Distorting voluntary CSR culture

-This article was originally published in The Himlayan Times by Aayushma Shrestha on April 30, 2017.

The unseen side of mandatory corporate social responsibility

The new Industrial Enterprise Act, 2016 has made it mandatory for all industries and companies making annual business transaction of above NRs 150 million to contribute at least 1% of their annual profit to Corporate Social Responsibility (CSR). The Minister himself appears to have been very interested in this idea of mandatory CSR, and has been engaging with various stakeholders regarding formation of a CSR Fund and preparation of working procedure to operationalize the Fund.

As per the ongoing talks, the collected endowment is planned to be set aside in Children Welfare Fund with the intention to increase access of education, health and skill development opportunities for children living in remote areas. Meanwhile, two state-owned cement factories have already committed to allocate at least NRs 1.5 to NRs 2 per sack sold for CSR. Nepal Rastra Bank (NRB) has also issued a circular for Banks and Financial Institutions to contribute at least 1% of their net profit to various CSR activities.

While the intention of the government—making the profit-making firms responsible for the welfare of the society and environment it operates in—is straightforward, delving into the implications of such legislation reveals unseen consequences. It is evident in economics that any policy-related change leads to changes in behavioral responses. Thus, while enforcing new legislation, legislators need to be weary of what kind of incentives or disincentives their legislation are laying down for people; legislation that are not well-thought through have a potential to cause more harm than the intended good.

Tax burden

Any type of mandatory expenditure can be regarded as tax. This implies that the greater the contribution of a business in CSR fund, the lesser will be their disposable income. It is bound to make Nepal a less attractive investment destination. Moreover, Nepal’s propensity to legislate new regulations is not helping itself. Investors seek predictability and security in any potential investment destination. When there is a degree of political instability as in Nepal, and when every new government introduces a new legislation, it is natural for investors to start exploring alternative destinations.

This legislation is going to increase cost of doing business for domestic investors alike. Moreover, it will be perfectly rational for enterprises with annual transactions less than NRs. 150 million to avoid expanding their business as there are greater disadvantages for the entrepreneur with more legal obligations. Also, as in case of high taxes, other businesses will be rather encouraged to explore loopholes in the law to avoid greater portion of their fruits of labour being taken away.

A mere reallocation of resources

Speaking of private enterprises, the activities that these enterprises undertake are both profitable and good for society, as they expand economic opportunities. By engaging in production, profit making firms create employment opportunities, and continuously serve consumers with products and services that ultimately uplift their quality of life. Though the direct motive of such firms to make profit for their shareholders is most apparent to the public, they eventually are also benefiting their employees and consumers who are a component of the society.

Besides, many businesses in Nepal are already voluntarily engaged in philanthropic activities. Imposing mandatory CSR on such profit-making private firms will distort the voluntary CSR culture. The government control on these funds will divert funds to other democratically determined sectors than where the businesses had previously been spending. The problem lies in the fact that this does not increase the welfare of the nation as one developmental activity is being funded at the cost of another activity. Through CSR fund, the government is not creating new CSR activities but is simply shifting it from one sector to another.

Shareholder and consumer point-of-view

Ultimately, shareholders are the rightful owners of any business’s gains because it is their investment that generates any gains in the first place. Voluntary CSRs happen because they are mutually beneficial to both the shareholders and the society. Companies try to align CSR with company’s objectives in order to create win-win situation.

That said, any provision of mandatory CSR spending is an exploitation of shareholder wealth, as it will neutralize any gains that the shareholder or the business itself would achieve. What is even more important from the well-being of the society’s perspective is that when businesses are forced to engage in activities that increase their cost of doing business, any additional burden is transferred to the consumers by means of higher prices for goods and services. At this point, programs like mandatory CSR start rendering a negative impact in the well-being of the society instead.

Weak administrative capacity

Irrespective of the government’s genuine welfare intentions, Nepal is a poor country whose government has a weak fiscal and administrative capacity. The government has very limited knowledge about efficient management of the little resources at our disposal. There are various evidences of the government initiated activities delivering sub-par results for the same reason. Moreover, lack of incentives within the government administration can be regarded as one of the reasons behind recurring inefficiencies in materializing even the national priority projects. In such situation, it cannot be considered as a smart move for the government to add on additional responsibility instead of concentrating on the already existing projects.

The result of this coercive mechanism is bound to be counter-productive. This regulation provokes more bad than good for the shareholders, consumers and the needy sector as well. The government should rather focus on making a policy that is effective and beneficial to all. The Government of Nepal needs to concentrate on making favorable investment climate and contributing to organically raise corporate standards which will eventually uplift the socio-economic condition of Nepal rather than piling up multiple responsibilities that are unattainable all at once.

A rational policy would not be to make endowment compulsory but to encourage corporate houses to contribute in CSR activities through acknowledgement and reward mechanisms. CSR activities are sustainable only when done with the best interest of all the stakeholders. Market-awarded social responsibility for business is more guaranteed than the government mandated one.