Introduction

The contemporary study of corporate governance focuses primarily on minimising agency costs. While standard models assume shareholders uniformly seek to maximise share value, many equity investors, if fully informed, would sacrifice returns to advance social objectives. The report investigates whether these willing-to-sacrifice investors currently affect firm behaviour and if legal reform is necessary to accommodate their preferences.

Shareholder Influence On Corporate Behaviour, Holding Fixed Each Firm’s Shareholder Base

Under current law, firm decisions are made by managers rather than shareholders. If willing-to-sacrifice investors are to impact behaviour, they must use indirect means. One channel is the shareholder franchise, but its effectiveness is limited. For example, while approximately 70% of eligible American voters participated in a federal election between 2018 and 2022, estimates for retail shareholders hover around 30% (Page 23). This lack of engagement means social issues often get lost in general elections.

Another channel is the managerial incentive structure. Currently, managers are predominantly incentivised to maximise share value. For instance, in S&P 100 firms, Environmental, Social, and Governance (ESG) metrics account for only 1.5% to 3% of total CEO pay (Page 41). Thus, the presence of socially-minded shareholders rarely leads managers to make decisions differently than if all shareholders sought solely to maximise returns.

Investor Sorting And Its Implications For Corporate Behaviour

Identity investing occurs when investors exclude shares of companies whose behaviour they disapprove of from their portfolios. Institutional investors collectively hold 78% of the shares in the largest quintile of publicly traded firms (Page 25), giving them significant potential scale economies. However, the report shows that identity investing reinforces the limitations of the first two channels. Firms engaging in disapproved activities will have a smaller proportion of willing-to-sacrifice shareholders, reducing their influence.

Theory suggests identity investing depresses the share price of excluded firms, which could incentivise managers to avoid disapproved activities. However, empirical evidence indicates the price impact is currently minimal. For example, ESG investors avoiding ‘dirty’ firms is causing the difference in rates of return between dirty and clean firms’ stock to increase by just 0.44 basis points (Page 53). Therefore, it is uncertain if identity investing significantly alters corporate behaviour at present levels.

Should There Be Legal Reform That More Closely Aligns Corporate Behaviour With The Preferences Of Willing-To-Sacrifice Investors?

The report evaluates whether legal reforms should give willing-to-sacrifice investors greater influence. Some scholars propose allowing binding shareholder votes on specific share-value-reducing behaviours. However, the report cautions that this would divert resources and political energy from the public political process, which is generally more efficient.

Instead, the report recommends that policymakers focus on modifying securities and pension laws. Specifically, mandating the disclosure of a firm’s social impacts could facilitate greater identity investing. This would increase the impact on corporate behaviour through share prices. The report suggests experimentation to determine if the resulting changes in firm behaviour would be significant enough to justify the considerable costs of these new disclosures.

Conclusion

The report demonstrates that willing-to-sacrifice investors cannot meaningfully change firm behaviour through the franchise under current law. While identity investing currently shows minimal effects, the report concludes it has the potential to be more effective at higher levels and could bring about corporate change without the substantial costs associated with reforming the shareholder franchise.