Systematic Stewardship on the Waterbed

Abstract

This paper examines the limits of corporate governance as a tool for advancing climate transition. While capital market mechanisms, shareholder stewardship, say-on-climate votes, and ESG-linked executive compensation are often presented as effective levers for greening corporate behavior, their transformative capacity is systematically constrained. Building on insights from financial economics and agency theory, the paper highlights incentive distortions within the complex investment ecosystem and introduces the “waterbed effect” as a central, yet underappreciated, limitation. Firm-specific governance interventions alter marginal abatement incentives asymmetrically, inducing competitive reallocation of emissions or production that may fully offset intended environmental gains. A formal model demonstrates how such interventions fail to reduce aggregate emissions under emissions trading systems and may even be counterproductive in competitive product markets. The analysis suggests that corporate governance can complement, but not substitute for, universally applicable regulatory instruments such as carbon pricing or comprehensive emissions caps. Overreliance on governance-based solutions risks inefficient resource allocation and may crowd out the political momentum necessary for effective climate regulation.

Keywords: Corporate governance, Climate change, Waterbed effect, Systematic stewardship, ESG, Emissions trading

JEL Classification: D62, D86, G34, K22, Q54