India Inc.’s Day Care Experiment

In 1998, two economists ran a freakish experiment in Israel.  They were trying to get tardy parents to pick up their children on time from Haifa’s day-care centers. Haifa’s day-care centers close at 4 pm, but parents were not penalized for showing up late.  The economists had six out of the ten participating centers impose a fine. The imposition of a fine, they argued, would force delinquent parents to arrive on time. They were wrong. The number of parents who reported late to pick up their children more than doubled. Faced with this startling finding, economists Gneezy and Rustichini reasoned that money wasn’t always a great incentive.  Having to apologize to a day care worker who had taken care of their child exerted a far more powerful if unseen hold on parents. Imposing a fine eased their conscience. It crowded out the moral and ethical stigma of inconveniencing their children’s daytime guardians and allowed parents to view late coming as a legitimate option purchasable by money.

If Haifa’s six day-care centers seem like a small sample size, India’s Ministry of Corporate Affairs has kick-started a massive experiment of its own. In 2013, India enacted a new company law. The law introduced mandatory spending on corporate social responsibility (CSR) activities for companies exceeding a threshold net worth, revenues, or profits. Apart from framing and implementing a CSR policy that targets any of the enumerated socio-economic goals within the law, a company is required to spend 2 percent of the average net profit for the previous three years in implementing the policy. Non-compliance will lead to disclosure of the same to stock exchanges. The law therefore aims to use a name-and-shame approach as a stick with which to have companies bite the CSR carrot. Fail to spend and your wrongdoing will be disclosed to the world at large.

The mandatory spending requirement is unique and unusual. Traditionally, academic opinion has questioned the purpose of CSR. According to one school of thought, a company exists for the sole purpose of profiting its shareholders: directors may not concern themselves with problems of society. In Dodge v Ford Motor Co, for instance, Ford Motors dispensed with special dividends for shareholders altogether so that funds could instead be invested in increasing production, employing more workers, and increasing their wages to “spread the benefits of this industrial system to the greatest possible number.” The Michigan Supreme Court promptly struck down the move, citing a breach of the directorial duty to maximize shareholder profits.

In contrast, another school of thought views corporations as social entities—created and governed by societal laws, existing not just for the creation of wealth for a narrow class of shareholders whose identity changes with every transfer of share, but rather to create value for society at large. For such scholars, a company may profit in a manner that is socially beneficial and responsible. CSR fits within this “company as a social entity” conception of corporations. But even on this spectrum, the mandatory spending rule represents a new extremity altogether. While companies have previously been constrained by CSR rules and other socially beneficent labor and environmental statutes, they have never been made to mandatorily spend on CSR activities.

In fairness, reports indicate that the older law implemented in 2012 appeared to cause a spike in CSR spending compared to previous years. Similarly, the mandatory spending requirement is expected to generate another spike in CSR funding amongst companies. Supporters argue that such funding is necessary to evenly distribute the gains from India’s fast-growing economy. Yet there are at least three principled objections with the new CSR law.

First, the mandatory spending law equates CSR with corporate charity. Not only is this a hopelessly outdated understanding of CSR, but far more egregiously, it allows delinquent companies the right to buy their way out of wrongful conduct much like Haifa’s delinquent parents. The CSR equals charity approach entitles a company to ignore stakeholder interests and harm community norms as long as it spends 2 percent of its net profit on its favorite charity. On the scale of CSR involvement, experts peg corporate charity as the very least companies can do. Companies could be far more usefully involved in CSR work if they worked on delivering social or environmental benefits to stakeholders, consistently complied with scrupulous norms of business conduct, or created new business models to address socio-economic problems.

Second, notwithstanding the conceptual problem of equating CSR with charity, the law is poorly envisioned and badly drafted.  There is little regulatory oversight to ensure that money is not tunneled out for self-serving purposes or used as illicit campaign finance. The Airport Authority of India for instance, announced plans last year to spend Rs. 100 million ($1.5 million) for building wrestling arenas in the constituency of the then-civil aviation minister. Such instances lend credence to claims that mandatory CSR spending will be grossly misused.

Third, even assuming that the mandatory spending requirement may deliver credible CSR activity, the law presently comes with little sanction for non-compliance. Delinquent companies must explain why they failed to spend the requisite amounts, but there are no accompanying fines or penalties. The “comply or explain” approach has a proven track record of failure in India’s context. The older CSR law enacted by India’s securities regulator in 2011 employed a similar method. Companies that did not comply with the voluntary business responsibility guidelines had to explain their non-compliance in reports filed with the regulator. But actual enquiries into non-compliance were rare. Consequently compliance was low, and where companies did in fact comply, CSR was reduced to a “tick-the-box” exercise, one amongst the numerous documents company secretaries would routinely file. In making CSR compliance a board-level issue requiring directorial oversight, the new act does take a step forward. But absent a stronger sanction, reports suggest that CSR spending is unlikely to be adopted by companies in letter or in spirit.

Making the country’s richest corporations co-sharers to India’s socio-economic responsibilities is an irreproachable aim. The mandatory spending law, however, errs in both intent and implementation. Other countries have provided for stakeholder (not merely shareholder) consultation and have made directorial sign-offs mandatory on decisions affecting stakeholder interests. Such measures make socially responsible behavior an ongoing duty for companies, forcing mangers to continually confront the moral outcomes of their less-than-palatable actions. On the other hand, the mandatory spending requirement may crowd out these ethical factors, ease prickly consciences and even provide a valuable public relations opportunity to otherwise deviant companies. If Gneezy and Rustichini had any doubt of their findings, adequate confirmatory proof is most likely on its way.

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