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Externalities and the Common Owner Washington Law Review Volume 95 Number 1 3-2020 Externalities and the Common Owner Madison Condon New York University School of Law, [email protected] Follow this and additional works at: https://digitalcommons.law.uw.edu/wlr Part of the Antitrust and Trade Regulation Commons, and the Business Organizations Law Commons Recommended Citation Madison Condon, Externalities and the Common Owner, 95 Wash. L. Rev. 1 (2020). Available at: https://digitalcommons.law.uw.edu/wlr/vol95/iss1/4 This Article is brought to you for free and open access by the Law Reviews and Journals at UW Law Digital Commons. It has been accepted for inclusion in Washington Law Review by an authorized editor of UW Law Digital Commons. For more information, please contact [email protected]. 04 Condon.docx (Do Not Delete) 4/28/20 6:39 PM EXTERNALITIES AND THE COMMON OWNER Madison Condon* Abstract: Due to the embrace of modern portfolio theory, most of the stock market is controlled by institutional investors holding broadly diversified economy-mirroring portfolios. Recent scholarship has revealed the anti-competitive incentives that arise when a firm’s largest shareholders own similarly sized stakes in the firm’s industry competitors. This Article expands the consideration of the effects of common ownership from the industry level to the market portfolio level and argues that diversified investors should rationally be motivated to internalize intra-portfolio negative externalities. This portfolio perspective can explain the increasing climate change related activism of institutional investors, who have applied coordinated shareholder power to pressure fossil fuel producers into substantially reducing greenhouse gas emissions. While institutional investors have protested their ability to influence firm-level supply and pricing decisions in the service of muting competition, they are more willing to advertise their role in seeking emissions reduction commitments, even admitting they are for the benefit of portfolio returns. These commitments, however, affect product supply and imply market power in much the same way, and provide further evidence that institutional investors are able to influence managerial decisions at the firm level for the benefit of their broader portfolio. This insight requires amendment of the traditional view that diversified investors are “rationally reticent” and lack the incentive to engage in monitoring of firm behavior. It additionally challenges a fundamental norm of corporate governance law: the theory of shareholder primacy rests on the premise that shareholders homogeneously seek to maximize corporate profits and share value. This Article shows that in certain circumstances a majority of minority shareholders may direct the firm away from a profit-maximizing objective. INTRODUCTION ........................................................................... 2 I. INSTITUTIONAL INVESTORS’ EXTERNALITY INTERNALIZATION ......................................................... 10 A. Portfolio-Maximizing Objective of Common Owners ......................................................................... 12 B. Reduction of Systemic Climate Risks ......................... 17 C. Shareholder Activism for Climate Change Mitigation ..................................................................... 18 1. Outcomes Sought from Portfolio Companies ........ 19 a. Emissions Reduction Targets .......................... 19 b. Suspension of Anti-Regulation Lobbying ....... 23 * Attorney, Institute for Policy Integrity, New York University School of Law. I am grateful for comments on earlier drafts from Patrick Corrigan, Jeffrey Gordon, Peter Howard, Marcel Kahan, Benedict Kingsbury, Sarah Light, Eric Posner, Richard Revesz, Ed Rock, Jeff Schwartz, Ganesh Sitaraman, Leo Strine, Jr., Nicole Summers, and Michael Vandenbergh. This Article benefitted from presentations at NYU’s Law and Economics Workshop, Columbia’s Associates in Law Workshop, the Academy of Legal Studies in Law and business Conference, the Society for Environmental Law and Economics Conference, and the National business Law Scholars Conference. 1 04 Condon.docx (Do Not Delete) 4/28/20 6:39 PM 2 WASHINGTON LAW REVIEW [Vol. 95:1 c. Climate Risk Disclosure .................................. 24 2. Legitimacy of Firm-Specific business Purpose ..... 26 a. Assessing Outcomes ........................................ 27 b. Portfolio Purpose and Retail Opposition ......... 35 3. Impact on Emissions Reductions ........................... 38 D. Internalization of Climate Externalities: Cost-Benefit Analysis of Climate Intervention ................... 43 II. ABILITY AND INCENTIVES OF COMMON OWNERS ............................................................................ 48 A. Mechanisms for Influencing Managers ....................... 50 B. Liability for Violation of Fiduciary Duty .................... 56 1. Investor Duty to Underlying Beneficiaries ............ 57 2. Fiduciary Duties of Managers ................................ 59 C. Incentive to Intervene: Amending Model of Rational Reticence ....................................................... 60 III. IMPLICATIONS OF DIVERSIFIED SHAREHOLDER ObJECTIVES ....................................... 65 A. Welfare Effects ............................................................ 65 B. Market Concentration and Investor as Regulator ........ 70 C. Shareholder Primacy and Efficiency Framing ............. 75 CONCLUSION .............................................................................. 80 INTRODUCTION In December 2018, Royal Dutch Shell announced that it was setting emissions reduction targets, aiming to reduce its net carbon footprint (including emissions from the sale of its products) 20% by 2035, and 50% by 2050.1 According to The Wall Street Journal, Shell executives were initially opposed to these goals—the CEO had described them as “onerous and cumbersome” just six months before—but they eventually capitulated “to months of investor pressure.”2 The announcement was jointly made with Climate Action 100+, a coalition made up of more than 360 institutional investors that control $34 trillion in assets, or 40% of global GDP.3 In a press release, Climate Action 100+ stated that its success at 1. Press Release, Joint Statement between Institutional Investors on behalf of Climate Action 100+ and Royal Dutch Shell Plc (Shell) (Dec. 3, 2018) [hereinafter Shell Emissions Commitment], https://www.shell.com/media/news-and-media-releases/2018/joint-statement-between-institutional- investors-on-behalf-of-climate-action-and-shell.html [https://perma.cc/2HE8-KH2A]. 2. Sarah Kent, Shell to Link Carbon Emissions Targets to Executive Pay, WALL ST. J. (Dec. 3, 2018), https://www.wsj.com/articles/shell-to-link-carbon-emissions-targets-to-executives-pay- 1543843441 [https://perma.cc/7HRL-32Fb]. 3. GDP (current US$), World Bank national accounts data and OECD National Accounts data files, WORLD bANK, https://data.worldbank.org/indicator/NY.GDP.MKTP.CD 04 Condon.docx (Do Not Delete) 4/28/20 6:39 PM 2020] EXTERNALITIES AND THE COMMON OWNER 3 Shell “demonstrates the power of collective global investor engagement” and that the coalition planned to “use the commitment to raise the bar for the oil and gas industry as a whole.”4 Shortly thereafter, investors filed shareholder proposals for the 2019 proxy season seeking similar emissions targets from Exxon Mobil, Chevron, and bP.5 The climate activism of Shell’s investors presents two paradoxes for scholars of corporate governance. First, much of the theory behind the law of corporate governance rests on the assumption that shareholders’ rational self-interest drives them to exercise their governance rights with the singular goal of maximizing corporate value.6 But voluntary emissions reduction is at odds with the aim of profit maximization.7 Pollution regulation is “supposed” to be the exclusive realm of government actors, not the investment community.8 And second, broadly diversified investors are typically described as poor monitors of corporate behavior, lacking the incentive and capacity to exercise their shareholder power to discipline management.9 Because engagement is costly and they own only a small [https://perma.cc/6Pb4-MMAD] (listing world GDP as $80.951 trillion in 2017). Since the December 2018 announcement, several more institutional investors have joined the coalition. Ranks now stand at more than 450 investors controlling more than $40 trillion. Frequently Asked Questions, CLIMATE ACTION 100+, https://climateaction100.wordpress.com/faq/ [https://perma.cc/WM7P-XCQ6]. 4. Press Release, Climate Action 100+, Shell Announces Comprehensive Carbon Emissions Reductions Commitment with Climate Action 100+ Investors (Dec. 3, 2018) [hereinafter Press Release, Shell], https://www.ceres.org/news-center/press-releases/shell-announces-comprehensive- carbon-emissions-reductions-commitment [https://perma.cc/F36Z-FZKV]. 5. Ed Crooks, Investors Push Exxon to List Emissions Targets in Annual RePorts, FIN. TIMES (Dec. 16, 2018), https://www.ft.com/content/ba611d60-0152-11e9-99df-6183d3002ee1[https://perma. cc/D7Wb-X257]; Jennifer Hiller & Shadia Nasralla, Five Oil Majors Face 2019 Climate Target Pressure by Investors, REUTERS (Dec. 19, 2018), https://www.reuters.com/article/us-chevron- shareholders-resolution/five-oil-majors-face-2019-climate-target-pressure-by-investors- idUSKbN1OI14V [https://perma.cc/Z2bF-U5VD]. 6. See, e.g., FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW
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