1. Introduction
The financial crises of 2007–2008, which was coupled with financial scandals, has created a great deal of mistrust amongst the different stakeholders in the economies around the world. This has caused a great deal of distress for companies and in order to regain the trust of the stakeholders, the companies have started to commit themselves towards social responsibility and have started to consider CSR, ethical behaviour, and disclosures relating to CSR as a vital part of their reporting mechanisms [
1]. They realized that they not only needed to survive, but they also need to ensure growth and the future stability of their revenues along with their financial positions. Ameer [
2] states that, by keeping these factors in mind, the companies have considered comprehensive environmental alertness, ethical behavior, and practices. The past research is inconclusive regarding whether CSR and ethical practices have a positive or a detrimental impact on a business’s reporting quality [
3]. Shleifer [
4] contended that socially responsible companies are less likely to undertake earnings management (EM) activities, because they can have a determinant impact on their established reputation.
In recent times, the corporations have changed their perspective regarding financial assistance in the form of corporate donations and are moving towards the betterment of the overall community by involving their employees. According to Porter and Kramer [
5], corporations are coming up with charitable programs that are designed in such a way that it not only involves the community but also satisfies the employees; as a result, not only does the reputation of the business improve, but the morale of employees also improves, along with improvements in the environment and overall living standard of the community. Along this line, Lewin and Sabater [
6] state the example of IBM, who has launched programs such as social volunteering, which has led to the improvement of not only the corporate reputation but also overall employee satisfaction.
There is consensus amongst researchers and academics that such programs are only successful if they are in line with the strategic vision and objectives of the companies. Along with that, the social activities selected for such programs and their potential impact on society or the environment needs to be communicated to such volunteers. This not only motivates the employees involved in the activity but also improves their commitment towards the cause and the organization as a whole. According to Brewis [
7], such exercises not only improve employee satisfaction but also result in positive influences that reaffirm employee loyalty, as it aligns with that of the organization. He further states that this also has a positive impact on the overall corporate image of the organization in the eyes of both employees and society as a whole.
Castelo Branco and Lima Rodriques [
8] state that CSR and ethics are related to the characteristics of corporate decision-making that are related to moral issues, such as environmental protection, practices related to the wellbeing of human resources, and helping deprived communities establish good working relations with customers and employees. CSR engagements by companies improve their social profiles and enhance their corporate reputations [
9], which in turn not only satisfies the stakeholders but also reduces the financial risks for companies involved in these types of activities [
9].
Over the last 30 years, the Chinese economy has experienced phenomenal growth. China has attained the status of the second largest economy in the world by surpassing Japan in 2017, and the Chinese economy is expected to surpass the USA in the next decade. According to Keely and Anderson [
10], a report from the international monetary fund (IMF) showed that the Chinese economy cannot sustain its current structure as an export-oriented economy for much longer, and it needs to convert itself into a consumer-oriented economy if it wants to retain its economic status (IMF2017). It is transforming itself, and it is fast becoming a consumer-oriented economy. The Chinese firms are becoming multinational firms and foreign investment is pouring intothe companies that have acknowledged the importance of CSR and ethical practices. One has to keep in mind that the need for CSR and ethical activities is mainly driven by the domestic stakeholders, and their practices are more oriented towards Chinese domestic audiences. This is an important factor in analyzing the CSR and ethical activities conducted by Chinese companies. They are considered as a part of a larger national development plan [
11,
12].
These activities bare telltale signs of the government influence of CSR and ethical activities. The reason could be attributed to past issues faced by the Chinese exporters who were penalized for a lack of CSR activities by developed nations [
12,
13]. With changes in the legal setup, it has now become imperative for all companies to perform. This intermediate transformation in the Chinese CSR and ethical practices becomes more substantial, and other emerging markets are emulating the Chinese growth model CSR practices [
14,
15].
Even though there has been plenty of research on CSR in China, it can be considered irrelevant for two main reasons. A major portion of the research has utilized the accrual earnings management (AEM) (discretionary accruals) approach to measure the EM [
3,
16,
17,
18,
19]. This can easily be manipulated by changing the operating activities rather than manipulating the discretionary accruals. This technique is commonly known as real earnings management (REM) [
20,
21]. Kim et al. [
21] stated that the REM-based approach has seldom been applied in the Chinese context, and a similar view is held by Bozzolan et al. (2015) [
22]. Nonetheless, Kuo and Ning [
23] imply that Kim et al. [
21] and Bozzolan et al. [
22] held that the conclusions based upon AEM lack consistency with the Chinese EM practices. The second reason relates to the institutional factors, which are essentially varied from other countries when it comes to CSR and ethical practices in China. The sample size of the previous research was very limited, and it accounted for no more than five percent of the entire firms population [
3]. These researchers are not alone, because Scholtens and Kang (2013) [
17] and Bozzolan et al. (2015) [
22] also support similar notions.
This study mainly focuses on the relationships between CSR and EM practices in the context of companies based and operating in China. Based on our research study, we concluded that socially responsible companies in China are less likely to engage in AEM and REM activities. The major contributions of this study are as follows.
Our interest in China was motivated for socio-economic reasons. Firstly, China is the biggest developing nation and the world’s second largest economy after the USA. China also has problems associated with developing nations [
24,
25]. Of particular relevance to this point, it was rightly observed [
26,
27,
28,
29,
30] that few studies on CSR and EM have been conducted outside developed nations such as USA and UK, which very clearly enjoyed corporate governance, legal, economic, and institutional contexts. However, developing economies, such as the Chinese, have received little attention. It is strongly argued that their different corporate governance CG, legal, and economic environments deserve to be investigated. The degree to which formal mechanisms of CG can contain a managerial ability to engage in EM may differ. Moreover, the importance of emerging markets has been addressed in several studies [
24,
31,
32,
33,
34,
35,
36,
37,
38,
39,
40,
41,
42,
43,
44,
45,
46,
47,
48,
49,
50,
51,
52], and China is the largest economy offering an interesting context.
Secondly, as reported by Li et al. [
53], the relation between CSR and REM has not yet been thoroughly investigated. For instance, there is a relative dearth of research on the impact of CSR on EM. Achleitner et al. [
54], Zang [
55], and Cohen and Zarowin [
56] agree that most previous investigations of EM have focused on manipulating discretionary accruals and might be very productive to investigate EM as a technique to manipulate real earnings. Managers have been frequently observed using both practices alternatively. Cohen and Zarowin [
56], Francis et al. [
57] argued that, after the 2002 Sarbanes–Oxley Act (SOX), real EM became the central attraction of managers and researchers instead of accrual EM. These scholars explained this shift of interest by the fact that real EM is costly and harder to deduct from regulators and auditors.
Third, many previous studies on this topic have been inconclusive, or they presented contradictions with the relationship between CSR and EM. These studies mainly include [
3], and their findings were further endorsed in [
16]. Meanwhile, Kim et al. [
21], which was followed by [
58], also held similar conclusions, and these were supported by the research in [
22]. Even though studies by Noronha et al. [
59] had provided circumstantial evidence aimed at the relationship between CSR and EM in the Chinese context, which was followed by [
15], there were not any conclusive results that were provided. The study [
14] also suffers from similar issues. Meanwhile, our study provides conclusive evidence regarding a negative relationship between CSR and EM.
Fourth, rather than relying on one method to measure EM, we applied both the AEM and the REM methods. By following both methods, we not only validated our findings, but we were able to check the impact of CSR on AEM and REM distinctly. It is generally held that the political costs and the acceptability of issues relating to AEM are higher than those of REM. In [
55], it was explained that the main reason for this relates to the fact that AEM is the focus of an examination by auditors during annual audits and regulators alike [
60].
Fifth, companies in China practice a wide variety of CSR activities, and they have experienced a great degree of changes over time at the corporate and the institutional levels. The rise of the Chinese economy along with its stable growth pattern has provided ideal circumstances to observe the external institutional mechanisms discussed in [
12]. Yin [
61] also researched the same topic, which was followed by Islam [
15] and Parsa et al. [
14], and they all have similar conclusions. These researchers have also pointed out that the CSR and ethical behaviour practices of Chinese companies conform to their social and cultural practices of creating harmony in society. This might seem to differ from the conventional practices and objectives of Western companies, but they conform to wider Asian and South East Asian societies. As a result, this research can be considered as a stepping stone for further research into the topic, especially in these countries.
This paper follows the following pattern. In the second section, a detailed literature review is presented. We formulated our hypothesis based upon the literature review. The third section includes a research design, and the methods that are implemented and the choice variables are discussed in detail. The fourth section provides the results. The last section contains the discussion and the implications of the research, followed by the conclusion.
5. Conclusions and Future Research
For the current research, the sample consisted of 5457 Chinese firm-year observation data on CSR activities from 2010 to 2019. We considered two main methods to measure the levels of EM: AEM and REM. Through our research, we identified the state control of firms as one of the major institutional factors moderating the relationship between CSR and EM. In the first step of our research, we found that the relationship between CSR and EM was negative. Afterwards, we explored the impact of the moderating variable, such as state control, on the above-mentioned relationship. To address the possible effects of endogeneity, the regression approach of 2SLS was adopted to test our research models.
To satisfy the stakeholders both internal and external, organizations need to incorporate CSR- and ethical-behavior-based policies not only into their operating environment but also into their organization’s culture. This view is backed by [
65], the authors of which hold that employees are major (internal) stakeholders of any organization. As employees are major stakeholders, they also demand that the organization pay attention to CSR activities, i.e. ethical behavior, and when such expectations are fulfilled by organizations, the overall morale of the employees becomes satisfactory. This leads to an improvement in organizational commitment, a reduction in turnover, and an increase in productivity [
115,
116].
Our results confirmed the theoretical connections established earlier. We found that there was a negative relationship between CSR activities and EM. This means that, when Chinese firms increased their CSR activities, they tended to be less involved in EM activities. On the other hand, we also discovered that state-owned firms were more likely to increase REM while increasing CSR activities, because they were more likely to face increased legitimacy risk. At the same time, the possible incentives for potential EM are greater compared to the private sector companies [
3]. In line with this notion, Shleifer [
4] stated that companies with higher CSR activities are less likely to be involved in EM, because the general public and other stakeholders are more interested in their financial results, and the incentives for managers to practice unethical practices are usually lower.
These firms always prefer to benefit from these types of social relationships in the long term, and they ignore the short-term gains from indulging in EM activities. The quality of the earnings is preferred by these firms, because they are always under the public focus and other stakeholders. Researchers such as Orlitzky and Schmidt [
9] and Brammer and Millington [
117] have held that CSR and profitability are positively linked. Francoeur and Labelle [
118] added that companies with a high level of CSR activities usually have a higher quality of earnings, compared to those that have a lower level of CSR activities.
The present research is helpful for both Chinese regulators and firms alike to understand the importance of CSR practices. The findings are important in the context of international and local investors along with academics, because they indicate the importance of CSR practices in the context of EM. This study can also be seen as a benchmark for other Asian markets that share similar characteristics with the Chinese markets [
14,
15]. Most of the Asian financial markets are considered as emerging markets, and they are of great importance for both local and international investors.
Nowadays, every organization wants to achieve a competitive advantage over its competitors and because of the additional financial resources required, achieving such an advantage isvery limited and hard to obtain. One way of achieving this is by having well trained and motivated employees. As most of the companies within a specific sector and category have similar financial resources, the human resource is the main defining factor in achieving this advantage [
119]. Organizations can only achieve this if they cultivate a CSR- and ethics-based corporate culture, as only then can they realize the synergistic benefits. Gazzola [
120] held that such a culture cannot be developed without the participation of employee satisfaction. The human resources department needs to take a lead role in encouraging employee participation in CSR- and ethics-based activities at all levels. This improves the working environment and culture of the organization, resulting in the positive work and ethical behaviour of employees ensuring long-term success for both the employees and the organization.
CSR and ethical behaviour not only have a positive impact on employee satisfaction but also improve investor confidence. Therefore, it has become vital for the organization to manage their volunteers and their CSR- and ethics-based projects in such a way that they not only help to improve an organization’s image but also prove to be a motivating and healthy activity for employee satisfaction.
Even though this study provides deep insight into the relationship between CSR and EM, it has a few limitations, because the study only encompasses Chinese listed firms that disclosed CSR practices and other information, such as control structure. The limitation mainly exists because many Chinese state-owned corporations are not even listed on the stock exchanges [
121]. At the same time, we varied the types of institutional environments, which might greatly differ from one another depending upon the nature of their operations and the amount of information they tend to disclose. It is very difficult to gauge the level of EM in those enterprises. Many works in the past on topics such as Islam had have also argued about the impact of international markets on CSR practices in Chinese companies. Future studies can consider the present study as a foundation to investigate phenomena in Chinese financial markets. Any China-based international company may be more concerned about the image it portrays to its international investors and thus would extend its CSR practices, because they are of major concern for investors based in developed countries as compared to the local Chinese companies. In the future, researchers can compare the local CSR practices of local and international Chinese companies to validate or reject this type of hypothesis. We also conclude that there are issues of transparency when it comes to CSR practices and reporting with Chinese companies in general, even though China has made great progress in regard to the implementation of CSR reporting. These transparencies might be better than other developing countries, but they still significantly lag behind the developed markets.
This study provides useful insight into the CSR practices and their impact in terms of developing markets, but the researchers have to be careful with generalizing this study for all developing markets, because they might have different legal institutional requirements. Even though many Asian countries share a border with China, their legal and corporate sectors are much different than those of China, which is a result of the differences in culture, history, and colonial backgrounds.