Systemic Stewardship with Tradeoffs

Abstract

Many have started to look to the corporate sector to control carbon emissions, mitigate climate change, and redress other problems. But any serious effort to control carbon emissions (or other problems) will have winners and losers: companies that will benefit from reduction; and companies that will bear the brunt of mitigation efforts. In particular, concentrated carbon emitters such as oil exploration and production companies are likely to suffer. If so, who will force the carbon emitters to cut their carbon output? Who will be the agents of change in the corporate sector?

In recent years, the proponents of a corporate focused strategy have started to look to “universal owners” – the asset managers and owners that hold a significant swath of many public companies. Some commentators have argued that universal owners should use their influence in portfolio companies to maximize the value of the overall portfolio, rather than the value of any particular company. For some, this means that universal owners should adopt “systemic stewardship” that would push for market wide initiatives to reduce environmental externalities and control systemic risk (e.g., standardized climate risk disclosure). According to others, universal owners should pursue a more ambitious agenda and take affirmative steps to mitigate the risks of climate change to the long-term value of the portfolio by, for example, pushing carbon emitters to cut output, whether or not that promotes individual firm value.

But shareholders, even universal owners, do not manage companies. Rather, the business and affairs of a corporation are managed by full time senior management teams under the general oversight of a board of directors, within a framework created by corporate law. In this article, we analyze the extent to which universal owners can and should be expected to sacrifice single firm value even when doing so increases the value of the overall portfolio. We are quite pessimistic about the potential of systemic stewardship that entails substantial tradeoffs among portfolio companies.

This is for three principal reasons. First, universal owners would have to take into account the possibility that inducing some firms to reduce environmental externalities and mitigate risk will generate a competitive response that will eliminate the benefits from these actions for their other portfolio companies. If that were to happen, universal owners would be stuck with the losses without receiving any corresponding gains. Second, corporate law, as it currently stands, has a strong “single firm focus” (“SFF”) that stands in sharp contrast to the potential “multi-firm focus” (“MFF”) of large portfolio investors. If universal owners were to work individually or together to protect their overall portfolios from systemic risk, it would clash with corporate law in a fundamental way that could create significant risks of liability. Third, universal owners typically manage a wide variety of different portfolios for different clients each of whom is owed fiduciary duties. A “tradeoff” strategy that would benefit some portfolios at the expense of other portfolios would conflict with these fiduciary duties as well as with the core multi-client multi-portfolio business model. As a result, we expect that universal owners will not act in concert and will not openly pursue a MFF strategy. Rather, they will act unilaterally and under cloak of promoting single firm value. But because any serious effort to mitigate climate change will involve tradeoffs, we do not expect universal owners to be effective in controlling carbon emissions.