Institutional Investors as Climate Activists—Curb Your Enthusiasm
In my article ‘Institutional Investors as Climate Activists – Curb Your Enthusiasm’, I explore the potential and the limits of institutional investors—most notably the largest asset managers, often dubbed the ‘Big Three’—using their positions as shareholders to lobby for climate-friendly policies.
This uplifting idea is rooted in a rather dystopian scenario: What if a sizable portion of all votes in major public companies were controlled by only a handful of actors? Given the meteoric rise of asset managers and index funds, this question addresses the world we live in rather than a ‘what-if’ scenario. A recent empirical study suggests that the Big Three now own a median stake of 21.5% in S&P500 companies and a median 27.6% of the votes cast at annual meetings. These figures are projected to rise steadily. As a result, many observers have cast the Big Three as villains endangering open competition between, or viable corporate governance within, portfolio companies. Labels such as ‘The Specter of the Giant Three’ or ‘The Problem of Twelve’ encapsulate the discomfort caused by an unprecedented concentration of capital, ownership and voting rights.
A contrasting vision, however, has the Big Three auditioning for a heroic role in tackling humanity’s most pressing problems. This view is premised on the notion that shareholders with broadly diversified portfolios are only vulnerable to systemic risks to the economy. The most salient example of such a risk, of course, is anthropogenic climate change. As a result, powerful investors such as the Big Three have a rational incentive to lobby portfolio companies for reductions in greenhouse gas (‘GHG’) emissions.
This model deviates from the traditional paradigm of shareholders’ interests. As individual shareholders, the Big Three would wish every portfolio company to maximize its value. However, for more than a few of those firms, decarbonization would be akin to phasing out their business models. Why, then, would shareholders prefer ‘their’ companies to opt for self-harm? Enter the concept of portfolio primacy, according to which broadly-invested, or ‘horizontal’ shareholders seek to maximize the long-term value of their portfolios, not that of individual portfolio firms. As a result, they would happily sacrifice some value of companies that would otherwise generate externalities at the expense of the portfolio.
Indeed, the Big Three are emphasizing sustainability and have, on occasion, sided with climate-activist shareholders in high-profile proxy fights. Are we, thus, witnessing large asset managers acting as regulators where governments fail to deliver?
The incentive structure sketched out above, plausible as it may be, is only a starting point. My analysis, in line with other recent scholarship, points out some important limitations, both economic and legal in nature, which cast doubt on the hypothesis that portfolio primacy will translate into effective climate activism by large institutional shareholders.
First, The Big Three’s spheres of influence are limited. Their portfolios exclude private and state-owned companies, whereas they include companies with controlling shareholders. These blind spots include many of the world’s most prolific GHG emitters and the option of taking a company private could serve as a safety valve to evade zealous climate stewards. Even if asset managers convinced portfolio companies to implement sweeping decarbonization measures, the results may prove disappointing. Assuming there remains an appreciable market for carbon-emitting products, this would almost certainly involve selling off GHG-intensive assets to less scrupulous third parties. In fact, we can already observe this pattern in practice. Such transactions are a zero-sum game for the planet.
Second, the economic concept of portfolio primacy cannot exist in a legal vacuum. The basic idea of pressuring firms to act against their own, and non-diversified shareholders’, economic interests is bound to collide with fiduciary duties. Thus, a portfolio company’s management’s choice to internalize externalities with the aim to create value for certain shareholders outside the corporation would amount to a violation of fiduciary duties—albeit one that may be reasonably easy to cloak in the rhetoric of necessary transition.
Asset managers, at least in principle, owe no comparable duties to other shareholders. They would, however, skirt the boundaries of their fiduciary duties towards some of their clients when adopting strategies that disadvantage investors in more carbon-heavy products within their mutual funds. While this conflict could be resolved by adopting fund-specific voting policies, this would drive up transaction costs and split voting almost never occurs in practice.
Finally, other institutional investors such as pension funds must, absent a formal authorization to prioritize environmental considerations, be able to square climate activism with their fiduciary duties as trustees. Like other ESG-inspired measures, such decisions are acceptable if they aim to improve risk-adjusted returns. While they can make this case, trustees operate on somewhat shaky ground because they do not enjoy the privilege of a safe haven akin to the business judgment rule.
It remains a fascinating observation that large investors’ financial interests and humanity’s urgent need for sustainability do in fact converge. However, given legal and economic constraints, even the Big Three can hardly subvert the market forces operating on an individual-firm level. While climate activism by institutional shareholders is not a pipe dream per se, it is unlikely to achieve sweeping effects. Most importantly, it must not create a false sense of optimism that alleviates the pressure on state actors who are far better positioned to effect meaningful change.
Markus Lieberknecht is Senior Researcher at Heidelberg University, Institute for Comparative Law, Conflict of Laws and International Business Law.
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