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E-MailWolf-Georg Ringe is Professor of Law & Finance at the University of Hamburg Faculty of Law. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here).
ESG investing is undoubtedly on the rise. However, many contributors to this Forum and other academic commentators remain skeptical as to the incentives and genuine interests of institutional investors in pursuing sustainability goals. For example, in a recent post, Roberto Tallarita exposes the limits of portfolio primacy and explains why policymakers should revert to traditional legal instruments for furthering such policy objectives. In this spirit, regulators frequently seek to prescribe and regulate how firms may address ESG concerns by formulating conduct standards. For example, the European Union is poised to redefine directors’ duties to include sustainability and climate objectives.
Deviating from this viewpoint, my recent paper, Investor-led Sustainability in Corporate Governance, takes a more optimistic view and makes the case for the empowerment of investors to achieve greater sustainability in capital markets. Put differently, I shift the focus of ESG away from regulatory intervention to instead favor a market-led approach in ESG investments.
This trust in the market itself is grounded in various recent developments both on the supply side and the demand side of financial markets. For example, offering ESG investment opportunities may be motivated by purely financial reasons as these are a lucrative source of revenue for normally low-fee oriented index funds. On the demand side, the millennial generation predominantly holds very different sets of values than previous generations and increasingly prefers to invest also for non-financial returns. Moreover, the global trend towards common ownership further pushes markets forces towards ESG: While common ownership has mostly been criticized for having anti-competitive effects, I explain that it has positive implications in terms of its penchant for favoring policies and initiatives that support market-wide ESG values.
The need to build coalitions among different types of asset managers or institutional investors, and to convince fellow investors of a given initiative, can then act as an in-built filter helping to overcome the pursuit of idiosyncratic motives and supporting only those campaigns that are seconded by a majority of the investors. In particular, institutionalized investor platforms have emerged over recent years as a force for investor empowerment, serving to coordinate investor campaigns and to share the costs of engagement.
ESG engagement has the potential to become a very powerful driver towards a more sustainability-oriented future. Indeed, I show that investor-led sustainability has many advantages compared to a more prescriptive, regulatory approach where legislatures are in the driver’s seat. For example, a focus on investor-led priorities would follow a more flexible and dynamic pattern rather than complying with inflexible pre-defined criteria. Moreover, investor-promoted assessments are not likely to impair welfare creation in the same way as ill-defined legal standards; they will also not trigger regulatory arbitrage and would avoid deadlock situations in corporate decision-making. Any regulatory activity should then be limited to a facilitative and supportive role that supports investor engagement and private ordering, for example by promoting standardization of ESG classifications.
The full paper is available for download here.
