In February of this year (2014), the Government notified the Corporate Social Responsibility (CSR) norms making it mandatory for companies to take a 2% cut in their net profits and use that money for the betterment of the society.

I have maintained this from the very beginning that not only will this create more wastefulness, particularly for PSU’s but will also give rise to further corruption in the public sector.

Now that these norms have started running in trouble and voices are being raised against them from more quarters, I thought I will write about exactly why I was convinced that this will fail.

To which companies do the CSR norms apply?

The norms apply to all companies, public or private, which:

a)      Report at least Rs. 5 Cr. in net profit for the year; OR,

b)     Report a gross turnover of Rs 1,000 Cr; OR,

c)      Have a net worth of Rs 500 CR.

Why this is bad news for shareholders of PSUs?

The large private sector companies will eventually figure a way out to effectively utilize this money. Most likely they will benefit people and towns of strategic importance to them. Once implemented, in the ultimate scenario I see a situation where companies in the private sector will start benefitting other companies and find a way to set off the costs when doing business with that company.

For example, a software company may pitch in with a steel company in developing a township for all the steel factory workers. In return, they may win a software contract from the latter. There is absolutely nothing wrong with that. In fact, this I believe is the intended goal of such norms.

I am not so sure how the Public Sector Undertakings (PSU) will deal with this. I don’t want to generalize but public companies do suffer from the problem of not having loyal managers. When a manager is also a majority shareholder, his goal is to maximize the benefits of all expenses for the company in which he has a majority holding.

PSU managers on the other hand are more likely to award projects purely to fulfill their CSR obligation and at worst may be for personal enrichment or to those who work closely with them. Read the CSR activity clause of the norms below and the immense potential for irregularities becomes clear:

Clause 4 (2) – “The Board of a company may decide to undertake its CSR activities approved by the CSR committee, through a registered trust or a registered society or a company established by the company or its holding or subsidiary or associate company under section 8 of the Act or otherwise:

Provided that-

(i) if such trust, society or company is not established by the company or its holding or subsidiary or associate company, it shall have an established track record of three years in undertaking similar programs or projects;

(ii) the company has specified the project or programs to be undertaken through these entities, the modalities of utilization of funds on such projects and programs and the monitoring and reporting mechanism.

(3) A company nay also collaborate with other companies for moderating projects or programs or CSR activities in such a manner that the CSR committees of respective companies are in a position to report separately on such projects or programs in accordance with these rules.

Further, the CSR projects to be awarded are by no means of any small amount. Below, I have listed 10 PSUs, all of which are a part of the Nifty 50 companies. Look at what 2% of their net profit translates to:

Company Net Profit (FY 2014) 2% of Net Profit
ONGC                              26,506.53                          530.13
State Bank of India                              14,173.77                        283.48
NTPC Limited                              11,403.61                          228.07
Coal India                              15,111.67                        302.23
BHEL                                3,502.86                              70.06
Power Grid Corporation                                4,547.58                            90.95
Gail                                4,786.22                              95.72
NMDC                                6,420.08                        128.40
BPCL                                3,910.68                              78.21
Bank of Baroda                                5,000.73                        100.01

No wonder then that there is almost a new line of consultants and NGOs who specialize in assisting companies do “social welfare”. In fact if any corporate or PSU manager happens to read this, I am sticking my hand out to spread financial literacy amongst whatever you may define as a segment needing social welfare (the Social Welfare Segment).

A more viable solution – CSR for encouraging entrepreneurship

If you have to constitute committees to overlook how shareholder money is spent, why not constitute it in a way that shareholders become owners in more businesses. By encouraging entrepreneurship, the Government can transform people from job seekers to job providers.

  • Help people from the Social Welfare Segment set up more businesses.
  • Hold a majority shareholding in these businesses.
  • Ensures that these businesses engage only people from the Social Welfare Segment as owners, employees and vendors.

This way money will not only trickle down to the Social Welfare Segment, in doing so it will create new businessit will transform people from job seekers to job providers. Besides, shareholders will be happier off holding shares in younger businesses than just letting the PSU’s use the money for social welfare. The latter will surely make the PSU companies less competitive compared to their private sector peers. At least 2% less competitive.

A final point which has annoyed me the most about these norms is that somewhere you get the sense that they encourage companies to fabricate accounts. Instead of promoting clear financial statements, companies will now try to under report. There is the excise, income tax, sales tax and now a CSR tax.

Am I the only one who feels 2% of net profits is a lot of money? This for me is one more reason to prefer private sector instead of the already suffering PSUs.