Prof. Satish Deodhar

 

“The responsibility of business is to increase its profits,” was the title of a New York Times article by Nobel laureate, economist, and the evangelical supporter of free enterprise Milton Friedman in 1970. Friedman wrote that a corporate executive is an agent of the shareholders and his responsibility is to make as much money as possible, while confirming to the basic rules of society, embodied both in the law and ethical system.

His important qualification of embodiment of law and ethical system is good enough to justify fulfilling corporate social responsibility (CSR). In fact, CSR efforts help a company attain the Triple Bottom Line (TBL) of profit, people and planet. Shareholders are interested not only in the single bottom line figure of profit in their books of accounts because they recognize that profits are organically linked to communities and environments, without which a company cannot operate effectively. More than two centuries prior to Friedman, another free trader and father of moden economics, Adam Smith, had already echoed the social responsibility aspect of business in his 1759 treatise, The Theory of Moral Sentiments.

In India, Mahatma Gandhi evoked the notions of trusteeship and voluntary individual philanthropy, which were prevalent in the culture and history of the nation. The prevalence of dharamshalas for travellers; common animal sheds called panjrapols for animal health; the construction of ghats along the rivers; and the establishment of pathshalas by trading communities were examples of this approach.

After India’s independence, a moden but statist model advocated by Jawaharlal Nehru characterized social responsibility as a completely overarching state-driven endeavour. Market failure arguments, even if correct in principle, were overemphasized and the state started dictating terms in every sphere of life. The experience of seven decades since Independence has showed the glaring failure of the state in these efforts.

And today, while the govenment is rightly restricting itself strictly to the market failure sphere, guided purely by economic logic, it is co-opting the private sector through “mandatory trusteeship.” According to the new Companies Act of 2013, if a company has a net profit before tax (PBT) of at least Rs.5 crore, or a net worth of at least Rs.500 crore, or tunover of at least Rs.1,000 crore, then it is required to spend 2% of its average net PBT of the preceding three years on CSR activities.

As detailed in the Act, a company covered by the Act is required to establish a CSR committee, set CSR objectives, monitor CSR activities and report the same in their annual financial statements. If the company wishes, the activities can be performed through a foundation formed by the company specifically for this purpose. The Act specifies quite a few types of CSR activities, including those that encompass training, education, health, sanitation and environmental sustainability. An important caveat for these activities is that CSR expenditures must be spent on extenal stakeholders. That is, the activities cannot be aimed at welfare of company employees. Moreover, the activities should not be in the region or area of operations of the company. Besides, a company can make contributions to state or central govenment funds such as the Prime Minister’s National Relief Fund.

It is not surprising that many large companies have already been engaged in CSR activities for many years. In fact, many of them have created their own company foundations for this purpose. Quite a few of them already spend more than the mandatory 2% of their net PBT on such activities. The difference is that now they will have to make sure that these amounts are spent on activities that are not related to welfare of their own employees. If they spend on their own activities, it will be in addition to the 2% norm.

The implementation of CSR norms is in its early stages. The ministry of corporate affairs had expected that CSR expenditure of about Rs.10,000-12,000 crore would have been generated during 2014-15. (However, the actual figure may be about half of this amount.) Companies that have not been spending on CSR activities or have been spending less than 2% of their net PBT have to gear up to comply with the Act as quickly as possible.

While reporting of the CSR spending in annual reports is mandatory and there are no specific penalties for not spending, the Act has certain general penalty provisions which the govenment could potentially invoke. Though the mandatory CSR norms may seem coercive in nature, the intention is to institutionalize philanthropy and bring in accountability.

Gearing up for CSR spending would involve engaging with non-govenmental organizations (NGOs) that undertake social, developmental and educational activities and/or form specialized foundations to do such tasks.

In the short-run, while companies can choose from the different philanthropic activities listed in the Act, CSR activities constitute only one of the three different channels of TBL efforts. In the medium to long term, companies can engage in two other channels of TBL activities.

For example, improving efficiency within the organization can lead to energy conservation, and would not only help companies save on costs but promote environmental sustainability as well. Companies such as Infosys Ltd have started using building materials, paints, interiors and windows that are designed to prevent energy loss. The company has started other initiatives, including the recycling of heavy metals such as mercury from used CFL bulbs/tubes and installing biogas plants that use canteen and kitchen waste.

The third channel of TBL activities is to create shared value among business vendors and suppliers. For example, Jain Irrigation Systems Ltd helps farmers in improving their irrigation practices through drip irrigation technique and procures improved quality agricultural produce from them for their other operations. This has resulted in shared value creation for the company and the farmers. It also promotes water conservation and prevents environmental (land) degradation. When a company such as Ambuja Cements Ltd mines lands for cement, it also helps neighbouring farmers in the water-recharging of those lands. This improves both environmental sustainability and land productivity.

While some companies are engaged in the second and third channels of TBL activities described above, it may take some time to establish these channels into the list of acceptable CSR activities as per the Act. Despite this, companies can engage in all the three channels irrespective of whether or not they are covered by the Act, for it would help them improve their TBL—create a brand image for themselves, create shared value among the other stakeholders and protect the environment. To include the second and third channel in the approved list of CSR activities, impact assessment audits will have to be institutionalized first.

All in all, the new Act has certainly made companies think of TBL. The three channels mentioned above would take them in the right direction to promote their profits, improve people’s lives and protect the planet. While one talks of CSR and TBL, inadvertently, the attention gets focused only on large corporations. However, small and medium enterprises (SMEs) are also an integral part of the Indian economy. Today, SMEs account for about 40% of India’s exports and 45% of India’s manufacturing output, and contribute about 10% of India’s GDP. More than 100 SMEs are listed on a separate platform on BSE and the National Stock Exchange, with a market capitalization of more than Rs.10,000 crore. Many private limited SME companies make profits more than Rs.5 crore, one of the limits stipulated by the Act for mandatory CSR spending. Quite a few SMEs that are in the export business face intenational pressures to conduct their business keeping TBL in mind; otherwise they risk threats of import bans.

SMEs act as nurseries for entrepreneurship and provide a natural habitat for burgeoning enterprises that will grow large in future. Therefore, from all the three perspectives of TBL, SMEs also have to inculcate social enterprise initiatives, irrespective of whether or not they are covered by the mandatory norms. While establishing separate foundations may not be feasible for SMEs, they can pool resources among themselves through philanthropic organizations such as the Rotary Club and the Lions Club. They can also tie up with foundations of other large companies, and coordinate efforts among SMEs through industry associations such as the Confederation of Indian Industy and the Federation of Indian Chambers of Commerce and Industry.

In the immediate future, until they get geared up for TBL processes, SMEs covered by the Act may comply with its requirements by contributing to the Prime Minister’s National Relief Fund and similar funds of state govenments.

 

Dr Satish Y. Deodhar is professor of economics at the Indian Institute of Management Ahmedabad.

The article presents the author’s personal views and should not be construed to represent the institute’s position on the subject.

 

First published in 'View from IIMA' column in Mint.