How shareholders can maximize their social impact
Oil and gas giant Exxon Mobil has funded climate-change deniers and campaigned against the Kyoto Protocol, which aimed to reduce global warming. But the company is now committed to investing $15 billion in low-carbon solutions, hit 2025 greenhouse gas emission–reduction targets four years early, and has a new business-solutions unit initially focused on carbon capture and storage.
These actions come on the heels of a push by one small activist investment firm. In December 2020, hedge fund Engine No. 1 launched a campaign to challenge Exxon to reduce its carbon footprint. In June 2021, the firm made headlines when it helped install three independent directors to Exxon’s board.
Engine No. 1, with $275 million in assets under management, held just 0.02 percent of Exxon’s shares. But it had the support of the energy behemoth’s three largest shareholders: BlackRock, State Street, and Vanguard, which together held close to 20 percent of the company. With climate change a public issue that corporations cannot ignore, Engine No. 1 convinced the large investors to vote against management, something institutional shareholders have rarely done.
Investors and consumers are increasingly eager to push companies to be more responsible. Close to $97 billion in net new money flowed to global sustainable funds in the first quarter of 2022, according to a report by Morningstar. While that was down 36 percent from the previous quarter, environmental, social, and governance (ESG)–focused funds received inflows above the broader market, which saw a slump of 73 percent over the same period, per Morningstar.
A growing number of institutions and mutual funds have begun to take a more active stand on ESG. In 2016, only 3 percent of ESG-related shareholder proposals received a majority of votes, notes research by University of Trento’s Eleonora Broccardo, Harvard’s Oliver Hart (a Nobel laureate), and Chicago Booth’s Luigi Zingales, citing a report by EY Center for Board Matters. In 2020, 12 percent of proposals achieved more than 50 percent of the votes. For shareholder meetings through June 30, 2021, 20 percent of ESG proposals received greater than 50 percent support.
Consumers also appear eager to shun companies whose actions run counter to their values; a 2022 survey from LendingTree finds that 25 percent of Americans were boycotting a product or company they had spent money on in the past. All of this illustrates the intensified pressure companies are under by investors and consumers to focus on changing their environmental, political, and social policies—and, by extension, the opportunities investors have to drive that change.
How best to do that? Broccardo, Hart, and Zingales examined the effectiveness of two popular shareholder options, “voice” and “exit,” in bringing about corporate social change. Voice essentially means taking a stand through voting or communicating with corporate management, while exit refers to investors leading with their feet, hoping to punish a company by hurting its bottom line.
For Engine No. 1 founder Chris James, there was no question about how to proceed. Even with a minuscule amount of total assets, Engine No. 1 raised its voice, and bigger investors amplified it. “The idea that by divesting and giving up your vote, that is going to effect change, I think is insane,” James said last year when discussing his win with Zingales on the Capitalisn’t podcast. (Listen to the full episode, “Capitalisn’t: David versus Goliath.”)
Zingales says he agrees that divesting fails to accomplish what most activists want, but he notes that James’s position was that, as he puts it, “investing in renewable sources is both very profitable and good for the planet. If it is both, great, but what happens when it is not? How do we resolve this trade-off?” This is where his research with Broccardo and Hart could be useful, as the results not only demonstrate why voice tends to be more effective in bringing about better social outcomes, but also help investors weighing their own personal costs.
Social good versus personal cost
It is possible to be socially responsible and financially successful. Research by University of Chicago PhD student Daniel Hedblom (now at the Trade Desk), UChicago’s John A. List, and Washington University in St. Louis’s Brent R. Hickman finds that corporate responsibility “should not be viewed as a necessary distraction from a profit motive, but rather as an important part of profit maximization.”
However, there are times when those goals can be at odds, or responsibility can involve some short-term costs. “It is important to be clear about your motive for holding companies to account for ESG issues,” says London Business School’s Alex Edmans. “Some shareholders claim that ESG always improves financial performance, but the evidence shows that this isn’t the case.”
To weigh the relative advantages of voice and exit, Broccardo, Hart, and Zingales constructed a theoretical model in which polluting companies cause harm globally, and used it to examine how shareholders using either exit or voice affect corporate policy. They focused on two main types of investors—those who are strictly selfish, caring only about their own self-interest, and those who care, to varying degrees, about the overall welfare of the broad population. (At the level of institutions, the model applies to the person making investment decisions.)
The researchers note that this form of caring about the social good differs from a selfish approach but neither is it “based on purely deontological considerations.” A deontological (or moral) investor will choose not to put money into a company because she finds the business repugnant, not because she wants to effect change. A strict teetotaler, for example, may not want to support a company that produces alcoholic beverages, regardless of the impact her decision may have on the overall consumption of alcohol.
“The reason a lot of people are boycotting oil companies is not because they think it’s morally wrong to extract oil,” Zingales says. “It’s because they’re concerned about global warming.”
The model makes several assumptions, first that shareholders are somewhat socially responsible, meaning they care at least a little bit about the greater good. It also assumes companies can choose to be either “clean” or “dirty,” and if a dirty polluter decides to clean up, it will incur costs that will push down the value of its shares. Lastly, the model presumes that all shareholders vote their preferences.
The results imply that voice often wins out: when shareholders are at least somewhat socially responsible, voice is the most effective means of promoting social change at the corporate level. Particularly, shareholders with a well-diversified investment portfolio are willing to accept the lower share price that could result from the costs of implementing environmentally desirable policies, as long as the social benefit outweighs the loss.
And in fact, these investors are committed to the cause, in that they will continue to make this same decision even if they vote for all the companies they own to become clean, the researchers note. While the financial hit would be bigger, the social benefit would increase too. Thus, the researchers find, smaller, diversified shareholders tend to have the best overall incentives, and naturally, their voice is particularly effective if they comprise a majority of shareholders.
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