Will Systematic Stewardship Save the Planet?

Abstract

The largest institutional investors have solidified their status as “universal owners,” holding almost eighty percent of the U.S. stock market. The growing influence of these investors over the companies they invest in has sparked optimism among scholars and activists that asset managers will use their clout to steer firms towards Environmental, Social, and Governance (ESG) objectives. But such optimism may be misplaced. Focusing on a key ESG aspect, carbon emission reduction, we argue that universal owners lack the necessary incentives and competence to pressure corporations to lower emissions through systematic stewardship.

Universal owners have distorted incentives, as they market ESG funds with conflicting promises: "Doing well while doing good." This untenable promise that ESG-fund will “do well,” or match the returns of non-ESG funds, prevents universal owners from effectively “doing good,” or meaningfully compelling corporations to reduce emissions. Furthermore, universal owners lack competence to fulfill this role because, although climate change is a systematic risk, addressing it requires firm-specific engagement, as well as economy-wide coordination, which universal owners cannot provide.

Worse yet, we demonstrate that no other actors have the incentives or competence to provide the required firm-specific engagement. Ultimately, we conclude that investor stewardship is a very poor substitute for environmental regulation. While universal owners are ill-equipped to direct corporations toward efficient climate solutions, these investors still have a role to play. Universal owners have proven adept at directing politicians to protect their interests through prodigious lobbying efforts. Therefore, the most effective systematic stewardship that universal owners can provide is repurposing their political capture machine from protecting themselves to protecting the universe.

Keywords: systematic stewardship, carbon emissions, ESG, ESG funds, universal owners, hedge funds, agency costs

JEL Classification: k22, k32,