Understanding what drives social and environmental disclosure by corporations in

China: does Western thinking apply?

Dennis Taylor (Prof)School of Accounting

RMIT University

RMIT@Asia Seminar Series October, 2010

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The Research Issue

• Are Western-derived theories from socio-political and economics-based perspectives able to provide predictable explanations of the extent of voluntary corporate social and environmental reporting (CSER), or lack of, by companies operating in China?

• Or does the business and socio-political context in a non-Western culture reveal a lack of support for, or even anomalies in, these theoretical explanations of CSER?

• If so, can alternative explanations of CSER embedded in the business context of a transitional economy and the socio-political context of China, be developed?

• To address this issue, seven Western-derived theoretical perspectives on incentives for CSER are modelled.

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Objectives

1. Identify the type, extent and quality of social and environmental reporting in the annual reports of large Chinese-controlled companies (Red-chip and A-Share)

2. Test hypotheses about the relationships between elements of Western-developed legitimacy, stakeholder and signalling theories and the quantity and quality of CSER by Chinese companies.

3. Discuss whether:

(a) various Western-developed theoretical perspectives on CSER are sufficiently robust to be transferable to the setting of China;

(b) implications of relying on these Western-developed theories to drive growth in the practice of CSER in China.

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MOTIVATION

• China’s heavy dependence on burning coal to fuel its rapid economic growth.

If emission trends are left unchecked, “in 25 years

the carbon-dioxide from China alone will be double

that which comes from all the OECD countries

put together” (Bezlova 2007, p.9)

• Gap in the literature on up-to-date evidence of patterns of CSER by listed companies controlled by shareholders from mainland China.

• Evidence of the transferability of Western-derived theories as determinants of CSER can contribute to the policy debate about regulation of CSER.

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Socio-political and economic theories of CSER

• Socio-political theories

• Socio-political theories including political economy, legitimacy theory, and stakeholder theory suggest that CSER is a function of social and political pressures facing the corporation (Patten, 2002).

• Under stakeholder theory, there is literature about the debtholder power perspective where management is reliant on debtholders finance.

• Under legitimacy theory, there is literature on several theoretical perspectives, including strategic posturing by management, political cost of failure to disclose, media attention given to companies, and paroxysmic incident responses by companies.

• Economic-based Theories

• Economic-based voluntary disclosure theory (Dye,1985; Verrecchia, 1983) predicts that firms with superior economic performance (in terms of financial returns and financial risk) will convey their quality ‘‘type’’ to investors.  

• Under signalling theory, there is literature referring to a profitability success reinforcement perspective, and stability reinforcement perspective.

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Literature and Hypotheses using Western thinking; the context in China

1. Debtholder power perspective in stakeholder theory

• Stakeholder theory posits that managers will formulate and implement strategies to manage the potential demands of the more powerful stakeholder groups (Freeman, 1984).

• Debtholders can be salient stakeholders. Roberts (1992) states “the greater the degree to which a corporation relies on debt financing to fund capital projects, the more corporate management would be expected to respond to creditor expectations concerning a corporation’s role in socially responsibility activities” (pp. 602-603).

• H1: The greater a firm’s reliance on debtholder finance, the higher the

quantity and quality of CSER disclosure in the firm’s annual report.

• In China, Shirai (2002) found favourable banks’ lending biases toward large, less profitable firms with greater State ownership, particularly after initial public offerings of A-shares. Such favourable financing conditions from banks mean management has low incentive to diversify into equity finance despite rising stock prices.

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2. Strategic posture perspective in legitimacy theory

• Ullmann (1985) conceptualizes that when stakeholder power is high, strategic posture by management will be active and CSER will be high.

• Roberts (1992) argues that corporate charitable contributions can be viewed as representing the strategic posturing of management in order to mitigate demands of stakeholders on the company.

• H2: The existence of active strategic posturing by reporting charitable donations during the year is positively related the quantity and quality of CSER disclosure in the firm’s annual report.

• In China, philanthropic giving has traditionally involved the concept of “clan associations … in a culture that emphasizes face” (Acs and Dana, 2001, p. 72). This is compatible with a top management practice of strategic posture through corporate contributions to ‘ancestral villages’ for themselves personally rather than their company.

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3. Profitability success reinforcement perspective of signalling theory

• Management in high profitable firms are motivated to signal their quality or success, not only through profit reports but also through their effective management of corporate social and environmental responsibility (Wallace & Naser, 1995).

• H3: The higher a firm’s profitability, the higher the extent and quality of CSER disclosure in the firm’s annual report.

• Whether management of firms with high profitability in China have more incentives to signal to the market and show-off their other successful activities in social and environmental areas to gain favour with is a matter to be tested.

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4. Stability reinforcement perspective of signalling theory

• Roberts (1992) establishes a relationship between a firm’s equity systematic risk and level of CSER disclosure. The reasoning is firms with lower beta have a more stable pattern of share-market returns, allowing more steady discretionary spending on social and environmental activities and, through through greater CSER, enhance the firm’s image of being a responsible community contributor and able to manage both its economic and social risks well.

• H4: The lower a firm’s equity systematic risk, the higher the extent and quality of CSER disclosure in the firm’s annual report.

• Whether lower equity systematic risk by a Chinese company translates into management undertaking more stable discretionary spending on social and environmental activities and, in turn, providing greater CSER, particularly when most listed companies have high government ownership and control, is a matter to be tested.

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5. Political cost perspective of legitimacy theory

• Larger firms will have a greater incentive to mitigate political costs and manage their ‘social contract’ than smaller firms. (Dowling & Pfeffer (1975); Deegan & Carroll (1993); Hossain et al. (1995); Cullen & Christopher (2002); Haniffa & Cooke (2005)).

H5: The larger the firm size, the higher is the quantity and quality of CSER disclosure.

• However, the Western-developed assumption that larger companies will face greater potential political costs in the form of public resentment, consumer hostility, militant employees and the attention of government regulatory bodies may be questionable in China’s corporate and social context.

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6. Media attention perspective of legitimacy theory

• Legitimacy theory research extends to examining the role that media coverage plays in increasing the public policy pressures faced by companies (Patten, 2002). Brown and Deegan (1998) and Deegan, Rankin and Voght (2000), Liu & Taylor (2008)).

H6: The higher the print media attention specific to a firm’s CSER during a year, the higher is the extent and quality of CSER disclosure in the firm’s annual report.

• Would this hypothesis be expected to be supported in the context of media agenda-setting in China? Government continues to keep tight control of newspapers (the State Press and Public Administration) and business enterprises can ‘manage’ journalists (‘three-warranty reporting’).

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7. Paroxysmic incident response perspective of legitimacy theory• Public dissatisfaction (threat) with a firm’s event (incident) can result

in a decline its legitimacy in society. This dissatisfaction not only relates to the particular firm responsible for the specific incident, but also to the general impact on other firms in the society (Patten, 1992).

• Prior empirical studies conclude that a paroxysmic environmental or social incident resulting from a firm will produce greater CSER disclosures by that firm and others in the industry or country (Patten, 1992; Gray, Kouhy & Lavers, 1995; Deegan, & Rankin, 1996; Li, Richardson & Thornton, 1997; Hutchings & Taylor, 2000; Cunningham & Gadenne, 2003).

H7: The Songhua River pollution spill incident significantly increased the quantity and quality of CSER disclosure in firms’ annual reports.

• The Songhua River water pollution incident in northern China revealed the limited capacity of local environmental protection bureaus to regulate industrial environmental activities and a failure to enforce the relevant national policies and regulations created by SEPA.

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Research method

The model

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Definition and measurement of variables (Table 2)

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Definition and measurement of variables (Table 2) continued

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Definition and measurement of variables (Table 2) continued

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Sampling

• Drawn from the H-Share and Red-Chip companies listed on the Hong Kong Stock Exchange (HKSE) in 2005 and 2006.

• The annual reports for both years of H-Share and Red-Chip companies were progressively searched for evidence of any CSER disclosures, working through these companies in order of size (capitalization).

• Beyond the largest 56 companies, the incidence of CSER disclosure by smaller H-Share and Red-Chip companies was found to be almost completely absent in annual reports.

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Results

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Panel regression analysis to test hypotheses

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Panel regression analysis to test hypotheses continued

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Summary of findings

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Conclusions (1)

Implications for the use of Western-derived theoretical perspectives to understand or seek to change CSER practices in China. The findings suggest:

1. Two anomalous theories that provide misleading predictions. –The power of debtholders (major banks in China) as a

stakeholders to demand greater CSER disclosure from corporate management. In fact, in their collusive relationships, major debtholders prefer less CSER.

–The signalling by management of the ‘quality’ of their firm through the reinforcement of successful profit results with greater CSER disclosure. In fact, signalling of financial success only appears synonymous with ‘quality’ of management in China’s economic growth ethos. Disclosures such as emissions controls and work safety are substitute signals for ‘quality’ of management, used mainly when quality cannot be conveyed in financial performance.

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Conclusions (2)

2. Three legitimacy theory perspectives are found to motivate CSER disclosures by corporate managers, but they are largely beyond the bounds of on-going stakeholder or regulatory control of CSER in China.

–The strategic posturing by top managers in providing company donations is related to higher CSER. However, this relationship may not reflect a top management incentive to mitigate stakeholder pressure, but instead reflect the use of company donations to ‘buy’ clan prestige and leadership positions.

–A paroxysmic incident (because of a wide-spread surge in public dissatisfaction that reduces firms’ legitimacy) is related to higher CSER. However, such incidents are one-off occurrences which probably have a short-term impact on CSER in China.

–The very large companies (because of their concern about exposure to potential political costs) are related to higher CSER. However, company size is a variable that is confounded.

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Conclusions (3)

3. Two Western theoretical perspectives are found have no motivating influence on CSER disclosures in China.

–The signalling by management of the ‘quality’ of their firm through the reinforcement of financial and market stability with greater CSER disclosure. The Western belief that management that achieves more financial stability will budget more discretionary expenditure to social and environmental performance and signal this through higher CSER, is not evident in China.

–The extent of media attention to corporate social and environmental activities is found to not affect CSER in China. This is lack of media impact is expected to continue while government in China continues to keep tight control of newspapers and where business enterprises can ‘manage’ journalists.

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Limitations and Further Research

Limitations include:

• Sampling – small number of companies

• Source of CSER – only from annual reports of HKSE listed red-chip and A-share companies

• Proxies for IVs – limited face validity for ‘political cost’, ‘strategic posture’, ‘debtholder power’.

Further research suggestions:

• Qualitative multiple-case-study research into CSER decision-making by corporate management in China

• Replicate this study on a larger sample of environmentally sensitive and work-practice sensitive industries in China where companies are grouped into those providing and not providing CSER.