Under Section 245 and 246 of the Bill, class-action suits may be filed by investors in a court of law if they believe that the affairs of the company are being conducted in a manner detrimental to the interest of the company and its shareholders. Enabling such class-action suits should, in the long-run, help improve the quality of financial reporting as well as the quality of corporate governance among firms.
The importance of the provision can be gauged by the experience of the Satyam fraud. Well over three years after the scandal broke; Indian investors are yet to get any significant compensation in the 8,000-crore fraud allegedly committed by the promoters of Satyam Computer Services. But some of their counterparts in the US, who owned American depositary receipts, have made the company commit to pay $125 million in settlement by taking recourse to the strong class-action framework.
Other provision in the Bill that has arguably ignited the biggest debate is the provision of mandatory spending on corporate social responsibility (CSR). The legislation, to be now introduced in the Rajya Sabha during the budget session, has put the philanthropy by India Inc back in the limelight. Even as corporate have largely voiced their concerns over the mandatory nature of the provision, the jury is still out on whether the CSR spending track record will, in the coming years, impact the valuation of a company by investors.
The concept of mandatory CSR spends, in the Indian context, according to analysts, it would take some time to sink in. But as has been the experience in the West, as consumers and investors become more socially aware, they are more likely to prefer companies that have a better tract record on discharging their social commitments, including possibly CSR activities, as compared to those who are found wanting on these fronts. This might not work over a short-term horizon, but in the long run, those adhering to the norms are likely to be preferred by investors, job seekers, advertisers, among others.
This is precisely the point that the government is banking on, by making it mandatory for firms to spend a share of profits but stopping short of prescribing a penalty for those not in compliance, but merely the need to mention this in their annual reports. Peer pressure, as they say, is a big force multiplier.
According to the Bill, every company having net worth or net profit of more than Rs 500 crore or turnover of more than Rs 1,000 crore will have to “ensure” that it spends at least 2 per cent of the average net profits of the company made during the last three financial years towards CSR activities. In case it does not, the company will have to give an explanation and will have to disclose it in the annual accounts. However, given the wide scope of definition of CSR, the company can undertake a wide range of activities and fulfill the norm.
The question is whether spending money towards these activities yield pays off in form of a better valuation and perhaps high shareholder preference for stocks of such companies. Kaushik Dutta, director at Thought Arbitrage Research Institute (TARI) says that there is no co-relation between the valuation of a company and the amount it spends towards the society. All the same, he said, “There are certain social funds which invest only in such companies which have ethical investments,” that is, such companies avoid investing in companies associated with alcohol, tobacco, gambling, violating environmental laws and involved in child labour.”
In fact, though the exercise helps in better brand building, shareholders view CSR with skepticism, as more spending on CSR means less profit for dividend.
“So you can say that CSR is in a sense anti-shareholder. In my view, if at all the CSR activities have to be done, they should be carried out by the promoters and not the company. With it becoming mandatory, it will end up as more of an accounting activity,” Prithvi Haldia, CMD, Prime Database, said.
On the other hand, the promoters of CSR activities say that the more socially responsible a company becomes, the more goodwill it earns, making it an obvious ethical choice for some investors. CSR, as a definition, does impact the way a company is viewed, Bhaskar Chatterjee, director general and CEO of the Indian Institute of Corporate Affairs (IICA), said.
“Notionally, you can say, it does happen. In the last 3-4 years, consumers and stakeholders have become far more conscious of products and the services being offered to the community. The companies that are seen to have diluted their commitments to society are not being viewed in a positive light,” he said.
The trigger for this change, he said, is more awareness and education among people about their surroundings, environment, social values across the world.
According to a research paper by Caroline Flammer of the MIT Sloan School of Management titled ‘Corporate Social Responsibility and Stock Prices: The Environmental Awareness of Shareholders’ dated May 2012, anecdotal evidence in the US suggests that “a company’s environmental footprint can affect stock prices.”
Taking the example of British Petroleum’s (BP) oil spill incident in April 2010, the paper sheds light on how the oil spill that contaminated a large area of marine environment along the Gulf of Mexico, affected BP’s stock prices. While on the day of the incident, BP’s stock price was $59.5. In just two months the stock price had dropped to $28.9. On the other hand, 11 years earlier, in the Exxon’s oil spill case in March 1989, considered one of the most damaging incidents to the environment, the company’s stock price decreased only marginally. On the day of the incident, Exxon stock price was $44.5. It went down to $41.75 in April, quickly recovering to its pre-incident level by June 1989. Analysts point to the fact that investor response to events such as the Exxon oil spill over two decades ago was much more muted that the BP experience in 2010, reflecting the increase in investor perceptiveness to such incidents.
Sanjay Mukherjee, professor of business ethics at IIM Shillong, said that with the increasing awareness among investors, the trend of investment in companies with a strong CSR record is likely to grow. The changing notion of CSR has prompted the companies to carry such activities not only for common people but also for stakeholders, he said. “Earlier, CSR was philanthropy but now it’s more participative in nature,” he said.
Back then, the companies wanted to change their image from profit-hungry entities to magnanimous philanthropists. The investors do buy shares based on company rating and peer group suggestion, a shift in buying behaviour is bound to happen with changing times, he said.
All in all, the concept of CSR as a core function of a company, is still in early stages. But as companies that set the benchmarks by extending themselves beyond their narrow commercial interests beginning to command greater respect, the mandatory CSR spend declaration could spur thing on in the coming years.