Corporate Governance and Corporate Social Responsibility

Abstract

The environmental, financial, social, and governance crisis, which countries across the globe are struggling with, warns the world of a resource constrained future where progress can no longer be sustained. This has made it imperative for companies, governments and civil societies to act together to address the common, universal cause of saving the ‘People’ (society), the ‘Planet’ (environment) in the process of making ‘Profits’ (economic development). The concept of corporate sustainability (CS) has come from environmental concerns, the concept of corporate social responsibility (CSR) has emerged from social concerns, and the concept of corporate governance (CG) has originated from agency problems. They all seem to have evolved to embrace the three pillars of corporate responsibility toward environmental balance, social justice and economic prosperity. This broad concept of corporate responsibility has almost become synonymous with ‘corporate sustainability.’ Within the overall broad realms of corporate sustainability, CSR can be narrowly looked upon as the responsibilities of companies toward the society in which they operate and on which they thrive. The concept of CG evolved around the ‘way’ in which business corporations should be managed and governed toward achieving their objectives, with the primary focus being maximisation of shareholders’ interests. In this chapter, an attempt has been made to understand the inter relationships between these concepts and their implications. The interrelationships are discussed through factors such as institutional investors, risk management, information asymmetry, board of directors, regulations, media, ethics and financial performance. A brief empirical analysis has also been conducted in the Indian corporate context to check whether CG has any impact on CS.

These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

1 Introduction

This paper intends to bring together two dynamic and fundamental concepts, namely ‘Corporate Social Responsibility’ and ‘Corporate Governance’ within the overall umbrella of ‘corporate sustainability.’ These concepts have been occupying a large space in the academic literature and business world and are assuming ever-increasing importance primarily due to growing concerns associated with the ‘power and accountability of corporations.’

Business corporations do bring in overall well-being in society through beneficial effects such as creating jobs, generating wealth, and providing goods which fulfill the needs of customers. But business corporations have become so large, visible, and powerful that market forces and regulations are not deemed good enough anymore to restrain their inappropriate conduct, if any. Due to this situation, many corporations are found to have achieved their growth and affluence in complete defiance of consequent negative externalities such as exhaustion of scarce natural resources, global warming, exploitation of stakeholders (such as employees and consumers), and expropriation of investors’ interests. So, the corporations, considered as engines of economic development, have been accused of having prospered at the cost of damage to the environment and society. The damage has been perceived to be higher due to globalisation which has enabled these powerful corporations to make use of resources from across the globe, particularly from the underdeveloped/developing nations and without adequate accountability. Such power and accountability concerns related to the corporations have given rise to the three concepts of ‘corporate social responsibility’ (CSR), ‘corporate governance’ (CG), and ‘corporate sustainability’ (CS).

The chapter starts with a brief primer on the concepts of ‘corporate sustainability,’ ‘corporate social responsibility,’ and ‘corporate governance’ in section 8.2. Section 8.3 involves delving deeper into the concepts individually and their integration through the lens of the extant literature. This will be followed by discussions in the later sections about the factors which create interlinkages between these concepts and the implications of such interlinkages.

2 A Brief Primer on the Concepts

2.1 Corporate Sustainability (CS)

The concept of ‘corporate sustainability’ (CS) finds its root in the term ‘sustainable development.’ The term ‘sustainable development’ came into vogue when leaders across the world from business, government and civil society joined hands to hold Earth Summits (in 1992, 2002 and 2012) to recognise that economic development which comes at the cost of environment and society is not sustainable. The concept primarily evolved from the concerns to handle global environmental challenges such as climate change, water scarcity, land degradation, erosion of biodiversity, and the fuel crisis. The Brundtland Commission Report, ‘Our Common Future’ [World Commission on Environment and Development (WCED) 1987] defined ‘sustainable development’ as ‘… development that meets the needs of the present world without compromising the ability of future generations to meet their own needs.’ The definition emphasises a quality of development which ensures equitable fulfillment of intra-generational and intergenerational needs.

The concept of ‘sustainable development’ when incorporated into corporate strategies became popular as ‘corporate sustainability.’ In line with the above WCED definition, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) has defined ‘corporate sustainability’ as ‘meeting the needs of a firm’s direct and indirect stakeholders without compromising its ability to meet the needs of future stakeholders.’ The definition has both a time dimension as well as a stakeholder dimension. Dow Jones Sustainability index (DJSI) defines CS as ‘a business approach that creates long-term shareholder value by embracing opportunities and managing risks deriving from economic, environmental and social developments.’ Such definitions look at CS as a business approach with a clear focus on the creation of long-term value for shareholders.

Overall, one can say that ‘corporate sustainability’ suggests that corporations seek to achieve the triple bottom-line goals (Elkington 1997) of economic prosperity (profit), social equity (people), and environmental balance (planet). So, companies operating in a sustainable manner behave in a way which is not only in the interest of people and planet, but also in the interest of their own long-term survival and growth. One can thus note that the concept of ‘corporate sustainability’ (CS) originally emerged from environmental concerns and then has been broadened to include all three pillars of economic growth, environmental protection, and social equality.

2.2 Corporate Social Responsibility (CSR)

There is hardly any universal consensus on defining the concept of CSR. CSR can be looked upon as the social component of corporate responsibility (CR) contained in the broader set of corporate sustainability (CS). One of the very popular definitions of CSR is the ‘obligations of businessmen to pursue those policies, to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society’ (Bowen 1953). CSR is also often viewed to be voluntary in nature and to be manifested in the form of philanthropy and corporate charity toward creating a positive impact on society. Davis (1960) linked the power and accountability of business by holding that ‘social responsibilities of business need to be commensurate with their social power.’ The Committee for Economic Development (CED) 1971¹ introduced CSR by saying ‘business functions by public consent and its basic purpose is to serve constructively the needs of society to the satisfaction of society.’ This definition also has a social focus.

WBCSD (World Business Council for Sustainable Development) goes a little broader and defines corporate social responsibility as, ‘the commitment of business to contribute to sustainable economic development, working with employees, their families, the local community and society at large to improve their quality of life.’ So, based on these definitions, one can say that CSR is one of the means of achieving the triple-bottom-line goals of ‘Corporate Sustainability’ (Fig. 8.1).

Fig. 8.1

Corporate sustainability, corporate responsibility and the three subsets

2.3 Corporate Governance

The concept of corporate governance found its origin in ‘agency concerns’ in business corporations, arising primarily due to conflicts of interest between shareholders and managers. The term ‘governance’ derives its root from the Latin word ‘gubemar’ which means, ‘to steer.’ So ‘corporate governance’ broadly refers to ‘the system by which companies are directed and controlled’ (Cadbury Committee Report 1992, UK). The concept is fundamental to the continuing operations of a company. Corporate governance is about leading a company in a fair, transparent, and accountable manner while protecting the rights of the shareholders. When companies are run in this fashion, it builds the confidence of the investors as well as promotes transparency and efficiency in capital markets. This often acts as an important factor in attracting foreign investments.

Failures of corporate governance found in corporate scandals (like Enron, WorldCom, Tyco in the US; or Parmalat, A hold in Europe; or Satyam in India) as well as in vulnerable capital markets (like the East Asian financial crisis of 1997), triggered the need for formulation of CG norms. The norms were found to need further strengthening in light of the global financial crisis of 2008.

3 Theories of Corporate Governance (CG) and Corporate Social Responsibility (CSR)

This section will dig deeper into the literature of CG and CSR to set the context for understanding the interrelationships among them. Corporate governance involves deciding about the objectives of a corporation. It comprises of a system of controls and incentives which govern the corporations toward meeting their objectives. The definition triggers the question as to what is the objective of a corporation and in whose interest it should be run.

3.1 Shareholder Theory versus Stakeholder Theory of CG

The question has bought in an interesting debate between two contrasting views, namely a ‘shareholders’ view’ and a ‘stakeholders’ view’. According to the ‘shareholders’ view,’ also called the traditional view, the objective of a corporation should be to maximise value for its shareholders. Shareholders provide the risk capital for the company and, therefore, are the owners and residual claimants of a company. So, going by the property rights of the investment and the risks undertaken by the shareholders, it is argued that the company should be directed and controlled in the best interest of shareholders only. This fits with CG defined as ‘the ways in which suppliers of finance assure themselves of getting a return on their investment’ (Shleifer and Vishny 1997). The shareholders view goes to the extent of arguing that the one and only one social responsibility of business is to maximise profits, of course, without committing any fraud (Friedman 1970). So as per the traditionalist, shareholders view, popular in 1970s, spending money for socially responsible causes might not be the way shareholders want to spend their money. Shareholders might prefer the company resources to be utilised toward core commercial activities. So, CSR would look like doing philanthropy and the squandering of useful corporate resources and thus somewhat of a violation of the fiduciary duty entrusted to the managers. There was also a moral hazard argument according to which managers (agents) spend money on CSR opportunistically to build their own reputation and promote their own political, social or career agendas, which compromises on the interests of the shareholders (principals). So, this view has contended that CSR is value destroying and against ‘desirable CG,’ which should protect the interests of shareholders.

On the other hand, the ‘stakeholders view’ has widened the accountability of companies and posited that in order to be successful, it is critical for a company to go beyond the maximisation of shareholders’ interests to taking actions which balance the interests of wider, multiple groups of stakeholders such as employees, suppliers, customers, communities, government, trade associations, regulatory authorities, media, and NGOs (Freeman 1984; Roberts 1992). This is in line with the resource dependency theory which proposes directors of a company to be the lynchpin between the company and the external resources the company needs to achieve its goals.

The stakeholder view has made CSR look positive, in light of the social contract of the firm with society. The argument was that companies operate in a social environment comprising of various stakeholders and if a company fails to operate in a way consistent with what is expected or considered legitimate by the stakeholders, its survival might be threatened (legitimacy theory). So, undertaking CSR activities was considered important to meet the stakeholders’ expectations as contained in the institutional framework of formal regulations or in informal norms (institutional theory). Other than ‘shareholders’ theory’ and ‘stakeholders’ theory,’ there are various other theories of CG and CSR, the discussion of which is done in the following part of this section.

3.2 Other Theories of CG

A significant body of CG literature has developed in the context of ‘Agency Theory’ where a firm is believed to be a nexus of contracts (Berle and Means 1932; Jensen and Meckling 1976). It is argued that separation of ownership and control due to the ownership of companies by multiple, dispersed shareholders (principals), and delegation of decision making authority by shareholders to managers (agents) leads to information asymmetry between the principal and agent. The delegation assumes an expectation that the managers will make best possible use of the financial resources entrusted to them and generate maximum returns on their investments. But if both the parties are utility maximisers, there is a potential that managers might make use of the information asymmetry to conduct business operations in their own personal interest, to the detriment of the shareholders’ best interests. For example, the managers might have a tendency to invest in their favourite projects and build an empire, even if the projects are not in the best interest of the company (adverse selection). They might have a tendency to get themselves overpaid (expropriation). The managers might be lazy, inefficient, and shirking on their stewardship role in particular, because this behaviour is difficult to observe (moral hazard). All this would erode firm value. This reduction or erosion in firm value arising out of the separation of ownership and control is termed as ‘agency costs,’ which the corporate governance mechanisms seek to minimise. Agency costs can be minimised and thus firm value improved through monitoring and exercise of control on the managers through CG mechanisms, external or internal to the company.

• a. Internal governance mechanisms can include the following:

  • i. Ex-ante monitoring and disciplining managerial actions undertaken by the board of directors (who are elected by the shareholders), internal audit and controls, and large shareholders (block-holders).

  • ii. It can also include incentivising the managers to act in congruence with organisational interests by designing managerial compensation, which aligns the interests of managers with that of the shareholders (say, through profit-linked bonus, share-based compensation etc.).

• b. External governance mechanisms can be in the form of:

  • i. Ex-ante monitoring by institutional investors or,

  • ii. Market-based controls arising from product market competition, labor market² competition, market for corporate control/takeovers³, capital markets, and security analysts or,

  • iii. Ex-post monitoring of disclosures by external auditors, or debt covenants levied by lenders, or regulations like investor protection laws (La Porta et al. 2000) or, pressure from the media.

Transaction Cost theory from economics, which is based on the ‘nexus of contracts’ view of the firm (Coase 1937), argues that a firm exists because there are economic benefits to undertaking transactions internally rather than externally. But since the contracts by their very nature are likely to be imperfect and incomplete, it looks at the governance structure as a mechanism to handle decisions in such contracts in a way which aligns the interest of the principal and agent.

The Stewardship Theory of CG complements the agency theory by arguing that managers might not always be opportunistic but they might act as responsible, trustworthy stewards protecting and making the best use of the resources entrusted to them by the shareholders (James et al. 1997).

This belief would require managers to be empowered for decision making rather than controlled.

Under Managerial Hegemony Theory, directors consider themselves as elites and they recruit/promote new directors based on their criteria of elitism while Class Hegemony Theory believes that the managers, through their operational knowledge, can dominate and control the directors as well as weaken the influence of directors on decision making.

Corporate governance concerns and therefore, the CG norms differ across countries depending upon the institutional environment, enforceability of investor protection laws, efficiency of capital markets, and reliability of accounting standards as well as the culture and societal values of the country. For example, unlike in Anglo-Saxon countries, the CG concern in Asian economies is about expropriation of minority shareholders’ interests by large, controlling shareholders (typically family control) (principal-principal agency problem).

3.3 Theories of CSR

CSR can be strategic, coercive, and altruistic (Husted and Salazar 2006). Strategic CSR focuses on maximising profits and firm value and has a business case. It can be said to fall within the realms of acceptability of agency theory. Coercive CSR makes use of regulations, taxes, and subsidies to force CSR behaviour when CSR is needed and voluntary CSR is missing. A few examples of such regulations are pollution control laws and mandatory 2 % CSR spending required of companies of certain financial health in India by the Companies Act 2013. If there are regulations driving certain CSR behaviour, companies would undertake such CSR simply in order to comply with the regulations and to avoid penalties, if any, associated with non-compliance. Altruistic CSR focuses on social good and charity. Companies are said to be good ‘corporate citizens’ if they undertake CSR out of philanthropy to meet the general expectations of society, over and above those required by law.

Apart from the economic, social, and legal dimensions, Carroll brought in an ‘ethical’ and ‘philanthropy’ dimension to CSR. She proposed a three-part conceptual model for ‘Corporate Social Performance (CSP)’ containing four responsibility dimensions (economic, legal, ethical, and philanthropic), related responsibility issues, and possible organisational responses (such as reactive, defensive, accommodative, and proactive) (Carroll 1979, 1991, 1999). Wood (1991) came up with a more comprehensive theory of CSP based on stakeholders’ expectations and talked about the principles of CSR at three levels (institutional, organisational and managerial), processes of corporate responsiveness, and outcomes of CSR behaviour. Principles at institutional level focused on legitimacy and considered business obligations such as social institution in the context of the power-responsibility equation; principles at organisational level were about public responsibility confined to outcomes related to the involvement of business with society; and principles at managerial level left CSR upto the discretion of managers, who were considered moral actors.

There has evolved a huge literature on strategic CSR which focused on the business case of CSR and how CSR can provide competitive advantage. For example, the Supply and demand view of CSR (McWilliams and Siegel 2001) theorised that companies would undertake CSR as a means to leverage the demands of the external environment as opportunities, with a view to maximise profits. The Resource-based view holds that companies choose to go for CSR in order to create firm-specific intangible resources which are costly to imitate and hence provide a long-term competitive advantage (Clarkson et al. 2011; Russo and Fouts 1997; Porter and Kramer 2006). The competitive advantage can be in terms of internal benefits related to know-how, corporate culture, committed workforce etc., or external reputational benefits (Russo and Fouts 1997). This falls in line with Elkington (1997), who referred to business firms as:

‘cannibals’ who would use the ‘fork’ of the ‘concept of sustainable business’ to devour their competitors and progress into a new stage of civilization.

When the triple-bottom-line goals of economic prosperity, social justice and environmental protection are put together, it leads to the concept of ‘corporate responsibility’ or ‘corporate sustainability.’ So, CG and CSR can be regarded as two of the three ‘prongs’ of the corporate sustainability ‘fork’.

4 Integration of the Concepts

Most of these theories of CG and theories on strategic CSR looked at taking care of the interest of multiple, broad groups of stakeholders as the means of achieving wealth maximisation for shareholders and not necessarily taking care of the interests of the stakeholders if it comes at the expense of reduction in shareholders’ wealth. This is reverberated in the G20/OECD Principles of Corporate Governance (2015) which mention that:

Corporations should recognise that the contributions of stakeholders constitute a valuable resource for building competitive and profitable companies. It is, therefore, in the long-term interest of corporations to foster wealth-creating cooperation among stakeholders.

It suggests that CG, in a broad sense, means aligning and balancing the interests of all stakeholders. A broad view of CG can also be found in the words of Sir Adrian Cadbury,⁴ ‘corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals.’ The broad view is even clearer in the following quote:

‘Good corporate governance is the glue that holds together responsible business practices, which ensures positive workplace management, marketplace responsibility, environmental stewardship, community engagement, and sustained financial performance.’ Thierry Buchs, Head, Private Sector Development Division of Switzerland’s State Secretariat for Economic Affairs (SECO).

CG failures affect all stakeholders. It is important to note that corporate collapses have adverse consequences not only for the shareholders, but also for other stakeholders such as employees, suppliers, and customers in the value chain, NGOs, and ultimately the society as a whole. So, the responsibility of the companies toward meeting their economic goals also takes care of stakeholders’ interests to a large extent. Therefore, we can say that a company, maximising shareholders’ wealth, is benefitting the society and therefore, is socially responsible on its own. It can also be said that the shareholders’ interests and other stakeholders’ interests are not necessarily at the opposite ends of the continuum as shareholders, particularly, the institutional investors might also be committed to economic, social, and governance issues. In such scenarios, taking care of these issues can be said to be tantamount to taking care of shareholders’ interests.

After having discussed the two concepts of CG and CSR at length, the following sections will deliberate on the factors which provide inter linkages between the two concepts and the implications of such interlinkages.

4.1 Institutional Investors as Corporate Governance Mechanism as Well as Driver of CSR and Sustainability

The ownership structure of the corporations has been undergoing significant change and is gradually getting concentrated in the hands of institutional investors. Institutional investors such as banks, mutual funds, pension funds, insurance companies, and hedge funds have become very powerful by virtue of the huge amount of wealth they control, and the significantly large and increasing percentage of equity investments they hold. Investment in companies by institutional investors is perceived as a corporate governance solution to the ‘free-rider problem’ in monitoring the companies which can arise out of dispersed ownership. Institutional investors are more sophisticated, more knowledgeable about business, and have better monitoring skills than dispersed owners. Owing to their large equity stakes in the companies, they have more power and ability to garner more information about the operations of the company. So, institutional investors are expected to provide better ex-ante monitoring of the companies and therefore, they have become a very important part of the CG mechanism.

Due to the large amount of wealth at their disposal, institutional investors are expected to behave as responsible guardians of people’s money and engage in ‘Responsible Investing.’ Accordingly, they have started using environmental, social, and governance (ESG) screens in their investment decisions. Long-term value (Bebbington 2001) and returns comparable with conventional investments associated with use of such screens has led to the growth of Socially Responsible Investments (SRI)⁵ (Renneboog et al. 2008) and the development of various sustainability indices across the world, like the Dow Jones Sustainability Index (DJSI). Trading by institutional investors is also likely to have an influence on stock prices. So, one can infer that by running business in a socially responsible way and by reporting the same, a company can attract investments from institutional shareholders. This can go a long way in increasing a company’s access to capital markets and reduction of its cost of capital. It therefore becomes imperative for CSR and sustainability issues to be incorporated in corporate strategies. Empirical literature has also found institutional ownership to be positively associated with corporate social performance (Coffey and Fryxell 1991). It is clear that institutional investors, who provide one of the important mechanisms of corporate governance, seem to be getting interested in investing in companies which are more engaged in CSR and sustainability activities. This phenomenon can play an important role in bringing CSR and corporate sustainability into the portfolio of corporate governance issues.

4.2 Incorporation of ‘Risk Management’ into the Concepts of CG, CSR, and Sustainability

Running any business involves handling uncertainties and managing risks, more so in today’s volatile and globalised, connected business environment. So, ‘risk management’ is considered to be an integral part of corporate governance, and ‘risk-oversight’ is considered one of the important responsibilities of the board of directors. Directors of a company need to understand the risks facing a company holistically at the enterprise level, in the context of business strategy, while keeping in mind the company’s risk appetite and risk capacity, so that they can ensure that an appropriate risk response has been devised (i.e., the risks to be avoided, minimised, accepted, transferred, and used to create value). However, during the global financial crisis of 2008, risk management was found to be one of the important weak areas of the prevailing CG practice. Several companies suffered huge losses due to failed risk management. If risk management is truly embedded in CG practice, it has been found to act as a source of core competence and competitive advantage.⁶

Risk Management in a company cannot be considered holistic if risks such as compliance risks, legitimacy risks, and sustainability risks stand ignored. For example, a company might have to pay a huge penalty for failing to comply with environmental rules; its legitimate existence might be threatened in the face of loss of reputation. With rising levels of stakeholder sophistication, stakeholder empowerment, and their increasing expectations, a company cannot afford to ignore these risks.

CSR can be very important in the corporate risk management process, by way of helping companies identify potential sustainability risks and devising appropriate response mechanisms. This facilitates an effective way of managing relationships with various stakeholders. The key to effective risk management thus lies in engagement with all stakeholders, managing their expectations, and making them participate in the risk management process. The importance of CSR in risk management is reflected in ‘Sustainability Risks’ being incorporated in COSO’s Enterprise Risk Management (ERM) framework.

Rather than using CSR to react to survival threats, companies can use CSR proactively as a real option tool of risk management, thereby focusing on its upside potential. For example, companies can engage in CSR activities in an innovative way to exceed stakeholders’ expectations, which can lead to large intangible benefits. The view of risk management has thus evolved from focusing on ‘economic issues’ to include broader risks associated with environmental as well as social issues, which can have long-term implications. These risks can be minimised by incorporation of sustainable development goals in corporate strategies, linking the broader stakeholders’ concerns with core business operations, and inviting stakeholders’ participation in the risk management process.

4.3 Effect of CG and CSR in Reducing Information Asymmetry and Cost of Capital

Corporate governance mechanisms such as monitoring and disclosures are expected to reduce information asymmetry between the managers and the outsiders, and bring down agency costs. This can bring reduction in the cost of capital of the company, which in turn can increase firm value. Evidence of the reduction in information asymmetry has been found for companies scoring high on CSR activities (Lopatta et al. 2015). It might be because companies engaging in CSR, through effective stakeholders’ management, gain higher confidence of the investors. They are perceived to have higher moral standards and higher transparency. It is also possible that the companies which engage in CSR also put in effort to minimise information asymmetry.

So both CG and CSR are found to bring a reduction in information asymmetry as one of the common outcomes, which in turn can be expected to boost firm value, through lower cost of capital.

4.4 Role of the Board of Directors in Leading from the Top—Creating Long Term Value

Another factor which creates an interlinkage between CG and CSR is the role of the board of directors. The board of directors of a company comprises the most important internal mechanism of corporate governance. They provide oversight as well as overall strategic direction to the companies. Corporations have realised that social responsibility and sustainability goals need to be incorporated into core corporate strategy, and that implementation of the same requires leadership from the top. The recent global crisis has found gaps in corporate governance which suggest that rather than adopting a checkbox approach to corporate governance, it is important for the board to provide thought leadership to the firm in achieving its objectives.

Boards of directors have started recognising that in governing corporations, it is important to adopt ‘CSR’ and ‘sustainability’ as part of corporate strategy because it would help companies gain competitive advantage and create long-term value for the shareholders. They have an important leadership role to play in sensitising senior managers to the risks and long-term value associated with handling CSR and sustainability issues. It is important for boards of directors to appreciate that the firm value can be created as well as long-term license to operate can be achieved by a company, by taking care of the stakeholders as follows:

• Employees: Boards should understand that the company will build reputation as employer and attract talent, not only if it provides fair recruitment, fair wages, timely promotion, and safe working environment, but also if it takes care of their health, education, and training (Greening and Turban 2000). All these would create a productive, skilled, healthy, motivated, and committed work force, a very valuable intangible resource which can be used further, to improve upon product quality though innovation.

• Customers: Boards should also take cognizance that a company cannot survive if it does not invest in customer satisfaction and loyalty through fair prices, safe products/services, and responsible marketing of their products (Pivato et al. 2008). Sophisticated customers today are willing to pay a premium for sustainability⁷ and sustainable products. All this helps boost the profits of the company through higher market share and differentiation pricing.

• Environment: Boards should also be conscious about the impact of the company on the environment. A company causing harm to the environment not only gets negative publicity, but also lands up spending money on fines and legal costs of fighting suits (Chen and Metcalf 1980). A company should, rather, make efficient use of natural resources (material, energy, water etc.), adopt clean technology to minimise pollution, preserve biodiversity, and recycle waste. Being environment friendly adds to the reputation and brand value of the company.

• Investors: Boards should also realise that the investors need to have confidence in the company to ensure that they supply their funds to the company. CSR practices and sustainability reporting can help build credibility in their eyes. A positive image can also have the effect of lowering the cost of capital (Ng and Rezaee 2012) and thereby increasing firm value.

• Community: Directors should be caring about the well-being of the local community and its inclusive growth. It can get employees and suppliers from the locality, provide charitable contributions toward building schools, hospitals, toilets, and require its employees to engage some hours in helping people around. This will help the company win the trust of the community, which then acts with greater cooperation.

• Human Rights and Anti-corruption: Human right abuses like discrimination in the workplace based on gender/ethnicity etc., use of child labor, forced labor etc., hurts individuals and society while anti-corruption measures win the trust of the stakeholders. Boards should understand the threat to corporate reputation if the company fails to ensure that it is against human rights abuses and does not have anti-corruption mechanisms in place.

• Regulators and civil society: The directors should also be able to see that companies engaged in superior CSR are likely to get favourable treatment from the regulators and government. It also leads to favourable media coverage and least disruptive intervention from NGOs.

A company, whose board encourages it to adopt CSR and sustainability as a strategic imperative is likely to differentiate itself by exploring innovations in using resources efficiently, in using technology and in producing customer-friendly products. So, boards by incorporating CSR and sustainability focus in their governing role can help companies gain competitive advantage and thereby enable them to outperform their peers in the long run. Overall, the companies can build intangible assets such as brand value and reputation for themselves. Intangibles are valuable assets which are attributed to be as high as 80 % of the true value of an average firm for S&P 500 companies.⁸

Among various criteria, which make the board of directors an effective corporate governance mechanism are as follows: size, independence, and ability of the directors to devote adequate time to the company affairs, etc. One can therefore expect these board characteristics to be positively associated with a company’s sustainability performance. I summarise these observations for Indian companies in a later part of the chapter. Having at least one woman on the board is considered to be a desirable CG practice. It can also have a positive influence on the CSR practice of a company.

5 Regulations Related to Corporate Governance, CSR, and Sustainability

Corporate governance and corporate sustainability regulations and norms developed in an isolated way. The need for bringing in mandatory regulation is felt strongly when market mechanisms are not effectively operational. Information asymmetry, which is at the heart of corporate governance is possibly increasing with increasing complexities in business and with increasing information load caused by technological advances. Increasing dispersion in the ownership of companies aggravates the free-rider problem in monitoring corporate behaviour. So, with lesser complexities, CG norms were voluntary in nature in the initial years. But with increasing information asymmetry and free-rider problems, they have evolved to become more mandatory in nature.

CG norms are different across countries and have changed over time. High-profile corporate governance failures⁹ have given rise to CG norms world-wide. The more important CG norms which had national and international impact include the Cadbury Report (1992), Sarbanes-Oxley Act (2002), and OECD Principles of Corporate Governance (1999, 2004, 2015). One can classify CG norms into two broad categories: Principle based and Rules based. For example, CG practice in the US as per the Sarbanes Oxley Act and other regulations from SEC/US stock exchange is rule based and mandatory, requires more disclosures, and is subject to severe non-compliance penalties. On the other hand, CG practice in United Kingdom as per the Combined Code in the UK; or CG as practiced in OECD countries as per the OECD Principles of CG is principle based. Companies are expected to ‘comply or explain.’

The recent financial crisis of 2007–2008 showed the need for strengthening CG norms further. The Dodd Frank Act 2010 was enacted in the US (to bring greater transparency to boards, top management positions, and their compensation). According to OECD studies (Kirkpatrick 2009), the recent global financial crisis of 2008 can be largely attributed to the failure and weaknesses in corporate governance particularly in the areas of risk management, board practices, the exercise of shareholder rights, and executive remuneration. This provided the most recent trigger for the ‘OECD Corporate Governance Committee’ to review and come up with a revised text for the ‘G20/OECD Principles of Corporate Governance’ (2015).

In India, the time line of corporate governance guidelines is as follows: It began in 1998 with the Confederation of Indian Industries (CII) bringing in ‘desirable corporate governance’ as a voluntary code for adoption by listed companies. This was followed by the Kumar Mangalam Birla Recommendations (1999), Clause 49 of the listing agreement of SEBI (2000), Narayanan Murthy Committee recommendations (2006), Naresh Chandra Committee Report (2009), Adi Godrej Committee recommendations (2012), Companies Act 2013, and SEBI’s new corporate governance norms (2014). All these guidelines have evolved commensurate with best practices in CG developed internationally and in tune with the country context. For instance, CG norms in the UK have a focus on strengthening the board, controlling the CEO, and in ex-ante monitoring and internal controls; while CG norms in the US focus on incentivising managers and ex-post monitoring through external audit. In India, the CG norms balance strengthening of board (independence, diversity, separation of CEO-Chairman duality, committees) with disclosure requirements. The norms are partly mandatory and partly voluntary. It is believed that the companies will adopt the best practices beyond the rubric of law.

5.1 Guidelines on CSR and Sustainability Reporting

The idea of triple-bottom line goals brings in accountability which in turn can be demonstrated through corporate reporting. Several initiatives have been taken worldwide to encourage corporate sustainability reporting. Global Reporting Initiatives (GRI) G3 guidelines, United Nations Global Compact (UNGC)’s annual ‘Communication of Progress (COP)’ and Carbon Disclosure Project (CDP)’s annual questionnaires are some of the popular global frameworks available for sustainability reporting. All these put pressure on companies to act in a sustainable way as well as report how well they are performing on triple-bottom-line counts.

In India, some environmental disclosure regulations were in place since the 1980s.¹⁰ Clearer sustainability reporting rules however have emerged lately. In December 2009, the Ministry of Corporate Affairs (MCA) issued CSR Voluntary guidelines ¹¹ to encourage businesses toward socially, environmentally, and ethically responsible behaviour. Two years down the line, in July 2011, MCA released National Voluntary Guidelines on Social, Environmental, and Economic Responsibilities of business (NVG), which laid down nine comprehensive core principles to be adopted by companies as part of their business practice and structured a format for business responsibility reporting. A company was required to either report its sustainability performance or explain the reason for not doing so.

Within a year from the release of NVG, in August 2012, Securities and Exchange Board of India (SEBI) issued a circular mandating the top 100 listed companies (based on market capitalisation) to submit a Business Responsibility (BR) Report as part of their annual report, with effect from financial year ending on/after December 31, 2012. This is in tune with the recent inclination of global investors toward an ‘integrated reporting framework,’¹² which will help comparison of companies across markets.

The Companies Act 2013 requires companies which meet certain thresholds in terms of sales, net worth, or profits to have a committee on CSR, a CSR Policy on the Board’s report and to spend 2 % of their 3-year average profits¹³ on CSR activities. With this requirement, India became the first and the only country in the world to have mandated CSR spending.

So one can see how over time, the government and regulatory bodies in India changed their role from being ‘enablers’ to becoming ‘enforcers’ of CSR spending and corporate sustainability reporting. With the new regulations, companies in India can be expected to be active on CSR and sustainability performance.

6 Market, Media, and Ethics—CG and CSR linkages

Markets and media act as a CG mechanism as well as pressure factors discouraging socially irresponsible behaviour. The customers in product markets, employees in the labor market, and investors in the capital market are likely to choose and engage with a company with better CG and superior CSR. Even the ‘purchase consideration’ in the market for mergers and acquisitions can be influenced by the CG and CSR superiority of the target company. Media also acts as one of the important means to make the companies accountable to the minimum standards of ethics, responsibility, and governance. Media can create a positive image about firms particularly, before seasoned equity offerings, at the time of low investor sentiment, and when operating in sin industries (Cahan et al. 2015). It is also often used for ‘green-washing,’ to conceal harmful impact of a company’s operations on environment. Corporate ethics provides an important link with both CG and CSR. Unethical behaviour has been found to lie at the heart of numerous corporate failures like Enron. This has motivated companies to engage in various ethics programmes, so as to encourage and monitor ethical performance and make ethics part of the corporate culture. A company, which has strong ethics integrated in its corporate culture, is less likely to have corporate governance failures. Johnson et al. (2008) proposed that companies can choose from four possible ‘ethical stances,’ namely short-term shareholder interest, longer term shareholder interest, multiple stakeholder obligation and shaper of society. ‘Short-term shareholder interest’ is the least ethical stance while the ‘shaper of society’ is the best. The ethical dimensions, when embedded in corporate culture, can not only be expected to encourage better CG, but also would take CSR activities to a progressive level.

7 Effect of CSR and CG on Financial Performance

Both CSR and CG can be expected to affect the financial performance of a company and its value. CSR can be value destroying if it is driven by the manager’s personal agenda of social reputation, political connections, or career advancements (agency concerns). However, CSR is expected to have a positive influence on firm performance if it is undertaken to balance the diverse interests of multiple stakeholders (stakeholder theory). When engagement and care of the stakeholders such as employees, suppliers, customers, government, civil society, community, and investors brings their trust and confidence in a company, its sustainability risks get minimised. Reduced sustainability risks can be expected to bring down the ‘risk-adjusted cost of capital ‘of a company. CSR can also increase the number of years of future expected cash inflows, by providing the company with a longer period of license to operate in society.

Higher ‘future expected cash flows’ discounted by a lower ‘risk-adjusted cost of capital’ can be theorised to have a higher firm value. An overwhelming number of studies attempted to find out whether corporate social performance (CSP) has a positive influence on corporate financial performance (CFP), but no clear evidence could be gathered yet (Margolis and Walsh 2001; Orlitzky et al. 2003; Allouche and Laroche 2005; Lo and Sheu 2007; Rashid and Radiah 2012). A comprehensive meta-analysis covering studies from 1972 to 2007 found affirmative results for only 28 % of the sample (Margolis et al. 2009).

CG is expected to increase firm value by minimisation of agency costs, achieved through the CG mechanisms of monitoring, incentivising, and directing managerial behaviour. CG mechanisms also lead to minimisation of information asymmetry through better disclosures, which in turn can lead to reduced cost of capital and higher firm value. Several studies looked into the effect of good corporate governance on firm performance (Parigi et al. 2015; Bebchuk et al. 2009; Gompers et al. 2003) but found mixed results. However, the association between CG and CSR (or CSP used interchangeably) is less researched. Such association can help researchers and policymakers understand the links between CG and CFP as well as those between CSR and CFP more clearly. Jo and Harjoto (2011) asked similar questions in their study and found the lag of CSR to affect CG and not vice versa and also that CSR led to increase in firm value.

8 Importance of CG and CSR in the Indian Context

Emerging economies like India have been experiencing rapid growth resulting in more wealth. But fast growth also means a higher demand for resources, higher pollution, and greater stress on environment and society, which can constrain future growth. Globalisation has encouraged Indian companies to go abroad and allowed the flow of foreign investments into the country. The global investors and customers the Indian businesses are now dealing with are highly conscious of CSR and sustainability issues. Civil society at home and abroad has also become very strong and active. These developments have made CSR, sustainability and sustainability reporting very important for Indian businesses. A strong CSR and CG can prove very valuable to investors, particularly because India is found to have a weak institutional environment—with weak investor protection and enforcement, and poor transparency (Leuz et al. 2003; Dhaliwal et al. 2012; Dowell 2000). Indian companies are found to have started embracing CSR and sustainability reporting, driven by the ‘strengthening of brand & reputation’ and ‘ethical considerations’ (KPMG 2011).

8.1 Empirical Evidence of the Relationship Between CG and CS in India

A superior CSR and corporate sustainability can lead to improvement in financial performance through increase in revenues, decrease in costs, optimal risk management, or a combination of the three. There is also likely to be a favourable impact of CS on firm value through higher ‘future expected cash flows’ and lower ‘risk-adjusted cost of capital’. A recent study examining the top 200 listed companies in India revealed that superior sustainability performance led to superior financial performance in the form of higher ROA, ROE, and Tobin’s Q ratio (Ghosh 2013). Superior sustainability performance was captured through the consistent appearance of the companies on S&P ESG index. The Indian context was examined to see whether companies which have superior corporate governance are superior in Corporate Sustainability Performance (CSP).¹⁴ Table 8.1 below shows a comparison of the corporate governance characteristics of superior CSP firms with those of non-CSP firms.

Table 8.1 Corporate governance characteristics of CSP versus non-CSP firms

A one way Anova test confirms that board independence and board size are statistically and significantly different for CSP leaders and non-CSP companies. CSP leaders on an average have higher levels of board independence and larger board size when compared to non-CSP companies. However, the CEO-Chairman duality was not found to be statistically different for the two groups. As far as the ownership variables are concerned, the oneway anova test showed that the percentage of shares held by institutional investors and average block holding is statistically and significantly different for CSP leaders versus non-CSP firms. CSP leaders have a higher level of institutional investors and a lower level of average block holding. The statistics thus suggest that CG factors, such as large and more independent boards, ownership by institutional investors, and average block-holding (large shareholders), do influence sustainability performance.

9 Concluding Remarks–A Different Past and a Common Future

The power and need for the accountability of corporations have given rise to the concepts of CG and CSR. With globalisation, the negative externalities of corporations adversely affecting stakeholders are on the rise and enforceability of contracts is becoming increasingly difficult. This underscores the increasing expectations from the corporations to engage in self-regulated CSR.

The concept of CSR has been continuously evolving and broadening from a mere focus on the obligations of business to that of society. According to the United Nations Industrial Development Organization’ (UNIDO),¹⁵ ‘CSR is generally understood as being the way through which a company achieves a balance of economic, environmental and social imperatives (‘Triple-Bottom-Line-Approach’), while at the same time addressing the expectations of shareholders and stakeholders.’

Forces behind CSR are changing the CG landscape. It has broadened the number of stakeholders to which a company is accountable. It is interesting to note that the ‘G20/OECD Principles of corporate governance (2015)’ recognises the importance of the role of stakeholders in the following words: ‘The competitiveness and ultimate success of a corporation is the result of teamwork that embodies contributions from a range of different resource providers including investors, employees, creditors, customers, and suppliers, and other stakeholders.’ The definition of CG now stands expanded as a ‘system by which companies are directed and controlled in the interest of shareholders and other stakeholders.’

This chapter discussed how some CG factors (such as ownership by institutional investors, board of directors, risk management) play an important role in CSR practices. CG and CSR also have common outcomes in the form of a reduction in information asymmetry, decrease in cost of capital, and increase in firm value. One can see that while the concepts of ‘corporate governance,’ ‘corporate social responsibility,’ and ‘corporate sustainability’ might have developed independently with different beginnings, the concepts have broadened so much that they are more or less converging to a common future.