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What happens when companies are mandated to report and spend on CSR?

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Gordon Richardson

“It pays to be green,” is pretty much Gordon Richardson’s motto.

The Rotman School of Management accounting professor has done what he calls “a fair amount of corporate social responsibility [CSR] research,” which often shows that companies that take environmental and social issues seriously outperform their peers.

Recently, Richardson turned his attention to India. Because of a shift in accounting regulations in 2014 — which require companies report on their CSR initiatives and spend two per cent of their average net profits on these programs — the country offers a unique look at how compulsory CSR spending plays out on a large scale.

He collaborated with Sudipta Bose, senior lecturer in accounting at the University of Newcastle, and Peter Clarkson, professor in accounting from the University of Queensland and adjunct professor at Simon Fraser University. Published in ABACUS — A Journal of Accounting, Finance and Business, their paper, “Valuation Implications of Mandatory CSR Expenditures in India,” looked at 1,493 firms, their CSR spending before and after the rule change, and their market performance over four years.

The researchers discovered that making social responsibility a mandatory requirement tinkers with how much it pays to go green. “Every company had their optimal CSR strategy,” says Richardson. “But when you make it mandatory, the optimal strategy and the optimal spend is not as clear.”

The study looked at 216 Indian companies that invested in CSR pre- and post-2014 (voluntary spenders) and 1,277 firms that did not previously invest in CSR initiatives but were compelled to spend after the regulatory change (forced spenders).

Prior to 2014, organizations that voluntarily spent on CSR programs saw a return on their investment through stock market valuation — every dollar they spent enhanced firm value by $2.39. Following the shift, their investments didn’t translate as strongly into market valuation. That CSR dollar led to just $1.408 in enhanced valuation.

Richardson thinks it became harder for firms that invested in CSR of their own volition to signal their beliefs to their customers and make sales based on ethics.

In comparison, forced spenders got minimal bang for their buck following the regulatory change. Richardson says such companies often view such spending as a tax, and their customers and investors pick up on this sentiment. When they spent a dollar, they got a mere $0.872 in firm valuation return.

When Richardson and his team looked at whether companies achieved or surpassed the two per cent spending goal, the small group of voluntary spenders ended up in a bind. (Companies that don’t make their targets can put money aside to spend it in another fiscal year. If they never spend it, they can be fined.)

If voluntary spenders came in shy of the target, the market penalized them. “Investors are saying, ‘if you are such a virtuous firm, you’ve got to spend at least the two per cent,’” Richardson says. Meanwhile, if they overspent, they didn’t get much of a corresponding bump in their value. “You could spend more, but it’s not so obvious you’re the virtuous type because everyone else is spending too. This CSR spend has lost its signalling value.”

In comparison, forced spenders that didn’t meet their targets saw a boost in their market valuation, while surpassing the two per cent spend did not result in a bump. “The reward they get from CSR spend is lower,” says Richardson.

That being said, advertising proved to be a great leveller when it came to market performance and CSR. When firms invested in spreading the word of their good deeds, they got a corresponding bump in their market value that mitigated some of the penalties their CSR spends caused. “It’s one thing to adopt a CSR strategy, it’s another to convey it to consumers,” Richardson says.

After the regulatory change in 2014, voluntary spenders with generous ad budgets that surpassed the two per cent threshold saw increases when compared to those with leaner ad budgets. (However, a robust marketing budget didn’t help these companies if they didn’t meet the two per cent goal.) Forced spenders who budgeted generously for advertising also got more valuation for their CSR spend post 2014, plus their marketing efforts blunted the ill effects of under or over spending.

Across the board, firms in India aren’t paying the two-per-cent rule much heed. Even the voluntary CSR spenders spent less once the rules were enacted; the mean of what they spent was 1.5 per cent of their three-year average earnings after 2014, down from 1.85 per cent before the regulator changes. Voluntary spenders still spent more on CSR initiatives than their forced spender counterparts, which spent just 1.12 per cent of their three-year earnings average.

India provides a test case that could prove valuable in the coming years.

“In Canada, we’re headed for mandatory sustainability disclosures,” says Richardson. The newly formed Canada Sustainability Standards Board is developing reporting standards, which won’t likely require a minimum spend but will likely require mandatory sustainability reporting.

This shift will set strict rules around reporting — CSR reports will go into core filings, so greenwashing will be harder to pull off. If Richardson’s study proves transferrable to Canada, companies that spend on social projects today could lose some of their edge in the marketplace if mandatory CSR spending were to come into force in Canada.

“Managers have to decide on their CSR strategies, how they position the firm and what strategy maximizes firm value,” says Richardson, who considers these exciting but challenging times for those working in CSR leadership, marketing and accounting. “And once they've made the decisions, they have to convey those decisions in an honest way to investors and stakeholders.”

Gordon Richardson is a professor of accounting with the Rotman School of Management.