By - Santoshi Shritha Pyada
Source: The Economic Times
Introduction
The economic framework of behavioural assumptions is crucial not just for individual ‘rational’ decision-making but also for understanding the decision-making process of organisations with respect to finances, management, operations, marketing etc. Even corporate leaders sometimes deviate from the standard neoclassical model of rational decision making thus display biases and loss aversion behaviour while taking corporate decisions. The same goes for corporations established by the very ‘rational’ being to further human interests. Corporate Finance enables these corporations to maximise their profit within the given capital allocation. However, decision-making is now amplified to brand image, market value, and company outreach. While deciding on which projects to invest in and how to invest, corporations are challenged with information entropy with respect to the prospects of the project and the future uncertainties that it might throw. Capital Budgeting facilitates shareholders to invest in the most profitable and promising project. Thus, the main focus of this paper is capital budgeting coupling it with the reality of CSR policy within the confines of India.
Capital Budgeting and its Techniques-
“Capital budgeting is the process of evaluating potential projects or investments because capital expenditure incurred today might yield benefits over time. The company assess the prospective project’s lifetime cash inflows and outflows to determine whether the potential returns generated would be sufficient to meet the target. Since the capital available with the business is limited, the management uses various capital budgeting methods to determine which project would yield the best return over time so that it can pursue that particular project.” The project with a rate of return greater than the cost of financing the project is selected after evaluating the project in terms of cost and benefits.
There are various techniques for evaluating potential investment projects that will enable a company to decide on the desirability of the project depending on its income-generating capacity. These include-
The Payback Period Method relies on the information available in the books of accounts in order to determine the desirability of the investment. The payback period can be defined as the ‘amount of time the project requires to recover its original cash outlay invested’.
Net Present Value- the mantra of corporate finance is that the company must select the project with a positive NPV and Highest IRR. NPV is the difference between the present value of the cashflows of the project and the cost of the project and the sum of the present values of the expected returns (cash inflows) discounted at a required rate. The discount rate can be either the cost of capital or the cost of the alternative investment.
The Internal Rate of Return is the discount rate that makes the present value of the cash inflows equal to the initial investment. Alternatively, it equates the present value of cash inflows with the cash outflows of the investment. To accept the project, it must have a high IRR. The primary advantage of implementing the IRR as a decision-making tool is that it provides a benchmark figure for every project that can be assessed in reference to a company's capital structure.
Corporate Social Responsibility Companies have a social responsibility to give back to society in any which way they can. Hence, corporations are growingly indulging in CSR (Corporate Social Responsibility). It is a broad framework of a self-regulating business model that enables a company to be socially accountable to itself, the stakeholders, and the public. By practising CSR, a company can be conscious of its impact it has on society- social, economic, and environmental. The company invests its profits in a project that enhances society and the environment instead of negatively impacting it.
The Ministry of Corporate affairs through a 2014 amendment to The Companies Act, 2013 made CSR policy a mandatory provision to be followed by Indian Corporates. Ss.134 and 135 of The Act deal with the CSR policy. S.135 pins down the CSR Policy that needs to be followed. It states that companies with a net worth of Rs.500 crore or more, or turnover of Rs.1000 crore or more or a net profit of Rs.5 crore during any financial year are mandatorily required to constitute a CSR committee consisting of three board members. This committee is required to-
Formulate and recommend to the board, a CSR Policy that shall indicate the activities that will be undertaken by the company. These activities have to comply with Schedule VII.
Recommend the expenditure to be incurred on these activities and monitor the CSR policy from time to time.
The board is entrusted with the task of ensuring the activities of the CSR Policy are duly undertaken by the company. The board also has to ensure that at least 2% of the average net profits made during the preceding financial years are used in pursuance of the CSR Policy. Companies are to note that expenses towards CSR activities cannot be deducted from taxable income.
Schedule VII mentions the activities that companies may include in their CSR Policy. They relate to eradicating poverty and hunger, promoting education, reducing child mortality and improving mental health, combating AIDS and other diseases, contributing to environmental sustainability, enhancing vocational skills of employees, etc.
On a close analysis of the CSR Policy, it is known that on a country level, the policy is quite appropriate as it has its own democratic value, mandatory compliance has no doubt increased the amount spent by companies manifold, but at the granular level, it can be said that the policy is no good because instead of concentrating on how a corporate makes its profit, the Indian narrative concentrates on how the profits so achieved are spent. It does not give importance to the ethical standard of making profits and the impact of the corporate’s products on the consumers and society in general. The notion, the purpose and the objectives of CSR are misplaced when it comes to the granular level.
Indian Narrative in comparison to the Global Standards of CSR
To get a closer look at how the CSR policy is being misused, we can compare the global standard of CSR with the Indian standard. For this purpose, we take Starbucks and TATA conglomerate.
Starbucks is known for its CSR and commitment to social responsibility. According to a 2019 Global report Starbucks has reached 99% of ethically sourced coffee, created a global network of farmers, established green buildings as its stores, contributed to community service by creating college programs for its employees etc. In my opinion, while evaluating the capital budget required for a specific project, Starbucks has incorporated the view of sustainability and social responsibility and has concentrated on how to make and spend its profits while adhering to ethical standards of profit-making.
Whereas
the TATAs have been performing a wonderful job of giving back to society through various CSR projects under various heads such as Arogya (health awareness), Vidyadhanam (education), Kaushalya (social) and Vasudhara (environment protection). It publishes the impact of these projects but does not publish how it gained the profit to invest in these CSR initiatives. Most of these initiatives are undertaken around the operation areas of their factories which adds to their workforce, improves their profits due to increased manufacturing, attributable to under the table activities veiling them under the umbrella of CSR initiatives.
In India, companies find CSR initiatives as an additional tax burden. By dodging the mandatory requirements of their CSR policy, Indian corporations fulfil their ulterior motives. They distribute the allocated funds, leading to the industrialisation of already developed or developing areas instead of alleviating underdeveloped areas. They have convoluted sustainability with their business strategy so that they can increase their profit margins. However, according to s.135 of The Act, these programmes do not fall under the CSR policy. There is also the problem of window dressing their accounts to falsely show that the prescribed amount was invested in CSR activities when in fact the company would have reinvested the amount or used it for other ulterior motives. Embezzlement of CSR funds in PSUs is something not unheard of in India. In this way, politicians and bureaucrats direct the manner in which corporates spend their earmarked amount of CSR. The earmarked amount is often written to a trust that involves 10 different social activities. After deducting its commission, the trust transfers the rest to the personal account of the promoter or directors who individually benefit at the cost of society.
Conclusion
There is a drastic difference between the perception of CSR in India and globally. It is immaterial for them as to how much is spent on such activities whereas in India it is nothing but considered as an additional tax that is evaded as usual. The lack of effective enforcement of laws also plays a role in the failure of CSR. “Social responsibility should not be equated with monetary contributions only.” This begs the question as to why capital budgeting should not be implemented in a manner that also caters to the CSR initiative when determining potential cash inflows of an economically desirable project. Why should companies wait until the profits are ascertained to indulge in activities that will benefit society when they use the scarce resources for achieving profits? No doubt the NPV-IRR method of capital budgeting is accurate for determining the profitability of the project and whether the company should invest in it or not. It should also implement a technique whereby after ascertaining profits, the fund manager along with the CSR committee should brainstorm on how to make those profits and decide on the activities while being sustainable and socially responsible.
Santoshi Shrithi Pyada is a third-year student at JGLS.
References:
Malmendier, Ulrike. 2018. “Behavioural Corporate Finance”. National Bureau of Economic Research: Working Papers. 1.
Investopedia. 2021. “An Introduction to Capital Budgeting.” Accessed May 14. https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation-methods.asp
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Investopedia. 2021. “An Introduction to Capital Budgeting.” Accessed May 15. https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation-methods.asp
Investopedia. 2021. “Corporate Social Responsibility.” Accessed May 16. https://www.investopedia.com/terms/c/corp-social-responsibility.asp
Hereinafter referred to as ‘The Act’.
Sections are denoted as Ss. throughout the paper.
Starbucks: Global Social Impact Report. 2019.
TATA Motors Annual CSR Report: 2019-2020.
Tax Guru. 2020. “Failure of CSR in India.” Accessed May 17.
The Economic Times. 2015. “How Indian Companies are misusing public trust to launder the CSR spending.” https://economictimes.indiatimes.com/blogs/it-doesnt-add-up/how-indian-companies-are-misusing-public-trusts-to-launder-their-csr-spending/
Tax Guru. 2020. “Failure of CSR in India.” Accessed May 17.
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