Leviathan Inc. and Corporate Environmental Engagement

Hao Liang is Assistant Professor of Finance at Singapore Management University. This post is based on a recent paper authored by Professor Liang; Po-Hsuan Hsu, Associate Professor of Finance at University of Hong Kong; and Pedro Matos, Associate Professor of Business Administration at University of Virginia Darden School of Business.

With the rise of emerging market economies in the last two decades, the role of state capitalism has attracted new attention. In China, companies in which the state is a majority shareholder account for over 60% of total stock market capitalization. Other emerging market governments such as Brazil or Russia also hold majority or significant minority stakes in local companies. These holdings can be direct through central or local governments but also indirect in the form of public pension funds or sovereign wealth funds. This pattern is contrary to that in many Western economies where large-scale privatizations in the 1980s and 1990s led to the decline in the role of the state in business. In the post-privatization era of the early 21st century, some of the world’s largest publicly-listed firms are now state-owned enterprises (SOEs).

The Economist (2010, 2014) calls these resurging state-owned mega-enterprises “Leviathan Inc.”, especially those in emerging economies, and warns about the danger of such a state capitalism model. [1] There is a large literature on the economic inefficiency of state ownership, mostly based on the agency cost view (Megginson et al. (1994), Shleifer (1998), Dewenter and Malatesta (2001)). This view argues that SOE managers are chosen for political reasons, have low-powered incentives, and are poorly monitored by boards packed with politicians (Shleifer and Vishny (1998); La Porta and Lopez-de-Silanes (1999)). Political elites who control SOEs may seek rents from society at the expense of other stakeholders, which can reduce economic efficiency through corruption, poor resource allocation, less innovation and skewed wealth creation. Yet other studies re-examining SOEs in emerging markets document some positive effects of this “new state capitalism” (Musacchio and Lazzarini (2014); Musacchio, Lazzarini, and Aguilera (2015)). There is some suggestion that SOEs may help emerging markets deal with market failures and externalities.

One crucial way state ownership of businesses can be a positive factor in the public interest is in addressing climate change. While developed nations have been the largest contributors to global warming, the growth rate in new emissions is now concentrated in emerging market economies. Governments can promote green technology by imposing carbon taxes and providing research subsidies. For example, in the U.S., green industrial policies include laws such as the Clean Air Act, tools like federal tax credits and programs such as state-level renewable portfolio standards. Rodrik (2014), however, concludes that these policies are “strong in theory, ambiguous in practice” (p.470). Alternatively, the state can use its “visible hand” by intervening in the form of stakes in public corporations. Initiatives related to environmental protection usually require substantial investment and long-term resource commitment, which private firms often cannot meet. State-owned firms, though, can coordinate resources through government procurement and state funding (examples including oil or other natural resources funds and public pension funds) to support such green investment.

Standard economic theories usually suggest that the private sector (the market) pursues profit maximization and efficiency, while the public sector (the state) corrects market failures such as negative externalities that corporations generate for the environment. Companies in developed countries tend to exhibit more shareholder-friendly corporate governance and perform better in terms of shareholder value maximization. Yet these companies do not internalize environmental (and social) costs. A company might improve shareholder value by outsourcing production to developing countries with looser environmental regulations. Firms in emerging countries may not have full incentives to pursue environmentally sustainable practices and instead maximize profits by using more polluting technologies. In this respect, emerging market SOEs may be the most prone to improve their environmental standards because of their state ownership.

We conduct an international study of the impact of state ownership on a firm’s engagement in environmental, social, and governance (ESG) issues. We compile a dataset of the level of state ownership and measures of ESG performance of publicly-listed firms in 45 countries over 2004-2014. There is considerable cross-country variation in state ownership in our sample. State ownership is more prevalent in emerging markets (24.8% of publicly-listed companies) than in developed economies (4.0%). SOEs represent more than 60% of the stock market in China, close to 40% in Russia, about 20% in Brazil, and 10% in France. They are insignificant in the U.S. and in other major developed economies. The prevalence of SOEs also differs across industries; in telecommunications, utilities, oil and gas, and financial services the government has greater presence. We focus primarily on how state ownership can address corporate environmental sustainability (the “E” in ESG) as it measures how a firm addresses market failures and externalities generated via its operation. We also touch on other sustainability issues such as corporate engagement in social issues (S) and corporate governance (G), and compare the state ownership effects on E and on the S and G dimensions to shed light on the relative strengths of state ownership.

Our findings are that SOEs engage more in environmental issues, especially in emission reduction and resource reduction. We provide evidence suggesting that state ownership has a causal effect on corporate environmental engagement by showing that SOEs reacted more significantly to the Copenhagen Accord signed in December 2009 in improving their environmental performance. Arguably, the Copenhagen Conference raised awareness of the severity of climate change and other environmental problems, which shifted the demand for environmental engagement by corporations worldwide. The results from difference-in-differences regressions are consistent with the notion that state-owned firms can be more proactive in dealing with environmental externalities.

Exploration of potential channels for the effect also supports a causal interpretation of our main findings. We document a stronger role of SOEs in environmental engagement among firms in energy-related industries (particularly in oil and gas), in countries with more energy independence, and in countries with greater conflict with neighboring states that may disrupt or cut necessary energy sources. We also document that the positive effect of state ownership on environmental engagement exists mainly in the subsample of companies in emerging countries rather than developed countries. We do not find such a pattern for other types of block-owners beyond the government, and we do not find it in firms held by foreign governments or by sovereign wealth funds. These results help further define the mechanism through which state ownership is related to solving environmental externalities: It stems from the fact that the state is the controlling owner and is not simply a mechanical effect of concentrated ownership.

Interestingly, we document that SOEs also engage more in social responsibility issues, but we find that they do not have better corporate governance practices. We also show that SOEs’ environmental engagement does not come at a cost to shareholder value in terms of Tobin’s Q and long-term profitability. We conclude that state control does not assume superior corporate governance or greater returns to shareholders, but it does contribute to the welfare of society at large, without significantly sacrificing shareholder interests.

The full paper is available for download here.


1“Leviathan” is something that is very large and powerful, or a sea monster in scriptural accounts. Leviathan is generally used to refer to the political state after its use in Thomas Hobbes’ “Leviathan or The Matter, Forme and Power of a Common Wealth Ecclesiastical and Civil” (1651).(go back)

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