Introduction

The paper examines the limits of corporate governance as a tool for climate transition. It argues that stewardship, ESG-linked remuneration and shareholder activism face structural constraints that reduce their ability to lower aggregate emissions. The central concern is the “waterbed effect”, where emissions reductions at targeted firms are offset elsewhere in the economy.

I Relation to the literature

The paper reviews evidence that investors reward sustainable firms through lower funding costs, climate risk premia and demand for “green” assets. However, these incentives are weakened by reliance on retained earnings, inconsistent ESG ratings and incomplete alignment between climate risks and actual emissions impacts.

The literature also highlights agency problems. Managers may avoid riskier transition projects, while institutional investors often lack incentives for deep engagement. Although diversified investors have incentives to reduce systemic climate risks across portfolios, the paper questions whether stewardship materially improves environmental outcomes.

II Systematic stewardship on the waterbed

Diversified investors cannot avoid systemic climate risks through portfolio selection alone because emissions affect all holdings. This creates incentives for “systematic stewardship”, where investors pressure firms to adopt transition plans and reduce emissions.

The paper argues these efforts are constrained by the waterbed effect. Under emissions trading systems, emissions reductions by targeted firms reduce permit demand and lower permit prices, allowing untargeted firms to emit more or reduce abatement efforts. Aggregate emissions therefore remain unchanged.

A formal model shows governance interventions impose a higher “shadow carbon price” only on targeted firms. This shifts production and emissions towards untargeted competitors. Even outside emissions trading systems, higher costs at targeted firms may raise product prices and encourage expansion by competitors, potentially offsetting or increasing total emissions.

The paper concludes that governance interventions are only effective when applied universally through carbon taxes, comprehensive emissions trading systems with cancellation mechanisms, or sector-wide regulation.

III Illustrations

Influence on firms’ product range and business fields

Shareholder pressure to divest carbon-intensive activities may improve a firm’s own emissions profile but not reduce economy-wide emissions if competitors or acquirers continue operations. Firms outside public markets, including private equity-backed and state-owned enterprises, may remain unaffected. The paper suggests broad regulation is more effective because it applies consistently across firms.

Say on climate

Say-on-climate votes allow shareholders to pressure boards to adopt stronger climate strategies. However, these campaigns are costly and rely heavily on proxy advisers and standardised assessments. The paper argues this creates one-size-fits-all governance approaches that may not reflect firm-specific conditions and can contribute to waterbed effects.

Executive compensation

ESG-linked executive remuneration is increasingly common, but the paper argues these arrangements often lack clear performance standards and may weaken accountability. Investors are unlikely to undertake the firm-level analysis required for effective implementation, increasing reliance on standardised approaches that create uneven incentives.

Conclusion

The paper concludes that climate-oriented corporate governance measures cannot substitute for universal regulation. While governance tools may support firm-level implementation, broad measures such as carbon pricing and comprehensive emissions caps are presented as more effective in reducing aggregate emissions and avoiding inefficient capital allocation.