The Big Three and Corporate Carbon Emissions Around the World

Jose Azar is Visiting Professor of Economics, Miguel Duro is Assistant Professor of Accounting and Control, Igor Kadach is Assistant Professor of Accounting and Control, and Gaizka Ormazabal is Associate Professor of Accounting and Control, all at the University of Navarra IESE Business School. This post is based on their recent paper, forthcoming in the Journal of Financial Economics. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

In our study The Big Three and Corporate Carbon Emissions Around the World, forthcoming at Journal of Financial Economics, we analyze the role of the three largest asset managers in the world—BlackRock, Vanguard and State Street Global Advisors—in reducing companies’ carbon emissions.

The current interest in the Big Three responds to the unique combination of characteristics of these investors. The first of these characteristics is their size; they manage an enormous (and growing) amount of investments. The second distinctive characteristic of the Big Three is that most of the investment vehicles sponsored by these investors are passively-managed.

The role of large passive investors in the economy is a subject of ongoing debate. While acknowledging the advantages of index fund investing in terms of diversification and lower management fees, some commentators have raised some concerns about the Big Three, including issues related to pricing efficiency and trading behavior, anti-competitive effects, and underinvestment in stewardship. In contrast to these issues, it is also argued that fund sponsors compete not only on fees but also on returns. Moreover, recent research suggests that passive investors have meaningful monitoring incentives when it comes to cross-cutting issues such as sustainability and certain aspects of corporate governance in which large investors can exploit economies of scale.

We add to this debate by studying a dimension of high social relevance: the reduction of carbon emissions. This dimension of the debate is not without controversy; for example, the fact that the Big Three have provided relatively little voting support to shareholder proposals related to climate issues is sometimes interpreted as evidence that these investors do not contribute to the global effort to reduce corporate carbon emissions.

Beyond possible altruistic reasons, the Big Three could have several economic incentives to engage with firms on environmental issues. One potential motivation is that these large investors believe that reducing CO2 emissions increases the value of their portfolio. As suggested by survey evidence, a non-trivial number of institutional investors believe that climate risks have financial implications for their portfolio firms and that the risks have already begun to materialize, particularly regulatory risks. An alternative motivation is that, by pushing firms to reduce CO2 emissions, the Big Three seek to attract or retain investment clients that are sensitive towards environmental concerns.

The evidence

Our empirical study is based on a sample made up of a total of 42,193 observations corresponding to approximately 8,000 firms around the world, of which we studied two key variables:

  1. Data on corporate CO2 emissions provided by Trucost, which collects data from more than 13,000 companies each year and thus covers a large percentage of the world market capitalization.
  2. The Big Three’s engagement actions with the companies in their portfolio as published by the asset management firms in their Investment Stewardship Reports.

We find that the Big Three are more likely to engage with those companies with the highest carbon emissions. In fact, the Big Three focus their engagement on large companies (those with greater potential to have an effect on global carbon emissions) and on those in which they have a more significant stake (and, therefore, a greater capacity to influence). The data reveals that there is a greater probability of the Big Three meeting with CEOs the higher the carbon emissions recorded by the company in the previous year. This result supports the idea that the Big Three push the most polluting companies to reduce their CO2 emissions.

We also observe that increases in Big Three ownership are associated with decreases in carbon emissions. The effect increases in intensity with these asset managers’ public commitment to reduce CO2 emissions. We corroborate our inferences by introducing a plausibly exogenous source of variation into the analysis; changes in Big Three ownership associated with inclusion in the Russell 1000/2000 indexes.

Our results also suggest that the influence of institutional investors in swaying the companies in their investment portfolios to reduce carbon emissions is a relatively recent phenomenon, which is consistent with an increasing popular pressure to deal with climate risk after the 2015 Paris Agreement.

The complete paper is available for download here.

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