CEO Characteristics and CSR Decoupling:
The Moderation Effect of Earnings
Management
David G. Larsson
S3199843
Thesis Supervisor: Dr. N. Hussain
Co-Assessor: Prof. dr. C.K. Hoi
Abstract
Several studies have attempted to link corporate social responsibility (CSR) and earnings management (EM), although, with conflicting results. This study uses the agency theory to build upon the link and investigate if CSR decoupling can be predicted by CEO characteristics. More specifically, this study investigates whether there is a relationship between CEO characteristics and CSR decoupling, as well as if there is a moderating effect from accrual-based earnings management. The study uses a sample from 65 various countries and contains 6101 firm-year observations from the years 2006-2017. A random effect regression model is used to conclude that there is a direct positive relationship between accrual-based earnings management and CSR decoupling. Also, there is a direct relationship between the nationality of the CEO and CSR decoupling. These findings support existing research and contribute to a new perspective on how CSR decoupling can be studied in the future, namely, by analysing various individual characteristics from upper-echelon managers.
Keywords: Earnings Management, CSR decoupling, CEO characteristics, Agency theory,
3 Table of Contents Introduction……….………4 Literature Review………7 CEO Characteristics……….11 Education………..11 Tenure………...12 Age………13
Gender & Nationality………...13
Corporate Social Responsibility……..……….14
Earnings Management………….……….17
Methodology ………20
Sample….………..20
Measures………...21
CSR Decoupling……….………….………..21
Accrual-Based Earnings Management……….……...……….22
CEO Characteristics……….………25
Control Variables………..25
Results………...27
Descriptive Statistics……….………....27
Test of Hypotheses……….…………...31
Discussion and Conclusion………...33
Limitation and Future Research ..……….37
Introduction
The idea of this paper is to study the influence that CEO characteristics have on CSR decoupling and the interaction effect from earnings management. Corporate social responsibility (CSR) is a firm’s initiative to undertake voluntary environmental, societal, and/or corporate governance actions (Carrol, 1979), to consider groups in society other than stakeholders (Jones, 1980, p. 59). Firms can respond to society by engaging in internal and external CSR activities (Hawn & Ioannou, 2016). Internal activities can be changes in the firm that supports the CSR performance and external activities is the disclosure to various stakeholders. Some managers may intentionally misalign these two activities to better respond to conflicting stakeholder pressures, which is referred to as CSR decoupling (Tashman, Marano, & Kostova, 2019). Earnings management (EM) has been described as “the process of taking deliberate steps within the constraints of generally accepted accounting principles to bring about a desired level of reported earnings.” (Beneish, 2001, p.2). Researchers within the discipline have attempted to investigate the motive behind any form of earnings management. It is argued that altering the accounting numbers of financial data is a tool to present distorted numbers to meet the expectations from shareholders and maintain a good relationship (Surroca & Tribó, 2008; Villarón-Peramato, Martínez-Ferrero, & García-Sánchez, 2018).
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the other hand, those upper echelon managers that do engage in earnings management to manage stakeholder pressure, are predicted to be more likely to engage in CSR decoupling as well. Both phenomena are tools for symbolic management and if an individual has the ethical orientation to engage earnings management, he/she has the capability to decouple the CSR activities too. Hence, the relationship between CEO characteristics and CSR decoupling is strengthened if a CEO is engaged in earnings management.
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Literature Review
9
CEO Characteristics
CSR is a strategic decision that firms take to increase firm value, thus it reflects various characteristics of the manager(s) that undertake the decision (Hambrick & Mason, 1984). Previous research on CEO characteristics has determined the core demographic dimensions that have the best chance to predict strategic decision-making. These are (1) nationality, (2) education, (3) age, (4) gender, and (5) tenure (Hambrick & Mason, 1984; Bantel & Jackson, 1989; Wiersema & Bantel, 1992). CSR performance is argued to be influenced by managerial values and beliefs; therefore, the previous literature has argued CEO characteristics to be a potential predictor for such relationship (McGuire, Dow, & Argheyd, 2003). Besides, it has been argued that manager characteristics significantly influence the viewpoint and perception of environmental issues (Cordano & Frieze, 2000; Egri & Herman, 2000; Sharma, 2000) as well as how the institutional environment surrounding the firm and its business is perceived (George, Chattopadhyay, Sitkin, & Barden, 2006).
Thaler, 1986; Marwell & Ames, 1981; Selten & Ockenfels, 1998). Finkelstein, Cannella, Hambrick, & Cannella (2009) have contributed to the research area by concluding a significant effect on firm outcomes from the educational background. Moreover, educational background has a strong positive effect on the extent to which a CEO is innovative. Also, there is supported evidence that CEOs with an MBA degree show better results in terms of firm value, as it is argued that such degree provides the individual with better capacity to exploit opportunities regard strategic decisions (Geletkanycz & Black, 2001). The literature agrees on the assumption that educational background, and specifically MBA graduates, plays an important role to predict firm behaviour based on CEO characteristics. It is important to clarify that the literature is distinguishing between an MBA degree and an MSc BA degree, as the former is an executive oriented education, meanwhile the latter is not. Due to the already profound research linking the educational background of the CEO and opportunistic firm behaviour, the following hypothesis is presented:
- H1: CEO education is associated with CSR decoupling
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a significant role in this research to better understand the relationship between CEO tenure and CSR decoupling. Hence, the following hypothesis is proposed:
- H2: CEO tenure is positively associated with CSR decoupling
age. The demographic trait effect discussed by Wiersma & Bantel (1992) presents how
individual characteristics of a CEO can be used to predict receptivity of change and risk aversion. Relatively young CEOs are argued to be more likely to take on a greater extent of risk, which is an indirect component of factors influencing CSR decoupling. Alutto, & Hrebiniak, (1975) have found in their research that older CEOs tend to be more committed towards the status quo, and therefore be less inclined to strive for a change. Other researchers further elaborate on the motives behind such behavior and conclude that senior executives do value security in terms of personal as well as career-wise in a different way (Carlson & Karlsson, 1970; Vroom & Pahl, 1971). Therefore, the following hypothesis is tested:
- H3: CEO age is negatively associated with CSR decoupling
gender and nationality. According to Carpenter, Geletkanycz, & Sanders, (2004), most
upper echelon research lack insight into the difference in firm behaviour while using gender as a predictor. It is argued to be difficult as the proportion is heavily skewed towards male CEOs and therefore sample size rarely reaches the level to make a significant contribution. Those studies that tested the difference in cooperative behaviour between economics student vs. others also found evidence that there is a difference between genders as well as nationalities (Frank, Gilovich, & Regan, 1993). Therefore, the following hypotheses are proposed:
Corporate Social Responsibility Decoupling
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(2014) and Martinez-Ferrero et al, (2016) argue that CSR decoupling is used to hide the negative effects of earnings management activities.
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Kostova, 2019; Hawn & Ioannou, 2016; Jamali, Lund-Thomsen, & Khara, 2017; Graafland & Smid, 2019; Sauerwald & Su, 2019).
Earnings Management
Earnings management (EM) is described as “the process of taking deliberate steps within the constraints of generally accepted accounting principles to bring about a desired level of reported earnings.” (Beneish, 2001, p.2). It has been proved that earnings management within the grey zone of the law is more successfully targeted by law authorities when investigating domestic firms as compared to cross-listed firms (Siegel, 2005). Business ethics researchers have described earnings management as poor corporate citizenship (Scholtens & Kang, 2013), as well as an unethical practice (Kaplan, 2001; Greenfield, Norman, & Wier, 2008). Nevertheless, the objective is not to conclude the morality of earnings management itself, but rather provide insight into its complex structure. Rosenfield (2000) adds to the complexity by concluding that there are forms of EM that are allowed by the US GAAP, such as: realise revenue before its recommended time, and/or reallocate debt to offshore organisations to enhance income figures. Greenfield, Norman, & Wier (2008) investigated the relationship between an individual´s ethical orientation and the perception of whether earnings management is ethical or unethical. He distinguishes between an idealistic ethical orientation which should avoid due to prevention of harm to others, and a relativistic ethical orientation which is lenient towards judgement of decisions and considering the circumstances which allow them to see earnings management as a less unethical practice.
reduce COGS, discount prices to increase sales, manipulate margins through reduction of discretionary expenditures (Roychowdhury, 2006). On the contrary, Zang (2012) describes accrual-based earnings management (AEM) as changing the accountancy method when reporting a specific transaction in the financial statements. Research has found that there has been a shift from AEM to REM post the Sarbanes-Oxley Act (SOX) that was enforced in 2002 since REM is more difficult to separate from normal business activities (Graham, Harvey, & Rajgopal, 2005; Cohen, Dey, & Lys, 2008). The SOX has influenced the way law enforcers control for EM in general and specifically target AEM (Cohen & Zarowin, 2010). Other scholars have confirmed that REM is more common nowadays and described the trade-off between the two as AEM to be less costly, but easier to detect (Garcia-Osma, 2008; Graham, Harvey, & Rajgopal, 2005; Cohen & Zarowin, 2010; Zang, 2012).
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business. Therefore, the framework will play an important role in this study to link CSR to EM as both practices seem to have motives related to the stakeholder theory as well as the agency theory. This study proposes the following hypotheses:
- H6a: Accrual-based earnings management is positively associated with CSR
decoupling
- H6b: Upward AEM is positively associated with CSR decoupling
- H6c: Accrual-based earnings management moderates the relationship between CEO
characteristics and CSR decoupling
Figure 1. Conceptual Model
Earnings Management
Methodology Sample
The data has been collected from various sources for a period of 12 years from 2006 to
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Figure 2. Continental Frequencies
Measures CSR Decoupling
activities of the firm. CSR disclosure is measured by the ESG score derived from Bloomberg which has a score from 0,1 to 100 and represents the external CSR activities of the firm. The ESG score measures transparency and quality of the disclosure and a higher score means that the firm is more willing to share its activities with its stakeholders. CSR decoupling is therefore measured by taking CSR disclosure from year t subtracted by CSR performance for year t-1.
Earnings Management
In this study, the focus will be solely on accrual-based earnings management (AEM) to predict whether firms engage in CSR decoupling. The reason is aligned with the idea discussed by several authors regarding AEM to be more detectable as compared to REM (Garciá-Osma, 2008; Graham, Harvey, & Raigopal, 2005; Cohen & Zarowin, 2010), which contributes to a less complex, but also more straight forward analysis towards the relationship among the variables. The implied limitations regarding such focus will be further discussed in the limitation section (see page 39).
accrual-based earnings management. AEM is argued by Jones (1991) to be measured
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The first step is to calculate total accruals, which is composed of several items on the balance sheet and can be illustrated in equation 1. This part is most consistent among various approaches of measuring AEM.
!"!" = (∆%&!"' ∆%)!"' ∆%&*+!", ∆*-.!"' ./0!")
&!,"$% (1)
Where
TAt = total accruals of time t for firm i
DCAt = change in current assets of time t for firm i
DCLt = change in current liabilities of time t for firm i
DCASHt = change in cash and cash equivalents of time t for firm i
DSTDt = change in debt incl. in current liabilities of time t for firm i
DEP = depreciation and amortisation of time t for firm i At-1 = total assets of time t-1 for firm i
Equation 2 enables us to calculate the total accruals of a given year (t). The next step involves the separation of discretionary accruals from non-discretionary accruals which is important to capture management discretion. Discretionary accruals are the measure for accrual-based earnings management and are defined as “actual total reported accruals subtracted by expected normal accruals” (Tendeloo and Vanstraelen 2005, p. 163). The following formula allows us to calculate the coefficients that we will use in a later step.
-&!," &!,"$% = %2& 2 &!,"$%' + %3& ∆4/5!," &!,"$% ' + %6& 00/!," &!,"$%' + ) (2) Where
TAi,t = total accruals of time t for firm i
DREVi,t = change in revenue of time t for firm i
PPEi,t = gross property, plant, and equipment of time t for firm i
Ai,t = total assets of time t for firm i
e = error term
The idea of this formula is to run an ordinary least square regression analysis while filling the values for total accruals and total asset which are derived from equation 3. By doing so, we will get three regression coefficients which are used in the next formula. The following formula is the modified Jones model.
*+"!," = %2&&2 !,"$%' + %3& ∆4/5"' ∆4/%" &!,"$% ' + %6& 00/!," &!,"$%' (3) where
NDAi,t = non-discretionary accruals for year t for firm i
DREVi,t = revenues in t subtracted by revenues in year t-1 scaled by total assets at year t-1 for
firm i
DRECi,t = net receivables in year t subtracted by net receivables in year t-1 scaled by total assets
at year t-1 for firm i
PPEi,t = gross property plant and equipment in year t scaled by total assets at year t-1
Ai,t-1 = total assets at year t-1 for firm i
25
CEO Characteristics
CEO characteristics are composed of the following dimensions: (1) age, (2) gender, (3) nationality, (4) tenure, (5) education. Tenure is derived from how long the CEO has been the CEO at the given point in time and is measure on a continuous scale. Age is a continuous variable presenting the age of the CEO at the given point in time. Education is a dummy variable that gives a score of 1 if the CEO has obtained an MBA degree, else it gives a score of 0. Other degrees are not accounted for in this study, which leads to a significant cluster of uncategorised CEOs. Gender is also a dummy variable giving a score of 1 if the CEO is male. Nationality is composed of several dummy variables for each continent excluding the Americas which is used as the reference variable.
Control Variables
Statistical Analysis
The methodology used in this study is a generalised least squares random effect regression analysis to predict the relationship between CEO characteristics and AEM on CSR decoupling. The random effect model helps to control for unobserved heterogeneity and assumes that there is no correlation between the independent variables and the unobserved heterogeneity. To control for outliers, the sample was cut-off at 95% and 5% of the distribution before running the test analysis. Equation 4 models the association between CEO characteristics, accrual-based earnings management, and CSR decoupling.
,-._+0,12345*6!" = 78+ 72"08!"+ 76"60!" + 79!0*2.0!" + 7:4*!"!" + 7;.1"!" + 7228".90!%&0!" + 726,"3_5*!!" + 729.+_5*!!" + 72:40:!" + 72;;1".+_5*+!"+ 738080"! + 732"5-"_3",! + 7338;"! + 73660*+0.! + 73<;1".+_-5<0! + (>! + ?!") (4)
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Results Descriptive Statistics
Table 4 presents the descriptive statistics of all variables as well as the inter-correlations among them. The mean of CSR decoupling is 0,6043 which means that on average, firms disclose more CSR activities than they engage in. On the other hand, CSR decoupling has a skewness of -0,451 and kurtosis of -0,018, which implies that the distribution is negatively skewed with a platykurtic tail. Accrual-based earnings management does have a mean of 0,4098, which means that on average, firms do engage in upward AEM. The variable does have values of skewness and kurtosis (3,156 and 10,8567) which means it is tailed towards the positive direction. CEO characteristics are composed of three constructs that are binary measures: Nationality which is referenced against Americas, MBA-degree, and gender. EMEA has a mean of 0,43 which means that 43% of the sample has a CEO originating from Europe, the Middle East, or Africa. CEOs originating from the Americas are 26% as the binary variable has a mean of 0,26. Asia-Pacific makes up the remaining part with a mean of 0,31 which equals 31%. The gender of the CEO distribution is heavily skewed towards males as 2% of the CEOs are female. A small fraction of the CEOs in this sample have obtained an MBA-degree as the mean is 0,0042, which implies only 0,42% of the sample. The average age of the CEOs is 55,25 years with a standard deviation of 7,879.
29
Test of Hypotheses
Tables 5 and 6 present the results of the random effect model regression analysis and can confirm the direct relationship between CEO characteristics and CSR decoupling. However, no moderating effect from accrual-based earnings management can be found in this study. Stata was used in this study to run the random-effect models. Each table presents the beta coefficient for each variable as well as the standard error. Also, the coefficient of determination is presented for each model to provide information to what extent the variation can be explained by the explanatory variables. The asterisk indicates whether a variable is significant to 5% or 1%.
33
Discussion and Conclusion
predictor for CSR decoupling relates to the individuals´ own choices to tackle pressure from various stakeholders. Stakeholder management is discussed as one of the motives for CSR decoupling by previous scholars but is not the only factor influencing CSR decoupling (Tashman, Marano, & Kostova, 2019). CEO characteristics have been used to understand which personal traits can be used to predict CSR decoupling among various firms. Such personality traits can explain which type of person is more willing to alter the truth for symbolic purposes and managing different types of pressures. It is clear that the motives behind CSR decoupling are similar to those for earnings management, and therefore the moderating effect was hypothesised. Such a relationship was never supported in this research which implies that one cannot confirm nor decline its influence.
35
Andersen (2011) papers as earnings management is a proxy for poor earnings quality. On the other hand, derived from the literature review of this study, we assume that there is a relationship between earnings management and a high CSR disclosure relative to CSR activities. Therefore, this paper connects both perspectives and is more concerned about whether CSR decoupling can be predicted by assessing individual characteristics.
37
Limitations and Further Research
39
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