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Acc. Fin. Review 2 (2) 15 – 25 (2017)

GATR JOURNALS

State Ownership, Family Ownership, and Sustainability Report Quality: The Moderating Role of Board Effectiveness

Astrid Rudyanto* Trisakti School of Management, Jl. Kyai Tapa No 20, 11440, Jakarta, Indonesia

ABSTRACT

Objective – This research analyzes the effect of state ownership, family ownership, and the effectiveness of the board’s moderating role on sustainability report quality of Indonesian companies. Methodology/Technique – Sustainability report quality is a factor analysis of percentage of disclosure quantity score with GRI G3 and G4 (content analysis), the natural logarithm of the number of pages, existence of opinion, and existence of an independent party assessment on GRI application check, independent party assessment. Board effectiveness is divided into three categories: independence, size, and competence. Findings – Using data of 123 companies listed on the Indonesian Stock Exchange between 2010 and 2014, it is found that state ownership, board effectiveness based on independence, and competence positively affect sustainability report quality while family ownership and board effectiveness based on size do not affect sustainability report quality. For board effectiveness moderating role, board effectiveness based on independence and size strengthen state ownership effect on sustainability report quality. Meanwhile, board effectiveness does not weaken family ownership effect on sustainability report quality. Novelty – This research contributes to literature regarding the relationship between corporate governance and sustainability report quality, particularly the effectiveness of a board’s moderating role to sustainability report quality, which is scarcely researched. Type of Paper: Empirical

Keywords: Sustainability Report Quality; State Ownership; Family Ownership; Board Effectiveness; Corporate Governance; Stakeholder. JEL Classification: G32, M41, Q56. _______________________________________________________________________________________

1. Introduction

Indonesia has the highest rates of corporate social responsibility reporting in the world (due to mandatory reporting) but does not fall within the top 12 states with the highest corporate social responsibility report quality (KPMG International, 2015). The mandatory corporate social responsibility report required in Indonesia is reported along with an annual company report. Chen, Miao, & Shevlin (2015) state that the measurement of report quality uses voluntary reporting. Therefore, voluntary reporting, such as sustainability reporting, is a useful measure. In five consecutive years, the winners of overall best sustainability report from the * Paper Info: Received: November 9, 2016

Accepted: April 12, 2017 * Corresponding author:

E-mail: [email protected] Affiliation: Trisakti School of Management, Indonesia

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16 Acc. Fin. Review 2 (2) 15 – 25 (2017)

Sustainability Report Award held by the National Center for Sustainability Reporting came from state-owned

companies (National Center for Sustainability Reporting, 2010-2015). La Porta, Lopez-de-Silanes & Shleifer

(1999) and Claessens, Djankov & Lang (2000) found that the most common type of controlling shareholders

among large corporations around the world, including Indonesia, are state and family members. Is the low

quality of Indonesian sustainability reports due to the fact that Indonesia has one of the largest population of

family-owned-companies? Sustainability report quality depends intimately on the corporate governance

structures of a company (McKoy, 2011). This dependency comes from the effectiveness of a company’s

monitoring role (Chtourou, 2003). Bethel and Liebeskind (1993) state that shareholders with a significant

ownership have the power to monitor the executive members and have the influence to bring about changes in

line with what they feel is important for the company, for example, corporate social responsibility. This

research aims to obtain empirical evidence about the effect of state ownership and family ownership on

sustainability report quality in Indonesia with board effectiveness as a moderating variable. This research is

important for highlighting the impact of ownership on the quality of Indonesian companies’ sustainability

reporting and to determine whether the board effectiveness is able to increase sustainability report quality. This

research provides a valuable contribution in revealing the effect of state ownership and family ownership on

sustainability report quality, which is the subject of little scholarly discussion.

2. Materials and Methods

Sustainability report quality depends on how social responsibility information is disclosed (Leitoniene &

Sapkauskiene, 2015). There is no unified standard to measure sustainability report quality. Man (2015) defines

three methods to measure sustainability report quality that have been used in previous research: disclosure

extent, disclosure index based on breadth, and disclosure index based on breadth and depth. Disclosure extent

refers to the number of words (ex: Deegan & Gordon, 1996), sentences (ex: Hooks & van Staden, 2011), pages

(Patten, 1992; Guthrie & Parker, 1989), and the proportion of pages (Haron, Yahya, Sharon & Ismail, 2006)

of the sustainability report. This method is not appropriate for measuring the quality of reports because it only

measures quantities. Quantity of content does not represent quality because less pages and words are also

capable of conveying sufficient information for producing a quality report, and lengthy reporting may also

contain irrelevant information (Man, 2015; Hammond & Miles, 2004; Unerman, 2000; Chiu & Wang, 2015;

Al-Tuwaijiri, Christenson & Hughes, 2004) Disclosure index based on breadth relates to the number of items

that a company report contains, using a nominal scale (ex: Khan, Muttakin & Siddiqui, 2013; Buniamin, 2010;

Hackston & Milne, 1996; Dilling, 2009).

However, this approach does not differentiate between disclosing decisions and decision quality (Man,

2015). It also ignores the quality of information (Leitoniene & Sapkauskiene, 2015). Disclosure index based

on breadth and depth is more complex than disclosure index based on breadth because it contains not only the

decision of information existence but also the depth of information reported. That measurement uses an interval

scale, instead of a nominal scale (ex: Gunawan, Djajadikerta & Smith, 2009; Abd-Mutalib, Muhammad Jamil

& Wan-Hussin, 2014; Aerts & Cormier, 2009). However, this approach is not flawless: determining the depth

of information requires a level of subjectivity (Bachoo, Tan & Wilson, 2013; Leitoniene & Sapkauskiene,

2015). Therefore, the best measurement for this research is to combine the disclosure extent and disclosure

index measurements (Man, 2015).

Stakeholder theory indicates that companies have a moral obligation to meet the needs of stakeholders and

balance the potential conflicts between them (Reynolds, Schultz, & Hekman, 2006; Man, 2015; Schrenk, 2006;

Neville & Menguc, 2006; Sen, Bhattacharya, & Korschun, 2006). This is what Fernandez-Sanchez et al (2011)

describes as the social sensibility of corporate governance (SSCG). SSCG is the capacity of a corporate

governance structure to respond to diverse stakeholder interests (Fernandez-Sanchez, Sotorrio & Diez, 2011).

Fernandez-Sanchez, Sotorrio & Diez (2011); Huang (2010) finds that SSCG can be measured by ownership

power and independence as well as the pluralism of the board. Power is the ability to bring a desire into an

outcome or the ability of someone to influence others to do the thing that they would have not done (Mitchell,

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17 Acc. Fin. Review 2 (2) 15 – 25 (2017)

Agle & Wood, 1997). The level of ownership power determines the power that an owner has to interpret his

moral value towards society in the company. The ownership power used in this research is state ownership and

family ownership as the largest ownership types in Indonesia (La Porta, Lopez-de-Silanes & Shleifer, 1999;

Claessens, Djankov & Lang, 2000). Independence and pluralism of the board are used as the SSCG

measurement because the board of commissioners not only act as monitoring agents, but also manage

stakeholders and enhance corporate social performance (Fernandez-Sanchez, Sotorrio & Diez, 2011; Carroll,

1979). Therefore, board effectiveness (which has inherent independence and pluralism) is used in this research.

Where the government is the owner of a company, concerns regarding the corporate social responsibility

of that company arise. There are several reasons why the government is interested in corporate social

responsibility. Firstly, corporate social responsibility is concerned with distributing company resources to the

public, which reflects the objectives of government bodies (Liston-Heyes & Ceton, 2007). Secondly,

government, as the most trusted body in a country, has to meet the needs and expectations of the stakeholders

(Muttakin & Subramanian, 2015). Government power as a shareholder, through state-owned companies,

therefore, affects the company’s social responsibility report in two ways. First, the government as a shareholder

can impose a particular regulation regarding corporate social responsibility reporting (Heath & Norman, 2004;

Toms, 2002). Second, state-owned companies are more politically-visible companies (Ghazali, 2007; Dincer,

2011). Muttakin & Subramanian (2015), Eng & Mak (2003), Ghazali (2007), Dincer (2011) found a positive

effect of state ownership on sustainability reporting. Given the nature of mandatory corporate social

responsibility reporting in Indonesia (Indonesia Company Act No 47/2007, Indonesia Company Act No

25/2007), and the government’s success in encouraging sustainability reporting through the implementation of

rules (Sinaga, 2017), it is hypothesized that state ownership positively affects sustainability report quality.

H1: State ownership positively affects sustainability report quality.

A sustainability report is a report that companies provide to lessen information asymmetry between

informed insiders and uninformed investors (Bachoo, Tan & Wilson, 2013; Lu & Chueh, 2015; Lopatta,

Buchholz & Kaspereit, 2015; Cormier, Ledoux & Magnan, 2011; Martinez-Ferrero, Rodrı´guez-Ariza,

Cuadrado-Ballesteros & García-Sánchez, 2017). Research by the Prince’s Accounting for Sustainability

Project (A4S) and the Global Reporting Initiative (GRI) reveal that sustainability reporting, non-mandatory

reporting of corporate social responsibility, is highly appreciated by analysts and investors. In addition,

research in Indonesia shows that corporate social responsibility disclosure increases companies’ abnormal

return (ex: Randa & Liman, 2012; Utaminingtyas & Ahalik, 2010). However, in family-owned companies,

family members actively participate in the management of the company and act as a director (Ho & Kang,

2013). This may eliminate the potential conflict between informed insiders and uninformed investors, thus

increasing the conflict of majority and minority owners (agency problem type II). Instead of disclosing

information needed by minority shareholders, family-owned companies tend to use the cost of reporting this

information to pursue their private benefits (Shleifer & Vishny, 1997). Block & Wagner (2013) show that

family ownership is negatively associated with community-related CSR performance. Rees and Rodionova

(2014), Wang (2014), Abdullah, Muhammad & Mokhtar (2011), Ho & Wong (2001) also find that family

ownership negatively affects sustainability report quality. In addition, Campopiano & De Massis (2015) state

that family firms are less compliant with social responsibility standards.

H2: Family ownership negatively affects sustainability report quality.

Indonesia adopts a two-tier board structure, dividing boards into the board of directors and the board of

commissioners. The Board of Commissioner’s function is to supervise management in order to act in the

interests of its stakeholders (Handajani et al., 2014). Afanador et al. (2017) states that the board of

commissioner’s job is to supervise the quality of financial and non-financial information, including

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sustainability reports. This research divides board effectiveness into three categories: independence, size, and

competence based on Hermawan (2009). The existence of an independent board may affect corporate social

responsibility as the existence of an outside board plays an important role in overseeing the sustainability report

producing process (Handajani, Subroto & Saraswati, 2014; Muttakin & Subramaniam, 2015; Haniffa & Cooke,

2002; Uwuigbe, Egbide & Ayokunle, 2011; Rouf, 2011). Independent boards can also improve information

quality (Rutherford & Buchholtz, 2007). Large board sizes can increase sustainability report quality because

of the availability of more valuable opinions (Handajani, Subroto & Saraswati 2014; Graf &Stiglbauer, 2009),

however, too many board committees may increase agency problems because of so called ‘free riders’

(Handajani, Subroto & Saraswati, 2014; Uwuigbe, Egbide & Ayokunle, 2011; McConnell & Sarvaes, 1990)

and flexibility and dynamism matters (Cheng, 2008). According to Hermawan (2009), the most effective board

size is 3 to 6 persons. Competence can be defined as a specification and application of knowledge and skills

in the workplace and standards of performance required (Alshareef & Sandhu, 2015). A competent board can

give valuable insight to the company’s business because of their experience, knowledge, and education

background (Hermawan, 2009). A competent board will therefore increase the performance of sustainability

report making and thus increase its quality (Dienes & Velte, 2016; Kruger, 2010).

H3, H4, H5: Board effectiveness based on independence, size and competence positively affects

sustainability report quality.

Agency theory states that the board of commissioner has the role of maximizing shareholder value and

protecting the owner’s interest (Garcia-Torea, Fernandez-Feijoo & Marta, 2016). This is a tough job since

shareholders and owners have different interests. The board of commissioner therefore has to encourage

shareholders and owners to think of future performance horizons, which involves encouraging stakeholders to

have a long-term relationship with the company by utilising corporate social responsibility measures. (Letza,

Sun & Kirkbride, 2004). Eisenhardt (1989) says that an effective board of commissioner makes owners engage

more with the stakeholders’ interest because of the richer availability of information an effective board

provides. In addition, Huang (2010); Garcia-Torea, Fernandez-Feijoo & Marta (2016) find that effective

boards and specific ownership characteristics have a significant effect on corporate social responsibility

performance. An effective board of commissioner in state-owned companies actively oversees the

management of the company’s strategy, rather than fulfilling the state’s expectations (Afanador, Bernal &

Oneto, 2017). However, if state expectations are in line with the company’s needs, an effective board will help

to fulfill those needs. Siagian (2011) examines state-owned companies in Indonesia and finds that state

ownership positively affects corporate governance, implying that state-owned companies are consistent with

the purpose of corporate governance to the protect public interest, which is reflected in sustainability reporting.

By having an effective board, the negative power of family boards on corporate social responsibility can be

reduced. Abdullah, Muhammad & Mokhtar (2011) find that family ownership negatively affects corporate

social responsibility due to board ineffectiveness.

H6, H7, H8: Board effectiveness based on independence, size, competence strengthens state ownership effect

on sustainability report quality.

H9, H10, H11: Board effectiveness based on independence, size, competence weakens family ownership

effect on sustainability report quality.

Sustainability report quality is taken from the results of the factor analysis of a percentage of the disclosure

quantity score with GRI G3 and G4 (content analysis), the natural logarithm of the number of pages, existence

of opinion, and the existence of an independent party assessment of the GRI application check, following Man

(2015), but based on GRI G3 and G4 (Dilling, 2009) and adding independent party assessment. The score for

GRI content analysis is 0 for components that are not disclosed, 1 for components expressed qualitatively, and

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2 for components expressed quantitatively. Board effectiveness (Hermawan, 2009) is a content analysis of

independence, size, and competence. State ownership is the percentage of equity stake owned by the

Indonesian government (Makhija & Patton, 2004). Family ownership, according to Arifin (2003) is measured

by the ownership percentage of all individuals and companies whose ownership is recorded, which is not a

public company, the government, financial institutions or publicly owned. This research uses stakeholder

pressure and profitability as control variables. Stakeholder pressure includes environmental pressure and

employee pressure. Environment pressure is measured using the measurement from Fernandez-Feijoo, Romero

& Ruiz (2014) which is 1 for firms in the agricultural, mining, chemical, machinery, automobile and

components, cables, property, housing, construction, energy, highways, airfields, ports, transport, construction

of non-building, and electronics industries and 0 for all others. Employee pressure (Saka & Noda, 2013) is a

natural logarithm of the number of employees. Profitability is measured by return on equity (Hermawan &

Mulyawan, 2014).

The population used in this study are all companies listed on the Indonesia Stock Exchange between 2010

and 2014. The year 2010 is chosen because in 2010, the ISO member countries (including Indonesia) agreed

to the issuance of ISO 26000 Guidance on Social Responsibility which provides guidelines for the

implementation of corporate social responsibility. ISO 26000 is also associated with GRI-measured

sustainability reporting.

3. Results

The number of samples includes 123 observations of 37 companies. The majority of the samples are in the

financial services industry (26.01%). The industries with the least sustainability reporting are trade, service,

and investment (retail industry) (3.25%). Descriptive statistics are presented in Table 1.

From Table 2, it can be concluded that state ownership positively affects sustainability report quality.

Therefore, H1 is accepted. Meanwhile, family ownership has no effect on sustainability report quality. H2 is

therefore not accepted. Board effectiveness based on independence and competence positively affects

sustainability report quality, however board effectiveness based on size has no effect. Therefore, H3 and H5 are

accepted and H4 is not accepted.

Table 3 describes the moderating effect of a board. This research finds that board effectiveness based on

independence and size strengthens state ownership effect on sustainability report quality while board

effectiveness based on competence fails to strengthen its effect. Therefore, H6 and H7 are accepted and H8 is

not accepted. Board effectiveness based on independence, size, and competence also fails to weaken the effect

of family ownership on sustainability report quality. Hence, H9, H10, and H11 are not accepted. In addition, this

research attempts to determine the overall moderating effect of a board of commissioner on sustainability

report quality. Altogether, board effectiveness strengthens the positive effect of state ownership on

sustainability report quality (sig=0,008) but does not weaken the effect of family ownership on sustainability

report quality.

Table 1. Descriptive Statistics

Variable Min Max Mean SD Variable Min Max Mean SD

QUAL -2.02 2.66 .00 1.00 BOCCOMP .42 1.00 .74 .15

GOV .00 .80 .27 .31 ESI .00 1.00 .67 .47

FAM .00 .97 .18 .30 EMP 5.44 12.33 8.71 1.46

BOCIND .50 .97 .76 .09 PROFIT -.53 .43 .17 .12

BOCSIZE .33 1.00 .85 .18

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Table 2. Test Result without a Moderating Effect

Variable t Sig Variable t Sig Variable t Sig

Constant -3.164 .002 BOCIND 2.180 .031* ESI 2.601 .011*

GOV 2.235 .027* BOCSIZE .674 .502 EMP .888 .376

FAM 1.251 .214 BOCCOMP 1.667 .098** PROFIT 2.336 .021*

*significant in 5% **significant in 10%

Table 3. Test Result with Moderating Effect

Variable t Sig Variable t Sig Variable t Sig

Constant -1.05 .294 BOCCOMP .151 .880 BOCSIZE*GOV 2.161 .033

GOV -3.64 .000 ESI 1.07 .287 BOCCOMP*GOV .596 .552

FAM 1.07 .286 EMP .418 .677 BOCIND*FAM -1.290 .200

BOCIND .297 .767 PROFIT 2.84 .005 BOCSIZE*FAM -.860 .391

BOCSIZE .875 .383 BOCIND*GOV 3.69 .000 BOCCOMP*FAM 1.004 .317

4. Discussion

State ownership positively affects sustainability report quality. These results are consistent with Dincer

(2011), Muttakin & Subramaniam (2015)). However, family ownership does not affect sustainability report

quality. This is not supported by Chau & Gray (2002), Barakat, Lopez-Perez & Rodriguez (2014), Khiari &

Karaa (2013). Gavana, Gottardo & Moisello (2016) which state that family firms are more sensitive to media

exposure and therefore, they enhance sustainability disclosure. The conflict between media exposure and

agency theory suppresses the effect of family controlled firms on sustainability report quality. Board

effectiveness based on independence and competence also positively affects sustainability report quality, but

board effectiveness based on size does not affect sustainability report quality. The result of H3 is supported by

Muttakin & Subramaniam (2015), Chau & Gray (2010). The result of the H4 is not supported by Rao, Tilt &

Lester (2012), Handajani, Subroto & Saraswati (2014). This might be due to different measurement being used

in this research. Huse, Nielsen & Hagen (2009); Kiel and Nicholson (2003) state that the most effective board

size is between 5 to 9 people. The result of H5 is supported by Alshareef & Sandhu (2015), Ingley & van der

Walt (2008).

Board effectiveness based on independence and size strengthens state ownership’s positive effect on

sustainability report quality. Board independence affects sustainability report quality and strengthens state

ownership effect on sustainability report quality. Muttakin & Subramanian (2015) find that board

independence, along with state ownership, increases the availability of community information. Board

effectiveness based on board size has no effect on sustainability report quality but increases state ownership

effect on sustainability report quality. The Indonesian government only needs support from 3 to 6 board

members to produce a high sustainability report quality. Board effectiveness based on competence affects

sustainability report quality, but state ownership does not need board competence to produce a high quality

sustainability report. Board effectiveness fails to weaken family ownership effect on sustainability report

quality which does not support the statement of Abdullah, Muhammad & Mokhtar (2011). Lam & Lee (2012)

state that the effect on the effectiveness of a board on company performance is contingent on family ownership.

It can be concluded that the quality of sustainability reports in Indonesia is still low, as demonstrated by the

low number of opinions on sustainability reports and independent party assessment on GRI application checks.

The small number of sustainability reports show that companies in Indonesia are still unaware of the

importance of corporate sustainability reporting to the public. However, the quality of sustainability reporting

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in Indonesia is increasing year by year, from 19 reports in 2010 to 32 reports in 2014. High levels of board

effectiveness and environmental pressure are common characteristics of companies who publish a

sustainability report.

5. Conclusion

The question of why Indonesia has low sustainability report quality is not the result of family ownership

(consistent with Rudyanto & Siregar (2016), Hirigoyen & Poulain-Rehm (2014)). The findings show that the

Indonesian government plays significant role in sustainability report quality whilst board independence and

size strengthen its role. On the other hand, as one of the top five largest family-owned-company countries,

Indonesian family-owned companies have the same social awareness as others and board effectiveness does

not play any moderating role. It can be concluded that board effectiveness only assists ownership in reporting

social responsibility when ownership has a positive effect on it. Shareholders can find this study useful in

selecting board members and considering state companies as a mechanism for enhancing socially responsible

investments, and not being afraid of investing in family-owned companies. This study also highlights the need

of higher sustainability report quality in Indonesia. However, this research is limited as it focuses only on the

effects of a controlled size of company and a certain year period of study, and other types of stakeholder

pressure.

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