INSIGHT by Jitendra Aswani, upcoming post-doctoral researcher at MIT Sloan School of Management, former corporate governance fellow at Harvard University
When discussing Corporate Social Responsibility (CSR) in academia, it is widely acknowledged that markets may not always price and provide public goods efficiently. However, it is important to note that firms cannot be solely expected to engage in socially or environmentally responsible practices while prioritizing profit maximization. Ultimately, the responsibility for managing externalities and providing public goods falls primarily on governments, as they are guided by public preferences and democratic decision-making. This differentiation between the roles of corporations and governments in society known as the classical dichotomy.1
Recent research has shifted its focus to examining the impact of CSR on the economy, shareholder value, and stakeholder welfare, rather than debating its existence. Scholars are attempting to understand the underlying motives driving CSR initiatives, such as value creation (or win-win scenarios), delegated philanthropy and manifestations of agency problems.2 However, a persistent challenge in these studies is that CSR is often voluntary, making it difficult to identify the exact driving force behind the observed outcomes. To address this limitation, I examine the influence of CSR on debt markets in India, where the government has imposed a mandatory CSR spending requirement for profitable firms. This unique setting allows me to investigate how mandatory CSR affects the pricing of debt securities.
The problem with voluntary CSR is that of self-selection, therefore, it fails to provide the causal inference of CSR’s impact on a firm’s behavior or investments. Consequently, I use a unique setting in India to resolve the self-selection and reverse causality issues in analyzing the effects of CSR on debt markets. The Indian government incorporated Clause 135 (henceforth, the CSR rule) in the Indian Companies Act 2013, mandating minimum amounts of CSR spending for profitable firms.
The rule imposes that a firm that has either,
- a net worth of at least 83 million USD (about 5 billion Indian rupees (INR)),
- sales of at least 167 million USD (about 10 billion INR), or
- a net profit of at least 0.83 million USD (about 50 million INR)
is required to spend 2% of their average net profit, calculated over three years, on CSR related activities.
A few of the permitted CSR activities include:
- Hunger and poverty eradication
- Promoting women’s empowerment
- Environmental sustainability
- Contributing to the prime minister’s national relief fund.
This policy change in India presents a natural setting for examining the causal impact of CSR on bondholders. I obtained data on bond issues by Indian firms in the three years before and after implementation of the CSR rule from the SDC Platinum Fixed-Income Issues database. I ignore all preferred stock issues and bonds with contingent features such as step-up and convertible bonds. I augment the bond issue data with company data from CMIE’s ProwessDx database. I can match data for 183 firms with 2,413 bond issues over the six years from 30th August 2010 to 30th August 2016.3
Empirical analysis shows that the mandatory CSR rule increases the yield spread by 43 basis points for the affected firms compared to others. Debundling the impact of other requirements of the Act from mandatory CSR rule exhibits that while the former helped reduce the yield spread, the mandatory CSR rule counteracted those benefits for the affected companies. Adjusting for bond characteristics, firm characteristics, and industry-fixed effects using difference-in-differences specification, the yield spread of bonds issued by affected firms increased to 103 basis points compared to bonds issued by unaffected firms. To ensure the accuracy of these results, I conducted a multi-dimension regression discontinuity design (MRDD) to identify the varying effects of the rule on firms that just met the CSR cutoff compared to those that narrowly missed the cutoff. This allowed for a more precise examination of the effects of the CSR rule on these specific sets of firms. The results indicated that the yield and yield spreads for bonds issued by firms that just met the criteria were higher than the yield and yield spreads for bonds that just missed meeting the CSR criteria. The mandatory CSR had a positive and significant impact on yield-spreads. To further investigate, I analyzed the impact of each of the three criteria used to determine whether a firm is subject to the CSR mandate and found that bonds issued by firms that were subject to mandatory CSR spending based on the individual criteria also had higher yields and yield spreads. Further analysis using the two-stage least square regression model reveals that the mandatory CSR rule impacted the yield and yield spread through the future free cash flow (FCF). Implementing CSR activities using 2% of the profits resulted in a decrease in FCF, which led to an increase in yield and yield spread.
Even though I report increases in the yield and yield spread of the affected firms’ post-CSR rule, understanding the channel through which it happens is crucial. Using a structured model of two-stage least square (2SLS) regression, I found that the mandatory CSR rule affected the yield and yield spread through future free cash flow (FCF). The expenditure of 2% profit on CSR activities decreases the future FCF, which increases the yield and yield spread in the current period.
To examine the differential treatment of the affected firms’ post-CSR rule, I collect detailed activity-level CSR expenditure data and information on the agencies used for dispensing these expenditures from the National Stock Exchange (NSE) Infobase. This database helped determine whether the affected firms disseminated the information on items such as deviation of CSR expenditure from expected value as per CSR rule and on agencies (in-house or third party) used for dispensing CSR expenditure. Firms providing information on CSR agencies are penalized less by the debt market, suggesting that transparency on CSR expense matters.
Understanding the capital market’s response towards mandatory CSR rule in India can guide our expectations about outcome on the recent debate on mandatory sustainability reporting. The “IFRS S1” standards issued by the ISSB as part of the Global Sustainability Disclosure Standards offer a relevant comparison to the mandatory CSR rule. Both aim to enhance sustainability reporting for transparency and societal well-being, yet they present distinct challenges. Quantifying social benefits from CSR expenditure is complex, like measuring sustainability performance under IFRS S1. Reliable information is crucial in both cases, but limited data availability hinders accurate assessment of the impact’s extent.4
General Requirements for Disclosure of Sustainability-related Financial Information (“IFRS S1”) requires an entity to disclose information about all sustainability-related risks and opportunities that could reasonably be expected to affect the entity’s prospects. The effect on the entity’s prospects refers to the effect on the entity’s cash flows, its access to finance, or cost of capital over the short, medium or long term.
The Mandatory CSR rule in India illustrates that an increase in negative externalities’ price can elevate firms’ cost of capital, potentially crowding out financially constrained companies in accessing external financing. Similar implications may arise with sustainability reporting standards like EFRAG’s European Sustainability Reporting Standards the SEC’s carbon disclosure rule and “IFRS S2” focusing on climate-related disclosures carbon pricing’s implementation and subsequent cash flow reduction can financially constrain firms addressing negative externalities, leading to higher capital costs and disadvantaging marginally positioned companies seeking external finance. This holds true globally, not just for India.
While sustainability reporting provides valuable information to regulators and stakeholders, its effectiveness in curbing carbon emissions and mitigating climate change remains uncertain. My research on green bonds suggests that firms have struggled to improve their environmental performance despite four years of issuance. However, enhancing environmental performance in long-term green projects requires time and dedication. Increased information disclosure can still play a vital role in stabilizing negative externalities over time, even if immediate and significant mitigation is challenging.
Mandatory sustainability reporting, as emphasized by “IFRS S1” and “IFRS S2”, goes beyond mere carbon disclosure, encompassing a broader scope that includes the reporting of ‘Environment’ and ‘Social’ factors. For firms, particularly those operating in polluting sectors like utilities, materials, industrial, and energy, this expanded reporting requirement could lead to increased costs if they fail to expedite their transition towards sustainable practices. However, a critical factor determining the true societal benefits of such reporting hinges on the pricing of negative externalities. However, even if the pricing mechanisms for these adverse impacts remain low after the implementation of mandatory sustainability reporting, accurately quantifying the advantages to society necessitates further comprehensive analysis.5
Jitendra Aswani is upcoming post-doctoral researcher at MIT Sloan. Prior to that, he was a corporate governance fellow at Harvard University. He has a Ph.D. in Finance from Gabelli School of Business, Fordham University. Before joining the Fordham, he did his M.Phil. (Economics) from Indira Gandhi Institute of Development Research (IGIDR) and B.S. (Chemical Engineering) from National Institute of Technology (Jaipur) in India. He has also worked for the Indian Oil Corporation (the national oil company of India) for a small stint.
His research focuses on corporate governance, ESG / CSR, corporate finance, debt markets, and behavioral finance. He has presented his research at well-known finance and economics conferences such as The Econometric Society meetings, SFS Cavalcade North America, Western Finance Associate (WFA), American Finance Association (AFA), MIT Asia Conference, Financial Management Association (FMA), China International Conference in Finance (CICF), Royal Economic Society (RES) Annual Meeting, Northeast Universities Development Consortium (NEUDC), UN PRI Academic Conference, and similar others. His work has published in top finance journals such as Review of Finance.
 Bénabou, Roland, and Jean Tirole. “Individual and corporate social responsibility.” Economica 77, no. 305 (2010): 1-19.
 Aswani, Jitendra. “Debt Markets Retort to Mandatory Corporate Social Responsibility.” Working Paper, 2022. SSRN Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4499400
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