Impact of CSR on Financial Performance of Company

TG Team 31 Dec 2014 28,045 Views 0 comment Print Company Law | Articles

CA Hemraj Kumawat

Impact Of Corporate Social Responsibility On Financial Performance Of The Company – “ A REVIEW OF ITC LTD.”

Abstract – Corporate Social Responsibility (CSR) is a concept that has attracted worldwide attention and acquired a new meaning in the global economy. Sharp interest in CSR in recent years has stemmed from the advent of globalization and international trade, which has reflected in increased business complexity and new demands for enhanced transparency and corporate citizenship. Moreover, while governments have traditionally assumed sole responsibility for the improvement of the living conditions of the population, society’s needs have exceeded the capabilities of the government to fulfill them. Security analysts are increasingly awarding more favorable ratings to firms with corporate socially responsible strategies. In this context, the spotlight is increasingly turning to focus on the role of business in society and progressive companies are seeking to differentiate themselves through engagement in what is referred to as CSR.

KEYWORDS : Economy, Business, Corporate, Financial Statement, Government

INTRODUCTION :

While there may be no single universally accepted definition of CSR, each definition that currently exists underpins the impact that businesses have on society at large and societal expectations of them. Although the roots of CSR lie in philanthropic activities such as donations, charity, relief work, etc. of corporations, globally, the concept of CSR has evolved and now encompasses all related concepts such as Triple Bottom Line, corporate citizenship, philanthropy, strategic philanthropy, shared value, corporate sustainability and business responsibility.

The entirety of CSR can be determined from the three words this phrase contains: corporate, social and responsibility. CSR covers the relationship between corporations or other large organizations and the societies with which they interact. CSR also includes the responsibilities that are inherent on both sides of these relationships. CSR defines society in its widest sense, and on many levels, to include all stakeholders and constituent groups that maintain an ongoing interest in the organization’s operations. CSR is generally understood to be the way a company balances the economical, environmental and social aspects of its operations, addressing the expectations of its stakeholders.

One early writer on CSR, Keith Davis, described CSR as ‘the firm’s consideration of, and response to, issues beyond the narrow economic, technical and legal requirements of the firm’, while a few years later Archie Carroll (1979) defined it much more broadly to include exactly those elements that Davis excluded: ‘the social responsibility of business encompasses the economic, legal, ethical and discretionary expectations that society has of organizations at a given point of time.’

According to Michael Hopkins, “CSR is concerned with treating the stakeholders of the firm ethically or in a responsible manner, meaning treating stakeholders in a manner deemed acceptable in civilized societies. The wider aim of social responsibility is to create higher and higher standards of living, while preserving the profitability of the corporation, for people both within and outside the corporation.”

According to CSR Asia, a social enterprise, “CSR is a company’s commitment to operate in an economically, socially and environmentally sustainable manner while balancing the interests of diverse stakeholders.”

According to World Business Council for Sustainable Development (WBCSD), “Corporate Social Responsibility is the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as the local community and society at large.”

From the above definitions it is clear that:

The CSR approach is holistic and integrated with the core business strategy for addressing social and environmental impacts of businesses,
CSR needs to address the well being of all stakeholders and not just the company’s shareholders.
Philanthropic activities are only a part of CSR, which otherwise constitutes a much larger set of activities entailing strategic business benefits.

OBJECTIVES AND IMPORTANCE :-

The main aim of this article is to analyze the concept of Corporate Social Responsibility which has gained huge popularity in recent times, and its impact on the financial performance of the firm. Companies have become quite conscious of the negative impact that they might have to face if they do not contribute to the needs and well being of the community and society at large. They have realized that an adequate transfer of profits to its Corporate Social Responsibility segment can not only help it to satisfy all its stakeholders but also help it to gain huge advantages over its competitors. In the light of the above statement, an analysis of India’s largest FMCG company- ITC Ltd is tried to be made, so as to get an idea of the impact that CSR initiatives of a company, which has won the award for Best CSR Practices since past 3 consecutive years, may have on not only its profits, market capitalization, and stock market price but also on its brand value, reputation and goodwill.

CSR AND SUSTAINNABILITY

Corporate Sustainability is derived from the concept of sustainable development. It essentially refers to the role that companies can play in meeting the agenda of sustainable development and entails a balanced approach to economic progress, social progress and environmental stewardship.

CSR in India tends to focus on what is done with profits after they are made. On the other hand, sustainability is about factoring the social and environmental impacts of conducting business, that is, how profits are made. Hence, much of the Indian practice of CSR is an important component of sustainability or responsible business, which is a larger idea, a fact that is evident from various sustainability frameworks. Globally, the notion of CSR and sustainability seems to be converging, as is evident from the various definitions of CSR put forth by global organizations. The genesis of this convergence can be observed from the preamble to the recently released draft rules relating to the CSR clause within the Companies Act, 2013 which talks about stakeholders and integrating it with the social, environmental and economic objectives, all of which constitute the idea of a triple bottom line approach. It is also acknowledged in the Guidelines on Corporate Social Responsibility and Sustainability for Central Public Sector Enterprises issued by the DPE in April 2013.

BENEFITS OF A ROBUST CSR PROGRAMME

As the business environment gets increasingly complex and stakeholders become vocal about their expectations, good CSR practices can only bring in greater benefits, some of which are as follows:

Communities provide the license to operate: Apart from internal drivers such as values and ethos, some of the key stakeholders that influence corporate behavior include governments (through laws and regulations), investors and customers. In India, a fourth and increasingly important stakeholder is the community, and many companies have started realizing that the ‘license to operate’ is no longer given by governments alone, but communities that are impacted by a company’s business operations. Thus, a robust CSR programme that meets the aspirations of these communities not only provides them with the license to operate, but also to maintain the license, thereby precluding the ‘trust deficit’.
Attracting and retaining employees: Several human resource studies have linked a company’s ability to attract, retain and motivate employees with their CSR commitments. Interventions that encourage and enable employees to participate are shown to increase employee morale and a sense of belonging to the company.
Communities as suppliers: There are certain innovative CSR initiatives emerging, wherein companies have invested in enhancing community livelihood by incorporating them into their supply chain. This has benefitted communities and increased their income levels, while providing these companies with an additional and secure supply chain.
Enhancing corporate reputation: The traditional benefit of generating goodwill, creating a positive image and branding benefits continue to exist for companies that operate effective CSR programmes. This allows companies to position themselves as responsible corporate citizens.

Clause 135 of Companies Act, 2013

In India, the concept of CSR is governed by Clause 135 of Companies Act, 2013. The CSR provisions within the Act are applicable to companies with an annual turnover of 1000 crore INR and more, or a net worth of 500 crore INR and more, or a net profit of five crore INR and more. The new rules also require companies to set up a CSR Committee consisting of their board members, including at least one independent director.

The Act encourages companies to spend at least 2% of their average net profits in the previous three years on CSR activities. The Act lists out a set of activities eligible under CSR. Companies may implement these activities taking into account the local conditions after seeking board approval. The indicative activities which can be undertaken by a company under CSR have been specified under Schedule VII of the Act, which are as follows:

Promotion of education
Eradication of extreme hunger and poverty
Gender equity and women empowerment
Reducing child mortality and improving maternal health
Combating HIV-AIDS, malaria and other diseases
Contribution to Prime Minister’s relief fund and other such state and central funds.
Social business projects
Environment sustainability
Employment enhancing vocational skills
And such other matters as may be prescribed

Role of the board

Form a CSR committee
Approve the CSR policy
Ensure implementation of the activities under CSR
Ensure 2% spend
Disclose reasons for not spending the amount (if applicable)

Role of the CSR Committee

Three or more directors with at least one independent director
Formulate and recommend a CSR policy to the board
Recommend activities and the amount of expenditure to be incurred
Monitor the CSR policy from time to time.

CORPORATE SOCIAL RESPONSIBILITY MODELS :

The history of CSR bifurcates it into four different models:

Ethical model: It mainly consists of philanthropic contributions by companies. Gandhi’s charisma compelled the companies to play active roles in nation building to promote socio-economic development. The history of Indian corporate philanthropy has encompassed cask or kind donations, community investment in trusts and provision of essential services such as schools, infirmaries, etc.
Statist model: It came into existence when India after independence adopted the socialist and mixed economy framework, with a large public sector and state-owned companies. The legal framework of various Indian laws and the state ownership reflect elements of CSR.
Liberal model: It states that the company has the responsibility towards the shareholders. This model argues that it is sufficient for business to operate the law and general wealth which through taxation and private charitable choices can be directed to social ends.
Stakeholder model: It aims to create loyal relationship with investors, customers, suppliers, employees and their commitment which leads to long term value of the company, commercial viability and business success. The growing awareness among public compels the organizations to take serious look over their consequences or else face public campaigns or actions against irresponsible behavior. Therefore, the companies are answerable to all the people associated directly or indirectly with the company.

MEASUREMENT OF CORPORATE SOCIAL RESPONSIBILITY

Past studies on CSR have often been criticized for using inappropriate measures of CSR. Researchers have used various proxy measures to assess CSR like one dimensional surrogate measures such as reputation ranking of companies on pollution control performance, Moskowitz’s social responsibility ratings and Fortune corporate reputation index. These measures have been criticized for their inability to incorporate stakeholder’s issues. To overcome such inadequacies, recent studies use CSR data developed by various agencies that evaluate CSR from stakeholders’ perspective.

Voluntary standards such as ISO 26000, UNGC, GRI Guidelines outline a wide range of responsible business practices related to stakeholder issues such as environment, occupational health and safety, labor, human rights, corruption, etc. In recent years, an increasing number of companies are making CSR disclosures as per these standards. Nearly 90% of Fortune 500 firms make CSR disclosures in their annual reports. However, Indian companies lag behind their global counterparts in terms of CSR disclosure. There is no systematic CSR database of companies in India. There are two widely used secondary databases on Indian companies, Prowess database of Centre for Monitoring Indian Economies and India Business Insight Database of Informatics India Limited. The former gives access to corporate governance reports and the latter includes newspaper articles on corporate activities including CSR initiatives. In this context, this study develops a comprehensive measure of CSR towards each primary stakeholder group incorporating corresponding social, ethical, legal, and economic issues derived from local and global standards.

Measurement of Firm performance

Past studies have shown that as many as 80 different measures have been used to measure the performance of the firm. Firm size, return on assets (ROA), return on equity, asset age and return on sales are frequently used FP measures. Particularly, ROA is consistently claimed to be an authentic measure of FP. Unlike other accounting measures such as return on equity or return on sales, ROA is not affected by the differential degree of leverage present in firms. Because ROA is positively correlated with the stock price, a higher ROA implies higher value creation for shareholders.

Financial performance measures are lag indicators and capture historical performance arising from mostly tangible assets. They often fail to properly record performance from intangible assets such as customer relationships, employee satisfaction, innovation, investment in research and development, and like that have become significant sources of competitive advantage for firms in recent times. In contrast, NFP measures focus on a firm’s long term success factors such as research and development, customer satisfaction, internal business process proficiency, innovation, and employee satisfaction, and capture performance improvements from intangible assets. Investments in intangible assets, such as research and development are expensed immediately instead of getting capitalized in the traditional accounting system. Such treatment depresses the profit in the current year though benefits from such investments accrue to the firm over a long period of time. By accounting for such performance improvements, NFP measures provide indirect indicators of firm performance. Because of their focus on consequences rather than causes of performance, NFP measures are considered as ‘lead indicators’. FP measures are objective in nature whereas NFP measures are subjective in nature that includes manager’s perception of firm performance on market share, employee health and safety, investment in research and development and others. Hence, FP measures along with NFP measures are used to assess firm performance historically.

The relationship between CSR and firm performance

The studies of the relationship between CSR and financial performance comprise essentially two types. The first uses the event study methodology to assess the short run financial impact (abnormal returns) when firms engage in their socially responsible or irresponsible acts. The second type of study examines the relationship between some measure of corporate social performance and measures of long-term financial performance, by using accounting or financial measures of profitability.

The relations between CSR and FP are mostly inconclusive, but positive relations between the two have been reported in most of the studies suggesting an instrumental orientation of CSR initiatives. It suggests the alignment of social goal with the business goal where CSR is considered as a strategic tool to promote the economic objective of the firm. Managers foresee significant value additions in firm performance due to strengthened stakeholder relations. Management theorists argue that by improving CSR towards stakeholders, firm performance is augmented.

The influence of stakeholder-oriented CSR on firm performance can be understood with the help of three theories: (a) Consumer inference making, (b) Signaling theory, (c) Social identity theory. Consumer inference making theory suggests that if a consumer knows that the manufacture of the product is a responsible firm, he/she can infer positively about the product. Such inferences induce consumer goodwill that influences purchase intention. Signaling theory suggests that in situations where there is information asymmetry between buyers and sellers, consumers look for information/signals that distinguish company’s performing well on attributes of interest compared to companies performing poorly. Signals such as warranties indicating reliability and higher quality of products enable consumers to decide between companies. Consumers associate higher product quality with proactive corporate citizenship and potential job seekers value CSR record of companies as a signal for organizational attractiveness. Social identity theory emphasizes that one’s self concept is influenced by membership in different social organizations, including the company for which an individual works. Employees’ self image is influenced by the image and reputation of their employers, consumers identify themselves with organizations or brands involved in discretionary citizenship, and institutional investors like to be associated with socially responsible firms. Such bonds of identification encourage positive evaluation of a firm’s products and reap value addition through customer loyalty, advocacy, positive words of mouth, and resilience to negative brand information.

Alternatively, irresponsible behavior by firms agitates stakeholders. They often react by boycotting the company, reducing consumption of company’s products, initiating legal action against the company, or spreading bad words of mouth about irresponsible business practices. Boycotting of Nike products due to human rights’ abuse and unsafe working conditions at suppliers’ location in Asia, or sharp reaction from environmentalists and consumers to the pesticide content in Pepsi and Coca-Cola beverages in India are few such instances. While improved stakeholder relations have the potential to improve a firm’s reputation and performance, strained relations have the risk of adversely affecting a firm’s performance. Thus, favorable CSR towards stakeholders will positively impact the firms’ FP and NFP.

Hypotheses:

H1: CSR has significant impact on firm’s financial performance

H2: CSR has significant impact on firm’s net profit

H3: CSR has significant impact on firm’s total assets

THE EFFECT OF CSR PRACTICES ON FINANCIAL PERFORMANCE: AN ANALYSIS OF ITC LTD.

ITC is one of India’s foremost private sector companies with a market capitalization of US $45 billion and a turnover of US $7 billion. ITC is rated among the World’s Best Big Companies, Asia’s Fab 50, and the World’s Most Reputable Companies by Forbes magazine and among India’s Most Valuable Companies by Business Today. ITC ranks among India’s Most Valuable (Company) Brands, in a study conducted by Brand Finance and published by The Economic Times. ITC also ranks among Asia’s 50 best performing companies compiled by Business Week.

ITC’s aspiration to create enduring value for the nation and its stakeholders is manifest in its robust portfolio of traditional and Greenfield businesses encompassing Fast Moving Consumer Goods, Hotels Paperboards and Specialty Papers, Packaging, Agri-Business and Information Technology. The competitiveness of ITC’s diverse businesses rest on the strong foundations of institutional strengths derived from its deep consumer insights, cutting-edge Research and Development, differentiated product development capacity, brand-building capability, world-class manufacturing infrastructure, extensive rural linkages, efficient trade marketing and distribution network and dedicated human resources.

ITC is pursuing innovative business strategies that synergize the creation of sustainable livelihoods and the preservation of natural capital with the building of shareholder value. This Triple Bottom Line strategy of building economic, social and environmental capital involves: Embedding Sustainability in Business, Investing in Social Development, and Adopting a Low Carbon Growth Path and a Cleaner Environment Approach.

CSR Practices at ITC

ITC is the only company in the world to be carbon positive, water positive and solid waste recycling positive. ITC’s businesses and associated value chains support 5 million livelihoods. The CSR activities of the company involve e-Choupal rural digital physical infrastructure, Farm to Food Products Value Chain, Social and Farm Forestry, Tree to Textbook Value Chain, Integrated Watershed Development, Dairy Development, Women’s Empowerment Programme, Supplementary Education Programme, Green Centre, ITC Hotels- the World’s Greenest Luxury Hotel Chain, Renewable Energy at ITC, WOW- Wealth Out Of Waste, Sangeet Research Academy- A corporate tribute to the rich tradition of Hindustani Classical Music.

Because of all these contributions, ITC has won many awards and has gained constant improvement in its rankings. Businessworld FICCI CSR award in Large Enterprise Category, AIM Asian CSR Award by the Asian Forum on Corporate Social Responsibility, Best Overall Corporate Social Responsibility Performance by Institute of Public Enterprise, Corporate Social Responsibility Award from The Energy and Resources Institute (TERI) are some of the awards that have been won by ITC foe its exemplary contribution to the Triple Bottom Line. ITC was also perceived to be the ‘Company Most Active in CSR’ for the third year in a row.

ITC has, along with Reliance Industries Ltd., received top rating in Asia for their Corporate Social Responsibility initiatives, according to report by the Hong Kong based brokerage and investment firm CLSA, which has given a rating of five points from 1 to 5 to both these companies.

Over the period of one year from 2013 to 2014, paid up capital of ITC has increased from 790.18 crore INR to 795.32 crore INR, total turnover from 41809.82 crore INR to 46712.62 crore INR, total PAT from 7418.39 crore INR to 8785.21 crore INR. With such a tremendous increase in the profits and turnover, its contribution and the total spending on Corporate Social Responsibility has also increased from 82.34 crores INR in 2013 to 106.63 crores INR in 2014. The list of activities on which the expenditure on CSR has been incurred is as follows:

Areas listed under Schedule VII to the Companies Act, 2013	ITC Interventions
(i) Eradicating hunger, poverty and malnutrition	Providing preventive healthcare through civic/sanitation infrastructure and services.
(ii) Promoting education	Improving quality of education, government school infrastructure, skill development and integrated animal husbandry services.
(iii) Promoting gender equality and empowering women	Promoting micro-enterprises for women for sustainable livelihoods.
(iv) Ensuring environmental sustainability	Implementing social forestry programmes, water resources development and promoting sustainability practices through the CII-ITC Centre of Excellence for Sustainable Development.
(v) Protection of national heritage, art and culture	Promoting Indian classical music
(vi) Rural Development projects	Providing agri-extension services and farm productivity enhancement measures.

On the basis of all these contributions, the financial performance of ITC can be analyzed. H1 lists the impact of CSR on the financial performance which gets reflected in the Market price of the shares of the company listed on a recognized stock exchange. H2 lists the impact of CSR on the Net Profits of the company which can be adjudged from the PAT of ITC. H3 enlists the impact of CSR on the Total Assets of the company. These three figures of ITC over the last 10 years have been incorporated below:

YEAR	Share Price as on 31 March of respective year (in INR)	PAT- PROFIT AFTER TAXES (in crores)	TOTAL ASSETS (in crores)
2005	44.79	2191	11550
2006	97.48	2235	13084
2007	75.20	2700	14968
2008	103.18	3120	17249
2009	92.40	3264	19484
2010	131.58	4061	23005
2011	181.45	4988	25434
2012	226.85	6162	28988
2013	309.10	7418	34017
2014	360.60	8785	39229

Thus, from the analysis of the performance of ITC over the past ten years, it is evident that the company has grown consistently over the time period. Not only has the financial performance of the company improved, but it has also incorporated more and more brands in its segment of FMCG and has also improved its rankings and ratings thereby replacing TCS as the most admired company. Not only the profits and share prices have been positively affected by its CSR practices but also the Return on Equity has grown over the period from 25.68% in 2005 to 36.19% in 2014.

Over the ten year period, Net Worth per share of ITC has increased from 10.55 INR to 33.02 INR, Return on Average Capital Employed from 35.88% to 49.47%, and Earnings Per Share from 2.43 INR to 11.05 INR. All these parameters and ratios clearly indicate the financial advantages coming to the company through its CSR implications.

Total shareholder returns measured in terms of Market Capitalization and dividends grew at a compound rate of around 27% per annum over the last 17 years

CONCLUSION:

From an analysis of the Sustainability Reports and the Financial Accounts of ITC, it can be evidently concluded that CSR has positive impact on the financial performance of the companies. The companies that enthusiastically engage themselves in CSR practices, definitely have advantage over other companies in financial perspectives, lenient taxation provisions, ratings and rankings, brand reputation and last but not the least, customer loyalty and stakeholder trust. Thus, the CSR initiatives should be strictly followed by all those companies that wish to get a financial advantage over other firms in the long run.

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