THE EFFECT OF CORPORATE SOCIAL RESPONSIBILITY ON CORPORATE FINANCIAL PERFORMANCE WITH FIRM SIZE AS MODERATING VARIABLE

Written by: Yusuf Indrajaya 10/309742/PEK/15175

Ratified on June 20, 2012 Supervisor

Dr. Mamduh M. Hanafi, M.B.A.

INTRODUCTION Companys existence in the community provides a positive and a negative aspect. The positive aspects are providing goods, services and jobs needed by the community, however, the negative impacts of the companys business activities are frequently happen on the community. Many cases of public dissatisfaction arise regarding the environmental pollution, energy and natural resources exploitation that cause damage to the nature and the injustice on the workers. The merely a financial condition is incapable of ensuring the sustainable growth of the companys value. Corporate sustainability is assured only if the company pays more attention to social and environmental dimensions. It has been the facts that the resistances of the community to the company frequently come up to the company that are assumed not to give attention to the social and environment. It promotes changes in the level of public awareness that stimulate a new view of the importance of implementing what we know today as the corporate social responsibility (CSR). The understanding provides guidelines that corporations no longer the only a self-interest entity, but a business entity required to adapt culturally to their social environment. In Indonesia, many public companies have been consistently implementing CSR programs and have revealed its performance in corporate financial reporting. Hal ini tercermin dari pengungkapan informasi CSR yang terus meningkat (Lako, 2010). Since the Indonesian parliament (DPR) assigned the constitution No. 40 Year 2007, regarding limited company which requires for the company to carry out CSR and reporting on performance in annual reports, corporate public awareness of CSR is increased. This was reflected in the increasing CSR disclosure (Lako, 2010). The issue that then arises is whether the concern of companies implement CSR brings financial benefits to the company. On the other hand, CSR is the expense a cash drain, lower corporate earnings and equity value in the long term. Cowen et al. (1987) in Hackston and Milne (1996) revealed that the practice of social responsibility is more widespread, companies can demonstrate corporate

social performance is assessed based on the activities of corporate social responsibility to the community. In the case of a positive image of the company is expected to be maintained, which will ultimately have a positive influence on the level of sales. Increased level of sales will increase the companys profitability as well. In addition, the level of corporate social performance will attract high investors, customers or motivate employees to perform better and will reduce costs, so that will drive the companys financial performance (Suharto, 2008). On the other hand, Aupperle et al. (1985) argues that corporate social performance will cause a competitive disadvantage for the company, it was because the company bear the costs that would otherwise be avoided or be the responsibility of another party (eg, individual or government) that invest in environmentally and socially will reduce the profitability of the company. Studies conducted to examine the relationship corporate social performance and corporate financial performance produced contradictory results. Tsoutsoura (2004) found a positive relationship corporate social responsibility on corporate financial performance. Similar results were also found in empirical studies conducted by Muhamad et al. (2008) and Yang et al. (2009). Brammer et al. (2005) examined the relationship between corporate social performance and corporate financial performance as measured by stock returns for companies in the UK and found that the CSR category of environment and labor have a negative effect on stock return while the CSR category of community have a positive effect on stock return. Fiori et al. (2007) examined the CSR related to investor reaction using stock price, the empirical results indicate the CSR did not significantly affect the stock price. In the context of Indonesia also found a positive relationship between CSR and its financial performance, among others, Fauzi and Idris (2009), Hariyani (2011) and Referli (2011). However, Ariyani (2010) found no significantly effect corporate social performance on financial performance.

Corporate social performance and firm size be related since the inception of the company's stand. At its establishment, the company's strategy focus on how they survive, and their ethical responsibility was limited to donations and charity, when the company grew, the company will not escape from the pressures, operating activities and its influence on society as well as greater focus on accountability social responsibility (Orlitzky, 2001; Itkonen, 2003 and Cowen et al., 1987 in Sembiring, 2005). Orlitzky (2001) revealed that not only the large companies involved in social activities and result in a better financial aspects of such activities. This suggests that the large and small companies can benefit from corporate social performance. Larger companies tend to have a higher public demand of information than smaller firms because they are the issuer that highlights (Waddock and Graves, 1997). The high attention and supervision of these stakeholders led to the company's reputation to be more sensitive to the social performance on large companies than smaller companies. Vitesic (2011) found a positive and significant influence of CSR activities in multinational companies against their reputations. The company's reputation is believed to be one of factor in the improved financial performance (Bowd et al., 2006). According to the perspective of reputation, corporate communications with external parties on social performance can help build a positive image to customers, investors, banks, and suppliers that will have a positive impact on profitability (Fombrun and Shanley, 1990 in Orlitzky et al., 2003). HYPOTHESIS AND RESEARCH MODEL The good management theory reveals that a company considered its stakeholders have a good reputation, through the market mechanism would be easier to achieve a good financial position as well, good labor relations are expected to increase morale, productivity, and satisfaction of the workforce. Besides the perfect community relations can provide incentives for local governments, reducing regulation, thereby reducing the costs of the company and will increase the financial performance (Waddock and Graves, 1997). McGuire et al. (1988) in his research
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findings reveal that support good management theory and empirically prove that the corporate financial performance as the dependent variable. Some studies generate a positive relationship corporate social performance on corporate financial performance based on good management theory. Tsoutsoura (2004) in his study found a positive relationship CSR on its financial performance. The research was done by taking a sample of firms included in the Domini Social Index rating in the Kinder Lydenberg Domini 400 (KLD). Waddock and Graves (1997) also found a positive effect CSP index on financial performance seen from the ROA. Similar results were also found in empirical studies conducted by Muhamad et al. (2008) which examines the relationship between CSR and its financial performance as measured by ROA, market return and Tobin's q ratio at 200 large companies in Malaysia. Yang et al. (2009) examined the 150 leading companies in Taiwan and found a positive influence on the CSP with ROA in the next period. Brammer et al. (2005) examined the relationship between corporate social performance and corporate financial performance as measured by stock returns for companies in the UK and found that the CSR category of environment and labor negatively affect the stock return, while the CSR category of community positively affect the stock return. Fiori et al. (2007) examined the CSR related to investor reaction using stock price, the empirical results indicate the CSR did not significantly affect the stock price. Fauzi and Idris (2009), and Referli (2011) studied manufacturing companies listed on the Indonesia Stock Exchange (BEI) and found a positive effect corporate social performance on corporate financial performance based on good management theory. Hariyani (2011) examined the differences in profitability before and after the implementation of CSR in the PT. Unilever Indonesia, the study revealed an increase in profitability as measured by ROA after the implementation of CSR in the company. Based on the above explanation, it can be determined first hypothesis:

H1:

Corporate social performance has a positive effect on corporate financial performance

McWilliams and Siegel (2001) revealed that the implementation of CSR in large corporations is more advanced, large companies make CSR as part of their business practices and strategies as compared to small companies that are still weak in systems management, financial and human resources. In addition, large companies reported a wider CSR activities and their costs, so they tend to be "omnipresent", both in media and academic literature (Baumann et al., 2011). This indicates that in addition to expect major benefits from CSR activities, large companies also use social and environmental issues as their business strategy, such as promotions, which are expected to have an impact on their profitability. For example, Coca-Cola makes advertising on awareness of AIDS diseases that serve as their marketing strategy (McKay, 2001 in Udayankar, 2007). While small companies have a tendency to engage in social responsibility activities through donations and charity (Madden et al., 2006). CSR activities in small firms are more additional, unstructured, and low visibility, so often appear the term sunken or silent CSR in representing CSR activities in small firms (Perrini et al., 2007). Fauzi et al. (2007) predicts the size of the company may moderate the relationship between corporate social performance and corporate financial performance. Based on these arguments, is expected to firm size may be a moderating variable and affect the relationship between corporate social performance and corporate financial performance, it can be determined the second hypothesis: H2: The effect of corporate social performance on corporate financial performance in large firms is greater than small firms

RESEARCH METHODS The population of this study is a company listed on the Indonesia Stock Exchange. Source of data used are from the company's annual report is available both from the Indonesia Stock Exchange (IDX) and the Indonesian Capital Market Directory (ICMD). This type of research data is a balanced panel data. The sample was selected by purposive sampling method with the following criteria: first, the company's non-financial companies listed on the Indonesia Stock Exchange from 2007 until 2010. Second, these companies have consistently revealed CSR reporting in the annual report for the period 2007 to 2009. As a result of sample selection in this study amounted to 22 non-financial companies by 66 observations. There are two main variables in this study, corporate social performance as the independent variable and the company's financial performance as the dependent variable. This study uses a one-year time lag, for example; the data in the 1999 independent variables to the dependent variable data in 2000, as research by Waddock and Graves (1997), Mohammed et al. (2008) and Yang et al. (2009). This method is based on the opinions expressed by Gray et al. (1995) in Hackston and Milne (1996), that the disclosure of CSR is not related to profitability in the same period. CSRI (Corporate Social Responsibility Index) measurement instruments research refers to the instruments used by Sembiring (2005), CSR information grouped into categories: environment, energy, labor, products, community involvement, and general. This category is adopted from Hackston and Milne (1996), Sembiring (2005) and Sayekti and Wondabio (2007). The seven categories are divided into 78 items of disclosure. Measurement of corporate financial performance uses some financial ratios, namely return on assets (ROA), return on equity (ROE) and return on sales (ROS) which are accounting-based financial performances (Waddock and Graves, 1997; Yang et al., 2010 ; Brine et al., 2007; and Tsoutsoura, 2004). In addition, this study

uses Tobin's q ratio, which is one proxy of market-based financial performance (Mohammed et al., 2008; and Choi et al., 2010). RESEARCH FINDINGS Descriptive statistics Table 1 is the descriptive statistics of variables used as input to the process of data processing. CSRI is a result of the calculation variables are taken from the company's data sampled in 2007-2009, while the ROA, ROE, ROS, LnTA and Lev is the calculation of corporate data sampled in 2008-2010 (one-year time lag). Based on table 4.4 can be explained that the average company's CSRI is a sample of 0.226711, or approximately 22.7%. This suggests that the social performance as measured by the CSR index of the sample is less than 50% of all items on the company's annual report disclosure. The maximum value of 0.512821, or approximately 51.3%, namely PT. United Tractor (in 2009) and the minimum value of 0.051282, or about 5.13%, namely PT. Hero Supermarket (in 2008). Table 1. Descriptive Statistics Research Variable Variable CSRI1 ROA ROE ROS Q LnTA Lev Observation 66 66 66 66 66 66 66 Average 0.226711 0.065467 0.154348 0.053866 1.329554 14.91751 0.574603 Maximum 0.512821 0.189895 0.350147 0.226019 3.239676 18.54163 0.744499 Minimum 0.051282 0.000806 0.001925 0.001088 0.575303 11.79381 0.351427 2008-2010 Year 2007-2009

Source: processed data

The average value of accounting-based financial performance that is Return on Assets (ROA) of 6.5%, Return on Equity (ROE) of 15.4% and Return on Sales (ROS) of 5.4% . It means the sample company's ability obtained an average return of

6.5% of total assets, 15.4% of total equity and 5.4% of total sales. The maximum value of the ROA of 18.9%, ROE of 35% and 22.6% ROS was entirely the value of the financial performance of PT. Petrosea in 2010. ROA and ROE minimum value that is equal to 0.08% and 0.19% obtained by PT. Bakrie Telecom in 2010, while the minimum value of ROS is 0.11% which is an ROS value of PT. Panorama Transportasi in 2010. The average value of market-based financial performance that is Tobin's q ratio is equal to 1.33 which means the shares of the sample firms on average in the overvalued condition (Tobin's q> 1), the average management average has been successfully managing the assets of the company and its growth potential is high. The largest value is 3.24 which is the ratio of Tobin's q of PT. Fastfood Indonesia in 2010, while the smallest value is 0.57 which is the ratio of Tobin's q of PT. Bakrie Telecom in 2008. Results of hypothesis testing The results of the first test can be seen in table 2. In the table can be seen that the variable CSRI showed a significant positive effect on all variables accountingbased financial performance (ROA, ROE and ROS), whereas the market-based financial performance (Q) does not have any effect. These results indicate that the higher of corporate social performance it will be followed by increased corporate financial performance in subsequent periods in accordance with good management theory and prove that the first hypothesis in this study supported when viewed from the accounting performance. The results are consistent with previous studies (Tsoutsoura, 2004; Waddock and Graves, 1997; Mohammed et al., 2008; Yang et al., 2009; Fauzi and Idris, 2009; Hariyani, 2011) which revealed that corporate social performance positively effect on the corporate financial performance based on good management theory.

Tabel 2. Regression test results (H1)

Dependent Var.

ROA Independent Var. Coef. -0.561160 C Prob. 0.1602 Coef. 0.208506** CSRI Prob. 0.0284 Coef. 0.050830 LnTA Prob. 0.0842 Coef. -0.311145*** Lev. Prob. 0.0020 F-value 9.551755 R2 0.848284 Source: processed data

ROE -1.179469 0.1643 0.647495*** 0.0019 0.087567 0.1586 -0.208008 0.3055 7.369271 0.811808

ROS -0.021544 0.6824 0.125433*** 0.0089 0.009549*** 0.0029 -0.166036*** 0.0012 22.08550 0.516594

Q 2.278203*** 0.0076 0.186241 0.7942 0.049019 0.3377 -2.995058*** 0.0001 6.535185 0.240248

Tabel 3. Regression test results (H2)

Dependent Var.

ROA Independent Var. Coef. -0.486542 C Prob. 0.2200 Coef. 0.001156 CSRI Prob. 0.9932 Coef. -0.044091 DSIZE Prob. 0.3278 Coef. 0.314828** DSIZE*CSRI Prob. 0.0317 Coef. 0.046131 LnTA Prob. 0.1208 Coef. -0.269859*** Lev. Prob. 0.0047 F-value 10.51505 R2 0.875157 Source: processed data

ROE
-0.762150 0.3717 0.427163 0.1475 0.007175 0.9409 0.380743 0.2197 0.055453 0.3830 -0.105802 0.5893 7.855216 0.839662

ROS
0.083439 0.2024 0.045913 0.4992 -0.005151 0.8097 0.172929** 0.0420 0.001059 0.8141 -0.131491*** 0.0094 13.21494 0.524092

Q
-24.94775*** 0.0001 -2.380994 0.2403 -0.792025 0.2401 1.647828 0.4391 2.056103*** 0.0000 -6.386878*** 0.0000 5.028121 0.770225

Testing are described in Table 3 with a dummy variable of firm size (large firm = 1 and small firm = 0) as a moderating variable. This test is used to prove the second hypothesis. According to the table it was found that the interaction between the dummy variables and variables CSRI have a positive and significant impact on ROA and ROS, while for ROE, and Q there is no effect whatsoever. These results support the second hypothesis in this study who stated that the effect of corporate social performance on corporate financial performance is greater in large firms than small firms, when viewed from its ROA and ROS. CONCLUSIONS, LIMITATION, AND SUGGESTIONS Corporate social performance has a positive effect on the financial performance of companies based on good management theory. A company is considered to be its stakeholders have a good reputation, through the market mechanism will be easier to achieve a good financial position. In this study, CSRI tests for ROA, ROE and ROS which is a proxy of accounting-based financial performance is positive and significant, while the testing of CSRI on Tobin's Q (Q) as a proxy of market-based financial performance is not significant. This means that in the context of Indonesia investors may not see the CSR activities reporting as a positive signal in the selection of shares, investors are more interested in financial information in investment decisions. The effect of corporate social performance on corporate financial performance in large firms is greater than small firms. CSR implementation in large firms is more advance, large firms make CSR as part of their business practices and strategies as compared to small companies that are still weak in systems management, financial and human resources (McWilliams and Siegel, 2001). These conditions led to much greater effect of social performance to financial performance in large firms than small firms. In addition, the results of this study also found that the ability to get the internal profitability of CSR implementation in large and small companies there is no visible difference from an insignificant effect on its return on equity. This is thought
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to be caused by the cost of CSR in large corporations in Indonesia comes from debt. In the examination of market performance (Tobin's q) also found no significant results, it is consistent with the discussion on the first hypothesis, that in the context of Indonesia socio-environmental activities reporting (non-profit) does not generate a positive response from the market. Limitation of this study was to determine the final amount of sample. This study only used a sample of 22 non-financial firms during the three years of the 20072009 period for corporate social performance and the 2008-2010 period for the company's financial performance (one-year time lag) by the number of observations 66. One cause of the small number of samples due to the use of balanced panel data. In addition, there are no definitive methods in the measurement of corporate social performance. The selection of samples using only non-financial companies could lead to bias in terms of industry characteristics. For further research to investigate the influence of social performance on financial performance for each industry and comparing one industry with another industry or notice a difference in the effect on firm characteristics (high profile and low profile). In addition, further research may add to the sample with a longer period and also may use different methods of measuring corporate social performance. In this study using a proxy for accounting performance ROA, ROE and ROS, while the proxy for market performance using Tobin's q. For further research can be used other proxies such as Economic Value Added (EVA), Sharpe measure, or Jensen measure to see the influence of social performance to the performance of accounting and market a comprehensive manner.

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