ISBInsight: Professor Ramachandran, could you set the context for us for CSR in India?
Kavil Ramachandran: In the last few decades, Corporate Social Responsibility (CSR) has become an integral part of the public discourse with academicians, practitioners, policy-makers and media laying stress on equitable outcomes through business-society interactions. This is also contextual because there is a greater concern about sustainability of all kinds across the world, perhaps triggered by a variety of factors including poverty, environment, global warming and so on.
In the past two decades, the social obligations of firms across the world have gradually moved towards greater formalisation and regulation by national and inter-governmental organisations. This has been necessitated by the rising income inequality as well as social and ecological imbalances, all manifested by the globalisation of the economy.
The imbalance has become even more evident in India, particularly because we have a huge disparity growing between the haves and the have nots with probably 21% of the population still living in extreme poverty, large number of children malnourished and so on.
What is the consequence of this disparity?
The role of the corporation in the narrative of creating socially equitable outcomes has become inevitable in the light of this glaring divide between the haves and the have nots.
While there was a general agreement that businesses needed to do more to be socially and environmentally responsible, a far-ranging debate has ensued amongst various stakeholders to determine the exact nature of these obligations. In this backdrop, the Government of India passed a prescriptive law under the Companies Act of 2013 making CSR mandatory for certain class of companies from the financial year (FY) 2014-15.
Have there been studies earlier in the area of CSR?
Kavil Ramachandran: No. We are the pioneers in terms of undertaking a detailed study. A Giving to the society is part of the Indian culture and many of the large established multi-generational organisations have been doing a lot of charitable and philanthropic activities without even calling them CSR activities. But there was no major systematic study to understand this. We only have some case studies or some illustrations. This law has created an opportunity to undertake research because there are mandatory disclosures of social spends as per a standard prescribed format. Therefore, the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business (ISB) sees this as a responsibility to study these kinds of activities.
Since we are pioneering in research on family business in the Indian context, we took it as an opportunity to study the characteristic differences in the CSR spends and behaviours of family firms as well as non-family firms across a large set of representative firms. This has become very easy particularly because of the uniform regulatory landscape that has emerged with the recent law. So here we are trying to understand heterogeneity in behaviours across different categories of firms based on ownership structures.
Dr Nupur, even traditionally, in India, family firms have, of their own volition, taken part in social welfare activities like building schools and temples. How is CSR different?
Nupur Pavan Bang: Traditionally, the social welfare activities undertaken by firms in India were more in the nature of philanthropy. For example, the family business groups like the Birlas built temples and schools, the Tatas built educational institutions and hospitals. While CSR has its roots in philanthropy, it is a broader concept that encompasses the varying perspectives of business-society interactions. The concept of CSR focuses on developing far-sighted and responsible business practices with an eye towards future social and environmental challenges. It has long-term economic concerns and introduces strategic business concepts that are sustainable. So, CSR and long-term corporate performance are not at odds but are rather interdependent.
A well-defined CSR strategy helps the firm maintain its social license to operate within communities. For example, the Tatas were one of the pioneers in the private sector in the sense that they built the city of Jamshedpur around Tata Steel. It helped them attract and retain talent and also enhance corporate reputation. So, CSR activities may also lead to improved access to capital by attracting foreign institutional investment or investors who are willing to pay a premium for companies which have better CSR policies. It leads to other strategic competitive advantages and, as a result, creates long-term value for shareholders.
Despite this rising awareness and strategic distinction of CSR, widespread adoption of voluntary CSR continued to be muted in India.
What kind of companies fall under the purview of the CSR mandate?
Nupur Pavan Bang: The Government of India (GOI) passed the mandatory CSR law under Section 135 of the Companies Act of 2013 which required any company registered in India and having either a net worth of INR 500 crore or more or a turnover of INR 1000 crore or more or a net profit of INR 5 crores or more, in any financial year, to spend 2% of the average net profits of the immediately preceding three financial years towards CSR activities and make mandatory disclosures about their spending. Preference would be given to local areas in which the company operates. India thus became the first country to mandate a defined CSR spend and the only one of the three countries, along with Indonesia and Philippines, to undertake legislative action to mandate CSR.
The focus on the social performance of the company is now inevitable in the globalised economy that firms operate in. This paper has attempted to provide an overview of CSR behaviours of different classes of firms by ownership in India, given the unique regulatory landscape prevailing in the country. The antecedents and motivation for CSR are different for each of the classes in our cohort and results exhibit heterogeneity in behaviours.
This is a large-sample study of the CSR behaviours of family firms vis-a-vis non-family firms in India. Eraj, can you elaborate on the data used for the study?
Syed Eraj Hassan: CSR was made mandatory from financial year 2014-15. The Ministry of Corporate Affairs in February 2014 had come out with a policy circular instituting statutory reporting mechanism for all companies listed under the CSR law. This reporting framework was to be made part of the annual report for all listed companies each year.
We had a wide range of parameters in hand, including the average net profits for the last three years and the CSR prescribed expenditure which is 2% of the average net profits as well as the CSR spent by the company in that financial year. Also, we had project level information from the CSR activity undertaken by the company, the development sector targeted and the mode of implementation of the project.
Around the same time, when we initiated the study in early 2018, the Government of India had launched the National CSR Portal which had aggregated information for the past three financial years from 2014-15 right to 2016-17 of companies which were eligible under the CSR law. We scraped data off nearly 2000 companies and found certain data inaccuracy and inconsistency issues. So, at the Centre, we undertook a massive data cleaning exercise and we used the Board reports as the source of truth to ensure that the data was ready for analysis.
What really enriches our analysis is the past work we had undertaken at the Centre where we divided firms into family and non-family firms on the basis of the minimum equity ownership by family members and also the management control by virtue of Board representation, succession and business continuity. These family firms are then further classified into Family Business Group firms and Standalone Family Firms (SFFs) and Non-Family Firms (NFs) are further classified into State Owned Enterprises (SOEs), Multinational Subsidiaries (MNCs), Other Business Groups affiliated Firms (OBGFs) and Standalone Non-Family Firms. When this data was merged with the CSR database, we had an initial database ready.
Further, we created a cohort of companies which were eligible for CSR from 2014-15 to ensure that we could do a systematic analysis in our study. This left us with about 1210 firms with nearly 3,630 firm-year observations and 16,470 project-level observations. Family firms comprise 87% of our sample of which SFFs were 46% of the family firms. The number of MNCs and SOEs in our sample comprised majority of the non-family firms. This is in accordance with the last two studies, we had done. NFs and OBGFs formed nearly 2.3% of our sample of firms which is representative of the larger population of firms in India.
And what exactly are the consequences for non-compliant companies?
Syed Eraj Hassan: That’s an interesting question. In fact, section 135 of the Companies Act states that if a company is not meeting compliance, it needs to provide a reason in the statutory reporting framework. That qualifies the understanding of mandatory CSR as more of a soft hard law. Section 135 then goes further and states that if this reporting disclosure is not met, then the company can face a fine up to INR 25 lakhs and Directors can face a prison term of nearly 3 years. But none of that has seemed to happen till now.
In fact, the Anil Baijal Committee that was constituted by the Ministry of Corporate Affairs has said that there should be a grace period provided to all companies until they get a handle on the policy. But starting this year, the Ministry of Corporate Affairs has moved quickly to errant companies. A lot of show cause notices have already started going out. What further course of action is to be taken is still something that has not been decided by the Ministry. It is a wait and watch game for the companies that had remained non-complaint so far.
Ownership of a firm has implications for strategic priorities and decision-making processes of the firm. Hence, it follows that the CSR performance of the firms could also be driven by ownership structures. Professor Chittoor, can you take us through the findings of the study with respect to the different ownership categories?
Raveendra Chittoor: First of all, at the very broad level, if you look at the key criteria of the proportion of firms meeting this norm of 2% spent over 3 years, the surprising finding is that nearly 50% actually failed to meet the 2% spent norms on an average, across 3 years. Now, within this, if you examine the spending of the different categories of firms, family firms clearly outperform non-family firms, using the criteria of proportion of firms meeting the prescribed CSR spending norms. Within family firms, primarily the firms affiliated to family business groups outperform the standalone family firms. Probably, this is not surprising because business-group firms have a long legacy of spending on social welfare activities and they also have well- established structures to carry out CSR activities.
And how does this play out with non-family firms?
Raveendra Chittoor: Now, if you come to non-family firms, by far, the state-owned enterprises do very well in terms of meeting the CSR spending norms. In fact, across all categories of firms, they are the category which spends the most over the prescribed limits, i.e. state-owned enterprises spend more than the 2% norm. Again, there is a background to this. Much before the government regulation, the state-owned enterprises were required to spend on CSR activities because of a government mandate. So, they had a legacy of spending which they continue. It is easy for them to meet the new 2% norm.
The next category is MNCs. They lag behind the SOEs, but they are still doing fairly well in meeting the norm. The interesting aspect is the areas in which they are spending for CSR: they seem to be influenced by the parent companies. For example, a good number are spending on environmental concerns, which could be stemming from the parent companies’ concern about climate change etc. Also, MNCs are keen to establish legitimacy in the host country and so are willing to meet the CSR norm.
Surprisingly, the one category of firms which is almost abysmal in meeting the norms—nearly 70 to 80% of them don’t meet the 2% prescribed norms—are the category of OBGFs and NFs. Broadly, they can be classified as widely held firms, held by a large number of shareholders with one single owner. This raises the question: if you don’t have a single owner driving this, as is the case with family owned firms or with state enterprises, are concerns of broader social welfare lost on management? We suggest this is probably why they are lagging behind.
The last issue I want to highlight is how the CSR spending is actually implemented. Normally this is done through a direct mode, such as a Foundation, or through an indirect mode which is through third party spending. In this, there is some clear distinction between family and non-family firm spending. The vehicle for family firm spending also seems to be run by the family, such as through a Foundation. One needs to understand whether such spending is driven more by the majority owners, ignoring the interests of minority owners.
It’s interesting to see that a greater proportion of family firms meet and go beyond the 2% CSR spend as compared to non-family firms. However, Professor Ramachandran, what are the implications of the CSR law and your study in particular for the corporate India and policy makers?
Kavil Ramachandran: India has pioneered a new law, which needs to be understood. Even the companies are not yet well-prepared into playing a very active role in CSR.
The mandatory CSR policy was enacted in an environment where there was growing clamour for companies to become socially responsible. Without a doubt, there are more funds that are being redirected towards social programmes in India now. But questions arise in terms of their effectiveness, efficiency, impact (such as social returns) and sustainability. Therefore, for policy makers, as evidenced by our study, a multitude of unresolved issues and doubts about the implementation of the law could come to the fore. This could lead to some modifications to the law.
Since this is the beginning of the journey, as I said, there are possibilities of changes happening. We have started this initiative; many others have to contribute to bring about a change and get it institutionalised.
For example, limiting the focus of CSR to a philanthropic agenda stymies the possibilities for firms to fully leverage long-term benefits of CSR. For companies that adopt a typical philanthropic approach, the level of commitment is subject to a variety of factors, such as the vicissitudes of short-term profits, senior management interest, societal attention to philanthropy and other such factors that affect the CSR’s impact negatively, particularly in terms of implementation.
Yet another area of challenge is the antiquated tax laws, with firms more likely to choose avenues that provide tax benefits, impinging on the spirit of the law. Experts also believe that in the ideal case, the CSR spends should be complementary to the government spends in a sector.
Profesoor Raveendra, what would you add to this from your research on the anchoring effect?
Raveendra Chittoor: Research on the anchoring effect has shown that there is a tendency for human beings to be significantly influenced by initial information at the time of making decisions. One critical question here is: why 2%? Many of these firms might have spent more than 2%, particularly the family firms or state-owned enterprises. But now they are spending only 2%. So, the question arises: what is the overall spending and has that overall spending increased after the law as compared to before it came into existence? Unfortunately, there is not much data for us yet to examine that. Even if we could examine this with a small group of firms, that could be useful.
Second, what do we do with the firms which are not meeting the law? Right now, you are letting them go scot-free. There have to be more mechanisms for ensuring that everybody meets the law and to encourage those companies to spend more than 2% as they did in the past through some kind of incentives or benefits for firms going beyond the law.
The last one, I want to highlight is what Professor Ram mentioned, i.e. the tax benefits. If companies are going to be driven by either tax benefits or investing in government schemes and so on, this is again going to defeat the overall spirit of CSR spending. One needs to introduce measures to ensure that this is not happening primarily due to some of these extraneous benefits.
Any insights from the governance angle of CSR, Dr Nupur?
Nupur Pavan Bang: I would like to highlight two main points here- one is the vehicle of CSR spending which Professor Ravee brought up and the possible principal- principal agency cost that may arise if the family firms use their own Trust or Foundation to spend their own money. So, is the money being spent through the family foundation benefitting the family in any way or used for activities that are hurting the spirit of the CSR law?
In addition, the annual report on CSR activities is the only financial document that is not required to be externally audited. This is a lacuna in the policy, placing the burden of truth of the CSR activities on the directors of the company. Further, the Ministry of Corporate Affairs (MCA) has clarified in a circular that no role will be played by the government in forming an external monitoring or impact assessment mechanism to check the quality and efficacy of CSR expenditures. So, the MCA has passed this responsibility back to the Board of Directors/CSR Committees, who have been entrusted with self-regulating the quality of their firms’ social responsibility practices, in addition to being custodians of shareholder wealth. There may be a few other governance angles, but these are the main ones.
Professor Ramachandran, what are the takeaways for CSR corporate practice and for policy in India?
Kavil Ramachandran: We have just started the journey. If you want to be responsible to the society, the process of formulating the law is one part. The ownership has to rest with the companies. So, the companies have to formulate strategies- just as they do for business, they should formulate strategies for socially responsible activities. Then, the question is about implementation. It is a work in progress. As we travel through this terrain, we find the possible limitations. We find that more than 50 per cent of all firms in our sample remain non-compliant. They could be a variety of reasons: maybe they don’t know what to do or do not like this change. Their expertise may not be in the CSR area. So, we have to ensure that policymakers, government agencies and all stakeholders look at our study as a beginning to give some idea about what is happening.
Simultaneously, firms would do well to understand that a well-defined CSR strategy has several advantages to the firm in the long-term, beyond being socially responsible. Without enlightened promoters aided by independent directors and a complementary policy framework – at the government and corporate level—the universal adoption of well-meaning and highly spirited CSR pursuits will continue to remain a distant dream.
In essence, CSR should move away from a fringe activity to form the core of the organisation. We have enough experience from the Indian context previously from multi-generational family, non-family, state owned firms that took it as an important part of their purpose of existence. They contributed to the society, whether there was a law or not. And now that there is an enactment and companies have started practising this, we have opened the gates for new knowledge, created new platforms and have taken the first steps in terms of studying CSR in India.
Thank you, Professor Ramachandran, Professor Chittoor, Dr Nupur and Eraj. Your findings on the mandatory CSR law in India have been very interesting. You have clarified how the promoters of family firms carry the main burden to leverage CSR in a scrupulous manner in India. Better governance as well as more transparency will go a long way in achieving the objectives of the CSR law as well as creating stakeholder value.