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CAN CSR DISCLOSURE REDUCE THE LEVEL OF FINANCIAL DISTRESS?

ANALYSIS OF THE COVID-19 PANDEMIC PERIOD

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 South East Asia Journal of Contemporary Business, Economics and Law, Vol. 26, Issue 1
(April) ISSN 2289-1560
2022

CAN CSR DISCLOSURE REDUCE THE LEVEL OF FINANCIAL DISTRESS? ANALYSIS OF

THE COVID-19 PANDEMIC PERIOD
Reyhan Theodorus
Astrid Rudyanto

ABSTRACT

CSR disclosure is very much needed by companies in demonstrating their ability to survive during the COVID 19 pandemic. CSR
disclosure last year could increase stakeholder trust so as to reduce the level of financial distress this year. The purpose of this
research is to analyze whether CSR disclosure last year has negative effect on financial distress as well as examine further whether
CSR disclosure last year can reduce financial distress this year. Using a fixed effect multiple regression model on 132
manufacturing companies listed on the Indonesia Stock Exchange during the pandemic period (2019-2021), this research shows
that CSR disclosure last year in the annual report has a negative influence on the level of financial distress this year. However,
further testing using propensity score matching shows that the last year’s CSR disclosure in the annual report is not able to reduce
the level of financial distress this year. Propensity score matching is used to analyze whether companies with the same
characteristics (firm size level) but with different CSR disclosure scores have different level of financial distress. It indicates that
CSR disclosure in the annual report cannot reduce the level of financial distress. CSR disclosure in the annual report is considered
good by stakeholders, but it does not make stakeholders do something that can reduce the level of financial distress. This result
can be due to the fact that CSR disclosure in the annual report is not based on the information needs of stakeholders, unlike
sustainability reports. Therefore, this research supports SEOJK No. 16 regarding the obligation to make sustainability reports for
the listed companies.

Keywords: CSR disclosure, financial distress, COVID 19, propensity score matching

INTRODUCTION

The COVID-19 pandemic first appeared in the early 2019 until today has been causing, in almost all the countries in the world
(including Indonesia), serious negative impacts on economic sectors. In Indonesia, beside multinational companies, six large firms
and 48.6% of MSMEs (Micro, Small, and Medium-Sized Enterprises) have gone bankrupt or have had serious financial distress
(Mukaromah, 2020; Soenarso, 2020). Most of the companies which have this problem is a manufacturing company (Soenarso,
2020). To reduce it, a company requires to show their ability of dealing with a crisis to the stakeholders. Corporate Social
Responsibility (CSR) report indicates the ability of a company in dealing with a crisis by communicating their CSR activities
which become a demand from stakeholders (Herzig et al., 2012). Some researches show that, during the COVID 19 pandemic,
some companies increase their investment in CSR activities (Mahmud et al., 2021). As indicated by Intel chairperson, “You can’t
save your way out of a recession—you have to invest your way out. We look at our CSR activities the same way: you can’t just do
them in good times and then forget about them in bad times and hope to get any results.” (CNN, 2009). Therefore, according to
the agency theory, the more information about CSR activities revealed in CSR report, the greater stakeholder trust in the ability of
a company to deal with crisis. Stakeholder trust is able to reduce cost of capital (Reverte, 2012) and increase company value (Cahan
et al., 2016; Reverte, 2016) so as to reduce financial distress. Recent researches show that stakeholders influence corporate financial
distress (Cohn & Wardlaw, 2016; Lian, 2017).

The purpose of this research is to examine negative impacts of CSR disclosure last year on the level of financial distress this year,
as well as examine further whether CSR disclosure last year can reduce the level of financial distress this year. As companies
which disclose more CSR activities this year will gain greater stakeholder trust, those companies will get less financial problem in
the next year (Reverte, 2012) and thus less financial distress. Previous studies have investigated the impact of CSR disclosure or
CSR activities on the level of financial distress (Farooq & Noor, 2021; Tarighi et al., 2022). However, it does not focus on the
impact of CSR disclosure of the level of financial distress when COVID-19 happened. Unlike other economic crisis, the COVID-
19 pandemic happens when CSR and stakeholders are imperative to business. As COVID-19 highlights the importance of business
responsibility to stakeholders, it is crucial to analyze whether disclosing CSR in the COVID-19 era can reduce the level of financial
distress. Regardless of the characteristics of company, the pandemic has been happening more than two years resulting in financial
distress in most companies, and it is also a natural phenomenon which is so relevant to observe the effectiveness of CSR disclosure
in reducing the level of financial distress. This paper contributes towards the analysis of the impact of CSR disclosure on the level
of financial distress in the COVID 19 era.

Furthermore, this research also focuses on CSR report of corporate annual report. In 2017, OJK (Financial Services Authority) had
obligated to make sustainability report for financial companies (starting from 2019), and non-financial companies (starting from
2022) (Pemerintah Republik Indonesia, 2021). Sustainability report is a sustainable business result report containing economic,
financial, social, and environmental performances of financial service institution, issuer, and public company (Pemerintah
Republik Indonesia, 2021). The sustainability report referred to SEOJK no.16 is different from the CSR report usually reported in
corporate annual report in Indonesia. This CSR report which, for all this time, has been reported in annual report is not based on
GRI (Global Reporting Initiative) standard, and only reports CSR activities carried out without being adjusted to stakeholder needs
(as they demand in sustainability report) (Global Reporting Initiative, 2014).

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This regulation gets some companies in Indonesia into trouble. Even though the companies have already got used to CSR activities
reporting in annual report, in fact, sustainability report is not as easy as making CSR report in annual report. Sustainability report
requires good sustainability management system so as to generate good economic, social, and environmental performances (Traxler
et al., 2020). It also requires good and continuous communication with stakeholders (Skouloudis et al., 2014). Although, some
companies have made sustainability reports before they are obligated to do so, the numbers of companies which make sustainability
reports are very small (Rudyanto & Siregar, 2018). Thus, many parties are questioning whether CSR report in annual report is
sufficient or insufficient to give information regarding company ability in dealing with crisis. By focusing on CSR report in
corporate annual report, this research is able to answer this question.

For the next chapter, this research will discuss agency theory that becomes a main theory in this research explaining about CSR
report and financial distress, and subsequently followed by hypothesis development. Research method will be explained afterwards,
and followed by results and discussion. Conclusion, implication, and limitation are the last parts of this research.

LITERATURE STUDY AND HYPOTHESIS DEVELOPMENT

Agency Theory and Legitimacy Theory

Financial distress has been analyzed as an agency problem. The more severe the asymmetry information between principal and
agent, the lower the managerial effort and firm performance and the higher financial distress (Ceustermans et al., 2017; Jensen &
Meckling, 1976; Ugur et al., 2022). To reduce information asymmetry, an agent gives corporate performance report to the principal.
One of the corporate performance reports needs to made by an agent is CSR report. CSR report is a report containing company
activities and performances in environmental, social, and economic sectors (CSR). According to legitimacy theory, CSR is a way
that a company can gain legitimacy from stakeholders (Hahn & Kühnen, 2013; Yu & Zheng, 2018). CSR is a social contract
between organization and society, while the organization with higher CSR disclosure wants to be respected by the society, because
it could be easily survive as long as their legitimacy confirmed by the society (Tarighi et al., 2022). Legitimacy indicates acceptance
level of stakeholder on a company (Chiu & Sharfman, 2011). Legitimacy is also able to improve company’s image so that it attracts
capital owners to make investment (Chiu & Sharfman, 2011; Magnanelli & Izzo, 2017), improve productivity of employee (Sun
& Yu, 2015), and improve consumer loyalty (Martínez & Rodríguez del Bosque, 2013). Stakeholders not only react to how
companies treat them but also how companies treat other parties (Cuypers et al., 2015). Therefore, companies’ commitment to
CSR, even during critical period, helps the companies to retain stakeholders’ support (Aguilera et al., 2007). Thus, the more the
CSR disclosure, the lower the level of financial distress in that company.

Financial Distress
A company is considered having financial distress if it is not able to fulfill debt obligation when it has been due (Farooq & Noor,
2021), which increases the likelihood of default (Pham et al., 2022). Furthermore, Platt and Platt (2002) defined financial distress
as a final stage of decreasing company condition and followed by worst situation, such as bankruptcy or liquidation. The first sign
of trouble is usually shown by violating debt contract agreement and also accompanied by omission or reduction of dividends. The
indication shows that a company is close to financial distress can be seen from the parties of the company initiating managerial
acts to prevent financial distress, conducting merger or being made an acquisition by a better-managed company, and giving early
warning about the possibilities of bankruptcy. According to trade off theory, financial distress is so detrimental to a company due
to cooperate capacity limitation for collecting funds in the time needed and taking advantages of tax protection, so that company
value can decrease (Farooq & Noor, 2021). Previous studies found that a company that has and experiences financial distress is
able to reduce market share (Opler & Titman, 1994), sells their assets at a price well below the market (Shleifer & Vishny, 1992).
Considering the risk and loss of financial distress, companies carry out many ways to prevent financial distress. One of them is to
disclose corporate CSR activities.

Influence of CSR Disclosure on Financial Distress

Previous studies show that there are three mechanisms that can describe how CSR could negatively affect financial distress. Firstly,
CSR is able to reduce business risk (which ultimately reduce the level of financial distress) (Albuquerque et al., 2018; Cui et al.,
2016). Secondly, CSR is able to increase company’s financial condition so as to reduce the level of financial distress (Madueño et
al., 2016; Theodoulidis et al., 2017). Thirdly, CSR is able to develop stakeholder trust so as to reduce the level of financial distress
as well. This research focuses on the third mechanism, which is the development of stakeholder trust can reduce the level of
financial distress.

According to legitimacy theory, CSR is able to develop stakeholder trust so as to give company legitimacy to survive. For instance,
CSR can reduce cost of capital (Chiu & Sharfman, 2011; Magnanelli & Izzo, 2017), improve productivity of employee (Sun &
Yu, 2015), and improve consumer loyalty (Martínez & Rodríguez del Bosque, 2013). Therefore, stakeholders need to understand
CSR activities carried out by a company. Agency theory explains that to reduce CSR information asymmetry between stakeholder
and manager, the manager needs to make CSR disclosure. The more CSR disclosures made by manager, the higher the level of
manager transparency. Previous studies show that transparent company when they disclose CSR, they do not hide bad incidents
happened in their company. Therefore, even bad things happen in that company, the stakeholder does not blame the transparent
company in disclosing CSR (Godfrey et al., 2009; Gupta & Krishnamurti, 2018).

However, some previous studies show that, when economic crisis happens, the stakeholder gives negative response to CSR
disclosure, because excessive CSR disclosure can increase burden on the company (Sakawa & Watanabel, 2020). Furthermore,
excessive CSR disclosure on a company that has bad financial condition can be defined as a camouflage to cover company’s
financial condition (Salehi et al., 2019).

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Although COVID-19 brought economic crisis, ethical responsibilities of companies are crucial in the COVID 19 era to answer
stakeholders’ expectation of what companies should do to protect their stakeholders, especially employees and customers (Carroll,
2021). As companies have economic responsibility to stakeholders, it is imperative that governance responsibilities which pay
more attention to stakeholders are addressed. These are in line with CSR thinking (Paine, 2020). In addition, when the COVID-19
pandemic happened, Indonesia actually implemented the obligatory of making sustainability report. This obligatory was based on
stakeholder needs, especially investors (CNBC Indonesia, 2021). It indicates that stakeholder values CSR information, so that the
company which discloses more CSR information will gain greater legitimacy. It could have a negative influence on company’s
level of financial distress. Thus, the hypothesis constructed is:

H: CSR disclosure has a negative influence on the level of financial distress.

RESEARCH METHOD

This research uses manufacturing companies listed on the Indonesia Stock Exchange in 2019-2020 as a sample and rupiah currency.
The reason of selecting manufacturing companies selection is that most of companies who have gone bankrupt in the time of
COVID-19 are manufacturing companies (Soenarso, 2020) and the comparison of the level of financial distress by using Altman
Z Score can only be used for manufacturing company (Altman, 1968). This research uses companies with rupiah currency so as to
be more easily compared. Based on the sample selection, there are 132 observations selected to be used. Financial distress measure
used is Altman Z score, which is:

Z = 1,2 (X1) + 1,4 (X2) + 3,3 (X3) + 0,6 (X4) + 1,0 (X5)

Description:

X1 = Working capital/Total assets

X2 = Retained Earnings/Total assets
X3 = Earnings before interest and taxes/Total assets
X4 = Market value equity/Book value of total debt
X5 = Sales/Total assets
Z = Bankruptcy Index

The bigger the value Z, the smaller the level of financial distress. CSR disclosure used is CSR disclosure of corporate annual report
with Sembiring index (2005) which consist of 78 item and divided into 7 categories, which are: environment, energy, labor safety
and health, another things about labor, product, involvement, society, and public. CSR disclosure used is the last year’s CSR report
which is disclosed this year. The last year’s CSR disclosure has been read by the stakeholder in this year so as to they can take
decision and influence financial distress in this year as well. In this research, scoring has been conducted for disclosing CSR with
an assistant to reduce subjectivity. Control variables used are profitability ratio (return to asset), leverage (debt to total asset),
liquidity (current ratio), firm size (Im total asset), sales growth.
The following is the model of the research:

Zit= αit+ β1CSRDit-1+ β2ROAit + β3DARit + β4CRit + β5FSit + β6SGit + eit

Description:
Z = Financial distress
CSRD = CSR disclosure
ROA = profitability
DAR = Leverage
CR = liquidity
FS = firm size
SG = sales growth
e = error
where H: β1>0

This research uses multiple regression model of fixed effect for main test. To prove that CSR disclosure can reduce the level of
financial distress, this research uses propensity score matching (Antonakis et al., 2010, 2014). Propensity score matching is a
quasi-experiment method which separates samples to a sample that does not receive treatment and a sample that receives treatment.
Both of the samples have same characteristics, except the treatment given (Imbens, 2004). By using this method, this research
conducts the test only on the samples that have same characteristics, but have different levels of CSR disclosure. Furthermore, this
research can draw some conclusions from the method, whether CSR disclosure can or cannot reduce the level of financial distress.
All tests use STATA 16.

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RESULTS AND DISCUSSION

Table 1 shows the result of descriptive statistics test. As mentioned in the result, the average of sample companies gets a high
result of financial distress which is 6. It indicates that the sample companies are having financial problems in the time of COVID-
19 pandemic. Sample companies also have low results of profitability, liquidity, and sales growth. CSR disclosure of samples
companies are also quite low, which is the maximum result is only 69%. Table 2 shows descriptive statistics of CSR disclosure. It
indicates that in the time of COVID-19, CSR disclosure of the companies focuses on labor. This result is different from other
previous studies in the time before the pandemic happened which have found out that CSR disclosure of companies focused on
environment (Rudyanto & Siregar, 2018). Meanwhile, in the time of COVID-19, the most important CSR activities is how the
companies keep improving the welfare of their labors or employees who experience economic difficulties.

Table 1. Descriptive Statistics

N Mean Std. dev Min max

Z 132 6,468 15,621 0,584 179,002
CSRD 132 38,306 15,849 10,256 69,231
ROA 132 0,072 0,072 0,001 0,416
DAR 132 0,367 0,186 0,003 0,827
CR 132 7,114 31,681 0,653 303,282
FS 132 28,859 1,606 25,974 33,495
SG 132 -0,016 0,216 -1 0,564
Description: Z= the level of financial distress, CSRD= CSR disclosure, ROA= profitability, DAR= leverage, CR= liquidity, FS=
firm size, SG= sales growth

Table 2. Descriptive Statistics of Company’s CSR Disclosure

Category of Disclosure 2019 (%) 2020 (%)

Environment 30,11765 32,11765
Labor 40,31797 42,25755
Product 34,35294 35,41176
Society 23,00654 24,57516

Correlation test (pearson correlation) conducted in the first place before t-test. Table 3 shows the result of correlation test. Table 3
indicates that CSR disclosure does not correlate with the level of financial distress. However, the influence of CSR disclosure on
the level of financial distress can be found out from t test and shown in Table 4.

Table 3. Pearson Correlation Table

Variables (1) (2) (3) (4) (5) (6) (7)

(1) Z 1.000
(2) CSRD 0.022 1.000
(3) ROA 0.118 0.118 1.000
(4) DAR -0.246* 0.170 -0.050 1.000
(5) CR 0.795* -0.079 -0.105 -0.267* 1.000
(6) FS -0.077 0.474* 0.190 0.282* -0.194 1.000
(7) SG -0.375* 0.039 0.122 0.127 -0.371* 0.116 1.000
Description: Z= the level of financial distress, CSRD= CSR disclosure, ROA= profitability, DAR= leverage, CR= liquidity,
FS= firm size, SG= sales growth; *** p<0.01, ** p<0.05, * p<0.1

Hausman test conducted in the first place before multiple regression test. The result is fixed effect is proven more suitable to use
in this research than random effect (p:0,000). Due to heteroscedasticity problem, this research uses fixed effect robust standard
error. T test result shows that CSR disclosure has a negative influence on the level of financial distress. The more the CSR
disclosure, the higher the Z-score which means the lower the level of financial distress. This result shows that the hypothesis is
accepted and in accordance with previous studies (Malik & Kanwal, 2018; Salehi et al., 2019; Tarighi et al., 2022). Based on the
agency theory, CSR disclosure can reduce CSR information asymmetry between manager and stakeholder. It can develop
stakeholder trust so as to reduce the level of financial distress

Table 4. t Test Result

Z Multiple Regression Propensity Score Matching

CSRD 0,318** 0,066
(2,03) (0,16)
ROA 34,705*** 39,890***
(2,56) (13,6)
DAR -23,668** -4,850***
(-2,12) (-4,08)

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CR 0,394** 0,577***
(2,32) (69,12)
FS -3,395* 0,842***
(-1,51) (5,16)
SG -2,452 -2,411**
(-0,6) (-1,95)
Constant 95,611* -21,656***
(1,49) (-4,55)
F 6,29 1251,48
Prob>F 0,000 0,000
Adjusted R2 0,5548 0,9867
N 132 102
Description: Z= the level of financial distress, CSRD= CSR disclosure, ROA= profitability, DAR= leverage, CR= liquidity, FS=
firm size, SG= sales growth; in the brackets: z-statistic score. *p<10%, **p<5%, ***p<1%

To find out whether CSR disclosure can or cannot reduce the level of financial distress, this research uses propensity score matching
and the result is shown in Table 4. Based on this result, this research uses a sample that has same firm size. By adjusting this sample
to firm size, t value of average treatment effect of the treated (ATT) decreases from -0.37 to -0.29. It indicates that difference level
of both samples has decreased after firm size is adjusted. The numbers of samples after firm size is adjusted is 102 observations.
After that, the association between CSR disclosure and the level of financial distress disappears. It indicates that CSR disclosure
is not able to decrease the level of financial distress, even though it has a negative influence on the level of financial distress. The
company that discloses more CSR has a low level of financial distress as well, though CSR disclosure does not reduce the level of
financial distress.

CONCLUSION, IMPLICATION, LIMITATION

As the COVID-19 pandemic have been stressing the importance of CSR, this research examines whether CSR disclosure can
reduce the companies’ level of financial distress. To answer the topic of this research, this research uses multiple regression mode
of fixed effect and propensity score matching. By using multiple regression, this research finds out that CSR disclosure has a
negative influence on financial distress. The result of propensity score matching shows that CSR disclosure is not able to reduce
financial distress. It indicates that CSR disclosure has a negative influence on financial distress, but not able to reduce corporate
level of financial distress. In conclusion, CSR disclosure has a negative influence on financial distress, but it is not powerful enough
to reduce the level of financial distress. CSR disclosure of annual report is insufficient to reduce corporate level of financial distress.
It might be caused by CSR disclosure in annual report that is not based on stakeholder needs. Thus, it does not answer stakeholder
needs of CSR report information. As a result, the stakeholder does not carry out anything to reduce corporate level of financial
distress. Implication of this research is that the companies require to disclose CSR as much as possible, because CSR disclosure
has a negative influence on financial distress. However, this disclosure in annual report cannot reduce the level of financial distress.
Therefore, according to SEOJK no. 16 of 2021, a company requires sustainability report which is a CSR information demanded
by stakeholder. The results of this research support the regulation of SEOJK no.16 of 2021, which is the obligation to make
sustainability report.

Regardless of the usefulness of this research results, this research has some limitations. Firstly, financial distress size used is
Altman Z Score. Other studies used loss accumulation (Tarighi et al., 2022), O score (Boubaker et al., 2020), or other measures.
For the next researcher, the other financial distress measures can be used. Secondly, this research uses Sembiring index (2005) for
CSR disclosure index. For the next researcher, the other indexes can be used or creating self-owned index for CSR research of
annual report.

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Reyhan Theodorus
Accounting Department
Trisakti School of Management, Jl Kyai Tapa No 20, Grogol, Jakarta
Email: 201850196@tsm.ac.id

Astrid Rudyanto
Accounting Department
Trisakti School of Management, Jl Kyai Tapa No 20, Grogol, Jakarta
Email: astrid@stietrisakti.ac.id

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