The Future of Disclosure: ESG, Common Ownership, and Systematic Risk

47 Pages Posted: 31 Aug 2020 Last revised: 30 Sep 2020

See all articles by John C. Coffee

John C. Coffee

Columbia Law School; European Corporate Governance Institute (ECGI); American Academy of Arts & Sciences

Date Written: September 21, 2020

Abstract

The U.S. securities markets have recently undergone (or are undergoing) three fundamental transitions: (1) institutionalization (with the result that institutional investors now dominate both trading and stock ownership); (2) extraordinary ownership concentration (with the consequence that the three largest U.S. institutional investors now hold 20% and vote 25% of the shares in S&P 500 companies); and (3) the introduction of ESG disclosures (which process has been driven in the U.S. by pressure from large institutional investors). In light of these transitions, how should disclosure policy change? Do institutions and retail investors have the same or different disclosure needs? Why are large institutions pressing for increased ESG disclosures?

This article will focus on the desire of institutions for greater ESG disclosures and suggest that two reasons underlie this demand for more information: (1) ESG disclosures overlap substantially with systematic risk, which is the primary concern of diversified investors; and (2) high common ownership enables institutions to take collective action to curb externalities caused by portfolio firms, so long as the gains to their portfolio from such action exceed the losses caused to the externality-creating firms. This transition to a portfolio-wide perspective (both in voting and investment decisions) has significant implications but also is likely to provoke political controversy. Indeed, the Trump Administration has proposed new rules that would discourage voting based on ESG criteria and thus would by extension chill ESG investing.

As institutions shift to portfolio-wide decision making, the disclosure needs of individual investors and institutional investors diverge and serious conflicts can arise. As an equity investor, institutional investors have the perspective of an option-holder and favor greater risk-taking, while typically the undiversified retail investor tends to have the opposite perspective and preferences.

Keywords: Black/Scholes Option Pricing Model, Capital Asset Pricing Model (CAPM), Common Ownership, Disclosure, ERISA, Externalities, Index Fund, Institutional Investor, SEC Sole Benefit Rule.

JEL Classification: G30, G32, G38, and H23

Suggested Citation

Coffee, John C., The Future of Disclosure: ESG, Common Ownership, and Systematic Risk (September 21, 2020). European Corporate Governance Institute - Law Working Paper 541/2020, Available at SSRN: https://ssrn.com/abstract=3678197 or http://dx.doi.org/10.2139/ssrn.3678197

John C. Coffee (Contact Author)

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