“If I put it into one sentence, I think, you really want to do things that make a difference.”
Sri Ratan Tata
Changing times demand that companies no longer exist and operate in isolation from broader society. Their identity as economic entities notwithstanding, they must take their responsibility towards society into account across all activities: defining values, building culture, strategizing, decision-making and operations.
Governments play an important role in ensuring the corporate sector functions in line with the norms of society. With this view, the Government of India stepped in. It amended the earlier Companies Act of 1956 with the Companies Act, 2013, adding Section 135. It stipulated that companies with net worth of INR500 crore or higher, or turnover of INR1,000 crore or above that, or a net profit of INR5 crore or more during the immediately preceding financial year, were required to compulsorily spend 2% of their average annual profit of the preceding three years on CSR activities.The law also made it mandatory to establish a CSR committee.
The enactment aims to achieve two results: one, sensitize smaller companies to their CSR-responsibilities and ensure genuine participation; and two, make reporting and monitoring of CSR programs/initiatives more stringent for effective implementation.
Thus, it becomes imperative to assess the impact of the government’s regulation on firm performance, especially in an emerging economy such as India.
A research article, published in ScienceDirect, “Mandatory corporate social responsibility and firm performance in emerging economies: An institution-based view”, provides interesting insights on the impact of mandatory CSR investment regulations. It cites research by several theorists in building the case point by point.
According to data released by the Ministry of Corporate Affairs (2022), Indian businesses spent nearly INR968 billion (US$13 billion) on 141,752 CSR projects from 2016–17 to 2020–21, with the average cost at US$200,000. These investments span a wide spectrum from health and sanitation to rural development, Swachh Bharat Abhiyan, slum development, sports, voluntary contribution to pandemic relief, etc.
Research shows that businesses in India, including financial institutions both domestic and foreign, perceive CSR mechanisms as having a direct link to consumer markets. The impact is visible as an increase in sales, higher margins and market share, and improved customer loyalty. Moreover, as CSR is a non-market strategy, it has a strong societal impact component. Following the introduction of new CSR rules in 2014, CSR spending by Indian firms has increased. This shows making CSR mandatory is persuading more businesses to implement such programs and contribute to nation building.
These include intangible assets, such as knowledge or learning capabilities. The advantages usually arise from managerial competency or innovative skills or R&D capability, brand positioning, network-building, scaling up of operations, etc. Research shows that companies in emerging markets are more likely to realize firm-specific benefits accruing from pursuing a CSR agenda.
Take the example of China. Mandatory CSR reporting has given a significant boost to green innovation, resulting in an average 26% growth in green patents is-à-vis non-CSR reporting firms,
In India, CSR consciousness among consumers is high. They are more likely to prefer brands that are environmentally conscious or follow legal and ethical reporting norms. In the financial sector, banks or other institutions pursuing financial inclusion or literacy programs are likely to have a better reputation among consumers and win the trust of their employees and management. Both these factors will lead to improvement in customer service quality.
CSR programs, therefore, have a positive effect on consumer perception and purchase intentions. They help enhance the quality of customer service, the company’s image and positioning, market share and competitive advantage.
Of course, the extent of advantages is a play of internal factors (such as individual styles of entrepreneurs, size of the firm, competition in the market, socially centric innovations, etc.) and external factors (namely, the level of economic growth in the country and types of laws).
Financial performance-specific impact
Firms that are cash-rich are definitely better disposed to invest in CSR activities compared to firms that are low in cash. Given that socially responsible activities are among the key influencers of market valuation and acquisitive behavior, it is important to understand the impact of CSR on a firm’s financial performance.
Recent research in India shows that spending on CSR activities directly affects performance-related parameters: finances; cash holding; cost of capital; earnings management; liquidity; market valuation; and accounting. For instance, CSR strategy, including corporate governance disclosures, has a direct bearing on the company’s market value through an increase in profitability, reflected in higher returns on assets, equity, capital employed, etc.
However, studies also show that performance is not consistent across industries and sectors. For example, CSR disclosures and financial performance are positively correlated in consumer goods and services, and heavy engineering, but not so in healthcare, energy, and utility. Likewise, for some firms, forced compliance with mandatory CSR spending has hurt their stock price, while firms that spend on advertising did not face any such repercussions.
Another aspect is that the CSR law has made corporate governance and reporting guidelines more stringent. This has acted as a deterrent, resulting in fewer instances of earnings manipulation compared to the period before implementation of the new act. Furthermore, accounting conservatism has improved as firms work to reduce compliance-related expenses.
Research also shows that higher CSR performance results in an increase in the cost of equity and lowers the cost of debt. Mandatory CSR lowers the cost of equity and the cost of debt. Moreover, mandated CSR firms have recorded higher stock market liquidity post- implementation of the act, especially those with low institutional shares and high promoter shares. This is not so for companies affiliated with any business group.
Therefore, mandatory CSR investments are more likely to have a positive influence on a firm’s performance. However, this depends on several factors –business- and industry-level –such as affiliation with a business group, stake of promoters, foreign institutional shareholding, size of the firm, etc.
In emerging markets, firms perceive CSR strategy as a process to build or enhance firm-specific advantages. It helps them understand consumer perception and purchase intention; increase brand awareness and strengthen their image in the market; and build long-term relationships with consumers. Having a good grasp on the expectations of customers enables them to effectively direct their R&D efforts and capabilities. As a result, they can come up with more innovative products. All of this provides a distinct competitive advantage.
By this standard, mandatory CSR spending or investments only add to the competitive edge.
Even while the initial cost may appear a little restrictive, since now it is compulsory to allocate funds for CSR activities, it will only benefit in the long term.
Relationship between focal and intermediary firms
The latest statutory guidelines require that CSR agencies be registered with the government. Moreover, the law requires the focal companies to assess the performance of CSR agencies to ensure funds are appropriately deployed for social programs and not misused; and report the assessment.
Focal CSR firms and CSR implementing agencies share a contractual relationship. In any such contract, trust is a key element in determining its success, other than the competency of the agency to glean information related to competitors or markets when planning CSR activities. All these factors will come into play when designing socially responsible programs, preparing the budget, or communicating the reporting or assessment. A good relationship that gives a positive outcome can provide a competitive advantage.
With mandatory CSR taking effect, focal companies will become even more selective in choosing their alliance partner. Given that the assessment of the agency’s performance has to be reported, it is important that the institutional environment be streamlined. Corporate governance is strengthened and there is legal transparency and efficiency.
This is a very critical aspect because the capability of the agency as a mediator will determine the performance of the focal company vis-à-vis mandatory CSR investment. If the agency is capable, networked well, has the expertise in delivering CSR programs—and this is buttressed with an efficient legal framework—the outcome will be positive.
Overall, mandatory corporate guidelines will help in improving the information environment, boost investor confidence, and pave the way for transparency and accountability.
The Indian Journal of Applied Research makes certain observations. Citing key philanthropic advisors and professors, it notes that, if executed strategically, investment under the CSR clause will contribute to the development of business goodwill with shareholders. It will enable companies to strike the right chord with consumers, the Indian government and citizens, and the international public at large.
It could help in increasing strategic advantages. For instance, Dow Chemical’s entry into China or Brazil. The company is using the same American sophisticated and advanced technology in these countries. With this, it is raising the expectations of people in these regions, alongside creating a strategic advantage. Its competitors will be compelled to match its standards and requirements by increasing costs, yielding ground to Dow.
Similarly, CSR initiatives in education and awareness will enable companies to not just contribute to the growth of the middle class, but also create a potential consumer base. Likewise, expanding from urban to rural regions, or remote areas, will open fresh opportunities to tap into new consumer segments, and a broader market.
Plus, having a good image in the market will help in dealing with the administration, attracting investors and promising business partners.
Therefore, over the long term, businesses stand to gain in financial terms by undertaking CSR initiatives.
What is the scope for SMEs
CSR is relevant to all companies, including SMEs. However, the mandatory regulation is applicable only to companies falling in a certain bracket. The challenge for SMEs is that their profits fluctuate, depending on the conditions in the market. SMEs undertake CSR activities, but the quantum of revenue directed towards it is small. Also, CSR activities undertaken by SMEs often don’t deliver optimal results because of the paucity of resources.
That said, any SME could enter the bracket for mandatory CSR down the line. They could also be voluntarily inclined to undertake CSR work. Therefore, it is important to understand the approach an SME needs to adopt, or the steps it should take to comply with the mandatory laws:
- Use resources optimally. An SME should prudently assess what works better for the organization—undertaking individual CSR activity, in collaboration with another company, or simply by contributing to a central or state fund. If you divert resources prudently, you will avoid wastage of efforts, time, money and human capital. For an SME whose profits are often unstable, this should be the guiding principle.
How will collaboration help?
Individual CSR efforts entail setting up a CSR department, gauging the requirements of the local communities, aligning with NGOs and undertaking impact assessment. Under collaboration, a common organization will cater to several companies and execute these tasks collectively. This will bring down the cost of operational management.
It will enable SMEs to undertake long-term projects. Usually, budgetary restrictions and fluctuating profits lead SMEs to take up only short-term projects. However, pooling resources under a collaborative venture will provide the financial strength required for executing bigger and extended projects, such as environment or social issues-related. This will also help in building better ties with the local communities that are increasingly taking part in such programs and realize their importance in enhancing the quality of life.
Collaboration is also helpful in drawing learning. Due to the larger collective pool of resources, SMEs can undertake critical due diligence and assessment studies. They can design more relevant programs to cater to more issues and the broader community. Moreover, collaborating on bigger projects will improve their image in the eyes of the buyers that are working to set up supply chains based on ethical practices and the international community.
- Build internal capacity. CSR activities are complex and time-consuming. Improper planning will only make it burdensome. When preparing the plan, an SME needs to mobilize internal resources efficiently. It makes sense to aim for only those programs that are achievable at your scale of operations; and go for activities that are aligned with the line of business. Start small.
SMEs need to strike the right balance between complying with the recommendations and maintaining operational costs. This is important because they are usually more vulnerable to fluctuations in the market. Their sales directly depend on how the market is doing. Any variations in market condition could send sales yo-yoing
- Appoint a CSR consultant to manage portfolio. The consultant will help the company craft an apt strategy in line with its vision and provide much-needed direction to its social programs and initiatives, including effective monitoring and assessment from time to time. This is important because when companies initially begin complying, they can lose sight of the objective and get too caught up with the legal paraphernalia. A consultant with expertise in the field will ensure the program is not derailed, and the company does not default on compliance.
- Set up a CSR committee for relevant recommendations on all aspects. Manned by directors from the board-level, the committee will plan a policy in line with the company’s objectives and requirements. The committee can give guidance on which activities need to be undertaken, and the amount of funds that need to be allocated, ensuring transparent utilization of resources. Setting up a CSR committee will help in judicious planning and effective implementation.
The committee can keep a track of unused funds and advise on how the SME should use it. Having a clear policy, in consultation with the audit committee, will prevent any misuse. For instance, the leftover funds are not to be diverted for business use; these should be carried forward to the next year. Having a proper enforcing infrastructure with the relevant committees will, therefore, enable the SMEs to adopt ethical practices.
- Be vigilant and monitor spending. One way SMEs can do this is by constituting a Management Committee for implementation of CSR initiatives or programs as planned by the CSR committee. This will ensure transparent monitoring of the initiatives undertaken by the company; timely review of performance and submission of quarterly/annual reports; and monitoring (revision/update)of CSR policy.
What India can learn from others…
Over the last decade, several countries have made CSR a legally binding and compulsory activity. Comparison often helps in understanding the direction the law should take. This is especially relevant for an emerging economy, such as India. Referring to first world counterparts will help in setting the right benchmark, addressing the loopholes, and in revamping policies where required.
Two countries that serve as a benchmark are Norway and the US.
CSR in Norway is ingrained in the corporate culture, with the state playing an active role. In the US, it is perceived as a social contract between companies and the society. Companies undertake CSR to meet societal expectations. Government’s involvement is far and few.
What India could focus on is how to revamp its approach to build a culture where the national development agenda integrates more into the sentiment of the corporations and the people.
Second, India could work to develop a policy that is more inclusive of SMEs. To create awareness and instill a culture of philanthropy, webinars or conferences could be organized by the respective ministries–those that handle different industries and those dedicated to developing socio-economic or welfare programs.
SMEs could be urged to make an allocation, irrespective of its size, regularly. Any SME that does this constantly should be recognized. Rewards, as well as other incentives, maybe through tax exemptions or other benefits, could help in fostering the culture of socially responsible actions.
CSR primarily has a voluntary overtone. Only recently, in the aftermath of the pandemic and tectonic socio-economic changes, such as DE&I issues, or amid growing environmental consciousness, focus is shifting to make it mandatory.
As countries and governments get involved, it is important to understand the switch from the perspective of the motive behind it. This will determine how the whole effort fructifies.
Is this just a political move to gain the confidence of the constituencies? Or, is the pursuit of the lofty ideal as true as it is being projected? The answers will come with time, only through concerted efforts over a period.
Making CSR mandatory could be a revolutionary step from the perspective of socio-economic development. Involving the corporate sector in national development can yield significant benefits for the nation and its people. Simultaneously, it makes perfect business sense for companies to pursue it.