The conception of Corporate Social Responsibility (hereinafter referred to as CSR), has faced tremendous changes and has morphed itself into a statutory provision in India. But there exists a growing concern with respect to the penal provisions and sanctions introduced by the Government in 2019, with respect to non-compliance of CSR obligations of companies, currently operating in India.
The first part of the paper proceeds to trace the history of CSR in India and the motives behind introducing it in the form of a statutory provision. The second part proceeds to talk about the penal sanctions, as introduced by the central government. The third part elucidates on the economic and sociological theories behind CSR, that motivate multinational corporations and philanthropists in allocating funds for specific social purposes. In the final section, the paper/article seeks to analyze if such benevolent social contributions have a tendency to get trammeled by the introduction of mandatory provisions affixed with penal sanctions.
INTRODUCTION
India has, since antiquity, observed philanthropic motives and social empathy in the actions of the affluent Indian classes, that deemed it a matter of equitableness in contributing to the welfare of the society, to distribute economic and social resources. It was never an obligation imposed by a higher hand. CSR as an idea conceptualized itself into a widely held norm amongst the business class, having been inspired by Gandhian principles.
However, in the year 2013, the Legislature passed the Companies (Amendment) Act 2013, which made CSR a statutory requirement. India was the first country in the world to undertake such a bold social measure in mandating corporations which meet the requisite criteria to unequivocally allocate a certain percentage of their profits, as a part of CSR, each year.
The Intention Behind Making CSR A Statutorily Mandated Provision
Any modern society encompasses three sectors, which ensure the viability and sustenance of such countries. They comprise of i) the Government sector ii) Private sector and, iii) the Social sector.
While the first two sectors prima facie convey the exclusive jurisdiction of the entities that handle either governmental or private activities, the third, the social sector, is the reason for the birth of CSR.
Education, healthcare, vocational training, hunger alleviation etc. are few of the fields that come under the ambit of the social sector. Owing to the vast resource requirements they necessitate, the social sector is conventionally to be undertaken and managed by the Government. The government is traditionally believed to possess greater strength in terms of financial resources and manpower, in managing the social sector. But there are circumstances in which the Government might be facing a deficit in its treasury, thereby making it arduous to undertake social activities. But owing to the urgency of expedient redressal of activities such as education and healthcare, the government might require external aid; and this external aid flows from corporate private entities, amassing huge wealth and encompassing greater financial capacity.
According to Section 135 of the Companies Act 2013, any company having a i) net worth of Rs. 500 cr. or more, or ii) turnover of Rs. 1000 cr. or more, or, iii) a net profit of Rs. 5 cr. or more, during the immediately preceding financial year shall constitute a CSR Committee which shall ensure that the company spends at least 2% of the average net profits of the company in its three immediately preceding financial years. The section also requires the constituted committee to consist of directors who are responsible for drafting a CSR Policy. In case the company having met the eligibility of the section, fails to spend the minimum of 2% on CSR, its directors and the Board are made answerable and are required to accord reasons for either non-allocation or under allocation of such funds.[1]
Introduction of Penal Provisions Under The Companies (Amendment) Act, 2019.
Prior to the amendments brought about in 2019, Section 135 did not encase any penalty provision for non-compliance. But presently, in the wake of its introduction, any violation or non-compliance with sub-sections (5) or (6) of s135, would trigger the amended Sections of 137 and 140. Accordingly, in cases of non-compliance, a company ‘shall’ face a fine ranging from Rs. 50,000 to Rs. 25,00,000, and every officer who has partaken in such default ‘shall’ be made punishable with imprisonment of up to three years or a fine ranging from Rs. 50,000 to Rs. 5,00,000, or both.[2]
Another change introduced in the amendment, which remains pertinent is that, companies which have been recently established without meeting the ‘three immediately preceding years’ criteria has been tweaked considerably. Currently, even companies with a single year of existence and operation in the market, having met the other criteria laid down in 135(1), are mandated to contribute 2% of their income/profits from such immediately preceding year.[3]
Theories encapsulating the CSR Ideal
There are two underlying theories in the CSR model; but before its overall impact and importance can be analyzed, it is important to identify and recognize the traditional conception.
The traditional conception pertaining to the rationale behind a company’s existence, was propounded extensively by the economist Milton Friedman. According to Friedman, the sole purpose for the existence of any corporation or company was to earn profit. While the question of ethical and social responsibility of companies frequently started to erupt in the early 90s, Friedman believed that the only social responsibility that companies owed to the community was to increase its profit.
As long as companies increased their profits, by engaging in free market competition while complying within the rules of the game, any form of extraneous responsibility that hampers this corporate effort to maximize profit would only lead to the potential distortion of economic freedom.[4] Mandatory or compulsory charitable activities on the part of companies, he believed, was one such activity that directly affected the profit earned and the dividend paid to the stakeholders.
However, Friedman’s theory is not averse to corporate CSR; he advocated for companies to undertake such activities, if the end goal was profit maximization. Social responsibility translates to ‘absolute altruism’, whereas corporate CSR has ‘reciprocal altruism’ entrenched in its functioning. Therefore, the two cannot coexist with a harboured meaning of social responsibility adopted by companies, that deviates from the main purpose of socially beneficial philanthropic activities.
But this traditional view can be tangibly tested in today’s context, both globally and with specific reference to India, owing to the large-scale community consciousness of the various stakeholders, encompassing the social community.
a. Corporate Social Responsibility
The World Business Council for Sustainable Development in its publication Making Good Business Sense by Lord Holme and Richard Watts, used the following definition:
“Corporate Social Responsibility is the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large”.[5] It deals with a broader question of community welfare and extends beyond the question of law.
CSR comprises of four obligations which indirectly dictate a particular order in which companies carry out their activities. This hierarchical order of obligations is pivotal to the very existence of a corporation and therefore implicates the need to follow such a deemed order.
Economic and Legal Responsibility warrant greater existence, as realization of profit and observance of rules and statutes of the operating market are intrinsic to the very sustainability and viability of a company.
However, Ethical and Philanthropic Responsibility arises from the credence of the company and a sense of selfless generosity to community welfare, believing itself to be a citizen or an essential constituent of the society; they are independent of a companies’ pecuniary interests.
b. Triple Bottom Line.
The Traditional Bottom Line affixed its entire focus on economic returns and tabulated its results (bottom line) on the monetary aspect of profit. This falls in line with the aforementioned Milton Friedman theory of economic responsibility of companies. But the triple bottom line approach considers i) Economic ii) Social and, iii) Environmental governance, as the sustainable bottom line of a company.[6] John Elkington propounded this theory.[7]
Sustainability as a brimful value refers to evaluating and valuing business plans that do not lead to quick bounties, but which also encompass measures that avoid calamitous losses. The triple bottom line lays its emphasis on long term sustainability of a company. In terms of economic sustainability, it seeks to ensure that a company prudently invests in ventures that have a plausible benefit not just to the company, but to various stakeholders. A stronger reputation and goodwill in the eyes of stakeholders leads to greater profits in the long run. With respect to social sustainability, a company values the quality of life of its stakeholders.
The working conditions of employees, the impact of the company’s activity on potential consumers and the society, the effect on the government in terms of its tax and economic regulation etc, is considered. At last, environment sustainability is crucial as it falls in line with the SDGs as laid down by the UNGA. It arises from the importance of safely garnering finite resources and the future impacts of companies on successive generations. It is the obligation of corporations who exploit such resources, to undertake measures to make good such losses and impacts, as this depletion affects the world community at large.
Another theory that gained an impetus is ‘Stakeholder Capitalism’.[8] It refers to a market strategy in which a company treats all its stakeholders, including employees, customers, society, government and shareholders equally, by providing them with leverage on moral claims in the decision making process, rather than solely fixating its interest on investors and shareholders. The recent US Business Roundtable Conference held in 2019, had 20 of the wealthiest American corporations signing a memoranda to transform their respective corporate governance, from ‘shareholder capitalism’ to ‘stakeholder capitalism’ .This was seen as a momentous strategic measure, as it witnessed a deviation from the traditional bottom line approach highly regarded by Friedman.
The Indian Context
The debate concerning the validity of the penal provisions for non-compliance of CSR centers around the idea of philanthropy. This argument can either be affirmed or negatived, after having recounted the implications.
Arguments in favour of the Amending Provision
- India particularly, has been facing a perennial need for social and educational improvement for its masses. India also houses few of the biggest tech giants and banking corporations, which have a stable and credible capital sourcing. The government would face potential financial impediments, if the responsibility to undertake societal and community measures were placed on its shoulders alone. Companies being a part of the community, owe a moral obligation to contribute to the welfare of such community as their action impact citizens; this gives the affected community a moral right such companies to undertake certain actions (even though they do not possess voting rights).
- Secondly, the issue of free-riding and hoarders cannot be slighted.
In the absence of mandatory penal provisions on firms that satisfy the conditions laid down in s135(1), few companies that undertake CSR activities out of purely humanitarian and philanthropic objectives, are put to disadvantage by other firms that seek to benefit from such measures, without incurring any costs on the CSR front. This is the free-rider concern, and it has the potential to impact the philanthropic and ethical objectives of companies that originally intended to contribute to CSR development.
Therefore, bringing in a mandatory statutory provision with strict compliance measures and scrutiny, will ensure a level playing field for all companies that satisfy s135(1), without disturbing the delicate stakeholder obligations of existing corporate culture.
- An argument raised frequently is that spending net profits and income on CSR might lead to losses, but statistics and investor behavior says otherwise. Customers have been found willing to switch to companies that support a social cause. It is also observed that customers choose companies that help build their self-identity through consumption choices. For instance, McDonalds, which is one of the biggest fast food chains, makes a substantial contribution to Ronald McDonald House Charities that caters to critically ill children in want of medical attention, by providing them with housing and medical care.[9] During the 1992 South Central Los Angeles riots, as pointed out by Philip Kotler and Nancy Lee in their book, Corporate Social Responsibility: Doing the Most Good for Your Company and Your Cause, “vandalism caused tremendous damage to business in the area… but rioters refused to harm (McDonald’s) outlets.”[10] As a result, McDonald’s acquired a competitive advantage against opponents by avoiding numerous vandalism expenses through its involvement in CSR and enhanced reputation.[11]
Arguments against the Amending Provision
- The prime contention raised against the penal provision, is the objective behind CSR in a free market economy; CSR is driven by purely voluntary and philanthropic ideals. By making it a mandatory provision attached with penal sanctions, it becomes a coercive governmental measure and its voluntary nature ceases. Moreover, such coercion from the government could create hostility in corporate culture and governance, by driving out humanitarian objectives that presently exist in companies. As can be observed in 2018 alone, there was a 47% increase in CSR expenditure as opposed to the amount spent in 2014-15 (Rs 7,536 crores).[12]
There is no incentive for companies to mandatorily comply with the new provision. In actuality, such coercive measures might be viewed by companies as a governmental rhetoric to disguise a dearth of efficiency and competence in catering to the society.
- Small and Medium Enterprises (SMEs) constitute a major chunk of India’s corporate pool and they contribute significantly to India’s economic growth. SMEs are in greater touch with the local community and its needs, and it has a greater immediate impact on such community.[13] But the qualifiers contained in 135(1), at times would make SMEs eligible for compulsory CSR contribution. But this can be detrimental owing to the following pertinent reason.
The contribution to CSR is contingent upon the profits that SMEs earn each successive year. But the profits earned in SMEs, as opposed to large corporations, is not uniform; it fluctuates on a yearly basis. when profits do reach the mark, these companies are required to contribute to CSR by keeping the operational costs of their other business operations low. The other alternative would be for companies operating in the same community to collaborate and jointly contribute to the CSR mandate. But owing to logistical difficulties and business interests, many of the SMEs prefer to make individual charitable contributions to NGOs, as opposed to a specific CSR measure mentioned in Schedule VII.
And even in instances where SMEs do meet the mark up value, they lack institutional capacity to formulate and implement CSR measures on their own. They require assistance in capacity building and incentivization, among other factors.
- A penal measure in enforcing mandatory CSR makes it a tax, as opposed to a social welfare measure. Only tax enforcing and regulating laws require strict scrutiny and implementation in bringing companies to comply with statutory provisions. But this amendment to the Companies Act has seen a disfavouring shift from ‘comply or explain’ to ‘comply or get punished’. This essentially abrogates the very essence of the CSR concept.
While the importance of stakeholder welfare is undisputed in Indian society, an iron handed top down governmental approach on private entities, in a free market to undertake socially beneficially measures, is not short of absurdity.
CONCLUSION
While the importance of social responsibility and sustainability goes unsaid, the direct benefit that it accrues to a company cannot be denied. It is proved that a company’s CSR initiatives actually bolsters investor interest and leads to direct increase in profits. Investors are highly attracted to sentiment driven actions of corporations. But this general tendency cannot and should not be construed as a universal opinion.
While in the 90s, investors world-wide inclined themselves towards dot-com companies, and in blockchain companies in the early 2000s, the corporate world today is seeing a significant inclination of a similar sort in terms of CSR driven initiatives.[14] This enables companies to not only attract employees and investors who are ready to undertake a job at lower pay scale with added social benefits and those that are ready to pay higher share prices for stocks in CSR active companies respectively, but also boosts its traditional bottom line owing to the same.
While these benefits seem alluring and the general shift in global investor mindset seems enchanting, a mandatory provision for CSR compliance, accompanied by penal sanctions results in paradigmic shifts.
The focus starts to center around spending a specific amount of money, rather than focusing on socially beneficial measures.[15] By enlisting a limited number of avenues in which companies can contribute their profits under Schedule VII, companies are most times effectively barred from pursuing their own social interests in the communities in which they function. This can have disastrous consequences.
Though there is a steady cash outflow of 2% of the company’s net profits of its preceding years (limited to three), the beneficiaries of such measures might not be its employees, its local community, the social groups that reside in its neighbourhood or local governmental authorities. This can create prejudice in the minds of relevant stakeholders at the supposed lackadaisical attitudes of the company to its own community. The prejudice can lead to a drastic fall in investor attractiveness and potentially affect the opinions of employees, leading directly to fall in share prices and losses.
Therefore, a vicious circle gets created where a sum of money constituting profits, is consistently pumped out of the company each year, while simultaneously, the entire stakeholders (including shareholders) are losing their faith in the company owing to its socially and ethically negligent approach in operations. Ultimately it is the business and the company that suffers from the hard-handed rule of a democratic government on a free competitive market.
Therefore, it is imperative to roll back the penal provisions attached to CSR and maintain the sanctity of philanthropic initiatives. While the benefits accruing to businesses and governments might be galore, the very nature and objective of the idea of CSR should not be pushed to the shadows; for it can cause a vicious cycle of no escape.
REFERENCES:
[1] Companies Act, 2013, § 135(1).
[2] The Companies (Amendment) Act, 2019, § 22.
[3] The Companies (Amendment) Act, 2019, § 21.
[4] Fulton Friedman, A Friednzon doctrine, The New York Times, Sept. 13, 1970, https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html.
[5] World Business Council for Sustainable Development, Corporate Social Responsibility: Making Good Business Sense, (Jan, 2000), http://ceads.org.ar/downloads/Making%20good%20business%20sense.pdf.
[6] Timothy F. Slaper, Tanya J. Hall, Comment, Triple Bottom Line- What Is It and How Does It Work?, Indiana Business Review, Vol. 86, No. 1 (2011).
[7] John Elkington, 25 Years Ago I Coined the phrase ‘Triple Bottom Line.’ Here’s Why Its Time to Rethink Tt, Harvard Business Review, (Jun. 25, 2018), https://hbr.org/2018/06/25-years-ago-i-coined-the-phrase-triple-bottom-line-heres-why-im-giving-up-on-it.
[8] Joseph E. Stiglitz, Is Stakeholder Capitalism Really Back?, Project Syndicate, (Aug. 27, 2019), https://www.project-syndicate.org/commentary/how-sincere-is-business-roundtable-embrace-of-stakeholder-capitalism-by-joseph-e-stiglitz-2019-08.
[9] Ronald McDonald House Charities, McDonald’s Relationship, (Sept. 21, 2012), http://rmhc.org/who-we-are/our-relationship-with-mcdonald-s/.
[10] PHILIP KOTLER AND NANCY LEE, CORPORATE SOCIAL RESPONSIBILITY: DOING THE MOST GOOD FOR YOUR COMPANY AND YOUR CAUSE 37 (2005).
[11] Palmer and Harmony J, Corporate Social Responsibility and Financial Performance: Does It Pay to Be Good? (2012) (unpublished, B.A. thesis, Claremont McKenna College) (on file with the Department of Economics-Accounting, Claremont McKenna College).
[12] Umakanth Varottil, Analyzing the CSR Spending Requirement Under Company Law, (May. 4, 2018).
[13] PriceWaterhouse Coopers (CII), Handbook on Corporate Social Responsibility in India (2014).
[14] Wan Lee Yok, Beyond the Bottom Line: Investors Favour Companies that Give Back, (Jul. 30, 2019), https://phys.org/news/209-07-bottom-line-investors-favour-companies.html.
[15] Anonymous, CSR: CII to Approach Govt in Penal Provisions; FICCI Says Changes to Encourage Tick-Box Compliance, The Financial Express, (Aug. 2, 2019, 10:55 PM), https://www.financialexpress.com/industry/csr-cii-to-approach-govt-on-penal-provisions-ficci-says-changes-to-encourage-tick-box-compliance/1664579/.
