Socially-Minded Investors and Corporate Behavior

Many equity investors are concerned with the world’s worsening social and environmental problems and are losing faith in the capacity of political institutions to respond. Where corporate behavior is contributing to these problems, these investors would, at least if fully informed as to costs and benefits involved, favor corrective changes even where that would lessen their investment returns. Two important questions arise: (1) given existing law, are such willing-to-sacrifice equity investors currently affecting firm behavior; and (2) should there be legal reform that makes firms more sensitive to these willing-to-sacrifice investors’ preferences? This Article seeks to answer these two questions, applying the teachings of corporate governance and financial economics. We go back to first principles to explore, relative to the politics of governmental regulation, this alternative way of harnessing people’s other-regarding values to improve social welfare.

Under current corporate governance arrangements, a firm’s business decisions are, in the first instance, the product of its managers, not its shareholders. If willing-to-sacrifice investors are to have any effect on firm behavior, it must be through some indirect means. One possible channel is to elect directors who pledge to make the firm conform to these investors’ wishes. A second is through these investors’ impact on the workings of the incentive structure within which the firm’s managers operate. A third possible channel—identity investing—involves these investors confining their stock portfolios to firms whose social behavior they approve, thereby affecting share prices in ways that incentivize managers to choose the approved behavior.

Theory, we show, predicts that under current law, willing-to-sacrifice equity investors will not significantly affect firm behavior through either of the first two channels, and we see little evidence to the contrary. As for the third, theory suggests that identity investing will have some impact on share prices. Empirical evidence is mixed as to whether the effect is currently large enough to incentivize managers of excluded firms to significantly change their behavior.

Should there be legal reform that makes the system more sensitive than now to the preferences of willing-to-sacrifice investors? Some scholars have championed allowing binding shareholder votes on individual business decisions to increase this sensitivity. The upside is that allowing such votes might sometimes alter corporate behavior in socially useful ways. This upside is likely more than counterbalanced by the downsides. Specifically, all vote-based choice systems, whether public or private, expend resources and political energy in informing and mobilizing voters, and require these voters’ time and effort in response. The reform would divert such resources and effort from the public political process, one where, because of the scale of impact, results can be attained more efficiently. Moreover, to give managers the discretion needed to implement the results of such a shareholder vote, their incentive structure needs to be made less constraining in ways that would simultaneously allow managers to alter firm behavior simply to benefit themselves.

Modifying securities and pension law offers an at least modestly more promising path forward. Mandating disclosure of a firm’s social impacts, for example, would facilitate more identity investing, with its resulting impact on corporate behavior through its effect on the firm’s share price. The difficult question, one worthy of experimentation to answer, is whether that impact would be great enough to justify such disclosure’s considerable costs.