Accounting Research Journal

Do governance mechanisms deter earnings management and promote corporate

social responsibility?
Eko Suyono, Omar Al Farooque,
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Corporate social
Do governance mechanisms deter responsibility
earnings management and
promote corporate social
responsibility? 479
Eko Suyono Received 11 September 2015
Revised 29 June 2016
Department of Accounting, Jenderal Soedirman University,
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28 December 2016
Purwokerto, Indonesia, and Accepted 7 February 2017

Omar Al Farooque
School of Business, University of New England, Armidale, Australia

Abstract
Purpose – This study aims to investigate the influences of corporate governance mechanisms on earnings
management practices and corporate social responsibility (CSR) disclosure, at the manufacturing companies
listed on the Indonesian Stock Exchange. The authors consider the moderating effect of earnings
management on the relationship between governance mechanisms and CSR.
Design/methodology/approach – Insights are drawn from five years company data generated between
2010 and 2014, thus covering a five-year period. Ordinary least squares (OLS) regression analysis is applied to
test the hypotheses developed.
Finding – OLS regression results indicate that institutional ownership, managerial ownership and
independent boards have a significant deterrent effect on earnings management, while institutional
ownership and board of directors have significant positive impact on CSR. Moreover, OLS results
reveal a strong moderation effect of earnings management and a positive link between governance
and CSR.
Originality/value – These findings have significant policy implications for public policy, regulatory
bodies, companies and other stakeholders including the investors in Indonesia. Insights from this study will
help to shape and implement an optimal governance system that can address the problem of earnings
management and CSR initiatives in Indonesian companies.
Keywords Earnings management, CSR disclosure, Moderating effect, Governance mechanisms,
Indonesian manufacturing companies
Paper type Research paper

1. Introduction
Extant literature on agency theory suggests divergence of interests and asymmetric
information problems between owners and managers (Jensen and Meckling, 1976; Fama
and Jensen, 1983) as well as controlling and noncontrolling shareholders (Shleifer and
Vishny, 1997; Villalonga and Amit, 2006). Insiders have more information about the
company than outsiders, which creates a condition of asymmetric information problem
leading the insiders to extract private benefits at the expense of the minority
shareholders and resulting in lower quality of reported earnings, manipulation and Accounting Research Journal
fraud (Healy, 1985). Vol. 31 No. 3, 2018
pp. 479-495
To mitigate these problems, a significant monitoring system, such as corporate © Emerald Publishing Limited
1030-9616
governance mechanisms are installed within the firm (Shleifer and Vishny, 1997). Corporate DOI 10.1108/ARJ-09-2015-0117
 ARJ governance is expected to reduce information asymmetry and nonaligned interests because
31,3 the agent will provide accurate information to the principal when the conflict of interest is
low (Kanagaretnam et al., 2007). However, despite substantial improvement in corporate
governance mechanisms, accounting manipulation and scandals are evident in recent years,
and these are attributed to poor corporate governance and low-quality earnings problems.
Earnings management (hereafter EM) is a managerial discretionary effort of taking
480 deliberate steps to bring about the desired level of reported earnings. EM occurs when
managers exercise their discretion over accounting numbers, with or without restrictions.
As suggested by Vander et al. (2003), managers may be inclined to manage earnings due to
the existence of the firm’s explicit and implicit contracts, relation with capital markets and
need for external financing, regulatory environment and political or several other specific
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circumstances. Dou et al. (2013) argue that the EM practices are greater in a country with a
weak legal system and in an industry where relationship-specific investments between
firms and suppliers are more important (i.e. in the manufacturing sector).
Corporate social responsibility (hereafter CSR) is recognized as a responsibility of
businesses to support the expectations of the society and stakeholders in the
environmental, social and economic aspects. It remains as a voluntary disclosure for long
period of time until now though has recently been getting more attention of the managers
because of stakeholder pressure and perceived benefits for the firms. With greater CSR
disclosure a firm can achieve the lower cost of capital, increased market share,
institutional ownership, reputation and so forth, than their counterparts. However, such
benefits may disappear in the presence of EM (Francis and Wang, 2008). Given the
benefits of CSR, it can also be argued that managers may engage in CSR not as in its
original purpose of showing company stewardship to the surrounding social
environment but more in pursuit of their self-interest or to cover up the effect of corporate
misconduct (McWilliams et al., 2006). Kim et al. (2012) contend that if managers engage in
CSR based on opportunistic incentives, they are likely to mislead stakeholders. In other
words, the CSR disclosure is an effective means by which managers try to hide the EM
activity. Such tendency is more pronounced in manufacturing firms with more complex
financial transactions and high volatility in annual earnings than other firms.
The main research question that this study is grappling with is whether or not
governance mechanisms can, respectively, constrain and promote EM and CSR, and
whether EM has any moderating effect on governance mechanisms in determining CSR.
This approach helps to extend prior studies by examining the link between corporate
governance, CSR and EM. To the best of knowledge, this study is the first in the
Indonesian context, to determine moderating roles of EM on CSR disclosure as measured
by using Global Reporting Initiative (GRI) guidelines. We control a number of
governance variables and assume that EM may lead to high CSR disclosure in
manufacturing companies that are listed on the Indonesian Stock Exchange. The findings
reveal that some corporate governance variables have a deterrent effect on EM as well as
positive effect on CSR. It was found that EM moderates the effects of governance
mechanisms on CSR. These findings have important policy implications for emerging
market like Indonesia that could contribute to the body of literature on corporate
governance, CSR and EM.
The remainder of the paper is structured as follows. Section 2 discusses the literature
and hypotheses development. Section 3 provides details of research methodology. Section
4 discusses the empirical findings, while Section 5 focuses on the discussion and
conclusion of the study.
 2. Literature review and hypotheses development Corporate social
2.1 Literature review responsibility
Corporate governance is a set of rules which deals with the relationship between right and
obligation of stockholders, managers, creditors, government agencies and other related
parties (OECD, 2004). The ownership separation between owners and managers and the rise
of the volume of investors and transactions in capital market trigger the need for good
corporate governance (Cuervo, 2002). The shortcomings in agency relationships stimulate
EM among managers (Jiraporn et al., 2008; Davidson et al., 2004), which has been viewed as 481
a form of agency cost, given that it causes information asymmetry and reduces principals’
understanding of a firm’s performance, which subsequently influences their investment
decisions. Managers have a tendency to engage in EM in situations where the shareholders
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are poorly informed and have limited access to company information, which in turn reduces
their capacity to monitor managers’ behavior (Schipper, 1989; Warfield et al., 1995).
Therefore, high-quality disclosures to shareholders through governance mechanisms can be
a possible solution to the problem of EM, as it decreases information asymmetry and
subsequently deters EM (Kanagaretnam et al., 2007).
Although the literature on the relation between corporate governance and EM and
corporate governance and CSR is abundant, there are fewer studies that examine corporate
governance, EM and CSR relationships jointly. Moreover, unlike research on CSR and
financial performance, research on the relationship between CSR and EM is still lacking and
the studies that exist provide conflicting results. The literature that examines the relation
between CSR and financial reporting behavior (e.g. EM) primarily focuses on the
opportunistic use of CSR within an agency theory framework. The present study, therefore,
uses agency theory to explain the relationship between corporate governance, EM and CSR.
If managers engage in CSR, based on opportunistic incentives, a positive relation between
CSR and EM will be evident. Hemingway and Maclagan (2004) and DeMaCarty (2009) found
a positive relationship between EM and CSR. In a similar vein, Prior et al. (2007) found a
positive relation between CSR and EM for regulated firms rather than nonregulated ones
and argue that CSR could be used strategically to disguise EM. Adding to this debate,
Gargouri et al. (2010) found a positive relation between CSR and EM. Similarly, Petrovits
(2006) provides evidence that firms reporting small earnings increase income-increasing
discretionary charitable foundation-funding choices. Chih et al. (2008) pointed out the
existence of different relationships between CSR and various EM tools, i.e. CSR firms are
more aggressive in accrual management but are less likely to engage in earnings smoothing
and earnings loss avoidance.
More recently, Martinez-Ferrero et al. (2016) found that CSR can be used to shield the
negative effect of discretionary accounting practices on the cost of capital, and it also helps
to cover up for EM practices. Gray et al. (2014) argue for managerial priorities in their CSR
strategies that the voluntary nature of CSR reporting allows the manager to design them to
fit their own interests rather than to benefit the community and stakeholders. Gargouri et al.
(2010), show that managers in companies that indulge in EM are more likely to carry out
CSR, possibly to help them secure their jobs and increase compensation.
Although CSR (Reinhardt et al., 2008) and EM practices (Leuz et al., 2003) vary across
countries given differences in accounting standards, laws and regulations, both practices
have a profound influence on the legal environment and the protection of investors’ rights
(Ball et al., 2000; Leuz et al., 2003; Li et al., 2011). Studies focusing on the CSR of listed
companies in developed countries found negative relationships between CSR and EM using
the perspective of moral obligation and reputational capital, as in Labelle et al. (2010) and
Hong and Andersen (2011). Similarly, Kim et al. (2012) found a negative relationship
 ARJ between CSR and EM, indicating that socially responsible firms are less likely to engage in
31,3 aggressive EM through discretionary accruals and/or real manipulation activities.
Consistent with other studies, Trebucq and Russ (2005) also found a negative relation
between proxies of CSR specifications and EM. The same pattern of results was confirmed
by Choi et al. (2013), who found that CSR ratings are negatively correlated with the level of
EM for all Korean firms, but the relationship becomes weaker for chaebol firms and firms
482 with highly concentrated ownership. This suggests that CSR can be abused by those firms
to conceal their poor earnings quality. On the other hand, the positive association between
EM and CSR is weakened when institutional investors own a high fraction of the shares,
which indicates that these investors serve as active monitors and have long-term investment
horizons.
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Unlike prior studies that highlight managerial incentives in explaining the effect of CSR
on EM, this study examines the moderating effect of EM on the relationship between
corporate governance and CSR. It explores whether the motives for CSR are influenced by
the selected corporate governance variables as well as EM practice.

2.2 Hypotheses development

The aims of this study are:

to examine the link between corporate governance variables and EM;

to determine the link between corporate governance variables and CSR disclosure;
and

to determine the interactions of governance and EM variables (moderation effect).

The hypotheses of the study are developed in three groups as mentioned below.
2.2.1 Link between corporate governance mechanisms and earnings management. Healy
and Wahlen (1999, p. 368) postulate that:
EM occurs when managers use judgment in financial reporting and in structuring transactions to
alter financial reports to either mislead some shareholders about the underlying economic
performance of the company, or to influence contractual outcomes that depend on reported
accounting numbers.
There are numerous situations or incentives that may motivate managers to become
involved in EM to influence stock market perceptions. These include to increase
management compensation, to reduce the likelihood of violations of lending agreements and
to avoid regulatory intervention. EM becomes of particular concern in markets where there
is poor legal protection and ineffective enforcement and the dominance of family owners and
political influence on reporting practices.
Drawing from the literature, this study makes an assumption that governance
mechanisms can effectively constrain EM through appropriate monitoring of executives’
activities. Agency theory suggests aligning managers’ interest with that of shareholders by
including managers in the firm’s ownership structure. Managers usually work in the interest
of firm if they are offered ownership stake in the company rather than carrying out EM
practice. Institutional investors are considered to be more capable to prevent the EM
activities because of their more professional ability in controlling their investment portfolio.
Balsam et al. (2003) argue that significant portion of institutional ownership create a
condition where they can monitor managers which can reduce EM. However, Porter (1992)
and Alves (2012) contend that institutional investors pressure managers to achieve short-
term profit goals at the expense of long-term equity value which influences EM practice. In
 emerging markets, dominating family ownership can create agency cost, as Almeida-Santos Corporate social
et al. (2013) report a positive influence of family ownership on EM in Brazilian companies. responsibility
Again, the board acts as an agent that is responsible for the company’s operating
activities. The larger the number of members on the board, the more ineffective the control
function that gives rise to the probability of EM activities. A board with fewer members can
reduce the possibility of EM activities because of more effective work coordination (NCGP,
2006). Additionally, the effectiveness of board supervision is influenced by how the
company’s board of directors was formed. The existence of the independent board of 483
directors bolsters the optimum control function. Within this context, Chtourou and Bedard
(2001) and Xie et al. (2003) found that EM is less likely to occur in companies with boards
having both more independent outside directors and directors with corporate experience.
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Previous research has also found a significant negative association between the independent
board of director and EM (Beasley, 1996; Klein, 2002; Davidson et al., 2004). Contrary to this,
Park and Shin (2004) and Peasnell et al. (2000) found no significant association between EM
and independence of the board. Moreover, the audit committee ensures the good
implementation of internal control. Krishnan (2005) and Yang et al. (2008) show a significant
negative relationship between the audit committee and EM. Based on the discussion above,
the following hypothesis is developed:
H1. Corporate governance mechanisms (i.e. institutional ownership, managerial
ownership, board of directors, audit committee and independent board of
commissioners/members) have significant deterring/negative effect on earnings
management.
2.2.2 Link between corporate governance mechanisms and corporate social responsibility
disclosure. The CSR disclosure is used by management as a means of communicating with
the public to influence their perception of the company. Thus, the business operations are
managed not only by a company that has more than financial benefits orientation but also a
company that pays attention to the problem of sustainable socio-economic development.
The GRI defines CSR as “a reporting process that divulges the environmental, social and
economic performance of any business to society” (Australian Council of Super Investors
2008, p. 4). Under GRI guidelines, the performance indicators are divided into three main
components, namely, environmental, social and economic. The aspects of the environmental,
social and economic are made up of nine for environmental, 22 for social and three for
economic, which includes a total of 30 indicators relating to the environment, 40 to social
and nine to economic (GRI, 2011).
In the literature, Chau and Gray (2002) argue that the extent of institutional investors is
positively associated with voluntary disclosures, including environmental disclosures.
Huafang and Jianguo (2007) are of the view that institutional ownership has a positive
significant influence on social disclosure in China. They also report that managerial
ownership does not have any significant influence on social disclosure; however,
independent directors have a positive significant influence on social disclosure. Dominating
family ownership also looks after their interest only rather than stakeholders with more
CSR. In Australia, Lim et al. (2007) found a positive association between independent board
and environmental disclosure. Building onto this debate, Post et al. (2011) suggest that a
higher proportion of outside board directors is associated with more favorable CSR
disclosures. On the contrary, Haniffa and Cooke (2002) and Eng and Mak (2003) found a
negative link between independent nonexecutive director and social reporting. Ghazali
(2007) shows that board of directors have a significant influence on CSR disclosure in
Malaysian companies. Gul and Leung (2004) document that the extent to which managers
 ARJ will disclose more corporate information is likely to be affected by the composition and
31,3 quality of the board of directors. Based on the discussion above, the following hypothesis is
developed:
H2. Corporate governance mechanisms (i.e. institutional ownership, managerial
ownership, board of directors, audit committee and independent board of
commissioners/members) have significant promoting/positive effect on CSR.
484
2.2.3 Moderation effect of earnings management on the link between corporate governance
mechanisms and corporate social responsibility disclosure. EM practices in a company pose
a tendency for managers to rely on CSR disclosure as a policy that is intended to benefit the
society, which also could be used as a way to cover up their EM behavior. This notion is in
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line with Prior et al. (2007) who contend that to avoid distrust of the shareholders/
stakeholders in the firms with EM practices, managers create a strategic policy through CSR
aligning to “legitimacy” and “stakeholder” perspectives. Managers in companies that
perform EM tend to be more active in enhancing public image of the company and draw
support from the stakeholders through CSR policy. Barnea and Rubin (2010) argue that
certain CSR may be connected to expropriation. Waddock (2004) and Surroca and Tribo
(2008) also provide evidence that managers engage in a broad array of CSR to justify
stakeholder concessions for their entrenchment. Therefore, it can be asssumed that
sometimes managers try to engage in CSR based on opportunistic incentives just to pursue
their self-interest or to cover up the effect of corporate misconduct or to hide the EM activity
and mislead stakeholders.
Moreover, it is perceived that effective implementation of corporate governance
mechanisms can make the CSR disclosure as a tool that can be used to combine attention to
the social environment into business decision-making process, which is not only beneficial
for investors but also for the wider community. However, this becomes challenging when
CSR are undertaken to hide the EM activities. Aiken and West (1991) and Fairchild and
MacKinnon (2009) emphasize on moderation effects, which is an interaction between
variables where the effects of one variable depend on levels of the other variable in the
analysis. To investigate the underlying reasons for unexpected interaction, or moderation
relation, it may be of interest to investigate the interaction effect of the mediator variable
which predicts the outcome, defined here as the mediation of a moderator effect, i.e. whether
the moderator relation of EM holds across different governance mechanisms in influencing
CSR. Therefore, the following hypothesis is developed to observe whether the moderator
effect depends on levels of EM:
H3. EM has a positive effect on CSR, and it moderates the promoting/positive effects of
corporate governance mechanisms (institutional ownership, managerial
ownership, audit committee, board of directors and independent board of
commissioners/members) on CSR.

3. Research methodology
3.1 Sample and data analysis
The data used in this study are secondary data from financial statements that are available
on www.idx.co.id. As the study relied on GRI guidelines for CSR disclosure, the sample
firms are confined to manufacturing companies listed on the Indonesia Stock Exchange
(IDX). The use of GRI indicators consisting of environmental, social and economic is more
relevant for manufacturing companies than other companies. Also, EM practice is greater in
manufacturing companies with more complex transactions than other companies. The
 following criteria are followed to carry out the sample selection from the population of 131 Corporate social
manufacturing companies for the year 2010 to 2014: responsibility

The manufacturing companies published audited financial statements for 2010 to
2014 periods which end on December 31.

Those companies did not incur loss during the observation period.

Those companies did not involve in acquisition, merger or change of business
groups during the sample period. 485

Those companies have a complete data related to the variables under the study.

Following the criteria, an initial sample of 45 companies was selected. As one of the key
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variables of this study is EM, following Ghozali’s (2006) “normality” of the data test is
performed for discretionary accruals. The Kolmogorov–Smirnov test result indicates that
some data are not normal. To normalize data, 16 companies are dropped from the sample of
45 companies, leaving a study sample of 29 companies. Data “outliers” test is also conducted
following Hair (1998) as cited by Ghozali (2006), and the test results show that all data from
29 companies pass this test. Therefore, the final sample is 29 companies for five years,
producing a total of 145 company years.

3.2 Methods applied

Ordinary least squares (OLS) regression was performed to observe whether the models
enable the testing of all three hypotheses. To test the link between corporate governance
variables and EM, the following regression model was developed:

EM ¼ a þ b 1 IO þ b 2 MO þ b 3 AC þ b 4 BOD þ b 5 IBC þ b 6 FAM

þ b 7 SIZE þ b 8 D1 þ b 9 D2 þ b 10 D3 þ b 11 D4 þ « (1)

Similarly, to test the link between corporate governance variables and CSR, the following
regression model was developed:

CSR ¼ a þ b 1 IO þ b 2 MO þ b 3 AC þ b 4 BOD þ b 5 IBC þ b 6 FAM

þ b 7 SIZE þ b 8 D1 þ b 9 D2 þ b 10 D3 þ b 11 D4 þ « (2)

Then, to test the moderating effect of EM on the relation between governance variables and
CSR, the following regression model was formulated:

CSR ¼ a þ b 1 IO þ b 2 MO þ b 3 AC þ b 4 BOD þ b 5 IBC

þ b 6 EM þ b 7 ðEM  IOÞ þ b 8 ðEM  MOÞþ b 9 ðEM  ACÞ

þ b 10 ðEM x BODÞ þ b 11 ðEM  IBCÞ þ b 12 FAM þ b 13 SIZE þ b 14 D1

þ b 15 D2 þ b 16 D3 þ b 17 D4 þ « (3)

where
EM = Earnings management;
CSR = Corporate social responsibility;
IO = Institutional ownership;
 ARJ MO = Managerial ownership;
31,3 AC = Audit committee size;
BOD = Board of directors’ size;
IBC = Independent board of commissioners/members;
FAM = Family ownership;
SIZE = Firm size; and
486 D1, D2, D3, D4 = year dummy for 2011, 2012, 2013, 2014, respectively.

3.3 Variable measurement

3.3.1 Corporate social responsibility disclosure. CSR disclosure index is estimated following
the GRI guidelines. There are total 79 CSR indicators in GRI, and these consist of
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environmental, social and economic indicators. CSR disclosure index can be formulated as
follows (NCGP, 2006):

The Disclosed number

CSR ¼  100%
79

3.3.2 Ownership, board governance and controls

Institutional ownership (X1): It is the ratio of the total number of shares owned by
institutions to total outstanding shares (Shleifer and Vishny, 1997).

Managerial ownership (X2): It is the ratio of total number of shares owned by
executive board to total outstanding shares (Shleifer and Vishny, 1997).

Audit committee size (X3): It is the total number of audit committee members
(Krishnan, 2005).

Board of directors’ size (X4): It is the total number of board of directors in the
company (Farooque et al., 2014).

Independent board of commissioners/members (X5): It is the ratio of total number of
independent board members to total number of board of commissioners (Beasley,
1996).

Family ownership: It is the ratio of total number of shares owned by family members
to total outstanding shares (Villalonga and Amit, 2006). It is separated from
managerial ownership.

Firm size: It is the natural log of total assets (Farooque et al., 2014).

Year dummy: It is measured by 1 for observed year and 0 otherwise (Ghozali, 2006).

3.3.3 Earnings management. EM practice is proxied by the value of discretionary accruals

(DA), which is the difference between total accruals and nondiscretionary accruals. There
are different discretionary accruals models in the literature. However, modified Jones model
(Dechow et al., 1995) is used in this study because it has the most relevant measurement
components related with manufacturing companies.

4. Empirical results
4.1 Descriptive statistics and correlation matrix
Table I below provides information about the characteristics of the variables used.
Descriptive statistics shows high IO in Indonesian manufacturing companies while
relatively low MO, with mean values, respectively, 59 and 35 per cent. Average size of
the BOD is five, which is a small size ranging between two to 12, but the AC size is 3,
 Variables N Mean SD Minimum Maximum
Corporate social
responsibility
CSR (Y) 145 0.20470 0.06460 0.05000 0.33333
IO (X1) 145 0.59275 0.18510 0.06600 0.18510
MO (X2) 145 0.35066 0.41255 0.00000 0.41255
AC (X3) 145 3.28966 0.73520 2.00000 8.00000
BOD (X4) 145 4.88966 2.30675 2.00000 12.00000
IBC (X5) 145 0.69635 0.24910 0.09704 1.00000 487
EM (Z) 145 0.21329 0.39631 3.40520 2.92000
FAM 145 0.26352 0.12331 0.11000 0.66000
SIZE 145 26.75531 2.41512 19.71000 33.59000
D1 145 0.20000 0.40139 0.00000 1.00000
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D2 145 0.20000 0.40139 0.00000 1.00000

D3 145 0.20000 0.40139 0.00000 1.00000
D4 145 0.20000 0.40139 0.00000 1.00000 Table I.
Valid N (list-wise) 145 Descriptive statistics

ranging between two to eight members. However, the mean value of IBC is 69.63 per
cent indicating high board independence in manufacturing companies. With regard to
EM, the mean value seems high as compared to other emerging countries, which is 21
per cent, with a minimum of 3.405 and maximum 2.92. This confirms that
manufacturing companies remains with high EM trend. Finally, the CSR disclosure
index shows a low mean value of 20 per cent, signifying that these firms are not active
in undertaking sufficient CSR disclosure.
Table II below presents correlation matrix between the variables used in the study. Most
of the governance variables reveal negative relation with EM except for BOD showing
positive association. On the other hand, most of the governance variables are positively
correlated with CSR except for AC and IBC showing negative association. Control variables
FAM and SIZE are positively related with both EM and CSR, while for year dummies all are
positively correlated with CSR and negatively with EM except for D4 showing positive
association. In addition, EM and CSR are negatively correlated as expected. Among the
independent variables, there remains low correlation, less than 0.90 as explained by Pallant
(2001) that multicollinearity exists when the independent variables are correlated with r =
0.90 and above. So, multicollinearity is not detected as a problem. Moreover, VIF results for
all variables indicate no multicollinearity problem (<10), with the value ranging from 1.142
(CSR) to 3.568 (D3).

4.2 Results of ordinary least squares regression analysis

To support the above developed hypotheses, OLS regression models were conducted and
produced the following results.
4.2.1 Link between earnings management and corporate governance mechanisms.
Table III above presents the relationship between EM as the dependent variable and
corporate governance variables as the independent variables and controls variables. The
evidence shows that IO, MO and IBC have negative significant effect on EM as per
expectation. Consistent with the alignment of interest hypothesis, this implies that higher
level of IO, MO and IBC can effectively restrain EM in the Indonesian market. However, AC
and BOD are showing insignificant effect on EM. Therefore, H1 is partly accepted only for
three governance variables constraining EM (i.e. IO, MO and IBC) and rejected for the rest
(i.e. AC and BOD). With regard to control variables, FAM, SIZE and year dummy D1 and D2
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31,3
ARJ

488

Table II.
Correlation matrix
CSR EM IO MO AC BOD IBC FAM SIZE D1 D2 D3 D4

CSR 1
EM 0.026 1
IO 0.195* 0.294** 1
MO 0.064 0.456** 0.342** 1
AC 0.030 0.019 0.079 0.112 1
BOD 0.185* 0.084 0.044 0.096 0.289** 1
IBC 0.120 0.421** 0.311** 0.641** 0.068 0.130 1
FAM 0.108 0.185* 0.163 0.164* 0.133 0.038 0.360** 1
SIZE 0.015 0.225** 0.196* 0.380** 0.196* 0.107 0.372** 0.075 1
D1 0.000 0.277** 0.213* 0.248** 0.056 0.074 0.256** 0.053 0.197* 1
D2 0.000 0.114 0.220** 0.222** 0.056 0.066 0.335** 0.209* 0.206* 0.250** 1
D3 0.000 0.175* 0.172* 0.258** 0.104 0.074 0.419** 0.088 0.267** 0.250** 0.250** 1
D4 0.000 0.325** 0.409** 0.614** 0.155 0.032 0.487** 0.088 0.386** 0.250** 0.250** 0.250** 1

Notes: ** Correlation is significant at the 0.01 level (two-tailed); * correlation is significant at the 0.05 level (two-tailed)
 No. Variable Expected sign Coefficient t-statistic Significance
Corporate social
responsibility
1 CONSTANT 0.666 0.514 0.608
2 IO  0.277 2.664 0.008
3 MO  0.437 2.704 0.008
4 AC  0.064 0.992 0.323
5 BOD þ 0.006 0.301 0.764
6 IBC  0.380 2.294 0.033 489
7 FAM þ 0.535 1.133 0.185
8 SIZE þ 0.013 0.575 0.566
9 D1 0.182 1.326 1.187
10 D2 0.145 1.049 0.296
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Table III.
11 D3 0.422 2.122 0.036
12 D4 0.526 2.607 0.010 Result of regression
Adj. R square 0.239 analysis: effect of
F-statistic 5.088 governance variables
Sig. F 0.000 on EM

reveal insignificant influence on EM, while year dummy D3 and D4 produce significant
positive influence on EM.
4.2.2 Link between corporate social responsibility disclosure and corporate governance
mechanisms. Table IV below reveals the relationship between CSR disclosure as the
dependent variable and corporate governance mechanisms as the independent variables
and control variables. For the governance mechanisms, the results show that IO and BOD
are positive significantly associated with CSR indicating that higher portion of IO as well
as a larger board can increase CSR disclosure in the Indonesian market. The other
governance instruments (i.e. MO, AC and IBC) have no significant explanatory power on
CSR. Therefore, H2 is partly accepted only for two governance mechanisms (i.e. IO and
BOD) promoting CSR and rejected for the remaining mechanisms (i.e. MO, AC and IBC).
As for the control variables, FAM, SIZE and all year dummies show insignificant effect
on CSR.

No. Variable Expected sign Coefficient t-statistic Significance

1 CONSTANT 0.282 3.059 0.003

2 IO þ 0.091 2.693 0.008
3 MO þ 0.005 0.265 0.791
4 AC þ 0.008 1.074 0.285
5 BOD þ 0.006 2.422 0.017
6 IBC þ 0.040 1.041 0.300
7 FAM  0.055 1.130 0.261
8 SIZE þ 0.000 0.148 0.882
9 D1 0.003 0.172 0.864
10 D2 0.004 0.221 0.825
Table IV.
11 D3 0.000 0.007 0.995
12 D4 0.012 0.489 0.628 Result of regression
Adj. R square 0.152 analysis: effect of
F-statistic 2.719 governance variables
Sig. F 0.006 on CSR disclosure
 ARJ 4.2.3 Link of corporate social responsibility disclosure with corporate governance, earnings
31,3 management and their moderation effect. Table V illustrates the moderation effect of EM on
the relationship between corporate governance variables and CSR, by including interaction
EM variable in the regression analysis with each of the governance variables to observe
their changing impact on CSR. The results reveal significant positive relationship of IO and
BOD with CSR, consistent with Table IV. While IO promotes CSR for the best interest of the
490 firms, BOD members restrict unnecessary CSR that are used by managers to hide EM
practices. Moreover, MO, AC and IBC variables have no significant explanatory power on
CSR. Further, EM variable also shows negative insignificant influence on CSR.
With regard to interaction variables in Table V, the positive effect of IO and BOD on CSR
remains unchanged with their EM interactions. However, increased magnitudes of
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coefficient values imply additional positive effects of the interaction variables of IO and
BOD with CSR. More importantly, while MO, AC and IBC reveal no significant relationship
with CSR, MO interaction with EM shows positive significant association with CSR. Also, it
is noted here that IBC has negative insignificant impact on CSR though its interactions with
EM has changed the sign from negative to positive. These findings provide evidence of
moderating effect of EM on the relationship between corporate governance variables (IO,
MO and BOD) and CSR. Therefore, H3 is partly accepted for 3 governance variables (IO, MO
and BOD) and rejecting for the rest (AC and IBC). Given the high level of EM in Indonesian
manufacturing companies, these findings cast doubt on the real motive of managers’
undertaking CSR. It is now evident here that they use CSR as a veil to hide their EM
practices and pursue their self-interest at the cost of the firm.

5. Discussion and conclusion

The OLS regression results indicate that H1 is partly accepted for three governance
variables (i.e. IO, MO and IBC) constraining EM. IO as long-term investors is capable

No. Variable Expected sign Coefficient t-statistic Significance

1 CONSTANT 0.679 0.857 0.393

2 IO þ 0.190 2.475 0.003
3 MO þ 0.175 0.914 0.362
4 AC þ 0.063 0.978 0.330
5 BOD þ 0.175 2.192 0.013
6 IBC þ 0.095 0.295 0.766
7 EM þ 0.013 0.367 0.490
8 EM  IO þ 0.326 2.514 0.032
9 EM  MO þ 0.271 2.319 0.042
10 EM  AC þ 0.157 0.155 0.365
11 EM  BOD þ 0.409 2.514 0.005
12 EM  IBC þ 0.051 0.611 0.149
13 FAM  0.058 1.234 0.219
Table V. 14 SIZE þ 0.008 0.033 0.973
Result of regression 15 D1 0.182 1.322 0.189
16 D2 0.145 1.043 0.299
analysis: effect of
17 D3 0.433 2.114 0.036
governance variables 18 D4 0.526 2.597 0.010
and EM and their Adj. R square 0.232
interaction terms on F-statistic 4.629
CSR disclosure Sig. F 0.000
 monitors in mitigating the problems related to managerial opportunism. MO confirms that Corporate social
managers owning a significant portion of the equity of a firm have less incentive to responsibility
manipulate reported accounting information (Warfield et al., 1995). Similarly, IBC supports
the view that the more the numbers of IBC members, the more optimal monitoring functions
and direct role in constraining EM (Davidson et al., 2004). Nevertheless, some governance
mechanisms (i.e. AC and BOD) do not influence EM, indicating that AC and BOD in
Indonesian companies have not performed their role optimally.
Moreover, the OLS findings suggest that H2 is partly accepted for two governance 491
variables (i.e. IO and BOD) boosting CSR disclosure. IO with large shareholding has
incentives and motivations to positively support CSR for a long-run performance of the firm
(Huafang and Jianguo, 2007). Similarly, the size and composition of the BOD can influence
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the extent to which managers will disclose more CSR information (Gul and Leung, 2004;
Ghazali, 2007). However, other governance mechanisms (i.e. MO, AC and IBC) show no
significant influence on CSR disclosure, implying that they are not yet focused on CSR
within the Indonesian context.
With regard to the third hypothesis, the OLS regression results confirm the moderation
effect of EM in determining CSR by three governance variables (IO, BOD and MO), thus
partly supporting H3. Findings reveal a positive moderation effect of EM on the relation
between governance mechanisms and CSR disclosure. It means that EM activities tighten
the association between both variables indicating that companies doing a lot of EM
activities will use the CSR policy to cover undertaken EM activities. It is becoming
increasingly evident when data from descriptive statistics show the high EM activities and
low CSR disclosure, indicating that Indonesian companies still do not give adequate
attention to CSR initiatives and use it only to cover their EM practices. This finding is
consistent with the findings of Gargouri et al. (2010), Gray et al. (2014), Martinez-Ferrero
et al. (2016) and in line with Prior et al. (2007) and Barnea and Rubin (2010) who argue that
certain CSR may be connected to expropriation.
This study contributes to the literature in the Indonesian context in identifying
governance mechanisms that are effective in controlling EM (i.e. IO, MO and IBC) and have
a significant positive role in affecting CSR disclosure (i.e. IO and BOD) of the companies.
More importantly, EM has strong moderation effect on governance variables to have an
impact on CSR. The interaction variables between governance (IO, BOD and MO) and EM
reveal a significant positive relationship with CSR, which implies strengthening the
governance and CSR relationship via EM. Such moderation effect of EM in the Indonesian
manufacturing sector is alarming, especially when the sector shows a significantly high EM.
Given that CSR disclosure still remains at its minimum level in Indonesian companies, this
evidence casts doubt on the managers’ intention of undertaking CSR. Therefore, it cannot be
ruled out that managers who are involved in EM practices sometimes use CSR disclosure to
cover-up EM practices, as moderation effects show stronger positive relationship between
governance variables and CSR via EM. This indicates the indirect controlling effect of EM
on CSR. In fact, CSR is undertaken to disguise EM practices. Managerial self-dealing in the
form of EM is manifested in their actions of taking some CSR disclosure.
Therefore, the findings of this study have significant policy implications for investors,
regulatory bodies, companies and other stakeholders to shape and implement an optimal
governance system that can address the problem of EM and CSR in Indonesian companies.
The implications of this research signify that although CSR disclosure is not huge in
Indonesian manufacturing sector, the CSR engagement is aimed at managerial
entrenchment motives as well as their empire building at the cost of shareholders and
stakeholders. From the regulator’s perspectives, it appears that CSR activities can lead to
 ARJ improve accountability to shareholders and stakeholders of the firm but that is not the case
31,3 in practice because of weak investors’ protection, poor legal environment and judiciary and
enforcement mechanism in place. The findings give strong evidence that almost Indonesian
companies engage in CSR disclosure, but they still fall short of complying with existing
regulations. On the other hand, relatively high EM activities indicate that CSR is often used
to shed EM activities undertaken by the managers. In this case, it needs for more definitive
492 legislation on CSR obligations of corporate firms. Regulatory bodies, especially the Institute
of Indonesian Accountants could tighten accounting standards to increasingly restrict EM
activities. From investors’ point of view, the CSR engagement can potentially create an
environment facilitating shareholders’ wealth creation, which is not happing in reality in
Indonesian firms. It rather serves the interest of managers in an environment of extensive
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practice of EM. The society as a whole or other stakeholders are also missing the benefits of
CSR, that warrants effective governance and disclosure regulations, strong investors’
protection with efficient law enforcement. Indonesian companies should consider
strategically the best portion of their ownership structure as part of governance mechanisms
that can support effective governance practices to mitigate EM practices and accelerate CSR
disclosure as well as growth.

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Corresponding author
Eko Suyono can be contacted at: ekyo75@yahoo.com

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