DETERMINANTS OF STOCK MARKET REACTION
TOWARD LEGAL REQUIREMENT OF CSR IN INDONESIA
Gatot
Soepriyanto
Accounting
Department Bina Nusantara (BINUS) University
Rudy Suryanto
Accounting
Department - Muhammadiyah University Yogyakarta (UMY)
ABSTRACT
Prior study on stock market reaction
toward mandatory Corporate Social Responsibility (CSR) implementation law in
Indonesia (article 74, Law No. 40/2007 on Limited Liability Company) present
evidence that the equity investors from
firms whose deal with or related to the management of natural resources,
reacted positively to the passage of the law. This suggests that investors view
mandatory CSR implementation law as “a good news” which in the long run may
increase firm values. This study, therefore, aims to investigate the economic
determinants that drive positive market reactions, as we found that the
magnitude of the reactions were vary among companies taken as sample. We
address five hypotheses that investor reaction is explained by: (a) size of
firms, (b) profitability of firms, (c) leverage of firms, (d) how long the firm
has been established and (e) whether the firms in are engaged in mining or
non-mining industry. These hypotheses are investigated through cross-sectional
regression analysis on firms that directly affected by the CSR law. We conclude
that the stock market reaction toward the law is determined by size, leverage,
age of firms and whether firms are engaged in mining industry or not. It also
concludes that investors react more (less) positive to small (big) firms and
high (low) leverage firms, suggesting that the investor consider the law as
“insurance” for company to sustain their operation.
Keywords:
CSR Mandatory Law, Stock Market Reaction, Economic Determinants
1. Introduction
After
a heated debate on whether mandatory corporate social responsibility (CSR)
implementation would benefit or harm the company, the House Representative
(DPR) finally approved the bill on July 20, 2007 – which require a company
whose activities deal with or related to the management of natural resources to
carry out a CSR program. This mandatory rule is enacted under article 74 of Law
no. 1, 2007 on Limited Liability Company (PT). Based on such research setting,
Soepriyanto and Suryanto (2008) examine stock price reactions to the passage of
the bill – specifically to the share price of firms that directly affected by
the law (i.e. seven sub industries whose activities deal with or related to the
management of natural resources) and find some evidence that on average, equity
investors react positively to the approval of mandatory CSR implementation law.
Their result consistent with prior studies which suggested that CSR will help
investor to minimize exposed risk of the companies (Heugens, 2007, Chih. et.al,
2007, Sarre, 2001) and maintain companies’ reputation (Rowe, 2007). In summary,
their result supports the view that CSR program will contribute positively to
the firm value.
Their study, however, posit another
interesting question – what factors determined the positive market reaction?
Further examination into the magnitude of abnormal return and three-day
cumulative abnormal returns around the event date of their sample companies
also demonstrate a wide variation. We speculate that market did not take for
granted the information related to CSR, but they will relate the information to
the economic characteristic of each company such as size, profitability and
leverage. This research, therefore, aims to investigate the economic
determinants that drive the market reactions toward mandatory CSR implementation
law.
In general, we find that market
consider company’s size, leverage, age and industry in determining their
response to legal requirement of CSR. Company’s age is proved to be a
significant determinant factor of market reactions, as well as company’s size,
leverage and type of industry. We find no significant association of
profitability to the market reactions, suggesting that the consequence of the
legal requirement of CSR is not related to company’s profitability.
2. Literature Review
The demand for companies to act in socially and
environmentally manner had started to emerge since 1970’s (Hines, 1991: 41).
The demand now is getting stronger, as society witnessed the damage caused by
big corporations to its environment in term of pollution, natural resource
destruction, dangerous wastes, products safety and limitation of workers’ right
(Gray et.al, 1995). Many view that the irresponsible manners of the big
corporations above were partly caused by a narrow focus of the companies to
maximize its shareholder value, and neglecting the other stakeholders’
interest.
The narrow focus of companies is
supported by neo classic economist’s perspective that stated manager’s main
objective is to make decisions in maximising shareholders value, and let the
government and other parties to take care of community (Friedman, 1970). This
argument then challenged by Freeman (2004) with his “stakeholder theory” which
states that management can only maximise shareholders value by maintaining a
good relationship with other stakeholders (Freeman, 2004). The effort to
balance the role of company to pursue profit and to contribute to its
environment is known as Corporate Social Responsibility (CSR).
In 1970, AICPA thought that there is
a need for companies Social Accounting to incorporate CSR in company annual
report (Hacston & Milne, 1996). However till date, there is no a generally
accepted framework for such accounting. Though, some international bodies had
formulated the guidelines for companies to perform and report CSR, such as UN
Compact released by the United Nations, the Global Reporting Initiative
released by Sustainability Accounting International (SAI) but there is no
binding rule for the guidelines. Therefore, CSR programs and reporting remain
voluntary.
Interestingly more companies now adopt CSR programs
and report them in their annual report (Stigson, 2002). Companies willing to invest in CSR and report
them in annual report, since they believe CSR programs are inline with their
business objectives (Stigson, 2002) and investors valued CSR programs (Bird,
2007, Mackey, et. al, 2007).
Indonesia had moved forward by enacted Law no
40/2007 in which mandated for certain companies to budget and allocate some
money in CSR programs. By this law, Indonesia might be the first country to
regulate CSR practice so it’s become mandatory. Wilmhurst (2000) stated that
government might intervene to the business process through regulation, whenever
community safeties are in danger. Indonesian public recently had outraged by a
number of pollution and major natural destruction done by companies, such as
the case of Inti Indo Rayon in North Sumatera, Newmont in Minahasa and Lapindo
Brantas in Sidoarjo. By examining news related to the passage of the mandatory
CSR implementation law, Soepriyanto and Suryanto (2008) find that in general
investor response positively to the regulation suggesting that investor views
the CSR law as “good news”.
Study on firm characteristic that may affect firms
CSR program is categorized into 2 streams. First stream is evaluating what
factors determine the amount and nature of CSR disclosures and second streams
is revealing what CSR impact to company performance, usually in term of
profitability or market price (Kusumawati, 2007).
3.
Hypotheses Development
Prior study (Soepriyanto &
Suryanto, 2008) finds that market react positively to legal requirement
stipulated in article 74, Law 40/2007 which mandates Indonesian companies whose
activities deal with or related to the management of natural resources to carry
out CSR programs. The market respond positively to the regulation as
illustrated by abnormal return and three-day cumulative abnormal returns that
significantly different from zero, on the event date related to the passage of
the regulation.
Some explanations on why market
reacted positively to the regulation are
(1) more CSR programs are conducted and reported by companies in mining
and other natural-resource related companies might lowered companies’ expose
risk (Sarre, et. al 2001), (2) the cost of that programs is below the expected
benefit for example the addition CSR cost will lower claims from community and
NGO (Mackey, et al. 2007, Bird et al, 2007) , (3) some mining companies
(high-profile industry) have undergone some CSR projects voluntarily, so they
will have no problems when CSR becomes mandatory (4) the additional activities
and reporting required by the law will increase the accuracy of market
expectation, lower information asymmetry, and lower market surprise (Na’im
& Rakhman, 2000).
4. Research Design and Methodology
4.1
Empirical Model
4.1.1 The Cross Sectional Regression Model
As the objective of this study is to
investigate the determinant of market reaction upon the obligation of CSR
implementation as prescribed by article 74 of Law no. 40, 2007, a cross
sectional analysis is employed. The
cross sectional regression model was used to examine the relationship between
stock price movements represented by abnormal return or cumulative abnormal
returns (CAR) from the event window and the range of variables outlined in the
hypothesis development section that were predicted to influence price reaction.
4.1.2 The Standard Market Model
In order to examine the hypothesis, we also
used the standard market model to calculate AR and CAR as our dependent
variable in Equation (1). This model allows us to measure the effect of a
particular event on the share return of the firms. To estimate the abnormal
return for the day related to the approval of mandatory CSR implementation law,
a standard market model is used (see Equation 2).
5. Empirical Results
5.1
Descriptive Statistics
Table 6 reports descriptive statistics for
abnormal returns and selected firm characteristics for the 21 sample firms.
Panel A and B show the descriptive statistics for daily abnormal return (AR)
and 3-day cumulative abnormal returns (CAR)
surrounding the passage of CSR mandatory implementation law. Meanwhile, Panel C
describes the descriptive statistics for independent variables.
5.2
Correlation Matrix
Table 7 reports the Pearson correlation
matrix for independent variables used in the cross sectional model. It shows
that there is a positive correlation between variable LOGTA and ROE. This
indicates that larger firms in the sample reports higher ROE than smaller firms
suggesting that larger firms are more profitable than smaller firms. Meanwhile,
the correlation between variable ROE and LEV is negative. This suggests that
more profitable firms have less leverage and thus less risky firms.
5.3
Empirical Results
Table 8 Panel A and Panel B reports the
cross sectional regression results of daily Abnormal Return (AR) and the 3-day CAR (CAR3) on independent
variables. The test variables are LOGTA which is measured by the natural
logarithm of the total assets of the firms, ROE represents the profitability of
the firms measured by profitability; LEV represents riskiness of the firms,
measured by the long term debt divided by the total assets; AGE represents age
of the firm measured by current year (2007) deducted by firm’s date of
establishment and IND as representation for type of industry – whether mining
firms or non mining firms, which is a dummy variable that is coded as 1 for
mining firm and 0 otherwise.
5.4.
Diagnostic Checks
Several statistical problems may impair the
inferences drawn from the results reported in Tables 8. Therefore, diagnostic
tests are performed to determine if reported results are affected by the
statistical problems.
6.
Conclusion and Limitation
The
purpose of this research was to examine the determinant and contextual factor
of market reaction to the news related to the passage of mandatory CSR
implementation law as stipulated in article 74, Law no. 40/2007 on PT. This
study extends Soepriyanto and Suryanto (2008) study who find a positive stock
market reaction to the approval of mandatory CSR law. The variation of abnormal
return is expected to be differed based on a several firm’s characteristics and
contextual factor, such as the size, the profitability, the leverage level, age
of the firms and whether firms engaged in mining industry or not. It is
hypothesised that the abnormal return will be more positive for firms that
profitable, high leverage, older firms and engaged in mining industry. It is
also hypothesised that the abnormal return will be more positive to smaller
firms. Using cross sectional regression analysis, the results of this study
provide support for the hypothesis.
The
results of the cross sectional regression, then, shows that there is strong
association between market reactions toward the legal requirement of CSR and
company’s age. Market react more positively to older companies, as market
perceived that the older companies have better experience in conducting CSR
program.
We
also document that market used company’s size, leverage and type of industry as
determinant factors in responding to the legal requirement of CSR.
Interestingly, market reacts more positively in smaller firms, suggesting that
market expect smaller firms to perform CSR. In general, previous studies show
that bigger firms have more CSR practice and disclosure. This result does not
oppose that general views, but somewhat complete them. As market expects that
bigger firms have already performed and disclosed CSR programs, such regulation
would not affect much. On the other hand, given the low practice and disclosure
of CSR in smaller firms, market view that such regulation will give smaller
firms a pressure to conduct and disclose CSR, which is valued by market.
The
similar explanation is given to why market reacts more positively to higher
leverage firms. Previous studies show that higher leverage firms will disclose
less CSR information in their annual report, suggesting that higher leverage
firms view CSR as an expense that should be minimised. The legal requirement of
CSR, therefore, will give pressure to higher leveraged firms to also perform
CSR. Hence, this result suggests that market also expect higher leverage firms
to perform CSR.
We
also find that type of industry, which is whether firms are in mining industry
or not, is significant as determinant factor. The law explicitly mentions
companies in whose deal with natural resources to perform CSR (e.g. mining
firms), while also mentioning the same obligation to companies whose related to
the management of natural resource. The last category is less clear therefore,
market reaction to the companies in last category is less strong than in first
category.
We
find that there is no significant association between market reaction and
profitability, suggesting that market view the consequence of the legal
requirement of CSR is not associated to company’s profitability.
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