a group of countries entitled the
“next eleven (or N‐11)”, which comprises potentially large and fast‐growing markets with the ability
to rival the G‐7 countries. They are the next set of large‐population countries beyond Brazil, Russia,
India and China (the BRICs). If gross domestic product (GDP) growth continues to increase at the
current rate, Bangladesh could possibly move from a low to a middle income country by 2016
(Abhayawansa and Azim, 2014).These institutional differences in characteristics make Bangladesh
exclusive from other developing countries. Furthermore, the garment/clothing industry is the prime
industry of Bangladesh. This industry provides employment to more than 4 million workers, with 3.2
million (80 per cent) of workers being women (Pennington, 2013). Workers in various factories are
almost always illiterate. They have very limited knowledge of human rights, working conditions and
labour standards. Workers in Bangladeshi industries often work long hours for unusually low pay,
notwithstanding the existence of laws mandating overtime pay or a minimum wage. Thus,
Bangladesh has been the subject of intense international scrutiny, particularly in terms of perceived
poor labour conditions and the associated treatment of employees in the garment sector.
Recently, Bangladesh garment exporters have been in tense negotiations with international buyers
to retain market share, as buyer concerns mount following the collapse of the building that housed
five clothing factories at Savar on 24th April 2013.The media in a number of countries have launched
protests against international retailers such as Walmart, Gap, H&M, Benetton, Mango, Joe Fresh,
Primark and C&A for sourcing cheap garments from Bangladesh at the expense of the lives of
hundreds of workers. In June 2013, US President Barack Obama announced the suspension of US
trade privileges for Bangladesh because of concerns over labour rights and worker safety
(Washington Post, 2013). These concerns have brought international attention to Bangladeshi
politics, labour rights and worker safety and have led to international buyers placing significant
pressure on Bangladesh businesses to improve their labour practices and to become more socially
responsible.
The failure by the Bangladeshi Government to observe its own national laws has prompted
international buyers to insist on their own codes of conduct with local companies. These buyers’
codes of conduct rely heavily on the idea of social compliance and for companies to act responsibly
and be accountable for the impacts they have on the social, political and ecological environments
(Azim et al., 2009). However, prior studies document that Bangladesh is still lagging behind with
regards to CSR disclosures (Belal et al., 1998; Imam, 2000; Belal, 2000, 2001; Belal and Owen, 2007).
These studies only document the nature and extent of CSR disclosures in company annual reports in
Bangladesh. There is scant Bangladeshi evidence that examines the relation between CSR disclosures
and earning quality and due to the difference in institutional settings; the findings from other
developed or emerging economies might not be generalisable for Bangladesh. Furthermore, the
findings of previous Bangladeshi studies (see, for example, Islam and Deegan, 2008) suggest that
international buyers in the export‐oriented sector, in particular, the garments industry, have
influenced the CSR practices and reporting by Bangladeshi companies. Therefore, we investigate
whether a powerful stakeholder group can influence the relation between CSR disclosures and
earnings quality.
For the purpose of this study, we investigate the relation between CSR disclosures and earnings
quality proxied by earnings management in Bangladesh during the period 2005 to 2009. Our results
indicate a positive relation between the level of CSR disclosures and earnings management
measured by discretionary accruals. In other words, managers in Bangladeshi firms use CSR
disclosures as a tool to mitigate their opportunistic behaviour. Our results further suggest that
such mitigation is done through income increasing discretionary accruals. We also find that the
export‐oriented industries disclosing CSR activities provide more transparent financial reports. In
particular, there is a negative significant interaction effect of export‐oriented industry and CSR
disclosures on earnings management. This is consistent with the notion that international buyers
exert pressure on export‐oriented firms to behave ethically and provide more transparent financial
reports through constraining earnings management. Our study makes a number of important
contributions to the existing literature. First, we provide evidence that managers of Bangladeshi
firms use CSR disclosures to mitigate their opportunistic behaviour. Second, previous studies (Belal
and Owen, 2007; Islam and Deegan, 2008) document that powerful international buyers influence
the CSR disclosures practices of export‐oriented industries, especially after the case of some major
incidence in garment industries. Many of the international buyers are now asking for following their
own Code of Conduct before any import order is placed (Ahamed, 2011). Our study extends such
findings by empirically testing the impact of such pressure on the financial reporting
transparency of firms operating in the export sector. International buyers have strong incentives to
prevent managers or controlling owners from pursuing self‐interests at the expense of other
stakeholders. Thus, in firms with powerful stakeholders, managers will be discouraged from
engaging in activities that are driven by managerial opportunism.
The remainder of this paper is as follows: Section 2 discusses the institutional background and CSR
disclosures in Bangladesh followed by the theoretical framework in Section 3. Section 4 presents the
literature review and develops the hypotheses. Section 5 sets out the study’s methodology and
discusses sample selection and model specification. Section 6 presents the results and Section 7
summarises the major themes covered.
2. Institutional background and CSR disclosures in
Bangladesh Bangladesh, which was a British colony for approximately 200 years, has a weak form of the Anglo‐
American corporate governance system. Some of the institutional features of Bangladesh include a
less developed capital market (World Bank, 2009), a “weak‐efficient” stock market (Islam and
Khaled, 2005), absence of active corporate control, a passive managerial labour market and poor
incentive contracts for management (Farooque et al., 2007). The minority shareholders are poorly
protected due to the absence of well‐defined property rights (Shleifer and Vishny, 1997). Unlike
other common law institutional frameworks present in developed nations, Bangladesh is tormented
by poor‐quality law enforcement which critically hinders the market’s potential growth (Farooque et
al., 2007). In the absence of market‐based monitoring and control measures, ownership‐based
monitoring and control function as a core governance mechanism (Farooque et al., 2007).
Like many other developing countries, Bangladesh focusses on rapid industrialisation to achieve
faster economic development. The industrial sector now makes a significant contribution to the
country’s economy[1]. Bangladesh Government pursues a private sector‐led industrial development
policy which aims to attract as much foreign investment as possible (Belal and Owen, 2007).
Increased industrialisation and growing foreign investment has implications for corporate
accountability to the society and its reporting practices. However, there is no provision regarding
environmental or social disclosures in the Companies Act, 1994 (GoB, 1994) which governs the
disclosures practices of listed companies.
Previous studies investigating CSR disclosures in Bangladesh have documented such disclosures
levels to be significantly low (for example, Belal (2000)) and of a rather descriptive nature, mostly
reporting positive news (Imam, 2000). Belal (2001) reported that a significant portion of the CSR‐
related disclosures involved employee‐related information. Belal’s analysis also questioned the
credibility of such information, as the disclosures were mostly descriptive in nature. Azim et al.
(2009), in a recent study of CSR disclosures by listed public companies in Bangladesh in 2007,
revealed that only around 16 per cent of companies made such voluntary disclosures. Consistent
with Imam (2000) and Belal (2001), that paper also reported that the disclosures were mostly
descriptive in nature, and no attempts for independent verification were made. The study also
reported that the highest level of CSR disclosures prevailed in the banking sector. Furthermore, prior
studies on CSR disclosures in Bangladesh suggest that pressures from powerful stakeholders, rather
than efficiency incentives, are the drivers for such disclosures (Belal and Owen, 2007; Islam and
Deegan, 2008). A recent study by Khan et al. (2013) also provides empirical support to this notion
and concludes that CSR disclosures are used by managers as a strategic tool to attain legitimacy.
3. Theoretical framework Any firm evolves within a broader societal context. Hence, its activities affect a wide range of other
stakeholders. Stakeholder theory considers the impact different stakeholder groups’ expectations
have on corporate disclosure policies. This theory suggests that corporate disclosure policy is a tool
that manages information to be provided to various stakeholder groups. These stakeholders include
employees, shareholders, investors, consumers, public authorities, etc. CSR disclosures can be
perceived to be a response to pressures exerted by various stakeholders (Neu et al., 1998). Hence, it
can be argued that there is an implicit social contract between the firm and those who are affected
by its operations (Brown and Deegan, 1998).
Furthermore, a firm may not respond to all stakeholders equally but may respond to the most
powerful stakeholders only (Buhr, 2002). A stakeholder’s power to influence the management can
be construed as a function of a stakeholder’s degree of control over resources required by the firm
(Ullman, 1985). The more critical the stakeholder’s resources are to the long‐term existence and
success of a firm, the greater the expectation that this stakeholder’s demands will be addressed. A
successful firm is considered to be one that satisfies the demands (sometimes conflicting) of the
various powerful stakeholder groups. Managers use information and, in particular, corporate social
activities‐related information, to manage or manipulate the most powerful stakeholders in an effort
to obtain their support (Gray et al., 1996).
Overall, the above theory considers firms as part of a broader social system, within which they exist.
Furthermore, a firm is influenced by and, in turn, influences the society with different stakeholders
group in which it operates (Deegan, 2009; Gray et al., 1995). Thus, according to the stakeholder
theory, CSR disclosures can be construed as a mechanism for ensuring commitment to the social
contract.
4. Literature review and hypotheses development Extensive research has been carried out on the relationship between CSR disclosures and financial
performance (Griffin and Mahon, 1997; Waddock and Graves, 1997; McWilliams and Siegel, 2001;
Ruf et al., 2001; Margolis and Walsh, 2003; Schuler and Cording, 2006; Callan and Thomas, 2009).
However, empirical evidence based on previous studies indicates mixed findings with respect to the
relation between CSR disclosures and financial performance. Other researchers (Kim et al., 2012;
Hong and Andersen, 2011; Yip et al., 2011) have investigated the relationship between CSR and the
quality of financial reporting which is usually measured by earnings quality.
Only a few empirical studies examine the relationship between CSR disclosures and earnings quality
measured by either earnings management or accruals quality. For example, in a recent study using a
sample of US firms, Kim et al. (2012) investigate whether socially responsible firms behave in a
different way compared to other firms in their financial reporting practices. They find that socially
responsible firms are less likely to engage in aggressive earnings management through discretionary
accruals, to manipulate operating activities and to be subject of Securities and Exchange Commission
(SEC) investigations. Consistent with the legitimacy theory, they argue that ethical and reputation
factors are likely to drive managers to produce high‐quality financial reports. Hong and Andersen
(2011) document that socially responsible firms have higher‐quality accruals and less activity‐based
earnings management both of which have an impact on financial reporting quality. They contend
that ethics play an important role in such relationships. Yip et al. (2011) examine whether CSR
disclosures are related to earnings management in a sample of US publicly listed food and oil and gas
companies. They find a negative relationship in the oil and gas industry and a positive relationship in
the food industry between CSR disclosures and earnings management. They conclude that the
relationship between CSR disclosures and earnings management is context‐specific and influenced
by the political environment of a firm rather than by ethical considerations. Furthermore, Laksmana
and Yang (2009) examine the relationship between corporate citizenship (which is often used
synonymously with CSR) and four earnings attributes, namely, persistence, predictability,
smoothness and accrual quality. They find that firms with high CSR disclosures have earnings that
are more predictable, more persistent and smoother than the earnings of firms with lower CSR.
Similarly, Choi and Pae (2011) find that firms with a higher level of ethical commitment engage in
less earnings management, report earnings more conservatively and predict future cash flows more
accurately than those with a lower level of ethical commitment.
Prior et al. (2008),on the other hand, using a sample of 593 firms from 26 countries for the period
2002 to 2004 find a positive relationship between CSR and earnings management. They argue that
managers who manipulate earnings for private benefit have incentives to engage in CSR activities, as
these constitute a powerful tool for avoiding stakeholder pressure. Scholtens and Kang (2013)
investigate whether earnings management is related to CSR in a sample consisting of139 firms in ten
Asian countries in 2009. They find that socially responsible firms are less likely to engage in earnings
management. They also find that investor protection is negatively related to earnings management
and that CSR may mitigate agency problems between managers and shareholders, as it reduces the
incentives to manage earnings. Using a sample of 258 firms in ten developed countries, Salewski and
Zulch (2012) find that firms with a higher level of CSR are more likely to engage in earnings
management and report bad news in a less timely fashion. They argue that firms may report more
CSR activities for opportunistic reasons such as management’s self‐interest. On this theme, the
findings of Chih et al. (2008) suggest that the type of relationship between CSR and earnings
management depends on which earnings management proxies are used. When earnings
management is measured by earnings smoothing and earnings losses avoidance, an increase in CSR
disclosures moderates earnings smoothing and earnings losses avoidance. These results support the
myopia avoidance hypothesis which states that socially responsible firms are less likely to engage in
earnings management due to their maintenance of financial transparency (Chih et al., 2008).
However, when earnings management is measured by earnings aggressiveness, an increase in CSR
disclosures increases earnings aggressiveness. Chih et al. (2008) refer to this as the multiple
objectives hypothesis which suggests that socially responsible firms may manage earnings to mask
their rent‐seeking activities from outsiders. Finally, they note that there could be no relationship
between CSR and earnings management if earnings management is driven by institutional factors
unrelated to CSR.
Based on the above discussion, it can be argued that socially responsible firms that expend effort
and resources in choosing and implementing CSR practices to meet social expectations are likely to
constrain earnings management, thereby providing investors with more transparent and reliable
financial information. However, the legal and institutional framework in Bangladesh is weak. In
particular, it is characterised by a less developed capital market (World Bank, 2009), a weak form of
market efficiency (Islam and Khaled, 2005), lack of shareholder activism, poor investor protection
and poor regulatory enforcement and monitoring (Siddiqui, 2010). Furthermore, most of the
investors have very little awareness of the corporate social as well as financial disclosures.
Here, the culture of disclosures by corporate body is mainly influenced by the requirements of the
Companies Act and the regulations of the Security Exchange Commission (Muttakin and Khan,
2014). Collectively, all these institutional characteristics could be conducive for managerial
opportunism and expropriation of minority shareholders as well as other stakeholders. A possible
way of diverting stakeholders’ attention on continuing managerial opportunism could be by
engaging in some sort of so‐called “CSR‐related activities”. Thus, managers in Bangladeshi firms
could use CSR disclosures practices to mitigate the impact of their opportunistic behaviour.
Accordingly, it is expected that managers of Bangladeshi firms could use CSR disclosures to
manipulate earnings. We therefore propose the following hypothesis:
H1. There is a positive relationship between the level of CSR disclosures and earnings accruals.
On the other hand, as discussed before, a number of recent studies (for example, Belal and Owen,
2007; Islam and Deegan, 2008; Khan et al., 2013) have identified pressure from important
stakeholders, such as international buyers, as a critical factor for making CSR disclosures. This means
that despite poor legal and institutional settings, managers in export‐oriented industries may have
sufficient incentives to provide more CSR disclosures to allay any potential concerns of their foreign
buyers. They are also motivated to provide more transparent information in terms of reported
earnings. To test this claim, we propose the following hypothesis:
H2. There is a negative association between the level of CSR disclosures in export‐oriented
industries and earnings accruals.
5. Methodology
5.1 Sample The sample selection procedure is reported in Table I. The sample consists of all 135 non‐financial
companies listed on the Dhaka Stock Exchange (DSE) in Bangladesh from 2005 to 2009. This study
selects year 2005, as the corporate governance code was introduced from 2005 which is likely to
have some influences on CSR practices and disclosures. Moreover, from 2005, the foreign buyers’
social codes of conduct[2] were introduced, with non‐compliance with codes resulting in
cancellation of orders (Rashid, 2006). We limit the analysis to 2009 because that is the latest year of
annual reports available when the research project begins. Our study period produces a total sample
of 675 sample year observations. Due to missing information, we excluded 95 firm year
observations, yielding a final sample of 580 firm year observations. The data are derived from many
sources of secondary data. We collected the financial and ownership data from the annual reports of
sample companies listed on the DSE. Social responsibility information was collected from CSR
disclosures, corporate governance disclosures, director reports, chairperson statements and notes to
the financial statements contained in annual reports.
The sample consists of the following sectors: cement (7), ceramics (4), engineering (19), food (21),
jute (3), paper and printing (2), pharmaceuticals (21), tannery (5) textile (23) and miscellaneous (11).
5.2 Model specification The following model is used to test our hypotheses:
Where,
DACC = discretionary accruals; CSRD = corporate social responsibility disclosures score/index; FSIZE = firm size; MB = market‐to‐book; LEV = leverage; LOSS = loss dummy; FAGE = firm age; LAGTACC = lagged total accruals; and AUD = auditor dummy.
In the above model, DACC is the dependent variable and CSRD is the independent variable. The level
of discretionary accruals (DACC) is a measure of earnings management. The control variables include
are firm size (FSIZE), market to book (MB) ratio, leverage (LEV), loss dummy (LOSS), firm age (FAGE)
and lagged total accruals (LAGTACC).
We follow previous studies and control for firm size by taking a natural log of book value of assets
(see for example, Klein, 2002; Setia‐Atmaja et al., 2011). Following previous studies, we take market‐
to‐book ratio as one of our control variables measured as market value of equity divided by the book
value of shareholders’ equity (Klein, 2002). Managers have incentives to use accounting discretion
when they are close to a debt covenant violation and leverage may capture such incentives (Klein,
2002). Leverage is calculated as the ratio of book value of total debt to book value of total assets.
Firms with negative earnings are associated with greater discretionary accruals (Wang, 2006). Hence,
we use a dummy variable equals “1” when a firm has negative earnings in a particular year and
otherwise “0”. Consistent with Kim et al. (2012), we include firm age to control for the potential
effect across different developmental stages of the business. Firm age is calculated as the natural log
of the number of years since firm inception. Accruals are mean reverting, with the majority of the
mean reversion occurring within a year (Dechow et al., 1995). A high level of lagged total accruals
will probably reduce managers’ ability to manage current period reported earnings upward and vice
versa. Therefore, we control for the total accruals of the previous period (Koh, 2003). Previous
research suggests that large audit firms (Big 4) are considered to be more effective monitors of the
financial reporting process compared to smaller businesses (Francis, 2004; Francis and Krishnan,
1999). Therefore, we use a dummy variable equals 1 and otherwise 0 to control for the effect of
auditor type on the level of discretionary accruals. We also use year dummies and industry dummies
for different industrial sectors.
5.3 Independent variable – corporate social responsibility disclosures indices
The CSRD index represents the dependent variable in this study. To assess the extent of CSR
disclosures in annual reports, a checklist containing 20 items was constructed (see Appendix) based
on previous Bangladeshi CSR studies (Rashid and Lodh, 2008; Khan et al., 2013).These 20 items are
related to six themes (community, environment, employee, product and service and value‐added
information) which have applicability to the Bangladeshi environment. A dichotomous procedure is
applied whereby a company is awardeda1 if an item included in the checklist is disclosed and 0 if it is
not disclosed. We do not penalise a firm for non‐disclosures if the item is not relevant to the firm.
Such a judgement can be made after reading the entire annual report (Cooke, 1992). Accordingly,
the CSRD index is derived by computing the ratio of actual scores awarded to the maximum score
attainable (20) by that company (Ghazali, 2007). Following Haniffa and Cooke (2002, 2005), the CSRD
index is calculated as follows:
Consistent with prior disclosure index studies (Botosan, 1997; Gul and Leung, 2004), we use the
Cronbach’s coefficient alpha (Cronbach, 1951) to assess the internal consistency of our disclosure
index. The coefficient alpha for the five different information categories in our disclosure index is
0.702. This statistic provides a good support in the situation where the set of items in the disclosure
scoring index captures the same underlying construct[3].
5.4 Dependent variable – earnings management There are a number of proxies available to measure earnings quality (see, for example Mouselli et
al., 2012; Beattie, 2005; Wang, 2006). We use the level of discretionary accruals (absolute value) as
our proxy of earnings quality. Furthermore, we use a cross‐sectional version of the modified Jones
model (Dechow et al., 1995) to measure discretionary accruals due to its superior specification and
less restrictive data requirements[4]. Under this model, the level of discretionary accruals for a
particular firm is calculated as the difference between the firm’s total accruals and its non‐
discretionary accruals (NDAC), as estimated by the following equation:
We use a cash‐flow approach to estimate total accruals (Jones and Hensher, 2007; Hribar and
Collins, 2002). This approach involves deducting the cash flow from operations obtained from the
statement of cash flows from the amount of net income (before extraordinary items) from the
income statement.
6. Results Table II provides the descriptive statistics for the variables used in this study. The average disclosure
score is 0.223 (median = 0.20). The average level of discretionary accruals (DACC) is 0.119. The
average level of firm size (FSIZE) is 8.70. The average market‐to‐book (MB) ratio is 2.23. On average,
21 per cent of our sample observations have incurred net losses.
Table III presents the correlation matrix among the designated variables. The CSRD score is positively
correlated with the level of DACC (p = 0.160). However, the CSRD score is negatively correlated with
loss (LOSS) (p = ‐0.139) and leverage (LEV) (p =‐0.192) and positively correlated with MB (p = 0.213).
Our dependent variable DACC is negatively correlated with Big 4 auditor (AUD) (p = ‐0.049), firm age
(FAGE) (p =‐0.069) and FSIZE (p = ‐0.096). This variable is also positively correlated with loss (LOSS) (p
= 0.008) and leverage (LEV) (p = 0.308).
Table IV reports the mean values of the explanatory variables under analysis across the CSRD scores
for both firms with a score higher than the median and those with a score lower than the median. To
test the statistical significance of the mean differences in different variables between both groups of
firms, we perform a t‐test. It can be observed that firms with a CSRD score higher than the median
have a higher level of DACC, LEV, FAGE and MB. Although firms disclosing more on CSR activities are
larger than those providing less disclosure, this difference is not statistically significant. Our analysis
further reveals that other variables such as LOSS and LAGTACC differ significantly between both
groups of firms.
Table V presents the results of regressing CSRD index on the level of discretionary accruals (DACC). In
model 1, we report the relationship between these two variables using the full sample. We find a
positive significant coefficient (β = 0.215, p < 0.05) for the CSRD variable. This implies that a higher
CSRD index results in more discretionary accruals (DACC). In other words, a higher CSRD index is
associated with more earnings accruals, resulting in lower‐quality earnings. This supports H1 and
implies that a possible way of diverting stakeholders’ attention on continuing managerial
opportunism could be by engaging in some sort of CSR‐related activities. Thus, managers in
Bangladeshi firms might possibly use CSR disclosures as a tool to mitigate their opportunistic
behaviour. Our result is consistent with the findings of Prior et al. (2008) who also document a
positive relationship between CSR disclosures and earnings management and contend that CSR
disclosures allow managers to reduce the likelihood of earnings management practices being
scrutinised by the firm’s stakeholders. Our findings could partially be explained by the weak
regulatory environment in Bangladesh and lack of awareness of corporate disclosures as well as
shareholder activism. The level of discretionary accruals is also influenced by other factors. In
particular, we find that FSIZE and AUD have a negative impact on the level of DACC, while LEV and
LOSS have positive impacts. The coefficients of these control variables are statistically significant.
In model 2, we explore the impact of CSRD index on the level of discretionary accruals (DACC) in
export‐oriented industries. Bangladesh is currently the world’s second largest exporter of textile
products. The textile industry is by far the most important industry in Bangladesh, as it generates
more than 80 per cent of the export earnings of the country. However, the industry and its large
foreign buyers (such as J. C. Penney, WalMart, etc.) do attract criticism from the international press
due to poor working conditions and levels of wages offered to workers. Islam and Deegan (2008)
report that multinational buyers now expect manufacturers in Bangladesh to attend to various social
and environmental issues, and failure to meet such expectations may lead to loss of supply
contracts. Belal and Owen (2007) also identify pressures from international buyers in the textile
industry in Bangladesh as an “extremely potent factor” influencing CSRD practices (Belal and Owen
2007, p. 485).
In a recent empirical study, Khan et al. (2013) document that although managerial ownership
generally has a negative relationship with the level of CSRD; such a relationship is significant and
positive for export‐oriented industries. This suggests that managers in export‐oriented firms may
have external pressures to provide more CSR disclosures.
To investigate whether such pressure by powerful international buyers influences companies to
provide transparent information, we create an interaction variable between the CSRD index variable
and the textile industry (EXP) variable. We find that CSRD has a positive but insignificant coefficient.
However, we document a negative significant coefficient of the interaction (CSRD*EXP) variable (β = ‐0.116, p < 0.05), indicating a moderating effect of export‐oriented industries on the positive
relationship between CSRD and level of DACC. In other words, there is a negative relationship
between CSRD index and discretionary accruals in the export‐oriented industry. Thus, our H2 is
supported. Our results imply that in export‐oriented industries, Bangladeshi firms disclosing more
CSR activities could provide more transparent financial reports through constraining earnings
management. Consistent with the stakeholder theory, our result suggests that managers do care
about ethics and accountability when there is pressure by a powerful stakeholder group. Our
findings further suggest the important role played by international buyers in promoting transparent
financial reporting by the export industry.
To gain further insight on whether the results concerning the CSR disclosures effect are driven by
either income increasing or decreasing earnings management, we run regressions separately for
sub‐samples of income increasing and decreasing absolute discretionary accruals (DACC). In models
3 and 4, we run the analysis using positive discretionary accruals. The observations with positive
discretionary accruals are consistent with income increasing discretionary accruals. In model 3, we
find that CSRD has a positive significant coefficient (β = 0.274, p < 0.01). This finding suggests that
firms reporting more CSR disclosures use income increasing discretionary accruals (DACC) to
overstate the earnings. In model 4, we find that CSRD has a positive significant coefficient (β = 0.215, p < 0.05), implying once again that a higher level of CSRD is associated with more income increasing
accruals. However, we find a negative significant coefficient for the interaction (CSRD*EXP) variable
(β = ‐0.046, p < 0.05), indicating a moderating effect of export‐oriented industries on the positive
relationship between CSRD and income increasing discretionary accruals (DACC).
In the next two models, we perform the same analysis using negative discretionary accruals. The
firm year observations with negative discretionary accruals are consistent with income decreasing
discretionary accruals. In models 5 and 6, we find that CSRD and the interaction of CSRD and the
export industry dummy variable (CSRD*EXP) have insignificant coefficients. Overall, this implies that
the level of discretionary accruals is not significantly associated with income decreasing
discretionary accruals.
We have undertaken several analyses to check the robustness of our results. Whilst we do not
report the results due to considerations of space, they are available on request to the authors. First,
prior research shows that the level of CSRD can also be influenced by a number of factors including
the level of discretionary accruals. In other words, the level of CSRD can be endogenous.
Accordingly, we perform the Hausman test proposed by Davidson and Mackinnon (1993), to test
whether CSRD is endogenously determined in the model examining the level of DACC. This is done
by regressing CSRD on the explanatory and control variables used to explain the dependent variable
as well as an instrumental variable that is correlated with CSRD in our first OLS regression. Then, the
residual from this first regression, is used as an additional regressor in equation (2) for the DACC
regression. If a sample firm belongs to an environment‐sensitive industry, we use an environment
dummy variable equal to 1 and otherwise 0.The results of the second regression suggest that the
residual obtained in the first regression is not significantly different from zero. This suggests that
CSRD is not endogenously determined in our dataset, thereby justifying our decision to report the
analysis without accounting for potential endogeneity. Second, an OLS regression test was
conducted by using the natural logarithm value of the CSR disclosures scores as the dependent
variable. Rerunning all the models (1 to 6) on this basis shows that our results do not differ
significantly from those contained in Table V. Third, consistent with Kothari et al. (2005), we
estimate discretionary accruals‐based earnings management after controlling for financial
performance (i.e. return on assets [ROA]). Our results are consistent with the findings reported in
Table V.
7. Conclusions This paper examines the association between the level of CSR disclosures and earnings quality in an
emerging economy using Bangladesh as a case. We use earnings management, measured by the
level of discretionary accruals, as a proxy of earning quality. Consistent with the stakeholder theory,
a firm is influenced by different stakeholder groups in the society and reports its activities
accordingly through CSR disclosures. Because socially responsible firms expend resources for
implementing CSR practices to meet social expectations, it is expected that they will report better
quality earnings through constraining earning management. However, the weak legal and
institutional characteristics as well as lack of awareness of corporate disclosures practices in
Bangladesh suggest that CSR disclosures allows management to reduce the likelihood of earnings
management practices being scrutinised by the firm’s stakeholders. Therefore, we hypothesised a
positive association between CSR activities and earnings management practices proxied by
discretionary accruals.
More specifically, in line with the view that managers have the incentives to behave
opportunistically and then use CSR disclosures to shift the focus of stakeholders from managerial
opportunism, our results suggest a positive relation between the level of CSR disclosures and
earnings management measured by discretionary accruals. Furthermore, we document that firms
that provide more CSR disclosures overstate their earnings through income increasing discretionary
accruals. We also find a significant negative interaction between CSR disclosures and export‐oriented
industries affecting the level of discretionary accruals. This implies that CSR engagement induced by
managerial opportunism will be less prominent in export‐oriented industries. This is consistent with
the notion that pressure from powerful stakeholders, rather than efficiency incentives, are the
drivers for such disclosures.
The findings of this study are significant for both investors and policymakers. Investors should not
take for granted that firms engage in CSR activities, behave ethically and provide transparent
financial reports. As we document that firms might manipulate earnings through discretionary
accruals and provide less transparent financial reports to shareholders, the credibility of firms’ CSR
policies could be assessed with caution. Policies directing at promoting socially responsible practices
instead of motivating the desired behaviour, may provide managers with additional incentives to
utilise CSR for opportunistic behaviour. Thus, policymakers need to be cautious about this
opportunistic behaviour and enhance monitoring to enforce social compliance. Possibly, some
guidelines can be introduced to confirm that CSR disclosures are based on actual practice and not
just a “wishy‐washy” statement to deceive stakeholders.
The result of this study should be carefully interpreted. Although we conjecture that earnings
management by Bangladeshi companies are driven by opportunistic motive, previous research
suggests that managers might manage earnings due to altruistic motive, speculative motive or
pressure from affiliates. This could normally be identified through a qualitative study using either a
questionnaire or a survey‐based methodology. A natural extension of our work is to focus on more
specific dimensions of a firm’s CSR to identify the most relevant stakeholders that a firm particularly
takes into account when it manages its earnings. We provide some initial evidence in this direction,
given that foreign buyers could be crucial target stakeholders for any manager concerned about
entrenchment. Also, it may be worth conducting this analysis by examining different sectors and
institutional frameworks. Another extension that we did not explore in this paper is ownership
structure. We expect a different connection between CSR and earnings management when the large
shareholders are institutions instead of individuals. Having just one independent variable could be a
limitation of our study, as determining the CSR index involves subjectivity. Finally, the development
of richer analytical models of earnings management that incorporate ethical considerations is an
objective that should be addressed in future research.
Notes 1. According to the Bangladesh Bureau of Statistics, the industrial sector contributed around
18% of the GDP in 2009.
2. The fundamental principles of the Code of Conduct have been adopted from the principles
of international human rights norms as outlined in International Labour Organization Conventions,
the United Nations Convention on the Rights of the Child and the Universal Declaration of Human
Rights. These are as follows: child labour, forced labour, health and safety, compensation, working
hours, discrimination, discipline, free association and collective bargaining and management systems
(Jennings and Maillard, 2000).
3. Botosan (1997) obtains a coefficient alpha computed on standardised data of 0.64. Gul and
Leung (2004) compute a coefficient alpha of 0.51.
4. Various discretionary accruals models of earnings management suffer from estimation
errors and are always subject to criticism (see, for example, Dechow et al., 1995). A major limitation
of this research is that existing techniques for measuring discretionary accruals lack power, as the
existing models have poor ability to isolate discretionary accruals. Furthermore, tests using these
techniques are misspecified due to correlated omitted variables in samples with extreme financial
performance, a situation that is not uncommon in tests for earnings management. Alternative
techniques have been proposed for identifying discretionary accruals (Dechow and Dichev, 2002),
but offer minimal improvements over previous models.
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Appendix CSR disclosure items:
(1) Community involvement:
• Charitable donations and subscriptions.
• Sponsorships and advertising.
‐ Community program (health and education).
(2) Environmental:
• Environmental policies.
(3) Employee information:
• Number of employees/human resource.
• Employee relations.
• Employee welfare.
• Employee education.
• Employee training and development.
• Employee profit sharing.
• Managerial remuneration.
• Workers’ occupational health and safety.
‐ Child labour and related actions.
(4) Product and service information:
• Types of products disclosed.
• Product development and research.
• Product quality and safety.
• Discussion of marketing network.
• Focus on customer service and satisfaction.
‐ Customer award/rating received.
(5) Value‐added information:
• Value‐added statement.
About the authors Mohammad Badrul Muttakina is a Lecturer at School of Accounting Economics & Finance, Faculty of
Business & Law, Deakin University. His main research interest includes corporate governance in
emerging market and corporate social responsibility reporting. He publishes research articles in
Journal of Business Ethics, Journal of Accounting in Emerging Economies and Corporate Board: Role,
Duties & Composition.
Arifur Khan completed his PhD from Monash University, Australia. His current research interests
include corporate governance, audit pricing and financial reporting and policy choice. He has
published his research in a number of academic journals including Corporate Governance: An
International Review, Journal of Business Ethics, Australian Journal of Management and Accounting
Research Journal.
Mohammad I. Azim is a Senior Lecturer in Accounting at Swinburne University of Technology. He has
over 12 years of teaching experience in Accounting and Finance. Prior to commencing at Swinburne
University, Mohammad previously held appointments at the University of South Australia, Australian
National University, University of Adelaide and University of Canberra. He has published two books,
number of research articles and in many conference papers. Mohammad I. Azim is a corresponding
author and can be contacted at: [email protected]