The economic responsibility of a business is to create value. Employment generation is incidental to the process of creating value. A firm creates value by ensuring sustainability of business. Sustainability of firm cannot be the economic responsibility of a firm. In a free market, sustainability of firm benefits only the managers, if it is achieved through unrelated diversification, which is a type of entrenchment.
Managers use the cash flows from existing business to invest in new businesses, which might not have synergy with the existing business. The closure of a firm might result in a loss to a group of stakeholders, but at the macro level no loss is caused to the society. However, in practice, managers pursue the objective of sustainability of the firm.
Take the example of ITC. It is investing in businesses that do not have close synergy with the traditional tobacco business. Had it returned the cash to shareholders, they could have invested the same in businesses in which ITC has diversified. Therefore, the strategy to diversify has not made shareholders better off than the strategy to return the excess cash to them. It might have made them worse off because some of new businesses are yet to build the strength to compete with leaders in those segments. But, it has definitely benefited the managers. The silver lining is that ITC is a very well-managed company.
Sustainability of business is essential for creating value. A business creates value only when it is sustainable and generates cash flows over a long period of time. Competition disciplines firms and compels them to provide goods and services ‘skillfully and cheaply’. In a competitive environment, sustainability of business requires continuous renewal and innovation. Renewal and innovation benefit the consumers with better and cheaper products and services. A firm that focuses too much on profitability often loses sight of the core economic responsibility of creating value.
The value that business creates is shared between those who participate in creating value based on their relative bargaining powers.
For example, customers, suppliers of inputs and employees share the value based on their relative bargaining powers. The value that remains goes to investors. Regulations protect the interest of those who have weak bargaining power. Minimum wages to workers and regulation of tariff in an oligopolistic competitive environment, where the market is dominated by a small number of players, are examples of government intervention in enhancing the bargaining power of employees and customers.
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How the value should be distributed to those groups that do not participate directly in creating value? For example, families which get displaced due to transfer of land to firms, contribute, although indirectly, in creating value.
Therefore, logically, they should have a share in the value that the firm expects to create in future. How much of the estimated value that the business will create should be allocated to them? This is a tricky question and depends on judgement and it cannot be firm-specific.
The current market value of the land reflects the cost of investment. Therefore, their share in the value that the firm will create in future should be built in the compensation payable to land losers. Issue of firm’s shares might not help because the gestation period is usually long and also because they do not have the risk-taking capacity. Their share in value is determined by their bargaining power.
Resettlement and Rehabilitation policy of the government and voluntary organisations provide bargaining power to displaced families. A firm should never invest in a project that is unviable even if it is due to reasonable compensation under R&R policy. Only if social benefits are expected to be significant, a part of the cost of compensation should be borne by the government. Low compensation should be seen as expropriation of wealth.
Should those who do not participate in value creation get a share in the value? Here comes the social responsibility. No firm will share the value with them unless it makes a business case. As a social responsibility, firms invest in building a healthy society and in providing skills under the banner of CSR. CSR is a business case as it makes the inequality, which is concomitant of high economic growth, tolerable. Moreover, it develops the healthy and skilled manpower that are necessary for the growth of the business. Firms that focus on short-term profit making do not see benefits from CSR. Perhaps, for this reason, the government felt the need to incorporate CSR provisions in the Companies Bill 2012.Another social responsibility of business is not to adversely affect the quality of living of marginalised groups of the society or to deprive any individual from core human rights.
Indian firms have moved forward a few steps to fulfill environmental responsibilities but are yet to internalise social responsibilities. Let us hope that scenario will change fast.
Affiliations: professor and head, School of Corporate Governance and Public Policy, Indian Institute of Corporate Affairs; advisor (Advanced Studies), Institute of Cost Accountants of India; Chairman, Riverside Management Academy Private Limited Email: asish.bhattacharyya@gmail.com