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The relationship between sustainability accounting and

diversity in boards of directors: Evidence from Latin

America.

Trabajo Nacional

Área temática – Investigación Contable

Subtema – 1.2 Balance social y gobierno corporativo en las empresas Latinoamericanas.

Marisela Santiago Castro, PhD prof.msantiagocastro@gmail.com

Aníbal Báez Díaz, PhD anibalbaez@yahoo.com

Seudónimo - Wanabis

Puerto Rico

The relationship between sustainability accounting and diversity in boards of directors:

Evidence from Latin America

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2 This research explores the importance of sustainability, the definition of sustainability accounting and reporting, the role of board of directors in accounting efforts, the relationship between diversity in boards of directors and sustainability. The analysis is made on Latin Americanfirms within the Dow Jones Sustainability World Index.

In general, the results, show that Brazil leads in terms of sustainability reporting practices by having the highest number of companies listed on the Index, and having the only LA company that was granted gold medal. This company reports having more women on the board and no CEO duality. This findings suggest some relationship between sustainability accounting and diversity in boards of directors. However, further research with more data from previous years or more companies is needed in order to generalize these results.

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The relationship between sustainability accounting and diversity in boards of directors:

Evidence from Latin America

The Chernobyl nuclear power plant explosion in Russia, the Exxon Valdez oil spill in the Alaskan waters, and the Kuwait oil-well fires during the Gulf War are examples of environmental disasters of the 1980s and 1990s, respectively. On the other hand, Enron, Tyco, and the sub-prime mortgage crisis in the United States (US) are cases of firms’ social irresponsibility. All of these scandals have fueled the global interest among industry, governments, and non-governments organizations for corporate sustainability (Christofi, Christofi, & Sisaye, 2012).

Along the efforts to share responsibility and respect for the laws that preserve the environment and its natural resources, companies have also began using sustainability reporting. Several frameworks for sustainability accounting measurement and reporting have been developed such as the integrated reporting and the triple bottom line. However, full standardization and enforcement is still to come.

Sustainability reporting has been around for quite time. The first round of sustainability reporting started in the 1970s in the US and Western Europe (Mori Junior, Best, & Cotter, 2014). At present time a formal standard for sustainability reporting is still lacking. Despite this, some companies have voluntarily adopted sustainability principles. Theoretically, being environmental and socially responsible lead to shareholder wealth maximization (Wilson, 2003). Moreover, as governments provide little guidelines on the implementation of sustainability at the corporate level, current efforts of firms reporting sustainability is a self-regulation expression (Searcy, 2012).

In fact, in 1997 the Global Reporting Initiative (GRI) was established, and currently is the most-used sustainability report guideline, recognized, and used world-wide (Mori Junior, Best, & Cotter, 2014). GRI define sustainability reporting as “the practice of measuring, disclosing, and being accountable to internal and external stakeholders for organizational performance towards the goal of sustainable development. A sustainability report should provide a balanced and reasonable representation of the sustainability performance of the reporting organization, including both positive and negative contributions” (GRI, 2011, p.3).

In 1999 the Dow Jones Sustainability World Index (DJSWI) was established to track the performance of corporate sustainability of the world’s largest companies. It is the first family of global indices to track financial performance of this type of enterprises (Malone, 2013). According to the creators of DJSWI corporate sustainability is “a business approach that creates long-term shareholder value by embracing opportunities and managing risks deriving from economic, environmental and social developments” (RobecoSAM, 2013).

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4 Why sustainability is important?

The concept of sustainability is multi- and interdisciplinary, and requires a variety of scholarly perspectives. From the natural sciences, bioversity protection is key to sustainability. Several branches of the economics debate about how the economy is a subsystem of the environment and subject to limits. The political scientists use the framework of people, profit and planet to decision making (Farley & Smith, 2013).

The origins of these debates about sustainability can be drawn to the 1987 Brundtland Commission Report on sustainable development. This report was a result of a commission of the United Nations that realized the presence of a misalignment between globalization and the environment. The report’s main aim is to unite countries to look for sustainable development.

Sustainable development “is a broad concept that balances the need for economic growth with environmental protection and social equity” (Daizy & Das, 2013, p. 8). These three concepts are also the core of sustainability accounting and reporting: profit, environment, and society.

Sustainable development has been adopted globally and there has been several significant international initiatives (Daizy & Das, 2013):

1. Rio Earth Summit – celebrated in 1992 and concluded with the Rio Declaration1 and Agenda 212.

2. United Nations (UN)Global Compact – voluntary initiative, launched in 2000, to support principles in the areas of human rights, labor, environment and anticorruption.

3. Millennium Development Goals – signed by all UN Member States in 2000, establishes eight goals for poverty, education, gender equality, and environmental sustainability3.

4. Organization for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises (2000) – set of voluntary recommendations to multinational enterprises in business ethics.

5. World Summit on Sustainable Development (2002) – follow up to the Rio Summit. It produces two other documents to guide governments for continuing sustainable development.

6. UN Norms on Human Rights Responsibilities of Companies (2003) – set of international human rights norms applicable to transnational corporations.

Despite the diverse international approaches to implement sustainable development there are some challengesto their success. Growing world population leads to shortage of

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The Rio Declaration is a set of 27 principles to protect the environment.

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Agenda 21 is a global plan for sustainable development based on national sustainable development strategies.

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5 natural and limited resources such as food and water. This leads to other challenges: human health, energy consumption, and deforestation. These challenges in turn have led to an implementation gap of the sustainable development initiatives between nations.

This scenario becomes more complicated as benefits of globalization are unevenly distributed and the harms unequally shared. Following there are some examples of this inequality:

1. The richest 10% of the people in the world hold 57% of global income; whereas the poorest 20% of people hold just 2%.

2. High-oncome countries, home to 16% of the world’s population, account for 64% of the World’s spending on consumer products and use 57% of the world’s electricity.

3. Humanity is using nitrogen at four times the globally sustainable rate (Farley & Smith, 2013).

What is sustainability accounting/reporting?

According to Schaltegger and Burrittb (2010) sustainability accounting is “a new information management and accounting method that attempts to create and provide high, relevant information to support corporations in relation to their sustainable development” (p. 377). Moreover, sustainability accounting reports the interaction and linkages among society, environment, and businesses, the three cornerstones of sustainability.

Various reasons have been discussed as why sustainability accounting is necessary for companies (Schaltegger & Burrittb, 2010):

1. Industry pressures that companies might follow to keep themselves into the game and survive globalization.

2. Greenwashing, which is a communication tool that companies might employ to signal their concerns of sustainable development.

3. External pressures from stakeholders, government, and other non-governmental organizations (NGOs).

4. Self-regulation which might be a result of to avoid further mandatory governmental regulations, increase firms’ reputation (brand name) or prevent competition by increasing the cost of keeping information.

5. Ethical reasons

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6 According to a 2014 report from the United Nations Conference on Trade and Development (UNCTAD), sustainability reporting can play “an important role in driving investment to sustainable business practices, financing the sustainability outcomes that the world seeks” (p. 7). A substantialpart of sustainability reporting comes from large corporationsquoted on the main stock exchange indexes (Ortas Fredes and Moneva Abadía, 2011). However, existing sustainability reporting practices differ greatly among countries.

Alonso-Almeida, Marimon and Llach (2015) state that previous studies show that developed countries have adopted sustainability practices faster than the rest. Ortas Fredes and Moneva Abadía (2011) indicate that Europe have always led the field in the number of sustainable reports disclosed4, although Northern America and Latin America show significant growth in this area.

In Latin America, according to Da Silva, de Oliveira, das Chargas, dos Santos y

Bollamann (2009, cited by Alonso-Almeida, Marimon and Llach, 2015), sustainability reporting is being integrated into the companies’ strategy, specificallyby large and more visible companies. These authors state that sustainability reporting is greater in industries associated with natural resources or that can affect negatively the environment (i.e. extractive and chemical industries).

Among the Latin American countries, Brazil, México and Chile lead in terms of sustainability reporting practices (Ortas Fredes and Moneva Abadía, 2011; Araya, 2006 and Baskin, 2006).The Brazilian Stock Exchange seems to be a factor that have motivated the publication of sustainability reports in Brazil. The Brazilian Stock Exchange recommends that listed companies publish a sustainability report or explain why not, provides training work-shops on sustainability reporting, and publishes an inventory of listed companies with sustainability reports (UNCTAD, 2014). In general, Latin American companies have adopted the Global Reporting Initiative’s (GRI) standards to prepare their reports (Alonso-Almeida, Marimon and Llach, 2015).

Perez-Batres, Miller and Pisani (2010) report that Latin American firms from countries with a greater European influence are twice as likely to be enrolled in the United Nations Global Compact or the Global Reporting Initiative (normative pressure); and Latin American firms listed on the New York Stock Exchange are also twice as likely to sign up under the GC/GRI (mimetic pressure). In terms of assurance services, Ortas Fredes and Moneva Abadía (2011) document that the model followed by Latin American countries consists of checking the GRI reports supplied through the GRI assurance service, and external assurance services is a secondary assurance model for this region.

Global Reporting Initiative

The GRI was founded in Boston. It emerges from the Coalition for Environmentally Responsible Economies (CERES) and the Tellus Institute, both U.S. non-profit organizations. Nowadays, its headquarters are located in Amsterdam, The Netherlands, and it has worldwide branches.

GRI’s mission is to make sustainability reporting a standard practice for all companies and organizations (GRI, 2015). It provides a reporting framework that companies adopt voluntarily. This framework includes metrics and methods for measuring and reporting sustainability-related impacts and performance.

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7 The Framework’s guidelines are result of GRI’s due process. This due process includes public hearings and discussion with international experts from different business areas. According to GRI’s website “this multi-stakeholder, consensus-based approach gives GRI’s principles and Standard Disclosures a unique credibility, completeness, and legitimacy”.

On May 2013, the GRI launched its newest guidelines: G-4.5 The G-4 Guidelines offer 58 General Standard Disclosures, 91 indicators for Specific Standard Disclosures and a generic set of Disclosures on Management Approach.6 The G-4 guidelines help organizations to report on the implementation of other sustainability frameworks or initiatives, such as:

- Organization for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises, 2011

- United Nations’ (UN) “Protect, Respect and Remedy” Framework, 2011

- UN’s Global Compact Ten Principles, 2000.

The GRI promotes its framework among companies identifying a series of internal and external benefits (GRI website, 2015). Among the internal benefits performance is key to some of them:

- Emphasis on the link between financial and non-financial performance

- Streamlining processes, reducing costs and improving efficiency

- Benchmarking and assessing sustainability performance with respect to laws, norms, codes, performance standards, and voluntary initiatives

- Comparing performance internally, and between organizations and sectors

Moreover, GRI reporting provides external benefits as reputation enhancement and brand loyalty, and enabling external stakeholders to understand the organization’s value.

Corporate social performance and corporate financial performance

The search for a link between corporate social performance and corporate financial performance began nearly 40 years ago (Roman, Hayibor, & Agle, 1999). While the results have been mixed, research tends to provide a positive relationship between the social and financial variables. Although the issue is an ongoing debate, research on the topic has shifted to identifying relevant variables that may moderate the relationship (Dixon-Fowler, Slater, Johnson, Ellstand, & Romi, 2013; Endrikat, Guenther, & Hoppe, 2014).

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The GRI would recognize reports based on previous guidelines (G-3 and G-3.1) up to December 31, 2015. After that date, reports should follow G-4.

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8 According to previous research, being socially responsible lead to better performance for several reasons (Dixon-Fowler et al., 2013):

1. Proxy for operational efficiency due to the savings from no wasting resources in pollution or its related costs. These improved efficiency in turn leads to competitive advantage.

2. Reflection of strong organizational and management capabilities from a long-term perspective. Thus, continuous innovation and reduced organizational risk.

3. Increased reputational benefits, which in turn brings better employees and increased sales.

4. Stronger relationship with diverse stakeholders with different expectations and needs.

On the other hand, some researchers have argued that pursuing sustainability may be both unprofitable and inappropriate for organizations. This argument rests on the economic trade-off argument that incurring in these additional costs of sustainability reporting do not exceed its benefits. Furthermore, pursuing such strategy is transferring a societal cost to the firms (Dixon-Fowler et al., 2013).

Dixon-Fowler and her colleagues (2013) report some potential moderators to the corporate social performance and financial performance. Their results are based on a meta-analysis of research on the topic; and supports that some firm characteristics (small and U.S. firms) and methodological issues (market based measures) have indeed moderating effects on the relationship of sustainability and performance.

Endrikat, et al. (2014) present further moderators to the positive relationship between social and financial performance. Their results are also based on a meta-analysis; and provide evidence for a bidirectional causation. Furthermore, the relationship is stronger for proactive approaches of sustainability, and it is influenced by firm’s financial risk, and by controlling samples’ endogeneity and type.

Despite this inconsistencies between the relationship of being sustainable and positive financial performance, in 1999 the DJSWI was launched. The family of indexes arethe result of the collaborative work of a Swiss investment specialist (RobecoSAM) and S&P Dow Jones Indices.

Dow Jones Sustainability Indexes

The DJSWI tracks the performance of the top sustainable companies of the 2,500 largest in the Dow Jones Global Total Stock Market Index. In addition, for 2013, there are 14 subset indices, derived from the World Index.

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9 The assessment is made using the responses that companies provide to a survey. This survey includes questions that capture general and industry-specific criteria covering three dimensions: economic, environmental, and social (RobecoSAM, 2013b). These dimensions are the three interlocking principles of the World Commission on Economic Development to conceptualize sustainability (Galbreath, 2011).

Companies included in the World Index have the highest sustainability score on the CSA. The score ranges from 0 to 100 and companies are ranked against other companies in the same industry (58 sectors for 2013). Only the top 10% of the companies of each sector based on the scores are included in the DJSWI.

Every year RobecoSAM publishes The Sustainability Yearbook. The list includes companies representing the highest 15 percent scores of the CSA for the previous year. Companies are presented by sectors. In addition, within each sector three categories are awarded: gold class, silver class, and bronze class. The gold class category is given to companies whose scores are within 1% of the sector’s leader. The silver class category is for companies with a score within a range of 1% and 5% from the sector’s leader. Companies withscores within a range of 5% to 10% from the score of sector’s leader receive the bronze class category. Along these three categories, a sector leader and a sector mover is also highlighted. The sector mover is the company that achieved the largest proportional improvement in its sustainability performance compared to the previous year. Finally, sectors identify runners up enterprises, which are not leaders, nor winners of any class.

Empirical research on Dow Jones Sustainability World Indexes

A couple of papers have employed the firms on the DJSWI as subjects of inquiries. For example, Ricart, Rodríguez, and Sánchez (2005) analyze how and to what extent DJSWI leaders were integrating sustainability into their corporate governance systems. Then, they develop a model for sustainable corporate governance based on their results. According to their model, the sustainable governance system should answerthe following four key questions: who the board’s members should be, what their most important roles should be, how the board should function to play those roles in an efficient and effective way, and why the board should do it.

Another example is López, García, and Rodríguez (2007) that examine whether business performance is affected by the adoption of practices of corporate social responsibility. They analyzed two groups of 55 firms; one group belong to the DJSWI and the other does not. Their analysis of accounting indicators reveals a difference in performance between both groups.

What is the role of boards of directors in corporate governance theory and accounting?

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10 Corporate governance academicians have dealt extensively with the relationship between the board composition and firm performance with the agency theory as a theoretical framework. In general, as the degree of boards’ independence increases, monitoring plays a more important role. The main empirical issue is proxing (or identifying an adequate proxy to measure) the degree of independence of a firm’s boards. The adopted assumption is that the characteristics of boards are related to the degree of independence. These characteristics are: board composition, board size, tenure of both the CEO and directors, leadership structure of the board, and ownership of both CEO and directors.

The composition or the type of members in boards has been classified into three categories: inside directors, affiliated outside directors, and independent outside directors (Baysinger & Butler, 1985; Byrd & Hickman, 1992). Inside directors are typically corporate officers or retirees and members of their families. Affiliated outside directors are not full-time employees but are somewhat associated with the firm. This class includes investment bankers, commercial bankers that have made loans to firms, lawyers proving services to the firm, consultants, officers and directors of the firm’s suppliers and customers, and interlocking directors. Independent outside directors have no affiliationwith the firm other than directorship, such as private investors, business executives, academicians, and decision makers from the public sector. The degree of independence depends on the number of outside directors.

Outside directors tend to perform diligently their duties, even when they have no financial stake in the company. Generally, outside directors are respected leaders from the business or academic community whose reputations suffer when associated with poorly performing companies (Fama, 1980; Fama & Jensen, 1983a; Weisbach, 1988).

Board size also plays a role in effective monitoring. Researchers propose three main sources for board-size effects (a) increased communication and coordination problems, (b) board’s decreased ability to control management, and (c) the cost of poor decision making spread among a larger group of firms (Eisenberg, Sundgren, & Wells, 1998; Yermack, 1996).

A powerful CEO can influence the board’s ability to carry out its legal role of representing shareholder interests or independence (Pearce & Zahra, 1991). Since the CEO has the ability to shape board membership over time, the CEO can gain power the longer he/she holds the position (Mishra & Nielsen, 2000). Moreover, if a CEO is also the Chairman of the board (CEO duality), independence may be adversely affected. The dual leadership structure allows the CEO to exert more power over the decisions and practices of the board, and also permits the CEO to effectively control the information available to other members of the board (Booth, Cornett, & Tehranian, 2002).

Weisbach (1988) presents evidence that CEOs with more share ownership have increased power in the firm. This ownership may provide an incentive to exclude outsiders from a board. A complementary argument, from Jensen and Meckling (1976), is that when owner-managers’ shareholdings grow as a fraction of their wealth, their interests become more aligned with the firm’s shareholders. Therefore, as the CEO ownership increases the potential for expropriation of minority shareholders’ rights might also decrease.

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Diversity in Boards of Directors

Research on diversity of boards of directors have grown significantly during the last two decades (Zhang, 2012). Diversity on the attributes of directors serving on boards is expected to improve linkages with stakeholders and increase sensitivity to differences and society’s concerns. Research has shown that women, minority or foreign-based directors tend to be more sensitive to social performance of an enterprise (Hafsi & Turgut, 2013).

Diversity in boards of directors “enhances the firm’s strategic decision making process through offering a broader range of perspectives and ideas and facilitates the acquisition of critical resources for the organization with wider social networks” (Zhang, 2012, p. 686). Furthermore, diversity has been linked to the independence of boards of directors. The main argument is that demographically different directors, who are not form the traditional set of directors, perform their duties better.

Diversity in board of directors has been measured in various forms ((Hafsi & Turgut, 2013), including diversity in gender, age, ethnicity, and tenure. Evidence suggests that a mixture of these variables tend to create a more sensitive environment for corporate sustainability. Research documents that women think more favorably of ethical matters than men (Luthar, DiBattissta, & Gautschi, 1997), and tend to be more sensitive to corporate social performance (Burgess & Tharenou, 2002). In addition, both mature and younger directors tend to be more socially responsible and environmentally friendly (Hafsi & Turgut, 2013). Moreover, ethnically diverse boards may facilitate interactions with different stakeholders groups and enhance firm’s response to environment (Zhang, 2012). Finally, diversity in directors’ tenure is expected to generate a mix of sensitivities that may favor corporate sustainability (Hafsi & Turgut, 2013).

Latin American Scenario

Classic agency theory framework and corporate mechanisms do not apply to the circumstances of LA countries (La Porta, Lopez-DeSilanes, Shleifer & Vishny, 1998). Agency problems do not arise with the separation of owners and managers; instead, agency problems might stem from the misalignment of interests between majority and minority shareholders. Moreover, corporate governance mechanisms differ from those in developed economies: (a) It seems that boards of directors in Latin America are under the influence of controlling shareholders and do not perform their legitimate fiduciary duty to safeguard minority shareholders’ interests; (b) ownership structure is concentrated in the hands of the controlling family or families; and (c) formal institutional protection is often lacking, corrupted, or not enforced. Looking at the LA scenario, the internal corporate governance mechanisms (board of directors and ownership structure) provide the opposite point from current research and may not provide the necessary protection as described by theory and suggested by the empirical evidence in developed economies.

Empirical evidence on LA provides the following conclusions (Santiago-Castro & Brown, 2009):

1. Boards of directors’ characteristic among LA countries vary.

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12 3. Increases in the tenure of independent outside directors, decreases in CEOs’ shareholdings and more interlocking directors on a board all serve to increase the monitoring role of boards of directors.

Diversity in boards of director and sustainability

Santiago-Castro (2014) explores whether there are significant differences in boardroom diversity among the different categories of groups that constitute the DJSWI for 2013. The results show that only ethnic diversity is positively related with a higher category of sustainability of the assessment made for DJSWI7. Based on this result, LA firms must include ethnically diverse directors as part of their boards.

However, the sample of the previous research only includes four LA companies. Of these firms, only one has a bronze medal, and the others are runner ups (2) and mover (1). Therefore, the applicability of the final results might be limited. For thisreason, the current paper looks in more detail LA firms on the DJSWI and its board of directors.

Methodology

Sample and Data Sources

The sample selection process initially identifies all the companies of the Sustainability Yearbook 2014.8Then, firms from Latin American were selected and further analyzed on its diversity in board of directors.

For each selected company the annual report was the main source of information for all the variables. The annual reports were obtained through the different web pages of the companies. If some additional data was necessary the Internet was employed.

Variables

Two different types of information from the annual reports were collected to create the necessary variables. The first set of information is company-related category within DJSWI including whether the firm is a: leader, gold class, silver class, bronze class, runner up, or mover. The second set covers director-related data, including age, gender, CEO duality, and director tenure.

Corporate sustainability is based on the assessment made by RobecoSAM to compile the DJSWI. Once the assessment is made, this company publishes an annual report identifying several classes of companies depending on the final score each company had. The highest class a company can obtain is becoming a leader within its sector, which means the highest score of that particular sector. Therefore, for the presentstudy, leaders are considered to have better sustainability practices than others firms. In addition, the other classes can be ordered in decreasing assessment scores as Gold, Silver, and Bronze. Furthermore, a firm without a medal class (a runner up or mover) had a lower assessment than a medal class company.

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This study explores the following diversity characteristics in board of directors: age, gender, ethnicity, CEO duality, and director tenure.

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13 Diversity in boards was measure for gender, age, ethnic background, and tenure. To measure diversity in gender, the number of females sitting on a board was computed. The age diversity, was the difference between the age of oldest and the youngest director serving on a board. Given that both mature and younger directors tend to be more socially responsible and environmentally friendly, as stated by Hafsi & Turgut (2013), the higher the range of ages in a board might lead to better sustainability practices. Ethnic diversitywas calculated as the sum of directors born outside the country where the firm operates. Finally, director tenureis the average numbers of years directors have been in their chairs.

Resultsand Conclusions

For 2014, 460 firms qualified to be included in the Sustainability Yearbook. From those, 238 obtained 2014’s membership. In addition, the following numbers represents the diverse categories: 70 gold class, 65 silver class, and 87 bronze class.

Looking at Latin America, only two countries make the list: Colombia and Brazil. Colombia appears with eight companies, whereas Brazil with twelve. Furthermore, only one of those LA companies, Brazilian Fibria Celulose SA, ranks among the diverse prize categories. This Brazilian company received a gold medal and the recognition of being the leader of its industrial sector. For 2013, Fibria Celulose SA received a silver medal, and was not the leader of its industry.

Despite the advancement of Fibria from 2013 to 2014, LA firms, in general, have worsen their sustainability profile for the same period. In 2013, there were three Brazilian companies that emerged as industry leaders: Itausa - Investimentos Itau SA, Braskem SA, and Duratex SA.

Looking into the diversity in boards of directors amongthe firms in our sample, we had a population of 181 directors. On average, only 5.52%(10 directors) of the members of the boards of directors in our sample are females. This contrast with 10% found in Fibria Celulose SA, the only gold medal receiver in the sample. The results of the Brazilian company are in favor of previous findings that suggest that women tend to be more sensitive to corporate social performance (Burgess & Tharenou, 2002). Therefore, it make sense to expect that the larger number of female members on the Board helped Fibria Celulose SA to obtain a golden medal among the other LA companies in the sample.

Even though, the average board’s size of the firms in the sample (9 directors) is smaller than the 10 directors found on Fibria Celulose SA, we think that the larger size of Fibria’s board of directors has not affected their ability to control management as some studies suggest. If the extra members in Fibria’s Board are the result of increasing their gender diversity on the Board, then it seems to have paid off in better decision making regarding the Company’s contribution to sustainability.

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15 Discussion guide:

1. Why sustainability is important?

2. What is sustainability accounting/reporting?

3. What is the role of boards of directors in corporate governance theory and accounting?

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