Monday, September 14, 2015

CSR Spending – For Whose Benefit?

Section 135 of the Companies Act 2013 requires every company having net worth of Rs 500 crores or more or turnover of Rs 1000 crores or more or net profit of Rs 5 crores or more in any of the previous three financial years to spend at least two per cent of the average of the ‘before tax profit’ of the previous three years in corporate social responsibility (CSR). Strictly speaking, spending is not mandatory. If a company fails to spend the specified amount on CSR in any year, it needs to explain the same. 2014-15 is the first year when companies were required to comply with the new law on CSR. Initial analysis shows that many companies have failed to spend the full two per cent of the average of the before tax profit of the previous three years. However, most companies have expressed their commitment to CSR.

Schedule VII in the Companies Act 2013, which list activities that qualify as CSR initiatives includes eradicating hunger, poverty and malnutrition; rural development project; slum development; promoting preventive health care and sanitation and making available safe drinking water; promoting education; promoting gender equality; empowering women; setting up old age homes; reducing inequalities faced by socially and economically backward groups; ensuring environmental sustainability; protection of national heritage; setting up of public libraries; promotion and development of traditional arts and handicrafts; training to promote sports; and measures for the benefits of armed forces veterans, war widows and their dependents. Contributions or funds provided to technology incubators located within academic institutions also qualify as CSR spending. Similarly, contributions to Swach Bharat Kosh, Clean Ganga Fund, Prime Minister’s National Relief fund or any other fund set up by the Central Government for socio-economic development and relief and welfare of the Scheduled Castes, the Scheduled Tribes, other backward classes, minorities and women. The government allows companies to liberally interpret the list.

A reading of the list might give an impression that CSR is about corporate spending on community development that benefits socially and economically vulnerable sections of the society and environment sustainability. But that is not correct. As per law it is not necessary that CSR expenditure should benefit socially and economically vulnerable sections. There are examples where companies have used the CSR fund to set up and support international school, university and world-class hospital in metro cities. Those institutions charge the market-based prices for their services and use the surplus for expansion. I doubt whether such initiatives improve the education or healthcare eco-systems to improve the average quality of education or health care system in the country, because such initiatives fail to build the critical mass necessary to catalyze the necessary transformation. Such CSR initiatives do not benefit the vulnerable sections of the society, directly or indirectly. The direct beneficiaries of those initiatives are the members of the business family, as their direct involvement with those activities enhances their social stature. It is appropriate to spend family wealth, rather than shareholders’ wealth for those activities.

Activities that are undertaken by the companies in the normal course of business do not qualify as CSR activities. However, most CSR initiatives are linked to business strategy. They create either valuable intangible assets or strengthen the input or output market of the company. For example, companies whose products or processes deplete or pollute the environment spend a significant portion of CSR fund in environment sustainability initiatives to dispel criticism. For others, environment sustainability is not a priority. Companies, such as chemical and mining companies, earn goodwill by spending CSR fund to reduce the pain inflicted on the community by their operations. A Company spends CSR fund to develop skills that are useful in its business. Similarly, a company in agri-business helps farmers to improve the farm productivity and quality of produce that it uses and shares the benefits with farmers. Companies producing sports goods spend money for promoting sports.

Companies comply with the new law by continuing with the same kind of activities that they used to carry to benefit the business in the garb of CSR. We may hope that spending on those activities will increase and a small portion of CSR spending will benefit the vulnerable sections of the society. Perhaps, companies will create little more positive externalities by not spending resources on initiatives that exclusively benefit employees or those who are directly linked to the value chain.

There is nothing wrong if CSR strategy flows from the business strategy. However, it is wrong to posture that companies have become more sensitive to the plights of vulnerable sections of the society and CSR spending is targeted at them. It is also wrong to spend shareholders’ wealth in activities that primarily benefit the promoter (and not the company), may not be financially, but otherwise.