CSR - Out of the Box: Mandated corporate social responsibility hurts shareholders, not firms

Dr. Shubhashis Gangopadhyay

The new Companies Act of 2013 stipulates that all companies with a net worth of Rs 500 crore or more, or a turnover of Rs 1,000 crore or more, or a net profit of Rs 5 crore or more in any financial year will have to constitute a corporate social responsibility (CSR) committee of the board. With the help of this committee, the board shall ensure that such a company spends at least two per cent of its net average profit of the last three years on activities that have been designated as CSR activities by the government. Newspaper reports suggest that the government has identified 10 areas in which such expenditures will be eligible to be considered as CSR spending. These include eradicating hunger, poverty, malnutrition and promoting preventive health care, promoting sanitation and availability of safe drinking water, promoting education, promoting gender equality, ensuring environmental sustainability and protection of national heritage.

A technical problem has arisen. At one level, the law stipulates that the (central) government will decide what legitimate CSR activities are; however, another part of the Act states that the company’s board can identify the CSR activity that the company wants to undertake. The law ministry wants to ensure that the company chooses one from the activities mentioned and that there is no scope for the company to interpret what CSR is. In the meantime, however, the minister of corporate affairs is reported to have said that since the amount spent on CSR is the company’s money, it should be the one deciding on how that money should be spent.

The theoretical literature and empirical studies on CSR have systematically shown that CSR plays a significant role as an important part of a company’s competitive strategy. Companies can compete by lowering prices without reducing the quality of the product, or by improving the quality without any significant increases in its price. Extending this logic, one hypothesises that when people are conscious about a company’s participation in the improvement of society, the company can compete by doing more for society. Indeed, the economics literature on voluntary environmental practices by firms strongly supports this hypothesis. The same has been found for firms following fair labour practices in production. Firms use their social activities as a signal to win over consumers who stay loyal to them and employees who prefer to work for them. However, such signalling works as a competitive strategy only if participation in such activities is voluntary. If such participation is made compulsory, it is no longer a strategy – for it cannot be used by stakeholders outside the company to distinguish among firms.

The two per cent CSR rule has become like a tax on medium and large firms. Just as outside stakeholders do not distinguish among firms by the taxes they pay (unless the companies are hauled up for non-payment of taxes), CSR expenditures will no longer be a distinguishing feature of a firm unless it is hauled up for not meeting its CSR responsibilities.

If CSR was a strategic choice, then firms would participate in those social activities in which they had expertise. For instance, a company in the hospitality business could focus on running old-age homes (incidentally, I do not know if this would qualify), while a mining company could focus on paying institutions that improve forest cover or help in generating alternative livelihoods for displaced persons. Or a profit-making company involved in education could run village schools. Since these would have been voluntary, companies would have had to convince stakeholders about the efficacy of their non-profit activities. This would have forced companies to carry out independent impact evaluation studies and that would have helped policymakers understand what works and what doesn’t. Now, since such activities will become compulsory, companies will no longer feel the pressure to justify such expenditures.

This is a very important aspect of what we are getting into. While the company is a legal entity, the company’s profit is actually not the company’s money, as the minister refers to it as, but the money of the shareholders. And the reason why companies voluntarily do CSR is that shareholders do not fire the managers who use the shareholders’ money to do these activities but want their company to do them. So, essentially, what this law does is tell the shareholders of eligible companies that whether you want them to do so or not, your companies will have to spend this money in a way that the government wants them to do. So, instead of being a load on the company, it is actually a load on the shareholder.

As a shareholder, if I have a choice between investing in a company that will just about be eligible and another that is otherwise identical but just not eligible, I will invest in the latter company, since it will save two per cent of its profits for me! This will, of course, translate into a higher capital cost for the first company.

This law reflects our mindset in two ways. First, we love “out-of-the-box” ideas because, by definition, they do not follow from anything and, hence, require no justification. Second, we love to target our policies – food security and health insurance only for below-poverty-line households, employment guarantee schemes only for the rural labour, relaxation of labour laws and other sops only for small enterprises, and so on. So, the two per cent CSR rule is only for particular types of firms, and not for all businesses. One of the reasons why there are so few “out-of-the-box” ideas is that while good ideas may be out of the box, most out-of-the-box ideas are very bad.

- Views by Dr. Shubhashis Gangopadhyay, Research Director, India Development Foundation, published in Business Standard