Emerging ESG-Driven Models of Shareholder Collaborative Engagement

In our recent paper, we look at currently emerging forms of ESG-driven shareholder collaborative engagement. We explore potential legal risks associated with and obstacles to these (new) forms of collaboration and suggest ways of bolstering opportunities for future collaboration.

Shareholder Collaborative Engagement: The Traditional Micro-Picture

The received view of shareholder engagement from a micro perspective holds that the difficulties of collective action and the resultant rational apathy on the part of shareholders discourage effective (collaborative) engagement. In theory, recent fundamental transitions in ownership structures should not alter shareholders’ rational incentives to remain passive, particularly because funds compete with each other in offering the lowest fees, and any engagement at the level of a single portfolio company brings with it increased costs. Free rider problems also contribute to shareholder passivity.

In practice, however, shareholder involvement has increased in recent years in spite of these disincentives. This development is traditionally attributed to four main factors: (i) the ‘Big Three’ of the investment fund industry are often too big to remain passive, (ii) institutional investors increasingly use proxy advisors, (iii) political pressure and stewardship considerations spur on proactive shareholder involvement, and (iv) institutional investors collaborate with each other.

In our paper, we further explore collaborative shareholder engagement. Collaboration between shareholders is, on a theoretical level, a way to overcome, or at least mitigate, some of these disincentives. This is because: (i) voting rights and the associated informal influence can be bundled through collaborative interaction, (ii) collaboration may mitigate the free rider problem, (iii) collaboration can reduce information costs by sharing resources, skills, and expertise among collaborators, and (iv) collaboration contributes to risk sharing among the participants in the collaboration.

Despite this potential mitigation of collective action problems and a reduction or sharing of information costs through collaborative action, the disincentives to engagement, especially among large, broadly diversified active and passive fund owners and managers, still work against—even collaborative—engagement.

ESG as a ‘game changer’?

We view the nascent ES(G)-era as a potential game changer with regard to shareholder collaborative engagement, and ask whether increasing interest in E and S issues, in particular, might serve as an additional incentive to institutional investors to collaborate. Irrespective of any lasting inconclusiveness as regards the incentives for ESG engagement in general, at least with regard to collaborative ESG engagement, some recent studies (Dimson et al 2015, Dimson et al 2021) suggest (i) a higher success rate of collaborative engagements and (ii) a sustainable positive effect of collaborative ESG campaigns on share price performance.

Collaboration among institutional investors is often seen as essential for encouraging companies to act responsibly. The future of E&S-driven collaboration, however, is still somewhat unclear, not least in light of the recent backlash from some value hedge funds and, particularly, politicians criticising the proliferation of ‘woke’ corporations. It may well be that, for some time at least, companies will find themselves somewhat torn between ESG-friendly collaborations, on the one hand, and value-focused collaborations, on the other. One may hope that the former will gain and then retain the upper hand, but without outside pressure and support from the political arena, regulators and society at large (NGOs), this is by no means certain.

Forms and Strategies of Collaboration

Against this backdrop, we present new ES(G)-driven approaches to collaboration among the Big Three, between hedge and impact funds, between non-activist institutional investors and on new institutionalized platforms (Climate Action 100+; PRI). In addition, we venture an outlook on potentially emergent types of collaborations. The increasing public interest in climate protection, in particular, leads us to expect a potential increase in collaborations between investors on the one hand and the public or public activists on the other hand in the future.

Obstacles to (Effective) Collaboration and Ways of Bolstering Opportunities for Future Collaboration

Given the great potential of collaborations for effectively carrying out engagements, we also take a closer look at potential legal risks associated with and obstacles to these (new) forms of collaboration (acting in concert, insider trading rules, antitrust law) and suggest ways of bolstering opportunities for future collaboration. In this respect, creating legal certainty regarding the admissible extent and content of collaborative engagement is of paramount importance. Specifically, ESMA should—as already indicated in its recent Sustainable Finance Roadmap 2022-2024—update its Acting-in-concert-Whitelist, and national regulators should also publish opinions on their interpretive practices on the concept of acting in concert. Furthermore, one could consider guidance on insider regulation. However, we should not expect too much in that regard given that impediments from the insider regulation are not covered as an issue in ESMAs Sustainable Finance Roadmap 2022-2024. Therefore, for collaborators, organizing an effective framework for detecting inside information and dealing with such information seems to be key. As regards the European Commission and the national antitrust authorities, they should explicitly extend the scope of the approach they have recently taken with regard to sustainability agreements between manufacturing companies, in particular, to include investor agreements.

This post is part of an OBLB series on Board-Shareholder Dialogue. The introductory post of the series is available here. Other posts in the series can be accessed from the OBLB series page.

Peter O. Mülbert is a Professor of Law at the University of Mainz, Germany.

Alexander Sajnovits is a Post-Doctoral Research Fellow at the University of Mainz, Germany.