The Taking Pledge: The Unmaking of CSR

Some people think I am an optimist because I don’t like to participate with a typical Indian 100 decibel voice in critiquing our political scenario. However, I like to look at myself as more of a realist – to borrow our Great Father’s words, if you can’t be the change (you wish to see in the world), stop bothering. After the recent years of scams, governance failures and Parliament cat-fights, many (especially the hot-shots tracking emerging economies from half the globe away) believe India cannot do any wrong any more – that we have hit rock-bottom. Yet sometimes, out comes a googly from our choked Legislative offices that makes me shake my head with disbelief.

The Law

The recently passed Companies Bill 2012 mandates certain companies (networth, turnover and profitability qualifications) to allocate 2% of their profits to corporate social responsibilities (CSR) initiatives. The Board is ‘entrusted’ the responsibility of ensuring this spend or providing ‘detailed reasons’ for non-compliance which can invite regulatory action, thereby making the provision for all practical purposes, mandatory. The Board is required to constitute an independent director containing ‘CSR Committee’ , which will formulate the ‘CSR Policy’ and recommend expenditures to the Board.

CSR is the new buzzword in town

The Philosophical Question

Article 19 (1) (g) of the Indian Constitution guarantees the freedom to practice any profession, or to carry on any occupation, trade or business. Article 19(6) allows the State to impose ‘reasonable restrictions’ on the said freedom. I am no expert on law (much less constitutional law), but in lay man terms what this means is that the Government cannot tell you how to run your business, much less tell you what and how much you should spend on, except via the imposition of taxes under law. While I cannot comment on the constitutionality of the said provision, from the standpoint of political philosophy, this virtually amounts to ‘appropriation’ of resources by the State.

The new Companies Act will mandate a 2% CSR spending

The responsibility (dharma, if you will) of a corporate entity is to earn a return for its owners/shareholders, within the operation of law of the land. The decision on how corporations and its individual owners choose to spend their purchasing power in a free society is their own individual choice. Indeed, many corporations are already engaged in widespread CSR activities (Kotak Education, Dhirubhai Ambani Foundation et al) – but to have the Government point a loaded shotgun to their foreheads seems ludicrous, pointless and shameful for a free society.

The Practical Problems

1. The giving model: Philantrophy works via several models, but globally, the largest foundations such as the Ford Foundation, Rockefeller Foundation, Bill and Melinda Gates Foundation et al have been possible via generous endowments made by uber-rich families . Through the efforts of the likes of Gates and Buffett, the Giving Pledge has also been popularised worldwide. In India, the likes of Azim Premji (Wipro) and Shiv Nadar (HCL) have transferred hundreds of millions of dollars worth of their shares to endow foundations to tackle social issues.

These generous contributions are indeed much larger than what the Bill has envisaged. However, since these endowments have been in effect, a transfer of shares by the promoter (which in Premji’s case equals an endowment by 79% of Wipro) , they will not be accounted for in the mandatory spending simply because of the narrow scope of the provision. On the other hand, this narrow trickle of spending based on profitability is hardly likely to create an institution of the likes of the Rockefeller Foundation in India.

The Rockefeller Foundation has been one of the most effective Foundations in the world

2. The agency problem: A company is a unique commercial body, in the sense that its ownership is diverse and divorced from its management. (Most) companies are run by professionals and owned by a group of shareholders, large and small. For a long time, people have debated on how does one ‘incentivise’ managers to run the company in the best interests of its owners – with limited answers. This provision, in effect, will allow the Board to super-impose its will and judgement over the individual freedom of choice of shareholders – and undoubtedly lead to $5000 black tie fundraiser dinners, honourary PhDs and University chairs for senior management and lots of photo-ops. Moreover, it provides shareholders no real say in choosing the causes their monies will be utilised for  – reducing them to mere spectators in another lawful exercise of managerial excess.

3. The wealth erosion – The current Sensex (India’s top 30 companies) market capitalisation is ~US$600 Bn. Since most companies are valued based on the Price/Earnings Ratio, a drop in 2% of earnings will directly erode ~$12Bn liquid wealth from the markets. Today, hundreds of small investors are invested in the equity markets via index funds and mutual funds, saving for their dream home or their children’s education. The compounding effect of a 2% leakage can be devastating in the long run -consider that a company has a capital base of Rs 100 which it can invest at 15%. Over 10 years, that translates to ~404.55. If however, the growth rate is reduced to 14.7% (15% – 2% of 15) translates to ~394. 12 – an effective of leakage of 2.64%. Extend this exercise to 20 years, and the leakage hits 5.36%, compounding as we increase the years.

Sachin Pilot, one of India’s youngest and most educated politicians

Sachin Pilot, the new Minister of Corporate Affairs is the poster boy of new India. He is young, suave and well-travelled. Not withstanding for his lack of experience in company law and overlooking the obvious questions the provisions raise (tax implications? related party CSR activities? et al), he represents hope for the middle-class youngsters out to make it in an inflation-ridden India. Moving the bill in the Parliament, he remarked that these provisions did not amount to the return of the ‘inspector raj’ and that this was an ‘evolving idea’ (given that no developed nation has thought it wise to legislate on this subject).

‘Sustainability’ and ‘CSR’ are the new buzzwords of the time, and philantrophy is ‘in’. But, no amount of CSR spending can ‘wash away’ poor corporate practices or bad governance – Satyam was a ‘model citizen’ until the fateful letter made the press. While hospitals and schools make for great photo-ops, the voice of a young entrepreneur who struggles to finance a machinery overhaul because his free cash flow is burdened by another ‘tax’ or those educated but left unemployed because a foreign investor, never sure of the ‘cost of doing business’ in India chose to allocate his capital elsewhere remain unheard. One would have expected better from Stephens and Wharton.

(Views are personal. The author can be reached at aniket.nikumb@gmail.com or via twitter at @aniket_nikumb)

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