In their recent post ‘Corporate Carbon Reduction Pledges: Beyond Greenwashing’, John Armour, Luca Enriques & Thom Wetzer (AEW) open up a number of important issues worthy of further consideration. Over the past two years, a growing number of corporations have made public statements espousing their commitment to carbon neutrality, racial justice, sustainability and other societal values, values that are often described as ESG or stakeholder governance. One challenge in evaluating these statements is that many initiatives require an extended time horizon to be effective. Climate change is a particularly compelling example. When Ford announces its plan to be carbon neutral by the year 2050, it is hard to determine, from its operations today, whether it will meet that goal. Even if the goals announced by a corporation are honestly held by corporate officials, they are unlikely to result in meaningful operational changes unless the corporation is able to make a long-term commitment. At the same time, commitments to operational changes, even if profitable in the long run, may be costly in the shorter term, and corporations face pressure to defect from their pledges.
One possible solution is regulation that imposes hard limits on corporate operations, such as a carbon tax. As AEW observe, however, the involvement of corporations in the political process is often viewed as a powerful obstacle to socially-optimal levels of regulation. Complicating the matter are both a coordination problem, among corporations, and a commitment problem at each individual corporation.
The central role of the shareholder in corporate law exacerbates the situation. Under the long-dominant shareholder primacy norm, corporate executives may be reluctant to make business decisions that potentially sacrifice shareholder value, even in the short term, out of a concern that such decisions are inconsistent with their fiduciary duties. The recent rise of stakeholder capitalism is motivated, in part, by the desire to reorient the corporation’s objectives and normalize the incorporation of non-shareholder interests. At the end of the day, however, shareholders play a dominant role in the existing corporate structure through their ability to set capital prices, elect corporate boards and support activist efforts to effect change (as further explored in a forthcoming publication). Although today’s shareholders increasingly appear to endorse stakeholder capitalism, AEW worry that the profits available from environmentally unfriendly or ‘brown’ profits will result in capital market pressure to defect from environmentally responsible or ‘green’ strategies at the expense of the planet.
AEW’s chapter is an ambitious effort to address this commitment problem. Their central proposal is a ‘green pill’. The green pill ties a firm’s financing costs to its achievement of specified climate goals. In effect, the pill serves as a type of voluntary carbon tax by requiring the firm to pay a penalty in the form of a higher interest rate if it fails to live up to its climate-related commitments. AEW carefully analyze the legal and practical impediments to the green pill, noting in particular the possibility of structuring the payout so as to insulate the pill from the potential for strategic behavior by capital market participants. They demonstrate how a green pill can enable meaningful commitment at the level of an individual corporation, offering a way to move the ball forward on addressing climate change without the need for government action.
The green pill is a well-designed and practical solution to the corporate commitment problem. The prospect that corporations might adopt such a pill raises questions, however, about how corporate decisionmakers should set their climate goals, a question that AEW do not address but that is critical because those goals will be embedded in the terms of the green pill. Notably, AEW frame the corporate decision about whether to be environmentally sensitive as a binary choice—a corporation is either green or brown. I would argue, however, that the challenge, both for corporations and society, is to determine how green a corporation should be. This analysis requires sensitivity to the range of ways that a corporation contributes to society through the goods and services it provides, the people it employs, and so forth. The analysis also requires considering the degree to which the corporation contributes to climate change, both on absolute terms and relative to other market participants.
Whether corporate managers are qualified to make these judgments and determine how green their corporation should be is not a trivial question, particularly in an environment in which an increasing number of commentators argue that being carbon neutral is not enough and urge businesses such as Microsoft to become carbon negative. AEW’s chapter raises the difficult question of whether individual corporate action can serve as an effective substitute for the political process in making these types of policy choices. AEW are particularly wary of leaving such decisions to government action because of corporate power to influence the ‘rules of the game’ through lobbying. As AEW demonstrate, however, both corporations and government actors face considerable uncertainty regarding the costs and benefits of proposals to address climate change. Consequently, well-designed regulatory policy requires industry input to be effective. It would be interesting to consider whether individualized commitment devices, such as green pills, incentivize corporations to provide more reliable input into the regulatory process.
Jill Fisch is the Saul A. Fox Distinguished Professor of Business Law at the University of Pennsylvania Law School.
This post is part of the series ‘Business Law and the Transition to a Net Zero Carbon Economy’. This series consists mainly of posts summarizing papers presented and presentations made at the 5th Annual Oxford Business Law Blog conference on ‘Business Law and the Transition to a Net Zero Carbon Economy’ which took place online on 25 to 27 May 2021. The recordings are available here. This post is forthcoming in Andreas Engert, Luca Enriques, Georg Ringe, Umakanth Varottil and Thom Wetzer (eds), Business Law and the Transition to a Net Zero Carbon Economy (CH Beck - Hart Publishing 2021) (forthcoming).