Recently I attended presentations by seven experts at the SME (Small & Medium Enterprises) Conclave at Kolkata. It was a highly informative and educated evening session with three experienced bankers and an experienced credit rating expert spoke along with three relatively young speakers. The four experienced speakers dealt with the various problems of the SMEs including the increasing uncertainty arising out of liberalisation and globalisation as also the problems associated with financing SMEs and the various facilities and schemes the banks are introducing to expand their business of lending to SME sector. The realtively younger speakers dealt with more modern aspects on the subject like progress in the use of information technology in the SME sector, the emerging era of SME share trading (the new BSE sponsored stock exchange will be shortly functional with much more stronger and reliable platform than what the currently-defunct OTCEI started providing from the late 1980s) and the potential of value creation through SME brand development.
The speakers highlighted the importance of the SMEs in the Indian economy: they account for 45% of the value of India's industrial production, 40% of India's exports, generate 1.3 million new jobs every year and their number is in the range of 26 million accounting for 98% or so of all non-farm firms. However, most of these are in the organised sector and only 18% of them are in manufacturing (mostly located in 15 clusters and in just nine industrial segments, while the remaining 82% of the 26 million engaged in services sector.
And, they are faced with several problems: low scale of operations and consequent low ability to withstand external shocks, low level of technology and inability to absorb new technology, dependence on few customers where the work as ancillary, inadequate availability and high cost of credit, weak marketing, complete dependence on one or a few key managerial personnel, poor book keeping and record keeping and absolute lack of risk assessment and management. Surveys have revealed that promoters are highly secretive about their operations even with the bankers they wish to depend on for cheap credit (and, of course credit rating agencies) and not very reluctant to upgrade technology and management. The incidence of default to bankers is very high among SMEs and therefore bankers are very cautious about lending to units in this sector because of their inherent high risk, low equity risk capital and little tangible security to offer as collateral.Surprisingly, they face all these problems despite the existence of a plethora of government sponsored supporting agencies at various levels throughout the country.
I recall that 40 years ago, when I began my career with a nationalized banks, the situation of SME sector was by and large the same: they enjoyed the same importance, showed the same potential and suffered from the same problems. And, yet this sector continued to grow over time. Currently, SME sector is growing at the rate of 15%-16% per year according to one speaker. Everyone recognised that many SMEs of the past have become large industrial companies over the years, although many more became sick, closed and dead. Equally interesting, the solutions offered now are also similar: creation of common infrastructure, assistance in marketing and procurement, help in improved designs, special banking facilities tailor-made for small units, support in technology up gradation and use of computers and information technology, help in brand building that creates value and access to stock exchange facility tailored to meet the special requirements of the SMEs. The Truth is 40 years down the line, SMEs will show more or the same situation. The Truth is that a seminar or conference or conclave on SMEs will always be of very little use and waste of time.
To my mind, SMEs always capture the relative importance that they deserve. They will always be the dominant munber of units in all most all economies at any stage of development and engage a significan number of entrepreneurs and workers. They may extract sops and concessions from government but that would never give them any higher importance. This will be true even forty years later or eighty years later in India, the US or Japan and the mortality rate of these units will generally be higher (except in countries like India where their lives will be prolonged at great economic efficiency cost trading off for shortem employment and vote protection).
To be useful the focus has to shift from clubbing all kinds of animals together to properly disaggregated classes of SMEs by their varying sizes, the nature of their activity (specific goods or services), target market (local or regional or all-India and dependence on few, large industrial customers), the promoters' willingness to expand, promoters' ability to do anything other than what they have been doing, and so on. Each class will have problems specific to them and solutions required. Not all wayside cigarette-pan shops will remain in the ownership of the same person or family: but many will do and never change their business or expand. Some wayside confectioneries/ eating houses will grow, even at the cost of encroaching footpaths for their use, but only a few of them would create a chain in a city or operate in various cities. Some of them may create their own brands without spending much, have websites and even arrangements for door-to-door delivery service locally and able to attract funds from banks or NBFCs on the strength of the collateral security they can offer. And, many owners of such SMEs are most reluctant to dilute ownership, except accepting some passive minority shareholders without any intention to give them any say in the business operations.
And, there are many others with excellent ideas and adequate technical background in need of large debt and equity from banks and the formal financial sector, after they have spent some of their own savings in the development of products up to a stage. Their ideas are really big and can succeed provided that get adequate finance and are willing to listen to private equity hand-holding financiers. But most of them want the finance to be extended to them but would demand high prices of shares for the small percentage of equity and look upon private equity investors and banks close monitoring and handholding as unnecessary evil. They will always complain of inadequate bank finance. But it is better that the country does not waste resources on them that have very little chance of being successful.
And, there are many other SMEs, whose promoters employ Chartered Accountant consultants with exposure to bank credit officers to prepare excellent project reports that the banks will find acceptable, though due diligence and rigorous risk assessment would not be feasible. They try with many bankers and sometimes are able to hoodwink one of them. When they fail they complain of shortage of bank credit.
And, there are many SMES who are unfortunate because their inability to see the writing on the wall that they are in the midst of a prolonged downturn in their industry with stocks piling up and receivables bulging or they have become already sick because of the entry of highly competitive, technologically and managerially more savvy SMEs or because of dumping by the Chinese firms. They plead for additional bank working capital but seldom banks are imprudent enough to accede to their request.
The plethora of govt- sponsored supporting agencies is a share waste: these institutions do not keep continuous track of the SMEs of various sizes and location to know in advance if many such units are going to get in trouble due to external market factors and RBI's monetary policy and rush to them to find out who really needs what kind of support and deserves such support.
While many SME owners operate on satisficing levels of profit and market share and may show various degrees of reluctance to grow beyond a point, some of them do graduate at varying pace to become big businesses because of owners' determination coupled with huge latent maket opportunity they happen to exploit. There are still some other owners of SMEs who seek opportunities of luring venture capitalists and other financiers to share the better part of the hogh risk associated with their businesess: most such business firms fail, but a few succeed and suceed to eventually become big corporations. This risk cannot be wished away. All this is an integral part of natural dynamics of emergence, growth and demise of business firms. The Indians, however, have been tuaght since the beginning of Independence to love SMEs and hate large businesses and never try to understand economic dynamics of business organizations. Generally poor people jealous of the rich find mental comfort in this manner, even if such emotions cost them dearly in economic terms. They want to be rich but do not know how and hence defend their poorness in various ways.
We gathered a whole lot of knowledge on the aggregate of the SMEs at the Conclave but were still in search of operationally more useful knowledge at the disaggregated level of different classes, types and sizes of SMEs producing different goods and services. With limited knowledge, it is hardly surprising that SME Conclaves will remain conclaves of exchanging knowledge that is already known or easily accessible to everyone attending the Conclave.
And, I complement the sponsors of the Conclave that they brought home this realization that the Truth about SMEs is all hidden in the aggregation. Small is really too Big to be meaningfully empowered with operationally useful knowledge. Maybe, as a follow-up step, the sponsors may think of organizing conclaves aimed at a few specific class/ type/ size of SMEs with speakers from experts on those specific class of SMEs including some SME owners/ managers. I must admit that I enjoyed listening to all the seven speakers.
PS: Some comments received:
# There have many studies pointing to the importance of SmE for job creation and transformation of industries. In the modern high tech area, the universities have assumed the role of engine of development. Examples are MIT, Stanford, Berkeley, Cambridge, helsiniki Univ of Technology. This idea has not been much appreciated by regular economists and hence not appreciated in India. Finland has done well to develop their SME sector. I brought a group from Finland to work with IiMc, but there was no taker, indian's obsession with brand was a problem.
# I think the importance of SMEs is somewhat over-hyped and romanticized. By now there is enough empirical research that shows SMEs do not have any significant impact on growth, job creation, poverty and inequality. I am all for big corporates replacing the lakhs of low productivity SMEs in India. Bigger companies enjoy economies of scale, provide better quality employment (research shows this) and have the financial muscle to invest in R&D. I am not sure if Indian SMEs are interested in growing beyond a point -- think of a typical Kolkata SME owner and offer him huge financing in return for 50% ownership. I am sure he will ask you to take a hike as he is happy with the modest growth that brings home his daily bread. I vote for big bazaar over nager bazaar any day.
Saturday, July 23, 2011
Saturday, June 18, 2011
Shareholders (& Customers) Beware: Fishing in Corporate Social Responsibilty Waters
Fashions wasting Resources?
Corporate Social Responsibility (CSR) has become a buzz word among politicians, bureaucrats, business leaders, corporate executives in both private and public sectors, and, of course, business school academicians. It has become a fashion and fad to deliberate on CSR, project the great contribution of specific corporations and business groups to the society through CSR. When some activity or a subject becomes a fashion or a fad, there is a great risk that in reality very little of substance is generated while there is lot of waste of resources. While certainly lot of substantive societal welfare is contributed by CSR activities of companies and organizations, there is definitely a complete anarchy of CSR preaching gurus trying to impose their half-baked thoughts that have not passed the rigours of scientific tests, paving the way forward for wasting resources in the name of CSR.
This is the essence of my own perception after attending a recent one and a half day seminar on CSR that was attended by about 100 delegates and invitees. The organizers had collected over 40 papers to be presented and discussed over six sessions – three were primarily designed to deal with conceptual issues and three were devoted to empirical evidence of CSR activities by different industries and individual companies. In addition, there were about three/ four long guest lecture preaching sessions that effectively cut short the time available for effective deliberations. What questions did the Conference could provide reasonable answers and what were the take away lessons I could gather?
Reluctance to Conceptualise Definition and Scope of CSR
First, is about the definition of CSR on which the deliberations reflected virtual chaos among the lead speakers and discussants. No one was probably prepared that such a basic issue could come up and therefore tried to be smart on defending their half-baked ideas. One approach was to define what CSR is not. An important view probably specializing in guiding the central public sector companies claimed that anything spent by a company itself is not CSR, implying that the companies are only to allocate certain percentage of the profits after tax as appropriation for CSR expenditure that would be actually spent through specialist NGOs (non-governmental, not-for-profit organizations) that has respectable accreditation or rating and spent on specific identified schemes and projects to be monitored by the Board of the company. This seems to be the government approach to public corporate sector social responsibility: hardly surprising, the government administration in India is used to implanting projects and schemes with cost and time over-runs, beside leakages through corruption. The government, as the major shareholder of public sector enterprises (PSEs) would like PSEs to discharge corporate social responsibility in the same way as the Government discharges Government’s own social responsibility! The Government and the government’s officers’ approach, of course, would naturally be inclined to taking the credit of what PSEs do as CSR (and assign the responsibility of failures to the PSE executives) and therefore stop PSEs to directly spend their CSR budgets through their own employees. The government officers’ are the controlling directors on the Boards of PSEs: why should they allow PSE executives to decide how to dole out the CSR money instead of having a mechanism that they could use to influence such spending. Maybe, they claim to be experts in CSR as well given their record of performance in discharging the Government’s social responsibility in various areas like taking electricity to all villages, eliminating corruption and bribery incidence in different departments of the government itself.
Relevance of Social Responsibility Standards of Governments, Citizens and othersThis, in turn, raises the second issue of how far the society can really expect the companies’ to be socially responsible when the society has not been able to set up very high standards of social responsibility for the governments, the political parties, the professionals like medical practioners, the teachers, cine stars, etc, the trade unions, the individuals and even the so-called NGOs other than some well-run religious missionaries? This issue could be raised but the speakers and delegates are not interested in an issue that tries to examine the relationship among social responsibility of corporate entities and others. The unscientific fiat is that corporate entities make money (PAT) and therefore should be forced to spend money for the benefit of others in the society.
It is surprising that the intellectuals and the elite in India consider that the only group of animals in the society which is capable of and yet not doing sufficiently is the corporate sector: all other sectors are so excellent in discharging social responsibilities in accordance with their capability. The predominant view is the corporations make money (PAT) by exploiting the society and hence they are the ones who should be forced pay for social responsibility. Such a view is, of course, typically Indian brought up in the mythical brain-washing of socialism and communism. This view is not based on historical/ empirical evidence. The origin of companies lie in the need to create institutions that would serve a specific societal need. The companies are supposed to be socially responsible by birth as is the Government. If governments can often be socially irresponsible, so can the companies. There is no difference between companies and other institutions including the governments in terms of the need to satisfy the social justification of their existence.
Primary Social Responsibity of Businesses
What is the fundamental responsibility of a company to justify its existence? A company must be generating goods or services that satisfy the socially agreed needs of the society at the least cost and in the most efficient manner as also adhering to all the relevant laws and restrictions imposed by the society and yet maximize its after tax profits. A company that does not make sufficient profits continuously for years together is socially irresponsible and loses the justification of its existence. The same is true of a company that breaches any law of the land continuously or a company that is cost-wise uncompetitive or inefficient or produces shoddy products and services, A company that evades taxes, pays bribes, misleads/ cheats customers are engaged in socially irresponsible manner. If they happen to spend a percentage of their profits on so-called CSR activities do not make them socially responsible. Yet, the present dominant Indian intellectual view is that companies must spend money on CSR to be socially responsible. If a company is socially responsible then it must prove that it is cost competitive, efficient user of the resources it draws from the society, adheres to all applicable laws including those on environment and payment of taxes, does not pay or accept bribes and does not contribute to the generation of black money / wealth, producers goods/ services with quality that people find worthwhile buying at the competitive market prices, pays competitive market prices for the services and materials it procures from other companies or citizens and at the same time generates profits after tax consistently (allowing for business cycle downturn fluctuations) that is competitive. This is the fundamental corporate social responsibility: those companies which do not meet most of these criteria consistently for long periods are socially irresponsible enough to lose the justification of their existence even if they happen to make some profits and forced to spend some percentage of the profits after tax on CSR. The profits after tax are for the companies’ shareholders as to how that should be appropriated and distributed: if they happen to spend something on CSR that would be secondary, voluntary corporate social responsibility chosen by the company’s shareholders. Indian mind seems to be value more the secondary CSR more irrespective of the performance on primary corporate social responsibility. Those companies which fail in primary CSR should be penalized and punished and if required a hefty primary CSR cell should be levied on their profits every year of their default: monies so collected may be used by the Government to fund schemes like national rural employment guarantee.
Secondary CSR of philanthrpy
Only those who have fulfilled their primary social responsibility should be allowed to take up the secondary, voluntary CSR subject to the shareholders approval (in the name of CSR, the principles of corporate governance and democracy cannot be violated either by the executives of the companies or by the political governments by making mandatory spending on by corporate entities on secondary CSR. If the Government needs to step up spending on activities that it considers corporate entities to spend out of their profits after tax, it is better for the Governments to be socially responsible by collecting that amount as a cess/ tax and spending it efficiently with due public acknowledgement of the funding by the corporate sector.
Corporate Governance & CSR
Interestingly, speakers and discussants could not afford to ignore certain equally important buzz words like Corporate Governance (CG) and Business Strategy relevant to their community. It was emphasized that companies with good CG would tend to have good CSR: this may be true of primary CSR but appropriation of net profits is an issue of shareholders – they may prefer to use the surplus to flow to them in the form of dividend and then decide whether or not use a part of the dividend received for individual social responsibility of social philanthropy. Even where the Government is the dominant shareholder, it may consider taking a higher dividend and decide how to use it – whether for reducing budget deficit or spending on augmenting the health care system or the NGO system- all of which are social responsibilities of the Government. Why should the government consider the Board of the PSEs to be more effective on discharging social responsibility by giving them the power to use shareholders’ money outside a formal audit system of the Government or the PSE companies concerned, unless it can be demonstrated that Government’s direct use of money is less effective and this effectiveness cannot be improved? And, in the case of listed PSEs, proper corporate governance demands that the company’s charter/ articles are amended at the annual general meeting providing for not only including the objective of CSR but also specifying an upper limit on such expenditure.
Business Strategy Spillover CSR
The issue of incorporating CSR business strategy is not a very simple one. No official business strategy document can be inconsistent with the requirements of primary CSR as defined in this paper: however, in reality, a company may operationally pursue a business strategy to dodge the exchequer or bribe government employees for favor or violate safety procedures or environmental restrictions imposed by the State. So, it is not a question of business strategy documentation but an issue of companies’ not adhering to primary social responsibility despite its corporate governance system and therefore companies attracting regulatory/ state enforcement action.
It is indeed possible for companies to formulate and implement business strategy in a fundamentally different way to ensure that the company’s decision-making criteria and operating processes make the actual business strategy enhance its market competitiveness, shareholder value creation capability, long-term sustainability and at the same time be socially more responsible than meeting primary CSR and spending a part of the profit after-tax on secondary CSR projects/ schemes. The companies that can afford to develop and implement such business strategies in which CSR is an integral and organic component tend to adopt the three-bottom lines approach. Here the companies CSR outcome is the result of the pursuit of efficiency, long-term sustainability, and maximum shareholder value creation. They try to resolve the apparent conflict between profits and spending on CSR into a profits-CSR relationship that is consistent and sustainable. They tend to take cuts in short-term profits to change their operating systems to change over from conventional fossil fuel energy use to currently more expensive non-conventional, renewable, environment-friendly energy, to change over to more energy-efficient costlier equipment, to change over to costlier but more environment friendly office / factory/ premises design, to resort to rain harvesting, to adopt solid waste recycling systems. All this are as much socially responsible acts as they are contributors to sustainability of the companies’ ability to create shareholder value. They tend to help farmer households with free information access facility and with inexpensive better variety seeds/ saplings to enhance the income of these households as also participate in education, healthcare, soil conservation and social assets creation activities of communities who live in and around their areas of operation. All this costs money and managerial resources of the companies and reduces their short-term profits but has the potential to increase societal welfare and mitigate the risks of the company’s future ability to sustain their operations and ability to create shareholder value over the long term.
One would be quick to point out that these companies do such things because they want to benefit themselves and therefore is not true corporate social responsibility. By the same logic, the governments are interested in faster economic growth and larger spending for the people below the poverty line simply because this helps the government to get more tax revenues to spend away and get more votes in the election and hence government’s such activity is not a reflection of governments social responsibility. Or, the individual citizen’s efforts to increase his knowledge and expertise for developing technology for common use are not social responsibility but selfish motive. The contribution of the great scholars, innovators, discoverers, novelists, poets, philosophers and Olympic medalists has nothing to with social responsibility because these contributors benefited themselves in terms of fame and monetary rewards. The idea of social responsibility being only linked to sacrificing self-interest is illogical. To be a worthy citizen of a country is both a reflection of self-interest and social responsibility. The art of being socially responsible lies in making it consistent with self interest. This is what is meant by socially responsible business strategy (goal/ objective/ plan). Indian intellect seems to ignore this fundamental point about what I would call Spill-over Social Responsibility.
Empirical Evidence on CSR
Many of the papers presented at the seminar reflected the various different ways companies and other organizations perceive and discharge their social responsibility: these included case studies on ITC Ltd, Infosys Limited, Bharat Petroleum Corporation Ltd, Singareni Collieries Ltd, Mahindra & Mahindra Ltd, National Institute of Industrial Training & Engineering, Roorkee Engineering University Alumni Association, Power Grid Corporation and various companies in the banking and hotel sectors. These papers illustrated that depending on the size, resources and nature of business of the companies, their approaches differed as did the nature of CSR initiatives and their direct involvement in the execution of the CSR activities. In one case, it was so clear that even the company and its consulting engineering company could collaborate to augment social welfare as well as derive direct benefits for both the companies through CSR. The NIITE's CSR activity enables students to become self-reliant while studying management, direct exposure in production and marketting, spreading of ther messages of great social reformers like Vivekanda and Gandhi as an avenue of secondary CSR for companies in general.
Evaluating and Ranking CSR performance in Search of Scientific and Meaningful Methodology
As usual a professor asked me during a coffee break about my views on developing a methodology of rating companies in terns of CSR. I admitted my in capability to form a well-informed view but opined against a straight jacket rating methodology for all companies irrespective of their size, nature of business, resources, capability to implement CS initiatives. To my find, there should first be a broad definition of CSR. A company can be socially responsive broadly in three different ways: (a) Primary CSR:by being cost competitive, shareholder value maximising, producing and selling a socially accepted product in demand without short-changing/ misleading/ cheating the customers, without adopting business practices that are not in accordance with law (that is, no tax evasion, no bribery, no violation of environmental norms, etc), (b) Secondary CSR of philanthropy or charity: by making a part of its profits available for the benefit of poor and weaker sections of the society directly or through appropriate NGOs including religious missionaries, and (c) Business Strategy Spillover CSR: by making available or using its resources of skills, expertise, funds, knowledge, technology, manpower to undertake activities that not only contributes to social welfare but also its own ability to sustain shareholder value creation.
Some companies can do all three: some cannot do more than (a) and may be donating some monies to social welfare causes while others can do both (a) and (b) both directly or through donations. All companies need to be appreciated and evaluated on each of these counts. It is not necessary to assume that the mere existence of a company implies that the primary CSR is satisfied. Data may be difficult to collect in this area but it is easy to know those who do not generate minimum acceptable return on funds deployed for years together – they are socially irresponsible drags on the society in the same way as persistent tax payment defaulters or delayed payments to suppliers. Due account has to be taken into account of the social irresponsibility of government departments (taking bribes, delaying payments of incentives/ other dues to companies) on the ability of the companies to meet their primary social responsibility obligations. For a rating system to be valuable, it is not enough to have used the system to declare who stands where among the top hundred or five hundred: all companies need to be evaluated on primary social responsibility to rank the top 100 and 500 socially most irresponsible. As a next step, those companies that contribute to secondary CSR through donations could be evaluated. Next would be the evaluation of those who contribute directly as well as through donations to secondary CSR. Amount of money spent on Secondary CSR is no measure of social responsibility discharged: the impact on social welfare increase is (one may spend more but the impact could be very little because of inefficiency and leakages)There would be hardly a few companies who, besides meeting primary CSR responsibility and discharging secondary philanthropy/ charity CSR consciously create business strategy-implied spillover CSR, to evaluate and rank.
Beware of Fishing in CSR water
CSR is not a mere activity of charity/ philantropy out of the profits of a company unlike what government may want to make PSE executives and stakekolders believe or a societal punitive hafta obligations on companies as some want some independent directors or arm-chair pseudo-intellectals would jealously would like to perceive. Shareholders must beware that inappropriate classification of companies and application of evaluator-biased criteria and technically weak methodologies can provide misleading evaluation and ranking of the companies’ social responsibility performance. One needs to be certain about the social responsibility of the evaluators also. The customers also beware: social responsibility rankings may not reveal the reality of the social responsibility of business in terms of the quality and prices of the products sold. Shareholders and customers must stop smart operators from fishing in the CSR water.
Corporate Social Responsibility (CSR) has become a buzz word among politicians, bureaucrats, business leaders, corporate executives in both private and public sectors, and, of course, business school academicians. It has become a fashion and fad to deliberate on CSR, project the great contribution of specific corporations and business groups to the society through CSR. When some activity or a subject becomes a fashion or a fad, there is a great risk that in reality very little of substance is generated while there is lot of waste of resources. While certainly lot of substantive societal welfare is contributed by CSR activities of companies and organizations, there is definitely a complete anarchy of CSR preaching gurus trying to impose their half-baked thoughts that have not passed the rigours of scientific tests, paving the way forward for wasting resources in the name of CSR.
This is the essence of my own perception after attending a recent one and a half day seminar on CSR that was attended by about 100 delegates and invitees. The organizers had collected over 40 papers to be presented and discussed over six sessions – three were primarily designed to deal with conceptual issues and three were devoted to empirical evidence of CSR activities by different industries and individual companies. In addition, there were about three/ four long guest lecture preaching sessions that effectively cut short the time available for effective deliberations. What questions did the Conference could provide reasonable answers and what were the take away lessons I could gather?
Reluctance to Conceptualise Definition and Scope of CSR
First, is about the definition of CSR on which the deliberations reflected virtual chaos among the lead speakers and discussants. No one was probably prepared that such a basic issue could come up and therefore tried to be smart on defending their half-baked ideas. One approach was to define what CSR is not. An important view probably specializing in guiding the central public sector companies claimed that anything spent by a company itself is not CSR, implying that the companies are only to allocate certain percentage of the profits after tax as appropriation for CSR expenditure that would be actually spent through specialist NGOs (non-governmental, not-for-profit organizations) that has respectable accreditation or rating and spent on specific identified schemes and projects to be monitored by the Board of the company. This seems to be the government approach to public corporate sector social responsibility: hardly surprising, the government administration in India is used to implanting projects and schemes with cost and time over-runs, beside leakages through corruption. The government, as the major shareholder of public sector enterprises (PSEs) would like PSEs to discharge corporate social responsibility in the same way as the Government discharges Government’s own social responsibility! The Government and the government’s officers’ approach, of course, would naturally be inclined to taking the credit of what PSEs do as CSR (and assign the responsibility of failures to the PSE executives) and therefore stop PSEs to directly spend their CSR budgets through their own employees. The government officers’ are the controlling directors on the Boards of PSEs: why should they allow PSE executives to decide how to dole out the CSR money instead of having a mechanism that they could use to influence such spending. Maybe, they claim to be experts in CSR as well given their record of performance in discharging the Government’s social responsibility in various areas like taking electricity to all villages, eliminating corruption and bribery incidence in different departments of the government itself.
Relevance of Social Responsibility Standards of Governments, Citizens and othersThis, in turn, raises the second issue of how far the society can really expect the companies’ to be socially responsible when the society has not been able to set up very high standards of social responsibility for the governments, the political parties, the professionals like medical practioners, the teachers, cine stars, etc, the trade unions, the individuals and even the so-called NGOs other than some well-run religious missionaries? This issue could be raised but the speakers and delegates are not interested in an issue that tries to examine the relationship among social responsibility of corporate entities and others. The unscientific fiat is that corporate entities make money (PAT) and therefore should be forced to spend money for the benefit of others in the society.
It is surprising that the intellectuals and the elite in India consider that the only group of animals in the society which is capable of and yet not doing sufficiently is the corporate sector: all other sectors are so excellent in discharging social responsibilities in accordance with their capability. The predominant view is the corporations make money (PAT) by exploiting the society and hence they are the ones who should be forced pay for social responsibility. Such a view is, of course, typically Indian brought up in the mythical brain-washing of socialism and communism. This view is not based on historical/ empirical evidence. The origin of companies lie in the need to create institutions that would serve a specific societal need. The companies are supposed to be socially responsible by birth as is the Government. If governments can often be socially irresponsible, so can the companies. There is no difference between companies and other institutions including the governments in terms of the need to satisfy the social justification of their existence.
Primary Social Responsibity of Businesses
What is the fundamental responsibility of a company to justify its existence? A company must be generating goods or services that satisfy the socially agreed needs of the society at the least cost and in the most efficient manner as also adhering to all the relevant laws and restrictions imposed by the society and yet maximize its after tax profits. A company that does not make sufficient profits continuously for years together is socially irresponsible and loses the justification of its existence. The same is true of a company that breaches any law of the land continuously or a company that is cost-wise uncompetitive or inefficient or produces shoddy products and services, A company that evades taxes, pays bribes, misleads/ cheats customers are engaged in socially irresponsible manner. If they happen to spend a percentage of their profits on so-called CSR activities do not make them socially responsible. Yet, the present dominant Indian intellectual view is that companies must spend money on CSR to be socially responsible. If a company is socially responsible then it must prove that it is cost competitive, efficient user of the resources it draws from the society, adheres to all applicable laws including those on environment and payment of taxes, does not pay or accept bribes and does not contribute to the generation of black money / wealth, producers goods/ services with quality that people find worthwhile buying at the competitive market prices, pays competitive market prices for the services and materials it procures from other companies or citizens and at the same time generates profits after tax consistently (allowing for business cycle downturn fluctuations) that is competitive. This is the fundamental corporate social responsibility: those companies which do not meet most of these criteria consistently for long periods are socially irresponsible enough to lose the justification of their existence even if they happen to make some profits and forced to spend some percentage of the profits after tax on CSR. The profits after tax are for the companies’ shareholders as to how that should be appropriated and distributed: if they happen to spend something on CSR that would be secondary, voluntary corporate social responsibility chosen by the company’s shareholders. Indian mind seems to be value more the secondary CSR more irrespective of the performance on primary corporate social responsibility. Those companies which fail in primary CSR should be penalized and punished and if required a hefty primary CSR cell should be levied on their profits every year of their default: monies so collected may be used by the Government to fund schemes like national rural employment guarantee.
Secondary CSR of philanthrpy
Only those who have fulfilled their primary social responsibility should be allowed to take up the secondary, voluntary CSR subject to the shareholders approval (in the name of CSR, the principles of corporate governance and democracy cannot be violated either by the executives of the companies or by the political governments by making mandatory spending on by corporate entities on secondary CSR. If the Government needs to step up spending on activities that it considers corporate entities to spend out of their profits after tax, it is better for the Governments to be socially responsible by collecting that amount as a cess/ tax and spending it efficiently with due public acknowledgement of the funding by the corporate sector.
Corporate Governance & CSR
Interestingly, speakers and discussants could not afford to ignore certain equally important buzz words like Corporate Governance (CG) and Business Strategy relevant to their community. It was emphasized that companies with good CG would tend to have good CSR: this may be true of primary CSR but appropriation of net profits is an issue of shareholders – they may prefer to use the surplus to flow to them in the form of dividend and then decide whether or not use a part of the dividend received for individual social responsibility of social philanthropy. Even where the Government is the dominant shareholder, it may consider taking a higher dividend and decide how to use it – whether for reducing budget deficit or spending on augmenting the health care system or the NGO system- all of which are social responsibilities of the Government. Why should the government consider the Board of the PSEs to be more effective on discharging social responsibility by giving them the power to use shareholders’ money outside a formal audit system of the Government or the PSE companies concerned, unless it can be demonstrated that Government’s direct use of money is less effective and this effectiveness cannot be improved? And, in the case of listed PSEs, proper corporate governance demands that the company’s charter/ articles are amended at the annual general meeting providing for not only including the objective of CSR but also specifying an upper limit on such expenditure.
Business Strategy Spillover CSR
The issue of incorporating CSR business strategy is not a very simple one. No official business strategy document can be inconsistent with the requirements of primary CSR as defined in this paper: however, in reality, a company may operationally pursue a business strategy to dodge the exchequer or bribe government employees for favor or violate safety procedures or environmental restrictions imposed by the State. So, it is not a question of business strategy documentation but an issue of companies’ not adhering to primary social responsibility despite its corporate governance system and therefore companies attracting regulatory/ state enforcement action.
It is indeed possible for companies to formulate and implement business strategy in a fundamentally different way to ensure that the company’s decision-making criteria and operating processes make the actual business strategy enhance its market competitiveness, shareholder value creation capability, long-term sustainability and at the same time be socially more responsible than meeting primary CSR and spending a part of the profit after-tax on secondary CSR projects/ schemes. The companies that can afford to develop and implement such business strategies in which CSR is an integral and organic component tend to adopt the three-bottom lines approach. Here the companies CSR outcome is the result of the pursuit of efficiency, long-term sustainability, and maximum shareholder value creation. They try to resolve the apparent conflict between profits and spending on CSR into a profits-CSR relationship that is consistent and sustainable. They tend to take cuts in short-term profits to change their operating systems to change over from conventional fossil fuel energy use to currently more expensive non-conventional, renewable, environment-friendly energy, to change over to more energy-efficient costlier equipment, to change over to costlier but more environment friendly office / factory/ premises design, to resort to rain harvesting, to adopt solid waste recycling systems. All this are as much socially responsible acts as they are contributors to sustainability of the companies’ ability to create shareholder value. They tend to help farmer households with free information access facility and with inexpensive better variety seeds/ saplings to enhance the income of these households as also participate in education, healthcare, soil conservation and social assets creation activities of communities who live in and around their areas of operation. All this costs money and managerial resources of the companies and reduces their short-term profits but has the potential to increase societal welfare and mitigate the risks of the company’s future ability to sustain their operations and ability to create shareholder value over the long term.
One would be quick to point out that these companies do such things because they want to benefit themselves and therefore is not true corporate social responsibility. By the same logic, the governments are interested in faster economic growth and larger spending for the people below the poverty line simply because this helps the government to get more tax revenues to spend away and get more votes in the election and hence government’s such activity is not a reflection of governments social responsibility. Or, the individual citizen’s efforts to increase his knowledge and expertise for developing technology for common use are not social responsibility but selfish motive. The contribution of the great scholars, innovators, discoverers, novelists, poets, philosophers and Olympic medalists has nothing to with social responsibility because these contributors benefited themselves in terms of fame and monetary rewards. The idea of social responsibility being only linked to sacrificing self-interest is illogical. To be a worthy citizen of a country is both a reflection of self-interest and social responsibility. The art of being socially responsible lies in making it consistent with self interest. This is what is meant by socially responsible business strategy (goal/ objective/ plan). Indian intellect seems to ignore this fundamental point about what I would call Spill-over Social Responsibility.
Empirical Evidence on CSR
Many of the papers presented at the seminar reflected the various different ways companies and other organizations perceive and discharge their social responsibility: these included case studies on ITC Ltd, Infosys Limited, Bharat Petroleum Corporation Ltd, Singareni Collieries Ltd, Mahindra & Mahindra Ltd, National Institute of Industrial Training & Engineering, Roorkee Engineering University Alumni Association, Power Grid Corporation and various companies in the banking and hotel sectors. These papers illustrated that depending on the size, resources and nature of business of the companies, their approaches differed as did the nature of CSR initiatives and their direct involvement in the execution of the CSR activities. In one case, it was so clear that even the company and its consulting engineering company could collaborate to augment social welfare as well as derive direct benefits for both the companies through CSR. The NIITE's CSR activity enables students to become self-reliant while studying management, direct exposure in production and marketting, spreading of ther messages of great social reformers like Vivekanda and Gandhi as an avenue of secondary CSR for companies in general.
Evaluating and Ranking CSR performance in Search of Scientific and Meaningful Methodology
As usual a professor asked me during a coffee break about my views on developing a methodology of rating companies in terns of CSR. I admitted my in capability to form a well-informed view but opined against a straight jacket rating methodology for all companies irrespective of their size, nature of business, resources, capability to implement CS initiatives. To my find, there should first be a broad definition of CSR. A company can be socially responsive broadly in three different ways: (a) Primary CSR:by being cost competitive, shareholder value maximising, producing and selling a socially accepted product in demand without short-changing/ misleading/ cheating the customers, without adopting business practices that are not in accordance with law (that is, no tax evasion, no bribery, no violation of environmental norms, etc), (b) Secondary CSR of philanthropy or charity: by making a part of its profits available for the benefit of poor and weaker sections of the society directly or through appropriate NGOs including religious missionaries, and (c) Business Strategy Spillover CSR: by making available or using its resources of skills, expertise, funds, knowledge, technology, manpower to undertake activities that not only contributes to social welfare but also its own ability to sustain shareholder value creation.
Some companies can do all three: some cannot do more than (a) and may be donating some monies to social welfare causes while others can do both (a) and (b) both directly or through donations. All companies need to be appreciated and evaluated on each of these counts. It is not necessary to assume that the mere existence of a company implies that the primary CSR is satisfied. Data may be difficult to collect in this area but it is easy to know those who do not generate minimum acceptable return on funds deployed for years together – they are socially irresponsible drags on the society in the same way as persistent tax payment defaulters or delayed payments to suppliers. Due account has to be taken into account of the social irresponsibility of government departments (taking bribes, delaying payments of incentives/ other dues to companies) on the ability of the companies to meet their primary social responsibility obligations. For a rating system to be valuable, it is not enough to have used the system to declare who stands where among the top hundred or five hundred: all companies need to be evaluated on primary social responsibility to rank the top 100 and 500 socially most irresponsible. As a next step, those companies that contribute to secondary CSR through donations could be evaluated. Next would be the evaluation of those who contribute directly as well as through donations to secondary CSR. Amount of money spent on Secondary CSR is no measure of social responsibility discharged: the impact on social welfare increase is (one may spend more but the impact could be very little because of inefficiency and leakages)There would be hardly a few companies who, besides meeting primary CSR responsibility and discharging secondary philanthropy/ charity CSR consciously create business strategy-implied spillover CSR, to evaluate and rank.
Beware of Fishing in CSR water
CSR is not a mere activity of charity/ philantropy out of the profits of a company unlike what government may want to make PSE executives and stakekolders believe or a societal punitive hafta obligations on companies as some want some independent directors or arm-chair pseudo-intellectals would jealously would like to perceive. Shareholders must beware that inappropriate classification of companies and application of evaluator-biased criteria and technically weak methodologies can provide misleading evaluation and ranking of the companies’ social responsibility performance. One needs to be certain about the social responsibility of the evaluators also. The customers also beware: social responsibility rankings may not reveal the reality of the social responsibility of business in terms of the quality and prices of the products sold. Shareholders and customers must stop smart operators from fishing in the CSR water.
Tuesday, February 2, 2010
Global Equity Portfolio for Indians?
Indians are generally too poor to invest in equity marketsin any significant measure.. But there are large number of rich enough Indians who could have, if they were not scared or if they cared not to remain ill-informed, invested in a portfolio of shares of foreiogn companies by taking advantage of the $200,000 per annum per resident Indian ceiling of investing in foreign equity markets. The number of such wealthy persons. By doing that they could have both reduced risk as also earned higher return, according to Sowmdeb Sen, my son who has been in the US since 1998. This is what he has to say:
Global Opportunities for Indian Portfolio Investors
"Early in this decade the Indian regulatory authorities had allowed Indian investors to invest in foreign financial markets through mutual funds and also directly up to $200,000 every year. It does not appear however that the Indian investors have been much enthused: the amount of investment by resident Indians in financial markets abroad has been insignificant even after taking into account investment in convertible bonds of Indian companies listed/ traded abroad. Indian portfolio investors may not have as yet been able to appreciate the potential of higher return and risk reduction through investing in foreign equity markets. However, with hindsight, it seems that they could have benefited by taking opportunities for higher risk-adjusted returns in selected Emerging and Frontier markets. Just to illustrate with a few countries like Russia, Brazil, Columbia and China: if an Indian investor had 10 years ago invested in a portfolio of the stock market indices of these countries and India with equal weights (20% for each country), the return after adjusting for currency depreciation/ appreciation, would have 14.5% as against the Indian market return of 11%. If the investor had built such a portfolio five years back, the return would have been close to 22% as against the Indian market return of 21%.
If we were to replace Russia with either Peru or Indonesia, then the new strategy would have worked for 1, 3, 5 and 10 year periods and with better excess returns than that of the strategy of equally weghted porfolio of four BRIC countries and Columbia. The conclusion is that over the last 10, 5. 3 and 1 year periods, Indian investors could have had better returns by investing in an appropriately diversified portfolio spread in the five/six different emerging equity markets including India rather than investing entirely or largely in India.
Would such a diversification of investment portfolio have exposed the Indian investor to higher risk for getting the higher return? This apprehension is not justified by the historical data. In three of the four foreign markets mentioned above, returns per unit of risk were not lower than that in India - both for the 5 year and 10 year period.
The conclusions above are based on MSCI emerging market indices: but they should hold true using cross-country indices like the BSE Sensex, Brazil Bovespa and the likes because of the correlation between such domestic market indices and the corresponding MSCI indices. It is also to be recognized that a mere passively diversified emerging market index portfolio may not yield a higher risk-adjusted return sought by the Indian investors: the overall emerging market MSCI index which comprises of more than 20 countries returned 14% and 8% in the 5 year and 10 year time-frame respectively. The choice of markets and their weights need to be dynamically set for such diversified international portfolios to meet the return and risk objectives of the Indian investor. What has happened in the past may not necessarily repeat in the future. Skilled investment management and advice backed by global experience will help Indian investors to exploit the opportunities of enhancing portfolio return adjusted for both market and currency risks through appropriate diversification of equity investment portfolio.
It is nearly two decades since India embarked on the path of economic and associated financial liberalization. The country’s oldest fund had in the early 1990s proposed to invest a part of its largest scheme (about Rs35, 000 Crore-asset size then) to invest in global markets but failed to secure regulatory nod. In the late 1990s, based on a committee report, mutual funds in India were allowed to lunch funds that could invest abroad. Currently, however, only a few Indian mutual funds manage offer foreign market equity exposure: Templeton Indian Equity Income fund, Birla Sun life International Equity, Sundaram BNP Global Advantage, Principal Global Opportunities Fund - they manage about Rs 2,000 crores (negligible share in equity assets of Indian mutual funds). These funds are about two - five years in operation: the size of the oldest has grown from Rs 50 crore in 2004 to Rs 160 crore currently. Only one funds is 100% internationally invested with more than 50% of assets in mature developed markets like US, Germany and Switzerland where the returns are lower. Other funds are more than 50% invested in Indian equity and some of them are weighted more towards Asian stock markets. So the returns yielded by these have been inferior to the strategy of being equally invested in the five different markets. The best among these funds have given a much higher return by taking exposure in some of the emerging markets mentioned earlier.
Indian investment management industry may benefit from strategic initiatives to explore more actively the scope of enhancing the risk-adjusted return on the globally-invested equity portfolios of the Indian investors. The next decade may mark the rise of India as a source of portfolio investment in global equity markets even as foreign portfolio investments continue to claim a significant share in India stock markets."
Sowmdeb, Indians do not get so easily enthused to get out of their comfort of being scared of investing abroad. Indian equity is what they can at best trust.
Global Opportunities for Indian Portfolio Investors
"Early in this decade the Indian regulatory authorities had allowed Indian investors to invest in foreign financial markets through mutual funds and also directly up to $200,000 every year. It does not appear however that the Indian investors have been much enthused: the amount of investment by resident Indians in financial markets abroad has been insignificant even after taking into account investment in convertible bonds of Indian companies listed/ traded abroad. Indian portfolio investors may not have as yet been able to appreciate the potential of higher return and risk reduction through investing in foreign equity markets. However, with hindsight, it seems that they could have benefited by taking opportunities for higher risk-adjusted returns in selected Emerging and Frontier markets. Just to illustrate with a few countries like Russia, Brazil, Columbia and China: if an Indian investor had 10 years ago invested in a portfolio of the stock market indices of these countries and India with equal weights (20% for each country), the return after adjusting for currency depreciation/ appreciation, would have 14.5% as against the Indian market return of 11%. If the investor had built such a portfolio five years back, the return would have been close to 22% as against the Indian market return of 21%.
If we were to replace Russia with either Peru or Indonesia, then the new strategy would have worked for 1, 3, 5 and 10 year periods and with better excess returns than that of the strategy of equally weghted porfolio of four BRIC countries and Columbia. The conclusion is that over the last 10, 5. 3 and 1 year periods, Indian investors could have had better returns by investing in an appropriately diversified portfolio spread in the five/six different emerging equity markets including India rather than investing entirely or largely in India.
Would such a diversification of investment portfolio have exposed the Indian investor to higher risk for getting the higher return? This apprehension is not justified by the historical data. In three of the four foreign markets mentioned above, returns per unit of risk were not lower than that in India - both for the 5 year and 10 year period.
The conclusions above are based on MSCI emerging market indices: but they should hold true using cross-country indices like the BSE Sensex, Brazil Bovespa and the likes because of the correlation between such domestic market indices and the corresponding MSCI indices. It is also to be recognized that a mere passively diversified emerging market index portfolio may not yield a higher risk-adjusted return sought by the Indian investors: the overall emerging market MSCI index which comprises of more than 20 countries returned 14% and 8% in the 5 year and 10 year time-frame respectively. The choice of markets and their weights need to be dynamically set for such diversified international portfolios to meet the return and risk objectives of the Indian investor. What has happened in the past may not necessarily repeat in the future. Skilled investment management and advice backed by global experience will help Indian investors to exploit the opportunities of enhancing portfolio return adjusted for both market and currency risks through appropriate diversification of equity investment portfolio.
It is nearly two decades since India embarked on the path of economic and associated financial liberalization. The country’s oldest fund had in the early 1990s proposed to invest a part of its largest scheme (about Rs35, 000 Crore-asset size then) to invest in global markets but failed to secure regulatory nod. In the late 1990s, based on a committee report, mutual funds in India were allowed to lunch funds that could invest abroad. Currently, however, only a few Indian mutual funds manage offer foreign market equity exposure: Templeton Indian Equity Income fund, Birla Sun life International Equity, Sundaram BNP Global Advantage, Principal Global Opportunities Fund - they manage about Rs 2,000 crores (negligible share in equity assets of Indian mutual funds). These funds are about two - five years in operation: the size of the oldest has grown from Rs 50 crore in 2004 to Rs 160 crore currently. Only one funds is 100% internationally invested with more than 50% of assets in mature developed markets like US, Germany and Switzerland where the returns are lower. Other funds are more than 50% invested in Indian equity and some of them are weighted more towards Asian stock markets. So the returns yielded by these have been inferior to the strategy of being equally invested in the five different markets. The best among these funds have given a much higher return by taking exposure in some of the emerging markets mentioned earlier.
Indian investment management industry may benefit from strategic initiatives to explore more actively the scope of enhancing the risk-adjusted return on the globally-invested equity portfolios of the Indian investors. The next decade may mark the rise of India as a source of portfolio investment in global equity markets even as foreign portfolio investments continue to claim a significant share in India stock markets."
Sowmdeb, Indians do not get so easily enthused to get out of their comfort of being scared of investing abroad. Indian equity is what they can at best trust.
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