The Case Against Corporate Social Responsibility

The new mandatory CSR spending rule is not just economically unsound but also socially counterproductive.

The NDA government has indicated that the Ministry of Corporate Affairs is going to relook certain aspects of the Companies Act. One of its many provisions that require amendment is the clause on Corporate Social Responsibility (CSR). As per the law that came into force from April 1 this year, every company beyond a minimum size has to spend at least 2% of its average net profits of the three preceding years on CSR activities. This rule is not just economically unsound but also socially counterproductive.

What Is the Role of Businesses In Society?

Businesses exist to serve the interests of their owners without harming the society. If businesses concentrate on doing just this, they contribute to social welfare in a number of ways. They produce useful goods and services for customers as well as generate employment and tax revenue. If managers do not do this to the best of their abilities, not only are they failing to deliver on the task that owners have entrusted them with but they are also not enhancing social welfare. The whole idea of corporate governance is built around this theme and by forcing managers to do otherwise is asking them to violate the principles of good governance. Of course it is praiseworthy when many business leaders spend from their fortunes on socially useful activities.

Industry captains, executives and even the ordinary worker in any sector should be encouraged to be philanthropic through use of their personal wealth and time. But that is quite different from using others’ money for purposes it is not intended for.

Every business has certain specializations or competitive advantage in particular activities. Microsoft is very good at making software but not so good at making mobile handsets. Mahindra & Mahindra makes excellent large vehicles but is not known for small cars. Similarly there are companies who have expertise in socially useful businesses and may have even spotted a market opportunity there such as in organic foods, fair trade or microfinance. Hero Group has recently entered the alternative energy sector as it makes business sense for them.

Is it anyone’s argument that a company that exploits its workers, pollutes the environment but spends 3% of its net profits on painting local school buildings is contributing more to society than a company that uses environment friendly technology, offers great working conditions to its factory workers but spends nothing on CSR. Why are we to assume that all companies can do a good job in the social sectors and why force them to devote resources to where it may be wasted in the absence of serious intent or capability?

Economic efficiency drives social welfare. Asking a company to take on activities beyond its interest or expertise is the surest path to inefficiency. Not only do companies have to allocate 2 percent of their net profits but set up new CSR departments to spend the money. To oversee these activities, companies are mandated to set up a CSR committee of its board with three or more directors. This amounts to further increase in costs and a distraction for the board and management at a time when businesses have been hit hard by the adverse economic environment.

There could be three types of responses by businesses to this new law. One, where the company adheres to the letter and spirit of the law by dedicatedly pursuing some activities that benefit society. Second, where the company follows the letter but not the spirit of the law and ends up spending on areas which require the least effort and time but may not be the ones that are in most need of the money. For example it would be easy to add a second coat of paint in a local school than identify one that needs it most, perhaps in a remote location.

Third, where CEOs decide that the board is most likely to reward them if they violate the CSR rules and adhere to good corporate governance instead. That is, work for higher profits rather than follow the law and get fired. Even the government would agree that the first scenario is the one that the law hopes to realize. But such companies would spend on CSR activities anyway even without the force of law. All that is needed is some encouragement from the government in the form of guidance or public private partnerships for a social cause.

Forcing CSR On The Unwilling

Kellogg’s has pledged to provide one billion breakfasts to hungry people across the world by 2016. Nike uses a materials sustainability index (based on factors such as amount of water used) to select its suppliers. Tata group has been involved in serving the community in countless ways since their inception. There are many such examples from foreign and Indian companies not because of any law but out of corporate choice. By all means do facilitate the work of socially inclined companies, but do not force inefficiency upon the disinterested.

What the provisions of the law amount to is the government abdicating its constitutional responsibility of working for the society and passing the onus on the corporate sector. Raising the rate of corporate tax would have achieved the same purpose in a much simpler way but then the government would have to take responsibility for delivery. Forcing companies to divert time, energy, funds and manpower against their wishes is to force inefficiency upon the disinterested rather than facilitating the activities of those that are socially inclined.

Had the same resources been devoted to core activities by companies, they could have generated much more value to all stakeholders including the society. Perhaps some part of the government realizes this. And that is why there is an escape route built into the law. If a company fails to spend the mandated amount on CSR activities, it has to explain the reasons for this failure while reporting its financial statements.

If it fails to do even that, it is liable to a fine of Rs 25000 and every officer who is responsible is liable to a fine of Rs 5000. Who decides whether the explanation is satisfactory or not and is the paltry penalty at all any incentive to follow the law? That the law itself is weak seems to be a saving grace. Throwing it out would be infinitely better of course.