THE 10th ISLAMIC BANKING, ACCOUNTING AND FINANCE INTERNATIONAL CONFERENCE 2022 (iBAF 2022)

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THE 10th ISLAMIC BANKING, ACCOUNTING AND FINANCE INTERNATIONAL CONFERENCE 2022

(iBAF 2022)

The Relationship of Board Characteristics on Corporate Social Responsibility Disclosure in Palestinian Companies: A Conceptual Model

Omar Tarda

Faculty of Economics and Muamalat, Universiti Sains Islam Malaysia (USIM), Bandar Baru Nilai, 71800 Nilai, Negeri Sembilan Malaysia

E-mail: [email protected]

Hasnah Haron

Tel: +606 7986304 E-mail: [email protected]

Nathasa Mazna Ramli

Tel: +606 798 6408 E-mail: [email protected]

Supiah Salleh

Tel: +606 7986317 E-mail: [email protected]

Abstract

There is little doubt that social responsibility and corporate governance are of current interest, as many Palestinian studies have addressed the issue of social responsibility and corporate governance for Palestinian companies listed on the Palestine Stock Exchange. The poor financial performance of companies may refer to the fall of social responsibility. The financial performance of Palestinian companies has fluctuated due to the Israeli occupation of the West Bank and the Gaza Strip since 1967, which has caused political and economic instability. The Palestine Stock Exchange is trying to attract investments by promoting the principles of governance and transparency. The characteristics of the board of directors are considered one of the most crucial factors affecting the disclosure of social responsibility and a means to help improve the company's reputation.

However, previous studies document inconclusive results regarding the characteristics of the board of directors and social responsibility. This study aims to provide a discussion that allows for a better understanding of the role of the independence of the board of directors and the size of the board of directors on the disclosure of social responsibility and aims to make constructive suggestions to guide future research.

Keywords: Palestine; Corporate social responsibility; BOD Independence and BOD Size

1. Introduction

Increased interest in CSR has forced companies to disclose information about their societal contribution in their annual reports. Some studies have examined the relationship between the characteristics of the board of directors and social responsibility in developed countries (Chan et al., 2014). Yet, there are inconsistent results, especially in developing countries. The disparity may refer to the core influence that decision-makers in the companies have on the disclosure of social responsibility (Khan et al., 2013). Previous studies have confirmed the relationship between the BOD independence and the BOD size to corporate social responsibility disclosure(CSRD) (Gallego & Pucheta (2020), Adnan et al., (2018), Ballesteros et al., (2017), Lone et al., (2016), Jizi et al., (2014), Orazalin (2019), Dias et al., (2017), Alia & Mardawi (2021), Zaid et al., (2019) and Fuente et al., (2017)).

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CSRD is a critical component of today's communication between businesses and their stakeholders and can help improve transparency and corporate image (Bhattacharya et al., 2009). Companies disclose CSR through their financial and environment information disclosed in their annual reports (Aribi and Gao, 2010; Kim et al., 2018). CSR is part of the reality of doing business in the twenty-first century (Beal& Neesham, 2016). According to Jamali et al., (2008), CSR is concerned with firms' commitment to contribute to sustainable development, stakeholder interests, and improvement of societal conditions. Previous statistics showed that the contributions of Palestinian companies towards social issues are still small, mainly due to the absence of a legal provision obligating companies to allocate part of their profits to social responsibility and the fluctuation of the financial performance of companies, which the Israeli occupation can be the reason since it imposes restrictions on the Palestinian economy (Barakat et al., (2015)).

The importance of corporate governance (CG) has increased worldwide in the past few decades, which aims to protect the interests of all relevant stakeholders while ensuring the company's economic efficiency and achieving sustainability (Crowther, 2008). Handling CG from contradicting perspectives has resulted in various definitions. Nevertheless, all these definitions have similar perspectives about the separation between proprietorships and control, since directors at times will perform their role that can cater for their best interests as compared to those of their stakeholders , which is in line with agency theory (Warrada and Khaddam, 2020).

Governance is applying sound systems and practices for those in charge of managing the company and directing the board of directors to adopt the best practices that run the company’s business (Jamali et al., 2008). Many Palestinian studies have examined the issue of corporate governance of companies listed on the Palestine Stock Exchange. For instance, Al-Bakri (2018) indicated that companies listed on the Palestine Exchange (PEX) apply the principles of corporate governance following the principles of the Organization for Economic Cooperation and Development(OECD) in varying degrees. This study contributes to the literature that identified the factors affecting CSRD practices. Previous studies showed that better-managed companies are said to be more “corporate socially responsible” as their annual reports include higher disclosure of CSR. The problem of the study argues the weak disclosure of social responsibility in Palestinian companies and the inconsistency of results of previous studies in the relationship between the characteristics of the board of directors and the social responsibility disclosure. This study aims to discover the relationship between BOD independence and BOD size to CSRD. This paper consists of five sections, including the introduction, the literature review, the conceptual framework, the hypothesis development, and the discussion and conclusion of the study, respectively.

2. Literature review

2.1 Corporate Social Responsibility Disclosure (CSRD)

One of the most important concept is corporate social responsibility. Companies are not isolated from society and the environment and bear responsibilities toward multiple parties (Birindelli et al., 2018). The issue of corporate social responsibility remains the focus of attention and interest to stakeholders because it is the primary means of expressing the companies' belonging to the community in which they operate (Oh et al., 2017). With the advent of globalization and international trade around the world, there is an increased demand for better transparency and corporate citizenship to meet the needs of society. This has led to several concepts that can be linked to CSR, including corporate social performance (Wartick and Cochran, 1985) and corporate social responsiveness (Jamali et al., 2008). Disclosure of social responsibility by companies is one of the ways of accountability to society, which works to give legitimacy to the activities of companies and prove their existence.

There are many definitions of social responsibility, which differ according to different points of view on whether social responsibility is the companies’ responsibility. Some see it as voluntary initiatives undertaken by the companies toward society (Beal& Neesham, 2016). Others see it as one of the socially appropriate images required of companies (Amaeshi and Adi, 2007). The World Business Council for Sustainable Development defines social responsibility as the ongoing commitment by businesses to behave ethically and contribute to economic development and work to improve the quality of living conditions of the workforce and their families, the local community and society as a whole. The CSRD concept focuses on several issues, including voluntary work, charitable work, health, environmental protection, ethical issues, and human rights (Carol and Shabana, 2010). The European Commission defined CSRD as "The responsibility of firms for their impacts on society."

Respect for appropriate legislation and collective bargaining agreements between social partners are required to fulfil that obligation. To achieve social responsibility, companies must integrate social, environmental, ethical, human rights and consumer concerns into their business operations and core strategy in close collaboration with stakeholders to maximize shared value for shareholders and stakeholders and minimize the potential for harm (European Commission, 2011).

The CSRD phenomenon is considered a Western phenomenon. Many developed countries have encouraged companies to disclose their social practices; for example, France adopted a law requiring large companies to disclose social responsibility in their financial statements (Wanderley et al., 2008). In the United States, companies

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have disclosed many social indicators since 1990 (Domini Social Index). In 2005, the European Commissioner announced that companies in European countries must disclose their social contribution (Luetkenhorst, 2004).

However, similar initiatives are limited in developing countries, as a few studies only dealt with disclosure of corporate social responsibility in these countries. In general, social responsibility in developing countries is considered unsatisfactory and low; disclosure of social responsibility in Yemen and Bangladesh is very low (Imam 2000; Alawi and Rahman 2011), and in most Arab countries such as Syria, Egypt, Jordan, Bahrain and some Gulf countries as well, disclosure of corporate social responsibility is considered weak. Although social responsibility has been increasing in the later period, few studies have addressed this concept in developing countries (Rizk et al., 2008, Uwuigbe and Egbide, 2012). The decline in social responsibility in developing countries may be due to the economic weakness or weak laws, enforcing companies to contribute and disclose their social responsibility in these countries.

The Palestinian society, like other societies, suffers from a high rate of poverty, unemployment, environmental pollution and other social problems, which calls for the concerted efforts of all members and organizations of society to contribute to solving these problems and facing the dangers that surround them, through available means and methods. The role of accountability and disclosure of social responsibility, as one of these tools, is to help organizations fulfill their duties towards society and the environment and work on sustainable development. It is also necessary to strengthen the strategies and policies related to the social responsibility of Palestinian companies and study the obstacles and factors supporting the disclosure of social activities to develop this concept (PECDAR, 2010). Previous studies showed that the contributions of Palestinian companies to social issues are still small due to the absence of a legal article obligating companies to spend on these social issues. Al-Jamal (2017) indicated that the Palestinian companies' expenditure of their profits on society did not exceed 1.8 percent. According to Alia and Al-Mardawi (2021), companies disclose an average of 43.7% of the items included in the CSR index.

This study refers to corporate social responsibility disclosed in the annual reports as CSRD.

2.2 BOD Independence

The structure and characteristics of the board of directors and the experiences of board members determine the effectiveness and efficiency of the board of directors (Karusi et al., 2020). Therefore, some features such as the independence of board members and the size of the board affect the effectiveness of the board of directors (Kakanda et al., 2016a; Vafeas, 1999). Gallego & Pucheta (2020) defines the independence of the board of directors as the presence of independent non-executive directors on the board of directors. They usually represent stakeholders (Haniffa and Cook, 2005) and have a significant impact on balancing and enhancing the effectiveness of the board of directors (Haniffa and Cooke, 2002). The independence of the board of directors by scholars is a key to ensuring effective control and an effective tool for linking the strategic policies of companies with the interests and expectations of stakeholders ( Harjoto et al., 2015). Board independence plays a vital role in protecting the interests of shareholders and the interests of minority shareholders, in particular (Pucheta &

Gallego, 2019). Fama and Jensen (1983) point out that having independent members on the board supports control over management and behavior. The presence of independent directors is shown to be an effective CG mechanism that can lead to better supervision of board effectiveness (Said et al., 2009). The independent directors play a central role in speaking out in favor of strict compliance with the law and upholding minority stakeholders’

interests (Fama and Jensen, 1983; Naciti, 2019). Moreover, about corporate social responsibility (Zahra and Stanton, 1988). Independent members pursue long-term time horizons and are therefore willing to invest in long- term environmental and social projects (Villiers et al., 2011).

Agency theory suggests that independent directors have no concerns about their position in the company and are better able to meet the interests of stakeholders, thereby leading to greater disclosure of information, greater accountability and transparency, as well as a good image of the company (Fama and Jensen, 1983; Muttakin et al., 2015).

2.3 BOD Size

The number of board members plays a major role in explaining corporate governance issues (Fuente et al., 2017). Usually, stakeholders demand a great deal of transparency, as the more members are, the more appropriate and representative for them because of their positive impact on the company's disclosure policies (Dias et al., 2017). A large number of experienced managers within the board of directors can increase its effectiveness and protect the interests of shareholders (Akbar et al., 2020). They can divide, arrange the various functions within the company (setting out strategies, monitoring and constructive advice within the board of directors) and have an interest in social activities (Halme and Huse, 1997). The opinions of researchers differed about which of the councils is more effective, the largest or the smallest. From Jensen's point of view (1993), larger councils increase the conflict of interests. Similarly, Chaganti et al., (1985) sees that the smaller ones have a more beneficial supervisory role. On the other hand, other studies such as Akhtaruddin et al., (2009) prefer larger councils because

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they would enhance disclosure and control in the company due to the knowledge and experience it possesses.

Pfeffer and Salancik (2003) states that the pursuit of more personalities contributing to the positive activation of the business may attract more members to join the board of directors. Therefore, larger boards of directors will affect the corporate reporting practices positively since members of larger boards add different values, knowledge, ideas and perspectives to any organization, which is in line with the resource dependence theory.

2.4 Underpinning Theory

Problems such as moral hazard and adverse selection arise from the separation of ownership and control in modern corporate governance (Jensen & Meckling, 2019). To address these issues, boards of directors must oversee management to ensure that they behave in the best interests of shareholders (Lan & Heracleous, 2010).

Agency theorists point out that the board can control management, bringing down agency costs (Zahra & Pearce, 1989). Further, agency theory indicates that independent directors don't only critically examine the executive directors' recommendations but also provide a perfect monitoring system within the governing body (Bertoni et al., 2014). According to agency theory, a large percentage of independent members on the board of directors reduces agency costs. Independent directors serve better interests of stakeholders, as the agency's view indicates (Jizi et al., 2014), and have no concerns about their position in the company (Khan et al., 2013). Thus, an independent board will lead to greater disclosure of information, increased transparency and accountability, reduced information asymmetry and improved corporate image (Fama and Jensen, 1983; Muttakin et al., 2015).

According to resource dependence theory, organizations seek to preserve their existence and survival by obtaining the resources from their environment. Larger boards are more likely to have a positive impact on corporate reporting procedures and financial performance from the point of view of resource dependence theory because board members may bring a variety of values to the BOD, knowledge, ideas and perspectives to any organization (Pfeffer and Salancik, 2003). From the resource dependence theoretical perspective, larger boards of directors generate more talented, experienced, and informed individuals who can learn more accurately, make better decisions, and ultimately contribute to enhanced CSRD (Yameen et al., 2019; Warrada and Khaddam, 2020;

Khatib & Nour, 2021).

3. Proposed Conceptual Framework

Framework of the study can be seen in Figure 1. The BOD independence and BOD size are independent variables of the study. Previous studies on the relationship between BOD independence and BOD size yielded inconclusive results. Several studies found that BOD independence and BOD size can enhance the disclosure of corporate social responsibility, whereas other studies found that BOD independence and BOD size have negatively affected it.

Figure. 1. Conceptual Framework

4. Hypothesis Development

Previous studies have examined the relationship between BOD independence and CSRD; for instance, Gallego & Pucheta (2020) found a significant positive relationship between BOD independence and CSRD.

Adnan et al. (2018) concurred with these findings. Where the study confirmed the existence of Significant and positive impact a relationship between BOD independence and on CSRD. Besides, Ballesteros et al. (2017), Lone et al. (2016), and Jizi et al. (2014) agreed that there is a positive relationship between the independence of the board of directors and the CSRD. Although there are few Palestinian studies in this field, the results are positive.

Alia & Mardawi (2021) examined the impact of BOD independence on the level of CSRD. It came to the same agency theory results since it discovered a significant positive relationship between board independence and

BOD independence

BOD size

CSRD

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CSRD. In addition, Zaid et al. (2019) indicated similar results. The results are consistent with agency theory that independent directors are better monitors of managers, as they are independent of the top management team and the firm (Dalton et al., 1998). Independence directors may foster CSR more than others because they tend to pursue longer time horizons; thus, they are more likely to see the long-term potential of investments in environmental and social projects (Villiers et al., 2011; Post et al., 2011). It is hypothesized that,

H1: BOD independence has a positive relationship on the level of CSR disclosures in Palestinian companies According to the resource dependency theoretical perspective, larger boards are more likely to have a beneficial impact on corporate reporting practices because board members can bring a variety of values, information, ideas, and views to any firm (Pfeffer and Salancik, 2003). Larger boards of directors generate more talented, experienced, and informed individuals who can learn more accurately, make better decisions, and ultimately contribute to enhanced CSRD (Yameen et al., 2019; Warrada and Khaddam, 2020; Khatib & Nour, 2021).

Previous research records conflicting findings regarding the size of BOD and CSR. Liao & hang (2018), Adnan et al., (2018), Fuente et al., (2017), Jizi et al., (2014), Dias et al., (2017), and Zaid, Wang & Abuhijleh (2019) found a positive relationship between the size of BOD and CSRD. On the contrary, Ballesteros et al., (2017) and Alia & Mardawi (2021) found that BOD size has a significant and negative impact on CSR. As for Alshbili et al., (2019) and Orazalin (2019), there is no significant and positive relationship between BOD size and CSR.

Therefore, it is hypothesized that,

H2: BOD size has a positive relationship on the level of CSR disclosures in Palestinian companies

5. Discussion and Conclusion

This study discusses the relationship between the characteristics of the board of directors and the disclosure of social responsibility in Palestinian companies. Review of previous literature found that relationship between board independence and board size has conflicting findings on CSRD. Some studies indicate a positive relationship, some negative and some no relationship. This study hypothesizes that the higher BOD independence will result in a higher CSRD. It uses agency theory to explain the relationship of BOD independence and CSRD.

According to agency theory, which states that independent managers seek to satisfy stakeholders needs and thus will disclose more information about social responsibility and thus in so doing will reduce the agency costs.

Resource dependency theory explains the relationship of BOD size to CSRD. This study hypothesizes that a larger BOD size, will result in a higher CSRD. According to the theory, a larger BOD size will bring in more resources, whether internal or external, as well as whether they are tangible or intangible. Outside BOD will for example bring along with them their network, competency and experience, which will support a higher CSRD.

Palestinian studies found that companies vary in the application of governance rules and that their contribution to social responsibility is small. This variation may refer to the difficult financial situation of Palestinian companies, possibly caused by the Israeli occupation and its control over resources and shaking the foundations of establishing the Palestinian state. Further, Palestinian studies discovered inconsistent results between the BOD independence and the BOD size on the disclosure of social responsibility. It would be interesting to examine the relationship of these two variables in Palestine which is a developing country.

Once the relationship is established for Palestinian companies, future studies can consider other board characteristics, such as board ownership, gender diversity, the audit committee and the extent of the moral commitment of members of the board of directors to learn more about the board’s characteristics that may affect the disclosure of social responsibility and the resolution of inconsistent results of previous studies.

It is also suggested that Palestine make more efforts in the application of governance rules that provide the necessary protection for stakeholders. There should also be broader powers given to stakeholders for them to assist to monitor management and to support and encourage investors to request for a higher CSRD in annual reports to increase accountability and transparency of the companies that they have invested in.

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