Faculty of law blogs / UNIVERSITY OF OXFORD

Justifying Sustainability Disclosure: Investor Demand vs Market Efficiency


George S Georgiev
Associate Professor of Law, Emory University


Time to read

5 Minutes

Proponents of ESG have recently had to contend with two facts that, at first blush, appear somewhat inconvenient: investor support for sustainability-focused shareholder proposals has been declining year-on-year and, in addition, some investors have abandoned sustainability-themed funds. It is only natural to ask whether these trends suggest that investor demand for ESG—long considered its driving engine—is now on the wane. And if investor demand for ESG is not as strong as it once was, does this undermine regulators’ case for mandating climate-related and other sustainability disclosure?

Though these questions are not unreasonable, the answer to both is no. As I discussed in a recent article, the indicators of investor demand, murky even under the best of circumstances, are often misunderstood when it comes to ESG. The case for sustainability disclosure, moreover, does not hinge on a finding of investor demand; rather, market efficiency—encompassing both securities price accuracy and overall capital market allocative efficiency—provides a compelling standalone justification for sustainability disclosure that is supported by finance theory and recent empirical research as well as by the SEC rulemaking practice and judicial doctrine. Put simply, the role of sustainability disclosure is ‘market-essential’ and not contingent on evidence of investor demand.

Interpreting Investor Demand for ESG

The high level of interest in ESG disclosure, ESG stewardship, and ESG investing from large mainstream investors has offered a compelling datapoint in the policy and academic debates over ESG. For example, a 2022 analysis of the positions of 320 investors who collectively own or manage over $50 trillion in assets revealed that 97% support requiring climate disclosure on Form 10-K, 99% support requiring disclosure of Scope 1 and Scope 2 emissions, 97% support the qualified Scope 3 disclosure requirement contained in the SEC’s proposal, and 98% support governance disclosures related to board and management oversight of climate risk. Upon the release of the climate proposal, SEC Chair Gary Gensler noted that ‘investors with $130 trillion in assets under management have requested that companies disclose their climate risks.’ This evidence suggests that investor demand is real and near-universal, but there also appears to be contrary evidence in the form of declining support for ESG shareholder proposals and outflows from ESG funds.

ESG Shareholder Proposals. According to ISS data, the median level of support for environmental proposals in 2023 was 16%, down from 25.5% in 2022, and 49.4% in 2021. Another source puts the average level of support for environmental proposals in 2023 at 20%, down from 34% in 2022. A third source notes that only 3% of environmental proposals in 2023 received majority support, down from 32% in 2021. Support for social proposals has experienced a similar drop. Unsurprisingly, these declines have been described as ‘catastrophic,’ and have served as ammunition for opponents of ESG disclosure.

The reality is more complicated and considerably less gloomy. First, there is substantial heterogeneity in ESG proposals, both at different firms and from year to year, which makes aggregate data on shareholder support and multi-year comparisons suspect. Second, each year some of the most viable shareholder proposals are withdrawn as a result of settlements between management and the proposals’ proponents. According to the Conference Board, 31% of all ESG proposals in 2023 were withdrawn—a staggering figure when viewed alongside the very low withdrawal rates, generally less than 5%, for proposals in other areas. The settlement phenomenon is often overlooked because each settlement is unique, but settlements are an indispensable part of analyzing the fluctuating support rates for ESG proposals. Finally, in certain cases, pro-ESG and anti-ESG proposals are counted in the same category. The number of anti-ESG proposals has been on the rise but they receive very little support (generally around 3%), and combining them with pro-ESG proposals skews the numbers.

Outflows from ESG Funds. According to data from Morningstar, U.S. investors withdrew $5.1 billion from ESG funds in the fourth quarter of 2023. This amount was offset only partially by net inflows from Europe amounting to $3.3 billion, leading to the first instance of global net outflows in a given quarter. It would be both superficial and premature, however, to interpret this as an indicator of a permanent decline in investor demand for ESG. Here, too, precision is key. Even if the outflows suggest a rebalancing of investors’ interest in ESG-labeled funds, this says nothing about investor demand for ESG disclosure. The relevance of ESG disclosure is not limited only to the firms that find themselves in ESG funds; rather, ESG risks (eg climate change) apply to most firms across the economy and investors seek to understand these risks regardless of their level of investment in ESG funds. Moreover, the scarcity of standardized and accurate ESG information and the resulting greenwashing—at least partly a function of the roadblocks before the SEC—likely contributes to asset managers’ difficulties in formulating active ESG strategies or even assembling passive ESG funds that are truly ‘ESG.’

The Market-Essential Role of Sustainability Disclosure

In a general sense, the foregoing discussion demonstrates that investor preferences on ESG matters are just like investor preferences on many other matters—dynamic, heterogeneous, and difficult to divine and aggregate. This need not doom the case for ESG disclosure, however, because market efficiency provides a supplemental and standalone justification. Of course, this argument does not extend to any conceivable ESG disclosure topic and is limited to disclosure items and frameworks that contribute to ensuring securities price accuracy and overall capital market allocative efficiency. For the sake of precision, it is useful to focus on climate-related disclosure, which represents the category of ESG disclosure that has been at the forefront of debate. The considerations that follow are not novel, but the recent overemphasis on investor demand has caused some of them to be overlooked. 

Finance theory suggests that the more information that is incorporated into the price of a security, the more the price of such security correctly anticipates the future prospects of the company. Price accuracy is important at the level of the individual investor, whether active or passive, and also in the aggregate because it ensures that capital would be allocated to its highest-valued users. Empirical evidence about the links between climate information and firm valuations has started to emerge as well. For example, Bolton & Kacperczyk (2021) find that carbon emissions significantly affect stock returns. Bolton, Hale & Kacperczyk (2022) report that ‘financial markets are beginning to broadly discount companies whose high carbon emissions are viewed as subjecting them to higher levels of political and regulatory risk,’ which, in turn, translates into a higher cost of capital. There is also evidence that investors incorporate climate-related information in sophisticated ways when valuing firms.

If securities prices are sensitive to climate-related information, as this evidence suggests, then accurate and comparable information is needed to ensure the accuracy of securities prices and overall allocative efficiency within the economy. It is worth recalling that a number of SEC- and judge-made doctrines in securities law and in state corporation law are premised on the informational efficiency of securities prices. Price accuracy is also a foundational element of investor protection since price is the most significant term of most, if not all, securities transactions. 

The current policy moment, with the SEC expected to finalize its climate-related disclosure rules in the near term, makes it all the more important to focus on the plurality of legitimate disclosure justifications, understand the complexity of investor demand, and dispel critiques that zero in on what appears to be declining support for ESG shareholder proposals and outflows from ESG funds. And, of course, the debate over climate-related disclosure will not conclude once the SEC finalizes its much-criticized rules, since the rules are expected to be challenged in court. Moreover, these same critiques will likely be repeated in future disclosure rulemakings, including any potential rulemaking on enhanced human capital management disclosure.

George S. Georgiev is Professor at Emory University School of Law

The full article can be accessed here.


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