Debt Markets Retort to Mandatory Corporate Social Responsibility

Shareholder primacy and stakeholder capitalism represent contrasting viewpoints, with the former emphasizing shareholder interests and the latter advocating corporate social responsibility (CSR) and broader stakeholder engagement. Concerning CSR, it's acknowledged that markets may not efficiently address public goods. Firms, while pursuing profit, are not often expected to address social and environmental concerns. Instead, these roles are assigned to governments, reflecting the classical dichotomy that separates corporate and government responsibilities toward society (Friedman 1970).

Corporate Social Responsibility (CSR) policies diverts cash flows from creditors and stockholders. However, some argue that firms should view CSR as a value-enhancing corporate strategy (eg Freeman 1984), as CSR engenders benefits through increased goodwill that enhances productivity and firm performance. But the net impact on shareholders and bondholders is an empirical issue. There is significant research on the impact of CSR policies on shareholders but not much research has been conducted to investigate their impact on debt holders, especially when CSR becomes mandatory. My recent working paper fills that gap: first, by showing the causal relation between mandatory CSR policies and bond pricing, and second, by showing that mandatory CSR policies impact bond pricing by misallocating capital in activities that hamper future cash flow.  

I examine the influence of CSR policies 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 and amount of debt issued by relevant firms. The rule outlined under the Indian Companies Act 2013 provides that if during any fiscal year a firm has either (i) a net worth of Rs. 5,000 million (about US$ 83 million) or more; (ii) sales of Rs. 10,000 million (about US$ 167 million) or more; or (iii) a net profit of Rs. 50 million (about US$ 830,000) or more, it is required to spend 2% of its average net profits of the last three years on CSR related activities such as hunger and poverty eradication, promoting women’s empowerment, environmental sustainability, prime minister’s fund, and similar others.

Using the difference-in-differences and multi-dimensional regression discontinuity design (RDD) techniques on bond issuances from three years before the enactment date (29 August 2013) to three years post, I find that the mandatory CSR rule increases the cost of debt (proxied as yield spread) by 43 basis points for the affected firms compared to others. De-bundling the impact of other requirements of the Act from mandatory CSR rule reveals that while the Act helped reduce the cost of debt (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 by 103 basis points compared to bonds issued by unaffected firms.

To test whether reducing information asymmetry on CSR expenditure is rewarded by the debt market, I analyzed the details on CSR expenditure and found that affected firms which disburse an amount close to the prescribed one and disclose the names of the agencies  used for CSR expenditure are penalized less by the debt market. This supports the argument that firms are rewarded by the capital markets for reducing information asymmetry regarding CSR disbursements. It's important for firms to be transparent about their CSR spending, as this can have an impact on their cost of debt.

Overall, the study demonstrates that companies subject to India's mandatory CSR regulation encountered a rise in their cost of debt relative to other Indian companies. While additional provisions within the Companies Act contributed to lowering the costs of debt, the mandatory CSR provision offset these advantages for the affected firms. The heightened debt expenses stem from the adverse influence of obligatory CSR on anticipated cash flows. This impact is accentuated in cases of repeated issuances but moderately diminishes for firms that uphold transparency in disclosing CSR allocation. These findings shed light on the interplay between CSR regulations and dynamics within the debt market.

Jitendra Aswani is a Forthcoming Post-Doctoral Fellow at MIT Sloan.