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Corporate social responsibility Corporate social

responsibility
disclosures and earnings quality
Are they a reflection of managers’
opportunistic behavior? 277
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
Managerial Auditing Journal
Paper type Research paper Vol. 30 No. 3, 2015
pp. 277-298
© Emerald Group Publishing Limited
0268-6902
JEL classification – M1, M49 DOI 10.1108/MAJ-02-2014-0997
MAJ 1. Introduction
30,3 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
278 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 Corporate social
countries some of which are emerging economies. responsibility
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 279
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
MAJ or emerging economies might not be generalisable for Bangladesh. Furthermore, the
30,3 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.
280 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 Corporate social
control measures, ownership-based monitoring and control function as a core responsibility
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 281
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
MAJ activities-related information, to manage or manipulate the most powerful stakeholders
30,3 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
282 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 Corporate social
avoiding stakeholder pressure. Scholtens and Kang (2013) investigate whether earnings responsibility
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 258 283
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.
MAJ On the other hand, as discussed before, a number of recent studies (for example, Belal
30,3 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
284 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,

Panel A: Sample size

Number of firms 135

Less
Companies without necessary information 19
Total 116

Panel B: Industry wise distribution

Industry sector No. of firms

Cement 7
Ceramics 4
Engineering 19
Food 21
Jute 3
Paper & Printing 2
Miscellaneous 11
Pharmaceuticals 21
Tannery 5
Table I. Textile 23
Sample description Total 116
corporate governance disclosures, director reports, chairperson statements and notes to the Corporate social
financial statements contained in annual reports. responsibility
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 285

The following model is used to test our hypotheses:

DACC ⫽ ␣ ⫹ ␤1CSRD ⫹ ␤2FSIZE ⫹ ␤3MB ⫹ ␤4LEV ⫹ ␤5LOSS ⫹ ␤6FAGE

⫹ ␤8LAGTACC ⫹ ␤8AUD ⫹ ␤9INDUSTRY DUMMIES
⫹ ␤9YEAR DUMMIES ⫹ ␧

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
MAJ otherwise 0 to control for the effect of auditor type on the level of discretionary accruals.
30,3 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
286 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 awarded a 1 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:
• CSRDj Index ⫽ 兺 t⫽1 nj
Xij / nj ;
• CSRDj index ⫽ corporate social disclosure index for j-th firm
• nj ⫽ number of items expected for j-th firm, where n ⱕ 20;
• Xij⫽ 1, if i-th items are disclosed for firm j, otherwise 0; and
• So that 0 ⱕ CSRDj ⱕ 1.

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:

1 ⌬REVt ⫺ ⌬ARt PPEt

NDACt ⫽ ␣0 ⫹ ␣1 ⫹ ␣2
TAt⫺1 TAt⫺1 TAt⫺1

Where,
NDACt ⫽ non-discretionary accruals in year t;
TAt⫺1 ⫽ total assets in year t-1;
 ⌬REVt ⫽ change in revenue of firm i in year t; Corporate social
⌬ARt ⫽ change of accounts receivable of firm i in year t; and responsibility
PPEt ⫽ property plant and equipment of firm i in year t.
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. 287

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 (␳ ⫽ 0.160). However, the CSRD
score is negatively correlated with loss (LOSS) (␳ ⫽ ⫺0.139) and leverage (LEV) (␳ ⫽
⫺0.192) and positively correlated with MB (␳ ⫽ 0.213). Our dependent variable DACC is
negatively correlated with Big 4 auditor (AUD) (␳ ⫽ ⫺0.049), firm age (FAGE) (␳ ⫽
⫺0.069) and FSIZE (␳ ⫽ ⫺0.096). This variable is also positively correlated with loss
(LOSS) (␳ ⫽ 0.008) and leverage (LEV) (␳ ⫽ 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

Variables Mean Median SD

LOSS 0.213 0.000 0.410

DACC 0.119 0.063 0.139
CSRD 0.223 0.200 0.173
FSIZE 8.700 8.705 0.661
MB 2.234 2.285 11.948
LEV 0.776 0.626 0.807
LAGTACC ⫺0.137 ⫺0.111 0.207
FAGE 23.659 24.000 10.709
AUD 0.135 0.000 0.342

Notes: The following table presents descriptive statistics of dependent and independent variables.
Different notations used in the table are defined as follows: CSRD ⫽ corporate social responsibility
disclosure score/ index; LOSS ⫽ a dummy variable equals 1 if a firm incurs loss in t-1 year and
otherwise 0; DACC⫽ the level of discretionary accruals; FISZE ⫽ natural logarithm of total assets;
MB ⫽ ratio of market and book value of equity; LEV⫽ ratio of book value of total debt and total assets;
LAGTACC ⫽ total accruals of t-1 year; FAGE ⫽ natural log of the number of year since the firm’s Table II.
inception; AUD ⫽ a dummy variable equals 1 if a firm is audited by a big 4 auditor and otherwise 0 Descriptive statistics
 30,3

288
MAJ

Table III.
Correlation matrix
Variables LAGTACC EQ AUD CSRD LOSS FAGE MB LEV FSIZE

LAGTACC 1.000
EQ ⫺0.031** 1.000
AUD ⫺0.030* ⫺0.049* 1.000
CSRD 0.216** 0.160*** 0.230*** 1.000
LOSS 0.033 0.008* ⫺0.156** ⫺0.139** 1.000
FAGE ⫺0.075** ⫺0.069* 0.078** 0.203*** ⫺0.056 1.000
MB 0.040* 0.042*** 0.141* 0.213** ⫺0.182** 0.314 1.000
LEV ⫺0.037 0.307** 0.082** ⫺0.192*** 0.149** ⫺0.302* ⫺0.093** 1.000
FSIZE ⫺0.217** ⫺0.096*** 0.380*** 0.358*** ⫺0.160*** ⫺0.052 0.265** ⫺0.209*** 1.000

Notes: The following table presents the correlation matrix. Different notations used in the table are defined as follows: CSRD ⫽ corporate social
responsibility disclosure score/ index; LOSS ⫽ a dummy variable equals 1 if a firm incurs loss in t-1 year and otherwise 0; EQ ⫽ earnings quality measured
by the level of discretionary accruals; FISZE ⫽ natural logarithm of total assets; MB ⫽ ratio of market and book value of equity; LEV⫽ ratio of book value
of total debt and total assets; LAGTACC ⫽ total accruals of t-1 year; FAGE ⫽ natural log of the number of year since the firm’s inception; AUD ⫽ a dummy
variable equals 1 if a firm is audited by a big 4 auditor and otherwise 0; * , ** , *** ⫽ statistically significant at less than 0.10, 0.05 and 0.01 level
Variables CSRD ⬎ Median CSRD ⬍ Median p value
Corporate social
responsibility
DACC 0.087 0.049 0.027**
LOSS 0.18 0.23 0.057*
MB 4.267 3.263 0.017**
AUD 0.26 0.05 0.000***
LEV 0.63 0.94 0.000***
FAGE 24.6 22.57 0.027**
289
FSIZE 8.99 8.37 0.272
LAGTACC ⫺0.189 ⫺0.137 0.016**

Notes: The following table presents the results for the mean difference test among different variables.
Different notations used in the table are defined as follows: CSRD ⫽ corporate social responsibility Table IV.
disclosure score/ index; LOSS ⫽ a dummy variable equals 1 if a firm incurs loss in t-1 year and Differences in the
otherwise 0; DACC⫽ the level of discretionary accruals; FISZE ⫽ natural logarithm of total assets; value of the
MB ⫽ ratio of market and book value of equity; LEV⫽ ratio of book value of total debt and total assets; explanatory
LAGTACC ⫽ total accruals of t-1 year; FAGE ⫽ natural log of the number of year since the firm’s variables between
inception; AUD ⫽ a dummy variable equals 1 if a firm is audited by a big 4 auditor and otherwise firms with higher
0. * , ** , *** ⫽ statistically significant at less than 0.10, 0.05 and 0.01 level and lower CSRD

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 (␤ ⫽ 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
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Table V.

disclosure and
abnormal accruals
Regression results:
relation between CSR
Full sample Positive discretionary accruals Negative discretionary accruals
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Variable Coefficient Probability Coefficient Probability Coefficient Probability Coefficient Probability Coefficient Probability Coefficient Probability

Intercept 0.099 0.616 0.089 0.654 ⫺0.122 0.551 ⫺0.173 0.401 0.696 0.052 0.702 0.050
CSRD 0.215 0.017 0.198 0.139 0.274 0.007 0.215 0.044 0.041 0.781 0.063 0.691
EXP*CSRD ⫺0.116 0.062 ⫺0.046 0.037 ⫺0.165 0.684
FSIZE ⫺0.017 0.047 ⫺0.018 0.044 ⫺0.050 0.036 ⫺0.055 0.020 ⫺0.056 0.076 ⫺0.057 0.072
MB 0.001 0.822 0.001 0.829 0.001 0.539 0.001 0.542 0.001 0.362 0.001 0.570
LEV 0.130 0.000 0.111 0.000 0.054 0.017 0.056 0.014 0.127 0.000 0.126 0.000
LOSS 0.020 0.050 0.029 0.067 0.035 0.025 0.027 0.046 0.035 0.429 0.037 0.416
FAGE ⫺0.001 0.464 ⫺0.001 0.418 ⫺0.002 0.108 ⫺0.003 0.063 ⫺0.001 0.552 ⫺0.001 0.619
LAGTACC ⫺0.036 0.803 ⫺0.042 0.772 ⫺0.072 0.649 ⫺0.065 0.893 0.003 0.507 0.006 0.505
AUD ⫺0.009 0.083 ⫺0.004 0.091 ⫺0.013 0.063 ⫺0.034 0.061 ⫺0.033 0.037 ⫺0.037 0.066
EXP ⫺0.041 0.006 ⫺0.041 0.052 ⫺0.073 0.172
Year dummy Yes Yes Yes Yes Yes Yes
Industry dummy Yes Yes Yes Yes Yes Yes
Adjusted R 0.126 0.132 0.143 0.147 0.072 0.074
F stat 5.967 6.382 4.526 4.987 3.982 3.724

Notes: The following table presents the results of regression analyses. Different notations used in the table are defined as follows: CSRD ⫽ corporate social responsibility disclosure score/
index; LOSS ⫽ a dummy variable equals 1 if a firm incurs loss in t-1 year and otherwise 0; DACC⫽ the level of discretionary accruals; FISZE ⫽ natural logarithm of total assets; MB ⫽ ratio
of market and book value of equity; LEV⫽ ratio of book value of total debt and total assets; LAGTACC ⫽ total accruals of t-1 year; FAGE ⫽ natural log of the number of year since the firm’s
inception; AUD ⫽ a dummy variable equals 1 if a firm is audited by a big 4 auditor and otherwise 0; EXPO ⫽ dummy variable equals 1 if the firm belongs to textile or pharmaceutical
industry and otherwise 0
expect manufacturers in Bangladesh to attend to various social and environmental issues, Corporate social
and failure to meet such expectations may lead to loss of supply contracts. Belal and Owen responsibility
(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 291
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 (␤ ⫽ ⫺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 (␤ ⫽ 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 (␤ ⫽ 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 (␤ ⫽ ⫺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
MAJ Davidson and Mackinnon (1993), to test whether CSRD is endogenously determined in the
30,3 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
292 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 Corporate social
practices instead of motivating the desired behaviour, may provide managers with responsibility
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. 293
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).
MAJ (2) Environmental:
30,3 • Environmental policies.
(3) Employee information:
• Number of employees/human resource.
• Employee relations.
298 • 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:
mazim@swin.edu.au

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