ESG Demand-Side Regulation - Governing the Shareholders

Abstract

Traditionally, scholars treat boards and board members as the suppliers of ESG-oriented decision making, asking whether and how the directors’ fiduciary duties should entail stakeholder interests. This supply-side regulation has obvious disadvantages, e.g., the many-masters problem. Moreover, it fails to implement an effective incentive structure. Considering that shareholders vote on members of the board of directors, their demands set the norms a board maximizes. As long as shareholders measure return on their investment in monetary terms, supply-side regulation lacks teeth.
This chapter proposes a novel vantage point and presents demand-side regulation as a new regulatory concept. If a regulator (in the broadest sense of the word) aims at implementing ESG-oriented decision making in the structure of corporate governance, the regulatory strategy must include the shareholders and investors. When stockholders have to abide by norms mirroring those operating on the level of the corporate board, at least in theory, the incentives and investment goals of corporate directors and shareholders should align.
Major parts of new laws and legal frameworks in the US and Europe already reflect the idea of demand-side regulation. Notwithstanding their differences, they rest on a common denominator, namely the addressee: It is no longer the board of directors, but rather the shareholders and investors. After decades of debating directors’ duties vis-à-vis the corporation, stockholders, and society at large, this presents a major turn of events.
This chapter offers a two-fold contribution to the literature: It charts the territory and provides a description and analysis of legal instruments and regulatory strategies rulemakers already deploy for ESG demand-side regulation. Furthermore, it develops an analytical grid and evaluates promises and perils of the different ways to govern the shareholders. The chapter draws a basic distinction between direct and indirect demand-side regulation. Whereas the first type addresses shareholders and investors directly through ESG disclosure rules and requirements to commit to ESG, the second targets retail investors and tweaks their revealed preferences towards ESG, nudging retail investors into ESG products.

Keywords: ESG, CSR, sustainability, fiduciary duties, shareholder activism, ESG proposals, Taxonomy, SFDR, Sustainable Finance Disclosure Regulation

JEL Classification: G28, K22, L21, L22, M14