Adoption of Enlightened Shareholder Value in India and its relation with CSR

Historic business practices dictate that the sole responsibility of a business is to earn profits and in the realm of entities bearing corporate identities, the board of directors is primarily responsible to its shareholders to deliver the highest Earnings Per Share (“EPS”) to maximize shareholder wealth. This was termed and reported as the “Shareholder Theory” & “Friedman Doctrine” [1]. This primacy is the narrowest and singular form of looking at running businesses.

Enlightened Shareholder Value (“ESV”) is a direct contrast with this doctrine. It takes a utilitarian view of this doctrine as compared to Dr. Friedman’s myopic theory. ESV is founded on the idea that corporations should pursue shareholder wealth with a long-run orientation that seeks sustainable growth and profits based on responsible attention to the full range of relevant stakeholder interests [2]. These stakeholders may include but not be limited to employees, customers, creditors, the community, and the environment. The original proposer of ESV, Dr. Edward Freeman [3] considered it to be an important part of entities carrying out activities as a part of mandatory or voluntary Corporate Social Responsibility (“CSR”) as the ideas resonate with each other.

ESV has been enforced by the legal systems of various countries via “hard” law by way of legislation or “soft” law through industry standards laid down by business associations, market practices, or guidelines by government-recognized business bureaus.

ESV was formally inducted in the United Kingdom by way of Section 172 of the Companies Act, 2006. This legal provision was recommended by the Company Law Review SteeringGroup created to conduct a comprehensive review of the existing corporate law in the country. As per subsection 1, a director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:

1. The likely consequences of any decision in the long term;

2. The interests of the company’s employees;

3. The need to foster the company’s business relationships with suppliers, customers, and others;

4. The impact of the company’s operations on the community and the environment;

5. The desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly between the members of the company.

6. The resultant primary stakeholders are environmental matters, employees, social, community, and human rights issues.

ESV in a sense has already been adopted in India by way of the criteria set out in Section 135 of the Companies Act, 2013 and its corresponding CSR rules, 2014 along with mandatory contribution based on a combination of net worth, profit, and turnover. This has been further strayed towards the conventional ESV through the National Voluntary Guidelines (Environmental, Social & Economic Responsibilities of Business) of 2011.

When we peruse the Statement of Objects & Reasons that rationalize the above provision, it shows that the government cannot be always in all places. A financial distribution in labor through this mandatory CSR contribution and action coming from the companies that operate and benefit out of the Indian environment and its people through employees, customers, etc. The government considers these businesses to be responsible to their immediate society and environment for their betterment as much like the business itself, society and environment are also perpetual, but the quality of their existence is dependent on the intention of the business to maintain it to keep reaping the benefits out of the business- resource-market cycle.

It can be argued that a mandatory CSR contribution or action would reduce EPS as it is against the primary responsibility of the business and an additional government-imposed society benefit tax for exceeding financial limits set out in the section. However, this ESV-based hard law has been established with the sole idea of repatriation of benefits to the society and environment out of which they are earned. CSR is a more stringent form of ESV which would render ESV only as an additional reporting standard for securities unless it is specifically incorporated as a director duty which would be widely objected to by corporates, lawyers, and the market.

CSR expenses have a positive output of reducing litigation and reputational risk by the addition of tax exemptions, credits, and goodwill that overall have a mutually beneficial result to business and society. This would reduce traditional profit reporting, but government incentives and the reduction goodwill amortization would eventually show a positive bump on any company’s balance sheet regardless of it being a voluntary or mandatory CSR contribution.

Take the example of Tata Steel’s factory township of Jamshedpur. It is the most advanced and biggest steel production facility in India. Barring the factory management, the labor is local. Such large-scale manufacturing is controlled through the rigorous environmental safety and restoration methods to earn carbon and environmental credits given to them by the government for protecting the surroundings that a company operates in, this also met with community support. In addition, the company runs as a government-sanctioned municipal corporation funding societal improvement programs like education, parks, recreation centers, and overall infrastructure. This contributes to more skilled labor, political support to keep the plant running, increase in sales due to further expansion into the township that results in higher turnover, profit, and overall EPS.

If all the results of ESV are met barring it being a recognized metric of returns, the existing CSR provisions may be modified but meet and surpass the intent of ESV and will not require separate incorporation.

[1] A Friedman Doctrine-The Social Responsibility of Business is to Increase its Profits, Dr. Milton Friedman, The New York Times, September 13, 1970.

[2] Enlightened Shareholder Value, Social Responsibility, and the Redefinition of Corporate Purpose without Law, Dr. David Million, Washington & Lee University, Lexington, Virginia, Draft 2010.

[3] Strategic Management: A Strategic Approach, Dr. Edward Freeman, Cambridge University Press, March 11, 2010.

Art: "The Money Changer and His Wife" by Quentin Massys.