Internship Report

The Impact of Anchoring on Charitable

Contributions and CSR Spending

SUBMITTED BY:

Jatan GogriSecond Year UG, Economics & Finance

UoLIP-the LSEjatangogri@gmail.com

MENTOR:

Dr. Naman DesaiFinance & Accounting Area

Indian Institute of Management, Ahmedabadnamand@iimahd.ernet.in

Contents

Preface

Part 1: CSR1

Part 2: The Inevitable Anchoring Effect4

Part 3: Experiments7

References11

PREFACE

This report aims to summarize my internship study wherein fundamental objective was to examine the potential consequences of the Anchoring effect on charitable contributions and Corporate Social Responsibility (CSR) spending in the context of the minimum CSR spending limits imposed by the Companies Act (2013), in India.

The report is divided into three parts. Part 1 summaries the various benefits gained by firms who indulge in CSR activities and new 2% rule. Providing literature review of the Anchoring effect and its possible application to the 2% rule is the main theme of part 2. Part 3 presents the two experiments I assisted in, wherein the results confirm contamination of the charitable donation amount and CSR spending by an anchor.

More importantly, I would like to thank my mentors, Dr. Naman Desai and Dr.Viswanth Pingali, for providing a free space to chase my own curiosities, and in turn, experience grow. Thanks, again!

Jatan Gogri

PART 1 CORPORATE SOCIAL RESPONSIBILITY (CSR)

Introduction

There is no single universally accepted definition of CSR. It can be defined as

“discretionary business practices and contributions of corporate resources intended to

improve societal well-being” (Kotler & Lee, 2005) Not to ignore the fact, this is just one of

myriad interpretations of CSR. However, the key elements incorporated in most of the

definitions for CSR; in recent literature are: First, CSR refers to corporate actions that respect

and consider the interests of stakeholder groups; other than their shareholders and debt

holders. Second, those corporate actions go beyond the interests of the firm and that which

are required by law. In the Indian context, the World Bank Council for Sustainable

Development states CSR as a tool to improve overall human development and social

inclusion. More specifically, the World Bank envisions CSR as an activity that will ensure

that corporations will work with government, civil society, and community to improve the

lives of the underprivileged people of India by making growth more inclusive (World Bank,

2013).

Benefits of indulging in CSR

Theodore Levitt authored the HBR article “The Dangers of Social Responsibility,” in

which he cautions that “government’s job is not business, and business’s job is not

government” (1958, p. 47). Free-market propagandist Milton Friedman (1970) expressed the

same sentiment and added that the mere existence of CSR was a signal of an agency problem

within the firm. An agency theory perspective implies that CSR is a misuse of corporate

resources that would be better spent on valued-added internal projects or returned to

shareholders. However, recent research has suggested several economic and strategic benefits

accruing to companies that invest in CSR activities. For instance, there has been substantial

evidence indicating that companies with a good CSR spending record, and voluntarily

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disclosure of their CSR activities enjoy a significantly reduced cost of capital in comparison

to similar corporate houses that have a poor CSR performance record (Ghoul et al., 2011;

Dhaliwal et al., 2011; Richardson & Welker, 2001). Research also suggests that, CSR

activities can also lead to better financial performance by; improving the firm’s reputation

among customers which results in increased sales, improvement in the firm’s reputation with

regulators which helps in receiving more favorable treatment from such regulators,

improvement in ability to attract, retain and motivate employees, etc. (Dhaliwal et al., 2012;

Modi & Mishra, 2013; Korschun et al., 2014).

Research in the field of marketing indicates that there is a positive association

between a company’s CSR activities and consumers’ attitudes towards the company and its

products (Brown & Dacin, 1997; Creyer & Ross, 1997; Ellen, Mohr & Webb, 2000). Positive

CSR also raises the degree of brand loyalty, which in turn can make consumers less prone to

attitude change and reduce the effectiveness of competitors’ persuasion attempts (Krasnikov

et al., 2009). Additionally, Minor & Morgan (2011) indicate that a company’s CSR activities

can provide some insurance to the company against loss of reputation during turbulent

circumstances.

The 2% Rule

The Indian government became the first regulator in the world to mandate a minimum

CSR spending. In India, the concept of CSR is governed by clause 135 of the Companies Act,

2013, which was passed by both Houses of the Parliament, and had received the assent of the

President of India on August 29, 2013. The CSR provisions within the Act are applicable to

companies (publicly listed as well as private) with an annual turnover of 1,000 crore INR and

more, or a net worth of 500 crore INR and more, or a net profit of five crore INR and more.

These companies are mandated to annually spend 2% of average net profit of past three years

on certain approved CSR activities; the eligible activities have been specified under Schedule

VII of the Act. Additionally, the new Companies Act requires the board of the company to

disclose its CSR spending in their financial statements and in a separate individual CSR

report and publish the details on the company’s official website. If the company fails to spend

the prescribed amount, the board, in its report, shall specify the reasons. Through its disclose-

or-explain mandate, the state encourages that all corporate bodies contribute transparently to

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the betterment of the society as a whole, which in turn would make corporate growth more

inclusive and sustainable.

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PART 2 THE INEVITABLE ANCHORING EFFECT

Introduction

Cognitive Scientist Herbert Simon (1957) originally proposed the idea that human

judgements are based on Heuristics. Heuristics can be defined as the, “judgmental shortcuts

that generally get us where we need to go – and quickly – but at the cost of occasionally

sending us off course.” (Gilovich & Savitsky, 1996) The Seminal paper, Judgement under

uncertainty: heuristics and biases (Tversky & Kahneman, 1974) described three heuristics

that are employed to assess probabilities and to predict values; which lead to systematic bias.

Adjustment and anchoring (1974) being one of them. Anchoring is a judgemental heuristic

wherein the final estimate is contaminated by an exposure to an explicit (Cervone & Peake,

1986; Tversky & Kahneman, 1974; Strack & Mussweiler, 1997) or an implicit (Northcraft &

Neale, 1987; Wilson, Houston, Etling, & Brekke, 1996) anchor. The classic experiment to

demonstrate anchoring, conducted by Amos Tversky and Daniel Kahneman goes on

following lines…Subjects were asked two questions. First, whether the percentage of African

nations in the United Nations (UN) is higher or lower than an arbitrary number-the anchor

that had ostensibly been determined by spinning a wheel of fortune (65 percent or 10

percent). Participants were then asked to give their best estimate of this percentage. Absolute

judgments were assimilated to the provided anchor value. The mean estimate of those who

saw 10 and 65 were 25 percent and 65 per cent, respectively.

Literature Review

Anchoring effect is one most the most robust and easily replicable phenomenon in the

field of experimental psychology. Anchoring effects pervade a variety of judgments, from the

trivial; estimating the mean temperature in Antarctica (Strack & Mussweiler, 1999) to the

apocalyptic; estimating the likelihood of nuclear war (Plous, 1989). In particular, they have been observed in a broad array of different judgmental domains such as: General knowledge

questions (Strack & Mussweiler, 1997), Price estimates (Strack, Mussweiler, & Pfeiffer,

2000; Northcraft & Neale, 1987), Estimates of self-efficacy (Cervone & Peake, 1986),

Probability assessments (Plous, 1989), Evaluations of lotteries and gambles (Chapman &

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Johnson, 1994), Legal judgement (Chapman & Bornstein, 1996; Englich & Mussweiler,

2001), and Negotiation (Galinsky & Mussweiler, 2001). This could be the reason why first

offers may influence the final negotiation outcome, because they serve as judgmental anchors

to which the final outcome is assimilated.

Not only is this heuristic pervasive in a plethora of laboratory and real-world settings,

its influence is also remarkably robust. Surprisingly, anchoring is independent of many

potentially moderating variables. For one thing, anchoring occurs even if the anchor values

are clearly uninformative for the critical estimate (Tversky & Kahneman, 1974; Strack &

Mussweiler, 2000). Further, anchoring remains uninfluenced by the extremity of the anchor

(Chapman & Johnson, 1994; Strack & Mussweiler, 1997) so that even extremely implausible

starting points yield an effect. For instance, in one of the studies (Strack & Mussweiler, 1997)

estimates for Mahatma Gandhi’s age were assimilated to an unreasonably high anchor value

of 140 years. Furthermore, the Anchoring effect appears to be independent of participants’

motivation (Wilson, Houston, Etling, & Brekke, 1996). Specifically, there was an

unsuccessful attempt to improve accuracy by awarding a prize for the best estimate. In

addition, it has been demonstrated that anchoring occurs independently of participants’

expertise (Englich & Mussweiler, 2001; Northcraft & Neale, 1987). For example, study in the

legal domain (Englich & Mussweiler, 2001) wherein experienced judges and inexperienced

law students were both influenced by the anchor sentencing demand given by a computer

science student to similar degrees. Furthermore, anchoring effects are characterized by an

exceptional temporal robustness and persist over fairly long periods of time. In one study,

anchoring effects were still apparent one week after the anchor value had been considered

(Mussweiler, 2001).

Another striking demonstration of the robustness of the phenomenon, stems from

research demonstrating that explicit instructions to correct for a potential influence of an

anchor do not mitigate the effect (Wilson et al., 1996). Even explicitly forewarning judges

about the potential distortion and informing them about its direction does not diminish the

effect. The literature clearly indicates that anchoring is a ubiquitous and highly robust

phenomenon; difficult to escape. Some research (Mussweiler, Strack, Pfeiffer, 2000) has been

conducted to overcome this inevitable anchoring effect. This real world setting study

demonstrated that de-bias effect can be achieved by applying a consider-the-opposite

strategy; generating reasons why an anchor is inappropriate.

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“The terms Anchor and Anchoring effect have been used in the psychological

literature to cover a bewildering array of diverse experimental manipulations and results,

ranging from the effects of unjudged a stimuli on psychological states (Helson, 1964) to early

bids and offers in negotiations (Neal & Bazerman, 1991)” (Jacowitz & Kahneman, 1995) For

this report, an anchor is an arbitrary value which is considered by the subject before making a

numerical estimate.

Possible Implications of the 2% rule owing to the Anchoring effect

For long, the Anchoring effect had rather remained the enigmatic Anchoring effect.

“In current psychological research, few phenomena are easier to demonstrate and harder to

explain than the so-called anchoring effect.’’(Strack & Mussweiler, 1997) Earlier

experiments focused on either verifying or demonstrating the Anchoring effect in various

scenarios, or were inconclusive about the psychological mechanisms that underlie anchoring.

However, Daniel Kahneman suggests in his book, Thinking, Fast and Slow (2011); the

psychology of the Anchoring effect has finally been understood. The agenda of this study as

conceived by my mentors, Dr. Naman Desai and Dr. Vishwanath Pingali, is to examine the

prevalence of the Anchoring effect during charitable donations and possible implications of

the 2% rule. A potential problem with the 2% rule is that large companies, who usually spend

more than 2% of their profits on CSR related activities, could “anchor” their CSR spending

on the minimum stipulated limits which, in turn, could actually reduce their CSR spending.

Such a result would be contrary to the objectives of establishing such a minimum limit.

Hence, we examine the impact of anchoring on charitable contributions, and on the CSR

spending of companies.

Two experiments were conducted to examine our primary research questions. The

first experiment was conducted to establish the effects of reference points on decisions

related to charitable giving. The experiment result suggests that participants did anchor on the

minimum stipulated limit while deciding on the amount of charitable contribution. The

second experiment was conducted to examine if anchoring specifically affected CSR

investment decisions. The results of the experiment indicated that the amount of reported

CSR spending was lower when the minimum 2% rule was imposed versus when it was not.

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Furthermore, the results also indicate that when the 2% rule was not imposed the participants

appeared to anchor on the overall financial requirement of the CSR activity.

PART 3 EXPERIMENTS

Hypothesis

Despite the several strategic benefits already available to companies investing in CSR

activities (Malik, 2014), the Indian Government decided to impose minimum CSR spending

limits on companies. This minimum spending limit does have the potential of increasing the

number of companies investing in CSR activities. However, certain large companies whose

CSR related spending were in excess of 2% of their profits could start anchoring on the

minimum 2% limit, in turn, reducing their investment in social causes. Additionally, once the

2% rule takes effect, it might be difficult for the company’s management to explain any CSR

spending in excess of 2% to the shareholders.

Formally stated:

H1: Individuals and companies subject to minimum spending limits on social causes will

anchor on the stipulated minimum limits, and as a result, invest less in such social causes

than individuals and companies which are not subject to such minimum spending limits.

There could be other variables which could act as anchors in the absence of minimum

spending limits. One such factor could be the total requirement of a CSR project. If a

company decides to finance a CSR activity only partially, then, in the absence of a minimum

spending limit, it is possible that the total financial requirements of a CSR activity could act

as an anchor while deciding on the amount of CSR investment in a particular activity.

Formally stated:

Q1: In the absence of a minimum CSR spending limit would the amount of CSR spending be

anchored on the total funding requirement of a CSR activity?

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Experiment DesignTwo between-subjects experiments were conducted to test our hypotheses. The first

experiment was conducted to investigate if the donors were anchoring themselves to a

reference point. The experiment was conducted on undergraduate students in their last year of

study (before graduating) with the average age of 20.34 years. The participants were divided

in two treatments and were asked to answer 10 (multiple choice) quantitative aptitude

questions within a time limit of 15 minutes.1 The participants were paid 50 INR for every

correct answer and no penalty was imposed for inaccurate answers. Participants who were

unable to answer two questions (or less) correctly were still paid 100 INR for participating in

the study. After the pay outs were determined, participants in one treatment (control group)

were asked to voluntarily contribute a portion of their winnings to a charity of their choice.

The second treatment (treatment group) was similar to the first except that in this treatment a

minimum contribution limit of 5% was imposed on all winnings, and then the participants

had the option to voluntarily contribute any additional amount to a charity of their choice.2

The second experiment was conducted to examine how company executives react to

minimum CSR spending limits while deciding on the amount to be spent on a particular CSR

activity. The second experiment was a 2x2 between-subjects experiment where the presence

or absence of minimum spending limit and the total requirement of a CSR project (50 crores

INR versus 250 crores INR) were manipulated across treatments. All the participants of this

experiment were middle and top level company executives; who reported an average work

experience of 18.45 years. In this experiment the participants were provided with a brief

company description, the abbreviated financial statements of a company and a potential CSR

opportunity (improving schools’ infrastructure for the underprivileged). They were then

asked to determine the amount of CSR spending that would be committed on behalf of the

company on that particular project. This experiment was conducted to specifically examine if

the participants would anchor on the 2% minimum while deciding on their CSR spending.

Additionally, we also examined if the executives would anchor on the total requirements of

the social cause when no minimum spending limits were imposed.

1 The questions were selected from various GMAT practice tests.

2 The minimum 5% of contribution was also given to a charity of the participants’ choice.

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Results

The descriptive statistics in Table 1 indicate that, participants in the first experiment

contributed significantly more to a charity of their choice when no minimum contribution

limit was imposed, compared to when their earnings were subject to a 5% minimum

contribution (38.5% versus 24.9%).3 The results of the first experiment strongly indicate that

anchoring affects participants’ decision making related to charitable contributions.

Table 1: Descriptive Statistics for Experiment 1 (Indicating Charitable Contributions as a Percentage of Total Earnings)

Treatment N Mean Std. Dev. Minimum Maximum1 42 0.385 0.176 0.04 0.802 41 0.249 0.145 0.05 0.53

Total 83 0.318 0.174 0.04 0.80

Treatment 1 = no mandatory contributionTreatment 2 = 5% mandatory contribution

The second experiment was conducted to examine if the anchoring effects observed in

the context of charitable contributions actually extend to individuals making CSR spending

decisions. The descriptive statistics in Table 3 indicate that the CSR spending was higher

when no minimum was stipulated compared to conditions where a 2% minimum spending

limit was imposed. This result holds true irrespective of the overall requirement of the social

project (32.12 versus 25.42 and 28.49). Additionally, the CSR spending is the highest (42.40)

for the condition where fund requirement is relatively high (INR 250 crores versus INR 50

crores) and where no minimum CSR spending limits are imposed.

3 The contributions were significantly greater than the minimum 5% because of two primary reasons. First, the 5% of total earnings might have appeared to be too less in absolute numbers (For e.g. 5% of Rs 200 is only Rs 10 which is a very small and insignificant amount in India. Second, the currency denomination is such that participants would have found it difficult to contribute exact percentages and hence they may have rounded up or down to multiples of 10, 20 or 100 which are the most commonly used currency notes in India.

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Table 2: Descriptive Statistics for Experiment 2 Indicating Amount of CSR Spending

Mean (Std. Dev) Mean (Std. Dev)Project Requirement 50 crores Project Requirement 250 crores

Minimum 2% 25.42 (2.44) 28.49 (8.00)No Minimum 32.12 (10.67) 50.90 (38.88)

Conclusion

The results of this study have important implications for policy makers and regulators. While

the setting of a minimum CSR spending potentially increases the number of companies

investing in CSR activities, the minimum spending limit could actually act as an anchor and

potentially reduce the amount of CSR spending of certain large companies which spend more

than 2% of their profits on such activities which they are not legally obliged to. Therefore,

before stipulating any minimum limits regulators should clearly understand the implications

of such limits and also conduct a detailed analysis before deciding on the magnitude of any

minimum spending limit. Additionally, experiment results clearly suggest that corporate

bodies could ignore the strategic benefits gained through positive CSR investment and

instead anchor themselves solely on the minimum stipulated spending limit. This is consistent

with the past empirical evidence, which have persistently proved Anchoring effect to be a

robust, almost inescapable phenomenon.

More interestingly, our results also indicate that in the absence of minimum CSR spending

limits, the CSR spending appeared to be driven by the total requirement of the CSR project.

If such an anchoring leads to greater CSR spending than regulators should try and increase

awareness about the requirements of various CSR activities rather than imposing minimum

spending limits on corporations. Any such spending limit should be set strategically,

systematically and thoughtfully.

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References

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*Information about the 2% rule and Companies Act, 2013 was collected from: http://www.mca.gov.in/SearchableActs/Section135.htm

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