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India Improves Corporate Governance, But Also Mandates CSR

Posted on the 14 August 2013 by Center For International Private Enterprise @CIPEglobal
Corporate Affairs Minister Sachin Pilot (Photo: The New Indian Express)

Corporate Affairs Minister Sachin Pilot (Photo: The New Indian Express)

Last week, after nearly 12 years of debate, India’s parliament finally passed a sweeping new piece of corporate legislation. The 2012 Companies Bill replaces the previous 1956 law and introduces some major reforms to bolster corporate governance in the world’s largest democracy, which has faced questions about its potential for continued growth. According to Indian Corporate Affairs Minister Sachin Pilot, the law “aims at plugging loopholes in the system for a better… business environment,” and will “enhance transparency and ensure fewer regulations, self reporting and disclosure.”

Among other measures, the law defines the concept of “fraud” and empowers a new agency to investigate it; strengthens checks and balances in companies’ governance systems; makes board decisions more transparent; and seeks to increase the accountability of a company’s directors and auditors. The law also establishes that at least a third of directors should be independent, requires companies to rotate auditors, and tightens oversight of companies that take public deposits and of loans among a company and its subsidiaries.

At the same time, some of the reasoning behind other well-intentioned measures in the law is less clear-cut. For instance, certain classes of companies will now be required to have at least one woman board member. The overall goal here is important: to make boards more representative, thus building a more gender-equitable economy. Yet the effectiveness of such quotas has not been universally accepted, particularly because of the risk of creating “token” board slots.

At the firm level, there may be other positive incentives to get more women on boards, while at the macro level, governments in the region need to tackle a wide range of other policy and social barriers to women’s economic participation before they legislate firms’ governance structures. In addition, the new Companies Law introduces class action lawsuits, which some argue will benefit minority shareholders in various cases of fraud in India. But because such suits can be misused, they might be the wrong tool to accomplish that goal.

The law’s progress has been closely followed by those interested in issues of corporate social responsibility (CSR) because one of its aims, according to Corporate Affairs Minister Pilot, is “to structure the concept of putting back to communities in a formalized manner.” In other words, the new law mandates CSR: Indian companies will now be required to spend two percent of their net profits on CSR activities. There have been estimates that about 3,000 companies would be covered, bringing criticism from a diverse set of voices, across the business spectrum.

Practical questions abound, such as what types of activities will qualify, how the law will affect smaller firms, and how such spending will be verified. The theoretical questions are much larger: Is this just a hidden tax? Should companies be forced to fill a void in social services that the state should be providing? How effective can mandated CSR activities be? How to take into account the value that companies provide simply by employing and paying workers? How will the law affect companies whose business model is already based on addressing social issues through market mechanisms?

Indeed, for a different model of how governments can be more engaged with companies in encouraging CSR, one only need look across the border from India to Pakistan, where the Securities and Exchange Commission, the country’s main regulatory authority, recently issued a set of voluntary CSR guidelines. Many governments and exchanges have guidelines on disclosure and reporting of CSR spending, or use incentives to encourage such spending. Certainly, consumers worldwide are growing more vocal about wanting companies to engage on social issues, and shareholders and management are listening. But observers will be following India closely in the coming years to see the effect of this new law.

Marc Schleifer is Senior Program Officer for South Asia.

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