Financial Incentive for Corporate Social Responsibility

Corporate social responsibility (CSR) is the need of the hour as there are increasing concerns raised about the impact of corporate activities on society and the environment. A bad CSR image can cause too much damage to the company and its stakeholders, hence the need to comply with CSR activities. CSR is conducted with the incentive of goodwill and on self accord. However, due to escalating talk about sustainability, there is the insertion of socially responsible investing (SRI) in the financial sector. SRI is a process which integrates environmental, social, and governance (ESG) criteria into the traditional investment making process.

While discussing these concepts related to sustainability, this paper aims to ascertain a strong and direct relation between CSR and SRI while ESG issues being common ground. The establishment of this relation will substantiate the claim the SRI act as an incentive for CSR activities of the companies. Furthermore, this link will satisfy the presence of investment with social consideration and inclusion of CSR values in the financial sector.

A direct relation between SRI and CSR also entails a straight forwards logic i.e. the company with more CSR activities will attract more responsible investing. Moreover, the paper also entails that SRI is not just a one-time incentive as it can also be employed to keep a check on the CSR activities of the company in the course of business. SRI can also be utilized to make the CSR activities of the company more beneficial and transparent.

Keywords: Corporate Social Responsibility, Socially Responsible Investing, Environment Social and Governance (ESG), Sustainable Finance

Introduction

Corporate social responsibility (CSR) refers to a practice undertaken by businesses. CSR implies the firm dedication of companies to contribute towards the social and environmental benefits of society and the ecosystem. The activities carried out as CSR comprises of a wide range of options such as eradicating poverty or hunger, promoting education, endorsing gender equality, uplifting the oppressed in the society, ensuring environmental sustainability, protecting national assets, supporting the armed forces veterans and their dependents, encouraging sports, and contributing towards disaster management.

When a company indulges in socially responsible activities, it creates a business model that helps the company to be socially accountable to itself, its stakeholders, and the public at large. Moreover, when the companies practice CSR they act as corporate citizens conscious of the impact of their actions on all the aspects related to society i.e. social, environmental, and economic. There is increasing demand for CSR as the consumers and the public at large are getting aware of the bad effect of the business activities carried out by huge companies.

This increased demand for CSR activities can be very well substantiated by the raise in CSR activities and implementation of numerous codes of conduct in the past decades. The public image of the company act as an incentive for the companies to comply with CSR activities, the company with a bad image will lose its goodwill in the market, leading to a loss in the business as well. Moreover, the companies also performed CSR activities according to their own will when the company was guided by a leader with the perspective of giving back to society. However, in addition to these reasons for compliance with CSR, there must be other incentives for the companies to comply with CSR in order to have a greater impact on society.

Socially responsible investing (SRI) can be claimed to be one such incentive for large companies to comply with corporate social responsibility. This paper aims to establish this relationship between SRI and CSR; furthermore, it will establish the growth in SRI and inclusion of Environmental, Social, and Governance criteria in the financing framework to corroborate the strong impact of responsible investing into CSR activities of the companies.

Socially Responsible Investing (SRI)

Socially responsible investing is a financial framework, where the investors fund after considering the social and environmental outcome of their investments. Besides the financial performance of the company, the investors focus on non-financial indicators. This framework leads to the positive and negative financial analysis of the investment made. However, incorporating this framework of investing in the present market would result in the definition, where SRI is understood as a procedure of investing in the companies which comply or meet with a specific standard of corporate social responsibility. SRI can also be called sustainable and responsible investing and green investing.

However, the understanding of SRI has also changed from time to time:

• In 1983, SRI was considered as the inclusion of social or ethical decisive factor into the process of making an investment by the investor.
• After two decades, in 2001, ABN-AMRO defined the term differently as

“An investment process in which sustainability criteria relating to a company’s social and/or environmental behavior play a decisive role in the admittance of the company’s stocks to the investment portfolio.”

• In 2005, a broader definition of SRI was presented by the World Forum Report, which suggested that SRI is an investing manner that considers the impact of investment on wider society and the environment, this impact is analyzed in the timeline of present and future.

These definitions indicated the evolution taking place in the framework of responsible investing. The present and the broader connotation of socially responsible investing has widened the scope of responsible investing included the larger object of CSR such as social and environmental growth in both present and future. Furthermore, SRI has emerged as a new era of investing, which considers the social and environmental aspects of the investing industry.

Environmental, Social, and Governance (ESG)

Since socially responsible investing is a financing framework; there is a need for an indicator in this framework for better functions. Investors can invest responsibly when they know the social and environmental impact of the company and these impacts can be very well-identified with the help of the ESG indicator. ESG looks at the environmental, social, and governance practices of the company while providing the investor with a metric, where the investors can check the activities conducted by the companies in these areas.

The environmental aspect may take into consideration the impact of business on climate, deforestation, pollution, and how the company manages these areas of concern. Social factor in the indicator constitutes of worker safety and health, impact on locals, labour rules, human rights, equality, and diversity and how are these elements treated by the company. Governance looks after the status of the company regarding its activities with the shareholders and malpractices in the management.

All these considerations indicate that ESG can be used as a crucial non-financial indicator for responsible investing as it indicates the sustainability of the business. Moreover, ESG criteria facilitate the measuring of the company’s efforts to be socially and environmentally accountable via CSR. Hence, ESG issues help investors to analyze the company, and at the same time, it also provides companies with an indicator to attract investors and strengthen their goodwill.

Interrelation between Corporate Social Responsibility (CSR) and Socially Responsible Investing (SRI)

There are numerous studies focused on the interrelation between the investments via socially responsible investing and the firm’s activities as corporate social responsibility and these studies project a possible link between the two. The link can be helped with the help of the firm’s and investor’s point of view towards CSR and its benefit via SRI. From the firm’s viewpoint; it is argued that socially considerate and responsible firms often have lower systematic risk, and hence they get access to cheaper capital via SRI. (Ghoul et al., 2010 and Albuquerque et al., 2014)

Moreover, it is also suggested that due to CSR there is a deduction in the information asymmetry leading to increased transparency, which in turn result in decreased agency cost. This outcome may provide less obstruction for acquiring capital by the socially responsible funds. (Cheng et al., 2013) In addition to these claims concerning SRI and CSR, there is another claim which states that CSR policies give companies long-term stability by helping them strengthen their position in the market and due to this increased firm value, the firm becomes attractive for the SRI investors. (Bã Nabou & Tirole, 2010) These arguments presented on behalf of the firms indicate the significance of CSR in relation to acquiring capital from the market.

Besides the position of the firm, the point of view taken by the investors also establishes solid evidence towards the link between SRI and CSR. From the perspective of a socially responsible investor, the fund is more likely to be invested in firms with CSR practices. (Williams, 2005; Portney, 2008; and Karakas et al., 2015)

Furthermore, the institutional investors with social and environmental considerations increase their ownership in the firms that adopt CSR changes. (Karaks et al., 2015) The responsible investors also employ certain non-financial indicators like ESG for CSR screening of the companies and invest in the highly ranked companies. The stances presented on behalf of investors convey direct relation between SRI and CSR as more CSR means more responsible investment.

Responsible investors invest in companies which match their commitment to CSR and the investment also depends on the sensitivity of the investor towards the CSR activities taken up by the firm. There is a significant increase in the investment when the two criteria i.e., the commitment of the company and sensitivity of investor amplify. However, the first-ever investment of the responsible investors, primarily, depends on the CSR score of the company. Hence, there is a solid link between the CSR activities carried out by the company and the investment made by socially responsible investors (SRI). The establishment of this relationship demonstrates the point that SRI acts as an incentive for the companies to comply with CSR activities.

The Principles for Responsible Investment

In addition to the above-established relationship between CSR and SRI, the United Nations Principles for Responsible Investment (UNPRI) also provide for a strong correlation between the two concepts of SRI and CSR. These principles provide for a framework by which all the responsible investors can employ ESG indicators in their investing practices. Some of the relevant principles which define correlation are as follows:

• Incorporation of ESG issues into the investment process

By incorporating ESG indicator into the process of investing, a direct connection to the firms CSR activities has been developed as the ESG issues conveys the CSR score of the company. Hence, to attract investment firms will have to meet certain standards concerned with CSR scores.

• Be active owners to integrate ESG concerns in the company

This principle broadens the scope of CSR limited to investing as it entails the possibility of improvement in the CSR activities conducted by the company due to the presence of responsible investors. Furthermore, with the companies’ perspective of easy capital via SRI, it is reasonable to assume that the company will work according to the shareholder or stakeholder involved. Hence, this principle further acts as an incentive for the company to comply with the CSR guidelines.

• Disclosure on ESG issue

This principle is crucial as it created transparency in the functioning of the company and its initiative towards society and the environment. This creates certain credibility as the firm cannot defraud the investors by showing false information concerning its CSR initiatives.

These principles also help in concluding that SRI is not only effective for the promotion of CSR and related activities in the companies, but it also helps in maintaining the responsible work done by the company in the long run until the socially interested investors are in the company.

Besides these considerations on the relation between SRI and CSR, another claim can also be made that both the concepts are for the same cause, hence there must be a certain relationship. Both CSR and SRI bring in the aspect of giving back to society in order to have sustainable development in society. The same cause claim can also be supported by the supply and demand-driven theory of responsible activities.

CSR being the activity done by the company can be asserted as supply-driven because the company is willing to supply quality initiatives concerning society and the environment. However, every supply chain functions properly when there is demand for it.

In the case of CSR, there is demand from the concerned public and along with them responsible investors via SRI also creates demand for activities for the betterment of society and the environment while considering all the stakeholders related to the company. Hence, both SRI and CSR are directly related as they entail the demand and supply of quality activities to society and the environment. This direct relation is indicative of the fact that an increase in the demand for quality through SRI will act as an encouragement for the supply of quality activities via CSR by the companies.

Growth of Socially Responsible Investing

There are ample pieces of evidence to show the growth of socially responsible investing in the financing industry. Moreover, it is essential to track the growth of the concept as growth in responsible investing will directly promote the growth of CSR activities in the companies due to the direct relationship between the two concepts. Socially responsible investing has continued to grow at a faster rate than other conventional investment tactics in the sector.

The faster rate of responsible investing is due to the extra emphasis put on the ESG issues of the companies. ESG indicators of the companies are gaining more attention due to the increase in the risk concerning the environmental and social factors in the last few years. In 2019, four out of five global top risks were connected to societal or environmental issues. (Bhavani & Sharma, 2019)

There have been numerous corporate disasters related to the ESG issues in the last two decades and these disasters are not only affecting society or the environment but at the same time are also adversely affecting the businesses by financial complications and loss of public trust. (Bhavani & Sharma, 2019) Hence, due to this extended impact of bad policies of the companies, there are raising concerns related to the sustainability of the corporate sector. This increased concern is creating a push for more SRI as SRI acts as an incentive for CSR activities of the companies. Furthermore, the growth in the SRI is also crucial to bring the aspect of sustainability to the financial sector.

The growth of socially responsible investing can be substantiated by the global digits. In 2019, around USD 17.5 Trillion investments were undertaken with ESG integration into decision making. Investors are now geared to adopt ESG integration around their portfolio and 97% of asset owners and managers expect that ESG information is going to play a vital role in the investment process in the coming year. (Bhavani & Sharma, 2019)

In addition to the green investing strategies, there is also a hopeful trend of investors and funds divesting from the controversial sector. (Bhavani & Sharma, 2019) Based on the survey, some of the sectors which will face disinvestment by 2030 are nuclear weapons, tobacco, fossil fuels, alcohol, etc and these sectors are under the radar due to their impact on society and the environment. (Bhavani & Sharma, 2019) Moreover, the equity market is also turning responsible as some of the major ETFs are considering investments aligned with beneficial environmental and social impacts.

The self-initiative by the countries

In the current year, SEBI (Securities Exchange Board of India) has declared to issue some guidelines concerned with the environmental, social, and governance space due to the increasing demand for ESG related information by the investors. In 2008, European Union released an action plan for sustainable finance, which provided the framework to support and promote sustainable and responsible investing in the EU. The action plan entailed integrating ESG issues in the decision-making while increasing disclosure. Moreover, it also included integration of ESG in the credit rating of the companies.

Impact of pandemic

As the global concern related to the environment is at the peak due to the climate changes, on the other hand, due to the pandemic there is widespread social unrest around income inequality and worker safety. Due to this upheaval, the investors and the public at large are showing concern towards social issues. Furthermore, the pandemic has also encouraged investors to consider the financial realities of ESG risks and opportunities. Pandemic reinforced the interest for the ESG issues as it highlighted the marginalized and vulnerable communities in society, which are in extreme poverty, unemployment, and deprivation of healthcare.

These instances increased the concern about the CSR activities of the companies. Despite the pandemic, countries took major steps to join the global programs related to environmental well-being. Moreover, responsible investing will also attract more investors as the trend underlined by the world economic forum conveys that ESG funds outperformed the broader market during the covid-19 crisis.

The growing concern of the ESG indicator in the investing process indicates progress in sustainable and responsible investment which in turn will lead to more accountability of the companies regarding CSR activities and ESG issues.

Conclusion

In conclusion, it can be stated that corporate responsibility and accountability are no more untouched matter; instead, they are the necessity in the present scenario. It’s high time that the corporate must take action for the wrong happening in society and wrong done to the environment due to their business activities and the answer to this need is corporate social responsibility.

To fasten the process of corporate accountability there must be certain incentives and socially responsible investing is one of them. However, socially responsible investing is not a generic incentive but a sector-specific financial incentive, which entails the inclusion of ESG issues of the company in the investing process. Furthermore, increasing efforts for responsible investing and its direct relation with CSR corroborates the claim of SRI as a financial incentive for CSR activities of the companies. Hence, SRI funds may provide society an externality of improving CSR.

Moreover, with increasing demand for ESG inclusion by stakeholders, it can be claimed that there will be a significant improvement in the firm’s CSR activities after SRI and its growth in the financing sector. Additionally, the development of SRI can also be seen as an initiative for the inclusion of sustainability in the financial sector.

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