This article has been written by Arka Biswas and edited by Shashwat Kaushik.
Table of Contents
The governments of various countries started focusing on initiatives in corporate social responsibility (CSR). The European Union countries decided to legislate, mandating corporations submit their CSR activity reports. Canada and Denmark also passed similar legislation. Some countries, like India and Indonesia, went a step further and enacted laws that made not only disclosure but also spending on specific CSR activities mandatory.
However, the consequences of such a mandate model were not as satisfactory as desired. Experts have proposed an incentivising model to implement CSR activities by corporations.
What is CSR
CSR stands for “Corporate Social Responsibility”. The term Corporate Social Responsibility (CSR) depends on whether a business has social commitments beyond gaining profits. An organisation is responsible not exclusively for its investors but for every one of its stakeholders- clients, workers, suppliers, competitors, the government, and the social community. As a corporate resident, it should satisfy its financial, legal, moral, and ethical obligations.
It was introduced in India by the Companies Act of 2013. Section 135 of the Companies Act mandates that every company having a net worth of rupees five hundred crore or more, a turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during any financial year shall have to constitute a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of which at least one has to be independent. The Board’s report will disclose the composition of the Corporate Social Responsibility Committee. The committee will plan and recommend to the Board a Corporate Social Responsibility policy indicating the CSR initiatives that will be undertaken by the corporate firm as specified in Schedule VII of the Companies Act.
Schedule VII of the Companies Act, 2013 is a list of activities that companies can undertake as part of their Corporate Social Responsibility (CSR) initiatives. The Schedule was included in the Companies Act, 2013 to encourage companies to contribute to society beyond their core business activities.
The Schedule lists the following activities as part of CSR:
- Eradicating hunger, poverty, and malnutrition
- Promoting education, including vocational education and skill development
- Promoting gender equality and empowering women
- Reducing child mortality and improving maternal health
- Combating human immunodeficiency virus (HIV), acquired immune deficiency syndrome (AIDS), malaria, and other diseases
- Ensuring environmental sustainability by preserving natural resources, protecting flora and fauna, promoting agroforestry, and maintaining the quality of air, soil, and water.
- Protecting national heritage, art, and culture by preserving historic sites, monuments, and artifacts.
- Promoting traditional knowledge and practises of indigenous and local communities to preserve cultural diversity and promote sustainable development.
- Providing support for armed forces veterans, war widows, and their dependents.
- Promoting sports by providing training and support for rural sports, nationally recognised sports, and Paralympic sports.
- Contributing to socio-economic development and relief by donating to the Prime Minister’s National Relief Fund or other funds set up by the Central or state Governments to benefit scheduled castes, scheduled tribes, other backward classes, minorities, and women.
- Any other activities prescribed by the Central Government from time to time.
The Companies Act was implemented in India on April 1st, 2014, and it became the first law in the world to require companies to allocate 2% of their profits towards CSR initiatives. Upon examining the impact of this regulation and peer pressure on corporate firms’ CSR practises, it was discovered that the Act could not achieve its goal of 2% expenditure. However, it did result in a substantial increase in the reporting of CSR expenses, and companies ended up spending 1% of their profits on CSR initiatives. Although this falls short of the target, it still represents a significant improvement.
Furthermore, research has shown that the previously effective and statistically significant influence of peer pressure on encouraging CSR initiatives diminishes after the implementation of the Act, which establishes a new standard for CSR expenditures. This suggests that the regulation has resulted in the displacement of internal motivations for CSR by external factors.
Regulating corporate behaviour
Corporations must comply with numerous daily regulations, some of which are designed to promote good corporate citizenship or social responsibility. These regulations, which are often tailored to specific industries, can conflict with the primary corporate objective of maximising profits for shareholders. Positive law plays a significant role in defining standards and limits for corporate behaviour. Additionally, various regulations aimed at promoting corporate social responsibility require corporations to disclose their behaviour, resulting in market forces and consumer pressure that can influence corporate behaviour. Both approaches to guiding corporate behaviour have advantages and disadvantages but they represent the diverse range of tools that the government can use to shape corporate behaviour and promote corporate social responsibility.
Adverse effects of mandating CSR expenditures
The CSR policy is often aligned with the socialist policies of the state. The primary objective of mandating CSR is to encourage companies and business organisations to undertake activities that benefit society as a whole. The CSR order expects organisations to disclose their CSR activities in their annual reports freely, assuming that if the firm neglects to spend the necessary sum on CSR and does not clarify the reason for such neglect of expenditure in the Board of Director’s annual report, then, at that point, the firm and its officials are liable to fines and punished with imprisonment under the provisions of the Act. In addition to the “spend-or-explain” provisions, the CSR regulation requires companies to establish a CSR committee consisting of at least three board members, with at least one being an independent director. This committee is responsible for overseeing the company’s CSR activities and expenditures.
There are several reasons why a relationship between earnings management and CSR may not exist when CSR activities are mandated by the government. For instance, when companies are required to engage in CSR due to the Act, it is improbable that such activities will enhance their reputation. Additionally, economic idleness or signalling is unlikely to play a role for most companies when all firms that meet the government-mandated thresholds are required to comply with the mandate. Thus, among the arguments for a negative correlation between CSR and earnings management, only the link between CSR and ethics remains relevant in the context of mandatory reporting of CSR expenditure. In other words, if instituting CSR reporting increases the ethical consciousness of managers after the Act, then earnings management may decrease.
Mandating Corporate Social Responsibility can give rise to various malicious acts on the part of the management. Many companies resort to illegal methods to show records of CSR activities instead of actually complying with them. The records produced are far from reachable in reality. On top of that, it can also give rise to unethical piling up of money in the hands of the corporate in the name of the expenditure inculcated on the CSR activities.
Status before mandating CSR
Religious traditions such as daan, seva, and zakat have operated in India for centuries and have helped shape the relationship between the privileged and the dispossessed. Historically, the majority of philanthropy in India has been directed towards religious institutions, and this trend continues today. During the 19th century, early industrialists in India established corporate giving practises through trusts and endowed institutions controlled by members of business families. Following World War I, a new wave of business philanthropy emerged that drew business leaders into the political struggle for independence. It is widely recognised that M.K. Gandhi had close relationships with influential industrialists and proposed a concept of corporate trusteeship in which business leaders should be mindful of their responsibility as fiduciaries of society’s assets.
The Indian state’s role significantly increased in the years immediately following Independence, while the business sector took a backseat in efforts to advance development. Dissatisfaction eventually resulted from the State’s failures to combat poverty and promote economic progress. In 1991, India’s economy underwent liberalisation, ushering in a new era of globalisation and rapid growth in overall wealth.
The increasing wealth gap between the richest and poorest in India has led to new approaches in the corporate sector’s efforts to address social issues, and has prompted the government to seek the help of the thriving business community. The current state of CSR in India is noteworthy due to a shrinking State, a more globalised economy, and significant disparities between the commercial and social spheres. Since 2010, all Central Public Sector Enterprises (CPSE) have been following CSR guidelines issued by the Director of the Ministry of Heavy Industries and Public Enterprises. However, the Companies Act of 2013 finally addressed this issue by introducing Section 135.
Incentive based approach and probable outcomes
Many Indian companies have been contributing to society through CSR arms and foundations since their inception, like Tata Group and Aditya Birla Group, among many others. So, CSR is not a completely new concept in the Indian context. CSR advocates claim that it has the potential to generate income on its own. They assert that a business with environmentally friendly operations may benefit from more sales from clients who support its stance. It might draw in idealistic workers who put in extra effort or accept lower pay. Its initiatives might result in tax breaks or subsidies.
It is argued that incentivising CSR can be a better approach for several reasons, such as:
- First, mandating CSR can be seen as a form of government overreach. Companies are already subject to a wide range of regulations, and adding yet another layer of mandatory requirements can be seen as burdensome and unnecessary. Incentivising CSR, on the other hand, allows companies to voluntarily choose to engage in socially responsible activities, rather than being forced to do so.
- Second, mandating CSR can be seen as a form of “greenwashing”, where companies are simply doing very little to comply with the regulations rather than truly committing to making a positive impact. Incentivizing CSR, on the other hand, provides an incentive for companies to go above and beyond the minimum requirements in order to truly make a difference.
- Third, incentivising CSR can lead to more innovation and creativity in how companies approach social and environmental issues. When companies are free to choose how to engage in CSR, they are more inclined to develop unique and innovative solutions, rather than simply follow a set of mandatory requirements.
The rise in CSR activities and the implementation of several rules of conduct over the past few decades are excellent indicators of the rising need for CSR activities. The public image of the company serves as an incentive for businesses to participate in CSR initiatives; businesses with poor reputations will lose customers and suffer financial losses. Furthermore, when the business was led by a Leader who had the intention of giving back to society, the corporations also carried out CSR initiatives on their own. To have a stronger impact, however, there is a need for further motivation for corporations to adhere to CSR beyond these rationales
Socially Responsible Investing (SRI) can be considered an additional motivator for large companies to abide by their corporate social responsibility. The objective of this paper is to demonstrate the correlation between SRI and CSR. It will also establish an increase in SRI and the integration of environmental, social, and governance criteria into the financial framework to support the significant influence of responsible investing on the CSR endeavours of companies.
Socially responsible investing involves considering the social and environmental impact of investments, in addition to their financial performance. Non-financial indicators are taken into account by investors, leading to a positive or negative analysis of the investment. This framework is sometimes referred to as sustainable and responsible investing, or green investing. Incorporating SRI into the present market involves investing in companies that meet specific standards of corporate social responsibility.
Companies that prioritise CSR initiatives often implement them voluntarily, and many businesses already embrace socially responsible investment strategies that align with ESG principles. This approach is more efficient than mandated CSR and strengthens the case for eliminating mandatory CSR requirements. Examples of voluntary CSR activities that support the bottom line while contributing to the greater good include manufacturers investing in employee training and soap companies promoting handwashing. Profitable businesses inherently benefit society by creating jobs and income, addressing social needs, paying taxes, and enabling the conversion of savings into capital that generates returns for investors. Furthermore, these companies foster innovation and creativity that promote societal welfare.
Many businesses go above and beyond to address issues with the environment and socioeconomic underdevelopment. They start to attract ethical investors. Finally, requiring CSR is comparable to imposing an additional tax and expecting businesses to use the funds for their own purposes.
Additionally, because investors who respect its environmental grade will be content with relatively modest profits, its capital expenses may be lower than normal. However, it might be challenging to demonstrate that any particular CSR activity actually helps businesses bring in more money or pay their employees less. Additionally, there is no concrete proof that capital costs are decreasing, although this may be due to the difficulty in obtaining the long-term data necessary for a thorough examination.
In conclusion, while mandating CSR may seem straightforward, it can lead to negative consequences such as government overreach and a lack of true commitment. On the other hand, incentivizing CSR allows companies to make a positive impact voluntarily, and can lead to more innovation and creativity in how companies approach social and environmental issues.