Externalities and the common owner
This article analyses institutional investors’ incentives to internalise negative externalities across their portfolios. It focuses on climate change, showing how large asset managers influence fossil fuel companies to reduce emissions, disclose risks, and limit lobbying, reframing shareholder primacy by prioritising portfolio-wide welfare over firm-level profit maximisation.
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OVERVIEW
Introduction
The report explores the paradox of institutional investors pressing fossil fuel companies to cut emissions despite traditional assumptions that shareholders seek only profit maximisation. Cases such as Royal Dutch Shell’s 2018 pledge to reduce its carbon footprint by 20% by 2035 and 50% by 2050 highlight growing investor influence. The Climate Action 100+ coalition, representing more than US$34 trillion in assets, has coordinated commitments across major oil and gas firms. This activism challenges the conventional view of shareholder primacy and “rational reticence,” showing that diversified investors may act at the portfolio rather than firm level to reduce systemic risks like climate change.
Institutional investors’ externality internalisation
Diversified investors now control most of the equity market, with institutions holding around 78% of the Russell 3000 index by 2017. As “universal owners,” they are exposed to the economy-wide risks of climate change. Empirical studies show common ownership reduces competition and increases prices, but the same mechanism can also internalise negative externalities. Investors rationally support emissions reductions when portfolio-wide benefits outweigh the costs to specific firms. Climate risks are systemic, with one study estimating 53% of portfolio value is “unhedgeable.” Asset managers, including Schroders, have projected global economic losses of US$23 trillion under a 4°C warming scenario.
Shareholder activism for climate change mitigation
Investor action has focused on three main areas: emissions reduction goals, suspension of anti-regulation lobbying, and climate risk disclosure. The Climate Action 100+ coalition has secured commitments from over 100 high-emission companies, including Shell and BP, linking executive pay to emissions outcomes. By 2019, resolutions gained majority support at companies such as BP, Occidental, and PPL.
Investors have also pressed companies to align lobbying activities with climate goals. For example, Shell withdrew from the American Fuel and Petrochemical Manufacturers over policy misalignment. In 2018, seventy-four investors filed proposals at fourteen firms requesting lobbying disclosures.
On disclosure, investors demand “two-degree scenario analyses” to model exposure to climate regulation. In 2017, such proposals at ExxonMobil, Occidental, and PPL passed with majority support, aided by BlackRock and Vanguard. Many companies have since voluntarily committed to enhanced disclosure.
Ability and incentives of common owners
Institutional investors exert influence through board elections, direct communications, shareholder proposals, and linking executive pay to climate targets. BlackRock and State Street have voted against directors over climate policy, while BP and BHP have tied bonuses to emissions goals. Engagement often occurs privately, but public letters and open statements are also used. The effectiveness of these actions demonstrates that institutional investors are not passive, but capable of shaping firm-level outcomes in pursuit of portfolio-wide benefits.
Implications of diversified shareholder objectives
The externality-internalising actions of institutional investors raise questions about shareholder primacy. Diversified shareholders may prefer emissions reductions even when these decrease firm value, as they protect portfolio performance. While such actions reduce harmful externalities, they also highlight risks of concentrated investor power acting as a form of private regulation without public accountability. The welfare effects are therefore ambiguous: they reduce climate damages but may reinforce monopoly pricing or wage suppression associated with common ownership.
Conclusion
The report concludes that diversified institutional investors possess both the incentive and capacity to influence corporate decisions at the firm level to reduce climate risks. This behaviour contradicts assumptions that shareholders uniformly seek profit maximisation and compels reconsideration of the shareholder primacy norm in corporate governance.
