Does Corporate Sustainability Reporting Influence Financial Performance? Evidence from Kenyan Listed Companies

Corporate sustainability reporting is currently a prominent issue in the global business world, with companies worldwide actively publishing sustainability reports to meet the demands of different stakeholders regarding social, environmental, economic, and governance concerns. The existing literature has proved that companies that participate aggressively in corporate sustainability reporting tend to have higher firm value, experience tremendous growth rates in terms of size and profitability, have a high capital and asset base, are lowly geared, and gain a competitive edge in the industry in which they operate. The study examines the link between corporate sustainability reporting and the financial performance of firms listed at the Nairobi Securities Exchange. Corporate governance, social, environmental, and economic pillars were used as indicators of corporate sustainability reporting. The Global Reporting Initiative framework will be employed to establish the corporate sustainability reporting scores and construct the sustainability reporting index. Financial performance was measured by return on assets. The study is anchored on the stakeholder theory supported by legitimacy and the tripled bottom-line theories. The target population comprises sixty-seven companies listed in Kenya. Secondary data was collected from the company integrated reports, published accounts, and the accounts filed with the Nairobi Securities Exchange for the period 2011 to 2020. The study adopted a cross-sectional correlational research design. Descriptive statistical tests carried out include mean, standard deviation, kurtosis and skewness. Correlation analysis was done to test and establish the direction of the relationship between the study variables. Regression analysis was employed to test the hypotheses of the study. Generally, the study findings are that corporate sustainability reporting had a significant positive effect on financial performance. The empirical results of this study showed that corporate sustainability reporting led to improved financial performance among listed companies, although sustainability reporting in Kenya was purely voluntary. Therefore, Kenya’s Capital Markets Authority should consider making corporate sustainability reporting compulsory for all listed companies. Further research can be extended to include non-listed companies and the application of other sustainability reporting frameworks.

Keywords: Corporate Sustainability Reporting, Financial Performance, Global Reporting Initiative, Nairobi Securities Exchange.

Introduction

The rapid climatic change in the 21^st century has forced both developed and developing countries globally to create green economies so as to ensure human well-being and address social injustices and inequality while at the same time lowering environmental hazards, negative social and economic challenges, and ecological inadequacies (Syampoy, 2017). The unfavorable climatic conditions have been associated with increased industrial activities and market sophistication.

To respond to the issue of rapid climatic changes, both the private and public companies in the world have been forced to publish sustainability reports and disclosures in addition to the financial reports in order to demonstrate responsibility for the impact of their activities on the environment, economy, and community, so as to represent themselves as responsible corporate citizens, recruit customers and other stakeholders, and gain a competitive advantage (Gardberg & Fombrun, 2006). The increased demand for sustainability reports by investors and other stakeholders has also put much pressure on the boards of directors of different companies. The pressure has been driven by investors’ increasing desire to diversify their portfolios by investing in companies that are accurately responsive to corporate sustainability and have adopted green practices (Fischer & Sawczyn, 2013). Investors and other stakeholders, in general, have adopted this new investment strategy because they assume that, in the long run, shareholder value will be created by exploiting opportunities and managing risks emanating from the ongoing environmental, social, ecological, and economic developments (Knoepfel, 2001). Companies that uphold higher standards of sustainability reporting and exhibit greater efficiency are likelier to be larger in size, have lower leverage ratios, and have higher cash flows, experience faster growth rates, create higher share values, and have larger asset bases (Artiachet al., 2010). Additionally, corporate sustainability reporting is more beneficial than conventional financial reporting because it goes beyond reporting on financial performance to include governance, environmental, and social responsibility reporting among firms (Porter & Kramer, 2011). It is also worth noting that corporate sustainability reporting generates data that drives a sustainable future, firm financial performance, and economic development (Frow & Payne, 2011; Syampoy, 2017). Therefore, corporate sustainability reporting is a critical instrument for reducing information asymmetry and conflict between management and stakeholders (Shankman, 1999).

In Kenya, corporate sustainability reporting remains voluntary, and there is no law mandating its reporting. However, corporate governance reporting is mandatory among the listed companies. Most of the companies have applied the Global Reporting Initiative framework to prepare and publish sustainability reports.

Research Problem

In recent years, sustainability reporting has garnered considerable attention, with increasing emphasis on its impact on firms’ financial performance. Companies face significant pressure to adapt to the evolving demands of consumers, investors, suppliers, and regulatory bodies (Hongminget al., 2020). As a result of the immense pressure, companies are increasingly seeking to represent themselves as responsible corporate citizens by participating in social, economic, environmental, and governance reporting and to legitimize their existence in the eyes of their stakeholders so as to survive (Gardberg & Fombrun, 2006; Siew, 2015). Companies are increasingly required to be more accountable for the social and environmental consequences of their operations.

The underlying empirical studies show that there is no consensus among researchers on how corporate sustainability reporting affects their financial performance or the value added by investing in corporate sustainability reporting (Artiachet al., 2010). Consequently, the relationship between corporate sustainability reporting and financial performance can be positive, negative, or neutral (Barnett, 2007). Guensteret al. (2011) point out that firms with high sustainability performance experience better financial performance. Eccleset al. (2014) supported the argument by stating that companies that voluntarily disclose their sustainability performance experience better stock returns and financial performance (Orlitzkyet al., 2003). The lack of consensus on the linkage of corporate sustainability reporting and financial performance has been attributed to the varying conceptualizations and operationalization of the study variables by researchers (Aggarwal, 2013). The multifaceted essence of corporate sustainability reporting complicates its measurement. Studies have adopted different methods to measure corporate sustainability reporting (Moldavska, 2017). The Dow Jones Sustainability Indices, a stock market index, has been commonly used to measure sustainability reporting (Xiaoet al., 2013). Other metrics that have been applied to measure corporate sustainability reporting include the Global Reporting Initiative index, programs on qualitative sustainability, survey-based approaches, and benchmarking criteria. Return on assets (ROA), return on equity (ROE), return on capital employed (ROCE), return on investment (ROI), and revenue growth have been applied in many studies as measures of financial performance. Corporate social responsibility has been used by many scholars across the world as a single indicator of corporate sustainability reporting. Bassenet al. (2006) concluded that corporate social responsibility ratings had no significant relationship with financial performance metrics like ROA, ROE, and revenue growth. Nyamute and Batta (2014) conducted a similar analysis focusing on the Kenyan listed banks, and the findings were identical. Environmental reporting was used as a single indicator of sustainability reporting by Saidet al. (2015), yielding inconclusive results. The application of different measures of both corporate sustainability reporting and financial performance has been attributed to the mixed results reached. Therefore, whether corporate sustainability reporting improves financial performance or not remains a controversy. Additionally, the underlying literature on the relationship between the study variables in the Kenyan context remains scarce, and therefore, this also justifies the need for this study.

The concepts under study have been previously analyzed in different sectors and companies across countries in different parts of the world. The current study aims to bridge this gap by analyzing the study variables in the Kenyan Nairobi Securities Exchange. Apart from the conceptual gaps, the effect of the corporate sustainability reporting on the financial performance is contingent on the methodologies and data applied, the study’s geographical locations and the time period. To address these gaps, the study adopted the dominant GRI framework to construct the sustainability reporting index and establish the scores. The study also utilized ROA as a dominant measure of financial performance among sustainability reporting researchers. It is against the above-stated dilemmas that this study examines the corporate sustainability reporting-financial performance linkage among the NSE-listed firms. Therefore, the key question is: Does corporate sustainability reporting affect financial performance?

Research Objective

The main objective of this study is to establish the effect of corporate sustainability reporting on the financial performance of companies listed at the Nairobi Securities Exchange.

Theoretical Underpinnings

The relationship between corporate sustainability reporting and financial performance is founded on the stakeholder and legitimacy theories. The stakeholder theory was developed by Freeman (1984) and is the most popular theory explaining corporate sustainability reporting and financial performance among authors. The theory argues that corporations should not only be concerned with profit and wealth maximization but also should address the impact of their activities on the environment, society and economy as a whole (Mitchellet al., 1997). Corporations need to consider their relationships not only with conventional categories such as vendors, consumers, and staff but also with non-traditional groups such as the government, environmentalists, and civil society. In the society in which they operate, businesses must play a role, be accountable, and be responsible for the impact of their actions on stakeholders who are interested in the affairs of the company (Freemanet al., 2004). Therefore, by addressing the stakeholders’ concerns, firms are viewed as responsible citizens and create value for themselves (Gardberg & Fombrun, 2006). Corporate sustainability reporting initiatives and disclosures such as stakeholder dialogue, waste management and energy consumption reduction, and generally proper management of resources such as employees and product stewardship may lead to enhanced organizational capabilities such as reputation building (Orlitzkyet al., 2003), organization culture (Surrocaet al., 2010), managerial competencies (Orlitzkyet al., 2003), innovativeness (Blancoet al., 2013), and improved learning (Lankoski, 2008). Wang and Choi (2013) argued that failure by organizations to address stakeholder concerns may impede the accomplishment of the firm objectives and goals. The enhanced organizational capabilities and capacities may enable a firm to generate a competitive advantage in the industry in which it operates, and this, in turn, may lead to better financial performance (Barney, 1991). The legitimacy theory was propagated by Dowling and Pfeffer (1975). The theory is built on the premise that a social contract exists between the firm and the society in which the firm operates (Deegan, 2002). Businesses must continually strive towards meeting society’s expectations and interests (Deegan & Unerman, 2011). Legitimacy occurs where there is a conformity difference between the society’s expectations of how the firm should operate and how it is perceived that the organization has acted (Sethi, 1975). Firms are therefore forced to issue sustainability reports and disclosures so as to bridge the information asymmetry on how the firm is governed, matters firm’s economic contribution, social responsiveness and environmental management (Deegan, 2014). The two theories are very key to this study because they justify the need for corporate sustainability reporting and its contribution to financial performance among firms.

Empirical Literature

Umaret al. (2021) focus on sustainability reporting and financial performance. Empirical findings indicated that social and environmental aspects positively influenced the return on assets and returns on equity as measures of financial performance. The social aspect negatively impacted financial performance. The study supported the predicted direct relationship between corporate sustainability reporting and firm financial performance. The study addressed the consumer goods sub-sector of the listed companies in Nigeria. The study’s findings could not be generalized in other sectors. This study sought to address similar constructs in the Kenyan context, focusing on all listed companies.

Hongminget al. (2020) analyzed non-financial firms listed in Pakistan in relation to corporate sustainability reporting and financial performance. The study focused on the environmental, health and social factors. The study findings were that environmental, social, and health aspects of sustainability reporting, if well addressed, lead to improved returns on assets among firms. The focus of the study was on non-financial firms only, and the results may not be applicable to the listed financial firms. The study also focused on a developed economy and may not be generalizable in a developing economy.

Corporate sustainability reporting and firm financial performance were emphasized by Laskar (2018), who studied listed firms based in Asia, Japan, South Korea, India and Indonesia. Secondary data from 2011 to 2014 was used. The study concluded that corporate sustainability reporting and financial performance were positively correlated. The study further found out that the level of sustainability reporting and disclosure was 90% in Japan, India 80%, South Korea 85% and Indonesia 72%. The results also reveal that the negative effect of sustainability reporting on financial performance was felt much in developing economies like Asia as compared to the developed economies studied. The study was based on developing economies and, therefore, could not be generalizable and applicable to developing economies.

Conceptual Framework

The conceptual model depicts a relationship between corporate sustainability reporting and returns on assets as an indicator of the financial performance of listed companies. A possible connection between corporate sustainability reporting and financial performance was presented in the model. Fig. 1 illustrates the schematic connection between the variables of the study.

Fig. 1. Conceptual model.

Research Hypothesis

We hypothesized that the relationship between corporate sustainability reporting and financial performance is not significant.

Methodology

The target population in this study comprised sixty-seven companies listed at the Nairobi Securities Exchange as of December 2020. Of the 67 companies, only 49 met the sought data requirements for establishing governance, social, environmental and economic scores, as well as computing the return on assets from 2011 to 2020, which were encompassed in the study’s analysis. Secondary data used in the study was obtained from the integrated reports of the listed companies, audited financial reports, annual corporate governance statements, sustainability reports and disclosures, environmental reports and the NSE handbooks. Content analysis was employed to establish the sustainability scores.

Measurements

Corporate sustainability reporting was operationalized by establishing governance, social, environmental and economic scores. The GRI-G4 framework was applied to establish the scores. A total of 70 items of sustainability disclosures under governance, social, environmental and economic pillars were identified. A binary scoring system was adopted. Each item of disclosure was given a dummy weight of “0”, indicating the absence of the item in the report, while the weight of “1” indicated the presence of the item of disclosure in the report. Total scores under each pillar were computed and expressed as percentages. Return on assets as a financial performance measure was expressed as earnings before interest and tax divided by the firm’s total assets for each company between 2011 and 2020.

Data Analysis

The study utilized regression analysis to test the relationship between corporate sustainability reporting and financial performance as measured by return on assets. Correlation analysis was done to establish the association between the variables of the study and tell the direction, as well as the degree of the relationship between the study variables.

Model

The regression model we built was as follows: (1)FP=α+β1CGS+β2SS+β3ECOS+β4ENS+ε1

Where:

FP: Financial performance measured as return on assets,

CGS: Corporate governance score,

SS: Social score,

ENS: Environmental score,

ECOS: Economic score,

α: Regression constant,

β₁, β₂, β₃, β₄: the regression coefficients,

ɛ: the random error term that accounts for variability unexplained by linear effects.

The correlation coefficient was determined, and the tests of significance was done using t-test to establish existence of relationship between corporate sustainability reporting and financial performance as independent and dependent variables respectively. If the coefficients were found to be significant, then there existed a relationship between the study variables.

Findings and Discussion

Descriptive statistics for the study are shown in Table I. The scores for corporate sustainability reporting components or indicators were computed, and the descriptive statistics were summarized in Table I. The results of Table I indicate the mean value of return on assets is 0.0724 for companies while the standard deviation is 0.34. The value of the mean average of 0.0724 implies that financial performance in the listed firms is taking an upward direction and that the firms have realized high profits and their assets have increased tremendously as they continue reporting on sustainability. Financial performance with a positive kurtosis indicates a leptokurtic distribution measure and more values above the mean in the data series. The skewness for the financial performance measure is negative, suggesting that the distribution is skewed to the left.

Table I. Descriptive Statistics

	N	Mean		Max.	Min.	Std. dev.	SK	KU
ROA	490	0.072		3.58	−5.37	0.341	−5.181	159.99
CGS	490	0.164		0.25	0.00	0.052	−1.082	1.334
SS	490	0.076		0.2	0.00	0.037	0.360	0.051
ECOS	490	0.137		0.25	0.00	0.049	−0.277	−0.528
ENS	490	0.059		0.21	0.00	0.060	0.678	−0.081

Table I shows the results for the independent variables where the mean average corporate governance score was 0.16, with a minimum of 0.00, a maximum of 0.25, and a skewness of −1.08, indicating that the data is negatively skewed. Because the kurtosis value is less than 3, it implies that the series contains fewer values that are below the mean and, therefore, the distribution is platykurtic. The mean of 0.16 indicated that the level of disclosure and reporting on corporate governance was at 16% among the listed firms in Kenya. The mean social score was 0.08, with a range of 0.20 to 0, a minimum of 0, a standard deviation of 0.04 and a skewness of 0.36, indicating positively skewed data. The mean of 0.08 indicated that the level of disclosure and reporting on corporate social responsibility was at 16% among the listed firms.

Additionally, the data is platykurtic since the kurtosis value of 0.05 is less than 3, indicating that the series has more values that are below the mean. The environmental score had a mean of 0.06, a range of 0.21 to 0.0, a standard deviation of 0.06, and a skewness of 0.68, indicating positively skewed data. Additionally, the series is platykurtic because its kurtosis value of −0.81 is less than 3, indicating that it contains a greater number of values that are below the mean. The mean of 0.06 indicated that the level of disclosure and reporting on environmental matters was at 6% among the listed firms. The economic score had a mean of 0.14, a range of 0.14 to 1.18, a minimum of 0, a standard deviation of 0.05, and a skewness of −0.28 and a kurtosis of −0.53, respectively. The mean of 0.14 indicated that the level of disclosure and reporting on corporate social responsibility was 14% among the listed firms studied.

The results of correlation analysis between financial performance (return on assets) and corporate sustainability reporting were positive and statistically significant, where corporate governance score (r = 0.157), social reporting (r = 0.061), environmental reporting (r = 0.002) and economic reporting (r = 0.061). The regression analysis results are indicated in Table II. The relationship between corporate governance score and financial performance as measured by return on assets was statistically significant and positive with (β = 68.06, p < 0.05). The relationship between social score and financial performance was statistically insignificant but positive (β = −15.88, p > 0.05). The relationship between economic score and financial performance was positive but statistically insignificant (β = −1.9, p > 0.05). Additionally, the association between environmental score and financial performance was statistically significant but inverse (β = −28.83, p < 0.05).

Table II. Regression Results for Corporate Sustainability Reporting and Financial Performance

Variable	Coefficient	Std. error	t-statistic	Probability
C	5.7028	2.3583	2.4182	0.0160
CGS	68.0586	18.1922	3.7411	0.0002
SS	−15.8759	24.5976	−0.6454	0.519
ECOS	1.9014	20.6269	0.0922	0.9266
ENS	−28.8255	14.6098	−1.973	0.0491
R-squared: 0.0375
Adjusted R-squared: 0.0295
Std. error of estimate: 13.7831
Sum-squared resid.: 91947.1600
F-statistic 4.7097
Prob.: 0.001
Dependent variable: ROA
Predictors: Constant, CGS, SS, ECOS, ENS
Periods included: 10
Observations: 490

The overall model results reported a significant F value of 4.71 and a p-value below 0.001. The adjusted R² was 0.0295, while 0.9705 was presumed to be explained by other factors not studied and tested in this model. The overall was statistically significant since the value was 0.001, which is less than 5%. The research findings implied that corporate governance and social, economic, and environmental scores jointly influence the financial performance of listed companies in Kenya. The linear regression model was therefore presented in (2): (2)FP=5,70+68.06CGS−15.88SS+1.90ECOS−28.83ENS

Therefore, the study’s null hypothesis was thus rejected, and it was concluded that corporate sustainability reporting has a significant effect on the financial performance (as measured by return on assets) of companies listed at the Nairobi Securities Exchange.

The study results are consistent with those of Ngatia (2014), Siewet al. (2013), Hongminget al. (2020), and Nzekweet al. (2021). Their studies concluded that corporate sustainability reporting had a direct and positive effect on financial performance. Companies that participated aggressively in corporate sustainability reporting more stakeholders, such as investors, and, therefore, had a large capital base, asset base and high profits.

Recommendations

As documented in this study, the effects of corporate sustainability reporting on financial performance will provide corporate executives, company managers, governments, policymakers, professional bodies, standard developers and practitioners with a foundation from which to establish their strategies focused on directing the corporate financial performance. In Kenya, it is only corporate governance, a pillar of sustainability reporting has been mandatory. Reporting on social responsibility and environmental and economic performance is purely voluntary. The level of sustainability reporting by companies in Kenya and other developing economies is low compared to that of developed countries. Therefore, the study recommends that corporate sustainability reporting should be made compulsory among corporations. Corporate sustainability reporting standards that have already been developed should be adopted.

The study tested the direct relationship between corporate sustainability reporting and the financial performance of listed companies. The aspects of corporate sustainability reporting and their effect on the financial performance measured as return on assets were tested separately. A study can be conducted on the effect of the composite sustainability reporting index (corporate governance, social, environmental, and economic score) on financial performance. Other financial performance measures such as Tobin’s Q, return on investment, profitability and return on capital employed can also be studied. Further studies could also be carried out focusing on non-listed companies. Comparative studies can be made focused on corporates in other developing countries.