the effect of the audit committee and its characteristics
TRANSCRIPT
The effect of the audit committee and
its characteristics on CSR decoupling
Arjen Kuipers, S3531031
University of Groningen
Abstract
Based on the agency theory, this study investigates the effect of audit committee characteristics on CSR
decoupling. CSR decoupling can be described as the misalignment between CSR performance and CSR
reporting. Research shows that CSR decoupling leads to lower firm value which is the complete opposite
of the objective of the shareholders. Decoupling behavior by managers is possible because of
information asymmetry between the managers and stakeholders. The audit committee can solve this
agency problem by monitoring effectively and creating transparency. Based on a worldwide sample of
6,266 firm-year observations for 1,501 different listed companies in 41 different countries, I found that
larger audit committees with a higher percentage of female members have a negative effect on CSR
decoupling. In addition, audit committees consisting of on average older aged and longer tenured
members have a negative effect on CSR decoupling as well. This negative effect of these characteristics
results in a smaller gap between CSR performance and CSR reporting. I did not find significant evidence
that an independent audit committee has a negative effect on CSR decoupling. This study contributes to
the literature by linking the audit committee to CSR decoupling, thereby broadening the understanding
of the determinants of CSR decoupling.
Keywords: CSR decoupling, Audit committee, CSR performance, CSR reporting, Corporate
governance, Agency theory.
MSc Management Accounting and Control
January 20, 2020
Supervisor: dr. Nazim Hussain
Word count: 10,550
1
INTRODUCTION
In the last couple of decades, “corporate social responsibility” (CSR) has become more important due
to “growing institutional pressures for responsible practices, community involvement, increased
transparency, higher labour standards, reduced greenhouse gas emissions, and many other
environmental causes” (Hawn & Ioannou, 2016, p. 2569). However, literature about CSR started to
show up from 1950 and the construct of CSR dates back to the 1930s and 1940s (Carroll, 1999).
According to Bowen (1953), the hundred largest companies had so many power that their actions and
decisions had influence on the lives of citizens. He defined CSR as “the obligations of businessmen to
pursue those policies, to make those decisions, or to follow those lines of action that are desirable in
terms of the objectives and values of our society” (Bowen, 1953, p. 6). This definition of CSR has not
changed that much over time. McWilliams & Siegel (2001) described it as actions that are not required
by law and are beyond the interest of the firm but are undertaken to do something good for society.
One of the goals of CSR is making companies not only responsible for their own profits but also
for their stakeholders and the environment (Aguinis & Glavas, 2019). According to Boiral (2013), CSR
is a way of informing stakeholders about the social and environmental impact of business activities.
Another goal of reporting on CSR is taking away information asymmetry and thus agency problems
between managers and its stakeholders, like customers, governments, institutional owners, suppliers,
and employees (McWilliams & Siegel, 2001). Furthermore, in the literature researchers predominantly
agree that it pays to be sustainable (Kim, Kim, & Qian, 2018; Waddock & Graves, 1997). Although the
goals of CSR are clear, many studies found that CSR is more of improving a companies’ image and
social legitimacy (Duchon & Drake, 2009). Banerjee (2008) even states that CSR is nothing more than
window dressing. Furthermore, companies only adopt CSR when it fits in their strategic interests, and
it is only done to uphold competitors an ideal image (Graafland & Smid, 2019; Harrison & Freeman,
1999).
This window dressing behavior of companies can lead to organizational hypocrisy and
organizational facades (Cho, Laine, Roberts, & Rodrigue, 2015). According to Brunsson (2007),
organized hypocrisy is ‘‘a way of handling conflicts by reflecting them in inconsistencies among talk,
decisions, and actions’’ (p. 115). This organizational hypocrisy might eventually damage the integrity
and legitimacy of a company (Simons, 2002). It can lead to organizational facades as well, which is
defined by Abrahamson & Baumard (2008) as ‘‘a symbolic front erected by organizational participants
designed to reassure their organizational stakeholders of the legitimacy of the organization and its
management’’ (p. 437). This organized hypocrisy and organizational facades can become problematic
because society will not be able to monitor and evaluate the activities of a company effectively without
reliable reporting (Cho et al., 2015).
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This pressure for a company to gain social legitimacy from stakeholders on the one hand and
serving internal needs for efficiency and profits on the other hand might lead to decoupling behavior of
companies (Cho et al., 2015; Meyer & Rowan, 1977). CSR decoupling can be defined as “the condition
of full divergence among policies, programs, and impacts amounting to purely ceremonial CSR”
(Graafland & Smid, 2019, p. 231). Tashman, Marano and Kostova (2019) describe CSR decoupling as
the gap between CSR performance and CSR disclosure and Hawn and Ioannou (2016) describe it as the
gap between internal and external CSR actions. An example of CSR decoupling could be the investment
of 32 million USD by British Petroleum (BP) in a new beyond petroleum brand in 2000. Greenpeace
showed later that this was more about showing good intentions instead of actually investing in renewable
energy (Visser, 2011). Still, little research has been done about the determinants of CSR decoupling and
about CSR decoupling in general, while according to Graafland & Smid (2019), the whole concept of
CSR may become redundant when CSR has no observable impact on society anymore.
CSR decoupling is especially tempting in the absence of effective monitoring mechanisms
(Greenwood & Hinings, 1996). In case of CSR decoupling, there is clearly a problem of information
asymmetry between the stakeholders and the management (Spence, 2002). This might result in agency
costs which reduces the value of the firm (Tashman et al., 2019). According to the agency theory, one
way to solve information asymmetry and agency costs is monitoring by the board of directors and its
committees (Eisenhardt, 1989). In this paper, I have investigated the characteristics of the audit
committee because the goal of monitoring mechanisms to solve information asymmetry between
managers and stakeholders is especially important for investors and financial intermediaries
(Greenwood & Hinings, 1996). Furthermore, according to Appuhami & Tashakor (2017), the audit
committee is one of the most important governance mechanisms. The Enron and WorldCom fraud and
other financial misconducts showed that the audit committee has an important task in monitoring the
reliability of reports for stakeholders, together with managers and external auditors (Thiruvadi & Huang,
2011). The audit committee monitors the financial and non-financial reports and tries to minimise
information asymmetry (Karamanou & Vafeas, 2005). Because of the importance of the audit
committee, and the demand for more research into the determinants of CSR decoupling by Graafland
and Smid (2019), together with the future research direction into the role of the audit committee in CSR
performance as suggested by Hussain, Rigoni & Orij (2018), I answered the question how the
composition of the audit committee affects CSR decoupling. The characteristics I have hypothesized are
size, independency, gender diversity, tenure, and age. According to Bédard, Coulombe & Courteau
(2008), all these audit committee characteristics will have an impact on financial and non-financial
disclosures of a firm.
To answer the question whether the audit committee and its characteristics have an impact on
CSR decoupling, I followed the method used by Tashman et al. (2019) to measure CSR decoupling. In
their paper they measured CSR decoupling by subtracting CSR performance scores from CSR reporting
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scores. CSR performance scores are based on ESG ratings which consists of environment, social and
governance scores. CSR reporting scores are based on the intensity of CSR reporting of a company. The
misalignment between CSR performance and CSR reporting can be seen as CSR decoupling. As been
done in previous studies, I have used control variables that can influence CSR decoupling as well. The
control variables I have used in this research are firm size, firm performance, leverage, board
independence, board size, R&D intensity, capital intensity, CEO duality, organizational slack, and
analyst coverage (Appuhami & Tashakor, 2017; Graafland & Smid, 2019; Hawn & Ioannou, 2016;
Tashman et al., 2019). In addition to the original test, I have performed an additional analysis to test
dimensional decoupling. In this way I was able to determine whether the audit committee characteristics
only had influence on CSR decoupling as a whole or also on environmental and social decoupling
separately. To test the hypotheses, I have used a sample of 6,266 firm-year observations for 1,501
different listed firms from 41 different countries worldwide. The year span I investigated ranged from
2006 till 2017 and I included firm, year, and industry fixed effects. The data to measure CSR decoupling
were retrieved from Thomson Reuters ASSET4 and Bloomberg, and the audit committee data was
retrieved from BoardEx. The control variables were retrieved from Thomson Reuters ASSET4 and
BoardEx.
This paper makes two contributions to the literature. First, this is the first paper that explores
the effect of the audit committee characteristics on CSR decoupling based on a large worldwide sample
for the years 2006-2017. Both audit committee characteristics and CSR decoupling have been explored
independently but there are no studies that have linked these topics. Secondly, this study expands the
knowledge of CSR decoupling and its determinants which is underexplored at the moment according to
Graafland & Smid (2019).
In this research I hypothesized that audit committee size, independence, gender diversity, tenure,
and age will have a negative effect on CSR decoupling. This negative effect indicates a smaller gap
between CSR performance and CSR reporting. I found evidence that a larger audit committee and a
higher percentage of women on the audit committee will have a negative effect on CSR decoupling.
Furthermore, an audit committee with longer tenured and older members will have a negative effect on
CSR decoupling as a whole, and on environmental and social decoupling separately as well.
Additionally, the control variables showed that larger firms that are performing well and that are
monitored by an independent board are decoupling less. On the other hand, firms that are highly visible
due to high analyst coverage are decoupling more.
The remainder of this paper continues with the theory part in which the previous literature and
the hypotheses development are explained. The methodology part explains the main variables and the
method used for this study. The methodology section is followed by the results part in which the main
results of this study are given. The final section presents the discussion and conclusion of this study.
4
LITERATURE REVIEW AND HYPOTHESES
Literature review
CSR policies and actions are becoming more and more important, and as a result of this, more companies
start adopting CSR policies like ISO certifications, codes of conduct, and stakeholder initiatives
(Graafland & Smid, 2019). An important reason for this shift towards CSR compliance comes from the
increased pressure of stakeholders (Chen & Wang, 2011). Besides that, previous studies found that CSR
policies and actions will lead to a competitive advantage for companies due to the generation of valuable
firm resources (Choi & Wang, 2009; McWilliams & Siegel, 2001). This increased pressure of
stakeholders to be socially responsible, together with the possible competitive advantage can result in
decoupling behavior of companies. CSR decoupling can be described as the misalignment between
internal CSR performance and external CSR reporting (Tashman et al., 2019).
Some potential benefits of CSR decoupling can be that socially responsible companies have
better investment opportunities (Sen, Bhattacharya, & Korschun, 2006), are more attractive to
employees, and are better able to retain employees (Greening & Turban, 2000). Moreover, firms that
are decoupling have better access to capital, and companies that implement CSR policies have better
firm performance (Orlitzky, 2008; Saeidi, Sofian, Saeidi, Saeidi, & Saaeidi, 2015). On the other hand,
Hawn and Ioannou (2016) found that CSR decoupling is associated with lower firm value due to a wider
gap between internal and external CSR actions.
In contrast, the traditional goal of managers who are controlled by corporate governance
mechanisms, is to maximize firm value for the shareholders who own the company (Denis, 2016). There
is a clear conflict between the causes and results of CSR decoupling and the objectives of shareholders.
Managers trying to be sustainable in the long term and profitable in the short term which results in
conflicting demands (Cho et al., 2015). This conflict results in agency problems which might result in
agency costs. Agency problems arise due to conflicting interests between managers and shareholders,
information asymmetry, and opportunistic behavior of managers (Hussain et al., 2018). In case of CSR
decoupling, these agency problems arise because CSR decoupling results in information asymmetry
between the management and stakeholders (Hawn & Ioannou, 2016; Meyer & Rowan, 1977).
Stakeholders are unable to monitor a company effectively when companies are behaving ceremonial,
and don’t have the same information that is available for managers. Furthermore, information
asymmetry is possible according to Crilly et al. (2012) because “executives can deceive stakeholders
about the state of practice inside their firms to gain legitimacy whilst pursuing their personal
organizational interest” (P. 1431). This information asymmetry dissuades the stakeholders from
collaborating with the firm while collaboration will be beneficial to the firm (Axelrod, 1984).
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Following the agency theory, one way to solve this information asymmetry and reduce agency
costs is implementing effective corporate governance mechanisms, like monitoring by the board of
directors and its committees (Eisenhardt, 1989). Besides that, the agency theory implies that effective
corporate governance mechanisms improve a firms’ legitimacy (Michelon & Parbonetti, 2012). The
board of directors makes sure that the interest of the shareholders are guaranteed (Fama & Jensen, 1983).
According to King, Lenox & Terlaak (2005), boards can serve as a third party to communicate
compliance and give their certification. Furthermore, CSR decoupling can be reduced when the
responsibility for CSR reporting is shifted towards the board of directors, consisting of committed board
members (Graafland & Smid, 2019). Committed board members will have a positive effect on
decreasing decoupling because they will not be satisfied with decoupled communications which in the
end stimulates employees to reach their social responsible goals (Waldman, Siegel, & Javidan, 2006).
As mentioned before, CSR decoupling is more tempting in situations without monitoring mechanisms
(Greenwood & Hinings, 1996), and sometimes organizations deceive its board of directors in their
monitoring task (Egels-Zandén, 2007). Another reason that the board of directors can solve the CSR
decoupling problem is that the allocation of CSR programs to the top level of the company gives a strong
signal to the stakeholders that the company is really committed to CSR. This will lead to increased
legitimacy, and the company will maintain this by making sure that their commitment to CSR results in
CSR impact (Graafland & Smid, 2019). Based upon the above, the agency theory accentuates the
importance of the monitoring role of the board of directors to decrease CSR decoupling at the
management level. In addition to that, this monitoring role of the board will result in more transparency
which will decrease decoupling possibilities (Halme & Huse, 1997). In this research, I focus on one
specific committee of the board of directors, the audit committee.
The audit committees’ main tasks are minimising information asymmetry between management
and stakeholders, and monitoring the financial and non-financial reports (Karamanou & Vafeas, 2005).
According to Kolk & Pinkse (2010), the audit committee has to make sure that companies take
responsibility for long-term environmental, economic and social impact on stakeholders. The audit
committee is seen as the most important governance mechanism which makes sure that the firm is
transparent and credible for its activities (Appuhami & Tashakor, 2017). Following this stream of
literature, the main task of the audit committee is creating transparency which minimises the information
asymmetry between management and stakeholders. Therefore, the information asymmetry resulting
from CSR decoupling can be reduced by the audit committee.
In this research, I specifically look at the characteristics of the audit committee because,
according to Bédard et al. (2008), adequate characteristics of the audit committee will have impact on
the financial and non-financial (including CSR) disclosures of a firm. The characteristics I investigate
are size, independence, gender diversity, tenure, and age of the audit committee.
6
Hypotheses development
The Sarbanes-Oxley Act from 2004 states that American listed firms have to appoint an audit committee
and according to this act, the audit committee must consist of independent directors with at least one
director who is a financial expert (Rockness & Rockness, 2005). Adding to this, the Blue Ribbon
Committee (BRC) (1999) recommends a minimum size of the audit committee of 3 members and
according to the National Association of Corporate Directors (NACD) the size of the audit committee
should be limited to 6 members (NACD, 2000). Following the literature, large audit committees will
improve the monitoring quality and thus reduce CSR decoupling because they have more status and
power within an organization (Kalbers & Fogarty, 1993), and they have access to more valuable
resources (Pincus, Rusbarsky, & Wong, 1989). According to Bédard et al. (2004), large audit
committees have “the necessary strength, diversity of expertise and views to ensure appropriate
monitoring” (p. 18). Guest (2009) argues that more diversity in expertise will result in more qualitative
advice. Based on the agency theory I therefore expect that larger audit committees are better able to
monitor the managers which will decrease information asymmetry and thus have a negative effect on
CSR decoupling. Therefore, the first hypothesis is stated as follows:
H1: Larger audit committees have a negative effect on CSR decoupling.
When we look at the independence of the audit committee, the Sarbanes-Oxley Act states that
all the audit committee members should be independent outside directors (Rockness & Rockness, 2005).
A director is independent when he or she has no ties with the firm and is only paid for director services
(Zhang, Zhou, & Zhou, 2007). From the literature we see that audit committee independence is seen as
an important factor for effective controlling by the audit committee. Pucheta-Martinez and De Fuentes
(2007) found that “an audit committee formed exclusively of external and independent directors would
result in better accountability and transparency for organizations” (p. 308). Besides that, independent
audit committee members are better able to make independent decisions without influence from the
company, which enhances the credibility of the financial and non-financial reports (Mangena & Pike,
2005; Pucheta-Martınez & De Fuentes, 2007). Collier and Gregory (1999) found that insiders on the
audit committee have a negative impact on the activity of the audit committee. From an agency
perspective a more effective monitoring process as a result of an independent audit committee will
protect stakeholders from opportunistic behavior of the management (Jing Li, Mangena, & Pike, 2012).
Therefore, I expect that an independent audit committee will have a negative effect on CSR decoupling
because of the effective monitoring role of an independent audit committee. Hypothesis 2 is therefore
stated as follows:
H2: An independent audit committee has a negative effect on CSR decoupling.
Another characteristic that can have influence on the functioning of the audit committee is
gender diversity. According to the literature, more gender diverse audit committees will improve their
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monitoring and oversight function (Stewart & Munro, 2007). Following the agency theory, better
monitoring and oversight will lead to better financial reporting quality which in the end will lead to less
manipulation, fraud and earnings management (Thiruvadi & Huang, 2011). Furthermore, women in the
audit committee are more “risk averse, cautious and ethical than men” (Thiruvadi & Huang, 2011, p.
486). Also, audit committees with female members do have a positive influence on the reporting quality
of managers and it will have a positive effect on the audit quality (Thiruvadi & Huang, 2011). Moreover,
female members in the audit committee “will enhance the confidence of the public regarding accounting
information” (Thiruvadi & Huang, 2011, p. 484). They sent a positive signal about the trustworthy and
legitimacy of the accounting information to the stakeholders. This finding is also related to Stewart and
Munro (2007) who state that women are better communicators. Besides that, Orij (2010) found that
women in the board are more oriented towards social issues in comparison to men. Lastly, Halpern
(2012) found that the overall firm performance is higher for firms with gender diverse boards and gender
diversity will also lead to less corporate failures (Burgess & Tharenou, 2002). Based on these findings
I expect that a gender diverse audit committee will have a negative effective on CSR decoupling as a
result of better monitoring, oversight, and more ethical behavior of woman on the board. Therefore,
hypothesis 3 is stated as follows:
H3: A gender diverse audit committee has a negative effect on CSR decoupling.
Another audit committee characteristic that can have influence on CSR decoupling is director
tenure. Director tenure can be measured as the number of years a member of the committee serves on
the audit committee. Previous studies mainly agrees that longer tenured audit committee members are
better able to monitor the financial reporting because they have more firm-specific expertise (Sharma &
Iselin, 2012). Further, the longer the director is serving on the audit committee, the more significant
knowledge the director will gain about the company, the company’s environment, processes,
procedures, and risk management, which helps him or her to audit correctly (Vafeas, 2003). Based on
the organizational behavior theory, longer tenured audit committee members are more committed to the
firm (Buchanan, 1974). Besides that, longer tenured directors are better able to challenge the
management when needed and have more incentives to protect stakeholders (Sharma & Iselin, 2012).
Based on the above, I expect a negative effect of audit committee member tenure on CSR decoupling
because longer tenured audit committee members are better able to control the financial reporting and
protect stakeholders’ interests. Hypothesis 4 is therefore stated as follows:
H4: A higher average audit committee tenure has a negative effect on CSR decoupling.
The last audit committee characteristic I look at is the average age of the audit committee
members. Based on the Upper Echelons Theory it is expected that audit committee members from
different ages have different values and perceptions and that these values and perceptions influence the
audit committee members’ decisions (Carpenter, Geletkanycz, & Sanders, 2004; Hambrick & Mason,
8
1984). DeZoort (1998) found that older, more experienced audit committee members have better internal
control capabilities and are thus better able to function as internal auditor. Furthermore, older audit
committee members have more relevant technical knowledge because of previous experiences and
training (DeZoort, 1998). According to Hambrick and Mason (1984) older audit committee members
are more conservative and according to Qi and Jiaotong (2012) older audit committee members are
trying to avoid risky decisions like CSR decoupling. The aforementioned characteristics of older audit
committee members will have a positive effect on the monitoring effectiveness. Therefore, I expect that
a higher average age of the members of the audit committee will have a negative effect on CSR
decoupling. Hypothesis 5 is therefore stated as follows:
H5: Higher average age of the audit committee members has a negative effect on CSR
decoupling.
METHODOLOGY
Sample and Data collection
The sample I used for this study included in total 6,266 firm-year observations for 1,501 different listed
firms from 41 different countries worldwide for the years 2006 till 2017. The data was unbalanced
because not all the data was available for every year and for every company. The first two digits of the
SIC code were used to identify the 9 main industries the companies operate in. For most listed firms,
especially in the US because of the Sarbanes-Oxley act from 2004 (Rockness & Rockness, 2005), there
is an requirement to have an audit committee. The data for the audit committee characteristics is
retrieved from BoardEx. To measure CSR decoupling I followed the method used by Tashman et al.
(2019) who calculated CSR decoupling by subtracting CSR performance scores from CSR reporting
scores. The data for CSR performance are retrieved from Thomson Reuters ASSET4 while the data for
CSR reporting is retrieved from Bloomberg. These databases have already been validated by previous
CSR studies (Cheng, Ioannou, & Serafeim, 2014; Hawn & Ioannou, 2016; Ioannou & Serafeim, 2012).
According to Hawn and Ioannou (2016, p. 2576), ASSET 4 provides “objective, relevant, auditable, and
systematic CSR information”. The control variables are retrieved from Thomson Reuters ASSET4 and
BoardEx. All the variables including measurement and data sources can be found in table 1.
Dependent variable
CSR decoupling is defined as “the condition of full divergence among policies, programs, and impacts
amounting to purely ceremonial CSR” (Graafland & Smid, 2019, p. 231). To measure CSR decoupling
9
I followed the method used by Tashman et al. (2019) who measured CSR decoupling by the
misalignment between CSR reporting and CSR performance. The CSR performance score is based on
ESG ratings which are a combination of environmental, social and governance performance scores. CSR
reporting ratings are based on the intensity of CSR reporting by a company. Hawn and Ioannou (2016)
used a similar approach but they see CSR performance as internal CSR actions like the use of renewable
energy. In addition, they see CSR reporting as external actions like reports and disclosures that show
stakeholders what the company is doing in the field of CSR. CSR decoupling is the case when a company
is, intentionally, reporting more external CSR actions than they are actually implementing internal CSR
actions. This misalignment can be the other way around as well which results in understatement of CSR
performance and is called silent green. Silent green companies are performing more internal CSR actions
than they actually report about these actions (Delmas & Burbano, 2011). In this research I focus on the
overstatement of CSR performance.
The misalignment between CSR performance and CSR reporting is measured by subtracting the
standardized data for CSR performance from the standardized CSR reporting scores. A higher score
indicates a larger gap between CSR performance and CSR reporting, which implies more CSR
decoupling. This measurement has originally been developed by Marquis, Toffel & Zhou (2016) and
has been improved by Tashman et al. (2019).
Independent variables
The audit committee is seen as the most important governance mechanism which makes sure that the
firm is transparent and credible for its activities (Appuhami & Tashakor, 2017). In some countries an
audit committee is mandatory, like in the US. All listed firms in the US have to appoint an audit
committee according to the Sarbanes-Oxley Act of 2004 (Rockness & Rockness, 2005). The
characteristics of the audit committee I look at in this research are: size, independence, gender diversity,
tenure and age.
The size of the audit committee is measured by the logarithm of the total number of members
that are appointed to the audit committee for a specific year and company (Appuhami & Tashakor,
2017). The logarithm is used to normalize the data. The independence of the audit committee is
measured by the proportion of independent directors in the audit committee. An audit committee
member is independent when he or she has no ties the firm except for director services fees (Zhang et
al., 2007). Gender diversity is measured by the proportion of female members relative to the total
members of the audit committee and tenure is measured by the logarithm of the average years that the
committee members are working on the audit committee. Lastly, age is measured by the logarithm of
the average age of the members of the audit committee.
10
Control variables
To test the effect of audit committee characteristics on CSR decoupling I controlled for other variables
that might influence this relation. The first variable I control for is firm size, because previous studies
found that firm size is positively related to CSR disclosure (Li, Pike, & Haniffa, 2008). Besides that,
Lepoutre and Heene (2006) state that smaller companies are often less experienced and have less
knowledge which makes implementing CSR programmes more difficult. Also the appearance and
activity of an audit committee is dependent on the firm size, according to Collier and Gregory (1999).
The second variable I control for is firm performance because according to Graafland and Smid (2019)
it is easier to implement costly CSR programmes when companies are more profitable and have more
budget available. For companies who have less CSR budget available but still want to comply with the
pressures of stakeholders to be socially responsible it will be more tempting to decouple. On the other
hand, Delmas and Burbano (2011) argue that more profitable companies face less risk when they are
decoupling because they have budget to cover possible reputation damage. Firm performance is
measured by the Return On Assets (ROA), following Appuhami and Tashakor (2017). The third variable
I control for is leverage because according to previous literature (CSR) disclosure of firms increases
when firms are in need of a loan (Goss & Roberts, 2011). The following control variable I controlled
for is board independence because previous studies argued that audit committee effectiveness and
independence is related to board independence (Klein, 2002). Besides that, board size is included as
control variable as well because larger boards have higher CSR performance scores (De Villiers, Naiker,
& Staden, 2011). Following Tashman et al. (2019) I also controlled for R&D intensity, measured as the
logarithm of the ratio of R&D expenses to total sales. Firms with a higher R&D intensity are more
innovative, which has a positive effect on CSR performance (McWilliams & Siegel, 2000). Another
variable I controlled for is capital intensity, measured as the logarithm of ratio of total assets to total
sales (Tashman et al., 2019). The capital intensity of a firm can affect the acquirement of assets to
improve CSR performance (Russo & Fouts, 1997). Further, I controlled for CEO duality because a CEO
who is also chairperson of the board has more power which can be used to influence CSR reporting
(Sauerwald & Su, 2019). CEO duality is “1” if the CEO is also chairperson of the board and “0”
otherwise. Next, following Tashman et al. (2019), I controlled for organizational slack, measured as the
logarithm of the ratio of current assets to current liabilities. High organizational slack can be used to
improve and intensify CSR actions (Bansal, 2005). Lastly, following Hawn and Ioannou (2016), I also
controlled for analyst coverage to control for firm visibility, measured as the number of analysts that are
following a firm in a specific year.
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Empirical model
To test whether to use a random or fixed effect model for my panel data, I applied a Hausman
specification test (Hausman, 1978). Based on the results of this Hausman specification test, I used a
fixed effect regression to measure the effect of audit committee characteristics on CSR decoupling. In
this analysis I included firm, year and industry fixed effects. By using this method I can see what
influence the independent variables have on CSR decoupling and I can see how much of the variance is
explained by this model as a whole. To address non-normality issues I standardized the continuous
variables and I checked for multicollinearity problems analysing the variance inflation factor and the
bivariate correlations.
Table 1: Variables and data sources
Variable name Measurement Value Source
CSR decoupling CSR reporting score minus CSR performance
score
Continuous Asset 4,
Bloomberg
AC size Logarithm of number of members on the AC Continuous BoardEx
AC independence Proportion of independent members on the AC Continuous BoardEx
AC gender Proportion of female directors on the AC Continuous BoardEx
AC tenure Logarithm of the average tenure of AC members Continuous BoardEx
AC age Logarithm of average age of AC members Continuous BoardEx
Firm size Logarithm of the total assets Continuous Asset 4
Firm performance Measured as Return On Assets (ROA) Continuous Asset 4
Leverage Ratio of total liabilities to total assets Continuous Asset 4
Board independence Proportion of independent directors on the board Continuous BoardEx
Board size Logarithm of number of members on the AC Continuous BoardEx
R&D intensity Logarithm of the ratio of R&D expenses to sales Continuous Asset 4
Capital intensity Logarithm of the ratio of total assets to sales Continuous Asset 4
CEO duality 1 when CEO is also chairman of board, 0
otherwise
0 or 1 BoardEx
Organizational slack Ratio of current assets to current liabilities Continuous Asset 4
Analyst coverage Number of analysts Continuous Asset 4
RESULTS
Descriptive statistics and correlations
Table 2 presents the descriptive statistics of all the variables used in this research. The mean CSR
decoupling gap is negative, indicating that the majority of observations in our sample have higher CSR
performance scores than CSR reporting scores. This validates the measurement of CSR decoupling used
by Hawn and Ioannou (2016). The mean AC size of 4.22 is consistent with the recommendation of the
Blue Ribbon Committee (BRC) (1999) recommendation of a minimal audit committee size of 3
members. Also consistent with the requirement of the Sarbanes-Oxley Act (Rockness & Rockness,
2005) is the mean AC independence. This mean is 0.99 which indicates that almost all members of the
audit committees are independent directors. The descriptive statistics for AC age indicate that the audit
12
committee members in our sample are relative older directors with a minimum age of 39 and a maximum
age of 79.33. Lastly, the Analyst coverage of the firms in my sample have a mean of 13.98 which
indicates that the firms are highly visible and are relatively large, which is consistent with the sample of
Hawn and Ioannou (2016). The Variance Inflation Factor (VIF) values of al the independent variables
are not higher than 2, which is well below the threshold value of 10 and suggests that multicollinearity
is not a problem in this study (Belsley, Kuh, & Welsch, 1980).
Table 2: Descriptive statistics
Variable name Mean SD Min Max VIF
1. CSR decoupling - 28.60 22.91 - 92.53 47.57 -
2. AC size 4.22 1.28 1 14 1.25
3. AC independence 0.99 0.04 0 1 1.04
4. AC gender 0.26 0.30 0 1 1.08
5. AC tenure 4.25 2.40 0 16.25 1.27
6. AC age 61.19 5.05 39.00 79.33 1.19
7. Firm size 6.94 0.89 4.07 11.41 1.67
8. Firm performance 6.13 11.42 -338.50 132.58 1.15
9. Leverage 0.48 0.19 0.01 2.45 1.11
10. Board independence 0.68 0.23 0 1 1.27
11. Board size 10.28 3.04 2 35 1.45
12. R&D intensity - 1.39 0.88 - 3.30 4.06 1.11
13. Capital intensity 0.14 0.32 - 0.72 4.45 1.20
14. CEO duality 0.52 0.50 0 1 1.11
15. Organizational slack 1.22 0.78 -1.28 4.93 1.16
16. Analyst coverage 13.98 10.10 0 56 1.33
n = 6,266 observations for 1,501 firms. Unstandardized data.
Multicollinearity is also tested using a Pearson bivariate correlation test with the unstandardized
data as presented in table 3. All the correlations are well below the threshold of 0.8 which indicates that
also based on the correlations results, together with the low VIF values, multicollinearity is not a
problem in this study (Greene, 1999). A significant negative relation is found between AC size (- 0.177),
AC tenure (- 0.095) and AC age (- 0.037) on CSR decoupling. AC independence (- 0.018) and AC gender
(- 0.013) have a negative insignificant relation with CSR decoupling. Further, the table shows that for
the control variables, Firm size (- 0.144), Firm performance (- 0.147), Leverage (- 0.055), Board
independence (- 0.164), Board size (- 0.180), CEO duality (- 0.044), and Analyst coverage (- 0.198)
have a significant negative relation with CSR decoupling and R&D intensity (0.127), Capital intensity
(0.191), and Organizational slack (0.048) have a significant positive relation with CSR decoupling.
Lastly, the matrix shows that Board size (0.333) has a significant positive correlation with AC size and
that Firm size (0.388) has a significant positive correlation with Board size. This indicates that larger
firms have larger boards which in turn have larger audit committees.
13
Table 3: Pearson bivariate correlation matrix
Variable name 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
1. 1. CSR decoupling 1
2. AC size - 0.177** 1
3. AC independence - 0.018 0.006 1
4. AC gender - 0.013 - 0.23* 0.070** 1
5. AC tenure - 0.095** 0.081** 0.043** 0.094** 1
6. AC age - 0.037** 0.070** 0.016 - 0.029* 0.332** 1
7. Firm size - 0.144** 0.083** - 0.131** - 0.135** - 0.060** 0.078** 1
8. Firm performance - 0.147** 0.027* - 0.17 - 0.046** 0.046** 0.017 0.095** 1
9. Leverage - 0.055** 0.066** 0.008 0.034** - 0.030** - 0.050** 0.011 - 0.097** 1
10. Board independence - 0.164** 0.213** 0.134** 0.200** 0.202** 0.164** - 0.194** - 0.006 0.003 1
11. Board size - 0.180** 0.333** - 0.018 - 0.047** 0.047** 0.005 0.388** 0.045** 0.084** - 0.125** 1
12. R&D intensity 0.127** - 0.076** 0.034** 0.083** 0.027* - 0.034** - 0.154** - 0.108** - 0.050** 0.115** - 0.119** 1
13. Capital intensity 0.191** - 0.055** - 0.005 0.028* - 0.024* 0.004 0.084** - 0.250** - 0.154** - 0.068** - 0.033** 0.181** 1
14. CEO duality - 0.044** 0.128** 0.019 0.118** 0.162** 0.136** 0.044** 0.036** - 0.015 0.199** 0.113** 0.057** - 0.057** 1
15. Organizational slack 0.048** - 0.023* 0.026* 0.047** 0.083** 0.093** - 0.254** 0.022* - 0.196** 0.124** - 0.128** 0.078** - 0.104** 0.087** 1
16. Analyst coverage - 0.198** 0.061** - 0.010 - 0.036** 0.206** 0.035** 0.417** 0.080** - 0.012 - 0.011 0.213** - 0.033** 0.031** 0.029* - 0.087** 1
n = 6,266 observations for 1,501 firms. *: Correlation is significant at the 0.05 level (2-tailed). **: Correlation is significant at the 0.01 level (2-tailed). Unstandardized data.
14
Regression results
Table 4 presents the results of the fixed effect multiple regression analysis including firm, year and
industry fixed effects. The basic model with only the control variables is tested in model 1. In model 2
all the independent and control variables are added to test the hypotheses. In both models the continuous
variables are standardized to control for non-normality problems. Both models have significant
explanatory power to predict the effect on CSR decoupling because both P-values of the model are below
the 0.01 level. The adjusted R² of both models are respectively 0.032 and 0.044 indicating that the
independent variables are appropriate to measure CSR decoupling.
Model 1 presents a basic model with only control variables. The results of this multiple
regression show a significant negative effect of Firm size (β = - 0.886, p = 0.000), Firm performance (β
= - 0.006, p = 0.000), Board independence (β = - 0.003, p = 0.000), and Organizational slack (β = -
0.039, p = 0.008) on CSR decoupling. Further, Capital intensity (β = 0.296, p = 0.000) and Analyst
coverage (β = 0.006, p = 0.003) have a significant positive effect on CSR decoupling. This indicates that
firms with a higher amount of capital and firms that are more visible have more CSR decoupling. On
the other hand, larger firms who are performing well, have more resources unused, and being supervised
by an independent board have lower CSR decoupling.
Model 2 shows that AC size has a significant negative effect (β = - 0.209, p = 0.041) on CSR
decoupling which means that the predicted negative effect of AC size on CSR decoupling in hypothesis
1 is supported. The predicted negative effect of AC independence has an insignificant positive effect (β
= 0.011, p = 0.190) on CSR decoupling and thus is hypothesis 2 unsupported. Model 1 also represents
the results for hypothesis 3 that predicts that a higher percentage of females on the audit committee
results in less CSR decoupling. As predicted, AC gender has a significant negative effect (β = - 0.149,
p = 0.006) on CSR decoupling providing support for hypothesis 3. Further, model 1 finds a significant
negative effect (β = 0.389, p = 0.000) of AC tenure on CSR decoupling which supports the predicted
negative relation in hypothesis 4. Lastly, hypothesis 5 is supported as well because the negative
coefficient (β = 1.407, p = 0.007) of AC age and CSR decoupling is significant. The implications and
conclusions about the above results are discussed in the next chapter.
Additional test: Dimensional decoupling
To see what effect the audit committee characteristics have on the specific dimensions of CSR
decoupling, I used the triple bottom line method used by Hussain et al. (2018). The triple bottom line
approach gives equal weight to the three dimensions of CSR performance which are economic,
environmental and social performance (Elkington, 1997). In the original model of this study I tested
the effect of audit committee characteristics on CSR decoupling as a whole. In this additional
15
Table 4: Multiple regression results on CSR, Environmental and Social decoupling
(1) (2) (3) (4)
Variables CSR decoupling CSR decoupling Environmental decoupling Social decoupling
AC size - 0.209**
(0.041)
- 0.128
(0.244)
- 0.080
(0.491)
AC independence - 0.187
(0.557)
- 0.203
(0.556)
- 0.033
(0.927)
AC gender - 0.149***
(0.006)
- 0.109*
(0.062)
- 0.050
(0.410)
AC tenure - 0.389***
(0.000)
- 0.235***
(0.000)
- 0.151**
(0.012)
AC age - 1.407***
(0.007)
- 1.698***
(0.002)
- 1.963***
(0.001)
Firm size - 0.886***
(0.000)
- 0.909***
(0.000)
- 0.784***
(0.000)
- 0.506***
(0.000)
Firm performance - 0.006***
(0.000)
- 0.007***
(0.000)
0.000
(0.980)
- 0.003*
(0.068)
Leverage 0.001
(0.989)
0.002
(0.984)
- 0.144
(0.181)
- 0.257**
(0.022)
Board independence - 0.003***
(0.000)
- 0.003***
(0.000)
- 0.003***
(0.000)
0.000
(0.828)
Board size 0.160
(0.214)
0.413**
(0.012)
0.530**
(0.003)
0.259
(0.164)
R&D intensity - 0.004
(0.820)
- 0.009
(0.709)
- 0.028
(0.272)
0.018
(0.512)
Capital intensity 0.296***
(0.000)
0.474***
(0.000)
0.335**
(0.002)
0.149
(0.199)
CEO duality 0.011
(0.690)
0.021
(0.514)
0.026
(0.455)
- 0.053
(0.153)
Organizational slack - 0.039***
(0.008)
- 0.050***
(0.003)
- 0.021
(0.241)
- 0.014
(0.470)
Analyst coverage 0.006***
(0.003)
0.009***
(0.000)
0.005**
(0.043)
0.006**
(0.023)
Firm, year & industry fixed effects Yes Yes Yes Yes
Adjusted R² 0.032 0.044 0.042 0.066
n 6266 6266 6266 6266
n = 6,266 observations for 1,501 firms; P value in parentheses. *p< 0.1; **p< 0.05; ***p< 0.01
16
regression I tested whether these audit committee characteristics have an effect on environmental and
social decoupling separately, measured as the gap between environmental performance and reporting
and the gap between social performance and reporting. Whereas the environmental dimensions focuses
more on waste, emission, sustainable energy and environmental rules, the social dimension focuses
more on human rights, labour and society (Hussain et al., 2018). The economic dimension is not tested
in this additional analysis because this dimension is fundamental for a company and is already well
reported and checked in the financial statements (GRI, 2006).
The results of the additional analysis are shown in model 3 and 4 in table 4. Model 3 shows
the results of the effect of audit committee characteristics on environmental decoupling. AC tenure (β
= - 0.235, p = 0.000) has a significant negative effect on Environmental decoupling and AC age (β = -
1.198, p = 0.002) has a significant negative effect on Environmental decoupling as well. I was unable
to find a significant effect of AC size (β = - 0.128, p = 0.244), AC independence (β = - 0.203, p =
0.556), and Ac gender (β = - 0.109, p = 0.062) on Environmental decoupling. The results of the effect
of the audit committee characteristics on social decoupling are shown in model 4. AC tenure (β = -
0.151, p = 0.012) and AC age (β = - 1.963, p = 0.001) both have a significant negative effect on Social
decoupling. I did not find a significant relation between AC size (β = - 0.080, p = 0.491), AC
independence (β = - 0.033, p = 0.927), AC gender (β = - 0.050, p = 0.410), and Social decoupling. In
the next section I will discuss the above results for the original test and the additional tests.
DISCUSSION
In this study I investigated whether audit committee characteristics have an impact on CSR
decoupling. Building on the agency theory I proposed that monitoring by the audit committee could
take away the information asymmetry that makes CSR decoupling possible (Spence, 2002). My
analysis shows interesting results about the relationship between audit committee characteristics and
CSR decoupling. I found significant support for 4 out of 5 hypotheses building on agency theory.
Against my expectations I couldn’t find a significant relation between independence of the audit
committee and CSR decoupling (H2). A possible reason for this can be that the mean independence
ratio of the audit committee was 99%. This indicates that almost all of the observations had a highly
independent audit committee which makes it hard to predict if a high independence ratio has a
negative influence on CSR decoupling, compared to a low independence ratio.
The empirical results show that a larger audit committee has a negative effect on CSR
decoupling (H1). This result is in line with the arguments found based on the agency theory. Larger
audit committees are better able to monitor because they have more status and power within an
organization and they have access to more valuable resources (Kalbers & Fogarty, 1993; Pincus et al.,
17
1989). Furthermore, the results support the literature that larger audit committees have more diversity
in expertise which will result in more qualitative advice and monitoring (Guest, 2009).
In line with the agency theory and existing literature, the empirical results show support for
H3. A higher percentage of woman on the audit committee will lead to less CSR decoupling. The
monitoring function will be positively influenced by a more gender diverse audit committee because
woman are better communicators, more risk averse, ethical, and cautious than man (Stewart & Munro,
2007; Thiruvadi & Huang, 2011). The empirical results show support for H4 as well and are in line
with the agency theory and previous literature. The results show support for the negative effect of
longer tenured members of the audit committee on CSR decoupling because of more effective
monitoring. Longer tenured members are better able to monitor because they have more firm-specific
expertise, knowledge, and experience and are better able to challenge the management (Sharma &
Iselin, 2012; Vafeas, 2003).
Also consistent with the agency theory and previous literature is H5. The empirical results
support the negative effect of a higher average age of the audit committee members on CSR
decoupling. Older audit committee members are more experienced and have gained more knowledge,
which improves their monitoring effectiveness (DeZoort, 1998). Furthermore, older audit committee
members are more conservative and show less risk taking behavior which has a positive effect on their
monitoring activities (Hambrick & Mason, 1984; Qi & Jiaotong, 2012).
In the additional test I tested whether the audit committee characteristics also have an effect on
the separate dimensions of CSR decoupling. In this way I am able to see if the audit committee
characteristics only have influence on one dimensions of CSR decoupling or if they have influence on
CSR decoupling as a whole. My findings show that only age and tenure of audit committee members
have a significant negative effect on Environmental and Social decoupling separately. These results
indicate that audit committees consisting of older aged and longer tenured members have a negative
effect on environmental and social decoupling. These results are in line with the agency theory
because older aged and longer tenured members are better able to monitor which creates transparency
and in the end will reduce decoupling behavior. The insignificant results of the relation between the
size and gender diversity of audit committees and environmental and social decoupling indicates that
these characteristics are only effective in reducing CSR decoupling as a whole.
Taken together, my results show the negative effect of audit committee characteristics on CSR
decoupling based on agency theory. Larger audit committees with more females on the audit
committee will have a negative effect on CSR decoupling. Furthermore, audit committees with a
higher average age and tenure will have a negative effect on CSR decoupling as well. All these
characteristics will improve the monitoring function of the audit committee which is according to the
agency theory an effective governance mechanism to reduce the information asymmetry that makes
18
CSR decoupling possible. In addition to this, the size and gender diversity of the audit committee only
have a negative effect on CSR decoupling as a whole while the age and tenure of audit committee
members also have a negative effect on environmental and social decoupling separately.
CONCLUSION
The purpose of this study was to investigate the effect of audit committee characteristics on CSR
decoupling. CSR decoupling leads to lower firm value while the shareholders’ objective is to increase
firm value. This agency conflict can be solved by applying effective monitoring mechanisms like the
audit committee. Previous literate found that in case of CSR decoupling there is a problem of
information asymmetry between the management and the stakeholders (Spence, 2002). The main tasks
of the audit committee are creating transparency and solving information asymmetry and monitoring
the financial and non-financial reports. I found that larger audit committees with a higher percentage
of female members on the audit committee will have a negative effect on CSR decoupling.
Furthermore, higher average age and tenure of the audit committee will also have a negative effect on
CSR decoupling as a whole, as well as on environmental and social decoupling separately. These
results imply that effective corporate governance will improve CSR performance and helps to meet the
stakeholders’ objectives resulting in increased legitimacy.
This study makes two important contributions to the literature. First, this is the first study that
links CSR decoupling to audit committee characteristics, based on a large sample of worldwide listed
companies for the years 2006-2017. Both CSR decoupling and audit committee characteristics have
been investigated separately, but no study has found a significant link between these two topics, based
on the agency theory. Second, according to Graafland & Smid (2019), the determinants of CSR
decoupling are underexplored in the literature. In an attempt to fill this gap I draw on the agency
theory to see how the audit committee characteristics influence CSR decoupling. This study helps to
understand the negative effect of CSR decoupling for stakeholders and how specific audit committee
characteristics can decrease CSR decoupling. This understanding of the relation between audit
committee characteristics and CSR decoupling can help the board of directors in the formation of the
audit committee.
Although this study has some important contributions to the literature, it also suffers from
some limitations. The first limitation of this study is that this study is tested using data from worldwide
listed firms. In general, listed firms have more resources available to use for CSR investments than
medium and small sized unlisted firms. Besides that, listed firms have in general more corporate
governance mechanism than medium and small unlisted firms. The results of this study are therefore
limited to large listed firms. The second limitation of this study is that this study is based on secondary
19
data. More in-depth data based on interviews could result in more in-depth clarifications for certain
outcomes and results and it could also broaden our understanding why managers decouple.
To conclude, the limitations mentioned give opportunities for interesting directions of future
research. The understanding of the relationship between audit committee characteristics and CSR
decoupling can be validated by using more in-depth data acquired through interviews. Furthermore,
future research can focus on the effect of other committees on CSR decoupling, like the CSR
committee or nominating committee.
20
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