Debt Markets Retort to Mandatory Corporate Social Responsibility  

By | January 5, 2023

Over decades, scholars across disciplines have proposed and discussed myriad “objectives” of the firm—shareholder value maximization, stakeholder theory, long-term firm value maximization, shareholder welfare maximization, and shareholder wealth maximization with stakeholder interests. One extreme is shareholder primacy, and the other is stakeholder capitalism (or conscious capitalism). The latter advocates corporate social responsibility (CSR) and has long argued for a socially responsible strategy that includes a wide variety of participants, such as employees, the community, the environment, and lenders. 

While CSR diverts cash flows from bondholders and stockholders, the argument is that firms should view CSR as a value-enhancing corporate strategy (e.g., Freeman, 1984), as CSR engenders benefits through increased goodwill that enhances productivity and firm performance. The net impact on shareholders and bondholders is an empirical issue. Extensive literature has examined the net impact of CSR on stock markets. However, I focus my analysis on the effects of CSR on bond markets, as the impact of CSR on bondholders can differ from the results of CSR on stockholders and lends additional insight. The diverting cash flow to CSR activities before interest is paid directly impacts bondholders; however, even using cash flow from net income for such activities threatens future cash flows. The current study contributes to this growing literature in two aspects: first, by providing the causal relation between CSR and bond pricing, and second, by showing that CSR impacts bond pricing by misallocating capital in activities that hamper future cash flow.  

The problem with voluntary CSR is that of self-selection, therefore, it fails to provide the causal inference of CSR’s impact on a firm’s behavior or investments. Consequently, I use a unique setting in India to resolve the self-selection and reverse causality issues in analyzing the effects of CSR on debt markets. The Indian government incorporated Clause 135 (henceforth, the CSR rule) in the Indian Companies Act 2013, mandating minimum amounts of CSR spending for profitable firms.  

The rule imposes that a firm that has either 

  1. a net worth of at least 83 million USD (about 5 billion Indian rupees (INR)),  
  2. sales of at least 167 million USD (about 10 billion INR), or 
  3. a net profit of at least 0.83 million USD (about 50 million INR) is required to spend 2% of their average net profit, calculated over three years, on CSR related activities.  

A few of the approved CSR activities include:  

  1. Hunger and poverty eradication 
  2. Promoting women’s empowerment  
  3. Environmental sustainability 
  4. Contributing to the prime minister’s national relief fund.  

This policy change in India presents a natural setting for examining the causal impact of CSR on bondholders.  

I obtained data on bond issues by Indian firms in the three years before and after implementation of the CSR rule from the SDC Platinum Fixed-Income Issues database. I ignore all preferred stock issues and bonds with contingent features such as step-up and convertible bonds. I augment the bond issue data with company data from CMIE’s ProwessDx database. I can match data for 183 firms with 2,413 bond issues over the six years from 30th August 2010 to 30th August 2016. 

Using the difference-in-differences specification, after the CSR rule, the yield spread of bonds by affected firms increased by 103 basis points compared to bonds of unaffected firms. These results are robust to bond characteristics, firm characteristics, and industry-fixed effects. To confirm these results further, I exercise multi-dimension regression discontinuity design (MRDD) to capture the differential effects of the rule on firms that meet the CSR cutoff to those that miss the CSR cutoff by a small margin. Any CSR effects are likely to be the sharpest between these two sets of firms. The yield and yield spread for bonds issued by firms that just met the criteria are higher than the yield and yield spreads for bonds that just missed the CSR criteria. The impact of mandatory CSR on yield spread is positive and significant. 

Even though I report increases in the yield and yield spread of the affected firms’ post-CSR rule, understanding the channel through which it happens is crucial. Using a structured model of two-stage least square (2SLS) regression, I found that the mandatory CSR rule affected the yield and yield spread through future free cash flow (FCF). The expenditure of 2% profit on CSR activities decreases the future FCF, which increases the yield and yield spread in the current period.   

To examine the differential treatment of the affected firms’ post-CSR rule, I collect detailed activity-level CSR expenditure data and information on the agencies used for dispensing these expenditures from the National Stock Exchange (NSE) Infobase. This database helped determine whether the affected firms disseminated the information on items such as deviation of CSR expenditure from expected value as per CSR rule and on agencies (in-house or third party) used for dispensing CSR expenditure. Firms providing information on CSR agencies are penalized less by the debt market, suggesting that transparency on CSR expense matters. 

I extend the yield spread analysis by examining the CSR rule’s differential impact by analyzing carefully constructed subsamples based on shareholder ownership and corporate governance. I find that yield spreads are lower for bonds issued by firms that have robust external governance either through a significant fraction of independent directors or through appointing Big Four auditors. These results suggest that well-governed companies can better plan their CSR spending and maximize the strategic benefits of CSR activities.  

In summary, my findings are consistent with the idea that mandatory CSR reduces the cash available to firms to meet obligations and increases the perceived costs of financial distress. Nevertheless, characteristics such as good governance, group affiliation, and transparency about agencies used for dispensing CSR expenditures help mitigate the negative impact to an extent. 


Jitendra Aswani is a Corporate Governance Fellow at Harvard University.  

This post is based on his paper, “Debt Markets Retort to Mandatory Corporate Social Responsibility,” available on here 

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