1 Chapter I. Introduction I.1 Background Firms' do not necessarily have an obligation to increase their shareholders' prosperity, but also to increase their stakeholders' welfare as well (freeman, 1984). Firms' stakeholders divided into two main categories, internals (employees, shareholders, the boards) and external (competitors, suppliers, government, customers). Each stakeholder has its role as a facilitator to increase companies' performance and similarly, the company has the responsibility to reward each stakeholder by providing benefits that will guarantee their welfare. Here, the concept explained is known as corporate social responsibility (CSR). The Indonesian government has arranged for private and public companies to perform sustainability toward the society, as stated in UU CSR 2007. The concept of sustainability has several synonyms that used interchangeably, such as corporate social performance (CSP), conscious business, shared values, corporate citizenship, and triple bottom line. Here in this dissertation, we will focus on the term sustainability as one of our primary variables. Previous research regarding sustainability has been conducted everywhere, with the main focus varied range from corporate reputation (Fombrun, 1996), consumer support (Lev, Patrovits and Radhakrishnan,2010), employee commitment (Greening and Turban, 2010), legitimacy position within internal community (Fombrun et al. 2000), and increase governmental support (Wang and Qian, 2011). However, the most often discussed subject till nowadays focused on the relationship between sustainability and financial performance (FP). 2 Empirical evidence regarding the relationship between sustainability and financial performance gave some mixed results. Some previous studies have proven that sustainability is not necessarily served only as burden cost to the company, but also if appropriately managed, sustainability has the potential to gain profit for the company, in the long term. The results of studies done by Artiach.T et al. (2009)., Boesso and Michelon (2000), Saleh, et al. (2007), Chen and Wang (2010), Gama B. Et al. (2011) gave significant positive evidence on the relationship between sustainability and financial performance, while Brammer et al. (2006) and Galema.R, et al. (2012) gave negative results. Fauzi et al. (2009) gave no significant evidence of the relationship between sustainability and financial performance. The reasoning behind this may locate on the differences in measurement method and perspective regarding sustainability and FP. Corporate social responsibility required a multidimensional measurement method, and it consists of social, economic and environmental dimension, in which each dimension consist of multiple indicators and sub-indicators. Basic theory regarding the principle of sustainability evolved within time started from shareholder theory by Friedman(1970) and agency theory by Jensen and Meckling (1976) by the end of the 1970s. Next, followed by stakeholder theory (1984) and sustainable development model (1987) in 1980s. Stakeholder theory initially was built as an objection of shareholders. Carroll (1991) pyramid model of sustainability give a contribution to many academic studies regarding sustainability. The model, followed by stewardship theory (Davis, Schoorman and Donaldson, 1997) and the triple bottom line model (Elkington, 1998) showed the continual development of sustainability theories over time. In the 2000s, Aras and Crowther (2009) build a theoretical model of a sustainable development model that serves as a continual version of the sustainable development model in the 1980s, stewardship theory and triple bottom line in the 1990s. 3 Lastly, between the year of the 2010s until nowadays, there are three significant theories regarding sustainability topic. The three significant theories are the DNA of sustainability 2.0 model (Visser, 2010), a practitioner-based model of societal responsibilities (Pedersen, 2010), value creation model of sustainability (Gholami, 2011) and model of consumer-driven corporate responsibility (Claydon, 2011). Each of these theories has their strength and weakness, followed the recommendation of Krisnawati, Yudoko and Rosbangun (2014), these past theories regarding sustainability lack of four main ethical aspects, legal aspects, corporate performance and integration of sustainability programs with corporate strategies. The basic reasoning behind the lack of ethical aspects within sustainability theories related to the complexity to integrate between the concept of social within a business and the fundamental nature of business as a profit-oriented entity. Godfrey (2005) stated that firms' motivation to engage in sustainability are valued importantly by stakeholders, by performing sustainability firms can build moral capital that can guarded firms reputation against adverse events, in this way sustainability serves as insurance mechanism and decrease the potential against a lawsuit in the future. Firms need to maintain its public image and transparency of its business operation, and these two aspects need to consider carefully by the companies, if public feel cheated and lying into, society might disregard firms sustainability motives as a 'deceitful trick' to maintain a good reputation. This phenomena can we observed from multiple sin companies (i.e. Engaged in nature-destructive activities, such as tobacco companies, nuclear, weaponry and gambling companies) activities. The public assumed negatively of their sustainability activities, even though many of these companies gave a tremendous amount of sustainability funds toward the communities, the public seems to consider their action as 'wash away the sins'. Learned from the previous example, we can say that in this case, sustainability can serve as 'double swords' if not handled carefully. Environmental performance, sustainability can be a sensitive issue for several industries such as mining and geothermal energy companies. 4 Mining companies business activities depend entirely on the existent of natural resources, such as coals, nickels. In order to locate the resources, mining companies need to locate the exact location, blow up the location before extract the materials and cover the residual holes. These same type of operation keep on repeating over and over again, extend from one area to another. This type of how business operates can be considered as very risky and exposed to many environmental and social issues; therefore if we link this phenomenon to the sustainability and risk management, it is clear that mining companies are exposed to several types of risks before of this fact only, such as environmental risk, social risk, reputational risk. Types of risks that may able to threat companies’ ability to become sustainable is what we called as “sustainability risk”. Sustainability risk related tightly with companies business model and covered all risks that emerge from social, environmental and economic dimension. Companies’ in the different sector expose to different kind of risks and therefore, are exposed to different types of sustainability risks. The concept of sustainability put forward specific point on environmental and social dimensions, aside of economic dimension area. Therefore, companies are exposed to social risks and environmental risks, aside from economic risks. Relate to the information discussed above, and it will be natural to hypothesize that companies that are more sensitive to environmental issues and social issues, such as mining companies, are exposed to higher sustainability risks, rather than companies that are more friendly to the environment and social issues. Similarly with geothermal energy companies, the way how companies operate starting from building their shelter and so on, provides companies with many risks related, such as reputational risk, social risk and environmental risk. However, the fundamental characteristic of geothermal energy that depends on its sources based on geothermal energy gave a result in a different characteristic of sustainability and risk management strategy, compared to mining companies. They are not required to move their extraction places as often as mining companies. 5 Geothermal energy companies are hypothesized as less exposed to environmental and reputational risk, compared to mining companies and therefore, the way they strategize their sustainability strategy and risk management strategy can also be very different. Based on the previous explanation above, we can relate to the main benefit of sustainability, as mentioned by Godfrey (2005), that is, sustainability may serve as an insurance mechanism. Sustainability as insurance mechanisms have attracted attention to many researchers, academic, nor practitioners. The concept itself was said to relate with the concept of risk management since both were said to be built and designed to protect companies from all risks that may come from the uncertainties and opportunities embedded in all firms activities. However, this statement raised other questions from many parties, started from "what is the relationship between risk management and sustainability?", "What kind of risks that risk management and sustainability control, is there any difference within it?", "between the two, which one comes first. Can one be said to be an antecedent to another one?" "or is the relationship between sustainability and risk management explained from moderating view, where one can be said to be an intervening variable to the other one?". All these questions were often asked, but until now the answer itself were still clouded. Since the 2000s, the question has moved passed "what and why" era, and shifted to ask the question of "how and when". The public made aware of the importance of integrating sustainability and risk management into corporate strategy. However, the feasible way to integrate it and when is the right time to integrate it remains unsolved till now. Based on previous explanations, it is clear that these questions stated as research gaps that need to be solved. In this paper, we tried to answers all these questions by providing empirical evidence to the relationship between sustainability and risk management literature, with a focus directly to Indonesian business environment. List of general research questions within the literature of risk management and sustainability shown in the following Table I.1 below. 6 Table I.1 List Of Unresolved Questions Within the Topic of Sustainability, RM and FP What is the relationship between risk management and sustainability. Why companies need to perform risk management and sustainability. What kind of risks that risk management and sustainability control, is there any difference within it. Between the two, which one comes first. Can one be said to be an antecedent to another one. Where one must need to done first, before the other one followed. Is the relationship between sustainability and risk management can be explained from moderating view, where one can be said to be an intervening variable to the other one. Where one can strengthen or weakened the other one. Is the relationship between sustainability and risk management can be said as complementary. Where the existence of one complied and completed the other one. Or is it can be said as substitute, where one may act as substitute to the other one. Where the existence of one may be viewed as an alternative to the other one. 7 Table I.1 List Of Unresolved Questions Within the Topic of Sustainability, RM and FP (Cont.) How can companies integrate sustainability and risk management effectively into the company strategy. Is it need to be done one by one separately, or it need to be integrate into one big concept and performed simultaneously. When companies need to integrate sustainability and risk management effectively into the company strategy?do companies need to perform sustainability and risk management all the time, or is there any specific time that companies may not need to perform both and can choose one. What determinant functions that companies need to aware to make the best practice for conducting sustainability and risk management successfully. All the questions above refer to the unclearness of the relationship between sustainability and risk management. However, they all share the same idea, which explains that sustainability is related to risk management. Here in this paper, we will focus our research on the relationship between sustainability and risk management to companies' financial performance. The primary reasoning behind this located within the basic argument that since sustainability and risk management built as part of a reliable governance system, norm argument will say that both of them will answer to the companies' success, financially and non-financially. However, things are not exactly as easy as it is. Followed the recommendation from previous empirical evidence regarding the relationship between risk management and companies financial performance, it is a valid idea to say that proper risk management policy will be beneficial to the company and bring positive influence to the companies' financial performance. However, it is not the same thing with sustainability. 8 Past empirical evidence regarding the link between sustainability and financial performance is still mixed. Fauzi et al. (2007) found a positive sign between these two factors. Meanwhile, Brammer et al. (2006) found a negative sign. Evidence provided by Gama et al. (2010) gave no evidence of any relationship between the two variables. All this evidence suggests mixed evidence, yet still unclear up until now. These phenomena exist as potential research gap, which we will explore thoroughly in all related chapters in this dissertation. Basic definition regarding sustainability and risk management are different.