Corporate Responsibility learnings for India - from the book "Grow the Pie" by Alex Edmans

In the words of Alex Edmans , Professor of Finance at London Business School and a leading authority on reforming business to serve the common good (also the author of the book Grow the Pie: How great companies deliver both purpose and profit), it is the idea of a “responsible business which creates profits through creating value for society” that has inspired me to write this brief interpretation and sharing of learnings from his book.

Inherently, virtuous organisations survive, only if profitability at their base also is maintained. And even Milton Friedman’s argument, that the social responsibility of business is to increase its profits, is much more nuanced than commonly portrayed. When the business maximises profits, shareholders can decide what social causes to invest into. There are three critical assumptions here in Friedman’s view which are open to question, and weakens the case for the stand that Milton Friedman had taken.

·?????? Friedman assumes that a company has no comparative advantage in solving social problems. This could be true for quid-pro-quo or charitable donation cases, but, not true for intervention areas in their domain of expertise and influence.

·?????? Public choice theory clearly tells us how the politicians’ always have their self-interest and to be “in power’ as their top priority. So, they don’t always reflect citizens preferences in their actions. Regulation, often is ineffective in addressing outcome issues, due to the political process itself being slow and often even state capacity being debilitating to implement heavy regulations on this.

·?????? The assumption that leaders can forecast how an investment in stakeholders will affect profits – which is often very difficult to do in a world of VUCA – Volatile, Uncertain, Complex and Ambiguous.

As a thought experiment, just imagine if such forces of negative “externality” were considered internal to running a business. How would a business react to it? Regulations would then be set to punish disobedience within the operations. Such regulations to address negative externalities once they would happen, would not even be needed in the first place. The business would build such inefficiencies and costs into their product's P&L sheet – and their products would be costly because of such “internal” inefficiencies. The creative destruction forces of the market would then throw them out based on the lack of profitability and shareholder value they are generating. That is how creative destruction would take its 21st-century form - Profitable firms that do not destroy any existing environment or social value and get away by following weak regulations or carrying out “offset” socially sound activities in other locations.

Alex Edmans explains this succinctly, in highlighting a few inherent problems with an energy/externality-abating certification process -

·?????? The firms selling and buying are rarely in the same region. Hence, the region/aquifer/watershed/village clusters will never be better off. Once we think beyond an individual firm and more in an industrial cluster, such solutions make less sense.

·?????? The firm selling such certificates will always be incentivized to be the best fish in the available pond, not the best fish it could ever be. Innovation is not incentivized; merely being better than the 2nd worst is incentivized.

·?????? The firm buying such certificates is incentivized to save costs through inferior products or processing means to compensate for the additional costs it would have to pay for such “externality” abating certifications.

·?????? The aim must not be to normalise externalities through the action of giving them “property rights” and making them tradable – that never solves a purpose / spirit / value-orientation problem in the first place. It is like applying a band-aid to a patient with a broken arm.

I have taken the core of Alex’s suggestion to create an overview of the evaluation criteria for determining the areas of social and environment responsibility investments by corporates. These can be the following (first three from Alex’s analysis, and the final two added from a policy-makers perspective to help determine a regulatory environment around such a responsible-behaviour).

·?????? The multiplication effect ensures that the social benefit of an activity exceeds its private costs, so that the activity delivers value to society. This incentives companies to address activities which causes external harm.

·?????? The comparative advantage of doing an activity ensures that the social benefit of an activity exceeds its social costs, in turn creating value for the society

·?????? Focusing on stakeholder materiality while performing an activity ensures that the social benefit created will ultimately increase the company's profits while creating and delivering value to society.

·?????? Shareholders buy-in becomes an important evaluation criterion, so that profit as a motive is specifically weighed on the scale of the balance vis-à-vis responsible actions by corporates. Of course, no corporate would benefit by bankrupting its way into being a responsible entity.

·?????? The state’s institutional robustness is vital to ensure an alternative is embraced which results in minimum susceptibility to waste, fraud or abuse.

And when we extend this to India, we realise that the CSR spending in India is currently

·?????? Investing time, resources, and opportunities in a narrow focus in domains like education & health, capturing 80% of the CSR spending, where companies do not have a comparative advantage,

·?????? In limited geographies – with 33% of annual spending in just 5 states, where companies cannot create a multiplication effect, and

·?????? In projects with preferably more government participation – as high as 55% preference of companies in it (hence often not even central to its wider stakeholder materiality).

At its core, it is important for profitable firms to recognise that “polluters pay”, and not “pollute and pay”. And that difference is not just word-play, but a major differentiation between how a company approaches “responsible behaviour” and embed its into their business operations. I will cover further aspects of corporate responsibility and its applicability for India, through subsequent posts in the series of “book learnings” and even otherwise.