Corporate Purpose and the Dangers of Government-Mandated CSR

The debate about the purpose of corporations seems to have heated up after Larry Fink’s annual letter to the CEOs of companies in which BlackRock invests and again after the statement from the Business Roundtable. Both Fink’s letter and the Business Roundtable statement referred to global problems and how companies should embrace a greater responsibility to address them. The statement by the Business Roundtable has been perceived variously as a major shift in corporate law or as a PR exercise to prevent government regulation.

Irrespective of its motivations, while an acknowledgement that a consideration of stakeholder interests is useful, an invitation for government to require actions by companies to address these world problems would be problematic. As Professor Jeffrey Gordon posted here on this blog, it is the government’s responsibility to address these problems via taxation and redistribution as well as regulation in areas other than corporate law. Although Professor Tim Wu argued here that this amounts to passing the buck to government, a situation where we allow the government to require companies to perform public duties would amount to the government passing the buck to corporations. The example of India’s CSR law provides a cautionary tale.

India’s company law was amended in 2013 to include a provision that required companies to engage in “CSR activities” on a “comply or explain” basis. Essentially, it required large companies to annually spend at least 2 percent of their preceding three financial years’ average net profits on CSR activities. The law also specified what would be considered as a CSR activity and included areas like education, healthcare etc. The companies then had to disclose the details of the CSR spending in their annual report. If they had not complied with this provision, they had to explain the reasons for it. Thus, the law left it to shareholders to question management about non-compliance.

Although areas like education and healthcare are typically government responsibilities, many companies initially viewed this requirement as allowing them to enhance their reputation and goodwill. The Indian government saw the CSR requirement as good citizenship on the part of companies, and CSR activities as a contribution to the development of the country. Despite the government attempting to offload some of its responsibilities on to corporations, the law could be considered fairly benign, even positive, considering that it was only enforced via a comply or explain mechanism.

However, a recent amendment to this provision would have added stringent penalties, turning what started as a voluntary provision into a mandatory one with shark teeth.  As a first step, the amendment had proposed that any unspent CSR amount that was committed to ongoing projects would be transferred to an escrow account for three financial years. If the amount remained unspent after the three years, then it would have to be paid to the government. Failure to comply with these requirements could result in monetary penalties for not just the company but also every officer of the company. Additionally, company officers could also be subjected to imprisonment of up to three years.

The amendment provoked a lot of criticism, which resulted in its eventually being put on hold. Business executives were worried  that the penalties were too harsh and could lead to harassment of companies by government officials. Prior to the amendment, despite arguments to the contrary, the CSR provision did not constitute a tax because it was not collected and spent by the government. Rather, the provision nudged companies to spend a certain amount on CSR activities, and they would have to explain to shareholders via the annual report any failure to do so. With the amendment seeking to force companies to transfer unspent amounts to the government, the requirement would have taken the form of an additional tax on companies, with no justification provided. Had the amendment been enacted, companies might have preferred to simply treat the CSR spending as a tax and transferred the money to the government rather than risk starting projects that might not fully consume the allocated amount in the given time period. Mandatory CSR requirements thus risked killing voluntary initiatives of companies for the welfare of their stakeholders.

It is not far-fetched to imagine the debate about corporate purpose being extended to an argument for government intervention. In fact, Elizabeth Warren’s proposed Accountable Capitalism Act would require companies with over $1 billion in revenue to apply for a federal charter that would then tell company boards to consider the interests of all stakeholders and not just those of shareholders. This proposal is only one step away from telling corporations what societal problems to focus on. Such government intervention should be avoided not only because it would let the government pawn off its own responsibilities but also because it would detracts from the company’s actual business. In addition, it would chill actions that companies might have voluntarily initiated in favor of stakeholders because such actions would no longer distinguish them from other corporations.

This post comes to us from Dr. Akshaya Kamalnath, a lecturer in corporate law at Auckland University of Technology.

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