I have been critical of the popular notion of “true costing” (which tries to fully account for the impact of companies’ social and environmental costs) because it is too complex and expensive to practise, not “incentive-compatible” (i.e. no one wants to do it, except environmentalists) and ineffective in raising money for social and environmental goods.
Instead, I thought we can add one additional line to the existing financial statements to align all different stakeholders’ incentives to achieve sustainable growth. The key point is this: “What if all listed companies are asked to show their corporate social responsibility (CSR) in one line in the main profit and loss account?” In 2009, I proposed `one additional line’ to Salman Khurshid, then Union minister of corporate affairs. Since then, there have been several changes in the ministry and the government. In 2013, Sachin Pilot helped push the additional line, although we still faced challenges from those who did not wish to disclose their CSR expenses in a line.
Companies are not forced to pay a penny, but are asked to show how much money they spent for CSR in one line of the main financial statement. How would managers react to it? Knowing that they would be compared across companies, say by the media’s eye-catchy ranking tables, companies are likely to spend CSR money because they want to be seen as good citizens. What about investors? For example, many western and socially responsible investors cannot invest in Indian companies because there is no information about their environmental and human right violation risks. Nowadays, codes of good investment practices require fund managers to account for how they choose their stocks. So, if companies disclose their appropriate CSR activities, investors buy their shares.
Financial reporting
This is an institutional mechanism design developed specifically for large emerging economies like India, China and Brazil. In India, from now, both managers and investors will have to look at the level of CSR against profit and other line items such as sales, capital, etc. They will have to think of the balance between the level of profit and CSR – they will have to strike a balance based on their judgement. Other than the recommended minimum of two per cent, no one will force companies to spend money for CSR, but the market (widely defined, including investors, media, government, consumers, potential employees, among others) will monitor and react to companies’ attitudes towards CSR. This is something managers have to be aware of, because research shows that stakeholders (mainly investors, consumers and media) show a strong preference for pro-CSR companies.
The other point is that because one additional line alone cannot explain companies’ CSR activities well, there is a natural incentive for companies to explain the breakdown of the line in the form of a report. This way, CSR reports, which have traditionally been merely marketing brochures, become relevant for investment decisions. Of course, auditors have to check these because the additional line is an independent item of a profit and loss account and such certified details of CSR activity reports would be useful for media and local communities to check if the companies are good citizens for them.
Lesson for students
I tell students that accounting can change the world. Accounting is usually considered to be the neutral reflection of reality, whereas our accounting scheme is to design or reconstruct the reality. If a shared social goal is set, then accounting can be designed to help achieve it. So, traditionally `uninteresting’ bean counters can be much more exciting and important people.
One additional line, in particular, is a line item of the expense traditionally considered to be a negative factor for investment. However, research shows that the appropriate kind and amount of CSR expense, disclosed in an additional line and the CSR report, raise companies’ share prices. This means, the traditional “profit maximisation” principle no longer works.Rather, companies will need to maintain a balance between profitmaking work and CSR efforts.
Following the introduction of the new line, accountants will find more jobs through the CSR expense audit. Above all, society as a whole benefits from CSR work.This way, everybody has a private incentive to do the additional line and the overall collective effect has been considered to be more sustainable growth than before.
This article was taken from here.