Wednesday, August 31, 2011

RBI’s Draft Guidelines for Private Sector Banks

Following the Finance Minister’s announcement in his budget speech for 2010-11 and a discussion paper published by the Reserve Bank of India (RBI) in August 2010, the RBI has now released draft guidelines for licensing new banks in the private sector. The draft guidelines lay down the conditions on which corporate groups will be permitted to set up banks in India.
While the RBI seems keen to tap into the potential (financial and managerial) of the Indian corporate groups in establishing and managing banks so as to benefit the financial sector, the stringent conditions imposed by RBI in the regulations are an indication of the tight control that RBI wishes to retain over the process. In that sense, RBI seems unable to exorcise the demons from the pre-nationalization era where the nexus between corporates and the banking sector resulted in improper management of banks that put investors and depositors at grave risk.
The key proposals in the draft guidelines are as follows:
Eligible Promoters

Both objective and subjective criteria have been laid down to determine the eligiblity of promoters to set up a bank. The subjective elements include “diversified ownership, sound credentials and integrity”. Curiously, RBI has demonstrated some uneasiness with reference to other businesses that prospective promoters may be carrying on. Here are some extracts:
Banking is essentially based on fiduciary principles as depositors’ money is involved. It therefore becomes imperative that the fit and proper assessment framework for bank promoters is much more comprehensive in scope as compared to other sectors. Any such framework also needs to look into the nature of activities the promoter group of the bank is predominantly engaged in. There are certain activities, such as real estate and capital market activities, in particular broking activities which, apart from being inherently riskier, represent a business model and business culture which are quite misaligned with a banking model. Post-crisis, there are concerted moves even internationally to separate banking from proprietary trading. More importantly, in India, past experience with brokers on the boards of banks has not been satisfactory. It will therefore be necessary to ensure that any entity/ group undertaking such activities on a significant scale is not considered for a bank licence. Otherwise there will be real risks of the same business approach getting transmitted to the banks as well and it will be difficult to address this only through regulations. Accordingly, entities/groups that have significant (10% or more) income or assets or both from/ in such activities, including real estate construction and broking activities taken together in the last three years, shall not be eligible to promote banks.
It is not clear if tainting all players in a specific type of business activity with the same brush is a prudent approach. For example, as these comments observe, stock broking activity is a regulated industry subject to fitness norms and may not deserve the type of blacklisting treated meted out by the RBI.

Corporate Structure

RBI has specified the structure that corporates must be used while setting up banking activity. Promoters must set up a non-operative holding company (NOHC) through which they will hold the bank and all other regulated financial activities within the group. As the draft guidelines note, this is to “ring fence the regulated financial services activities of the group” from other non-financial activities. Depending on existing structures of corproate groups, successful licensee may need to restructure their group holdings to comply with the proposed structure.

Minimum Capital

An initial minimum capital requirement of Rs. 500 crores has been imposed. There are very specific requirements on shareholding limits of the NOHC in the bank. For instance, there is a lock-in of 40% shares of the NOHC in the bank for 5 years. Although the NOHC may start with a higher shareholding, it has to be pared down to 40% within 2 years from the date of licensing, to 20% within 10 years, and to 15% within 12 years. The bank will have to be listed on a stock exchange within 2 years, which is quite a short time frame. Hence, the establishment of the bank as well as its initial business operations must provide for early listing.

Foreign Shareholding

To begin with, a private sector bank can raise only up to 49% from foreign investors. It is only after 5 years that the prevailing policy of foreign investment in banking will become applicable, which is that foreign investment is allowed up to 74%. To that extent, RBI has followed a phased approach for the new private sector banks by not making the general foreign invstment policy applicable to them at their initial stage. This would mean that a private bank conducting an IPO in the first 2-year period will have to largely rely on the domestic supply of capital.

Corporate Governance

The draft guidelines provide some broad indication of the type of governance norms to be followed by private sector banks. The emphasis is on ring fencing all regulated activities under the umbrella of the NOHC. Moreover, the draft guidelines call for a separation of ownership and management in promoter companies that own or control the NOHC. This might be somewhat difficult to comply with, especially in the case of banks to be established by traditional family corporate groups. The only specific governance norm is that “at least 50% of the directors of the NOHC should be totally independent of the promoter / promoter group entities, their business associates, and their customers and suppliers”. In that sense, RBI appears less concerned with governance issues at the level of the bank itself, but more with the corporate group estaiblishing it, as these norms extend to both the NOHC as well as the promoters.

The draft guidelines set out several other operational conditions for grant of banking licences, including priority sector targets, mandate on core banking solutions, and the like. Other conditions include those relating to relationships between the bank and the promoter group entities, and how they are to be regulated.

Overall, while the RBI has taken the bold step of further opening up the private banking sector, it is treading with utmost caution. In terms of timing, it is unlikely that the regime for private banking licences will be in place anytime soon. As the draft guidelines themselves suggest, they will be finalised “and the process of inviting applications for setting up new banks in the private sector will be initiated only after the Banking Regulation Act is amended” to include various matters that are presently under consideration for legislative amendment, including removal of restriction on voting rights and RBI’s approval for change of shareholding beyond 5% in a bank. It is difficult to hazard a guess as to the timeframe within which the legislative amendments would be effected.

Monday, August 29, 2011

Diaspora Bonds

The Economist has a piece that discusses the advantages of diaspora bonds to poor countries. It notes:
The idea is simple. Poor-country governments can issue bonds and market them to emigrants in rich countries. There are several advantages to milking members of a diaspora. They are often patriotic: they like the idea that their savings will pay for bridges and clinics at home. They are patient, since they have a long-term tie to the issuer. They are less jittery than other investors, too, since they have friends who can tell them whether political unrest is really as bloody as it looks on television. And they are sanguine about currency risk. …
The idea of diaspora bonds is not new to India. The State Bank of India made a high profile issuance of the Resurgent India Bonds over a decade ago to non-resident Indians (NRIs). These have also been the subject matter of analysis (e.g., a law review article, and an economic study).

However, as the Economist article notes, there are obstacles to the utilization of these instruments by sovereigns, and not all diaspora bond offerings have been successful. See also a World Bank Blog on Diaspora Bonds.

Corporate Governance in Emerging Markets

A recent study by Melsa Ararat and George Dallas under the aegis of the International Finance Corporation (IFC) highlights some of the special issues affecting corporate governance in emerging markets. In their paper Corporate Governance in Emerging Markets: Why It Matters to Investors—and What They Can Do About It, the authors comment on the scholarly research in corporate governance in emerging markets. The foreword to the paper captures the relevance of the study:
Every day, institutional investors in emerging markets must make practical decisions on the basis of incomplete and at times conflicting information. So, it is critically important that they make the best use of this imperfect knowledge. Moreover, investors too often enter emerging markets with misguided perceptions of the underlying realities. And worse, they may cling to a conceptual framework of governance that does not allow them even to consider the searching questions they should be asking.

This Private Sector Opinion, by Melsa Ararat and George Dallas, explicitly highlights this problem. The authors identify a serious gap in research on emerging markets—between high-level cross-country studies, with their inconclusive findings on good governance indicators at the macro level, and the separate effort to establish firm-level or country-specific governance metrics, typically based on what works “in the West.” Unfortunately, fewer than one percent of the research papers available on corporate governance focus on emerging markets.

The challenge for institutional investors is how to weight country factors, even if the investors conclude, as this paper notes, that “optimal governance is firm-specific.” Alongside the country factors—rule of law, risk of corruption, competitive intensity, and capital market capabilities—the indicator that bridges to the firm-specific context is the structure of ownership. The heart of this paper is an exploration of two key dimensions of ownership structure: the quality of board independence, and mitigation of the risks of business group affiliations. The authors also provide practical guidance to investors in each of these areas.
This study points to the dearth of academic studies pertaining to emerging markets, which face issues that are different from those faced by developed markets (the subject matter of greater analysis).

Saturday, August 27, 2011

CCI Approves Acquisition of UTV by Walt Disney


(The following post has been contributed by Piyush Prasad, who is an alumnus (B.Sc. LL.B.) of the National Law University, Jodhpur)
The Competition Commission of India (“CCI”) on August 25, 2011 approved the proposed combination of Walt Disney Company (Southeast Asia) Pte. Limited (“the “Acquirer”) and UTV Software Communications Limited (“the “Acquired Enterprise”) under section 31 (1) of the Competition Act, 2002 (the “Act”).
Under the proposed combination, Walt Disney which already owns 50.44% stake in UTV, intends to take sole control of UTV by the following 2 step process-
a)     Acquisition of shares held by public sharholders through a delisting offer in terns of Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009; and
b)    Subject to a successful delisting offer, acquisition of the shares of the promoters.
The CCI while giving its nod to the proposed combination has stated the following:
Based on the facts on record and the notice of the proposed combination filed by the Acquirer under sub-section (2) of section 6 of the Act, and the examination of the businesses involved which are commonly characterized by the presence of a large number of players and prevalence of intense competition among them, availability of ample choice and variety of products to consumers, demand driven nature of the business, interchangeable and converging nature of the business involved, relative ease of entry and exit in these businesses, less likelihood of any co-ordinated or exclusionary behaviour, regulatory oversight in TV broadcasting and the future growth potential in addition to the fact that the Acquirer is already in joint control of the Acquired Enterprise, the Commission hereby approves the proposed combination under sub-section (1) of section 31 of the Act as it is not likely to have an appreciable adverse effect on competition.
Walt Disney and UTV are involved in the business of motion pictures, TV broadcasting and related activities and interactive media in India. In order to ascertain any appreciable adverse effect on competition in the relevant market, the CCI has taken into consideration the following factors, keeping in mind the types of business carried on by both the companies:
i)               Number of releases in the film industry-
Year
2009
2010
Total Indian Films
1288
1274
Total Hindi Films
235
215
Total English Films
283
298
Share of releases of Walt Disney and UTV in the film industry for the period 2008 to 2010-
Company
Walt Disney
UTV
Hindi Films
2
27
English Films
28
1
Regional Films
0
4
After referring to the above figures from the annual reports of Central Board of Film Certification (CBFC), the CCI observed that there are large numbers of market players in the business of motion pictures in India, big as well as small, with relatively low barriers to entry.
ii)             TV Broadcasting
After analysing the market for TV broadcasting based on the data of the Ministry of Information and Broadcasting, the CCI concluded that it is highly competitive, innovative and dynamic.
iii)            Interactive Media
The business of interactive media consists of gaming (online, computer, mobile and console) and digital media (music, video mobile and graphics etc.). In this business, the consumers prefer to access content across platforms on multiple devices which results in continuous growth and rapid innovation. The CCI has concluded that such is the nature of the business that, “it leads to intense competition amongst the content creators, distributors and retailers to cater to this market, characterised by ever increasing demand for new and innovative products.”
iv)            Character Merchandising
This business involves adaption of a character (real or fictional) in relation to goods or services, to create demand for acquiring those goods and services due to customers` affinity with that particular character. The CCI observed that although Disney is engaged in this business, UTV is not.
This notice was filed on August 1, 2011 and the order of the CCI was issued on the 25th day of the filing. In case of acquisition of shares of Bharti AXA Life Insurance Company Limited by Reliance Industries Limited from Bharti Enterprises Limited, the CCI had taken 18 days. Section 6 (2A) of the Act entitles the CCI to 210 days for passing its order. This duration has been a cause of concern for investors in the past during the drafting of the regulations on combinations, but these two recent orders seem to be a deliberate attempt on part of CCI to quell such an apprehension. Also, in both the orders, the CCI has followed the various factors enumerated in section 20(4) of the Act and substantiated the same with concrete figures.
- Piyush Prasad

Friday, August 26, 2011

Hybrid Companies and Restrictions on Transferability

We have previously discussed at length the law on the scope of s. 111A(2) of the Companies Act, 1956 [“CA 1956”]. In its recent judgment in Jer Rutton Kavasmanek v Gharda Chemicals, the Bombay High Court has considered this issue, as well as another controversial area in Indian company law – whether “public” and “private” are exhaustive of the types of companies contemplated by the CA 1956.

The case arose out of a long-drawn family dispute between the CMD of Gharda Chemicals Ltd. [“GCL”], Dr. Gharda, and his sister’s family (Mrs. Jer Rutton Kavasmanek). GCL had originally functioned as a partnership to which Mr Rutton Kavasmanek had contributed the bulk of the funds, but in which Dr Gharda held a 40 % share of the profits. Subsequently when the business was in dire straits Dr Gharda had received an injection of capital from the Rebello family, which, however, was eventually allotted less than its promised share in the business. When the partnership was incorporated as a private company, Dr Gharda held 60 % of the share capital, and art 57 of the Articles of Association provided that no member could sell his shares to an outsider if an existing member was willing to offer a fair price. On 17 August, 1988, the company became a deemed public company by virtue of the provisions of s. 43A. Subsequently, after the 2000 amendment to the definition of private company in s. 3(1)(iii)(d), the company proposed to alter its articles to bring them into conformity with the amendment, by providing that it could not accept deposits except as specified in that section. The Kavasmanek group voted against this resolution and it was defeated, after which GCL took the position that it had become a full-fledged public company, and that art 57 had ceased to be binding. Subsequently, there were multiple rounds of litigation between the parties (claims of oppression and mismanagement etc.) and the Kavasmanek group sought an injunction when it appeared that Dr Gharda intended to sell some of his shares to an outsider.

There were thus two important issues of law the single judge had to consider – first, whether s. 111A(2) applied to GCL on account of s. 43A/s. 3(1)(iii)(d) and secondly, if it did, whether art 57 had ceased to be binding. The first of these questions at first sight appears to be a non-issue, since the common assumption is that a company is either private or public. The uncertainty, however, arises from the language the legislature has chosen to use, especially post the 2000 amendment. In the CA 1956 as originally enacted, a public company was simply defined as a company which is “not a private company” – which is now sub-section (a) of s. 3(1)(iv). After the amendment, two additional conditions have been added – the share capital requirement, and s. 3(1)(iv)(c) – “a private company which is a subsidiary of a company which is not a private company”. One view is that a company incorporated as a private company which is then deemed to have become a public company (s. 43A for example, before its effective repeal) or becomes a subsidiary of a company which is a public company (for example on account of a change in shareholding pattern) does not for that reason cease to be a private company, because its “basic characteristics” remain the same. This view was accepted by the Company Law Board in Hillcrest Realty, a decision Mr Umakanth has discussed in more detail in this paper. In Jer Rutton Kavasmanek, this argument (without citing Hillcrest) was put to the single judge, so that there was no question of s. 111A(2) applying. His Lordship rejected it, holding that the legislature in 2000 had intended to entirely dispense with the concept of deemed public company that had been introduced by the 1974 amendment. Dharmadhikari J. observed that “[t]he effect of all this is that the concept of deemed public company under Section 43A and introduced by the Companies (Amendment) Act has now been abolished based on the recommendation of the working group the Companies Act, 1956.” The point was obiter, because the primary basis of Dharmadhikari J.’s conclusion was that the company had become a public company after the resolution in April 2001 to alter the articles was defeated. Nevertheless, the court’s general approach, and its reference to the Working Group, suggest that it is of the view that “public” and “private” are exhaustive.

One may have thought that the second question – s. 111A(2) – was concluded, so far as a single judge of the Bombay High Court is concerned, by the judgment of its Division Bench in Messer Holdings v SM Ruia. Yet, Dharmadhikari J. held that art 57 is void, because the shares of a public company are freely transferable, and that Messer Holdings is distinguishable because in that case the restriction appeared in a private agreement, while in this case it was part of the articles of association. While this distinction does exist, its force is perhaps somewhat undermined by the fact that the fulcrum of Messer was s. 111A(2), which, unlike s. 82, makes no reference to the source of the restriction. Readers may also wish to refer to the recent judgment of the Delhi High Court in Premier Hockey Development v IHF, where Sanghi J., following the judgment in Modi Rubber v Guardian International, has distinguished VB Rangaraj.

Several questions remain unanswered after these decisions – for example, whether s. 111A(2) distinguishes between different sources of a restriction, whether it is directed principally to the Board of Directors (as the Division Bench in Messer held) or to the subject matter of the sale (as Chandrachud J. in Bajaj Auto held), what the nature of a “restriction” is etc.

Wednesday, August 24, 2011

Fiduciary Duties and the Nature of an LLP


While the position of law in relation to the inter-se relationship between partners of a firm is fairly well-settled, there is no great clarity on similar issues arising in the context of LLPs. It is clear that the “double agency” rule of partnerships does not apply to LLPs: but, if LLPs are seen as a hybrid form of a partnership and a company, does the law impose any fiduciary duties on members of an LLP? To what extent can features of partnership law be applied to LLP as being based on general principles? This question arose before the England & Wales High Court in Barthelemy v. F&C Investments [2011] EWHC 1731 (Ch).
 
The Court held that a member of an LLP does not as such owe fiduciary duties to other members. The Court held that the LLP Act established a wholly new form of entity, which “may be expected to have its own corporate governance structures”. Referring specifically to Section 1(5) of the LLP Act 2000, the Court held that the general law of partnerships does not apply to LLPs at all, unless specifically stated to apply. Insofar as the question of fiduciary duties was concerned, the Court relied on the classic paragraph in White v Jones [1995] 2 AC 207 where Lord Browne-Wilkinson explains how fiduciary duties arise:

The paradigm of the circumstances in which equity will find a fiduciary relationship is where one party, A, has assumed to act in relation to the property or affairs of another, B. A, having assumed responsibility, pro tanto, for B's affairs, is taken to have assumed certain duties in relation to the conduct of those affairs, including normally a duty of care. Thus, a trustee assumes responsibility for the management of the property of the beneficiary, a company director for the affairs of the company and an agent for those of his principal. By so assuming to act in B's affairs, A comes under fiduciary duties to B. Although the extent of those fiduciary duties (including duties of care) will vary from case to case some duties (including a duty of care) arise in each case. The importance of these considerations for present purposes is that the special relationship (i.e. a fiduciary relationship) giving rise to the assumption of responsibility held to exist in Nocton's case [Nocton v Lord Ashburton [1914] AC 932] does not depend on any mutual dealing between A and B, let alone on any relationship akin to contract. Although such factors may be present, equity imposes the obligation because A has assumed to act in B's affairs. Thus, a trustee is under a duty of care to his beneficiary whether or not he has had any dealing with him: indeed he may be as yet unborn or unascertained and therefore any direct dealing would be impossible…

Noting the principle laid down in this paragraph, the Court in Barthelemy nonetheless held that in the context of LLPs, no such general assumption of responsibility could arise. It was also held, following the typical reluctance of the common law to impose good faith obligations, that there was no duty of good faith owed by the members of an LLP to one another. 

The Court noted the view in Palmer on LLPs that there was a general fiduciary obligation; noting (with some understatement) that “the discussion in Palmer proceeds a little too quickly here”. It was held that the view that ‘as a general rule, members of an LLP owe fiduciary duties to one another’ may not be appropriate. This is because under s 1(5) of the English LLP Act, the general principles of partnership law cannot be read in to the law governing LLPs. Further, an LLP has a separate corporate personality unlike a typical partnership, and the Act leaves open a large window of flexibility for structuring relationships through the LLP form. In such a scenario, the Court held that a general rule would not be appropriate. Thus, the Court seems to leave open the issue that there may be cases where the Agreement between the members is such that an “assumption of responsibility” situation arises: in such cases, based on White v. Jones, fiduciary duties may well arise. The Court held, refusing to lay down a rule of general application, “it is necessary to look at the specific roles and responsibilities [of the member] arising in the particular context in question in order to assess whether and what fiduciary obligations might arise…”

The decision of the English Court also contains a discussion of the general content of fiduciary obligations in the common law. Another excellent discussion of fiduciary duties is available in J. Edelman, “When Do Fiduciary Duties Arise?” (2010) 126 LQR 302.

Tuesday, August 23, 2011

Retailers Assoc. v. Union: Bombay High Court on Service Tax



In a previous post, I had briefly mentioned the judgment of a Division Bench (D.Y. Chandrachud and  A.V.Mohta, JJ.) the Bombay High Court, where the constitutional validity of service tax on renting of immovable property was upheld. The judgment (Retailers Association v. Union of India) is available on the Bombay High Court website (linked here). A perusal of the judgment shows that three separate challenges were urged before the Court:
(i) The essence of a “service tax” is the rendering of a service or of a value addition, and in the case of renting of immovable property, no service element is involved; consequently, the charge must fail
(ii) The impugned levy fell under Entry 49, List II, and was outside the legislative competence of Parliament
(iii)  In any case, levying the tax retrospectively from 1st June 2007 was unconstitutional

After discussing the relevant Supreme Court decisions on the point, the High Court noted “the settled principle of law is that a tax on lands and buildings is a tax on the general ownership of lands and buildings. In order that a tax must fall under Entry 49 of List II, the tax must be one directly on lands and buildings. A tax which is levied on the income which is received from lands or buildings is not a tax on lands or buildings. A tax levied on an activity or service rendered on or in connection with lands and buildings does not fall within the description of a tax on lands and buildings.” The Court next examined the charging section, Section 66 of the Finance Act, 1994. It noted that the charge was on “taxable services”. Looking at the character of the impugned levy, it was held “The charge of tax is on a taxable service. The measure of tax is the gross amount charged by the service provider. The charge of tax is not on lands or buildings as a unit nor is the tax on lands or buildings. To be a tax on lands and buildings under Entry 49 of List II, the tax must be directly a tax on lands and buildings. That is not the true character of an impost on taxable services.” The measure of the tax may be the rental income; that does not mean that the nature of the tax is itself a tax on land.

Next, turning to the argument that there is no “service” involved in mere renting, the Court held that when Parliament legislates on a matter, it is open to Parliament to make assessments of fact on the basis of which a legislation can be drafted. Importantly – and perhaps, in a comment of wider constitutional significance – the Court held, “An underlying assessment of fact by Parliament on the basis of which a law has been enacted cannot be amenable to judicial review absent a case of manifest arbitrariness.” Apart from this, the Court noted that it is open to Parliament to enact deeming fictions as well. The only limitation on the exercise of the power is that the Legislature cannot by deeming fiction “transgress upon a constitutional restriction or a field of legislation that is reserved to another legislature.” Considering in this case that there was no transgression into List II, there was no question of there being any limitation on the power of Parliament to treat renting as a service. The Court explained, “Once the Court comes to the conclusion that the law is not a law with respect to the legislative entry of taxes on land and buildings, the field of the legislation would necessarily fall within List I and more particularly, the residuary entry of List I. The levy of tax on a taxable service provided or to be provided to any person, by any other person, by the renting of immovable property is based on a considered determination by Parliament that such transactions do in fact involve an element of service. The fact that the service which is provided may not, to the Petitioners, accord with what is commonly regarded as a service would not militate against the validity of the legislation.

Insofar as the challenge on the basis of retrospectivity is concerned, the Court noted the legislative history, by which it could fairly be said that the retrospective amendment was curative / validating, and intended to bring out the true intent of Parliament in enacting the Finance Act 2007. The amendment was intended to remove the basis of Delhi high Court’s the ruling in Home Retail, and was a permissible exercise of legislative power. (The test for judging the validity of such laws has been laid down by the Supreme Court in several cases – see this post, for a brief discussion. When compared to some other exercises of retrospective taxation, the impugned amendment in this case is quite benign!) 

The judgment of the Bombay High Court contains a careful analysis of the law in relation to all the three contentions; and the decision rests on a strong principled basis. The issue is pending in the Supreme Court in Home Retail, but it seems unlikely on the basis of the law as it currently stands that the Supreme Curt will take a different view.

Monday, August 22, 2011

Enforceability of Put and Call Options in India

I have posted a working paper tentatively titled Investment Agreements in India: Is There an 'Option'?, the abstract of which is as follows:
Put and call options are ubiquitous in modern investment agreements, such as those involving joint ventures as well as private equity and venture capital investments. The enforceability of put and call options in Indian companies has been the subject matter of debate due to the existence of stringent securities legislation that has been supported by strict judicial interpretation. Moreover, recent pronouncements by India’s securities regulator, the Securities and Exchange Board of India, have expressly disallowed options in securities of Indian companies (except private companies).

This article embarks on the modest task of mapping out the legal landscape that presently shapes the enforceability of put and call options in Indian companies. It seeks to review applicable legislation and analyze key judicial pronouncements that hold sway over the field. It finds that the current legal regime governing put and call options in investment agreements is fragmented and hazy and unnecessarily restricts the ability of investors in Indian companies to enter into such arrangements to protect their own interests. It calls for a reconsideration of the legal regime so that physically settled options that are customary in investment agreements may be treated as valid and legally enforceable.
The paper essentially deals with issues arising under the Securities Contracts (Regulation) Act, 1956, the notifications issued under that legislation and various court decisions interpreting those. Comments are welcome.

Corporate Philanthropy: Strategies & Incentives

The Harvard Corporate Governance Forum has an interesting and detailed post on corporate philanthropy that examines the various incentives that operate in this space. The post first seeks to identify the concept of corporate philanthropy:
This report focuses on corporate philanthropy, which includes direct cash giving, foundation grants, stock donations, employee time, product donations, and other gifts in kind. Corporate philanthropy is one component of corporate social responsibility, albeit an important, highly visible component. The issues surrounding corporate philanthropy apply to a wide cross-section of companies in every industry, from small, family firms to large, multinational ones. …
The post then goes on to discuss the various incentives that operate with reference to managers as well as the company that may determine their interest in corporate philanthropy. Based on the study, the authors conclude that there must always be a strong business case for corporate philanthropy:
Managers are most likely to make self-serving business decisions in companies with excess cash and little monitoring. Corporate philanthropy is one area in which managers often have discretion to use a company’s slack resources independent of business objectives. In particular, because charitable causes benefit from corporate giving, many stakeholders perceive it as a benevolent and unconditionally laudable activity. This perception results in a “halo effect” over corporate philanthropy. The “halo effect” may cause directors to fear being labeled misanthropes if they question giving decisions and may result in less oversight of charitable contributions than other business activities.

An executive can reap personal benefit from corporate philanthropy in several ways. Even when a gift is fully funded with company money, the executive often receives some credit. These awards, honors, and accolades provide the executive with a psychic benefit and elevate his status in elite social circles. In addition, an executive can use corporate contributions to advance his personal preferences, for example, by supporting an organization with his ideological agenda or the pet charity of a family member. Finally, an executive can further his career by using charitable contributions to gain favor with board members. Although the board should be supervising the executive, they may be swayed by corporate gifts in their name to their favorite cause.



The empirical evidence reveals that executives make giving decisions with a mix of intentions. In actuality, some corporate philanthropy is opportunistic behavior and some is good business strategy. The different motives are not necessarily mutually exclusive. For example, a contribution can help a member of top management attain higher social status while simultaneously enhancing the firm’s reputation. Nevertheless, an executive imposes costs on shareholders when he uses the corporate giving program purely for self-interest. Likewise, it is not enough for corporate philanthropy to simply provide a “warm glow” or “good feeling.” Some return is essential for corporate giving to be able to continue in the long run. Thus, making a sound business case is extremely important.
After considering various other governance issues including the role of institutional investors, independent directors and the extent of disclosures, the post concludes: “Executives can justify charitable contributions by applying the same prudence to giving decisions that they do to other business activities.” It then provides various recommendations for making corporate philanthropy more effective.
Although corporate philanthropy is not synonymous with corporate social responsibility (CSR), the discussion regarding incentives and business strategy must have an important role to play in shaping the CSR regime in countries such as India. This will particularly assist in addressing the debate as to whether CSR should be mandatory or voluntary, on which there continues to be some amount of ambivalence and it is not clear how the company law reform will finally take shape on the issue.

Sunday, August 21, 2011

Trade, Law & Development: Call for Submissions


The Editors of Trade, Law & Development (TL&D), a bi-annual, student-run, academic journal published by National Law University, Jodhpur, India, invite submission of unpublished, original works for publication in the forthcoming Special Issue of TL&D (vol.4, no.1 (2012)). The theme for the Special Issue is: Dispute Settlement at the World Trade Organization.
Manuscripts received by 31st October, 2011 shall be considered for publication in the TL&D Special Issue on Dispute Settlement at the WTO.
Submissions can be made online through the journal’s website, ExpressO, LexOpus, or by way of e-mail. Further details, including submission guidelines, are available at the journal’s website.