When BlackRock CEO Laurence Fink announced that his $6 trillion investment firm wanted to support companies that benefit the “communities in which they operate,” it sounded like a shot across the bow: companies could either invest in socially responsible initiatives, or no longer get BlackRock’s investment.
“Society is demanding that companies, both public and private, serve a social purpose,” Fink wrote in his annual letter to S&P 500 CEOs. “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”
Fink was tossing fuel on a heated debate of whether it should be compulsory for companies to engage in corporate social responsibility (CSR). Given that BlackRock, as the world’s largest money manager, controls an amount equal to the gross domestic product of Japan, Fink’s words can carry the weight of law, which begs the question: Should it be an actual law for companies to do CSR?
It’s a timely question, given how many countries are considering legislation that would require companies report CSR and even spend on CSR. India in 2013 became the first country to mandate companies spend on CSR, and Indonesia’s legislature is now considering a similar bill.
But investment firms and governments alike should think twice before mandating CSR spending, according to Shivaram Rajgopal, the Roy Bernard Kester and T.W. Byrnes Professor of Accounting and Auditing. Drawing on empirical evidence from India, Rajgopal warns that forcing companies to take on socially responsible initiatives can backfire by causing a decline in CSR spending. His two multi-year studies add to a growing body of skepticism around the bottom-line benefits of CSR
“Once you start mandating good behavior, it becomes a compliance exercise,” says Rajgopal. “People start gaming the system, they start doing the bare minimum.”
Because of India’s position as the world’s only country to legally require CSR spending, it provided Rajgopal with a unique case study. Legislation requires that companies with profit of at least 50 million Indian rupees ($678,000), net worth of at least 50 billion ($678 million), or sales of at least 10 billion Indian rupees ($135 million) invest 2 percent of profits into CSR. The law took effect for the financial year 2014-2015.
The impact was immediate. Rajgopal found that firms affected by the law saw an average 4.1 percent decline in their stock value, according to his first paper, “Does Corporate Social Responsibility Create Shareholder Value?” — co-written with Hariom Manchiraju of the Indian School of Business and published in December 2017 in the Journal of Accounting Research. Moreover, affected firms had a lower Q ratio, which is a way of measuring long-term market value, which contradicts other research that argues CSR can boost a firm’s value.
Companies that previously invested heavily in CSR also pulled back in such spending, Rajgopal discovered in a follow-up working paper co-written with Prasanna Tantri of Indian School of Business, titled “Does Mandated Corporate Social Responsibility Reduce Intrinsic Motivation?” CSR spending declined 67 percent among Indian firms who had previously voluntarily engaged in such initiatives, seemingly because the political mandate diminished management’s intrinsic motivation to do good.
“Charitable giving used to be a big reputation builder for us,” as one executive from an Indian firm told the Guardian in 2016, “now it’s just about legal compliance.”
Two years after India’s law took effect, 37 of India’s 100 largest companies were still spending less than the required 2 percent on CSR, according to auditor KPMG — underscoring how enforcing CSR is difficult. India’s law has also been criticized for mandating that companies invest in the region where they operate, which means that the poorest and neediest regions do not benefit. The quality of CSR spending is also difficult to quantify because of India’s lax rules around how charity organizations and family foundation report income and operations, making it hard to analyze whether CSR investments are having a positive impact, adds Rajgopal.
To be sure, since India’s new law went into effect, overall CSR spending in India has still grown by about 20 percent to 70 billion Indian rupees ($950 million), according to data from auditor KPMG. That compares to single digit annual increases for all charitable giving by American firms and individuals, according to trade association the Giving Institute.
For policymakers and other countries considering similar laws, should it matter if CSR spending declines among some firms if overall CSR spending still grows? Rajgopal argues that the short-term increase in CSR spending from India’s law could have negative long-term effects. “If the compulsion to spend on CSR reduces firms’ intrinsic motivation to do good, then such a mandate may lead to a reduction in CSR spending in the long run,” according to the second paper.
As for Larry Fink’s call for companies to behave in a socially responsible manner if they want BlackRock’s investment, Rajgopal says that the lesson from India is that mandatory CSR is difficult to implement and perhaps impossible to measure.
“There’s this big hype about CSR,” Rajgopal says. “It’s a good thing — you want companies to think beyond daily profit. But there are many questions.”
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About the researcher
Shiva Rajgopal is the Kester and Byrnes Professor of Accounting and Auditing at Columbia Business School. He has also been a faculty member...Read more.