The Nexus Between Board Diversity and Sustainability Reporting: The Moderating Role of Supervisory Effectiveness and Quality in a Two-Tier Board System

Abstract

This study aimed to investigate how Board of Director (BOD) diversity affected sustainability reporting in Islamic banks in Indonesia. The effectiveness of three supervisory bodies, namely the Board of Commissioners (BOC), the Audit Committee (AC), and the Sharia Supervisory Board (SSB), was explored to determine their ability to enhance sustainability performance. The study was based on a sample of 13 Islamic banks listed with the Financial Services Authority between 2012 and 2021. Moderated Regression Analysis was applied to test the hypotheses. It was found that board diversity had a positive influence on sustainability reporting. The regression results for all three moderation variables showed positive and significant findings, indicating that the interactions between the BOC, the AC, the SSB, with the BOD played an effective role in enhancing sustainability disclosure. board ’diversity’s importance and supervisory boards’ effectiveness. This study fills a research gap on the relationship between corporate governance and sustainability disclosure, especially in developing countries that adhere to a dual board governance system, specifically Islamic banks that comply with Sharia governance. The research results underscore the need for a diverse board of directors and the effectiveness of the supervisory board as the party responsible for meeting stakeholder demands through its role in encouraging companies to be actively involved in sustainability performance.

Plain language summary

Companies today are not only focused on achieving financial targets such as increasing profits, but must also be able to benefit the welfare of society and environmental sustainability. Therefore, it is important for companies to engage in sustainability-oriented activities. Reporting on company sustainability activities is required for parties who have a relationship with the company. It cannot be denied that sustainability activities and reporting will run well if all elements of the company work optimally, including the operational executive board and company supervisory board.

Keywords

sustainability reporting Islamic bank board diversity board of commissioners audit committee Sharia supervisory board

Introduction

The Sustainable Development Goals (SDGs) agenda was formulated at the global level, involving leaders from 193 member countries of the United Nations at the end of September 2015 (Fauziyah & Trisnawati, 2022). Sustainable development, as a global action plan implemented until 2030, has five basic principles: People, Planet, Prosperity, Peace, and Partnership. The SDGs consist of 17 Goals and 169 targets that encompass social, economic, and environmental dimensions in an integrated manner. The achievement of SDG targets is a national development priority that requires good synergy between the government and the private sector. The Financial Services Authority, as the institution responsible for regulating and supervising the financial services sector, continues to promote the development of Islamic banks (IBs). IBs are expected to be part of the solution in achieving the SDG targets due to their unique Islamic financial principles that prioritize income distribution and have a social and environmental orientation, making them highly relevant to the SDGs (Hambali & Adhariani, 2023).

Ideologically, IBs differ from conventional banks, as their primary objective is not profit maximization but the promotion of social justice (Mohammed & Mansor, 2021; Ullah & Khanam, 2018). Myers and Hassanzadeh (2013) assert that Islamic finance principles offer a just socio-economic system committed to achieving a prosperous, fair, and well-being-oriented society. Conformity of sustainability principles and Sharia goals does not necessarily make IBs in Indonesia carry out quality sustainability disclosures. Although the number of disclosures has increased annually, their quality remains poor because banks fail to disclose material facts in their sustainability reports (SWA Online, 2023). The tangible manifestation of SDG achievement policies in Indonesia can be seen in the implementation of sustainable finance as stated in the regulation of the Financial Services Authority (Otoritas Jasa Keuangan-OJK) No. 51/POJK.03/2017 concerning the Implementation of Sustainable Finance for Financial Institutions, Issuers, and Public Companies. The Transformasi untuk Keadilan Indonesia (TuK INDONESIA) Association, in collaboration with the Trisakti Sustainability Center, conducted an evaluation of compliance by Indonesian banks with this regulation. The analysis results indicate that the quality of disclosure by Indonesian banks can still be considered insufficient. Amidjaya and Widagdo (2020) and Saadah et al. (2023) highlight the lack of understanding among companies in Indonesia regarding the consequences of social disclosure, with the main reason for disclosure being suspected as merely a formality to gain a favorable public perception. This may be due to a lack of ineffective supervision and regulation processes for Islamic banks in Indonesia (Wijayanti et al., 2020).

Research on the role of governance in corporate sustainability activities is very interesting, especially for IBs in Indonesia, for three main reasons. First, Indonesia is categorized as a developing country with a majority Muslim population. However, most Indonesians prefer conventional banks to manage their money compared to IBs. Second, Indonesia is a country that adheres to a dual board governance system, in which companies have two boards in their organizational structure, namely the Board of Directors (BOD) and the Board of Commissioners (BOC). Ironically, the study by Muttakin et al. (2015) stated that developing countries have low financial transparency and accountability, weak rule of law, poor governance, and lack of investor protection. Third, IB has a function and structure different from conventional banks. This causes IB to have unique agency problems compared to conventional banks (Al-Nasser Mohammed & Muhammed, 2017; Farag et al., 2018). IB managers are obligated to comply with SSB supervision to legitimize their operations according to religious regulations (Baklouti, 2022). According to Abdelsalam et al. (2016), the SSB provides an additional monitoring mechanism to mitigate agency problems. Thus, it is imperative for IBs to have a proficient SSB capable of fulfilling its responsibilities in controlling the BOD and managers (Zulfikar, Nursiam, Mujiyati, et al., 2021), ensuring their adherence to Shariah principles (Mollah & Zaman, 2015).

The board of directors (BOD) is widely recognized as the most influential factor in corporate disclosure. Sarea and Salami (2021) posits that the BOD assumes primary responsibility for implementing policies, practices, and business strategies. The challenges posed by sustainability necessitate the consideration of diverse board characteristics (Naheed et al., 2021). Consistent with the resource dependence theory, a board composed of members with diverse backgrounds and skills brings about enhanced knowledge insights (Khatib et al., 2021), thereby leading to improved firm performance (Hosny & Elgharbawy, 2022). Kusumastati et al. (2022) argues that a diverse board represents cultural, political, and social perspectives, enabling companies to engage in sustainability activities with positive effects on performance. Furthermore, a diversified board’s characteristics provide a valuable foundation for assessing investments in social initiatives due to their ability to capture stakeholder loyalty (Khan, Khan, & Senturk, 2019; Khan, Yang, & Waheed, 2019). Aligned with agency theory, a diverse composition of the BOD can mitigate agency problems. Assurance statements by the BOD are regarded as monitoring mechanisms that help reduce information asymmetry between CSR information providers and users, consequently enhancing the credibility of sustainability reporting (Tyson & Adams, 2020).

The BOC plays a crucial role in overseeing management performance, making their presence essential in monitoring policies that may give rise to conflicts of interest between principals and agents (Susbiyani et al., 2022). As an independent body, the BOC is expected to effectively encourage the BOD to enhance their supervisory capacity. This becomes particularly relevant as the BOD, representing shareholders, has recently faced significant criticism, especially concerning their oversight responsibilities (Trinugroho et al., 2022). Hence, the effectiveness of the BOC becomes necessary in driving the BOD’s ability to exercise effective oversight. Effective oversight, in turn, fosters management transparency by providing widely accessible information.

The AC which is part of the BOC, serves the function of enhancing the reliability of accounting information through monitoring and oversight of the company’s financial reporting processes (Ryu et al., 2021). According to Tumwebaze et al. (2022), the AC also has the potential to influence the BOD in making policies that impact sustainability reporting practices. This assertion is further supported by Bin-Ghanem and Ariff (2016), who state that the AC has the responsibility to ensure the effective management of agency problems between managers and stakeholders, including enhancing the quality of reporting. Notably, when the AC reviews non-financial information, it encompasses sustainability-related information. If sustainability information is absent, the AC can recommend its inclusion to the entire board (Tumwebaze et al., 2022). Therefore, the effectiveness of the AC can be regarded as a factor influencing the board’s implementation of sustainability reporting practices.

This study makes three contributions. Firstly, most prior studies examining the role of board diversity have predominantly focused on advanced Western countries. This study fills the gap by shedding light on how diverse board characteristics can promote sustainability reporting in the context of a developing country, namely Indonesia. The prominence of Indonesian Islamic banks in the Islamic financial market makes them an intriguing subject for investigation. Secondly, the study capitalizes on Indonesia’s unique characteristics as a predominantly Muslim country that adopts a dual governance system, encompassing both operational and supervisory roles of the BOD and the BOC, respectively. This enables the exploration of the influence of these two boards on sustainability reporting practices. Thirdly, the study recognizes the significance of the SSB as an additional governance mechanism exclusive to Islamic financial institutions (IFIs). To the authors’ knowledge, this is the first study to include the existence of corporate oversight organs (the BOC, the AC, and the SSB) within a single research framework in an effort to support effective sustainability disclosure in IB.

The remainder of this article is organized as follows: Section “Literature Review and Hypotheses Development” provides a comprehensive literature review, including the underlying theoretical foundations and the contextual backdrop of the study. This is followed by the development of hypotheses and the research framework. Section “Method” presents the methodological aspects of the study. The analysis and discussion of the findings are presented in Section “Results and Discussion”. Finally, Section “Conclusion” summarizes the key findings of this research in the conclusion.

Literature Review and Hypotheses Development

Theoretical Background

The agency theory, as formulated by Jensen and Meckling (1976), offers a valuable theoretical lens to explore the influence of board diversity on enhancing monitoring and controlling the opportunistic behavior of managers. Within the agency theory framework, moral hazard arises when managers, acting as agents for principals, possess superior information regarding the firm’s actions. Managers, driven by self-interest, often prioritize personal gains over the long-term sustainability of the organization (Rudyanto & Siregar, 2018). Diverse BOD plays a crucial role in mitigating such agency problems through two key mechanisms. Firstly, the presence of heterogeneous board members empowers them to influence managerial decision-making, steering the company toward strategies that align with the broader interests of stakeholders. Secondly, the diversity of board composition enhances the effectiveness of internal control mechanisms, aligning corporate practices with stakeholder interests, and aspirations (Kusumastati et al., 2022).

Furthermore, viewed through the lens of the resource dependence theory, the BOD acts as a vital source of critical resources for the organization, leveraging their skills, experience, and knowledge to create sustainable competitive advantages (Issa et al., 2022). Board diversity, in this context, is recognized as a strategic resource that enables firms to respond effectively to stakeholder demands by issuing comprehensive sustainability reports (Elleuch Lahyani, 2022). These reports are regarded as crucial tools for reducing information asymmetry and meeting stakeholder expectations regarding socially and environmentally responsible business operations.

Setting Contextual of the Study

In Indonesia, companies operate under a two-tier governance system consisting of the BOD and the BOC. The BOD assumes responsibility for managing the company, while the BOC oversees policies and overall organizational management. The roles, authorities, and responsibilities of the BOD and BOC are detailed in Regulation No. 33/POJK.04/2014, issued by the Financial Services Authority (OJK) specifically addressing Directors and Commissioners of Public Companies. Islamic banks in Indonesia, in addition to adhering to the dual board governance structure, also follow Islamic governance principles. An integral component of Islamic governance is the SSB (Zulfikar, Purbasari, Puspawati, 2021). As explained by Mersni and Ben Othman (2016), the SSB serves as an internal committee within Islamic banks, ensuring adherence to Sharia principles in policies and operations. Typically, the SSB is positioned at the same level as the BOC in each Islamic bank, thus ensuring the efficacy of its decisions.

The requirement for companies in Indonesia to report on their social and environmental responsibilities is governed by Law No. 40 of 2007 concerning Limited Liability Companies. Article 66 stipulates that the BOD must submit an annual report that includes, at the very least, the company’s corporate social responsibility (CSR) initiatives. CSR is defined as a company’s commitment to engaging in sustainable economic development to improve overall quality of life. Furthermore, Government Regulation No. 47/2012, addressing the social and environmental responsibilities of limited liability companies, emphasizes that companies involved in natural resource-related activities are obligated to report on their sustainability endeavors.

On December 31, 2013, regulatory and supervisory functions for the banking sector were transferred to the Financial Services Authority (OJK), previously overseen by Bank Indonesia. As a tangible step toward achieving the Sustainable Development Goals (SDGs), the Financial Services Authority (OJK) issued Regulation No. 51/POJK.03/2017 on the Implementation of Sustainable Finance for Financial Institutions, Issuers, and Public Companies. This regulation mandates that financial institutions incorporate sustainability reporting within their annual reports or as separate reports.

Hypotheses Development

Board diversity refers to the heterogeneous composition of the BOD, encompassing demographic aspects such as gender and ethnicity, as well as cognitive factors like educational background, expertise, and experience (Katmon et al., 2019). Board diversity brings various benefits to companies, such as controlling managerial opportunistic behavior and reducing information asymmetry (Liao et al., 2015; Martínez-Ferrero & García-Sánchez, 2017; Michelon & Parbonetti, 2012); offering knowledge, networks, and better insights (Hillman & Dalziel, 2003); enhancing accountability through information disclosure (Liao et al., 2015); identifying strategies and alternatives for better decision-making (Kagzi & Guha, 2018); facilitating ethical and effective decision-making through improved information flow (Terjesen et al., 2016), and enhancing organizational legitimacy (Hoang et al., 2018).

Previous research has linked board diversity to sustainability performance (Erin et al., 2022; Girella et al., 2022; Githaiga & Kosgei, 2023; Gold & Taib, 2023). Rao and Tilt (2016) argue that board diversity in terms of independence, educational background, and professional skills can support environmentally friendly policies. Heterogeneous board composition fosters board dynamics, in-depth discussions, and generates constructive perspectives on social and environmental issues (Beji et al., 2021; Khatib et al., 2021). Previous empirical literature has extensively utilized proxies for board diversity as determinants of voluntary disclosure, such as gender, age, culture, tenure, expertise, education level, industry experience, and board busyness (Cucari et al., 2018; Katmon et al., 2019; Khan, Yang, Waheed, 2019; Kusumastati et al., 2022; Ntim & Soobaroyen, 2013; Rao & Tilt, 2016). We argue that board diversity aids in promoting transparency and accountability through sustainability reporting. Therefore, it is expected that:

H1: Board diversity has a positive influence on sustainability reporting in Islamic banks.

Bank Indonesia Regulation No. 11/33/PBI/2009 provides a definition of the BOC as a corporate body responsible for oversight and advisory functions to the BOD. This definition is reinforced by Article 28 of Financial Services Authority Regulation No. 33/POJK.04/2014, which stipulates that the BOC is accountable for supervising the company’s management policies. According to Darmadi (2011), the BOC can be considered as representatives of shareholders, comprising exclusively of non-executive members from outside the company. In the Indonesian context, the BOC serves as the highest control mechanism within the governance structure, with the primary objective of ensuring that the company acts in the best interests of its shareholders. Through effective monitoring, the BOC plays a crucial role in bridging the information asymmetry between owners and managers (Susbiyani et al., 2022).

The existence of the BOC plays a significant role in promoting transparency. By carrying out effective monitoring activities, the BOC can encourage companies to provide adequate information in sustainability reporting (Susbiyani et al., 2022). This finding is supported by a study conducted by Rudyanto and Siregar (2018), which reveals that the effectiveness of the BOC has an influence on the quality of sustainability reporting. Building upon the previous discussion, this research predicts that the effectiveness of the BOC can strengthen the positive relationship between board diversity and sustainability reporting. Hence, the following hypothesis is proposed:

H2: The effectiveness of the board of commissioners strengthens the influence of board diversity on sustainability reporting in Islamic banks.

The AC serves as a technical committee with responsibilities related to audit and reporting matters. As corporate reporting continues to evolve, the scope of the AC’s duties has expanded beyond traditional financial oversight. Now, the committee’s input is sought to enhance the implementation of sustainability practices (Tumwebaze et al., 2022). The effectiveness of the AC can be evaluated based on its characteristics, including independence, meeting frequency, authority, financial expertise, and the number of members (Ahmed Haji & Anifowose, 2016; Bananuka et al., 2019; Bin-Ghanem & Ariff, 2016; Buallay & Al-Ajmi, 2020).

The literature suggests that an effective AC contributes to corporate accountability, as it enhances the practices of financial and non-financial information reporting (Bananuka et al., 2019). Tumwebaze et al. (2022) argue that the AC has the ability to influence the BOD to improve reporting practices, ultimately addressing agency issues between managers and investors (Bin-Ghanem & Ariff, 2016). In the context of enhancing the quality of sustainability reporting, the AC plays a crucial role in monitoring and overseeing the reporting processes within organizations (Amidjaya & Widagdo, 2020; Boiral et al., 2019). Building on these arguments, we propose the following hypothesis.

H3: The effectiveness of the audit committee strengthens the influence of board diversity on sustainability reporting in Islamic banks.

The SSB is entrusted with the authority to oversee and provide guidance to the BOD regarding compliance with Sharia principles, ensuring stakeholder trust and legitimacy of business transactions (Harun et al., 2020; Rashid et al., 2022). It is crucial for Muslim individuals to have confidence that their dealings with Islamic banks adhere to religious regulations and Sharia principles (Al-Bassam et al., 2018). This underscores the SSB’s responsibility in monitoring and enforcing Sharia compliance, extending beyond traditional financial oversight to include sustainable practices (Tumwebaze et al., 2022). The effectiveness of the SSB can be evaluated based on its characteristics, such as independence, meeting frequency, authority, financial expertise, and board size (Ahmed Haji & Anifowose, 2016; Bananuka et al., 2019; Bin-Ghanem & Ariff, 2016; Buallay & Al-Ajmi, 2020).

Previous research has demonstrated the contribution of an effective SSB to corporate accountability, as it enhances the quality of financial and non-financial reporting practices (Bananuka et al., 2019). The SSB has the ability to influence the BOD to improve reporting practices (Tumwebaze et al., 2022) and control agency conflicts between managers and investors (Bin-Ghanem & Ariff, 2016). In the context of enhancing the quality of sustainability reporting, the SSB plays a vital role in monitoring and overseeing the reporting process of the company (Amidjaya & Widagdo, 2020; Boiral et al., 2019). Consequently, we propose the following hypothesis:

H4: The quality of the Sharia Supervisory Board strengthens the influence of board diversity on sustainability reporting in Islamic banks.

Research Framework

The research framework for this study can be seen in Figure 1, which is based on the previously described issues.

Figure 1.

Research framework.

Method

Data and Sample

This study targets Islamic Banks listed on the Financial Services Authority as the research population. This study used a purposive sampling technique to obtain a representative sample according to the specified criteria. Unbalanced panel data consisting of 122 observations covering 13 IB and 10 years, namely 2012 to 2021, were examined to obtain accurate findings. The chosen research design for this study follows a quantitative approach. The data used are secondary in nature and sourced from annual reports and sustainability reports published by the sample companies. These reports are accessible from the respective banks’ websites. The content of the audited annual reports of the sample companies was carefully analyzed to extract relevant information.

Definition and Measurement of Variables

Each variable used in this study is described coherently along with how to measure it. To facilitate understanding, Table 1 is arranged as a resume.

Table 1.

Summary of Variables and Their Measurement.

Variables	Symbols	Variable measurement
Sustainability reporting index	SRI	Ratio of disclosed items score, obtained through weighted content analysis (0, 1, 2)
Board of directors’ diversity	BODD	Composite index which combines eight elements covering age, gender, culture, tenure, expertise, educational level, industry experience, and dual membership of the BOD
Board of commissioners’ effectiveness	BOCE	Ratio of the BOC effectiveness score consists of 17 questions covering independence, size, activity, and expertise and competence
Audit committees’ effectiveness	ACE	Ratio of the AC effectiveness score consists of 11 questions covering activity, size, and expertise and competence
Sharia supervisory boards’ quality	SSBQ	Ratio of the SSB quality score consists of four elements covering existence, size, expertise, and doctoral education level
Bank size	SIZE	Natural logarithm of the total assets
Bank age	AGE	Date of financial statements less date of foundation
Bank profitability	PROFIT	The ratio of net income to total assets
Bank leverage	LEV	The ratio of total debts to total assets
Foreign ownership	FOROWN	Percentage of shares owned by foreign owners

Dependent Variable

Sustainability reporting plays a crucial role in disseminating information regarding the economic, social, and environmental performance of companies to diverse stakeholders, aiming to ascertain their contributions to sustainability and sustainable development goals (de Villiers & Sharma, 2020; Tumwebaze et al., 2022). The measurement of sustainability reporting, specifically the sustainability reporting index (SRI), relies on indicators developed by Jan et al. (2019). The assessment involves a weighted content analysis approach, wherein scores ranging from 0 to 2 are assigned. A score of 0 is given when no information is disclosed, a score of 1 is assigned for brief descriptions, and a score of 2 is granted for detailed disclosures. The SRI score is derived by calculating the ratio between the actual score and the maximum permissible score.

Independent Variable

BOD diversity encompasses various heterogeneous characteristics of directors, such as age, gender, tenure, culture, educational background, expertise, and industry experience (Kusumastati et al., 2022). The measurement of BOD diversity employs a composite index, which combines eight elements that represent these characteristics, including age, gender, culture, tenure, expertise, educational level, industry experience, and outside directorship (dual board membership). The composite index used in this study is adapted from the research conducted by Kusumastati et al. (2022). Each element is calculated using the Blau Index, which effectively captures the diversity exhibited within each characteristic. The resulting composite index value ranges from 0 to 1, with a value closer to 1 indicating a higher level of diversity.

Moderating Variables

There are three moderating variables used to explore their influence on the relationship between BOD’s diversity and sustainability reporting: the effectiveness of the BOC, the effectiveness of the AC, and the quality of the SSB. Following the study conducted by Rudyanto and Siregar (2018), the effectiveness of the BOC is measured using four categories and 17 questions developed by Hermawan (2009). These categories include independence, size, activity, and expertise and competence of the BOC. The effectiveness of the AC is measured using an index also developed by Hermawan (2009), consisting of 11 questions that assess the activity, size, and expertise and competence of the AC. A higher index value for the effectiveness of the BOD and AC indicates greater performance effectiveness.

The measurement of the quality of the SSB is based on the research by Prasojo et al. (2022), which utilizes a proxy index for the SSB incorporating the factors of existence, number of members, expertise in finance and accounting, and possession of a doctoral degree. If an SSB is present, it is assigned a score of 1; otherwise, it is assigned a score of 0. A score of 1 is given if the SSB has more than three members, while a score of 0 is assigned if it has fewer members. Expertise in the field of accounting and finance is scored as 1, while any other expertise is scored as 0. If any member of the SSB holds a doctoral degree, a score of 1 is assigned; otherwise, a score of 0 is given. The scores for each factor are summed and converted into a percentage. A higher value indicates a higher quality of the SSB.

Control Variables

This study incorporates several control variables to be examined, aiming to enhance the accuracy of the findings. Control variables, such as firm size, profitability, company age, leverage, and foreign ownership, are included in the statistical analysis as they are considered potential factors that may influence the relationship between the independent and dependent variables in the context of sustainability reporting.

Firm size is measured by the natural logarithm of the total assets of Islamic banks. Larger entities tend to be subject to stricter supervision, face pressure from multiple stakeholders, and have higher exposure, leading them to engage in more extensive disclosure practices (Rudyanto & Siregar, 2018). Company age is also a determinant of a company’s involvement in sustainability reporting. Older companies have accumulated more experience regarding the social and environmental impacts of their operations, which makes them more inclined to disclose a greater amount of information (Githaiga & Kosgei, 2023). Company age is defined as the number of years since its establishment.

According to Al-Sartawi and Reyad (2019), companies with satisfactory financial performance are more likely to disclose their accomplishments to the public. Profitability is measured using the return on assets (ROA) ratio. Financial leverage is assessed by the ratio of total liabilities to total assets. Lower levels of debt indicate favorable company performance and a reduced risk of bankruptcy, thereby prompting companies to provide more information to stakeholders (Sarea & Salami, 2021). Foreign investors can influence companies to disclose sustainability reporting due to their understanding of international business, which heightens their awareness of the significance of a company’s social performance (Muttakin & Subramaniam, 2015). Foreign ownership is quantified as the percentage of shares held by foreign investors.

Regression Model

This study uses panel data regression analysis to test the hypothesis. Test 1 was conducted to investigate the effect of BOD diversity on sustainability reporting. The regression model is stated as follows:

\begin{matrix} SR I_{it} = α + β_{1} BOD D_{it} + β_{2} SIZ E_{it} + β_{3} AG E_{it} \\ + β_{4} PROFI T_{it} + β_{5} LE V_{it} + β_{6} FOROW N_{it} + ε_{it} . . \end{matrix}

(1)

Test 2 includes independent and moderating variables to determine the effect of each variable on the dependent variable.

\begin{matrix} SR I_{it} = α + β_{1} BOD D_{it} + β_{2} BOC E_{it} + β_{3} AC E_{it} \\ + β_{4} SSB Q_{it} + β_{5} SIZ E_{it} + β_{6} AG E_{it} + β_{7} PROFI T_{it} \\ + β_{8} LE V_{it} + β_{9} FOROW N_{it} + ε_{it} . . . . . . . \end{matrix}

(2)

Test 3 is a Moderated Regression Analysis (MRA). Regression was carried out between independent, moderating, and interactions between independent and moderation variables to dependent variables.

\begin{matrix} SR I_{it} = α + β_{1} BOD D_{it} + β_{2} BOC E_{it} + β_{3} AC E_{it} + β_{4} SSB Q_{it} \\ + β_{5} BODD * BOC E_{it} + β_{6} BODD * ACE \\ + β_{7} BODD * SSB Q_{it} + β_{8} SIZ E_{it} + β_{9} AG E_{it} \\ + β_{10} PROFI T_{it} + β_{11} LE V_{it} + β_{12} FOROW N_{it} + ε_{it} . . . . . . . \end{matrix}

(3)

Where:

SRI: Sustainability Reporting Index

BODD: Board of Directors Diversity

BOCE: Board of Commissioners Effectiveness

ACE: Audit Committee Effectiveness

SSBQ: Sharia Supervisory Board Quality

SIZE: Bank size

AGE: Bank age

PROFIT: Bank profitability

LEV: Bank leverage

FOROWN: Foreign ownership

An indication that a variable can act as a moderator can be determined from the following criteria (Rahadi & Farid, 2021).

- If the BOCE/ACE/SSBQ in Equation 2 have an effect and the interaction between the BOCE/ACE/SSBQ moderating and the independent variables (BODD*BOCE/BODD*ACE/BODD*SSBQ) in Equation 3 also has an effect, it is called a quasi moderator.

- If the BOCE/ACE/SSBQ in Equation 2 have no effect, on the contrary, the interaction between the BOCE/ACE/SSBQ moderating and the independent variables (BODD*BOCE/BODD*ACE/BODD*SSBQ) in Equation 3 has an effect, it is called a pure moderator.

- If the BOCE/ACE/SSBQ in Equation 2 have an effect, but on the contrary, the interaction between the BOCE/ACE/SSBQ moderating and the independent variables (BODD*BOCE/BODD*ACE/BODD*SSBQ) in Equation 3 has no effect, it is called a predictor moderator. The moderating variable used only functions as an independent variable.

- If the BOCE/ACE/SSBQ in Equation 2 and the interaction between the BOCE/ACE/SSBQ moderating and the independent variables (BODD*BOCE/BODD*ACE/BODD*SSBQ) in Equation 3 have no effect, it is called a homologizer moderator.

Results and Discussion

Descriptive Statistics

The number of samples that meet the criteria is 122 observations, with a total of 13 Islamic Banks (IBs). Descriptive statistics for all variables are presented in Table 2. The statistical results indicate that sustainability reporting by IBs in Indonesia is still low. Overall, the number of sustainability reports in Indonesian IBs is still limited, but in 2020 and 2021, all IB samples have issued separate sustainability reports. The composition of the BOD in Indonesia can also be considered as highly homogeneous, with a minimum value of 1 and an average of 2.1453. It can be said that the BOD composition is still heavily concentrated within certain groups. The BOC and AC indices are above 0.84, indicating that the effectiveness of BOC and AC in IBs can be considered as very good. Similarly, the SSB quality shows an average of 0.75, indicating that the characteristics of high-quality SSBs are well met.

Table 2.

Descriptive Statistics.

Variable	Obs	Mean	Std.Dev	Min	Max
SRI	122	0.2737	0.1496	0.0538	0.6615
BODD	122	2.1453	0.9190	1	6
BOCE	122	0.8425	0.0634	0.4901	0.9411
ACE	122	0.8447	0.1055	0.5151	1
SSBQ	122	0.7459	0.1759	0	1
BODD × BOCE	122	1.7975	0.7128	0.8039	4.92
BODD × ACE	122	1.8087	0.7054	0.6060	4.5454
BODD × SSBQ	122	1.5321	0.6282	0	4.5
SIZE	122	30.3056	1.2347	27.566	32.6987
AGE	115	13.7913	7.9532	1	30
PROFIT	122	0.7925	1.1786	−0.1123	5.62
LEV	122	0.5804	0.3342	0.0548	0.9970
FOROWN	122	0.0886	0.2361	0	0.8742

When looking at the bank size, it can be observed that it is relatively dispersed based on the average. However, in terms of age, IBs in Indonesia are still considered very young, with an average age of around 13 years. Over the 10 year period, there were recorded cases of negative financial performance in Indonesian IBs, indicated by a −11% ROA. Additionally, the debt levels of some IBs reached nearly 100% of their total assets.

Based on the average values, there are still very few IBs with foreign ownership. Nevertheless, there are IBs with foreign ownership exceeding 87% in percentage.

Correlation Analysis

Multicollinearity problems occur when coefficient values exceed 0.80, as stated by Gujarati and Porter (2009). The correlation matrix in Table 3 displays the interrelationships among variables and indicates that the regression model is free from multicollinearity issues.

Table 3.

Pearson Correlation Matrix.

	BODD	BOCE	ACE	SSBQ	BODD × BOCE	BODD × ACE	BODD × SSBQ	SIZE	AGE	PROFIT	LEV	FOROWN
BODD	1.0000
BOCE	.0855	1.0000
ACE	.0031	.4424	1.0000
SSBQ	.0331	.3585	.4247	1.0000
BODD × BOCE	.2284	.0074	.0502	−.3380	1.0000
BODD × ACE	.1984	−.0404	.2471	−.2837	.6652	1.0000
BODD × SSBQ	.1450	.2085	.3072	.5784	.4544	.4692	1.0000
SIZE	−.0441	.3754	.3665	.2614	.0473	.0766	.1888	1.0000
AGE	−.1874	.0727	.0959	.0237	−.1452	−.1227	−.2514	.2061	1.0000
PROFIT	−.5366	.0273	.0377	−.0517	−.1303	−.1151	−.1023	.1087	−.2737	1.0000
LEV	.2108	−.1792	−.0388	−.4309	.6799	.6537	.3585	−.0199	−.1319	−.1332	1.0000
FOROWN	.0412	.2686	.1480	.3055	−.0752	−.0894	.0758	.2281	.3229	−.2302	−.1117	1.0000

Regression Analysis

The results of the initial regression are presented in Table 4, aiming to investigate the influence of BOD diversity on sustainability reporting. The test results for H1 indicate a statistically significant F probability value of 0.0000, suggesting that all variables included in the equation exert a significant influence on the dependent variable (SRI). The R-square value of 24.37% indicates that the variables utilized in the initial test can explain 24.37% of the variability in SRI.

Table 4.

Equation 1 Testing Result.

SRI	Coefficient	Std. Error	T	Sig.
BODD	0.1454469	0.0475535	3.06	.003***
SIZE	0.0209826	0.0104137	2.01	.046**
AGE	0.0088586	0.0018618	4.76	.000***
PROFIT	0.0641832	0.0199779	3.21	.002***
LEV	−0.0244741	0.0133283	−1.84	.069*
FOROWN	−0.1427924	0.0552021	−2.59	.011**
F -sig	0.0000
Adjusted R ²	0.2437

Note. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

The analysis reveals a positive effect of BOD diversity on sustainability reporting (β = .145, p < .01), thereby accepting Hypothesis 1. The findings of this study suggest that firms with diverse BODs are more inclined to disclose information regarding their sustainability practices. This finding aligns with agency theory, which posits that a highly diverse board contributes to improved leadership and effective management oversight (Jan et al., 2021). Management oversight by the BOD to align company actions with stakeholders’ interests. Management as an agent tends to behave opportunistically by taking policies that can maximize their welfare. As a result, stakeholders who suffer from information asymmetry do not fully understand whether the company’s actions align with their needs and interests. BOD members who are heterogeneous in terms of gender can generate many decision-making alternatives (Quintana-García & Benavides-Velasco, 2016). BOD’s tenure also determines his experience. BOD members who have been working for a long time can build various perspectives because of the many interactions that exist with colleagues. Meanwhile, new members are considered to bring change because they represent a new generation that is more creative, communicative, and able to adapt quickly to environmental changes. The various BOD education levels have a positive impact on the company. According to Bernile et al. (2018), the type and level of a person’s education shape a person’s mindset, perspective, and habits. IB can take advantage of the educational diversity of board members to find out how they respond to sustainability issues from various scientific perspectives. Furthermore, industry experience provides board members with specific knowledge about their industry, such as production processes, market share, and technology used (Drobetz et al., 2018). So, it can be concluded that the diversity of the board is unique, different, and special, which makes it an asset for IB to improve modern business performance, such as disclosure of sustainability reporting.

Furthermore, four control variables were identified as influential factors in sustainability disclosure. Firm size, age, and profitability demonstrate a positive correlation with reporting, while foreign ownership exhibits a negative association. Larger, more profitable, and established companies are more inclined to disclose sustainability information. Aside from financial resources, these companies face increased exposure and public pressure to contribute to societal and environmental well-being.

The effect of the moderating variable on the dependent variable can be seen in Table 5. Meanwhile, Table 6 reveals the regression results where there is an interaction between the independent variable BODD and the three moderator variables (BOCE, ACE, and SSBQ) on the SRI dependent variable. The conclusion from the research results uses the criteria disclosed in the Method section.

Table 5.

Equation 2 Testing Result.

SRI	Coefficient	Std. error	T	Sig.
BODD	0.1378765	0.0470504	2.93	.004***
BOCE	0.1220121	0.2234143	0.55	.586
ACE	0.3345212	0.1355441	2.47	.015**
SSBQ	0.1356727	0.089835	1.51	.135
SIZE	0.0138607	0.0111511	1.24	.217
AGE	0.008207	0.0018621	4.41	.000***
PROFIT	0.0577546	0.0197856	2.92	.004***
LEV	−0.0333525	0.0151096	−2.21	.029**
FOROWN	−0.1366789	0.0565301	−2.42	.017**
F -sig	.0000
Adjusted R ²	.2778

Note. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

Table 6.

Equation 3 Testing Result.

SRI	Coefficient	Std. Error	T	Sig.
BODD	0.1725594	0.0456829	3.78	.000***
BOCE	1.603424	0.9763845	1.64	.104
ACE	0.8682183	0.4122245	2.11	.038**
SSBQ	0.5982696	0.1866141	3.21	.002***
BODD*BOCE	0.8214804	0.4706987	1.75	.044**
BODD*ACE	0.6625878	0.2062225	3.21	.002***
BODD*SSBQ	0.1687802	0.0664491	2.54	.013**
SIZE	0.0130408	0.0102407	1.27	.206
AGE	0.010313	0.0018576	5.55	.000***
PROFIT	0.0689822	0.0187247	3.68	.000***
LEV	−0.042649	0.3298833	−0.13	.897
FOROWN	−0.0848067	0.0543526	−1.56	.122
F -sig	0.0000
Adjusted R ²	0.421

Note. *, **, and *** represent significance at the 10%, 5%, and 1% level, respectively.

The results of testing Equation 2 show that the effectiveness of the BOC does not affect sustainability reporting (β = .122, p > .1). However, in Tables 6 and 7, the interaction between BOC effectiveness and BOD diversity shows a positive direction (β = .821, p < .05) on sustainability reporting. That is, BOCE acts as a pure moderator. This finding simultaneously confirms the acceptance of Hypothesis 2 and supports agency theory. The effectiveness of the role of the BOC means that the BOC can carry out its duties and responsibilities as a supervisor of the company optimally. When the board’s performance is effective, the oversight function will encourage IB to carry out activities that are more requested by stakeholders (Khlif & Samaha, 2014).

Table 7.

Endogeneity Testing Result.

Regression model 4			Regression model 5
SRI	Coefficient	Sig.	SRI	Coefficient	Sig.
Dependent lag 1	0.83003333	.000	Dependent lag 1	0.7991717	.000
BODD	0.0637211	.053	BODD	0.068849	.025
BOCE	−0.2790405	.032	BOCE	0.0797422	.825
ACE	0.0105663	.911	ACE	0.0644239	.693
SSBQ	0.0538443	.098	SSBQ	0.0847456	.477
SIZE	0.0460222	.078	BODD × BOCE	0.1657232	.318
AGE	0.0090529	.011	BODD × ACE	0.0351916	.695
PROFIT	−0.0190188	.565	BODD*SSBQ	0.0442707	.199
LEV	0.0017255	.816	SIZE	0.0494759	.047
FOROWN	0.0269625	.546	AGE	0.0089136	.014
			PROFIT	0.0212049	.532
			LEV	0.0811119	.478
			FOROWN	0.0256019	.571
Sargan test of over-identifying restrictions	37.70156	.3467	Sargan test of over-identifying restrictions	37.11251	.3718
Arellano-bond test for AR (1)	−2.5877	.0097	Arellano-bond test for AR (1)	−2.5817	.0098
Arellano-bond test for AR (2)	0.7977	.4250	Arellano-bond test for AR (2)	0.84316	.3991

One of the effectiveness of BOCE is influenced by its independence. The BOC is the highest internal control mechanism in the corporate governance structure in Indonesia (Bezemer et al., 2014). Their inherent independent and neutral nature makes them able to represent the interests of stakeholders by monitoring incidents that have the potential to cause a conflict of interest between principals and agents. The BOC, in its task of ensuring that companies act in the interests of stakeholders, one of which is by transparently providing information. According to Susbiyani et al. (2022), an effective BOC can encourage companies to increase transparency in their information disclosure. BOC activity can also determine its effectiveness. The BOC assesses the reports made by management regarding the company’s activities in one period. In this case, the BOC can act as an assessor, supervisor, and adviser, including the extent to which the company discloses its responsibility for sustainability. BOC expertise and competence are important in assisting the BOD in formulating company strategy. They need to have an educational background and experience that will bring them to an understanding of the importance of sustainability, potential violations that companies can commit, and how to minimize their impact. Expertise in accounting, finance, and business benefits IB, especially when non-financial disclosure obligations affect the fulfillment of financial commitments to shareholders.

The variable of the AC effectiveness demonstrates a positive influence on sustainability reporting, both directly (β = .334, p < .05) and in interaction with BOD diversity (β = .662, p < .01). This finding also confirms that ACE is a quasi moderator in the relationship between BODD and SRI. AC’s activity in reviewing financial reports encourages AC to play an important role in improving the quality of the sustainability report. AC is also responsible for evaluating internal control and legal compliance so that AC indirectly ensures that IB carries out its activities according to the rules and does not violate ethics in doing business. Therefore, when AC performs its function effectively, it will impact corporate transparency in disclosing sustainability information. Previous research by Tumwebaze et al. (2022) found that the effectiveness of AC has a positive effect on sustainability reporting. This could be attributed to the fact that voluntary disclosure requires expertise in accounting and auditing to assess the quality of the disclosed information (Musallam, 2018).

Table 5 illustrates that the quality of the SSB does not exert a direct influence on IB sustainability reporting in Indonesia (β = .135, p > .1). However, the interaction between the SSB and BOD diversity reveals a positive effect (β = .168, p < .05). Thus, Hypothesis 4 is supported. This means that SSBQ is a pure moderator in the relationship between BODD and SRI. SSB size can be an indication of the effectiveness of the SSB in carrying out its duties. The number of members allows SSB to divide its functional tasks so that each role can be more optimal. Large SSB members provide them with discretion to monitor IB activities, especially those related to the disclosure of information to stakeholders. This finding confirms the results of Ningrum et al. (2013), who stated that the large size of the SSB illustrates the diversity of perspectives and business experience, leading to a better review of IB reporting. Adequate finance, banking and business expertise supports SSB’s activities supervisory function. In addition, SSB is expected to have an in-depth understanding of social responsibility practices according to Sharia; this is important because it affects the scope of disclosure. Wijayanti and Setiawan (2022) uses the IG Score as a proxy for the quality of SSB, finding that a competent, reputable, and experienced SSB with a relevant educational background is more effective in encouraging IB to engage in social disclosure. This finding aligns with research conducted by Farook et al. (2011).

Additional Endogeneity Test

The main regression results show that BODD has a positive effect on SRI. BOCE, ACE, and SSBQ have been shown to act as moderator variables in the relationship between BODD and SRI. As an additional test, dynamic panel data regression analysis (SYS-GMM) was run while still considering the endogeneity of the variables. This study follows Blundell and Bond (1998), who used dynamic panel data (SYS-GMM) to solve potential endogeneity problems and check the robustness of the regression results. GMM regression estimation can be seen in the following model.

\begin{matrix} SR I_{it} = α + β_{1} SR I_{it - 1} + β_{2} BOD D_{it} + β_{3} BOC E_{it} \\ + β_{4} AC E_{it} + β_{5} SSB Q_{it} + β_{6} SIZ E_{it} + β_{7} AG E_{it} \\ + β_{8} PROFI T_{it} + β_{9} LE V_{it} + β_{10} FOROW N_{it} + μ_{it} \\ + η_{it} . . . . . \end{matrix}

(4)

\begin{matrix} SR I_{it} = α + β_{1} SR I_{it - 1} + β_{2} BOD D_{it} + β_{3} BOC E_{it} \\ + β_{4} AC E_{it} + β_{5} SSB Q_{it} + β_{6} BODD * BOC E_{it} \\ + β_{7} BODD * ACE + β_{8} BODD * SSB Q_{it} \\ + β_{9} SIZ E_{it} + β_{10} AG E_{it} + β_{11} PROFI T_{it} \\ + β_{12} LE V_{it} + β_{13} FOROW N_{it} + μ_{it} + η_{it} . . . . . . \end{matrix}

(5)

Reverse causality can bias the regression coefficients so that endogeneity problems can occur. This test is carried out by adding a 1 year lag for the dependent variable to determine that causality does not affect the results. The GMM approach uses a two-step estimator, namely the Sargan and serial correlation tests (Arellano & Bond, 1991). The Sargan test requires the rejection of the null hypothesis, which indicates that the instrument used is valid. Meanwhile, for the serial correlation test, the first order (AR1), the null hypothesis stating that there is no serial correlation, must be rejected. The second order (AR2) with the null hypothesis, which states no correlation, must be accepted. Estimation results for dynamic panel data are presented in Table 7.

Based on the data in Table 7, the insignificant Sargan test indicates that all the instruments used are valid. Meanwhile, the null hypothesis without first-order correlation (AR1) is rejected, but the null hypothesis without second-order correlation (AR2) is not rejected. This indicates that there is a first-order correlation and no second-order correlation. So, it can be said that the regression model meets the consistency requirements.

Conclusion

Sustainability reports are a form of responsibility for the impact of company activities and the company’s commitment to support the government’s agenda to achieve the Sustainable Development Goals (SDGs). IB, which is expected to make Indonesia’s economic power represent the financial sector is inseparable from the obligation to be involved in sustainability activities. The study results show that the reporting level on IB’s sustainability performance is still relatively low, with an average disclosure of only 27%. However, it is undeniable that there is an increase every year. Sustainability reporting practices are a tool companies use to stay aligned with stakeholders’ interests. The company’s contribution to sustainability activities is based on the 3P concept (profit, people, planet). This means that the company’s actions impact the welfare of shareholders through the profits earned and the welfare of society and environmental sustainability. Many stakeholders are interested in sustainability reporting, providing separate consequences for management to improve reporting. As a policy maker, the government is expected to be able to accommodate the needs of stakeholders by drafting laws or regulations that encourage companies to carry out sustainability reporting.

This paper examines the role of important company organs in the success of company policies to engage in sustainability activities. This research aims to review whether the diverse characteristics of the board of directors can influence its ability to initiate sustainability reporting. In addition, research was developed to understand the strategic role of supervisory organs (the BOC, the AC, and the SSB) in supporting the BOD’s policies. The results show that board diversity positively affects sustainability reporting, and the roles of the BOC, the AC, and the SSB have been shown to strengthen this influence. That is, the company’s policy to engage in social and environmental activities is greatly influenced by the characteristics of the various boards and the effectiveness and quality of the supervisory board. The research results make a theoretical contribution by supporting the resource dependence theory. The board of directors with heterogeneous characteristics is a critical corporate resource that is considered capable of understanding the needs of various stakeholders. One is the need for transparency regarding the impact of company activities on three main dimensions: economic, social, and environmental. In terms of agency theory, the findings prove that the heterogeneous characteristics of the BOD make it more powerful in encouraging management to act based on the interests of the principal. In addition, an effective and quality monitoring system from the BOC, the AC, and the SSB can stimulate company managers to be involved in social, environmental, and sustainability activities.

This research provides important implications for management, government as policymakers, and investors. IB management needs to optimize the BOD diversity and the SSB’s effectiveness, as it has been proven that their presence significantly promotes a climate of greater transparency and accountability. Company efforts to achieve this goal can be done by setting requirements for the number of members, length of service, competency, experience, skills, and education to maximize company performance. Companies need to accommodate the development of professional knowledge, competencies, and abilities of the company board through training to be in tune with the latest developments in the industry, especially regarding sustainability issues. The training can cover general knowledge about sustainability, the impact of disengagement, problem solutions, as well as risk management and value creation through sustainability innovation.

In addition, these findings make management aware of the importance of sustainability reporting as a form of responsibility if the company is managed in line with the wishes of stakeholders. It is important for investors to understand the extent to which companies integrate and assimilate sustainability issues into their business strategies. Companies also need to open the door to stakeholder involvement in order to obtain feedback on their sustainability reporting. This opportunity is considered significant to build greater trust from stakeholders and to obtain external assurance.

For policymakers, the research results can be an impetus for making regulations that optimize corporate governance mechanisms, especially those related to the board’s role in the company. The research findings highlight the importance of synergy and collaboration between existing boards in a company, both management and supervisory boards. It requires full involvement of all elements of the company to be able to work together on the journey toward sustainability transformation.

Regarding the low level of reporting, the government must regulate the format and method of presenting sustainability information by Sharia principles. Finally, for potential investors, this finding also confirms that a board in a company can represent investors’ interests. So, it is important for investors to use the board’s diversity, effectiveness, and quality as a reference for selecting profitable issuers.

Like any other research, this study has limitations. We advise readers of this paper to interpret our results with caution. Our study only focuses on companies in Indonesia which adhere to a two-tier board system, where management and supervision functions are separate responsibilities. This system differs from the one-board system as most countries stick to it. Therefore, it is important to place emphasis in interpreting research results. The research was conducted on IBs with SSB as a supervisory organ and a feature of IBs that distinguishes them from conventional financial services company banks. The conceptualization of the effectiveness of the BOC, the AC, and the SSB quality may not have considered other important aspects, such as knowledge about corporate sustainability. Future research may consider expanding board effectiveness and quality measures to include more measurement dimensions. Researchers can conduct interviews or preliminary surveys to understand the dynamics in the field.

Footnotes

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author(s) received no financial support for the research, authorship, and/or publication of this article.

Ethical Approval

The authors believes that there is no need for ethical clearance. This research is limited to the use of secondary data, library data, or published data, systematic reviews, and/or old material that may be used publicly in the form of manuscripts.

ORCID iDs

Rita Wijayanti

Doddy Setiawan

Data Availability Statement

All authors had full access to all the data in the study and final responsibility for the decision to submit for publication.

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