Private Companies, Brown-Spinning, and Climate-Related Disclosures in the U.S.

Wolf-Georg Ringe is Director of the Institute of Law & Economics at the University of Hamburg and Visiting Professor at the University of Oxford Faculty of Law; Alperen A. Gözlügöl is Assistant Professor at the Law & Finance cluster of the Leibniz Institute for Financial Research SAFE. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; and For Whom Corporate Leaders Bargain (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID, both by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

Global consensus is growing on the contribution that corporations and financial markets must make towards the net-zero transition in line with the Paris Agreement goals. Regulatory measures and shareholder or stakeholder initiatives now abound to create a more sustainable economy. Crucially, however, the focus of those initiatives largely remains on public companies. In a new paper, we show why we should be concerned about the role of private companies on the path to net zero and explore ways to address this gap.

Public companies had once constituted a large part of the economy, especially in the United States. This no longer holds true with a decreasing number of IPOs and a strong surge in delistings (see, e.g., Asker et al., 2015). Private companies also impose significant externalities on the environment in the U.S. A recent report from the Clean Air Task Force and Ceres provides the most damning evidence. Hilcorp Energy Co., a private oil and gas company in the U.S., is the largest methane emitter in the country, reporting almost 50 per cent more methane (a pernicious type of greenhouse gas (GHG)) emissions than the largest public counterpart, ExxonMobil. For other GHG emissions, Hilcorp is only slightly edged out by ExxonMobil, with this pair taking second and first place respectively. Overall, in the top 10 methane emitters in the U.S., there are five private companies. In terms of other GHG emissions, there are six private companies in the top 20. A cursory look at the website of these companies reveals that they neither report their environmental impact nor do they have any climate strategy and targets.

Furthermore, a concerning development regarding private companies’ environmental footprint and performance is the phenomenon of brown-spinning. Here, we refer to the trend whereby public companies divest their carbon-intensive assets by selling them to private players. It is a convenient way for public carbon majors to reduce their emissions and achieve their climate targets as they come under increasing scrutiny from investors, regulators, and the public. Yet, if the divested assets operate in the same way under the ownership of private companies, there will be no overall reduction in the GHG emissions related to these assets.

For example, ConocoPhillips, one of the carbon majors located in the U.S., reported a whopping decrease of about 22 percent in its emissions in 2017. What was largely behind this decrease was that ConocoPhillips had sold off some of its oil and gas assets to Hilcorp Energy, the abovementioned highest-methane-emitter company in the U.S. (backed by the private equity giant, Carlyle). Recently, Hilcorp also acquired some Alaskan oil and gas assets from BP, another carbon major, based in the U.K. This divestment accounted for an emissions drop of more than five times the reduction BP achieved through operational improvements. However, statements from Hilcorp on these deals suggest that it intends to continue with the production and development of the bought assets. So, it is very doubtful whether there has been any overall emissions reduction in the atmosphere although these divestments have clearly helped the seller companies. Unlike its public counterparts, at the time of writing, Hilcorp does not report on its GHG emissions and does not have any net-zero target or strategy.

The financial press is now full of reports of (many, mostly unknown) private companies buying assets from public carbon majors in the U.S. (including companies such as ExxonMobil, Chevron Corp., Cairn Energy and American Electric Power, etc.). On the demand side, private equity has been particularly active, showing great appetite for the assets offloaded by public companies, which are still highly profitable. In a recent issue, The Economist noted that in the past two years alone, private equity firms acquired $60bn-worth of oil, gas, and coal assets, through 500 transactions, which is a third more than they invested in renewables. These include some multibillion deals with U.S.-based giants such as Blackstone, Carlyle and KKR. On the supply side, we can only expect more disposals by public carbon majors that come under increasing pressure to accelerate their net-zero transition and comply with their climate pledges. Private companies have so far remained immune to that pressure. Crucially, these differences (also involving reputational and regulatory disciplinary factors) seem to cause an arbitrage on which private companies and markets thrive. Investors seem to have eventually come to this conclusion as well. Remarkably, in its 2022 letter to CEOs, Larry Fink of Blackrock rightly noted that “[…] simply passing carbon-intensive assets from public markets to private markets will not get the world to net zero.”

We should note that these deals between public and private parties are not per se harmful. GHG-intensive assets should end up in the hands of the most efficient decarbonizer which can obviously include private companies. What remains concerning however is that high-polluting assets shift to a sphere where there is limited disclosure and market discipline which can shield private owners from scrutiny and pressure.

Private companies lack most of the disciplining mechanisms available to public companies that can play an important role in reducing environmental externalities. First, simply because these companies are privately owned (usually with the presence of controlling shareholder(s)), there will be a limited disciplining effect from institutional investors like the Big Three and activist investors. Second, although their effectiveness is disputed, certain governance arrangements such as executive compensation tied to sustainability measures and independent directors with relevant expertise will be rare commodities in private companies. Thirdly, private companies lack comparable transparency and disclosure requirements with regard to their contribution to climate change (or the impacts that their business operations may have on the environment generally).

In the U.S., until very recently, the SEC had demanded climate-related disclosures as far as they are relevant for traditional financial reporting items with its rarely enforced 2010 Guidance. However, the chasm between public and private companies is bound to grow with its recent Proposal for the Enhancement and Standardization of Climate-Related Disclosures. There is currently a great debate on whether the SEC has the mandate for requiring such disclosures. Whatever the conclusion, the disclosure requirements may ultimately only cover public firms. We would deem climate-related disclosures necessary, but we also believe that they should be mandatory for certain (large) private companies, too. We think that while they are relevant for investors (whether from a financial or non-financial perspective), these disclosures inevitably serve a broader audience (including stakeholders, media, NGOs, and the general public) and a broader purpose (promoting the transition to a greener economy), especially when they focus on the impact of the company on climate (or environment) rather than the impact of climate change and related developments on the company (i.e., physical or transition risks)—a concept known as “double materiality” in EU law.

However, in the private companies context, the case for SEC intervention and its mandate are rather weak, as (different from public markets) there are no large information asymmetries for investors that would be prohibitively costly to avoid in the absence of disclosure. Secondly, depending on how the “materiality” is to be understood (traditional financial materiality or broader materiality), the information to be disclosed can be quite limited. Therefore, a comprehensive and effective sustainability disclosure regime for private firms (that is not solely investor-oriented and would not be limited by what the SEC can or cannot do) ultimately seems to be a job for Congress.

As largely backed by growing empirical evidence, disclosure would provide three substantial benefits. First, there can be a nudge effect, stimulating large private companies to review, evaluate and benchmark their environmental impact. Second, disclosure should create a disciplining effect and decrease socially undesirable behavior by facilitating social/stakeholder pressure over the company to a certain extent. Third, disclosure would provide comprehensive and standardized information about the environmental impact of private companies that have hitherto been in the dark. This would level the uneven playing field between public and private companies. This will also help illuminate the brown-spinning phenomenon and alleviate a sort of regulatory and reputational arbitrage. In the case of uneven disclosure requirements and accompanying disciplining effects, private companies will have lower costs of bad sustainability performance as well as lower reputational costs, giving them incentives to acquire polluting assets from public counterparts (and vice versa). Accordingly, regardless of its merits, the recently proposed climate-related disclosure rules by the SEC can unintendedly contribute to brown-spinning as it (inevitably) relies on the traditional public/private divide in securities regulation. This is also why, in his 2022 letter to portfolio companies, State Street CEO Cyrus Taraporevala calls for a universal disclosure requirement for all companies of a certain size irrespective of whether they are publicly-traded or privately-held, to avoid the pernicious effects of brown-spinning. This is important especially in the U.S. context. The U.S. currently lacks a comprehensive carbon pricing system (via carbon tax or emissions trading system) that would cover and affect private and public players equally, and thus assuage these concerns. Looking across the Atlantic, along with strengthening its carbon pricing system, the E.U. has rightly made a first step towards requiring sustainability disclosures also by certain private companies.

The complete paper is available for download here.

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