Mandatory CSR May Raise Cost of Equity: IIM Lucknow Study
Indian companies’ mandatory Corporate Social Responsibility (CSR) spending under the Companies Act, 2013 may be increasing their cost of equity, as investors view it as a compliance burden rather than a strategic investment, according to a new study by Indian Institute of Management (IIM) Lucknow. The research, centered on the Indian market, finds that compulsory CSR outlays – particularly for poverty alleviation – can increase the implied cost of equity (CoE), reduce perceived corporate benefits, and weaken investor confidence, especially in the manufacturing and industrial sectors.
Published in the Journal of Accounting in Emerging Economies, the paper provides the first large‑scale empirical analysis of how India’s mandated CSR framework affects investor perceptions, risk assessments, and the pricing of equity capital. Led by Professor Seshadev Sahoo of the Finance and Accounting area at IIM Lucknow, the study analyzes panel data from 484 Indian firms that spent on poverty‑alleviation initiatives between 2014 and 2020, a period that captures the early implementation phase of the CSR mandate.
Research Objective and Scope
The core objective of the study is to examine whether mandatory CSR benefits or hurts Indian firms’ financial positions from an investor’s point of view. Rather than focusing only on social impact, the research zeroes in on how mandated CSR influences:
- Investors’ perception of firm risk
- The level of investor confidence in the company
- The implied cost at which the firm can raise fresh equity capital
By doing so, the study links regulatory policy – India’s 2% CSR rule for eligible firms – to the fundamental cost of capital, a key metric for corporate valuation and investment decisions.
Methodology: The OJ Model and Econometrics
To estimate the implied cost of equity, the research team applies the Ohlson and Juettner‑Nauroth (OJ) model, a widely used framework in finance that derives the market‑implied CoE from a firm’s earnings and payout dynamics. As Prof. Sahoo explains, the OJ model incorporates expected earnings growth and dividend payout ratios, offering a forward‑looking measure of how investors discount future cash flows, which is essential when evaluating the effects of policy‑driven expenditures like CSR.
In addition to the OJ model, the authors employ several econometric techniques – fixed‑effect regressions, robustness checks, and alternative specifications – to control for firm size, leverage, profitability, industry effects, and time‑varying macroeconomic conditions. This rigorous approach bolsters confidence that the observed relationship between CSR spending and the implied CoE is not driven by extraneous factors.
Key Finding: Mandatory CSR Raises Implied Cost of Equity
The central finding is that there is a positive correlation between mandated CSR spending on poverty alleviation and the implied cost of equity for Indian companies. Put simply, the more firms are required to spend on CSR, the higher the return on equity investors demand.
Prof. Sahoo explains this effect: “This signifies that there is a great deal of CSR expenditure that is mandatory, and investors require a greater return on equity as compensation for that spending. Mandatory CSR can reduce the perceived corporate benefits of those outlays, leading to lower investor confidence and a higher cost of equity.”
In other words, when legislation compels firms to spend on social initiatives, investors may interpret that spending as a non‑discretionary compliance cost. This perception shifts the narrative from CSR as a value‑creating, strategic investment to CSR as a regulatory burden, which in turn makes investors treat the firm as riskier and demand higher returns.
Sectoral Variation: Service Firms Are Different
Importantly, the relationship is not uniform across sectors. The study documents a contrasting trend in the service sector, where current‑year CSR spending actually lowers the implied cost of equity. Service‑oriented firms – such as those in finance, technology, consulting, and hospitality – appear to gain investor favor when they engage in CSR during the same year.
According to Prof. Sahoo, this pattern likely reflects the nature of service‑sector business models, which depend more on reputation, customer trust, brand equity, and intangible assets than on tangible capital alone. In these industries, authentic CSR initiatives can strengthen perceived reliability and social license to operate, thus reducing perceived risk and lowering the required return on equity.
However, even in these firms, the effect is conditional on the perceived authenticity and strategic alignment of CSR, not mere compliance.
Compliance‑Driven CSR vs. Strategic CSR
A key policy insight from the study is that compliance‑driven CSR tends to be viewed negatively, especially by socially responsible investors who may see it as a liability rather than a strategic asset. When companies fulfill CSR only to meet the 2% requirement without clearly linking projects to their core business model or long‑term strategy, investors remain skeptical about the value proposition.
By contrast, the research suggests that strategically aligned CSR – initiatives that dovetail with a firm’s products, supply chain, market positioning, or stakeholder ecosystem – can enhance investor trust, reduce perceived risk, and ultimately lower the cost of raising equity. Such initiatives signal to the market that the firm treats CSR as a long‑term value‑creation tool, not a box‑ticking exercise.
Broader Implications for Corporate Strategy
Beyond its financial implications, the study encourages firms to treat CSR as a strategic engagement rather than a compliance chore. Authentic CSR can:
- Strengthen corporate reputation and stakeholder trust
- Improve employee morale and attract talent
- Build resilience in local communities that supply inputs or host operations
- Support national development priorities, including Sustainable Development Goal 1 (SDG 1: No Poverty)
Prof. Sahoo highlights that poverty‑alleviation CSR, when implemented sincerely and strategically, can contribute to both societal welfare and long‑term corporate advantage. Firms that embed CSR into their core value chain – from supplier inclusion to inclusive markets and employee‑volunteer programs – are more likely to earn positive investor responses.
Policy and Practice Takeaways
For policymakers, the study underscores the importance of designing CSR frameworks that incentivize strategic, high‑impact projects while allowing firms flexibility in implementation. Rigid compliance mandates, without clear guidance on alignment with business strategy, may inadvertently raise the cost of capital and deter investment.
For corporate leaders, the message is clear:
- Treat CSR as a strategic lever, not a regulatory cost.
- Align CSR initiatives with core business activities and long‑term competitiveness.
- Communicate clearly how CSR reduces risks, builds trust, and creates shared value for shareholders and society alike.
The IIM Lucknow research thus bridges the gap between Indian corporate governance practice and investor behavior, offering a nuanced view of how well‑intentioned social mandates can affect the financial bottom line – and how firms can turn CSR from a constraint into a competitive advantage.